Happy Christmas Everyone!
It seems the bit of a Santa Rally has continued, although quite patchy in places. The popular stocks have done best, but some caution is perhaps warranted. As SDI showed a couple of weeks ago, short-term momentum doesn’t preclude a profits warning. Companies such as Gear4music, Focusrite and Mpac have all been strong in the last couple of weeks, and all look to have a risk of a future profits warning attached. Still, the average UK small cap looks materially undervalued, so it should be a fertile hunting ground, even if it would seem best not to follow the crowd blindly into what is hot. Likewise, we are getting to the time of the year when tipsters like to tip, and this may cause some material moves. It is worth a reminder that the average tip performs badly, and it is even worse once you exclude the initial untradable markup by market makers.
Conversely, this is a time when some funds may perform a bit of window dressing and sell their worst-performing stocks in order to keep them out of their end-of-year review. In illiquid markets, this can cause prices to drop precipitously. So, it may well pay to keep an eye on the markets when others aren’t. Occasionally, a bargain appears.
This is some of what we discussed on the Discord Server this week:
Capital Limited (CAPD.L) - Contract Award
This is a sizable contract win for their 82% owned subsidiary:
The contract is anticipated to generate ~$140 million over the five-year term, with annual revenues of ~$30 million once fully operational, making it the largest award of new business in the history of MSALABS.
With the initial operations in place relatively soon:
Phase I of the project will commence towards the end of H1 2024 with the commissioning of two Chrysos PhotonAssayTM units and a capacity of 80,000 samples per month.
We knew these three machines were coming to Barrick in Nevada since they were announced in October. However, this announcement gives the figures. Interestingly, this isn’t just a Chrysos implementation but will feature more traditional fire assay as well. It seems the traditional lab is added purely for multi-element testing. Chrysos claim their technology should be capable of handling many different elements, but it is currently only used for about 2 or 3 elements.
One of the things that stands out is the capex is relatively light:
Capital expenditure for the project is expected of ~$7 million in 2024.
With revenue of $30m/year, and assuming MSALABS generates similar EBITDA margins to the rest of the group of 20-25%, that means $5-6m EBIT/pa for $7m incremental Capex. The ROIC of this deal appears to be somewhere north of 50%. Sooner or later, the market may have to re-evaluate its opinion that this company should only ever trade at 2xEBITDA because it is “capex-heavy”.
Hargreaves Services (HSP.L) - Trading Update
In the last few years, the turnaround in profitability here has been driven by their German JV. Unfortunately, this is largely a black box; shareholders have little visibility over what is going to come out. It seems that Hargreaves management have no idea either:
As a result, the Board now expects that HRMS will record a net loss in the first half and that the full year profit after tax contribution from HRMS will be approximately one quarter of that originally expected and materially lower than the contribution in the comparative period of £15.5m.
So that’s a pretty significant warning and not a nice Christmas present. The other parts of the business are trading better:
The Services business had a strong first half to the year. The Board anticipates reporting a growth in Profit before Tax on the comparative interim period after adjusting for the £2.0m one-off gain on asset disposal recognised in the first half of the last financial year. Services profits for the full year are expected to be circa £2.0m higher than previously expected. Much of this improvement is due to the volume of activity at HS2 and other earthmoving activities, with activity in this segment expected to remain at elevated levels throughout calendar year 2024.
And the pension buyout is not as costly as previously anticipated:
Current indications suggest that the cost of closing out the Group's obligations under the scheme will be no higher than £9m, materially lower than our original estimate of £15m. The Board expects to complete the transaction in early 2024, thereby eliminating annual deficit reduction payments of £1.8m.
In light of this, they flag an increased dividend of 36p, which the board must feel is sustainable. It could just be an attempt to put lipstick on a pig, but equally, it could make the company an income buy if the market takes fright at the collapse in profits at the main earner. So far, the shares traded down on this news, but not far enough for us to consider buying purely for the dividend, given the risks of the German JV and exposure to HS2.
Tortilla Mexican Grill (MEX.L) - Trading Update
The headline figure of +13.8% revenue hides a real-term drop in LFL revenue:
YTD UK LFL (like for like) growth of +3.7% (+5.0% when adjusted for VAT)
This is said to be "slightly behind" expectations due to poor performance in regional high streets, which would appear to bode badly for further expansion, but on the other hand, franchise operations have performed well.
We don't immediately see anything to suggest this is a massive profits warning, but it looks like it is:
As a result of these factors, the Board currently anticipates Adjusted EBITDA for FY23 will be in the range of £4.5m - £4.6m.
On 3rd October, Cavendish forecast £10.7m, albeit in a note entitled rather ominously "work to do in H2". Liberum had already massively downgraded the same day that Cavendish published their 3rd October note, so this is not such a big miss as one might imagine.
Perhaps they will now write down some intangibles and then adjust them out, but depreciation and amortisation were previously forecast at £8.7m, so this looks like a massive EBIT (operating profit) loss. Liberum's EPS is cut from 2.6p to 0.8p, still scraping a profit. However, we will be on the lookout for exceptional writedowns.
RBG Holdings (RBGP.L) - Trading Update
Another massive posits warning here. £4m EBITDA vs £10-12m previously guided. More worryingly:
The Company recently announced that it had renewed and extended its existing borrowing facilities with its current lender, HSBC, under which the debt headroom was raised to £24.5m. The Company had a pre-IFRS 16 net debt position of £22.1m as at 15 December 2023.
They don’t mean “headroom”, as we would use the term. This is their debt ceiling. And they are pretty close to it. Given the debt and this drop in trading performance, this looks expensive despite a 32% drop this week.
Another 30% drop would see it trading around TBV, though, and a 50% drop may make it worth looking at again for a potential recovery. "Potential recovery", of course, refers to the right tail present in the return probability distribution for equities. This is longer than the left tail due to limited liability, but especially so when buying below TBV and is related to the concept of "option value". So maybe worth looking at again if it drops below 5p per share?
Triad (TRD.L) - Half-year Report
These are terrible, a big loss and the cash balance is plummeting.
Unexpectedly, trading has not been assisted by Chair John Rigg promoting Charlotte Rigg to Deputy Chair on the basis of her business experience with "an internationally recognised stud farm". But apparently, none of these losses are their fault, again.
The disappointing results announced above are the result of similar circumstances and influences as those we experienced during the first half of last year but significantly worse. We had expected this would not be the case, but unfortunately, once again due to factors entirely outside our control, this has not proved to be so.
They sound like they are once again hoping to make some of the losses back in H2 and muddle along for another year. We can’t believe that this still trades at the level it reached following the publicity around their unsuccessful foray into blockchain. Unbelievably, the share price is actually up this week. Shareholders presumably choosing to believe in the business acumen of Ms Rigg and following her into a purchase of £6k’s worth of shares, rather than looking at the actual results of the business.
That’s it for this week. Have a great Christmas!