Small Cap Value Report (Friday 9 July 2021) - COG, PMI, IKA, THS

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

Timing - TBC

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:

Cambridge Cognition Holdings (LON:COG) (I hold) - yet another contract win. Looking good.

Ilika (LON:IKA) - you heard it here first! As I suggested a few days ago, this jam tomorrow battery technology company is doing another big placing. Makes complete sense, given the sky-high market cap.

To follow.

Jack's Section:

Premier Miton (LON:PMI) - the trend of strong performance from fund managers continues. Profitable, scalable, modestly valued & with a 6% forecast yield - but exposed to market sentiment should conditions turn.

Tharisa (LON:THS) - platinum group metals producer reports a record Q3 and the shares continue to look cheap; key concerns include the sustainability of current PGM prices and the risk of additional Covid disruption in South Africa

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Paul’s Section

Cambridge Cognition Holdings (LON:COG)

(I hold)

165p (y’day’s closing price) - mkt cap £51m

Contract win

Another one! Something significant seems to be going on here. In the past COG seemed a serial disappointer, but the more commercially focused strategy under newish CEO Matthew Stork, is clearly working.

2021 forecast revenues are already in the bag, with signed contracts, so any additional contract wins are icing on this delicious cake. High margins too, so operationally-geared cake.

I hope some readers are enjoying this cake as much as I am, but it’s terribly illiquid, so it can be difficult to impossible to buy. Hence when positive newsflow occurs, holders can sit back and enjoy watching prospective buyers bidding up the price, as happened when Best Of The Best (LON:BOTB) shot up when the newsflow was good (not so much these days though with that one, but I reckon it could do alright longer term, there have been bumps in the road before).

I wonder if £100m+ market cap could be on the cards, in a bull market, for COG? Am sitting tight - run the winners, as my latest read, The Art of Execution, urges us.

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Ilika (LON:IKA)

151p (down 24%, at 09:35) - mkt cap £211m

Proposed Placing, Open Offer and Retail Offer

Ilika plc (AIM: IKA), the advanced solid-state battery company…

As suggested here a few days ago, it’s pleasing to see Ilika follow-up on my suggestion that they should take advantage of the sky-high market cap to do a big fundraising. Although they’ve baulked at my suggestion of £100m, and instead gone for a more modest £18m placing, a crushing 30% discount. But only 9.2% enlargement of the share capital. Sometimes deep discounts can attract “flippers”, who are motivated to bank profits fast - thus putting a lid on the share price, for as long as it takes buyers to absorb the overhang.

A 30% discount also confirms to me that the share price is inflated, probably by retail, speculative buying, and institutions aren’t generally convinced by the story. If they were, then the placing price would have been c.200p, not 140p.

A further £3.7m is being raised in an open offer.

On top of that, an additional £3.0m is being raised via Primary Bid - it’s nice to see that platform gaining traction. Roll up, you lucky people!

Directors are investing a paltry £15k, so it seems pretty obvious they’re in this for the remuneration & share options. Although some well-timed buys at 20p per share were made by Directors in 2018.

As you can probably tell, I don’t think much of this company, based on its lamentable track record. Who knows, it might be able to commercialise its battery technology at some point? The hefty market cap indicates that plenty of people believe the story. Unless you’re expert in battery technology, then this share is a total punt, not an investment, in my view.

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Jack’s section

Premier Miton (LON:PMI)

Share price: 188.95p (+2.14%)

Shares in issue: 147,491,470

Market cap: £278.7m

Premier Miton’s an active fund manager offering a range of funds including actively managed equity, multi-asset and fixed income funds, and investment trusts. Other managers such as Polar Capital Holdings (LON:POLR) and Tatton Asset Management (LON:TAM) are having a great time right now in terms of performance and fund inflows. When the going is good, these are high quality, profitable, cash generative businesses with impressive scale benefits.

This is reflected in the StockRanks - of the three listed above, Polar has a QM Rank of 99 and Tatton’s on 98, while Premier is on 97. Fortunes can change though for fund managers, exposed as these companies are to market sentiment and investor confidence.

PMI Ranks:

For now, on a valuation basis, it looks like there is scope for PMI relative strength to continue assuming the market holds up and inflows are healthy.

We have just had a fantastic twelve months or so with the rebound from Covid lows, and conditions now feel trickier. Investors are having to be more discerning in picking winners.

Q3 AuM update

This is a very brief update on what appears to be another quiet Friday. We’re entering the summer holiday months so light news days are to be expected for a little while.

Highlights:

• AuM up to an all-time high of £13.6bn from £12.6bn in Q2, marking the third successive quarter of positive net fund flow,
• Net inflows of £351m during the quarter
• Financial year to date net inflows of £710m (9 months to 30 June 2020: £615m net outflow)

During the Quarter, the group launched its Premier Miton European Sustainable Leaders Fund, which has attracted good investor interest since launch with AuM at the Period end of £60m. Another launch is planned for September 2021: the European equity income fund.

So Premier is expanding and diversifying its offering of actively managed funds. It also says its ‘business platform [is] capable of managing significantly higher levels of AuM’. So there’s scope for good, profitable growth here if the talent can attract further inflows.

Mike O'Shea, Chief Executive Officer, commented:

Since the beginning of the financial year, we have seen strong flows into our European and US equity funds. This has continued during the Quarter. In addition, we continue to see good flows into our top performing UK equity fund range. Our UK Multi Cap Income, UK Value Opportunities, UK Growth and UK Ethical funds all saw net inflows during the Period. I am also pleased to report that it was a good Quarter for our Diversified multi-asset fund range and for the fixed income bond funds.

Conclusion

It’s hard to pick any faults in today’s brief update, with AuM at record levels and new funds being launched. The valuation is undemanding and the StockRanks are picking up on favourable financial data. Fund managers are scalable, with great potential for operational gearing. Hence the rush for scale and M&A.

The obvious risk is if market sentiment turns, and potential outflows in the event of sustained underperformance. On that note the group’s funds all reported positive investment performance in Q3, although there were net outflows in its Multi-Asset and Investment trust funds.

That said, over a nine month period, total AuM has increased from £10.608bn to £13.612bn so it’s clearly a positive trend for now. There’s no denying the collective share price performance of fund managers in recent times - a very strong part of the market right now.

There’s a 6% forecast yield here to boot, so this ticks boxes across growth, value, quality, and income.

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Tharisa (LON:THS)

Share price: 129.16p (+0.51%)

Shares in issue: 269,059,931

Market cap: £347.5m

(I hold)

Tharisa is a producer of Platinum Group Metal (PGMs) and Chrome concentrates from its mining operations in South Africa. Its open pit Tharisa mine has 14 years of open pit and 40 years underground mine life.

In terms of additional projects, there is the Vulcan chrome processing plant and Salene Chrome in Zimbabwe that the company is spending money on.

It is producing prodigious amounts of cash at current spot prices. Yet it trades on a forecast PE ratio of just 4x. So are the current results sustainable? That concern must in part explain the stock’s apparent cheapness.

There are always reasons behind a low multiple. In Tharisa’s case, it is exposure to PGM prices that can fall down as quickly as they shoot up, and the territories in which it operates. South Africa might introduce an export tax on chrome and Covid has made production tricky in the past. Even so, Tharisa is well placed to continue operating responsibly and in a socially distanced manner due to the open pit nature of its central asset.

The fact that the group’s parent company is based in Cyprus means Tharisa has a slightly unusual structure to it. Add to that the fact that commodity prices can be fickle and we can conclude that Tharisa is not for everyone.

But those with a higher risk tolerance or that specialise in commodity producers might be interested. This is an SIC holding - you can read the more in depth pitch here, which goes into more detail around the supply/demand dynamics of PGMs.

Q3 production update

• Five million fatality free shifts (FFS)
• Record mining rates and tonnes processed; PGMs produced up 11.4% to 39 koz, Chrome Concentrates up 18.1% to 379.7m kt
• Average PGM basket price +138.8% to $3,804/oz
• Balance sheet strengthened with cash increasing to US$80.5m after US$10.8m interim dividend payment and capital expenditure on its Vulcan development

FY2021 guidance is maintained - that’s for 155 koz to 165 koz PGMs (6E basis) and 1.45 Mt to 1.55 Mt of chrome concentrates.

The average PGM basket price is up 15.6% quarter-on-quarter. It would be prudent to forecast a degree of reversion in Q4. The group says its basket price remained above US$3,000/oz ‘at the time of writing, despite the recent decline in the rhodium price’.

Stainless steel producers are operating at historic high levels, creating robust demand for ferrochrome, which bodes well for the current and future chrome ore price.

Sea borne logistics costs continued to trend upwards - this is from South Africa to China, so it sounds like this is an issue in many markets.

Net cash improved by c$13m despite paying $11m in dividends in the quarter and a significant amount on Vulcan capex. This project is set to finish in the coming quarter, in which case we might expect capex to reduce beyond that.

Phoevos Pouroulis, CEO of Tharisa, comments:

Operationally, the third quarter was one of the strongest in the Company's history, with record mining and processing rates, supported by strong PGM and chrome pricing… Revenues and margins continue to be healthy as the combination of our favourable PGM basket saw record prices, in addition to a steady increase in the pricing of our chrome concentrates.

These price increases are a direct result of the increase in demand for our critical metals as economies focus on rebuilding post the global pandemic. Moreover, given the rapid adoption of decarbonisation initiatives, we see these prices being sustainable for the foreseeable future.

Conclusion

At the half year mark, the group had produced 75.1 koz of PGMs and 730.7 kt of Chrome Concentrate for a profit before tax of $104.6m. Let’s book in another $60m of PBT for Q3 on account of the record basket price, and then another $40m in Q4 (somewhat below the $52m average of the first half). That yields an FY21 profit before tax of some $206.6m, or £150m, which would be a forecast PE ratio of just over 2x.

Or another way: Peel Hunt recently increased its FY21E EBITDA forecast by 71% to some $303m. Taking the current exchange rate, that’s £220m. Net cash in Q3 is $41.8m, up from $29.8m. Let’s assume that rate moderates (a lot) in Q4 and Tharisa ends the year with a round net cash figure of $50m - that would give an enterprise value of £304m, meaning the group would trade on an EV/EBITDA multiple of just 1.4x.

You can plug in any numbers you like of course - including more bearish projections as it’s possible that the group’s basket prices fall a long way - but even so, there are a lot of perfectly reasonable projections that conclude the group is undervalued. Given that, it would be good to see the group buy back shares at these levels. In fact, while the CEO is on the Major Shareholders list, there was actually quite a lot of director selling in the second half of 2020.

Let’s note that Rhodium, one of the key drivers here, has come down in price recently. So if that continues, it’s likely the Q3 performance will not be repeated on the same scale.

But Tharisa will remain profitable and cash generative barring a more serious decline in basket price. The key risk is ultimately the prices of the metals Tharisa produces. On that point the group comments:

The use of PGMs in the hydrogen economy has not been fully recognised… PGMs play a vital role not only in emission control in traditional drive engines but a major role in hydrogen fuel cells, the greening of the economy and PGMs continue to be a critical component of the changing drive train make-up. [The robust outlook is] evident in the demand for the precious metals in a number of growing diversified industries, while PGM production increases across the industry remain limited, therefore supporting stronger long-term prices

Covid is another concern. The group’s guidance is premised on the current level of economic activity being maintained, but South Africa is at an adjusted Alert Level 4 as Wave 3 reaches peak, and Tharisa has recorded an increase in active COVID-19 cases from prior waves. So that’s far from certain.

Risks aside, Tharisa’s growth projects remain on track. The construction of the proprietary Vulcan fine chrome recovery plant is on schedule for commissioning by year end and will add an additional 20% chrome to current production levels at low operating costs. The new development project in Zimbabwe, Salene Chrome, is also progressing well and is planned to be in production start-up before the end of the calendar year.

I don’t want to labour the point, but miners are risky and not for everyone. Many of the best long term investors leave this part of the market well alone. But if you do get involved, then the prospects at Tharisa look encouraging.