Small Cap Value Report (Fri 28 May 2021) - WJG, FUL, PMI

Good morning. Thanks to Roland for all his support this week, keeping me sane. what a star! I'm so lucky to have such smashing support here.

Timing - I have to be finished by noon, in order to meet a SCVR reader for lunch at TGIs, for research porpoises.

Agenda -

Fulham Shore (LON:FUL) - an encouraging trading update from this restaurant chain, with trade close to pre-pandemic levels despite space restrictions. Is the valuation up with events, though?

Premier Miton (LON:PMI) - half-year results from this fund manager and a welcome return to fund inflows but uncertainty remains over the merger.

Watkin Jones (LON:WJG) (I hold)

I'm sorry to see the founding family selling down again, a substantial amount (20.58m shares) at a discount, sold at 210p, 8% of the company. That messes up the upside case for me, so might have to top slice my own position. They cannot talk up the price, whilst selling, sorry call me old fashioned. Peel Hunt seem to be losing their touch. A poor price achieved here, and my city sources tell me that PH weren't really interested in the Revolution Bars (LON:RBG) (I hold) placing recently. Time to bring in more enthusiastic brokers maybe? Or is the market just suffering deal fatigue? Answers on a postcard to broadcasting house please.

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Roland’s section

Fulham Shore (LON:FUL)

16.5p (+4.6%) - market cap £98m

Trading update

Restaurant group Fulham Shore (LON:FUL), which runs the Franco Manca and The Real Greek chains, has issued a post-reopening trading update today. The numbers look encouraging to me and suggest there’s plenty of pent-up demand. Unsurprisingly, perhaps.

For some more background on this business, it’s worth looking at Paul’s last update in April.

Fulham Shore says that 71 out of its 73 restaurants have now reopened for indoor dining, while continuing to offer takeaway.

Revenues for the first full week of indoor dining (17-23 May) were 103% of the equivalent week in calendar 2019, when the company had 61 restaurants.

On a more meaningful like-for-like basis, revenue was 92% of 2019 levels.

I agree with the company’s view that this is “very encouraging”, given ongoing social distancing restrictions.

Interestingly, the company says that membership of its loyalty scheme has doubled since the start of the first lockdown (March 2020), to more than 220,000. It sounds like maintaining a takeaway/delivery service could deliver longer-lasting benefits in terms of customer loyalty.

Fulham Shore has previously said that restaurant operators looking for new space are currently able to strike attractive deals on pre-fitted units (where the previous operator has shut down).

The company has put actions to its words and recently opened a new Franco Manca on High Holborn in London. A further outlet is due to open in Glasgow next week. Two new restaurants are due to open in June in Covent Garden, with more sites in the pipeline.

My view

My impression is that Fulham Shore is a well-run operator that’s benefiting from having two attractive formats and a sound balance sheet.

However, we need to think about valuation. After this morning’s gains, Fulham Shore is trading at around 40 times pre-Covid underlying earnings. The stock is well above the levels seen in early 2020.

Although I think that the company’s profitability may have improved slightly as a result of changes over the last year, that still seems like a full valuation to me.

Restaurants are not generally high margin businesses. I’m not convinced that market conditions will support a rapid roll-out of new branches, once the best locations have been cherry picked.

I think the good news is probably already in the price, so I’m not tempted to buy at this level. But it’s a business I’ll continue to watch with interest.

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Premier Miton (LON:PMI)

175p (+2.0%) - market cap £271m

Half-year results

This fund management group was formed in 2019 from the merger of Premier Asset Management and Miton. The combined group has a 30 September year end, so today’s results cover the half year to 31 March 2021.

The headline figures do not suggest any serious problems and show a welcome return to fund inflows, reversing the outflows which followed the merger - a common hazard when fund managers combine.

Let’s take a look at some of these numbers.

AuM: Assets under management were £12.6bn at the end of the half year. Checking back to the full-year results, AuM was £10.6bn at the end of September, giving an increase of 19%. For comparison, the FTSE All-Share index rose by 16.7% over the same period.

When we factor in the impact of £359m of net inflows, it looks to me like the company’s investment performance was only just ahead of the wider market.

However, when we split out the company’s AuM performance into different segments, we can see that some areas are stronger than others:

The company’s core equity offering attracted quite strong net inflows and delivered a six-month investment performance gain of 18.9% - around 2% ahead of the FTSE All-Share index. Not all that impressive, in my view.

The other large segment is multi-asset funds, which saw strong outflows. The company appears to be aware of this problem and says that “a number of changes” have been made to the multi-asset funds, with the objective of “reducing overall costs”.

I’ll look at fee margins in a moment. But in fairness, the underlying investment performance of the multi-asset funds appears to have been acceptable, based on my understanding these funds are meant to deliver a less volatile performance than 100% equity funds.

Revenue & Fee Income: In yesterday’s report on wealth manager Charles Stanley, I noted that the company appeared to have maintained its fee margins over the last few years, despite industry pressure on pricing.

Economies of scale were one justification for the Premier Miton merger, so I’m interested to see how fee margins are holding up here:

It looks like fee margins are continuing to fall, with a steady progression down since H1 2020.

Although net management fees rose by 13% to £37.9m, this is a function of higher AuM - fees are generally a percentage of AuM. As we’ve seen already, equity AuM growth was only slightly ahead of market movements. In my view, the company’s fund managers do not seem to have added all that much value over the last 12 months.

The link between fees and AuM also highlights another risk -- fees income goes into reverse when the market slumps. This brings us back to fund managers’ growing quest for scale, hence the ongoing consolidation in this sector.

Profits: Premier Miton’s adjusted pre-tax profit of £11.2m and pre-tax profit of £6.2m are a long way apart. My first check is to understand what the difference is between them. It looks like all the usual suspects are present in the adjustments:

I’d be willing to ignore the merger costs, as presumably these are genuine one-offs and must be nearing an end. But I would argue that the remainder of these items are a regular part of doing business, whether they are cash or non-cash items.

Therefore my view is that Premier Miton’s true underlying pre-tax profit for the period is probably around £7.4m, down from £8.3m for the same period last year.

Why are profits falling? We can see that net revenue rose, helped by higher fee income. But the increase was outweighed by a 25% increase in administrative expenses. Drilling down further, it looks like most of these related to staffing costs, especially bonuses:

The merger does not yet seem to be delivering the hoped-for economies of scale.

Return on equity: My sums suggest a trailing 12-month return on equity of 6.1%, based on statutory after-tax earnings. That’s inline with the post-merger figure shown in Stockopedia for the FY20 year:

My view

I liked Miton Group as a potential investment when it was a standalone business. But I’m yet to be convinced that the merger with Premier has achieved much in terms of investment performance or economies of scale.

I admit that 12 months is too short a period to judge the success of any investment strategy. But the indications so far don’t seem positive - staff costs are rising, while fee margins are falling.

AuM growth in areas where Miton was historically strong (equity funds) is being offset by outflows in areas where - I’m speculating - the company may lack scale and competitive advantage.

For now, Premier Miton remains cash generative and profitable. The stock offers a forecast yield of nearly 5% and does not look overly expensive. But I don’t see any particularly compelling reason to invest.

My view on this sector at the moment is that the most attractive asset managers to own are those with proven specialities. I’m not convinced that Premier Miton’s ambition to become a larger generalist will necessarily create a lot of shareholder value.

That’s all from me for this week. Thanks for all your comments, enjoy the bank holiday weekend!