SIF Folio: K3 Capital Looks Like A Bet On The UK Economy

9th Jun '20 by Roland Head

9 comments 3310 reads

The rapid recovery of the stock market since March has been a pretty amazing experience. Will this be mirrored with a rapid economic rebound? There’s no way to know.

My instinct is to be skeptical. I’m not yet convinced that corporate earnings in 2020/21 will justify the rebound we’ve seen in the markets. When companies start issuing guidance again, I think we could have a few nasty surprises.

Of course, I would be very happy to be proved wrong.

Screening for consistency

Luckily, my trading decisions for the SIF Folio don’t depend on my macro views.By using a stock screen to pre-qualify stocks for the portfolio, I can be sure that the companies I select enjoy consistent characteristics.

Screening also has a second advantage, in my view. It gives me an objective way of comparing market conditions at different points in time. The number and variety of stocks which qualify for my screen at any one time provides an interesting window on valuation, momentum and earnings.

The message I’m getting today is that opportunities for affordable growth backed by strong fundamentals and positive momentum are limited. Only one stock qualifies for my screen at the time of writing. Unsurprisingly, it’s a Russian gold miner:

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I don’t really want any more exposure to gold. I’m already exposed to this sector through Capital Drilling. I also have a general policy against buying Russian stocks.

Taking a broader view

It’s been four weeks since I was last able to add a new stock to the SIF fund. This means that my rules allow me to relax my valuation and growth criteria slightly in search of new opportunities. I maintain a separate copy of my screen for this purpose, which you can find here.

This screen provides some slightly more interesting results:

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This time, we start with two Russian gold miners. Moving on, we find AIM-listed small caps K3 Capital and Cake Box Holdings.

Although I’d like more defensive stocks, I already own cake maker Finsbury Food. So the only stock I can consider is K3 Capital.

K3 Capital (LON:K3C)

I have to admit I was not familiar with K3 before I started working on this article. It turns out that this…

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Berksbee

9th Jun '20

Useful and thanks. Interesting that you hold FIF which I also hold on the basis of its score. Is there any where else I can read more about your portfolio? I cant find it on the site.

FREng

Roland,

Thanks for this. I have a naive question: how does K3 manage to generate more free cash per share each year than it generates earnings per share?

Roland Head

Hi Berksbee,

My articles are usually filed under the Stock in Focus blog, which you can find through Discuss / see all blogs. It's here:

https://www.stockopedia.com/co...

You can also see an archive of all my articles on my profile page:

It's not possible to share the actual portfolio with other subscribers, but I do include a snapshot in my monthly review piece each month.

Hope this helps,

Roland

Hi FREng,

Thanks for your comment. Good question!

Cash generation doesn't always map onto accounting (paper) earnings exactly, due to a range of factors. These often relate to timing and movements in working capital. I think that's the case here.

Looking directly at the K3 Capital (LON:K3C) accounts for the last two complete years (https://www.stockopedia.com/sh...) I get the following numbers:

2019 free cash flow: £3,296,000

2019 after-tax profit: £3,978,000

2018 free cash flow: £7,212,000

2018 after-tax profit: £5,953,000

So in 2019, free cash flow was less than profit. In 2018, FCF was greater than profit.

My impression is that the discrepancies relate to movements in working capital and the timing of tax payments. For example, the tax shown on the income statement for 2019 was £901k, but the actual cash outflow on tax in 2019 was £1,450k.

These factors normally even out over time, unless there are underlying problems - which I don't think is the case here.

One useful test is to sum earnings and free cash flow over multiple years - I've taken these numbers from the Stocko stats:

2015-18 eps: 35.9p

2015-18 fcfps: 36.5p

I think that's a fairly reassuring result, which suggests K3's after-tax profit is reliably converted to cash.

Regards,

Rusty2

Roland the second link is not working.

You can see the fund here: https://www.stockopedia.com/fantasy-funds/stock-in-focus-portfolio-6449/

but only on the old site.

Thanks. That's much clearer.

Thanks

mojomogoz

I think some of cash difference will be as paid retainer upfront which is then released thro earnings (I think over 6 mths).

Very hard to know how they trade through covid. They’d already experienced a brexit impact on commissions from large deals (the super sweet kick to earnings) which looked like it was beginning to clear up after Tory victory. It’s possible that more of these closed during covid simply as it gave a kick whereby sellers moved price down to buyers rather than wait out another problem. Not a forecast but an observation that covid might clear the market for them a bit.

Then on smaller deal bread and butter. Did new retainers slow down much? Obvs some business will go away but the flip side is that often they are providing exits for people deciding to retire or had enough of little business. It’s possible that covid has heightened this desire for some.

Awaiting trading update with anticipation. It’s a stock that could swing far either way

CamRaid

10th Jun '20

my understanding is they charge an upfront marketing fee and then a % of the sale fee of the business. There is no real marketing beyond the listing on the website. As such they can’t help but make a profit. An actual sale is a bonus. However, they do seem to be a well known brand for selling businesses. Almost like a Rightmove for houses. Reputation will be key going forward. This will rely on actual sales taking place rather than just fees from listings.

SIF Folio: K3 Capital looks like a bet on the UK economy

Screening for consistency

Taking a broader view

K3 Capital (LON:K3C)

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Roland Head

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