Small Cap Value Report (Thur 19 July 2018) - RDL, JIM, GOAL, SPE, SIS, DOTD, NICL

Good morning!

Many stocks I'm interested in have reported today.

• Jarvis Securities (LON:JIM)
• Goals Soccer Centres (LON:GOAL)
• Sopheon (LON:SPE)
• Science in Sport (LON:SIS)
• dotDigital (LON:DOTD)
• Nichols (LON:NICL)

1.15pm: Scholium (LON:SCHO) is too small while the AO World (LON:AO.) update is in line with expectations and with an unchanged share price, so I have taken them off the list. Everyman Media (LON:EMAN) also issued an "in line with expectations" update today.

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Ranger Direct Lending Fund (LON:RDL) (in which I hold a long position) produced its monthly update yesterday afternoon, showing NAV virtually unchanged at c. $183 million (872p at latest exchange rates, I think), with the assumption of a complete write-down of its bankrupt US investment.

It's a little disappointing to see NAV unchanged, naturally, but it's only one month and it was a turbulent period for the fund. 33 basis points of performance was spent on its management review process, and 17 basis points on legal expenses related to the bankruptcy case in the US.

I'm now looking forward to seeing how much value the new directors can realise. Only one of the original Board members is left.

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Jarvis Securities (LON:JIM)

• Share price: 447.5p (-5%)
• No. of shares: 11 million
• Market cap: £49 million

Interim Results

This is a company I know something about, as I have been a client for several years. I also briefly (and unsuccessfully) held the shares. It offers retail stockbroking and outsourced back office services for commercial institutions.

I often refer to it as the Ryanair Holdings (LON:RYA) of the stockbroking world. It's a no-frills experience, but it does work. I've never had any problems with customer service. And you'll struggle to find a cheaper service out there, with no management charges.

It's an exceptionally efficient operation, achieving mammoth returns on capital every year for shareholders, including for the founder-CEO whose family owns most of the company.

Jarvis is a good example of a company which sticks to its knitting. It knows what it does well, and it keeps doing it.

It has never had any need to build an empire with a buy-and-build strategy. Instead, it has simply made sure that its core business keeps running smoothly, and paid out nice dividends to shareholders.

It also offers the interest rate hedge which I think investors should crave: it would benefit greatly from higher interest rates, as its earnings on cash under administration would soar.

With that preamble out of the way, let's take a look at these results.

Interims

Regulatory changes, primarily associated with the EU's MIFID II directive, have increased costs and reduced margins in relation to Jarvis' commercial activities. It has therefore had to raise its prices, and says "margins have now been restored" as a result. Sounds ok.

In relation to the cash under administration, the chairman says "we are beginning to achieve a higher average interest rate on these funds" - very good!

I'm a bit of a pessimist in relation to the UK interest rate outlook. The US Federal Reserve is being far braver when it comes to bringing interest rates back to a reasonable level (and that's one of the reasons I've been investing in US debt funds). Gains in interest income at Jarvis will depend on how brave the Bank of England can be in following suit.

The numbers

Revenues are down slightly, but are effectively unchanged.

The major change is that administrative expenses have increased by more than 10%.

Apart from that, it's the standard result this company achieves: huge margins, huge returns on capital, and fantastic free cash flow generation (excluding a negative working capital movement).

If I did have one concern about this stock, it would be that I think the trading platform could do with a little more investment. It has looked the same for many years and with some new competitors popping up who are innovative and extremely well-invested (such as IG Group (LON:IGG), in which I hold a long position), I think opening the purse to improve the platform could be a wise move.

Fortunately, Jarvis has the underlying cash generation to afford to make this investment, when it chooses to do so.

With top-line growth having slowed down, I can see why its P/E multiple has compressed. I'd be interested to open a position in it again at some point, so will be keeping an eye on it.

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Goals Soccer Centres (LON:GOAL)

• Share price: 67.5p (-22%)
• No. of shares: 75 million
• Market cap: £51 million

Post-close trading update

A double-barrelled update from Goals today. In a separate announcement, the CFO has resigned. He will stay with Goals until his successor has started.

This company operates soccer pitches for 5-a-side matches. I tend to view it as a capital-intensive business without much of an economic moat, and this is born out by a return on capital figure of 6.5% (using Stocko figures).

Key points from today's update:

• Poor weather has resulted in like-for-like sales down 3%.
• 73% of the estate will have been modernised by the autumn
• Lenders have agreed to relax the net debt / EBITDA covenant for the June and September tests.
• Full-year results to be materially below expectations, due to the poor weather in H1.

My view

Whenever there is talk about covenants being temporarily relaxed, investors need to be worried.

I've opened up the final results statement again, and I see that Goals was carrying net debt of £30 million, with net debt/EBITDA at 2.97x.

This was set to reduce with the help of a company policy to restrict capex "to essential items only."

However, given that the covenant with the lender is being relaxed to 3.25x, it has evidently not reduced by much, if at all.

I do find it a bit strange the company has been modernising the estate after promising to restrict capex to essential items only. The modernisation spend must be considered essential in order to stay in business?

I wouldn't be interested to invest here unless it looked extremely cheap, and even then the debt covenant issues would be a worry.

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Sopheon (LON:SPE)

• Share price: 910p (+20%)
• No. of shares: 10 million
• Market cap: £92 million

Trading Update

I last covered this software company in January, when it said the 2017 result was going to be significantly ahead of expectations. The share price was 575p at the time.

Today, the company reports that is trading "comfortably in line with expectations".

That says to me that it is trading at least in line with expectations.

It has a track record of beating expectations, and this says to me that it might perhaps be in the habit of setting expectations at a conservative level.

Net cash has grown by $6 million to $15.5 million.

Paid-for research pegs full-year revenue at $30.1 million, and says that today's update is "very supportive" of this estimate. Last year's revenue was $28.5 million.

My view : the 20% share price gain this morning looks on the high side to me, given that analysts are leaving their estimates unchanged.

I can only assume that shareholders are pricing in yet another revenue and earnings beat for the full year, and I would agree that this is the most likely outcome, though it is not guaranteed.

It's a High Flyer (strong quality and momentum). High flyers tend to outperform:

Congratulations to anyone who has been holding this, as its performance has been spectacular.

I don't have any great insights into its products, but I suspect that its trading momentum is sufficient to justify its high rating. So I wouldn't necessarily be put off by the high P/E multiple. Assuming that we get another couple of years of growth at similar rates, it will be able to justify this.

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Science in Sport (LON:SIS)

• Share price: 75.5p (unch.)
• No. of shares: 68 million
• Market cap: £51 million

Half-year trading update

This is an unprofitable sports nutrition business. It makes powders and gels for cyclists and other athletes.

I've been watching it for a few years, looking forward to the day that it turns the corner into profitability and perhaps gets taken over at generous price to sales multiple by a multinational.

This H1 update tells us that sales are up 20% year-on-year to £9.9 million.

UK retail was the weak point, down 3%, but everything else was good. Online sales grew 25% and international sales grew 53%.

The Board remains confident in its outlookfor the full year.

My view: The main issue with this stock has been that its overhead and marketing budgets have been so huge, relative to the size of the company. Share-based payments have also been surprisingly large. Its losses have been growing even as its sales have been growing.

The consequence of running down its cash balance has been dilution, and it only took about two years for the share count to increase from 40 million to its current level.

So we haven't got much evidence yet that this is going to work out well for shareholders.

The gross margin is pretty good, at 60%. I'd like to think that it could eventually reach a level of brand recognition and repeat business such that sales volumes were sufficient to cover its costs.

It had cash of £16.6 million at December 2017. That should be enough to last for at least a couple of years.

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dotDigital (LON:DOTD)

• Share price: 85.5p (+17%)
• No. of shares: 297 million
• Market cap: £254 million

Trading Update

Paul has covered this one multiple times, most recently in February. It calls itself "a leading omnichannel marketing automation platform".

Its core product is Dotmailer (link), which has a testimonial on its website describing it as "like Mailchimp on steroids".

Running my own newsletter as I do, I know a thing or two about Mailchimp.

Mailchimp have never charged me a penny, because I don't send enough emails per month to cross over into their paid plans.

But I love the service. It's very easy to use, it has a clean appearance, and it has never let me down.

If I do cross over into the Mailchimp paid plans, I won't mind. Mailchimp has supported me virtually from day one, and never billed me, so I won't mind paying them some fees in the future.

Dotmailer is catering to a differing market. It doesn't offer a free service, and its pricing looks very expensive compared to Mailchimp - several times more expensive.

While 72% of Mailchimp's user are small businesses, only 40% of Dotmailer's customers fall into that category. (source)

So I'm getting the impression that Dotmailer is really a deluxe version of Mailchimp.

The overall Dotdigital group is showing excellent growth with this strategy. Key highlights from today's full-year update:

• revenues +35% to £43 million
• profit in line with expectations
• cash ahead of expectations
  
• recurring revenue +41%
• "no material impact" from GDPR on existing clients

It has strong partnerships with Microsoft and a range of eCommerce platform. Perhaps this is part of the value-add which enables it to charge its clients so much?

Outlook - in line with expectations.

My view - it's a really impressive story. Again, I'm not sure if I can get behind a 17% share price increase from a trading update which is merely in line with expectations (apart from the cash balance, which was ahead of expectations). I suppose this could be relief that GDPR hasn't caused any harm.

It's another High Flyer and I have a bit more confidence that this one can justify its high rating and its momentum. I have some familiarity with this type of product, and I reckon that the pricing Dotdigital has achieved (average revenue per user of £845/month) is extremely impressive.  It must be offering some very useful functionality to justify that sort of pricing.

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Nichols (LON:NICL)

• Share price: 1485p (unch.)
• No. of shares: 37 million
• Market cap: £549 million

Interim Results

Many experienced investors will be familiar with this soft drinks company. It is home to the Vimto brand as well as Levi Roots, Sunkist and others.

These H1 results show a modest improvement in revenues and profits. Performance is described as "solid".

Vimto is going from strength to strength in the UK, where its sales have jumped by 13%. I get the impression that this is a really strong brand which also benefits from the nostalgia of older generations.

International sales were significantly lower, down by 30%, due to conflict in the Middle East. So that's why the overall result is somewhat muted.

Dividend - up 12%, reflecting confidence.

Outlook - in line with expectations.

My view - there is no change in my overall view of this stock. A fine business and a worthy candidate for a long-term buy and hold.

Indeed, if I was shopping for new equities right now, I would be tempted to add a starter position in Nichols to my portfolio. In recent years, it has rarely traded at a P/E ratio of less than 20x and has often traded at a much higher level than that. It is currently at a forward multiple of 21x.

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I've run out of time for today, but I covered most of what I originally intended to. Cheers!

Graham