Small Caps Live Weekly Summary
ARDN INCE GDP IMMO AGFX SUP FCAP TIDE MRK
Another fairly quiet week and a reduced trading week means that you get the summary email a day early. Happy Easter!
Arden Partners (ARDN.L) & Ince (INCE.L) - Takeover Conditions Waived
The Arden-Ince saga has been going on for some time. Having almost got themselves delisted by making a takeover offer for their own NOMAD, we found out last week that Ince are having trouble being allowed to be a NOMAD if they takeover Arden:
On 6 April 2022, London Stock Exchange notified Arden that its NOMAD application in relation to the Change of Control had not been approved. Accordingly, Arden will not remain eligible to act as a Nominated Adviser in accordance with the AIM Rules for Nominated Advisers in the event of the Change of Control.
Given the number of tiny companies that you've never heard of that pop up as the NOMADs of micro-caps then failure to get approval to be a NOMAD is quite an embarrassment for Ince.
Mark thought this would put a stopper to the deal, however this week we get the following news:
Further to the London Stock Exchange notifying Arden that its application for continued Nominated Adviser status following the Change of Control (the "NOMAD condition") had not been approved, as announced on 7 April 2022, the Board of Ince has notifed Arden that Ince has waived the NOMAD condition to the Scheme and that it intends to complete the Acqusition.
Perhaps, the attraction to Ince remains that they get their hands on the Arden cash balance in an all-share deal. Still, this means that:
Completion of the Acquisition will therefore mean that following the Change of Control, Arden will no longer be able to provide Nominated Adviser services.
Some of Arden’s 40+ clients will now need a new NOMAD soon, which bodes well for the rest of the small cap broker space. Arden will remain active as a broker:
Although this is a significant change, the Board of Ince believes that Arden's reputation is primarily built around its ability to raise money for its clients and provide other broking and advisory services, and therefore the loss of its Nominated Adviser licence should not materially impact Arden's brand and ability to engage new clients nor its ability to provide fund raising and corporate broking services.
However, the new NOMADs are certainly going to want to be joint broker too, so this reduces the fees to Arden going forward from this side too.
The fact that Ince was not allowed to be a NOMAD is a big red flag for us though and makes Ince, and by proxy Arden, uninvestable for us.
Goldplat (GDP.L) - Extension of Buyback
This was one of the best performers earlier this week with the share price up 22% in response to this announcement. This is a very large reaction to such a tame RNS:
Following the successful completion on 8 April 2022 of the share buy-back programme initially announced on 29 March 2022, the Company has decided to extend the Programme for the repurchase of its ordinary shares of one penny each ("Ordinary Shares") for up to a further total value of £200,000.
The amounts here are relatively small - the previous £200k they blasted through in just over a week. As often is the case, the signalling here is perhaps as important as the actual event. The cheap valuation here is widely known. WH Ireland have an EPS forecast of 1.5p which with an 8.5p offer puts them on a P/E of 5.7.
However, the reality is that WH Ireland haven't reviewed their numbers on the company since they re-introduced forecasts in October last year. Since then, the company did 1.2p EPS in H1 and those who listened to the recent call realised that H2 was not going to be significantly worse than H1. 2.4p EPS, say, would put them on a P/E of 3.5.
Of course, this is a risky stock, operating in a risky sector in risky countries and with volatile historical results. So when they say:
The Board remains of the opinion that the Company's shares currently trade at a significant discount to their intrinsic value per share, despite the strong operational and financial momentum of the business, and therefore continues with the belief that share buybacks are an appropriate means of returning value whilst maximising sustainable long-term growth for shareholders, given the enhancement to net asset value, earnings and dividends per share that will result from reducing the number of shares in issue.
The market perhaps takes such messages with a pinch of salt. In current market conditions, the company is cash-generative, but the market's doubt has always been whether shareholders will see any of that cash or whether it will be wasted on re-investment into the business in the wrong places or at the wrong time. With this wider context, you can see why a commitment to a renewed buyback is greeted so positively this week.
The downsides in the short term, apart from the usual risks, are that there was a persistent seller at sub 7p recently even though all the above was well known - so perhaps someone over-leveraged into the recent market downturn? This must have been a sub-3% holder so the volumes and the buyback are enough to have cleared them. However, there's no guarantee that the overhang has cleared.
Secondly, the positive reaction today may mean no shares actually get bought back any time soon. As much as Mark would like to see the share count reduced, it is the strong operational and financial momentum of the business continuing that will drive the real returns.
Immotion (IMMO.L) - Trading Update
They start with:
Q1 2022 unaudited revenue £2m - more than double Q1 2021.
Not surprising that they were up versus a period with a significant period of lockdown in it and this is also down on the £3m they did in Q3 and £3.5m in Q4 last year. However, since Q1 follows the calendar year we expect this period would always be the relatively quiet one. Although they focus on indoor or covered VR rides, many of them are part of larger outdoor attractions that we would expect to perform much better in the summer and they are overwhelmingly Northern Hemisphere. Even fully indoor sites such as Sea Life London get far higher footfall in summer holiday periods and they generally get paid per ride.
So Q1 of £2m could easily equate to £12m annualised revenue without any further COVID recovery or secular growth. Forecasts in Stockopedia appear to be out-of-date ones from pre-covid. On the surface, then, a £17m market cap doesn’t seem large for a growth company with £12m of revenue. There are dilutive options for around 15% of the company out there, though, so that makes it look slightly less good value.
WH Ireland have put a note out, but forecasts remain suspended.
Ahead of full year results on 26 April, we leave our forecasts under review.
They say that revenue in March alone was £1m, which is an Q1 exit run rate similar to Q3 last year, although Q1 did include US Spring Break. Many will be modelling this on revenue per headset, terminal number of headsets and therefore ARR, but the reality is that coming out of covid and expansion means that revenue per headset is essentially unknown.
Advanced negotiations on first major 'Gorilla Trek' installations.
If they can repeat their aquarium success in zoos then there is significant growth right there. They also announce a number of additional installations substantially post Q1.
This stock was quite popular with small investors at one point and was often likely overvalued at times as a result. So it is worth surveying advfn and lse to see the current interest. There's a bit more activity than we'd like, but it all seems rather downbeat.
Overall, we think there's a potential opportunity here. The company is now EBITDA positive and is likely to remain so. We’d like to see H2 gross margins and dig into how they measure them, but potentially this could be good value. Ahead of forecasts potentially being published on the 26th, there may also be a particular opportunity for investors who come up with their own model.
Argentex (AGFX.L) - Trading Update
The much-awaited trading statement arrived from Argentex this week:
Strong growth in Group revenue of 23% to £34.5m (2021: £28.1m) with expected underlying* operating profit margins broadly in line with prior year (2021: 30.9%)
Revenue of £34.5m is a little behind consensus on Stockopedia, however, it still represents decent revenue growth. They don’t specifically mention profitability but gross margins are down a little, plus talk of investing in development means not much operational gearing and a slight miss on the EPS?
However, despite the chance of a miss on EPS, the share price reaction of down 10% or so looks perhaps a little harsh since revenue is still up 23%, the P/E is around 10 even after downgrades this week, and competitors such as Equals are barely profitable and going up. Also of note is:
Singer Capital Markets appointed sole Nominated Adviser and sole Broker
Our guess would be that management may be concerned that Numis were not engaging with them on forecasts as much as they would like, leading to these slight misses and a share price decline despite good growth rates. Argentex would be small fry for Numis plus the Numis notes are not available to PI’s who are the price setters here.
Argentex continues to invest in talent across the Group, having made 31 hires in the reported period bringing total current Group headcount to 100. In addition to 19 front office hires, it has increased bench strength across the support functions in order to enable the business to scale efficiently and maintain a robust approach to risk management.
This perhaps explains the more cautious tone on profits, since they have said in the past that it can take 6 months or so until new teams are fully delivering.
There is often a strange effect in small cap markets: if you have a loss-making company, the market ignores investment spend and only focuses on top-line growth. However, as soon as you have a profitable company, the market often punishes increased investment spend, at least if it is expensed or used to hire extra staff.
It perhaps comes down to the type of investor. Growth investors tend to be optimistic and give companies the benefit of the doubt. Too much so on average, as growth investors tend to underperform over the very long term. Value investors tend to be much more sceptical, so if you have companies such as CMC Markets, Somero or Zytronic, that have a lot of completely expensed innovation that is as yet unproven, then the market tends to discount these to zero.
On Argentex growth prospects, this is a good sign:
Continued strong client demand with 528 newly traded corporates (2021:499) and the total number of corporates trading in the year reached 1,624 (2021: 1,385)
So they have gotten better at winning new clients but 528 added results in an increase of only 239 actually trading. This sounds strange, but contributor Brookside Hardwick had previously spoken to management about this and says:
Management commented that given the onerous new client acceptance and money laundering procedures, it was unlikely that corporates were signing up for fun, and that they simply hadn't traded in the period since signing up. As a former SME CFO who used to use FX dealers and went through more new client sign up hoops than I care to remember (even with the pre-existing relationship banks!), I accepted that explanation as very credible. New client acceptance forms for banks & FX brokers is no CFO’s idea of fun. Typically, a growing SME will sign up with an FX broker when it wins a new contract that specifies it will be paid in an FX other than that used in its business, so that when the cash is eventually received you are ready to trade and convert to GBP. Or, on commencing the contract lock in an FX rate by forward selling your expected receipts to secure your margin on the basis you tendered. Much better to have the FX arrangements sorted in advance, rather than then having to go through 2-3 weeks of new client acceptance hoops when you have bills to pay today in GBP but USD receipts sitting around….
AGFX now regularly report both corporate clients trading in the year and new additions, so one of the things I track is the implied churn of the trading corporate client base vs. the prior year. In this respect, the figures this morning are encouraging. Implied churn for FY22 was 21%, lower than 27% in both FY21 and FY20.
Thanks to BH for the insight here.
It is certainly possible that profit growth can accelerate from here, and if it does this will look very cheap. However, management trust isn’t particularly high and will need to be rebuilt if this is ever to re-rate upwards.
Supreme (SUP.L) - Trading Update
Supreme reacted negatively to their trading statement this week with the share price down 20% on Tuesday. This may well be the reverse to Argentex where everyone expected forecasts here to be beaten rather than missed, and they perhaps haven't been:
The Company expects to report revenue in excess of £130 million (2021: £122 million) and Adjusted EBITDA1 of no less than £21 million for the year (2021: £19.3 million).
Stockopedia has £130m revenue consensus so although this is in line this is only 6.5% above 2021, and could well simply be inflation given their product categories.
Mark doesn’t have a detailed model here, however, simplistically, they did £10.1m Adjusted EBITDA in H1 which was 5.9p Adj EPS so £21m FY EBITDA would be 12.3p pro-rata. Assuming a bit of conservatism in there then the 12.5p forecast EPS looks achievable. This is about 12.8x P/E at the current 160p. So not crazy high following this week’s falls.
Since revenue only appears to have grown in line with inflation, the outlook is key here:
Looking at FY23, the Group is expecting to deliver another year of profitable growth and increasing levels of cash generation, predominantly driven by Supreme's strong Vaping sales footprint. However, this performance will be tempered by commodity price inflation within Sports Nutrition & Wellness and the increases in the overhead base relating to wage and transport costs. Management has already taken steps to mitigate the external factors, including buying forward whey, and will also be continually reviewing potential price increases and ongoing manufacturing and distribution rationalisation.
"profitable growth" may not mean growth in profits, and even if it does, top-line growth driven by inflation and bottom-line growth driven by cost-cutting are not usually rated highly by the market.
This may well simply be prejudice on Mark’s part, but he struggles to consider a supplier or batteries, vaping and protein powders a high-quality business, even if it is well-run. Others may disagree. Fast-moving consumer goods are generally considered quite high-quality businesses, particularly where they are staples that people will always buy. These particular categories can have negative connotations for some though.
Sports nutrition is the standout part of the business:
The Sports Nutrition & Wellness division has continued to demonstrate its potential with excess of 100% revenue growth.
It doesn’t take many years of 100% growth for this to become a significant profit generator. Although they now say:
However, raw material price inflation, particularly recently in relation to whey powder, has impacted profitability.
Which begs the question “if they had pricing power in sports nutrition, why haven't they put prices up as soon as whey prices increased?” This may be a strategy to win market share. But if sports nutrition is the only part of the business that can really grow long term it is slightly worrying that they don't think they are at the stage of being to price with the market.
Therefore the risk is that Supreme is the next Argentex - the EPS forecasts for 2023 definitely look at risk of being missed, and while the overall valuation doesn't look too demanding if those longer trends remain, the price will continue to drift downwards while everyone frets over the upcoming profit warning. Then we will be all saying "I can't believe how cheap this is for a growth stock, it is just a small miss in one year" and then the profit warning hits and it goes down another 10%.
finnCap (FCAP.L) - Unaudited FY22 Revenue
Mark presented a sector overview of the listed brokers at Mello Monday this week and it was great to get the feedback of Bruce Packard who has some experience working in this sector. One of the things the BASH panel was laughing about was that the brokers tend to tell their clients the importance of broker research & consistent communication and then never follow their own advice. The research part is perhaps understandable - no one wants to pay their competitor for a service they perform, yet they cannot produce research on themselves since this is an obvious conflict of interest.
Shareholder communication is one of the things that brokers should be able to get right, however. So it was disappointing to see this trading update released at 7:23 rather than the more normal 7:00.
Revenue was a decent beat but one we partially knew about. Again, M&A was the standout figure and it was the presence of a decent M&A business that made finnCap one of Mark’s picks from the sector on Mello Monday:
Mark doesn’t see this part of the business slowing down significantly in the short term but weaker ECM markets is clearly a risk.
Despite the revenue beat, profits are said to be in line due to increased costs. This is presumably why the market has taken a disliking to this trading statement on Thursday morning. Investment into the business is either a great sign of future long term growth or a strategic error depending on your viewpoint! As we’ve said about Argentex - when a profitable, cheap company prioritises growth through investment the market tends to punish rather than reward it. particularly when it is an investment in staff, not capital equipment. This is the reverse of what happens to unprofitable growth companies that are often rewarded for their cash burn. It perhaps says more about the preferences of investors and why they choose certain companies rather than any fundamental reasons.
The P/E of 7 remains undemanding and the dividend yield is around 6.5%, which is great value if you believe that finnCap can overcome short-term market conditions and continue its long-term growth track:
We would have liked to see a cash figure in the trading statement though, and a more comprehensive outlook. That they haven’t been able to provide any outlook detail suggests that this is still highly uncertain. If M&A starts to fall off then a return to long-term trend would see more like £30-35m revenue but with a much-increased cost-base, not all of which is variable compensation. This would, of course, negatively impact profitability.
Progressive have updated their forecasts in response to this update:
We raise our forecast for adjusted diluted earnings per share by 7% to 4.32p (from 4.03p).
However, Progressive are the only broker and the company said they were in line with the previous forecast. So a bit of a mystery here. Progressive also have also made no 2023E forecasts. Given the uncertainty, the results in July and subsequent management presentation will certainly make very interesting reading/viewing. As will the RNSes from companies where finnCap is the broker over the next year.
Crimson Tide (TIDE.L) - Preliminary Results
Leo caught up with these results from last week:
So a massive increase in admin costs has pushed them into a loss. This isn't really addressed in the commentary or the notes, except to point to an increase in marketing spend. Depreciation & amortisation rose from £384k to £579k due to an impairment of software development.
We have often been critical of the level of software development capitalisation and slow rate of amortisation at Crimson Tide, so this should come as no surprise, although we, again, note zero mention or explanation in the commentary.
At an online Mello presentation, Leo asked about the 10-year software amortisation policy and IIRC they said it was under review. Perhaps the excuse for such a crazy figure was that it had "always been that way". In which case how can they possibly justify this:
The amortisation period of the mpro5 intangible asset will be reduced from 10 to 7 years in 2022.
7 years remains an insanely long time to amortise any kind of software, but especially something with a significant mobile app component. Perhaps we are reading too much into this but it is noteworthy that the CFO hasn't put his name to the finance section, either here, nor in the previous full annual report.
As well as not mentioning the software write-down, there is also no mention of the costs of the fundraise in March / April last year. However, we know that £6m was raised before expenses and last week they confirmed this was £5.6m net. So that's £400k of genuine exceptionals in admin expenses.
So what about outlook and modelling? Here's the key figure:
Our key target is to double Annual Recurring Revenue in the medium term.
But the trouble is we are given very little idea what is in those increased admin costs and how much e.g. increased marketing costs would be annualised across a full year. That makes it impossible to model, even if you had any confidence that the 80% gross margin was being measured sensibly.
Despite hopes he had taken a step back, there may still be some of what we consider to be a less-than-shareholder-friendly approach from Barrie Whipp in the lack of disclosures, current trading or proper outlook, and the strange accounting policies. So, for us, this remains uninvestable despite having what is a good product with excellent potential.
Marks Electrical (MRK.L) - Pre-close Trading Update
Marks Electrical presented at our recent SCL Investor Meet so we read this update with interest. The figures here refer to the year ending 31st March and so are very fresh, as you might expect from a company like Marks:
Record full year revenue with growth of 44% to £80.5m (2021: £56.0m)
This is exactly what Equity Development guided in the note issued on 16th March. We would expect them to aim for guidance such that a small beat would be achieved if the last couple of weeks’ trading hit the central point of expectations. So perhaps there was a very slight weakness at the end. This is also a small miss versus Stockopedia consensus on 31st January of £81.2m which was presumably from Panmure Gordon. So perhaps their forecasting isn't as conservative as it could be? Or there was some weakness at the end? Or did they see an opportunity to trade revenue for profits?
the Group expected to achieve its full year Adjusted EBITDA margin target of 9.0% in line with market expectations
At least it was in line.
Strong trading period in Q4-22 with 19% revenue growth to £20.7m (Q4-21 £17.4m)
Just to put this in context, previous forecasts (and therefore Leo’s model) had this at 23%. So Q1 to Q4 YoY growth rates respectively are: +78%, +78%, +27%, +19%. Clearly quite a slow down post-covid.
Continued positive trading momentum in March 2022, with an exit growth rate in the final month of over 25% year on year
This is reassuring, but clearly, January and/or February were worse than +19%.
It is important to note that CPI was 6.2% in the year to February and the statistical method assumes a level of substitution amongst consumers to avoid rises in particular goods. Worse, "Major appliances and small electrical goods" are up 9.3% YoY on that basis.
Equity Development don’t project FY net cash figures and it is not trivial to derive them from their cashflow forecasts, but this does indeed seem ample compared to previous years:
Robust balance sheet, with closing net cash position of £3.9m
So, not the greatest of updates by itself. But this is the key part:
The fourth quarter was another excellent trading period for us, with 19% revenue growth vs. a particularly strong comparative of 127% in the prior year.
They were indeed up against exceptionally strong comparatives. And regarding those earlier Panmure Gordon forecasts, they were for 4.5p EPS whereas Equity Development leave their 4.7p EPS forecast unchanged. At the end of the day, it is profits that matter not revenue.
That’s it for a short week. Happy Easter everyone!