Small Cap Value Report (Fri 23 Oct 2020) - ALU, WATR, TRI, FRP, MCS, VNET

Good morning, it’s Paul here with the SCVR for Friday.

To start you off today, here are a few stragglers from yesterday’s agenda, which I prepared last night.

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Alumasc (LON:ALU)

92.5p (up 16% yesterday) - mkt cap £33.3m

It’s always worth looking at the top risers for the day, as there could be some important news out that could drive a bigger upward move. Some of my best investments have come from this, over the years.

This looks a belter of an update!

"Alumasc has begun the new financial year to 30 June 2021 strongly with record profits in the first quarter.

Each of our three divisions - Building Envelope, Water Management and Housebuilding Products - has contributed to this record performance. The restructuring over the previous year, which provided £2.4m in annual cost saving, undoubtedly benefitted margins, which were well ahead in the period, helping in particular Levolux and Gatic.

This profit performance has been accompanied by equally strong cash generation, reducing net bank borrowing of £4.3 million at 30 June 2020 to below £1 million at today's date, against total facilities of £24 million. Our borrowings continue to benefit from VAT deferrals of £1.8 million, payable later in this financial year. Furlough income received in respect of a low number of employees who have since become redundant has already been repaid to the Government.

Is this pent-up demand after lockdown? The company says it is too early to say, but says there is nothing abnormal about patterns of demand - implying that this might not be pent-up demand.

Export demand - described as “lively”

Order books - “robust in general”

UK Govt infrastructure spending - “early signs” of an acceleration, expected to “boost demand in the coming months”

The company’s products are well aligned with the environmental sustainability agenda.

My opinion - this is very impressive indeed, given the economic backdrop.

There’s a useful update note available from Finncap, which highlights the “erroneously low PER”.

Before we rush out and buy the shares, I would urge you revisit my notes here on 8 Sept 2020, for Alumasc’s results for FY 06/2020. I flagged the £19.3m pension deficit, which is sucking out £2.3m p.a. In deficit recovery payments - these are big numbers for a company valued at £33m. Companies with large pension deficits relative to their size, are usually valued on low PERs, because a lot of the profits/cashflow is spoken for, hence not available for payments to shareholders.

Still, that hasn’t stopped Alumasc paying generous divis in the past, and it looks as if those are rising again.

Overall, even taking into account the big pension deficit, Alumasc still looks fairly good value to me. There’s a lot of positive stuff in today’s update, and it’s possible that the company could grow enough to dilute the impact of the pension deficit. My worry is that, with the world now apparently locked into permanently low interest rates, there’s a risk that we could end up with negative interest rates, which I imagine would make pension deficits even worse? Therefore this is not without risk.

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Water Intelligence (LON:WATR)

526p (up 10%) - mkt cap £89m

Positive announcements seem to be coming thick & fast from this US-based small cap, which offers various services to trace & repair water leaks.

It raised £3.74m in a small placing at 475p, announced earlier this week.

WATR has just announced another contract win;

This new nationwide account for a major insurance customer is the second one gained during 2H. No financial details are given about the contract.

There are positive-sounding outlook comments, trumpeting continued growth prospects, and this is akin to an outlook statement, hence why I’m mentioning this company today (I wouldn’t normally mention a contract win announcement with no figures)

The third quarter was fast-paced with a national insurance account win, three franchise reacquisitions that were accretive to the Group's revenue and profits and receipt of the Green Economy Mark from the London Stock Exchange. The fourth quarter has kicked-off in similar fashion with a successful set of capital transactions to accelerate growth and now another insurance win. We will remain aggressive in our growth plan and seek to distinguish ourselves in today's marketplace. Demand is high for our solutions."

My opinion - as mentioned last time, WATR is clearly doing well, but personally I cannot get anywhere near its current lofty valuation. The market has already priced-in continued out-performance. Therefore investors need to see brokers increasing earnings forecasts to justify the big recent share price rise. Hopefully it will grow into the high valuation over time.

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Trifast (LON:TRI)

122p (up 2%) - mkt cap £166m

Trading update - for H1, the 6 months to 30 Sept 2020.

This update seems consistent with what the company said on 22 Sept 2020, which I covered here. The share price has bounced over20% since then, for no apparent reason, maybe it just got oversold? People like buying shares that look as if they’ve bottomed out, and are starting to rise, so this looks interesting on that basis, and it’s reasonably priced on fundamentals I think.

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Outlook - amongst other things, it says;

As we have said previously, the pipeline and activity levels around the Group remain encouraging.

My opinion - neutral. Wordy trading updates are all very well, but they’re no substitute for the numbers. I’ll check out the interim figures when they’re published c.24 Nov 2020.

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Frp Advisory (LON:FRP)

110p (down 2%) - mkt cap £264m

For background, I reviewed the Admission Document & shareholding/reward structure here on 27 Aug 2020.

This is a mid-tier insolvency & restructuring business. It’s a good business, and a respected name, but I found the valuation pretty full back in August.

The update yesterday says;

"Since announcing our final results on 27 August 2020, the Group has continued to grow and trading in our current financial year (ending 30 April 2021) to date remains in line with expectations. This has been achieved despite the significant reduction in the number of formal insolvency appointments compared with the prior year as a result of the support measures made available by the UK Government in response to COVID-19.

Many people seem to imagine that a large wave of unemployment & insolvencies is approaching us, but I’m not so sure about that. Why would the Govt throw hundreds of billions to support business so far, then just switch off support now? I think the Govt is pot committed to supporting jobs. That’s borne out by news this week of a large expansion of the Jobs Support Scheme, which has been made a lot more generous, just 4 weeks after originally being announced.

So my question is, will we really get a massive wave of insolvencies and job losses? Who knows, but it may not be as bad as some people fear, due to continuing Govt support.

Also, will many large companies go bust? The various Govt loan schemes seem to have been very effective, and equity markets have refinanced many companies. All of which means a lot fewer insolvencies than might have otherwise be the case, without support measures.

Another thing to consider, is that almost all companies I report on here, are saying that trading is gradually improving. We all know that hospitality, retailing, and travel, are suffering badly, but most other sectors seem to be doing alright, and improving. Also note how cash is piling up on company balance sheets. Even a basket case like Countrywide (LON:CWD) has accumulated substantially more cash this year, from delaying tax payments, and drawing down on borrowing facilities.

For these reasons, i think it’s currently uncertain whether Frp Advisory (LON:FRP) and Begbies Traynor (LON:BEG) are likely to see an upturn in business, and if so, how much?

FRP’s outlook comments say;

There remains a substantial degree of uncertainty around the shape and scale of economic recovery, combined with additional pressure as the Brexit transitional agreement comes to an end in 2020. Each FRP office can draw on specialists from other FRP services lines, as well as colleagues from different regions. Combined with additional hires, this resource flexibility means we are well positioned for an increase in demand. The medium-term outlook for our market is positive and the Board remains confident of making further progress in the current financial year."

My opinion - neutral. This share is valued at just over 19 times current year earnings, which strikes me as being about right. The dividend yield is reasonable at nearly 4%, assuming that the consensus forecast data is in the right ballpark.

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Mccarthy & Stone (LON:MCS)

(I hold)

Recommended Cash Offer

At 115p per share, from a US private equity fund.

I covered it here on 15 July 2020, noting the deep discount to NTAV, and the strong, low geared balance sheet. Also, retirement developments have a much greater appeal thanks to covid - avoiding care homes at all cost must surely be high up the priorities for retired people. That makes MCS supported independent living, a much better option, and MCS has made the low incidence of covid in its developments a key marketing message. I noticed that on a sales leaflet that came through my door over the summer, and that gave me a nudge to buy some shares in the company, after reviewing its figures here, a medium sized portfolio position. Hence I woke up to a very nice surprise this morning. It's been a while since I've had a takeover bid in my portfolio.

The quandary is always whether to lock in the profit by selling immediately, or to continue holding, in the hope of a higher competing bid, with the price underpinned by the existing bid. I'm mentally scarred for life with the aborted takeover bid for Revolution Bars (LON:RBG) a few years ago, where bizarrely the institutional shareholders rejected the offer. So a lovely profit turned into a huge loss, with the shares now over 95% below the bid price (mainly due to covid). For this reason I've decided to sell half my MCS shares this morning, to lock in the profit for half, and run the balance for a potential higher bid.

The recommended bid only has 17.2% irrevocable undertakings to vote in favour, which is low, so this is not yet a done deal. Although that may go up, as the company may not yet have spoken to its smaller institutional holders, possibly?

Plug for my favourite charity - ZANE

Probably like a lot of readers here, if I have a portfolio windfall, then I make a donation to my favourite charity, which is ZANE - here's a short introductory video below.

The founder of ZANE, Tom Benyon (who narrates the above video), is a reader here, and he invited me to meet for lunch, a few years ago. We became friends, and he invited me to visit Zimbabwe with the trustees, in early 2019. I conducted due diligence on ZANE on the ground, visiting many of their projects (care homes, a womens refuge, a clinic helped by ZANE in a hospital), and I met literally hundreds of people who receive food and medical assistance from ZANE, plus I met most of its dedicated & compassionate staff, and had many long & detailed conversations about the charity, and life in general in Zimbabwe.

At the time, the Govt had just confiscated US dollars in the banking system, and swapped them for a new currency of Zimbabwe dollars, or bond notes. This had only recently happened at the time of my visit, but already the starting exchange rate of parity had slipped to 5 Zimbabwe dollars to the US dollar, causing great anxiety to everyone, who had already seen their savings drop by 80%. Remember this is the fourth time that the Zimbabwe currency has collapsed since independence. So people who had been prudent & saved for their retirement, have ended up with nothing, hence the need for ZANE to help them.

Hyperinflation - this latest, very recent short audio interview from Zimbabwe horrified me. The situation has gone from bad, to diabolical. Zimbabwe dollars are now almost worthless, being 100 to 1 US dollar. I saw for myself, and talked to vulnerable people there, how economic mismanagement, and rampant inflation, had just wiped out peoples savings and quality of life. I accompanied a ZANE-funded health worker, as she visited care homes, dispensing life-saving medication (which is cheap and freely available in the West, but expensive and scarce in Zimbabwe) typically for diabetes, and high blood pressure. A donation of only £15 per month from a UK donor, will provide life-saving medication for one pensioner, for a month.

Even if you're not interested in donating, it's worth listening to this short video, because it's a warning to us all of the dangers of hyperinflation, and how it totally wrecks the lives of most of the population when it takes hold.

ZANE's donation page is here, if anyone does fancy helping out, which would be hugely appreciated by the charity, and me, and of course the vulnerable people that ZANE helps. I've met so many of them, and can tell you that they are just lovely people, who need our help for the basics to survive.

Right, back to shares!

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Vianet (LON:VNET)

68.5p (up 7%) - mkt cap £19.8m

Vianet Group plc (AIM: VNET), the international provider of actionable data and business insight through devices connected to its Internet of Things ("IOT") platform, today announces the following trading update and notifies that it will release its results for the half year ended 30 September 2020 on Tuesday, 8 December 2020.

Trading has been steadily recovering from the impact of covid/lockdown;

The Group is pleased to report that trading for the first half of the current financial year has been ahead of our COVID-19-revised ("C-19") management forecasts. There has been month-on-month improvement in operating profit and cash since the start of the financial year with September moving into profit.

Outlook comments sound upbeat but also mention the new restrictions coming into play recently, further harming the hospitality sector;

"However, we once again find ourselves in uncharted waters alongside our hospitality sector customers following the government's announcement of further new measures over the past two weeks. "The new restrictions on hospitality are extremely frustrating for the pub industry. Whilst a few instances of non-compliance inevitably gain high media exposure, the overwhelming story of compliance is not viewed as newsworthy....

My opinion - the forecast consensus earnings have clearly not been updated to reflect covid, and I can’t find any recent research. Therefore I think we have to ignore any forward looking measures until proper guidance is reinstated.

How to value this share? I suppose we could look back at historic earnings, and assume that the group could recover back to somewhere near that, once covid has been beaten. But how long is that going to take, and how many pubs will have permanently shut by then? (VNET’s main business is the Brulines beer flow monitoring system for tenanted pubs). Its other division, vending, doesn't look terribly interesting.

Previous basic EPS was 8.56p for FY 03/2020 (little covid impact). Put that on a PER of say 10-12, and I arrive at a share price of 86-103p. That’s not sufficiently far above the current share price of 68p to get me interested, because we might have to wait a year or two for everything to get back to normal, who knows?

Overall, the current share price looks about right to me.

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