Small Cap Value Report (Weds 4 Nov 2020) - MTO, STVG, WIL, GATC

Good morning, it's Paul here with the SCVR for Weds.

Timings - most of today's report is done (at 13:48), but I need to take a break for lunch now. I'll finish off the 2 last sections later this afternoon, which should only be quite short, as neither STOB nor WIL look particularly interesting!
Update at 16:14 - I've decided to abandon STOB, it's just too complicated, and I've done enough work for one day. Therefore today's report is now finished.

I finished off yesterday's SCVR quite late yesterday, so here is the link, in case you missed the new sections. Companies covered were:

ACRL, VCP, TCM, UPGS, WHR, OMG

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US Election - Exciting news overnight, that the US Election is tight, with the betting odds having switched around, with Trump now the favourite. We're only interested in shares here, there are plenty of other places to discuss the politics. So as regards my shares portfolio, I really cannot see any reason to make any changes, or that the election result would make much difference to my portfolio at all. Hence I've not made any changes to my shares portfolio. It is an uncertainty factor though, so we could see a market bounce once the result is known, as people put money back to work in UK small caps, maybe?

EDIT: Note that the betting odds have now switched back again, with Biden in the lead (at 11:59). I only mention this because the volatility in the betting markets has given us a rough idea of how the futures markets are likely to react to the outcome, and the answer seems to be: very little. A few single digit percentage points on the main indices, nothing more than that, is what I've observed in recent days. That's reassuring, as I think it means we don't have to particularly worry about the outcome re our shares. Nothing like the massive gyrations we saw in 2016 anyway, it would seem. End of Edit.

Covid testing - I feel the outlook re covid is now getting to the point where we can start to anticipate the benefit on share prices of mass testing, which in my view is probably more important than a vaccine in getting control of the situation. So I'll be looking to increase my positions in the best recovery situations for 2021. Markets are supposed to be forward-looking by about 6 months, hence we're overdue another rally in bombed out sectors that have been damaged by covid, in my opinion.

Agenda - these trading updates/results have caught my eye today;

Marks And Spencer (LON:MKS) - looks much better than I was expecting, for 26 weeks to 26 Sept 2020. I probably won’t do a section on it in this report, but just wanted to flag that it’s worth a look, having just skimmed through the announcement

Mitie (LON:MTO) - H1 trading update (Done)

Stv (LON:STVG) - Trading statement (Done)

Stobart (LON:STOB) - Interim results (Sorry, I've abandoned this one, as it's complicated & I'm tired, having spent all day on the other companies)

Wilmington (LON:WIL) - Trading statement (Done)

Gattaca (LON:GATC) - Results FY 07/2020 (Done)

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Gattaca (LON:GATC)

Share price: 62.5p (up 42% at 09:16)
No. shares: 32.3m
Market cap: £20.2m

Preliminary results for year ended 31 July 2020

I normally start off with the small caps, and work my way down to the micro caps. However, this share has moved up 42% this morning, so I’ll prioritise it, as there might be a buying opportunity here, possibly?

I was completely avoiding the recruitment/staffing sector, but recently heard some interesting comments on a Cloudcall (LON:CALL) (I hold) webinar. Although the comments pertained to the USA, it could still be relevant. The head of Bullhorn (a big partner to CloudCall, which sells software to the recruitment sector) was saying that recruiters are generally the first into, and the first out of recessions. He said the sector was coming alive again. Also, that unemployment may be rising, but it’s concentrated in relatively unskilled people, whilst white collar and more skilled staff had not been impacted much by covid/lockdown (outside of the obvious bad sectors like travel, hospitality, retail, etc). In fact, wages were having to rise, to coax people out of their homes, and there are many skills gaps, meaning that a lot of sectors are struggling to recruit people with the right skills & experience they need. Hence a potentially good & recovering market for recruitment companies.

For this reason, I’m thinking about possibly dipping my toe into the water with a smallish initial purchase of a recruitment/staffing business in the UK, but which one, is the question?

Well done to anyone who spotted the Gattaca results and bought first thing. The market cap (still) looks cheap, in my view.

Key points for FY 07/2020 -

• NFI (revenues, once pass-through contractor wages are removed): £54.3m (down 21% on LY)
• Underlying profit before tax (continuing ops): £4.6m (down 61%)
• Underlying EPS 10.3p (down 64%) - giving a PER of 6.1 - looks cheap, and that’s before we factor in an economic recovery and possibly higher future EPS
• Net cash of £27.3m - a staggering improvement on previously £24.8m net debt! This has mainly occurred due to a large reduction in the receivables book. Remember that staffing companies are cash generative in recessions, as receivables turn into cash
• Cash has also temporarily benefitted from £10.3m tax deferrals - remember this will unwind by March 2021
• RCF bank facility paid off in Oct 2020, so now covenant-free - a very good development which de-risks this investment considerably
• Balance sheet looks OK to me. NTAV of £27.0m is quite decent actually, below the market cap
• No divis for now, but want to reinstate them. I think the group should be in a position to pay divis again in 2021
• Outlook - encouraging signs, but mgt is cautious about outlook, given uncertainties.
• Cost savings achieved, with another £4m p.a. due from Nov 2020 - that could strongly boost profits in future
• Leases - work from home means that leases could now be seen as a nuisance, but amounts are not excessive
• Dept of Justice (DoJ) legal case worries me - substantial legal costs in last 2 years - what potential liabilities could this incur? An important issue that needs to be properly researched.

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My opinion - this looks very interesting, and still seems cheap, even after this morning’s 42% rise. Therefore, I think readers might want to take a closer look at this. I’ve got to move on to other stuff now.

As always, please remember that I'm only giving a quick view here on things. They're not recommendations, they're just my initial impressions of announcements. Its vital that readers do your own, more in depth research, as there could be things I've missed due to the time pressure I have to work under here, to cover 5-10 companies every day.

Interestingly, GATC crops up on a Benjamin Graham NCAV bargains stock screen. Looking at other companies which are picked up by that screen includes some housebuilders: Redrow (LON:RDW) , Crest Nicholson Holdings (LON:CRST) , and Cairn Homes (LON:CRN) - that is another sector I’ve been meaning to look at for potential bargain/recovery situations.

This screen is worth a look, although apparent bargains in a deep value screen like this, can often have something seriously wrong with them! (value traps), so extra careful research is needed, these should be treated as special situations (the smaller ones anyway);

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Mitie (LON:MTO)

Share price: 28.85p (up 6% at 10:58)
No. shares: 1,171.0m
Market cap: £337.8m

H1 FY 20/21 Trading Update

I haven’t looked at Mitie for 4 years, because its market cap got too big, but has now come back down again into the small caps area.

Scanning through the RNS, it did a highly dilutive rights issue in the summer;

11 for 5 rights issue of 805,069,771 New Shares at 25 pence per New Share announced on 25 June 2020

This raised £201m in gross proceeds, and was linked to an extension of the £250m bank facility (RCF) to Dec 2022. Covenant waivers from the bank, and loan note holders were secured as part of the fundraising.

£80m of the fresh equity is being used towards part of the acquisition cost of the facilities management division of Interserve.

Acquisition of Interserve fm div is a big deal - involving the issue of c.358m additional shares (as part consideration, but see below this figure has been renegotiated in Mitie's favour), and £120m in cash. This will bolt on £1.37bn revenues, and £42m EBITDA. Thus considerably increasing the scale of the combined business.

Balance sheet - I recall Mitie has a weak balance sheet, so have checked it out. NAV was £80.5m at 31 March 2020. Take off goodwill/intangibles of £329.5m, and we get NTAV of negative £(249.0)m - rather grim. This will have improved since the recent rights issue though.

Note the £74.0m actuarial pension deficit (as at 31 Mar 2017, an updated triennial valuation is pending), with Mitie committed to paying £55.4m in recovery payments to 31 March 2025, so a significant drain on cashflow.

OK, that’s the background so on to today’s update -

Mitie Group plc: H1 FY20/21 trading update

Much improved second quarter performance

Trading has continued to be more resilient than expected. Second quarter revenue was up 12% on the first quarter, with monthly sequential improvements in sales particularly across Cleaning, Security and fixed Technical Services contracts.

Our public sector contracts have shown good resilience during this challenging period and we have also seen strong performances from our food retail, online retail, healthcare and pharmaceuticals customers. However, demand from our property and finance & professional services clients remained weak, although the second quarter was somewhat better than the first quarter as office space reopened.

Group revenue from continuing operations for the second quarter was £514m versus £458m in the first quarter of FY20/21. For the six months ended 30 September 2020 revenue from continuing operations was £972m, which was 9.8% lower than the same period in the prior year. This revenue decline includes 3.8ppts from the known loss of the MOJ contract and the reduced scope of the NHS Properties contract.

Business services seem to be quite resilient, because new business is being won for increased cleaning, related to covid.

Technical services has suffered a 22% fall in H1 revenues, due to it being more project, and discretionary services for clients.

All the above is very interesting, but it doesn't tell us anything about what really matters - profitability!

Net debt - quite a few moving parts in here, particularly large tax deferral. I’m not sure whether the Interserve cash acquisition monies have been paid out yet or not? Which is a material amount.

For the six months to 30 September 2020 average daily net debt on a post IFRS16 basis was £69.3m (£351m for the six months to 30 September 2019). During this period we received £191.8m from the net proceeds of the Rights Issue and benefitted by £130.3m from the HMRC 'Time to Pay' tax deferral scheme.

Excluding the benefit of both the Rights Issue proceeds and the Time to Pay benefit, our underlying average daily net debt would be at a comparable level of £253m, with the c. £100m improvement in the period a result of better working capital management and the net proceeds from M&A.

*Note: Adoption of IFRS 16 has added c. £90m of additional lease liabilities to net debt.

Why are they quoting net debt including lease liabilities? Strikes me as an own goal.

No guidance, and no dividends.

Revised terms for Interserve acquisition - there’s a rather good RNS out separately today, which indicates Mitie has negotiated better terms for the acquisition;

"However, Mitie, in particular, has been successful at renewing strategic contracts and winning new business during this period. Recognising this momentum, we have renegotiated the terms of the Interserve Facilities Management transaction, reducing the vendor's consideration shares by 31% (110 million shares) to 248m shares (17.5% of the Enlarged Group), valuing the current consideration at £190m. [2] Mitie's existing shareholders will therefore hold a greater proportion (82.5%) of the Enlarged Group and enjoy a greater share of the benefits of the transaction.

That looks quite a coup by Mitie. Its share price has crashed in recent months, therefore I would have expected the Interserve deal to be renegotiated so that the vendor receives more Mitie shares, because they are worth so much less now. To twist their arms into accepting considerably fewer shares, is impressive negotiation!

My opinion - it would take me all day to properly dig into all the detail here, as this is quite a big, and complicated, business. Hence I’ve got to say I’m neutral on a rational basis, having only scratched the surface of it above.

However, as a punt, I think this looks interesting, and think I’ll pick up a little scrap of shares for my punting spread bet account.

The worry is that work might dry up over time, as offices close and get converted into residential, due to covid. But personally, I don’t think that’s such a big threat. Work from home clearly works quite well, but as covid hopefully disappears in 2021, then I reckon more & more companies are likely to want people back in the office, at least some of the time. Hence demand for office services provided by Mitie, could continue. Who can say, it’s unknown at this stage. Hence why I think this share can only really be seen as a punt. Not a bad one though, given the balance sheet partial repair earlier this year, and a big acquisition at what might turn out to be a fire sale price perhaps?

A dismal 5-year chart below, but remember that the heavily discounted 25p rights issue has reset the bar. Most shareholders will have paid 25p for most of their existing shares, in the rights issue. Therefore a recovery in the share price to say 50p, would generate a substantial profit for shareholders, equivalent to a much higher share price before the rights issue. Therefore the chart doesn't always tell the full picture, where there's been a large issue of new shares, like here.

Let's illustrate this with some numbers. Say you bought 10,000 Mitie shares in early 2018 at 100p per share, so a cost of £10k.
Your rights issue entitlement of 11 for 5 new shares would be 22,000 new shares at 25p each, costing £5,500.
You now have 32,000 shares in total, total cost £15,500. That's 48.4p average cost price.
So to breakeven on your investment, you don't need the share price to recover back to the 100p original purchase price, you only need it to recover to 48.4p, at which point the profit on the rights issue shares equals the loss on the original 100p shares.

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Stv (LON:STVG)

Share price: 260p (down c.1% at 13:11)
No. shares: 46.24m
Market cap: £120.2m

Trading Statement

This is another share which I haven’t looked at for about 4 years, so it’s taken me ages to re-familiarise myself with things, having to go through the last interim figures.

Pension scheme - by far the most important issue with this company, is the defined benefit pension scheme, which is massive. On an accounting basis (which is often under-stated compared with the actuarial basis, which drives deficit recovery payments), the scheme assets were (at 30 June 2020) £402.9m, and scheme liabilities were £479.8m.

Deficit recovery payments in H1 this year were £3.0m, but this seems to benefited from deferral of the Q2 payment until Dec 2020. Last year in H1 alone the deficit recovery payment was £4.5m.

In 2019, the full year deficit recovery payments totalled £10.3m. Huge numbers. STVG somehow managed to pay divis as well, in the past, but those seem to have stopped. They insulted the intelligence of shareholders by paying a meaningless 3p dividend in bonus shares this year. Since everyone gets bonus shares then nobody is any better off, and the share price just drops to offset the increased share count. Pointless!

All of the above is rather a pity, as the pension deficit problems are likely to linger for many years, and could get worse, as it looks like we’re in a permanently low interest rates environment - which inflates pension scheme liabilities. For me, the huge scale of the pension schemes, mean that this share is uninvestable for me. Which is a pity, because the company seems to be trading fairly well in the circumstances, and got through, and is recovering from covid, pretty well.

Interim results to 30 June 2020 showed that STVG remained profitable, although obviously down on 2019.

Exceptional charge of £8.7m being a receivables write-off called ELM, which looks like a sale of STVG’s lottery business, which appears to have fallen through?

Last reported NAV was negative, at £(63.0)m, reflecting the large pension deficit.

A placing this summer will have improved that 30 June 2020 balance sheet position, by about £15m (assuming costs of c.£1m), This placing at 230p happened after the half year end, and triggered a £20m extension in bank facilities.

Ad revenues were recovering strongly in July & August, and audiences have been good.

Today’s update -

Excellent viewing performance continues; advertising recovery ahead of expectations; short-term outlook still uncertain due to Covid-19

Ad revenues are now running only slightly below LY, which is good.

Viewer stats also sound good. The death of TV seems to have been greatly exaggerated!

Record viewing growth on TV and online continues

Outlook comments sound upbeat, but unless I missed it, I can’t find any financial guidance in today’s update;

Despite the ongoing challenges around Covid-19, I'm encouraged that the advertising market has recovered strongly across the summer and autumn, demonstrating the enduring power of television and our ability to come through further uncertainty with confidence. In particular, STV-controlled Scottish advertising and digital advertising have returned to year on year growth during the autumn, fuelled by our Growth Fund and the excellent performance of our streaming service STV Player.

We remain confident in our prospects for growth, and look forward to finishing the year strongly on screen with November traditionally our biggest month of the year thanks to the return of I'm a Celebrity; while in STV Studios our 14 new commissions so far this year means that 2021 promises to be our most successful year yet."

My opinion - this is all academic, because it doesn’t really matter to me whether the business is doing well or not. That’s because the vast pension scheme is a deal-breaker for me.

If interest rates were set to rise, then pension deficits would melt away. Trouble is, the opposite is happening in many cases deficits are rising.

As there is such material doubt over what the future holds, I really don’t want to get ensnared in anything where the pension scheme swallows up much, or even most, of the long term cashflows.

I wonder if some of the people buying on the recent bounce, may not have been aware of the huge pension deficit, or not realised its significance perhaps? Or alternatively, maybe investors might be hoping that the Govt could be persuaded to allow pension schemes to value liabilities on a reduced basis, thus requiring reduced cash contributions? I seem to recall a Scandinavian country did that a while ago, Sweden perhaps?

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I'm taking a break now, will be back later.

Since it’s the last day before lockdown 2.0 kicks in, I’ve decided to support my new favourite local in N1, The De Beauvoir Arms, and help put a bit of money in the till before they have to close again. I did plan to print off some copies of the lyrics to “We’ll Meet Again”, hand them out to everyone in the pub, and have a jolly good, albeit tearful, sing-song just before closing time tonight, but my friends all said that was completely over-the-top, even by my standards, and definitely not to do it. Aren’t people awfully reserved? It’s like when a gameshow contestant refuses to do their party piece on camera, for our amusement. It’s just disappointing. I’m all for a bit of Latin style exuberance.

Actually, it’s not really lockdown 2.0 is it? Many/most businesses will just carry on as normal this time, and people have found workarounds in other areas. I was talking to a barber/hairdresser yesterday, and probed about how they had managed during lockdown, with the shop closed. He told me that many people had made private arrangements via social media, and hairdressing continued largely unhindered, but by private appointments in people’s houses.

I also noticed yesterday, that on many busy buses in London, passing by, plenty of people were completely ignoring the requirement to wear masks, and nobody was enforcing the rules. Anyway, back to shares, I’d better speed this up, or pint number 3 which is pending, might impair my impartiality, (and ability to type).

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Wilmington (LON:WIL)

Share price: 128.6p (down c.1%)
No. shares: 87.56m
Market cap: £112.6m

I don’t know what’s going on today, but this is another share that I’ve not looked at for years, here are my notes from Feb 2014, for what it’s worth - I didn’t like the balance sheet, and see the share price has halved since then (although WIL has been generous with divis).

Wilmington plc, the provider of data, information, education and networking services in Risk & Compliance, Healthcare and Professional knowledge areas today announces an update on trading for the three months to 30 September 2020.

This is Q1, of FY 06/2021.

It sounds quite positive;

The Board is pleased to announce that financial results for the quarter have been encouraging and were ahead of management's previous expectations. Adjusted PBT was ahead of the corresponding period in the last financial year despite revenue being down around 6% on an underlying basis at constant currency due to the inability of the Group to run face-to-face training and events in the period.

This sounds like the type of business which could benefit from lockdown & Zoom/Teams, etc, moving to doing things online which they confirm today;

The Group's Preliminary Results announced on 17 September 2020 demonstrated the extent to which the digital transformation of face-to-face events and training to virtual formats had been successful. The speed with which this transformation was delivered helped to mitigate a significant element of the potential first quarter revenue impact from Covid-19.

Decisive action to reduce costs has also continued - the savings in direct costs as a result of this transition were augmented by an overhead reduction exercise that was undertaken over the summer resulting in the improved year-on-year profitability.

Each of the Group's three divisions has seen trading ahead of internal expectations. Notable performances were seen in our core subscription-led data businesses, which make up around 50% of Group revenues and which have continued to hold up well during the pandemic.

Debt is still quite significant, albeit reduced, and it seems with plenty of headroom;

Cashflow in the quarter was also better than previously expected with net debt as at 30 September 2020 of £28.0m (30 September 2019: £41.2m). In October, to secure its headroom, the Group extended by twelve months the term on its existing £65.0m revolving credit facility by exercising the pre-existing option that it had to do so. The facility will now expire on 3 July 2024.

Outlook - I’ll reproduce this in full, as it’s interesting, and has potential read-across for other companies -

Following the strong first quarter trading performance the Group is on track to at least achieve the expectations for the half year that it set out in the Preliminary Results announcement on 17 September 2020. This is for revenue and profit in the first half to be in line with that achieved in the second half of the year to 30 June 2020.

Predictions for second half performance remain difficult at this current time due to the uncertainty over the extent to which the Group will be able to run face-to-face events in that period. Recent lockdowns and developments globally in the spread of Covid-19 are likely to delay the resumption of face-to-face activities and it is not possible to say at this stage when that resumption will be. The Group is currently in active discussions with customers over its key H2 events such as RISE National and is considering all alternatives around format and timing.

In the Preliminary Results announcement we set out a range of potential outcomes for H2 depending on whether or not we could run face-to-face events and training. Recent trading experience leads us to believe that a fully virtual H2 would deliver better revenue and profitability than we guided to at that time as the lower end of the potential range. So whilst the chances of that scenario occurring have increased in recent weeks as the pandemic has developed, we feel increasingly confident in our ability to mitigate some of the associated financial effects of that potential outcome.

My opinion - I know little about this company, but have to say this update today has piqued my interest. One of my main investing themes at the moment, is to look for companies that are successfully migrating online. I think companies which move fast in this way, and establish dominance, could be the big winners of the future, in whatever niche they operate in.

Wilmington sounds as if it’s embracing moves online, whilst keeping its options open about resuming face-to-face activities. Whether people are WFH, or WFP (working from pub) as I am at the moment, it’s obvious that previously face-to-face events could be done much more economically online, if they’re done well.

Overall then, this share might be worth a closer look. Over to you!

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I'm calling it a day here, sorry but STOB interims look complicated, and I'm tired now.

See you in the morning!

Best wishes, Paul.