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After the plethora of trading statements last week, this was a much quieter week for news. However, to keep us entertained Leo presented at the Stockopedia Stockslam on Wednesday:
And good to learn that he retains a copy of Excellent Investing secreted about his person at all times. It will not only protect your portfolio from unexpected losses but also protects your body from wounding!*
*no warranty provided, actual results may vary.
Large Caps Live Monday 25th October
Vodafone (VOD.L)
First, let’s touch on Vodafone as I think it has a lot of lessons on growth investing. The following is a chart of Vodafone from Yahoo Finance. It was interesting to try to find a long term chart of the company:
So according to that chart, it was circa 13-14p in 1998. Of course, the key is the dividends. ut it also raises a structural issue with Vodafone and a more fundamental question -- what is it about. I think you can see the issue in these numbers:
I know it sounds old fashioned but a declining book value on a dividend-paying stock is often an alarm bell. You can see the way that the debt has been increasing.FCF has been, to be fair, increasing but there is clearly something not right if the debt is increasing. And here we can see that the top line has been 'lacklustre', with EPS and operating profits being erratic.
I think the issue is how you treat the spectrum payments. I think it is the equivalent of a fishing license or a building permit. We would not expect a housebuilder to say our profits before the costs of getting planning permission or buying the land were X? I think accounting can be criticised for hiding the economic truth, but sometimes it actually REVEALS the economic truth. In this case, it is that Vodafone probably overpaid for spectrum (but then would not be in business otherwise) and has been mediocre at capitalising on its 'fishing license'.
I think this is interesting - we tend to think of Vodafone as a British company but its biggest markets are Germany and Italy and then Vodacom (Africa):
The March 21 numbers will include their towers business - which would be quite the change in the balance sheet, but I think 70% - 80% of investors do not understand the complexities of what happened in India. And the deconsolidation of the towers business is, in my mind, a sign of weakness, not strength. There is also the issue of how lease liability accounting has altered the balance sheet over the years. The Towers business has a market cap of £12.65bn and £16.18bn enterprise value. Vodafone owns 81.05% according to Stockopedia. Clearly what the European mobile companies are trying to do is emulate the success of American Tower ($NYQ:AMT) which has a market cap of £92bn and a PE of about 50.
In essence, the business model of a tower company is:
buy a tower at say $100k
as part of a sale and leaseback so say get a $7k per year rental fee
get other operators to share the tower/site eg stick their antennae on it and charge them $8k each (often more as sites become harder to get)
2 operators sharing a tower is good, but if you can get 3 -4 you are in nirvana
with 4 operators you might get say $35k per year (you charge them more as the site becomes more critical)
And then your tower company is capitalised at 5% on $35k ie $700k valuation for the tower. The issue in the US is that AMT had an early mover advantage. In Europe, there was initially less site sharing. Another issue with shared infrastructure is that there were regulatory barriers against it initially. As we have moved to 5G we need more towers and the regulators are now more relaxed. But the power to some towers is limited (or cable bandwidth) so the later operators get charged more.
Anyway, with Vodafone, frankly, I think it is 1 - 3 years behind BT in realising that it needs to reinvest. And the revenue of the business is 90% from Vodafone itself and it is unlikely that the infrastructure is portable, which means it shouldn't have a valuation premium. A 'sum of the parts' story with listed subsidiaries is always value-destructive despite what the bankers say - unless you are John Malone.
Airtel Africa (AAF.L)
This floated in 2019 at circa 69p. I read a lot last night on investor chat boards about Airtel and how it was a play on African demographics and mobile payments. I think what is being missed is why it was listed in the first place. And the connections to what was its parent. So let’s take a step back.
In a galaxy far far away...there was a company called Bharti Enterprises which founded a mobile operator in India called Airtel. A bit like the UK, the Indian regulator auctioned their spectrum. However, with an additional twist, and copying the American model they auctioned it by 'circle' ie geographic region. So the Indian operators (a bit like what happened in the US with McCaw) spent 5 - 10 years eating each other up to get a pan-Indian network.
At one point, circa 2005 - 2006, I counted 22 mobile operators in India but that was almost certainly wrong as I missed some smaller players out. Anyway, the king at the top of that pile was Airtel - owned by Bharti Enterprises which was founded by Sunil Mittal. In many countries, the personality of the founder matters; and never more so than in India.
Airtel was tremendously successful - and imagine that this was in India - a nation with more population than Western Europe and North America (US + Canada) combined.
Now before we discuss the Airtel story further we need to discuss another Indian family - the Ambani family. The family fortune was founded by Dhirubhai Ambani who founded Reliance - one of India's biggest industrial groups (either #1 or #2 depending on how you count Tata). At times, Reliance has been said to be equivalent to 2-3% of India's entire GDP. When Dhirubhai Ambani died, his two sons - Mukesh and Anil had a massive fallout and split the empire between them with the older brother holding onto the petrochemical business and the younger (Anil) getting the sexy and fast-moving telecoms and media business.
At the time it was a serious fight between the brothers - with senior politicians involved to help sort it out. So fast forward a number of years and the older brother decides to enter the telecoms market with Reliance JIO.s a new entrant they used what some would say was a strawman company to bid for spectrum in a new round of auctions - and as no one was really looking they go spectrum CHEAP. So Reliance JIO launched with a classic new entrant strategy where the incumbents have a lot invested - they offered the product for effectively ZERO. I think it was zero for about 6 months but either way, it led to (1) massive mobile adoption (2) massive switching (3) collapse in market prices.
It meant that Airtel and other operators were basically pushed against the wall and I would suggest that the IPO of Airtel Africa was a defensive measure to create a sum of parts story and perhaps upstream some cash to the parent and deconsolidate some balance sheet +/- losses.......sounds a bit like......I don't know ......Vodafone?
The difference is that Airtel Africa is potentially a high growth company due to low but increasing penetration etc. And I believe it has also done a sale and leaseback of some towers to Helios Towers. And also got in minorities (MasterCard via Mobile BV for $100M and TPG via The Rise Fund for $200M) into its payments business which is thus valued at $2.65Bn whilst Airtel Africa has a market cap of £3.65bn but EV of £5.76bn.
At 10x PE it does look cheap. But the question is what discount should we apply for EM exposure and that you are buying a listed subsidiary. But then the positive is also in this box on stockopedia:
To show how good that is let me show you the equivalent for Vodafone:
I would suggest what the above really shows is that the market thinks Vodafone massively overpaid for spectrum and hence the low P/B (which also reflects the high debt - the EV/EBITDA is similar for both companies). But the difference in ROC, ROE and OpM reflects the management quality and also the cost of the spectrum etc.
Also remember that despite a HYPERCOMPETITIVE environment in India, Airtel was on top for many years - it knows how to operate in such an environment whilst Vodafone is perhaps more bureaucratic. So I am kicking myself that I did not even look at Airtel Africa when it was on 2-3x P/E. But historical errors should not impact our decision-making today.
Small Caps Live Wednesday 27th October
Sylvania Platinum (SLP.L) – Q1 Results
What’s good about these is that they give almost a full income statement. However, these are clearly very preliminary because the H1 & FY results don’t add up to the quarterly amounts. Also, there must be some other costs in there that are not SG&A or production costs, taxes or interest and AFAIAA the company has never revealed what these are, and they have become more significant lately.
Still, the headline figures are given which is more than some company’s quarterly announcements. These show that the company struggled this quarter:
Record PGM performance by Tweefontein contributed towards Sylvania Dump Operations ("SDO") achieving 15,771 4E PGM ounces in Q1 (Q4 FY2021: 16,289 ounces) despite the temporary production suspension at Lesedi;
SDO recorded $29.8 million net revenue for the quarter (Q4 FY2021: $48.4 million) impacted by 29% decrease in gross PGM basket price;
Group EBITDA of $13.6 million (Q4 FY2021: $28.7 million);
Net profit of $8.6 million ( Q4 FY2021: $14.7 million) ;
A combination of lower PGM prices plus production problems means EBITDA has halved Q-on-Q, and is down 77% from the peak in 21Q3. The good news is that the reduced production has freed up working capital which was reducing the free cash flow over the last few good quarters. Cash increased by c.$26m despite increased capex:
Cash balance of $132.7 million (Q4 FY2021: $106.1 million).
Although the management’s reluctance to return any meaningful amount of this cash balance to shareholders remains a concern.
The problems at Lesedi will be fully fixed by the end of Q2 and that adds 1.1koz back to production. They say:
The temporary suspension of operations at Lesedi extended through Q1 and will be ramped up to normal capacity towards the end of Q2, as hydro-mining of the affected tailings dam facility commenced at the end of September;
And they remain confident on their production target:
...we remain confident in attaining our annual production target of 70,000 ounces.
But this looks a stretch to me, they'd have to do may around 19koz per Quarter in Q3 & Q4 to catch up. They’ve not had this level of quarterly production since Sunamcor were producing Run of Mill tailings at a higher rate. And this is also the period they run the risk of power and water shortages. We can't imagine the SA power grid is in a much better position than the last few years, although presumably they are still burning coal so are in a better position than the UK.
Liberum are still positive here and they believe that PGM pricing will bounce back:
We remain bullish on the price outlook, as we assume the chip-related disruption to auto output will soon be resolved.
Their target price of 170p and forecasts are maintained. Mark is more circumspect. Unless, commodities have very clear supply-demand imbalances, such as Heavy Mineral Sands do at the moment, then it is often better to assume that current prices are the best guess for forward prices. After all, we don't think Liberum foresaw the big ramp up in Rhodium pricing or the chip shortage that caused the subsequent decline.
Assuming Sylvania hit their production target (which there is some doubt about) and taking today's spot prices then they will be generating c$60m of EBITDA at current spot prices. Even with the large cash balance then this is an EV/EBITDA of over 4 at a 107p share price. So this is now much more expensive than it has been recently on an earnings basis.
This means that a recovery in the PGM basket and hitting production targets are both now priced in. Any rise from here will require these expectations to be beaten, whereas a miss seems more likely given this weeks figures.
Yougene (YGEN.L) - Half Year Trading Update
The initial reaction to covid on the Yougene price presumably represented concerns that their products, such as NIPT, Cystic Fibrosis, DPYD genotyping, would be hit by the collapse in heathcare systems. This was apparently quickly followed by hopes that covid would bring lots of work for them. Presumably somebody who understood this stuff (and investing) could have made quite a killing. But the interesting thing is that they are now priced below pre-covid levels.
Yesterday they produced a half year trading update:
Revenues for the half grew strongly to £17.5m, more than double the £8.2m recorded for H1 FY21 and ahead of previous guidance of at least £15.0m
- Genomic Services revenues up 260% to £10.5m (H1 FY21: £2.9m), driven by COVID-19 testing
- Genomic Technologies revenues up 32% to £6.9m (H1 FY21: £5.3m)
The Genomic Services is involved in high throughput COVID-19 testing. On the Genomic Technologies side it is swings and roundabouts. Anyway, here's what N+1 Singer have to say:
Strong H1 update drives FY revenue upgrades
we nudge up our FY22E revenue assumptions by £2.0m to £27.0m but prudently leave our profit forecasts unchanged. Our FY23E and beyond forecasts are also unchanged, underpinned by the positive outlook and strong pipeline of business in the US in particular, which we expect to contribute materially from next year onwards.
Forecasts are for adjusted EPS of 0.3p in 2024.
And as you can see this relies on a "pipeline" of business from the US working out. Healthcare and the US has a habit of not panning out in my experience. So at 13p they seem crazy expensive. But perhaps not as expensive as they were pre-covid.
SmartSpace (SMRT.L) - Interim Results
We only covered SmartSpace on Friday following a trading update. The week they released results. Which begs the question “did they only realise that results were so bad when preparing these results that a trading update couldn't wait?”. Were they were forced to put out the trading statement by their NOMAD? Or perhaps they wanted to get the bad news out to promote the shares post-results. Or their management accounts are not kept up to date.
Anyway, nothing new in these results. The jury's still out onwhether they can grow into a profitable business and whether they will need additional capital to do so.
Ince & Arden (INCE.L & ARDN.L) - Offer for Arden Partners
It was announced this week that Ince are making an all-share offer for Arden Partners. When Leo wrote up the investment case for finnCap earlier this year he said:
Arden has in my view failed to reach scale and is perhaps more of a takeover target than a serious competitor.
Prescient, it seems.
This is a 7 for 12 all share offer. The market doesn't seem that enamoured with the deal, though. The stated value is 31p/share but the INCE share has dropped on this news so the current offer values it at c.28p. There was an arb available with Arden available to buy below the implied offe. But with large spreads and small cap stocks lacking borrow then this only really works if you want a slightly cheaper way into Ince stock.
The Ince balance sheet looks very weak with £67m current laibilities vs £54m current assets. However, Ince are getting £3m of Arden’s cash. And about £5m of Net Current Assets. So, this deal does actually improve the Ince balance sheet. It acts like a bit of a placing. If Ince simply did another few all-share offers for cash companies then they could actually rebuild their balance sheet.
The risk is that in the short term, people who were locked into Arden are going to be selling their Ince shares as soon as they get them.
And to complicate matters further, Arden were NOMAD to Ince so had to resign. So Ince then got themselves suspended from trading until they appoint a new NOMAD. We can’t help thinking that they should have known this, or at least their NOMAD should have told them! It raises lots of questions, given that Arden have known for some time about negotiations. We suppose they kept it a secret from the people advising Ince, which given the size of Arden is probably most of them. And they would have wanted to keep it a secret from fee earners anyway as any uncertainty might trigger them to look at moving. Really Ince should have known better and changed NOMAD ages ago.
Small Caps Live Friday 29th October
Hunting Group (HTG.L) – Q3 Trading Update
Hunting is an interesting company. It is an oilfield services company that is trying to diversify into more general engineering but has been severely hit by the drop in oil company spending. Yesterday they issued their Q3 trading statement. Here’s the headline:
In summary, management now anticipate the Group's EBITDA result for the 2021 full year will be broadly breakeven due to a combination of the above factors.
This is a reduction on where they were at the release of H1 results in August when they said:
However, given the overall trading seen in the current quarter and likely EBITDA run rate for the balance of the year, management now anticipates the 2021 full year EBITDA outturn to be c.$10m lower than the 2020 result, given the slower-than-anticipated recovery within our core energy markets.
2020 EBITDA was $26.1m so this has moved from $16m to zero in the last quarter. You can see why the share price was weak in response to this trading update. The reasons given are:
As a result, the macro economic outlook continues to improve. However, during the quarter, we faced weather and sporadic COVID-19 disruptions that weighed on both operating efficiencies and activity levels. Hurricane Ida took several operations in Louisiana offline for three weeks and disrupted our customers' offshore activities in the Gulf of Mexico. COVID-19 continues to disrupt our operations, and continues to create supply chain disruptions that have impacted global supply chain networks.
Supply chain issues are not unexpected, and we can question how well different management teams are coping with these issues, however, we don’t think the management can be criticised for being impacted by a hurricane. The market is, or at least should be forward-looking and on 2022 they say:
The recent IEA forecast for demand for oil and natural gas further underscores our belief that we are in the early stages of a strong, multi-year recovery that, although slow and steady in Q3 and likely Q4, will accelerate in 2022.
This was backed up by the H1 results call when the CEO seems to think that the bounce-back will be strong and O&G companies have not spent cash yet since they were working through hedges & rebuilding balance sheets. He said something like "this is why I'm very bullish about 2022".
So the fundamental question. Is demand permanently impaired?
One of the themes of 2021 is ESG investing and oil is suddenly persona non grata. It was amusing that they managed not to mention climate change in the whole statement. Instead, they avoid the reason for the anaemic drilling response. Which is, of course, no one wants to invest fresh capital in the sector. For example, Petrofac are having to price their senior secured bonds at 10%+. Now, one of the reasons they are raising capital is to pay their SFO fine, but still, in a world of negative yields, this is quite some spread.
We see this, in the North American rig count. In the last decade, the rig count has followed the oil price pretty closely but with a few months lag. Until this year. Where the recovery in the rig count has been much slower than the rise in the oil price. It could be that NA producers see the current oil price as transitory, but we think it is more likely that they just can't raise equity or debt at the same rate as before.
The impact of this will be a) a much slower commodity cycle and b) a delayed rise in the rig count. This is because the investment will come, but it will be the re-investment of the operating cash flow of existing producers once they have paid down debt, not from fresh equity or debt.
So Hunting looks expensive on earnings, but there is potential for high earnings for a number of years in the future as the rig count does eventually rise. And it is on a P/TBV of only around 0.5 making it one of the cheapest companies on the market on asset metrics. They say:
Inventory levels at the end of the quarter were c.$266.3m, reflecting continued strong capital discipline.
And:
The Group continues to report a strong cash position of c.$84.3m, before lease liabilities, as at 30 September 2021.
Which are the same level as at H1 end. So these assets are largely liquid.
The second factor to consider is timing. There is an opportunity cost owning any stock and if the recovery is many years away then this may not be a good investment now, regardless of how certain we are about future demand. This is a company that has continued to pay a dividend despite the severe turmoil in its end markets, though, which helps assuage any opportunity cost.
Vianet (VNET.L) - Trading Update
In the past, we have suggested that this is a company that may need fresh capital. And it certainly seems they are sensitive to this suggestion:
From the outset of the pandemic, we have worked closely with our customers and have focused on managing our cash. We remain confident that the Group has adequate funding to support our ongoing business requirements as well as our planned investment for a sustained period.
Our focus, throughout the pandemic, has been on working closely with our customers and suppliers, shrewd cash management...
But they don't go as far as telling us what the cash position actually is. Their H1 ended 30th September, so you'd have thought they would have been able to add the cash up by now. They even go as far as saying:
Subject to no further lockdowns or restrictions on the hospitality sector and no deterioration of semi-conductor supply, we expect H2 cash generation will enable the Board to reinstate a dividend in July for FY2022.
However, it wouldn't be the first time that companies have raised money at the same time as paying a dividend. So, parking the cash issue, how is trading?
The easing of Covid-19 restrictions has meant that the Smart Zones division has benefitted from strong momentum in Q2. Almost all our clients are now fully operational, and this has resulted in a strong rebound in revenues.
In the Smart Machines Division some 70% of our unattended machines have been fully operational throughout the pandemic. The gradual re-opening of city centres and the continued demand for cashless vending solutions has resulted in new sales and a 12.9% increase in total connected devices which has further contributed towards our strong H1 performance.
SmartZones is mostly beer flow monitoring tied pubs. Smart Machines is mostly vending machines. Note they do not say to what percentage either have rebounded. Although there may be 12.9% more connected vending machines, we don't know what activity they have compared to norms, so the run-rate could easily still be below pre-covid levels. SmartZones surely is.
Working with our suppliers, we have so far managed to mitigate the impact of the global semi-conductor supply shortages on customer installation programmes, however this has resulted in paying marginally higher stock premiums for components.
Nor would we expect semi-conductor issues. Everyday experience indicates there is no real shortage of everyday chips outside the major auto manufacturers.
Operational and Financial Updates
We are pleased to confirm the strong recovery in the Group's revenues through H1, with turnover up 55% to £6.3m (H1 2020: £4.1m and H1 2019: £8.4m) and pleasingly slightly above our expectations for the first six months of the year given restrictions ran late into the period and our supply chain costs were marginally higher. Whilst new device sales are encouraging the recurring revenues from long term customers have bounced back to being c. 90% of turnover.
As you can see, this is way down on the pre-covid period to September 2019, after which they had 5 months of growth before covid hit. Note that the 90% given is not 90% of normal. It is just saying of what turnover they did have, 90% is recurring. i.e. recurring revenue is way down. If anything is is bad news because it demonstrates just how unrecurring their recurring revenue can become. What we need to know to analyse this company is the recurring revenue run rate, and there are no hits of this. Some would consider this trading update evasive. The summary seems to be: H1 was terrible, but we really hope H2 will be better.
Cenkos have updated on the day of the statement:
So not exactly cheap on these forecasts.
Right, that’s it for this week. Have a great weekend!