Small Cap Value Report (Fri 9 Dec 2021) - RNWH, RBN, PHTM

Good morning, it's Paul here with the last SCVR for this week.

Agenda -

Paul's Section:

Lengthy preamble about current market conditions, and how I see the outlook for small caps, and areas of concern.

Renew Holdings (LON:RNWH) - another set of impressive results from this infrastructure support group. It's been a 25-bagger over 11 years, and still looks reasonably priced, considering earnings keep rising. Balance sheet still quite weak though.

Robinson (LON:RBN) - a profit warning due to higher costs. Profits expected to improve in 2022, as cost increases are passed on to customers. Surplus property disposals are imminent, but that cash looks necessary for debt reduction, which is too high. Overall then, it doesn't interest me.

Photo-me International (LON:PHTM) - reassuring update, trading towards top end of existing guidance for FY 10/2021. Looks great value on a PER basis. Might be worth a punt, but I'm not sure about the long-term outlook.

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Paul’s Market View

When markets are turbulent, I tend to be deluged with messages, asking for reassurance about particular shares (e.g. BOO & SAGA - two of my largest positions, which have been poor performers of late), and what my market view is.

I always emphasise that I don’t know (and don’t try to guess) what market prices will do in the short term - nobody knows, and I particularly dislike it when people comment that “this will happen”, etc, when we’re all just guessing. I prefer “could”, or “might” happen. Although it is easy to accidentally slip into overly confident language, so I’m sure there are plenty of examples of that to be found here in our archive too! We all tend to become over-confident in bull markets.

Small caps seem to have been absolutely dire in the last few months. As is often the case, many charts look strikingly similar. This is how I see things over the last couple of years -

• Late 2019/early 2020 - what they called the “Boris bounce” - removal of uncertainty over Brexit fuelled a big rally
• Massive sell-off in Feb/Mar 2020 when covid originally struck - wave after wave of panic selling, globally
• Strong recovery from April 2020 - driven by huge Govt stimulus & support packages (e.g. furlough), and re-opening in the summer
• Drifting down in the summer/autumn of 2020 - valuations extremely cheap by then
• Huge “everything rally” began around Oct/Nov 2020 on news of successful vaccines
• Bull run continued until the summer of 2021, with many valuations becoming stretched, and momentum/complacency fuelling further increases. Easy money pulled in many inexperienced new traders, who think markets only ever go up!
• Summer-2021 to now - a big sell-off in small caps, culminating in sometimes irrational, panic-driven selling, lack of liquidity in small caps, inflation & supply chain worries, and renewed covid fears

Nobody has to fill in a form to say why they’re selling or buying a share, so we just attribute reasons to market moves, which may or may not be accurate.

The above is obviously just my personal view, and with the benefit of hindsight.

Although to be fair, we did see the covid crash coming here at the SCVR - I remember writing about it in Feb 2020 before the big crash, as did Graham Neary, who was contributing at the time, discussing the different strategies when you think a big market downturn is coming, which are -

• Sell at the first sign of trouble, and sit in cash. If you’re going to sell, it’s usually best to be the first to sell
• Put on some short positions to hedge the longs (this is what I did in early 2020), or
• Do nothing - just ride out any downturn, in the knowledge that markets always come back up again, sooner or later (this was Graham’s approach at the time).
• The worst option, to be avoided at all costs - cling on, with increasing worry, then panic sell at or near the bottom, then watch from the sidelines as things bounce back.

When time permits it will be interesting to re-read some of the SCVRs from early 2020, to remind myself how things unfolded with the first wave of covid.

More recently, my usual strategy of hedging my longs by shorting US indices worked well until Sept 2021, but has since been an absolute disaster. The nightmare scenario has unfolded for me personally, with my hedges (shorts on US) soaring, thus incurring heavy losses, at the same time as some of my UK small cap longs plunging. So my portfolio has really taken a battering. My ungeared, long-term positions (SIPP & ISA) are down about 20% from the summer peak, but still up year to date. Whereas my geared portfolio must be down about 40% from the peak, but is also still up a bit year to date. All pretty grim, but not disastrous.

Markets go up & down, and we have to accept that. It’s certainly given me food for thought, and I won’t be using that hedging strategy again! (although it has worked really well in the past, just not this time).

So if your portfolio has taken a battering in recent months, you might get some solace from knowing that your % losses are probably less than mine!

Buying/Selling - I think it’s important to try to be clear in our own minds what we are doing in the markets. If you’re making buy/sell decisions based on the movements in share prices, then you’re trading, not investing. Nothing wrong in that, if it works for you. But don’t kid yourself that you’re an investor. I know lots of people who think they’re investing, but are constantly buying & selling shares, based on sentiment & emotions, not fundamentals.

Whereas if you’re investing, doing thorough research, and avoiding speculative shares, then you can ride out market downturns. If the fundamentals of a company are still good, then the share price should recover from any downturn. Although it’s always important to constantly check whether you’ve missed something important - e.g. a change in competitive landscape in an industry, or downside risks we may not have spotted before.

If doubts emerge, I find it’s usually best to sell at least some - e.g. as happened recently with Purplebricks (LON:PURP) - when I read negative press on it, I sold out at a loss, but the loss would have been larger if I’d dithered and put off the decision to sell.

We don’t have to be emotionally committed to any share - it’s not like supporting a football team. Changing our minds on shares, when the facts deteriorate, is probably the single most important way to avoid losses - which often means taking a small loss before it becomes a larger loss. I’m not preaching here, this is very much a memo to self, and it’s useful writing it down to collect my thoughts, and other people might find it interesting too.

Growth/value - looking at my own portfolio, it does seem that the value shares have generally fared a lot better than growth shares, with some exceptions. Car dealers have been particularly good this year, with their plentiful freehold property assets, and bumper one-off profits. Plus takeover activity emerging too with Marshall Motor Holdings (LON:MMH) (not one I hold, but could be indicative of takeover interest in the whole sector, I reckon). I think Vertu Motors (LON:VTU) (I hold) still looks cheap, and Redde Northgate (LON:REDD) (I hold) recently published fabulous numbers, helped by its fleet of vehicles rising in value, and strong demand for its leased white vans.

I’ve noticed that lots of small caps on (what I consider to be) irrationally high valuations, have plunged - examples that spring to mind are Tristel (LON:TSTL) and Dotdigital (LON:DOTD) . Maybe they’ll go back up again, I don’t know? But it could take a lot of good news to power expensive shares back up to previous highs, let alone exceed them.

For this reason, I’m currently not opening any new positions (or holding existing ones) where the valuation looks stretched. The danger is that they may have been resilient so far, but it only takes a bit of selling to smash a price down - e.g. Sdi (LON:SDI) earlier this week suddenly dropped 10% for no apparent reason. It could be a buying opportunity, but what if the seller has a big position to unwind? We just don’t know, that’s the trouble.

Are share prices rational? - in a word, no. Or more accurately, not always. Share prices are not an accurate valuation of a company and its prospects. The share price is just the current balance of marginal buyers & sellers. People buy & sell for all sorts of reasons, and using many different strategies.

This creates opportunities for us - every now and then, the market throws bargains at us, particularly when panic selling sets in, as it has done recently. If you’ve got an irrational seller, then the chances are they could be selling at the wrong price. Or, they could know something important that we don’t, which is always the worry.

This is why I tend to like buying things only if there’s been a fairly recent trading update. That reduces the risk of something bad lurking out of view.

It’s usually best to hold our nerve during periods of market volatility, in my view. Although an alternative view is that selling, sitting in cash, and buying back when the uncertainty has lifted, can be a good strategy too. Although you often have to pay more for less uncertainty.

Over/under shooting? I remember earlier this year, by spring/summer our comments on company updates here in the SCVRs usually seemed to say something like, nice company, trading well, but the valuation is too high.

I feel overall, the “everything rally” from last autumn got out of hand by spring/summer 2021, and we’ve now seen a correction of often inflated prices. Hence recent market falls could be seen as logical, as the froth comes off the market. A good example is Gattaca (LON:GATC) - it was a good recovery share, and I banked my profits at 150p earlier this year, based on that being a fair price for the share, in my assessment. Imagine my bewilderment then, when almost the next day, it began a powerful move up to over 250p! I checked the figures again, and couldn’t see any rational basis for that move. Since then, it’s come all the way back down again, and is now down to only about 132p. I’ve crunched the numbers again more recently here on 5 Nov, and think it looks quite good again now on fundamentals, providing nothing has gone wrong that the company hasn’t disclosed.

My point being that we shouldn’t anchor to the peak price of 260-270p in the summer, because that was probably an irrational, inflated price. So the price now being half the recent peak doesn’t necessarily mean the share is good value. In this case, I think it does look quite good value now on fundamentals, as you can see from the Growth & Value section of the StockReport -

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As always, this is not a recommendation. We don’t recommend shares here - Stockopedia is all about using the research tools, and thinking for ourselves. Writers discuss what shares we like, and why, but obviously some will do well, and some will do badly. That’s life, nobody is infallible, because the future is inherently unpredictable, and things change all the time.

I haven’t got a clue what the share price of GATC is going to do. But I’d rather buy now, when the valuation looks good value, than buying into a speculative, momentum-driven spike at double the price. People like buying shares that are going up in price, but if you detach too much from fundamental valuation, then it’s an accident waiting to happen. I like buying good companies when they’ve gone down a lot. Which sometimes works, and sometimes doesn’t, like all strategies.

Covid risk - where do we start with this?! I think the last 22 months has taught us one key thing - nobody knows what’s going to happen!

What we have seen though, is which companies & sectors coped best/worst with covid, and it was often very surprising.

Looking forwards, I’m no expert, but for me the key points are that vaccines can be quickly changed - both Moderna and Pfizer have said in the last week that work has already begun, and will take about 3 months, to adapt the vaccines to target the omicron variant more specifically. Hence the worst case seems to me another possible lockdown in the spring? Will the public stand for that though?

The shares I hold are all companies that are securely financed, with plenty of liquidity, so they could easily survive another lockdown, and then benefit from pent-up demand again afterwards. So this doesn’t worry me particularly, and arguably has already been priced-in, with travel/hospitality shares looking bombed out again.

New anti-viral drugs are coming in, which have shown very good results in trials.

I’ve read that viruses mutate over time, into milder illnesses, which is how Spanish Flu died out apparently. Anyway, I’m already way out of my area of expertise, so won’t go any further!

Following data from S.Africa, omicron is highly contagious, and is rapidly displacing delta as the main strain, and (so far) seems milder. If that remains the case, then it could be very good news. (Source: Dr John Campbell)

The key point is that the world has not come to an end with covid, and I suspect it might end up being a game of cat & mouse between the virus & mankind. Maybe with 6-monthly or annual booster jabs for the vulnerable, something like the seasonal flu jabs? Hence based on the information available now, I am not particularly worried about covid, or its impact on the long-term value of shares. It’s likely to cause plenty of volatility in the meantime though, with an ever-present risk of good or bad news.

Investors/traders seem to react, or over-react to every twist & turn of the covid situation, which creates buying & selling opportunities for people with a longer term investing perspective.

Inflation - this is a worry. As we’ve mentioned before, the main issues seem to be -

• Higher inflation could see expensive growth shares being de-rated to lower PERs
• Ability of companies to pass on price rises to customers - is the absolutely critical question
• Wages - I see in today’s paper, some Tesco workers are rejecting a 4% pay rise, saying it’s below inflation of 4.2%, and unions are planning strikes. That worries me, and could be the start of a self-fuelling run of inflation.

I’ve done a lot of research on the Thatcher era, as I’ve mentioned before, and inflation was incredibly difficult to eradicate. Once inflation expectations become embedded, then it tends to self-fuel. Government spending also runs out of control, mainly due to inflationary pay rises being required every year for millions of civil servants, benefit claimants, pensions, etc.

I reckon inflation was masked in recent decades by ever-cheaper imported goods from the Far East, offsetting price rises elsewhere. That's now reversed, this year anyway. In future, who knows?

There again, we had a couple of short-lived bursts of higher inflation in the last 10-15 years, linked to sharp falls in sterling triggering higher import costs, and it washed through the following year and inflation fell back down again. Maybe that could happen this time too, as supply chains get sorted out in 2022 or 2023?

Higher wages and possible industrial action are new things - e.g. press reports that some Tesco workers rejected a 4% pay rise, and threatened to strike, because it's below inflation at 4.2%. Plus remember that minimum wage goes up by over 6% in April 2022. Also I hear that companies are enhancing perks, to retain staff, so more hidden costs there. There again, higher wages gives workers more spending power, so they can afford to continue buying higher priced goods in the same quantity, which feeds through to higher revenues for companies selling them things.

Nobody knows, but at the moment I’m sceptical that higher inflation is just a blip. For that reason, I think property and shares are the only places to invest. Cash and bonds are the worst areas, where value is eroded by inflation. So I see higher inflation as potentially good for shares in companies with pricing power, and bad for shares where there isn’t pricing power. I wouldn’t touch supermarket shares, for example, or their low margin suppliers either.

Which brings me on to…

Supply chain - obviously this has been chaotic of late, with delays & huge cost increases primarily for imports from the Far East, but also lorry driver shortages in the UK & elsewhere.

Yes this is causing profit warnings for some companies, but it’s temporary. Supply chain problems always get resolved, but I have no idea how long this is going to take.

I take typically a 2-5 year view with my shares, so personally I’m looking through this, and accept that there might be some more profit warnings in my portfolio.

Once supply chains normalise, then inflationary pressures could reverse, and solve the issue of inflation, who knows?

We’ve seen this week a profit warning from Made.com (LON:MADE) which saw FY 12/2021 guidance on revenues fall by 10%, due to shipping delays. However, this year’s profit disappointment should feed through to next year’s profit boost, as the deferred sales are booked in 2022. We’ll probably get similar news from Scs (LON:SCS) and Dfs Furniture (LON:DFS) , both of which have fallen in sympathy. Again though, to long-term shareholders, this doesn’t matter at all, and provides a cheaper entry price.

Interest rates - the traditional link between inflation & interest rates doesn’t seem to exist any more. Governments need to borrow heavily, and what better way than to print money (QE) and buy up their own bonds using this newly created money.

I don’t believe that Govts can stop doing QE any time soon, whatever they say, and that interest rates seem likely to stay low maybe for a very long time.

Hence personally, I don’t see higher interest rates being a particular threat to equity markets.

With real interest rates (after inflation) now heavily negative, then holding cash only makes sense for shortish periods of time. Or if you‘re expecting an imminent market crash. After all, we can’t buy bargains if we don’t hold any cash. Holding cash comes at a cost though - with c.5% p.a. of that money’s purchasing power vanishing.

Overall - putting all that together, I’m happy to sit tight in my carefully chosen UK small caps.

I accept market volatility, even though it’s been painful in recent months, we have to take the rough with the smooth.

Everyone has their own strategy. Mine is to seek out large, multi-year rises, in value/GARP shares. I only need a couple of big winners each year for things to work out reasonably well. Inevitably, plenty of things go wrong, or disappoint. For example, I never imagined that Boohoo (LON:BOO) (I hold) would halve in price this year (along with sector peers), nor that Quiz (LON:QUIZ) (I hold) would double or French Connection (LON:FCCN) more than triple this year. It’s quite bizarre how things pan out sometimes, hence why we need to put our eggs in plenty of different baskets - over-concentration can be horrible when it goes wrong.

As always, the above is just my current view on things, which could turn out to be right or wrong, and is subject to change at any time.

On balance then, I’m expecting continued volatility, maybe some more profit warnings, but I think all my positions are companies which should be more valuable in 2-5 years’ time than they are now. Some are bound to go wrong, but that’s life. The winners should outweigh the losers, I hope.

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Robinson (LON:RBN)

82.5p (down 12% yesterday) - mkt cap £14m

Trading Statement (profit warning)

Robinson plc ("Robinson" or the "Group"; stock code: RBN), the custom manufacturer of plastic and paperboard packaging, today issues the following trading statement, prior to the announcement of its final results for the year ended 31 December 2021, which are scheduled to be released on 24 March 2022.

Revenue guidance for FY 12/2021 - £45m (up 21% on LY) - driven by an acquisition, and price rises (passing on higher resin costs)

Announced previously that Q3 demand was weak, which has continued (or worsened in some sectors) in Q4

Profit margins down, due to higher costs (eg energy, freight, wages)

Margins expected to “start to recover” in 2022, seeking “substantial price increases from all customers”

Small restructuring done in Nov 2021 - saving £0.3m annually, with exceptional costs of £0.2m

Property disposals - £3.4m gross proceeds expected to be split between 2021 and 2022, £2.4m above book value. Further disposals expected in 2022.

Profit guidance -

As a result of the lower sales volumes, the directors now anticipate that full year operating profit before exceptional costs and amortisation of intangible assets will be in the range of £1.2m - £1.3m.
Profits in the 2022 financial year are expected to be ahead of 2021.

My opinion - this is a very illiquid share, so doesn’t really interest me.

It’s only set to make 4.4p EPS in FY 12/2021, a PER of 18.8

However, the £14m market cap does look appealingly low, given the £3.4m property disposals, and that it’s still profitable, with 2022 figures set to improve on a disappointing 2021 (there are no forecasts for 2022).

However, the last balance sheet shows that debt has risen considerably following an acquisition and capex, with net debt too high at £13.7m as at 30 June 2021. I would therefore expect the cash from property disposals being needed to reduce debt, so no upside for shareholders.

Could be worth a little dabble possibly, if profits in 2022 can be managed upwards, but on balance I think the high net debt puts me off.

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Renew Holdings (LON:RNWH)

845p (up 5% yesterday) - mkt cap £665m

Final Results

Renew (AIM: RNWH), the leading Engineering Services Group supporting UK infrastructure, announces its preliminary results for the year ended 30 September 2021 ("the period").

Very good numbers - adj EPS is up 22.5% to 50.5p - giving a PER of 16.7

Outlook sounds confident -

Current Trading & Outlook
· Positive trading momentum carried into new financial year
· Strong forward order book underpins confidence in achieving further progress in 2022
· Confident in our future prospects and well positioned to capitalise on our strengths to target new opportunities in attractive markets

Balance sheet - is still weak, with NTAV negative at £(44.1)m - although there is very little net debt, so it seems to benefit from negative working capital.

My opinion - this share has been a huge success in the last 11 years, rising about 25-fold.

Well done to the company, and any shareholders who have held all the way up!

The valuation doesn’t look stretched, because rising earnings have justified a higher share price. As you can see from graph 4 below, the PER range has re-rated back up to where it was about 5-6 years ago.

Stockopedia shows the forward PER as about 15, which seems fair for a business that has established such a good long-term track record.

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Photo-me International (LON:PHTM)

58p (pre market open) - mkt cap £221m

Trading Update

Photo-Me International plc (PHTM.L), the instant-service equipment group, announces an update on the Group's trading for the financial year ended 31 October 2021.

This is self-explanatory, and very clear guidance, which sounds reassuring -

The Group's better than expected trading momentum in May, June and July continued in the fourth quarter of the financial year ended 31 October 2021, driven by continued recovery in photobooth activity and a strong Laundry performance.

Consequently, the Board expects that revenue will be slightly ahead of previous expectations of approximately £210 million, and profit before tax (before exceptional items) will come in towards the upper end of previous expectations of between £25 million and £30 million, subject to completion of the FY21 audit process.

Europe - trading well, particularly France

UK returned to profitability after restructuring

Japan revenues fell due to covid restrictions on travel (China similar impact)

Excluding Asia, the Group is making good progress in returning to pre-pandemic performance levels in the last months.

Expansion ongoing, of laundry & food vending machines

Healthy net cash of £33.8m, even after paying £10.8m for acquisitions this year

Outlook - “business activity is returning to pre-pandemic levels”.

Cautious about inflationary cost pressures.

My opinion - neutral, because as we’ve discussed before, the group doesn’t provide the information investors need to determine the revenue/growth/profits by division. The worry for many years has always been that photo booths are likely to ultimately be in structural decline, and could eventually disappear. Although I remember investors worrying about that for the last 20 years!

Valuation looks very attractive, with lots of green (long bars, for the colour-challenged) here, in particularly look at that low PER, which I’m drawn to like a moth to a lightbulb. So it could be worth a punt at this level, more as a trade than a long-term investment, maybe?

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