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Happy New Year!

It was an understandably quiet week, so there was no substantive news to report. However, Leo used the calm to review some of his larger positions, and these thoughts are worth sharing:

Capital Limited (CAPD.L)

Capital disappointed for a second year, continuing the relentless run of (individually) minor profits warnings that started in mid-2023.

In June 2023, broker Tamesis had forecasts of:

December 2023E 2024E

adj. EBITDA $m 93.7 89.1

EPS excl. gains $c 20.3 17.0

Net cash $m (50.8) (26.3)

As of October 2024, this is:

December 2023A 2024E

adj. EBITDA $m 91.8 88.5

EPS excl. gains $c 19.9 18.5

Net cash $m (68.2) (72.9)

The weak earnings were despite record gold prices and capex that stretched their balance sheet ($86.4m debt on 30th June). That balance sheet was despite net sales from their investment portfolio. The rollout of Chrysos PhotonAssay stalled, badly affecting the longer-term outlook and the sum-of-parts valuation.

Leo had reduced his position in mid-2023 and bought back some at lower prices but this wasn’t enough to make this a successful investment in 2024, given the starting position size.

I remain optimistic for 2025. Their investment portfolio gains are finally being liquidated, with more likely to come, hopefully ahead of any gold price crash. Their adventure into low-return mining has concluded, and the equipment is being sold off. We now have Rockwood to help focus management on shareholder returns, which are likely to include buybacks from all this cash and future operational cashflows.

Their core business remains solid, and long contracts ensure it is resilient to any downturn (which would, in any case, be cash flow positive). There's a good chance of another quarter of bad news from Chrysos or Nevada startup, and I have my doubts about the used mining equipment valuations, but the worst is surely over in each case.

The valuation is now very well supported by net assets - equity is forecast at $300m for the year-end with no material intangibles versus a market cap of $200m. The FY 2025 PE is around 7x on trough earnings and debt completely under control, and would be enhanced by any buybacks.

Mark agrees with this assessment but has also been running a reduced position size here, as the share price has held up well despite reduced forecasts. Any reduction is purely a function of how cheap the rest of the market is, rather than any concerns that the current trading weakness is anything but teething problems with significant new operations.

City of London Investment Group (CLIG), LionTrust (LIO.L), Impax Asset Management (IPX.L)

Leo thinks the whole fund management sector deserves a lot of attention right now. To a greater or lesser extent, these are people businesses with little in the way of tangible assets, but that also means they scale well and can be very cash-generative.

Worldwide there have been long-term headwinds from the move from active to passive fund management, led by the US, and pressure on fees. Added to this, those with UK customers and/or investing in UK-based assets have had considerable regulatory and performance headwinds over the past year, compounded by their own valuations on the UK stock market. Arguably, this has left the market over-fragmented with potential for consolidation. Fund manager valuations are highly volatile, with heavy exposure to both their AuM and general valuations. They tend to have a trajectory of fast organic growth followed by either acquisition-led growth with lower shareholder returns or stagnation and then a takeover.

Leo has traded Impax since 2017 and City of London since 2018, with Liontrust joining in 2023. Objectively, I have ended up with these mostly by chance, and there may be better options, although I suspect many are so complex as to be virtually impossible to understand. City of London has done well, up 33%, including dividends. He bought back heavily at the end of 2023 and took a few profits through the year.

Their core business plays the variable discounts offered by emerging market (EM) investment trusts, and so is constrained by liquidity there. Volatility and low correlation means that they tend to get investment flows in the opposite direction of performance, but in the short term strong EM is a plus, in the medium term they need periods of weak EM to widen discounts to provide future alpha, and long term EM weakness destroys their investee base.

They have diversified into fixed income with an acquisition, where the see considerable growth despite a client-specific outflow in the latest reporting period. They have also diversified into other equity investment trust trading strategies.

They like to say they have no star fund managers, but nonetheless, variable compensation is high, and there is a risk that employees could take an increasing share of income to the detriment of shareholders.

Like many fund management companies, there have been questions over the sustainability of their dividend, but the outlook here looks better than it did a year ago, with a yield of about 8.4%. Their valuation is towards the cheap end of their historic range, but expensive compared to many other fund managers.

Liontrust was down over the year, but my returns were good (easily 30%+ IRR) by taking advantage of strong trading opportunities to sell out entirely in May and buy back a little early in late October and add further near the November lows.

The principal issue here is that we could hardly make any sense of their reporting; most notably, their AuM take rate seemed to be misstated in the annual report, and I couldn't understand the variable compensation, which appeared to have at least three different layers. They also do seem to be exposed to star fund managers who demand higher pay and cause outflows if they leave. We are completely in the dark about why brokers are expecting AuM and earnings recovery beyond the hopes that most of us share about the equity market.

Nonetheless, they appear to have 1/3rd of their market cap in cash, and their yield is around 15% (peaked at 17%) with an apparent ability to continue paying this for at least a couple of years, even in something close to a worst case. Unless they can simplify their business or get much better at explaining it, Leo can never see this being in his top 10 positions, but it seems to make sense as part of a portfolio of fund managers.

With Impax, Leo has traded successfully for many years as the share price is very sensitive to sentiment and thus is far more volatile than its fundamental value - most notably, the Truss trough was particularly pronounced for something with so much overseas exposure. By the start of 2024, his position was large enough that it was always going to be difficult to make money from a 54% fall when they lost the second SJP mandate.

Leo did sell some on the lack of reaction from the first SJP loss on 22/10 but made the mistake of starting to buy back the very next day, assuming it must now be in the price. He added fairly aggressively on the day of the second SJP loss, partly based on Berenburg's update. However, he found the Equity Development note disappointing and is hardly surprised that the share price remains below his last buy.

This is yet another fund manager with a barely- or uncovered dividend yield of over 10% but several years of cash to maintain it. Compared to Liontrust’s it is much more sustainable and a return to underlying growth is more likely, but then the yield is far lower. While ED's forecasts assume AuM growth, they look more conservative on the revenue and cost side. However, Impax have cash and determination to hold the dividend until the end of 2028 without any further recovery in 2027 or 2028. That would mean receiving 110p dividends and a takeover if they throw in the towel.

Mark largely agrees with this sector view but would also add Premier Miton (PMI.L) to the mix. Recent results were well received, but even so, the company is on a forward yield of 10% and a P/E of 7. As small cap investors, we often look at the performance of the funds we know, such as the Microcap Trust and think it’s all a bit crap. However, the average fund here is much better than that, with 68% of funds in the first or second quartile of their respective sectors since launch or fund manager tenure.

Ramsdens (RFX.L)

This was a success. Although Leo missed the February lows, he bought materially lower and later than the year's opening share price of 220p, plus successfully did a bit of trading on the side, ensuring his IRR was over 30% versus the approximate 10% annual share price performance, including dividends.

The gold price (most relevantly in GBP) was an unexpected tailwind here, but our thesis around conservative forecasting and the regulatory environment for competing loans also proved correct. Higher staff costs were easily shaken off, unlike at H&T.

Leo remains optimistic for a small beat when the results are announced on 14th January, both for the previous and current year. Despite the strong share price performance, they still look cheap, and he has only trimmed to control portfolio sizing and on a trading view.

Mark agrees. The P/E of 9 is low for a business of this quality. In the short term, forecasts are for no growth, but this is due to specific headwinds that will abate and a fundamentally conservative approach to forecasting. H&T is a much lower-quality business but it is on the same rating when you include cash/debt.

While Mark is more guarded with revealing his portfolio holdings, conscious of the biases that such public statements create, his writings on Stockopedia mean that some positions are public knowledge. Here are a few comments on these:

Billington Holdings (BILN.L)

Billington has had a great year, with three forecast upgrades:

However, the price is just up 12% during the year. The numbers didn’t match the 2023 ones, which were always flagged as exceptional due to inflation moderating during the year with already-priced contracts. So, this may mean that some investors dismiss this, as does the cyclicality. However, it is worth asking where we are in the cycle, and it seems to Mark that we are much closer to the bottom than the top. So if the company can perform this well in challenging markets, how well will they do in better ones?

The answer is perhaps given by the fact that they are investing in automation to make their business both more efficient and add significant capacity. Their long-term record is excellent, and apart from during COVID when construction was held back, they have a strong ROE:

This would look even better if they didn’t hold significant cash balances in the latter years.

To Mark’s eye, this business is a quality compounder on a single-digit P/E value rating.

Digital Box (DBOX.L)

It is easy to focus on the product here, which is a series of websites, such as The Daily Mash, TV Guide and soap opera fansites, and dismiss this as a poor quality business. However, the cash flow suggests otherwise. The key product here is actually their advertising platform. This allows them to create or acquire new websites, drive traffic to them and generate cash through advertising sales. This makes the payback on any acquisition very quick and often under a year.

Like many media businesses, the very weak UK advertising markets have hampered their ambitions. However, this also gives them an opportunity to deploy their significant cash pile and acquire cheaply at the moment. There is currently a strategic review in place, driven by Downing. Mark doesn’t expect this to lead to a takeover but to an acceleration of their growth strategy. Companies of this size tend to scare investors. However, growth can be a double-whammy. Not only will it dilute listing costs, but as the company scales, it will allow more investors to acquire a meaningful stake and enhance the rating.

Goldplat (GDP.L)

This remains one of the cheapest stocks on the market, with a forward EV/EBITDA less than 2. Given that this company recovers gold from mine waste in Africa, many investors will think this rating matches the risk. However, this is very conservatively run, which is why the company has survived many challenges over the years. The bugbear of many investors is that these challenges have required the company to reinvest capital into the business rather than paying out dividends. However, with the planned capex now coming to an end, this should free up capital that can be directed to buybacks or dividends. Given the rating, it wouldn’t take that high a proportion of the operating cash flow to see a very material buyback or payout. This may finally lead to investors rating this more highly in 2025.

IG Design (IGR.L)

For Mark, this stock embodies the value that the SCL Discord server gives. Following recent HY results, robust discussions with others on SCL led Mark to re-evaluate this business and conclude that the market’s initial reaction to the results was wrong. Then, hearing the answers to his usual challenging and direct questions on the PI World call gave him greater confidence that the turnaround here would continue. Since then, the shares have risen around 30%. However, the shares still trade on only 0.6x TBV, where the majority of the assets are inventory and receivables. If the management are successful in their plans for making these assets productive and generating a reasonable return on capital, this will have much further to recover. The shares bottomed at around 40p in 2022. However, at that time, there was a significant risk of insolvency. With management actions so far, that risk has gone, and the company will have net cash for almost all their trading year, meaning the risk-reward is likely better today than at that time.

Jadestone (JSE.L)

This has to be the most hated oil & gas stock out there. That is some going considering that the company has no North Sea production and hence operates in more favourable tax regimes in Asia! The shares are some 30% lower over the year. Yet, this has been a year of significant production growth. The reality is that delays, on top of the issues the company had with Montara, mean that confidence has been completely lost in management to deliver. Mark has clearly been wrong to add to this, as it declined during the year. However, entering 2025, he is the most positive he has been on the company. The assets are now significantly de-risked, and the board has been re-shaped with a very definite focus on shifting away from big, high-risk developments or acquisitions to maximising the assets they have and using that cash flow on shareholder returns. Given the scale of the production, these could be significant.

That’s it for this week. A more normal service will return next week. Have a great weekend!