Small Cap Value Report (12 June 2020) - IQE, AIR, WAND, GAW

12th Jun '20 by Graham Neary

54 comments 11744 reads

Good morning!

The FTSE is back around 6000 after a rough session yesterday (down 250 points, or 4%) and more weakness this morning. This comes after the Federal Reserve indicated that the US economy would shrink by 6.5% this year, before returning to growth in 2021.

According to the ONS today, the UK economy contracted by a massive 20% in April, so that the overall economic contraction from lockdown is now c. 25%. It is hard to find comparisons in history for such a sharp and deep fall.

The VIX, the Fear Index which I keep a close eye on, continued its rebound and climbed by 50% to 40 yesterday. Fear remains elevated (for good reasons, I guess).

But there are strange discrepancies. Some of what I'd consider the most speculative stocks remain ebullient - Tesla ($TSLA) at $970 (market cap $180 billion), for example, but there are plenty of others, where confidence is high.

You have a bankrupt company like Hertz ($HTZ) whose market cap reached $700 million a few days ago (now lower). Hertz has even applied to issue $1 billion in new equity, which it could use to settle some of its debts. Many of the recent buyers of Hertz stock may be about to learn their first painful lesson in the stock market.

So it's a weird market - you have a terrible recession (depression?) on both sides of the Atlantic, you have lots of extremely scared investors hedging their market risk and buying up portfolio insurance, but you also have nosebleed valuations for some of the most speculative tech stocks and even for bankrupt companies. I suppose nobody ever said that any of this would make sense.

Some companies I've noticed today:

IQE (LON:IQE)
Air Partner (LON:AIR)
WANdisco (LON:WAND)
Games Workshop (LON:GAW)

Finished at 2pm.

IQE

Share price: 48.69p (+23%)
No. of shares: 796.5 million
Market cap: £375 million

Trading Statement

This manufacturer of semiconductor wafers fell all the way to 20p during the March crash. Wow! I've had an eye on it since 180p, a few years ago.

I'm obviously not the company's biggest fan - see February for my most recent comments, where I noted its arguably…

Unlock with Email

Unlock with Google

Already have an account?
Login here

kendal

12th Jun '20

Please do not say 'Well done' for using Primary Bid for retail investors. As an existing shareholder in Avacta, I tried to subscribe for its recent placing. Apparently, as all my system is Microsoft based, it is not possible to use Primary Bid as it is Android driven, whatever that means. I consulted my IT adviser and was informed that it would not be possible for me to download the App.

I gave up on my efforts to subscribe and also lost the will to live. It is a complete racket and as a holder of individual shares, I regard the process as a cheat on current shareholders.

Shame on you for supporting it and shame on managements for agreeing to use the system - it is a disgrace!

Chipspa

Hi Graham,

With respect to Games Workshop (LON:GAW) and its valuation, I take a lot of comfort from the incredibly high ROIC, coupled with the potential earnings growth for the company - I assume your valuation concern is from a purely p/e point of view rather than anything operational about this company.

I do understand this p/e concern, however the combination of the ROCE and earnings (largely driven by the ROIC) make me quite comfortable at this level and indeed higher. This can be quite hard to get your head around, but I found the following Credit Suisse research paper What does a price earnings multiple mean really helpful in this regard and would really recommend people give this a read.

A glance at the table on page 10, gives a real feel how high(er) ROIC (above the cost of capital) can really turbocharge what a fair or justifiable level of p/e can be.

Understanding this has helped me purchase a number of high quality companies, which have gone on to consistently increase their value, but which when purchasing always seemed to have uncomfortably high p/e's.

All IMO

Kind regards

Chris

dpanchal

sorry Graham.confused the 12th may with 12th june

simoan

Why didn't you just use a web browser? I found it really simple to sign up and it took less than 10 minutes to complete registration and request an allocation in the Air Partner (LON:AIR) placing. It really couldn't have been more straightforward.

BTW I don't have a smartphone so wouldn't even know where to start with an app!

All the best, Si

Graham Neary

Hi Kendal, I'm sorry to hear you had a bad experience with PB. I don't have any association with them, except that I like the principle of letting smaller investors take part in fundraisings.

Best,

Graham

No problem! G

Hi Chris - it's absolutely true that a company with high returns can justify a very high multiple. The maths behind that is 100% sound.

My issue is that I can't really predict GAW's future returns with the conviction needed to justify where it's currently valued. But the company is sufficiently unique that I'm to stay involved. Hopefully that is somewhat clear.

Thanks paraic, I'll correct the article.

TheArb

I think you are over reacting Kendal. I don't understand what you mean by 'as my system is Microsoft based.' You don't seem to have a very good grasp of technology and are blaming the company for your own lack of technical knowledge.

It sounds like the PrimaryBid app may only be available to Android users on mobile. Maybe you should google what that means . I run Microsoft windows 10 on my desktop. Three days ago I signed up to PrimaryBid on its website on my desktop, one of the simplest procedures I have ever encountered in the financial online world. A day later I participated in the Segro offer and today the shares arrived in my account. This is one of the best things that has happened to the retail investor in the UK after years of being shortchanged by the institutions as wealth has been transferred from the retail investor to institutions. PrimaryBid was set up 3 years ago and this is its time. I applaud it.

Cockerhoop

Hi timarr,

Games Workshop (LON:GAW)

I think your original analysis paints an slightly inaccurate picture in that it doesn't reflect the lumpiness of royalty revenue. If you remove this for H1 you get £58.6m - £10.7m =£47.9m PBT ex RR.

Then to match H1, H2 would require £47.9m (exRR) PBT + H2 royalty (which turned out to be £5.3m) so £53.2m making £111.8m for the FY.

So they've lost perhaps £27m in profitability due to a 6 week complete factory, warehouse and GAW online lockdown with longer closures for their own retail stores. Some independents maintained their online presence whilst they had stocks and were then restocked during May.

They are though pushing ahead with a new 9th edition 40k launch (with another big reveal on Saturday) in H121 which is traditionally the most buoyant release in the cycle so it will be interesting to monitor it's sales process.

john652

Thankyou Graham for the answer on put options. I bought Dec puts on the ftse & s&p in April via IG but i am yet to work out if i paid a good, bad or terrible price, the latter I suspect. I continued buying as the market rallied & stopped a few weeks ago. You suggested ig puts before so thanks for those ideas.

smatthews1

Comments have gone quiet on this one, so for what its worth I finally got rid of my last holding of these, My original reason behind buying their shares was there was a lot of positive news flow getting various governments from around Europe on board with their biometeric photo technology. Which if the rules are changed and this then becomes a requirement then their photo booths look useful again. Until then, they are a majority of their revenues which are in structural decline. I also didn't like the fact they had taken on more debt.

On the positive side, previous to this crisis their laundry business and their latest acquisition seemed to be going quite well. Maybe these can grow to split the revenue more evenly in future?

Paul Scott

I think I heard this chap many years ago, saying in a strident way, that the 2009-2018 bull market was a bear market rally.

As SuperForecasters says - write down what these strident people say, and then measure them on their results! I bet the results will be shite!

timarr

13th Jun '20

Re: Games Workshop (LON:GAW)

I think your original analysis paints an slightly inaccurate picture in that it doesn't reflect the lumpiness of royalty revenue.

Fair point - although the royalty revenues are a two way street. If they aren't predictable then you need to discount the valuation to reflect that.

However, if we remove royalties from the calculation we're looking at a 24% drop in underlying earnings against the original forecast due to the shutdown, which includes (I think) the government support that they're looking to repay. So it's probably a bit worse than that.

On the other hand, between the trading update at the end of April and this week's they've brought forward £15m in revenue. Assuming that wasn't purely expectation management then that presumably is the surge in pent-up demand as delivery reopened - so about £3 million a week, which is seriously impressive. What's unknown is where the missing £27m has gone - is it permanently lost or is it simply delayed?

Going forward there are - presumably - going to be production bottlenecks for a while until social distancing is relaxed and perhaps some restrictions in store (although the local one never seems to have more than a couple of people in it). If they repay government loans then that will also be a drag on earnings. Against that we have the new release, which will drive demand. And, of course, the royalty revenue is (so far) increasing steadily: it's obviously an area the management are handling well.

Regardless, if you'd picked these up at around £35 at the bottom in March you'd have made a good call. It's a great company with a fantastic management team which is always likely to surprise to the upside. I just think the price looks rich at this level given the fairly obvious headwinds. But I could say that about any number of companies. If you were going to pick one that will do well regardless then Games Workshop is probably it.

Trident

As a consumer I have fallen back in love with Marks and Spencer (LON:MKS) again. Just when Boots and some of the old names were looking tired they seem, to my eyes, to have had a new lease of life in these times.

That's not to say that a brand like Marks and Spencer (LON:MKS) makes the perfect investment, but I think like one of those relationships where a bit of distance or the prospect of never seeing one another again refires desire, they seem attractive again.

I suspect boredom with indoor life and having spare money that hasn't been spent on pubs, nights out, holidays, cinemas etc will be rattling in people's pockets, and the High Street stores will represent some new entertainment appeal. Judging by today's crowds in my home town, and the outdoor markets restarting, the good weather etc will provide at least a strong short-term boost at the least

Games Workshop (LON:GAW)
Royalty Revenues are on upward trajectory and will continue to rise as the 40 years of accumulated IP is finally exploited but will become more lumpy primarily due to IFRS15 forcing GAW to book minimum income guarantees on signing of contracts. Not quite sure why you consider that this increasing stream of almost pure profit should be discounted because of variations over HY periods. It's risen from virtually zero to £16m over the last few years and shows no signs of abating. Recent AoS deals with FDEV along with TV/Film developments and Marvel tie-ins highlight the ambition.

I think the £27m estimated loss of profitability should be considered lost rather than delayed. Production/distribution was curtailed, UK stores should open shortly but the building, painting & gaming that takes place instore won't start straight away due to social distancing. I'm not sure what will happen to new releases scheduled during the lockdown - some will be delayed and re-introduced later in the year depending on the ongoing game narrative but some may be lost (eg any 40k now superseded by 9th ed release) . It should be noted that during the lockdown Warhammer Community website usage has risen sharply so no sign of hobbyists drifting away.

I can't argue that the current rating isn't rich - I bought in Dec 16 when it was rated on a P/E in the low teens based on forecasts that were clearly going to be smashed but the company has evolved substantially since then with a clear IP runway and a geographical expansion plan. When you compare it's cash generation and conservative accounting to something like FDEV it appears an absolute bargain :-)

Momoko Miyamoto

I reckon it’s a value trap. Never seen anyone go anywhere near their outdoor laundry machines, I think covid-19 will choke off demand for most of their products for quite some time (kids rides, passport photos, coin op outdoor laundry, vending machines}

14th Jun '20

Not quite sure why you consider that this increasing stream of almost pure profit should be discounted because of variations over HY periods.

Hi Cockerhoop

RE: Games Workshop (LON:GAW)

I was merely making the point that if you wanted to look at underlying earnings ex-royalty revenues because otherwise I wasn't taking into account the lumpiness of said royalty revenues then you also have to reflect the fact that the aforementioned lumpiness means that those revenues need to be discounted a bit because, presumably, their growth is less reliable. But haven't looked into them - I was just reflecting your comment.

As for the other points perhaps the best thing I can say is that I'm kicking myself for selling out in the early £30's and for not buying back in during the March lows. My only small consolation is that the sale was forced for personal reasons and, frankly, back in March there were so many opportunities it was hard to pick one in particular.

Games Workshop (LON:GAW) is, I think, a prime example of how company culture can be a moat. They have plenty of others, but they always did and never managed to make much of it. Sometimes you need a catalyst and Kevin Rountree has done a fantastic job. And you're absolutely right - compared to a lot of other highly rated companies it's not overvalued.

On the other hand that does rather mean redefining the term "overvalued", but in a liquidity driven market where future earnings growth is highly prized perhaps that's something we all need to come to terms with. Generally I'm preferring to discount anything consumer facing, especially in-store, and discretionary out of (ahem) an abundance of caution.

Message from Lord L in this week's Weekend FT "Finally I welcome the partnership between Primary Bid and LSE, which enables private investors to participate in company fund raisings usually only available to institutions.......'

Timarr,

You certainly shouldn't be kicking yourself for not buying back at the March lows. I was negatively surprised by the announcement of the complete factory & warehouse closure as had been expecting them to maintain Games Workshop (LON:GAW) online sales - and bizarrely the price rose quite sharply on the announcement as Norges Bank looked to take a stake. As you suggest there were plenty of battered stocks out there to choose from.
I'd agree KR has been a catalyst, I think previously under Tom Kirby's influence they were very suspicious of losing control of the IP whilst now you can buy the tshirt, canvas print, play the computer game and soon be watching the TV series, reading the Marvel produced comic and trying to get out of the Warhammer themed Escape Room.

Small Cap Value Report (12 June 2020) - IQE, AIR, WAND, GAW

IQE

Unlock the rest of this article with a 14 day trial

About the Author

Graham Neary

54 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...