Mark’s on his honeymoon this week and so today’s summary is compiled by Leo. Due to limited time only a brief summary is provided from Tricorn onwards, with much more detail available in the original Small Caps Live chat on Discord.
Large Caps Live Monday 19th July
One of our regular contributors correctly predicted Tencent would buy Sumo quite a while ago. It is interesting as Tencent also owns Frontier Developments (FDEV.L). I was reading something from Baillie Gifford yesterday and I noted that they observed that Tencent's investment portfolio has built companies worth over $200M.
I was struck over the last few weeks / months by the multi-bagger books and by some materials on the Baillie Gifford website.
Where to invest cash and what do I think about the market right now? I guess what I am looking for is what companies have extreme growth. But what is the definition of extreme growth?
In my mind it needs to be consistent growth of at least 15% (ideally 20 -25% or above) in sales for a number of years (say at least 5)? Obviously there may be 1 year or so that is less but the point is that consistent high growth of sales drives value and also helps drive profitability. And I think that many 'extreme growth' companies have over a decade of high sales growth.
I am beginning to wonder if in the UK we have a mismatch between long term objectives and the short term in which we judge managers and boards.
I recall once reading that the average fund manager is in post no longer than 7 years. That was a decade ago and I suspect that the result now is even shorter. Similarly the UK corporate governance code essentially means that board members of investment companies only remain in office for 9 years. I reckon it takes about 2 years to understand the manager and the strategy. And in the last 2 years you are planning the successor. So it means that a board member is really only effective for about 5 years. That kind of a mismatch versus the 5 – 10 year investment horizon of eg Baillie Gifford.
I am beginning to think that it is a real issue in fund management and that the most successful fund managers are those that do not have external investors / PLC boards to answer to eg Baillie Gifford, Lindsell Train, Terry Smith.
In thinking this through the conclusions I came to were:
Having a day job inhibited me from making real money
I should be thinking global, not just the UK
Be a magpie – do not feel embarrassed to borrow ideas from others
Often before a massive growth phase a multibagger can have a period of being a value stock
Often the quarterly numbers are irrelevant to the long term story. Indeed sometimes focus on the short term means that you get shaken out the bigger moves
Work out the megatrends and a lot of other stuff falls into place
Look for world scale businesses. Not every company fulfils this criteria. A lot of businesses are literally going to only be local players – that is fine but maybe not for me.
Position sizing’ is massively undertaught in investment books. It is not the same as portfolio diversification. Indeed most investors do not really understand how to diversify. They diversify by adding mediocrity to their portfolio.
Look for extreme growth’ ie > 15% and ideally > 25% per year for a number of years – in sales. Usually sales growth brings everything else along with it – particularly for a subscription or quasi subscription business.
Analysts and markets miss the bleeding obvious
Assume everyone else is smarter or knows the company better
With experience your gut does give insight
Mega trends include climate change, bond yield / inflation direction, software, India, shifts in the value of property due to the internet.
My favourite example of a world-scale business is Coats (COA.L) — when I first looked at it, it was about 20p-25p. What struck me about COATS was that it was the world leader in thread (for sewing) and the 2nd biggest player in zips. The other thing I noticed when I started looking at the company was that it was changing from being a cash cow to starting to innovate, e.g. printing 3D zip prototypes in 2 - 5 days for designers (depending on if they were plastic or metal).
Small Caps Live Wednesday 21st July
Creightons (CRL.L) - Final Results
Background
Creightons was due to announce results on 7th July, but the day before they an announced an unspecified delay. The statement did not preclude the possibility that the auditors had previously highlighted a risk of not meeting the agreed timetable, but alternatively it could mean that they had diligently completed the work ahead of schedule but something else came to their attention before handover. I previously speculated that this something could be Innovaderma’s prior year balance sheet adjustments announced on 8th July, in particular:
Overstated inventory position due to incorrect accounting treatment including inventory write down of out-of-date stock which should have been written off in prior years (£1.5m)
Innovaderma operates in a similar market as CRL and were a short-lived takeover target in February, but always had a certain smell about them. Or, as the ASA put it:
ad (b) gave the misleading impression that Skinny Tan did not contain DHA and therefore smelt better than other tanning lotions;
The other reason to be concerned about Creightons’ inventory was that levels apparently jumped at the end of H1 and in the associated presentation they said that the market for hand sanitiser was “pretty much flooded” and “the main increase year on year and inventory is hygiene related at the year end”.
However, Creightons also reported regarding DHSC inventory that “as that contract gets completed by the end of next month - the end of January - some of that a lot of that hygiene related stock will come down”. Further research indicated that:
Distribution to primary healthcare (doctors surgeries, dentists etc) is managed via ebay systems and it is possible to see real time distribution numbers, for example here.
This page shows the last 100 transactions of 1079180 sold.
DHSC PPE supply arrangements to primary and secondary healthcare were extended.
They restarted manufacturing (or at least, bottle filling) in December for the DHSC contract, with the most recent date code seen in the field being 19th January on the 9th February.
But subsequent known deliveries have been from earlier stock and much of the handwash provided to centralised vaccination centres was from other suppliers.
Overall, not withstanding that some hygiene inventory was for retail, I expected at least all of this extra £1.8m of inventory to convert into sales with a gross margin of 40-50%, i.e. £3.6m of hygiene revenue in H2.
Results
Their full-year results were finally ready yesterday and were published on Wednesday.
Headlines look excellent:
Revenue increased by 28.9% to £61.6m (2020: £47.8m).
Operating profit increased by 43.7% to £5.4m (2020: £3.8m).
Operating profit margin of 8.8% (2020: 7.9%).
A tax charge of £0.8m (2020 - £0.4m) equates to an effective tax rate of 16.2% (2020: 10.8%).
The profit after tax for the year has increased by £1.1m to £4.3m (2020: £3.2m).
The profit increase has improved the fully diluted earnings per share to 5.89p (2020: 4.34p).
Balance sheet remains strong after significant investment in working capital, product development and fixed assets to support growth.
Net cash on hand (cash and cash equivalents less short-term element of obligations under finance leases and borrowings) is £6.2m (2020: £2.8m).
Proposed final dividend 0.50p per ordinary share (2020: 0.50p).
Detailed figures are given on each of their four categories, allowing absolute turnover to be derived even where not provided. Compared to my expectations:
Creightons owned brands, excluding hygiene grew more than I expected - H2 growth accelerated to 16% YoY (their quoted 16% FY YoY figure includes the benefit in Q2 of a brand acquisition - I estimate FY LFL growth of 14%)
Retailer’s own brand were broadly flat, as I expected
Contract manufacturing recovered much more - H2 looks flat YoY. They have some ability to flex this lower-margin revenue based on spare manufacturing capacity
BUT, H2 hygiene revenue was only £2.9m, lower than my estimates, albeit higher than some people might have expected given they reported it was “pretty much flooded” in the H1 presentation. Overall revenue was ahead of my expectations and of a higher quality.
Gross margins had been well guided and were in line with my expectations.
However there are some negatives, most notably the feared inventory write-downs identified earlier:
stock provisions increased to reflect the surplus stock on the market of hygiene products.
I believe this relates to retail product for the reasons given earlier. I don’t believe there is a problem on the DHSC side because of my research above and importantly they say:
No impact on year-end debtor provisions
However, cashflow was somewhat disappointing, with inventories and receivables only partially reversing since the end of H1 despite lower revenue in H2 and both pre- and post-tax cashflow from operations down on the previous year. And some of that inventory reversal is due to those provisions rather than conversion. I also note an increase in accruals apparently relating to H2 of £1m.
Inventory, receivables and payables as a percentage of the prior 6m revenue are actually stable to downward trending suggesting little scope for further working capital unwinding. I also note a surplus on the invoice financing facility, presumably inflating receivables at the expense of cash / increasing receivables quality.
While costs overall were higher than I expected, there is a lot of positive noises for the future here:
Higher operational costs arising on creating a safe working environment, which totalled £1.6m.
...
We have benefited from the economies of scale generated by sales growth, continued improvements in productivity and the successful re-sourcing of many raw materials during the year that have helped to offset the impact of the margin reduction and increases in the minimum wage. The re-sourcing exercise is ongoing and continues to contribute to margins.
Working environment costs included testing costs previously highlighted and also bonuses for reluctant staff to come into work. Also they didn't want to employ agency workers due to higher transmission risk and so had to pay employed staff overtime.
One interesting snippet for me was:
The discount sector continues to be a competitive market with many of the customers moving away from brands to focus on their private label offering.
This is precisely the opposite of what UPGS claim for their products. In previous commentary Creightons say this relates to dissatisfaction with price discounts negotiated with brand owners and a desire to control sustainability more tightly, reducing reliability on China...
Forecasts
Traditionally there are no broker forecasts, and I have not looked for any on this occasion. As a holder I have my own detailed model.
Based on zero hygiene sales in FY 2022, a full recovery in retailer’s own brand and contract manufacturing to 2019 levels (but no growth), very modest growth in Creighton’s owned brands of 5%, I get £50m of revenue for FY 2022.
For modelling purposes only I have assumed that the gross margin is maintained, but that 50% of the covid costs identified above come out of admin expenses (in fact, most will come from cost of sales). That gives an FD EPS of 5.1p (down from 5.9p) and EBITDA of £6.2m (down from £6.9m).
I have not factored in any acquisitions. I feel that the Innovaderma approach showed a lack of judgement and so this is both an opportunity and a risk. Clearly with cash of £6.2m and a further £6.4m of undrawn facilities versus a market cap of £50m there is considerable scope for earnings enhancement. And the maintained dividend is more about signalling opportunities for growth and maintaining capital for acquisitions than it is about future profit expectations.
So the rating doesn't look bad here on the 5.9p if they can utilise the cash for growth through additional brands. However, 5.1p EPS for 2022 makes those buying at 80p today paying over 15x future earnings, which have a declining trend, at least temporarily.
Though 5.1p is a baseline forecast, there will be some kind of a hiccup given hygiene was 24% of revenues.
I don’t think there will be further inventory writedowns because I suspect that management were conservative in their presentation of the issue to the auditors and the auditors were cautious on top of that.
My view is that the valuation is fair, but not cheap. This is something that could be said about a lot of stocks in today’s market after recent falls. The presentations usually impress and so it is probably worth holding to see how that goes.
Centaur Media (CAU.L) - H1 Results
Results are very credible with revenue & profit bouncing back.
Even netting off that cash balance you have a £50m EV and a maybe £5m FY EBITDA.
For a media business with a couple of niche publications. They generate cash but they are exactly that - niche. And you are paying 10x EV/EBITDA.
Pass
Northern Bear (NTBR.L) - Final Results
Cementing their reputation as not particularly shareholder friendly with an 8.21am release.
Agian, creditable for the period.
The cash balance flatters them somewhat, but full marks for disclosure on this:
The lowest position during the year was £1.1 million net bank debt, the highest was £2.2 million net cash, and the average was £0.2 million net cash.
Outlook is mixed:
We have seen some impact from this on our results, mainly in our Northern Bear Roofing division, and expect this situation could provide a short term headwind to operations until industry supply and demand revert to more typical levels.
But I don't see why they couldn't deliver £3-4m EBITDA again in the future. Versus a c£10m EV this is looking quite interesting for those willing to risk liquidity at this market cap level. And they say they would have paid 3.25p dividend if not for receiving government support during the year.
The only downside is an impairment on the value of one of the subsidiaries, and the balance sheet - with a current ratio hovering around just 1 this is not without risks, although they have always run this with this sort of ratio, so perhaps has unique characteristics of their contracts that make this possible.
This is firmly on my watchlist, not least because it fell today on these results.
Goldplat (GDP.L) - Transctions and Dividend
Goldplat have bought out most of their BEE (Black Economic Empowerment) partner in South Africa. There’s lots of detail but the most important part is the deal values their SA operations at c£20m on a read through basis. They now own 90% so £18m. On a similar basis you would perhaps value Ghana at £10m given lower tax rates and 100% ownership.
So on a £28m readthrough + a bit of cash = maybe £30m valuation vs a £13.5m market capitalisation.
There’s lots of risk here, but the company themselves appear to believe their equity to be materially undervalued.
They have also flagged their intentions to pay dividends which is very welcome of course, but wouldn’t share buybacks would be a better bet given the level of undervaluation?
Sanderson Design (SDG.L) - AGM Trading Update
This is the company previously known as Walter Greenbank. They say:
Sanderson Design Group PLC (AIM: SDG), the luxury interior design and furnishings group
…
The Company provides the following trading update in respect of the first 23 weeks of the current financial year ending 31 January 2022.The positive trading in February, March and April 2021, outlined in our full year results announcement on 18 May 2021, has continued throughout the 23-week period with the result that profits for the six months ending 31 July 2021 are expected to be ahead of Board expectations.
Unfortunately, they stopped paying Edison to produce forecasts back in November, so I've no idea what those expectations were. Stockopedia forecasts have already been updated to 12p EPS for FY 2022.
These trends are what you would expect given the statements from other consumer and housing exposed companies recently.
Strong performances from manufacturing [as opposed to licensing], the Morris & Co brand and the US market contributed to total Group sales in the first 23 weeks of the current financial year of £50.9 million (comprising Brand product and Manufacturing sales of £47.9 million along with licensing revenue and carriage) , up 39.8% compared with the same period in FY 2021 and up 1.4% compared with the same period in FY 2020 in reported currency.
Those comparisons in the statement are a bit confusing because of the year end. For FY 2021 read "2020" etc.
The comparison with the 2020 financial year [2019] is encouraging, given that the Brands have continued to be affected by Covid-related restrictions in the UK and other key European markets during the current half year.
OK, I'm not sure about this covid impact. What we've seen elsewhere is strong catch-up revenue in the last few weeks, not ongoing headwinds.
But, despite construction and house sales being strong, perhaps there is a lag before final decoration?
The Board believes the Group is benefiting from the convergence of three positive impacts: (1) pent up demand for home interiors, (2) the trend towards maximalism, and (3) the post-Brexit increased demand for British design and manufacturing.
OK, so are they benefitting from pent-up demand or not? I'm not sure they know where they are in the catch-up trade / recovery.
Maximalism I agree with. Improving British brand post brexit and given BJ's profile abroad seems extraordinarily unlikely.
My fear would be that they are much further along than they think and up 1.4% on precovid is very poor on that basis, especially when their share price chart looks like this:
Wickes just said they are up 22.4% over 2 years LFL. A different business, but its got to be the same underlying reason of the punters spending money on their homes as they are mostly not spending it on holidays & the like. Many a company have confused skill with luck.
But with 13p EPS on the horizon they hardly look expensive, and I think this "maximalism" is a multi year, potentially multi-decade trend. Also, most of the board have changed since October 2018 and a rather accident-prone period where underlying figures were obscured by a series of natural disasters. Perhaps they're better run now.
They do seem to have some momentum behind them, so well worth a look.
Tricorn (TCN.L) - Formal Sale Process
The company is putting itself up for sale or possibly closing bits down. he shareprice today has fallen about a quarter. The market cap is now £2.95M with an EV of nearly £11M. The full year results only came out in June and there was this interesting bit in them:
The Group has certain borrowing facilities as set out in note 21. Of these facilities, £2.6m are repayable on demand and should this amount be recalled by the bank the Group does not have sufficient liquid resources to make repayment.
…
substantial investment is needed in both capital expenditure and people during the next 12-18 months and the Group's borrowing facilities alone do not provide the Group with the necessary cash to make the required investment, deliver the strategy and return the Group to profitability and cash generative activity levels…the directors…acknowledge at the date of approval of the financial statements the requirement for further funding over and above the existing facilities and the requirement for ongoing support from their bankers not to recall facilities repayable on demand present material uncertainties which may cast significant doubt about the Company's and Group's ability to continue as a going concern.
So we can see that the group was having a liquidity issue even at the full year results, but I also think that the requirement to look further forward for going concern is an issue. In one of their statements they say that they have done a 24 month cashflow and found they need money.
Previously they raised money from the market last year - and frankly I think they did not raise enough.
Small Caps Live Friday 23rd July
AJ Bell (AJB.L) - Q3 Trading Update
What is particularly noteworthy is the increase in customers - up 6% quarter-on-quarter at a time when you might expect growth be slowing more than from 30% to 26% annualised. My interest here is more about read across to my significant portfolio position in CMCX - both on recent trading and the size of the market they are hoping to directly muscle in on.
IG Group (IGG.L) - Final Results
Again, these are excellent figures, albeit only up to 31st May, with active customers up 31% and client retention boding well for the future.
They seem to be pulling in two directions - the low quality retail end with Tasty Trade and the prime brokerage at the high end, while alienating their core professional individual investors in the middle.
They disclose that the regulatory capital buffer dipped in the aftermath of the Tasty Trade acquisition and although it has since recovered they have announced a review of capital requirements and are holding the dividend in the interim.
Record (REC.L) - Q1 Update
The company likes to think of itself as a fund manager, but the reality of this is questionable. They stand to do well this year due to due to a higher margin mandate from a single US entity and other new ventures show some promise. Extraordinarily high financial and operational gearing on their highly nominal $85bn “assets” under “management” provide significant potential upside.
Xaar (XAR.L) - Trading Update
This is inline, but despite protestations the sale of their stake in Xaar 3D seems to be progressing very slowly and time is running out for this to have any value. Clearly trading has been far better than the worst fears in March 2020, but the core business appears to have only been cashflow neutral on an adjusted basis. The current share price is inexplicable.
Premier Foods (PFD.L) - Q1 Update
Right now I’m looking for any indication I can of how different sectors of the economy are doing as increasing disruption is balanced by reduced restrictions and foreign holidays start to become possible, if difficult. I also commented on the contrast between claims from UPGS and Creightons about retailers preference for branded vs own-brand.
The biggest message for me from this update was that branded significantly outperformed unbranded since 2019. Figures for 2020 were distorted, presumably due to reduced food service sales. COVID trends continued during the quarter, perhaps more than might be expected.
More evidence the UK consumer is still spending.
BOKU (BOKU.L) - Update
Historically BOKU’s updates often sounded much better than was supported by the underlying figures, but covid has provided a major tailwind, and additionally today’s trading update is “ahead of expectations” with strong cashflow. Sequential EBITDA growth continues with $6.4m, $8.6m and $9.6m over the past three half-years.
Pleasingly, revenue has grown ahead of total payment volumes, although not terminal active users. Indications are that online transactions will not suddenly fall back post-covid, but a pause in growth is a real possibility as people go outside and do something more interesting instead. For me, I recognise that they are doing well and that share price strength in late 2020 / early 2021 was justified, but I find them fairly consistently overpriced given long term uncertainties over their business model.
Centamin (CEY.L) - Q2 Update
This looks like a solid, but unexceptional update. As a Capital (CAPD.L) holder, it is pleasing to see they spent much of their first paragraph praising them. Production and costs look to be inline with the bottom end of guidance, but they appear to be operating with a longer-term horizon and there are plenty of levers they could pull to improve short term results. From CAPD’s perspective, short term movements in the gold price not withstanding, there is every indication that the current investment / exploration cycle has further to run.
Medica (MGP.L) - H1 Update
This update doesn’t seem to reflect the reality of the way the third wave is increasingly impacting the NHS, no analysable numbers are provided.
The Liberum note is particularly spintastic, but for what it’s worth they made no changes to forecasts off the back of this update and predict EPS of 7.3p and 9.0p for FY 2021 and 2022 respectively. With near-term risks of another regression in trading, medium-term risks that the NHS cut out the middle-man, and questionable execution, 160p seems far too expensive for a company that may prove to be little more than a specialist supplier of agency staff.
Personal Group (PGH.L) - H1 Update
There’s only one figure that really matters here, and that’s how many new policies they’ve sold over the last 6 months. We know that retention is higher than historically, but fundamentally if they can’t sell new policies then the medium term outlook is going to continue to worsen. Today’s H1 trading update does not give this figure or allow it to be estimated.
The lag between new insurance sales and changes to the size of the recurring insurance book mean that at least another 12 months of falling earnings are already baked in and the recovery will be relatively slow. With short-term uncertainties abound, forecasts of 12p EPS in 2021 and the lack of any 2022 forecast does not make the current share price of 260p look attractive.