Small Cap Value Report (Fri 16 April 2021) - ZANE fundraising, KNOS, AXS

Good morning! It's Paul and Jack with a catch up report.

My attention is mainly focused on a charity fundraising effort for ZANE.

Amazing donations already from our subscribers, thank you, £1,600 already! Update - stunning generosity from you, thanks again, we're up to £5.6k already, and of course that will be doubled by several big donors lined up!

https://www.justgiving.com/fun...

Thank you from the bottom of my heart to everyone who wants to contribute. This could snow build into something really good. Already, HNW individuals are saying to me that they want to contribute £x-k, on a matching basis. Companies are saying to me, how can we contribute Paul? So I'm, really excited about this. Everyone chip in, and we'll add to it. Whoop whoop! I think £4k could become £12k or more for ZANE! :-)

Timing - we're going at a leisurely pace today, because it's Friday. Estimated finish time, about 3pm.

Agenda -

Paul -

Accsys Technologies (LON:AXS) - interesting products, but glacial pace of expansion.

Jack

Kainos (LON:KNOS) - trading continues to be impressive at this high quality digital services and platforms company, but you pay a premium!

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Paul’s Section

Accsys Technologies (LON:AXS)

149p (up 4% at 11:45) - mkt cap £252m

This company makes the popular Accoya processed wood product.

Short video is here:

Trading Update

Accsys, the fast-growing and eco-friendly company that combines chemistry and technology to create high performance, sustainable wood building products, today announces a trading update for the 12 months ended 31 March 2021 ("FY21"), on an unaudited basis.

• Recovery in H2 at +23% on H2 LY
• Revenues of 98m euros
• “Further progression on profitability” - very vague, I would prefer facts & figures
• Inventory levels have fallen, due to supply chain disruption
• Aiming to double production capacity in the current year
• Delay of 3-6 months in new plant being built in Hull - which will ramp up production over 3 years - seems very slow
• Plant in Arnhem is also being expanded to increase capacity
• Planning for a joint venture (60%) production facility in USA
• Significant demand, but supply constraints - a long-running problem with this share
• Net debt reduced to 12.5m euros - seems modest for a capital-intensive business

My opinion - I think the historical graphs below paint a clear picture - steadily rising revenues, but no profits! It’s taking an eternity to build this business up, and it’s still sub-scale. Are management ambitious enough? Or have they just been held back by inadequate funding?

Lots of people have told me that the product is excellent, a hard-wearing, very attractive wood product. Supply constraints are the main issue. It doesn’t interest me for that reason. I want to invest in companies that have good products, and are able to scale up fast to exploit the market opportunity.

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The share price has had a good run, so I certainly wouldn't be interested in buying at this level. Looks like people are happy to take the profits when it goes over 150p.
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Jack's section

Kainos (LON:KNOS)

Share price: 1,697p (pre-open)

Shares in issue: 122,785,147

Market cap: £2.08bn

It seems like a slow news day today so let’s have a look at the Kainos (LON:KNOS) trading update. This is a highly ranked Tech stock, with excellent Quality metrics but eye-watering valuations. No surprise then to see it classed as a High Flyer.

With a market cap of over £2bn, a forecast valuation of some 46.8x looks rich but Kainos has assembled an impressive track record of revenue growth, and its quality metrics are excellent (although there have been some signs of declining margins).

Meanwhile broker estimates have been on the up. So it’s possible that Kainos has growth left in the tank but, given its valuation, this has to be the case otherwise the shares could derate.

Founded in 1986, Kainos Group plc is a leading high-growth and high-margin provider of digital services and platforms to public and private organisations around the globe.

It’s one of the longest standing independent digital companies in the UK has operated successfully for over 34 years, with a history of delivering complex projects and saving money for customers in the public and private sector. There are two divisions.

Digital Services delivers digital transformation solutions for government departments and agencies and for the commercial sector. It is truly embedded in the UK government, operating across multiple departments. The group also provides consulting, project management, integration and post deployment services for its Workday’s software suite, which includes cloud-based software for Human Capital Management (HCM) and Financial Management. Kainos remains the only boutique Workday partner headquartered in the UK and one of only 35 partners globally accredited to implement Workday’s innovative SaaS platform.

Digital Platforms comprises specialised digital platforms in the mobile healthcare and automated testing arenas. Smart is an automated testing platform for Workday customers; Evolve Electronic Medical Records (‘EMR’) is the market-leading product for the digitisation of patient notes in the Acute sector of the NHS; and Evolve Integrated Care (‘IC’) is a SaaS-based integrated care platform for the NHS and international healthcare providers.

Trading update

It’s a short update today for the year ended 31 March 2021. As noted above, broker estimates have been increasing quite a lot so clearly Kainos doing something right.

The momentum outlined back in January has been maintained and Kainos expects full year results to be at the upper end of current market consensus forecasts.

Demand from existing and new customers has been ‘robust’ and, following strong recruitment, the number of employees and contractors worldwide has increased by 309, to reach a total of 2,024 people at the end of March 2021.

The group has a robust pipeline, a net cash balance sheet, and a ‘significant contracted backlog’.

Conclusion

The balance sheet is very light so we can focus squarely on valuation.

It’s hard to find good UK tech stocks, and when you do they can look outrageously expensive. Is that a sign of a valuation bubble, or are traditional valuation metrics just not up to the task of reflecting the future earnings of these companies?

Take the Value Rank, for instance. The Value school of investing stretches way back to Benjamin Graham in the early 20th century. We live in a different world now and a lot of these metrics such as net tangible asset value simply no longer apply to post-internet companies.

So what is the optimal valuation tool for Tech? Perhaps the discounted cash flow, which requires a more in depth look at each company on a case-by-case basis in order to discern the scale of the future market opportunity. Those cash flows can then be discounted back to the present day to get a risk-adjusted valuation. This can be far more time consuming if you want to do it right.

Earnings and free cash flow multiples are still applicable for this type of stock - as long as you bear in mind the limitations - and, for Kainos, these metrics are comfortably in the 40s.

While Paul Gannon retains a 6.3% stake, he has been reducing this over the years but I don’t read too much into that. The steadily increasing valuation is harder to ignore though:

No doubt this is a quality stock but to really outperform you need both earnings growth and multiple expansion. The trouble is, finding both of those things in the Tech sector is very difficult and so if you do want exposure, you will probably just have to pay up at the moment.

It would be interesting to hear people’s picks in this sector though, as the recent Alta Fox Makings of a Multibagger report noted that Tech and Healthcare are two of the best sectors in which to find stocks with compounding potential.