Small Cap Value Report (Thu 8 July 2021) - AIR, MPAC, RWA, EQLS, RNO

Good morning, it's Paul & Jack here with the SCVR for Thursday.

Timing - today's report is now finished. Sorry I didn't get around to looking at Avingtrans.

Disclaimer -

A friendly reminder that we don’t recommend any stocks. We aim to cover notable trading updates & results of the day and offer our opinions on them as possible candidates for further research if they pique your interest. We tend to stick to companies that have news out on the day, and market caps up to about £700m. We avoid the smallest, blue sky type companies, and a few specialist sectors (e.g. resources, pharma/biotech).

A central assumption is that readers then DYOR (do your own research) and discuss in the comments below. The comments, incidentally, sometimes add just as much value as the articles. We welcome all rational views, whether bull or bear!

It's helpful if you include the company name or ticker within reader comments, otherwise some readers may not be aware of what company you are commenting on.

Agenda -

Paul's Section:

This podcast with Andy Haldane of the Bank of England is excellent - particularly focusing on the outlook for inflation, economic recovery, and bitcoin. It's really helped me clarify my macro thinking (which is always guesswork mainly), but is a necessary framework for investing. I only flag things here if they're good.

Mpac (LON:MPAC) - in line trading update today. This looks a good company, on a reasonable valuation. Need to check the situation with the large pension scheme though.

Robert Walters (LON:RWA) - from yesterday. A notably strong Q2 (Apr-Jun 2021). Note this is now a mainly overseas business. Broker forecasts look far too low still. Recent strong rises in share price look fully justified to me.

Renold (LON:RNO) (I hold) - breaking news. Delayed accounts due out next Friday, 16 July. Confirms results, and current trading are in line. A big sigh of relief for shareholders here.

Jack's Section:

Air Partner (LON:AIR) - positive momentum continues at this air charter services company and the shares are up. Prudent broker forecasts and strong current trading suggests scope for upgrades, assuming trends continue. Air Partner has benefitted from lockdowns in certain departments though, so how it fares in the year ahead requires some thought.

Equals (LON:EQLS) - good revenue growth at this financial services company and a resumption in travel should provide an additional boost in future, but shareholders have been diluted in the past and the group says top line progress does not change EBITDA guidance.

---

Paul’s Section

Mpac (LON:MPAC)

477p (y’day close) - mkt cap £95m

Trading Update

Preamble - like so many other shares, this packaging machinery maker has had a terrific run. It’s amazing how the charts look the same for so many companies. Lots of shares have doubled or tripled from the pandemic panic lows of March 2020 to now. Although with many, the pattern seems to be a peak c. March 2021, then profit-taking since. It seems to need fresh, positive news, to bolster prices, or drive further gains - much harder to come by these days. We need to wean ourselves off the drug of automatic daily increases in our portfolios.

It’s easy to slip into bad habits in a bull run, and start buying things on tips without researching them, lowering quality standards, and buying purely because shares are going up. Those bad habits don’t usually end well - corrections can be fast, and unexpected, and you may not even be able to exit, if you take big positions in small companies - which greatly damages risk:reward in my opinion. That's what screwed up things for me in 2008 - the financial system shook itself to pieces, and I couldn't get out of my geared positions in micro caps - no buyers in any size. Disaster followed, that took about 8 years to recover from.

I do like MPAC - it seems an impressive company, with a decent StockRank of 79. For more background about the company, there are some good video webinars & research notes here at Equity Development.

The share price has fallen back a fair bit from the recent peak, is it time to start buying back in, I wonder? To get up to speed on the accounting situation, here are my notes from 30 March 2021, covering the results for FY 12/2020, key points being - large pension scheme, underlying EPS of 31.4p in a covid-impacted year. Balance sheet is OK, but cash was flattered by stretched creditors. Acquisition of Switchback going well.

.

Today’s update -

Mpac Group plc, a global leader in high-speed packaging and automation solutions, issues a trading update ahead of the release of its unaudited results for the six months ended 30 June 2021.

Continued momentum and strong order book

• Strong momentum from LY has continued into 2021
• Order intake (all regions, US particularly good) significantly above H1 2020 - to be expected, since LY was impacted by covid
• Order book up in last 6 months, but we’re not given a figure, other than that it’s above opening order book of £55.5m (probably not up by much, or they would have trumpeted the figure!)
• Comfortable with current market expectations for FY 12/2021
• Switchback (acquisition) trading ahead of expectations
• Systems were amalgamated in H1 successfully (I recall them talking previously about installing new ERP software, and that it had gone well)
• Travel restrictions problematic, but mitigated by digital alternatives (they’ve told us this before, e.g. setting up machines remotely, holding meetings on Teams or Zoom, etc, nothing earth-shattering, it’s what we’re all doing now!)
• Diary date - 2 Sept 2021 for H1 results to 30 June.

Outlook -

"I am pleased to report a strong start to 2021 across all regions. The outlook is positive based on trends in new prospects and customer investment discussions, and we enter the second half of 2021 with both a strong order book and a developing prospect pipeline and we remain confident that we can leverage the One Mpac operating model to deliver sustainable profitability".

Valuation - the latest forecast from Equity Development (i.e. effectively from MPAC) for FY 12/2021 is: revenue £95.0m, adj PBT £7.5m, adj EPS 32.3p, rising to 36.3p in 2022, and 40.0p EPS in 2023.

At 477p per share, the forward PERs are therefore 14.8 (12/2021), 13.1 (12/2022), and 11.9 (12/2023)

The forecasts don’t look particularly demanding, and in strongly recovering economies, I’d say there should be scope for forecasts to rise possibly, hence lowering the future PER.

MPAC shares look good value, in a generally expensive market.

My opinion - this seems a decent investment proposition to me. A good company, which also seems to know what it’s doing in terms of acquisitions (Switchback having gone well). It’s performing in line with expectations. The valuation looks modest. More acquisitions seem likely, which could help drive up the share price, providing they don't mess up.

One thing people do need to check carefully, is the pension scheme, which I recall was quite large, but the company was trying to de-risk it, so that would be my main line of enquiry if Q&A comes up.

Other than that question over pensions, this share looks good, and reasonably priced.

.

---

Robert Walters (LON:RWA)

756p - mkt cap £577m

Trading Update for Q2 (ended 30 June 2021)

This is from yesterday.

About Robert Walters Group
The Robert Walters Group is a market-leading international specialist professional recruitment group with over 3,200 staff spanning 31 countries. We specialise in the placement of the highest calibre professionals across the disciplines of accountancy and finance, banking, engineering, HR, IT, legal, sales, marketing, secretarial and support and supply chain and procurement...

STRONG SECOND QUARTER.

PROFIT EXPECTED TO BE SIGNIFICANTLY AHEAD OF EXPECTATIONS

Net fee income for Q2 is 25% ahead of LY - hardly surprising since Apr-Jun 2020 was the worst of lockdown 1.

Business improving within Q1 2021, June being “particularly strong” - although this growth mainly in overseas market (UK fee income only up 9%)

Half year net fee income is up 8%, indicating a poor Q1, and big recovery in Q2

RWA will increase its headcount in regions with strongest growth

International - is now 80% of net fee income, with Asia Pacific the largest region at 46%

UK improving - this bit is interesting, and could augur well for a recovery in London’s economy maybe? Also it’s becoming increasingly clear that the “catastrophic” damage to The City (and everything else, for that matter) predicted in many quarters re Brexit just hasn’t happened, so far anyway, and doesn’t look like it’s pending either. Makes me wonder what all the fuss was about? Of all the c.500 companies I cover here, I can’t recall any of them saying Brexit has done serious damage. Minor problems yes, but little more than that. People and businesses have proven particularly adept at adapting - think about what we've coped with in the last 18 months - Brexit, a pandemic, and yet for most people life & the economy has continued largely intact, apart from a couple of days when we couldn't buy loo rolls.

Candidate and client confidence continued to improve across the UK market, with recruitment activity levels highest in London across commerce finance, legal and technology.

As an aside, on a recent call with management of Various Eateries (LON:VARE) they blamed staff shortages mainly on the furlough scheme. Apparently large numbers of Europeans have, perfectly legally and within the rules, returned home whilst being paid furlough by the UK taxpayer, and thus possibly receiving two incomes. Hence there is no incentive to come back to the UK until the furlough scheme ends. This is evident particularly in the hospitality sector, and truck drivers.

So it will be interesting to see if labour shortages in those sectors sort themselves out gradually when furlough ends? That passes the common sense test to me. Bear in mind also that c.6m Europeans have applied for the right to live in the UK. Of course, it’s a red herring to say that number are currently living here, many will have gone back home, but clearly have an appetite to possibly return in the future, or why bother filling out the forms?

Hence my layman’s view on this, is that we’ll still have ready access to plenty of labour, once the pandemic & furlough schemes end, although maybe at higher cost than before, as recovering European economies compete to attract labour.

It’s important to think about this issue, because it’s a key factor in assessing whether labour cost rises at the moment are going to be transitory, or continuing. The evidence suggests to me it’s probably a transitory thing for this year, and maybe into next year, who knows? Andy Haldane says something similar in the podcast I refer to above (well worth a listen), which helped steer my view.

As always, the most important point is to watch the facts like a hawk, and change our minds if things are not turning out how we thought they would (which is most of the time!). Forming & holding on to a dogmatic opinion, despite evidence proving it wrong, is the ruin of many investors. It amazes me how many commentators seem absolutely certain in their views, yet are nearly always wrong! As Superforecasting (one of my favourite books) points out, pundits just need to sound certain, tell a compelling story, and people take them seriously. No one ever checks back to see if their predictions/views were actually correct or not! It's crazy.

Back to RWS, sorry I’ve rambled off the point a bit.

Liquidity - sounds strong -

Strong balance sheet with net cash of £112.8m as at 30 June 2021 (30 June 2020: £119.0m). The Group also has a £60.0m committed loan facility which expires in 2024.

Outlook - cautiously optimistic for H2 -

"The Group is benefitting from operational gearing and due to a very strong close to the quarter, I am delighted to say that profit for the full year is expected to be significantly ahead of current market expectations.

No footnote to say what those expectations are.

My opinion - lots of detail in this announcement.

What a pity the company didn’t give any specific profit guidance (there’s no footnote), which is best practice these days. “Significantly ahead” is good, but too vague.

Look at where brokers forecasts were pre-pandemic (see below). There has been no dilution during the pandemic, I’ve checked that the number of shares in issue currently (at the bottom of the StockReport) is the same as before, which it is.

So if EPS gets back up to say 50-60p predicted pre-pandemic, then put it on a PER of say 15, and we get to a target of 750-900p. The current share price is 756p, so I’d say the share price has already factored in economic recovery. Therefore anyone holding this share must be assuming that a higher PER is justified, and/or that earnings could exceed pre-pandemic levels - perfectly possible, as many companies have restructured in the last year, becoming more efficient.

.

Overall, I think the current share price stacks up, and the big rise in the last year or so is justified. Note the high StockRank too, so Stockopedia’s computers have given it the once over, and like it too.

.

.

---

Renold (LON:RNO)

(I hold)

22.25p (unchanged at 11:07) - mkt cap £47m

Notice of results for year ended 31 March 2021

Renold shareholders can breath a sigh of relief, after a rather concerning delay (twice) in publication of its results for FY 03/2021, due to audit delays.

At 09:47 today the company updates us -

The Group will publish its results for the year ended 31 March 2021, on Friday 16 July 2021.

The Board confirms that trading for the year ended 31 March 2021 was in line with its previous expectations and that expectations for the current year are unchanged.

Crystal clear, that's how it's done! (take note Gateley Holdings (LON:GTLY) which put out a muddled statement yesterday on the same issue of delayed accounts)

Investor presentation - well done to the company for making this open to all -

Chief Executive, Robert Purcell, and Group Finance Director, Jim Haughey, will provide an online investor presentation on Monday 19 July 2021 at 5.30 pm BST.

The presentation is open to all existing and potential shareholders. Those wishing to attend should email renold@investor-focus.co.uk and they will be provided with log in details. There will be the opportunity for participants to ask questions at the end of the presentation. Questions can also be emailed to the above address ahead of the presentation.

.

---

Jack’s section

Air Partner (LON:AIR)

Share price: 88.2p (+8.89%)

Shares in issue: 63,562,601

Market cap: £56.1m

Founded in 1961, Air Partner is a global aviation services group providing aircraft charter and aviation safety & security solutions to industry, commerce, governments and private individuals, across civil and military organisations.

The group has two divisions: Air Partner Charter and Air Partner Safety & Security (formerly Consulting & Training).

While most companies exposed to air travel have had a dire twelve months operationally speaking, Air Partner’s charter services have actually been in high demand as a result of evacuation activities and sports & government business. In its last update, the group described this as a record year with trading ahead of expectations.

I had assumed that the shares would rerate and remain at higher levels but interestingly they have come back a bit.

It looks to be a well managed company, albeit one with choppy revenue. The StockRank has remained elevated since November 2020 so clearly something has turned for the better.

The Quality Rank of 98 is particularly notable - this is probably the most long term rank (see more on its calculation here).

Trading update

Air Partner, the global aviation services group, is pleased to report that it has enjoyed strong trading over the first five months of its financial year and now expects to surpass management expectations for the year ending 31 January 2022.

The group says it is now trading ‘well ahead’ of pre-Covid levels, driven in part by the ongoing high levels of activity in US Private Jets. Here the large domestic market has enabled HNWIs to continue flying.

Trading is also strong in Group Charter, with business coming from government, sports and cruise sector work.

Momentum is also building in UK Private Jets, with business now back at pre-COVID levels, and this is expected to continue as the vaccine roll-out drives the return of business and leisure travel.

Freight was busy at the start of the financial year, delivering COVID-19 test kits and vaccine raw materials, but this activity has now reduced. As a region, Europe remains challenging, and the Group does not currently expect to see a material recovery until 2022. That’s surprising given that so many companies are reporting troubles in sourcing parts, but air freight is quite a lot more expensive than ocean. So perhaps companies would rather sort out ocean freight issues than turn to faster air solutions? It must also be far less practical in terms of the scale of imports that are possible by plane compared to large cargo tankers.

Private Jets continues to benefit from the JetCard programme, which allows clients to buy private jet flying 'hours' in advance, while offering fixed rates and the ability to change booking details at short notice, without penalty. It is proving popular as it gives travellers the ability to fly in safety the moment travel restrictions are lifted.

New JetCard sales in the current financial year, as at the end of June 2021, are up 36.8% versus the prior period and JetCard deposits now stand at £18.9m, up 6.2% on the year-end balance.

The Safety & Security division continues to improve as airports scale up operations in anticipation of increased passenger numbers. Following the successful conversion of many of its safety training courses from classrooms to virtual delivery, Baines Simmons is seeing a strong recovery with the military sector, with customers including the UK Military Aviation Authority, Leonardo and the Royal New Zealand Defence Force.

Work with commercial aviation organisations remains subdued as a result of government restrictions but Air Partner notes ‘strong potential going forward’.

Government restrictions have also led to a slower recovery at Redline on account of low airport movements.

Outlook - the group expects to see the ongoing recovery of the aviation industry drive strong demand for Air Partner's Safety & Security services, and previously mothballed operations will be brought back into action.

The group remains debt free with cash of around £11m.

Conclusion

Having covered Air Partner a few times now, this looks like one of the better managed companies out there. A lot of airline and similar companies are naturally risky due to high input costs, often low margins, and weak balance sheets.

This is a different model though and Air Partner has remained profitable through the lockdowns. The 2020 £7.5m share placing looks to have been unnecessary in retrospect but it does add to the group’s financial strength.

It’s worth remembering that the net cash position of £11.1m (excluding JetCard) gives the company an enterprise value of around £45m on annual revenue of £71.2m and FY21 net profit of £5.63m.

FY22 forecasts are more modest though, with expected net profits of £1.2m. That’s a sizable difference. As with other stocks that have experienced Covid tailwinds, there’s the likelihood that at least some of Air Partner’s momentum will revert to previous levels over the next year or so. But there are other parts of its business that have suffered and will recover. Understanding what a ‘normalised’ level of trading is, and how that is split between its various operations, is uncertain.

On that note, brokers appear to be conservatively forecasting a return to less than FY19 levels of profitability in FY22. Given that the group is trading ahead of its own expectations and with various parts of the business exceeding pre-Covid levels of trade, there’s a fair chance of upgrades here in my opinion so it’s worth looking into a little more deeply.

---

Equals (LON:EQLS)

Share price: 46.4p (-0.22%)

Shares in issue: 178,741,807

Market cap: £82.9m

Equals Group is a challenger in the financial services sector. Its e-money licence allows it to provide various products to small and medium-sized enterprises (SMEs). These include international payments, expense management, current accounts, credit facilities, multi-currency cards and travel cash.

The subsidiary, Spectrum Payment Services (SPS), gives access to real-time settlement accounts with the Bank of England and is a member of the UK Faster Payments Scheme (meaning customers can transfer and receive funds with immediate effect). SPS is also approved by the FCA to provide credit facilities acting as a broker.

It took me a second to connect the dots this morning (slow start - apparently there was a football match last night) but Equals used to trade as FairFX. Performance so far has been extremely volatile so caution is advised. There has also been consistent and material shareholder dilution over the years so the upside is ever reducing.

That’s a compound annual growth rate (CAGR) of 20% from 72m shares in FY15 to 179m shares in FY20.

Following a precipitous fall in share price value there has been renewed buying activity, however, so perhaps now is a good time to take a look.

H1 trading update

21% Y-on-Y revenue growth; record quarter in Q2-2021; benefits of cost restructuring now coming through in cash returns.

H1 revenue was up 21% to £16.7m despite the continued absence of travel-related activity. There’s an improving trend here, with revenue also up 11% on H2 2020. Q2-2021 was a record quarter for the group, driven by International Payment transactions, record activity on the Spend platform and buoyant revenues from banking-style products.

Usually, travel-related activity is around 30% of business but it was less than 5% of revenue in Q2-2021. There’s potential for increased travel money revenues as Covid restrictions are relaxed.

‘Broad-based’ growth in the Equals Money product suite for corporate customers.

International payments - the group is trying to attract more sophisticated B2B customers and there is a resulting increase in dealing in forward contracts, which are higher margin. The number of forward transactions rose by over 200% and the average order size rose from £90k to £114k.

Revenues from forward contracts now represent 45% of the total International Payments' revenue stream. The group’s own-name multi-currency IBAN capability also fared well, as did its white-label business, Equals Connect.

Banking - Equals opened just under 1,600 new B2B accounts in H1-2021 across traditional channels and a further 1,600 new B2B customers were added through the new Equals Money portal. Deposits from B2B customers (an indication of revenues to be earned when the funds are spent) was up 60% year-on-year at £337m.

Spend platform - this is now achieving record levels of loads and is set to accelerate further if travel restrictions are relaxed. New customer acquisition was strong with 574 new business customers being added bringing the active customer total on the platform to 5,644.

Equals B2B Solutions - larger companies with complicated and high-volume international flows use Equals Solutions. This could be a good source of higher margin growth. The group reports strong revenues and a robust pipeline here, although it’s light on numbers.

Cost Base - Equals has been reducing headcount and reshaping its cost base throughout 2021. Headcount remains the same but with a significantly lower cost footprint - now around £0.9m of base pay per month compared to £0.96m in June 2020, and £1.2m in January 2020. So does this mean employees have effectively taken a permanent pay cut?

The increase in revenue will most likely not translate into higher profits as the group will invest in additional product development and marketing to drive further growth. It has also strengthened its internal control environment and ‘provisioned for a greater frequency of external audit requirements in the highly regulated space which Equals occupies’. I wonder whether the need for this increased cost has been flagged previously, or is news to existing shareholders.

Cash position - Equals became operationally cash break-even in Q4-2020 and had £9.2m of cash at bank as of 30 June 2021. An important point, given the track record of dilution.

Conclusion

Beneath all the bells and whistles, for a long time now, what Equals has needed to do is prove it can break even, generate cash, and stop diluting shareholders.

The group might be approaching an inflection point in this regard now that it has reached cash flow breakeven after some tough work over the past twelve months. It’s worth bearing in mind that the company has raised £57m of cash from shareholders to get to this point though, and the current increase in revenue will likely not drop through to profits.

Yes, companies that invest for long term growth at the expense of shorter term profits can end up being fantastic investments - but arguably not when they are diluting existing shareholders to such an extent at the same time.

There could be a real opportunity for Equals though - the 5Y revenue CAGR of 31.2% is a good clip, and the FX markets it operates in must be substantial. Trading is good when you consider Travel has basically stopped and will come back at some point in the near future. I would expect that to revert from c5% of revenue back up to 30%. It will be a material tailwind.

So, clear progress on the whole with the potential for further good news, but I remain wary given the levels of dilution in the past, its history of losses, and the fact the increased revenue will not translate into any change in EBITDA guidance.