Small Cap Value Report (29 Feb 2016) - WTM, RTC, DX.
I'm posting this article 2 days late, as I was unwell on Monday, so apologies again for the delay. Let's catch up!
The main company I want to report on is this engineering & environmental consultancy;
Waterman (LON:WTM)
Share price: 95p
No. shares: 30.8m
Market cap: £29.3m
(at the time of writing, I hold a long position in this share)
Background - regular readers here will know that I've been positive about this consultancy group for a while now. It's not a madly exciting company, but the economic cycle has been working in the company's favour, and it had turnaround potential due to having one division making heavy losses, thus diluting overall group profitability, which management were focused on sorting out.
For further background info, see my archive of articles on this company (as with any company, just find the company's StockReport, then click on the "Discuss" tab, to see a list of all mine, and other peoples' articles which relate to that company). Incidentally, I was really pleased to see one reader comment that when researching a company, he first looks at the StockReport, and if he likes that, then his second step is to click "Discuss", and read my views on the company. He reckons that saves a lot of time when researching companies, to decide whether or not to then continue to do his own in-depth research.
To give investors a chance to ask questions, and to get a flavour for the person running a business, I also try to interview CEOs of my favourite companies - so this link (audio and transcript) is my interview with Waterman's CEO, Nick Taylor, on 15 Oct 2015. He seemed fairly upbeat about the outlook for the next couple of years, and strikes me as a grounded, sensible CEO - the best type, in my view. With small caps, I don't want visionaries, I want hands-on, motivated, honest, and competent manager/entrepreneurs.
Results for y/e 30 Jun 2015 were good, and the shares moved up from around 70p to c.90p after the results were published in Oct 2015. The share price had been held back somewhat by a selling overhang, although the seller (Ruffer) seems to have stopped selling now, and Hargreave Hale took a decent chunk from them (c.6% of the company) - see Holding in Company RNSs in Nov 2015.
Interim results, 6m to 31 Dec 2015 - to save me re-typing the detail, here is the highlights section reproduced;
(problem graphic removed, as corrupted article)
I've highlighted the items which matter most to me.
Note that, refreshingly, the adjusted profit figure actually shows a lower growth rate than the headline figure. Usually companies just use adjustments to present a more flattering view of profits, so it's a sign of management with integrity when they highlight a less favourable adjustment. The reason is that last year had some exceptional costs, whereas this year doesn't.
Adjusted EPS seems to have done comparatively well (up 54%) because of a greater proportion of profits being attributable to owners of the parent company, and less to non-controlling interests.
Interim divi up 50% is a strong statement.
Balance sheet - overall this looks fairly sound to me. Note that Receivables is rather high, at £29.9m. That represents 32.9% of annual turnover (which I have annualised simply by doubling H1 turnover of £45.4m, to arrive at a full year turnover of £90.8m). Normally I like to see receivables under 25% of annual turnover. So it's an amber flag.
I have investigated this issue before, and the reason that receivables is high, is essentially the nature of the business - doing long term contract work, it is unavoidable that work done, but unbilled, does build up, and is then invoiced periodically.
There's a balance sheet entry going the other way in trade payables, with £14.2m shown as "amounts due to customers on long term contracts".
There's no denying that this business model does carry some risk, so it's worth bearing in mind.
Although it's pleasing to see that the trend for receivables is positive - the figure has reduced by £2m vs a year ago, despite turnover having risen 10%. This is reflected in a more healthy cash position - with net funds up £3m to £6.6m.
So whilst acknowledging the inherent risk in the business model (big debtors & big creditors creates scope for things to go wrong), the position looks under control, and improving.
Outlook - this all sounds very positive to me;
Waterman is on target to exceed its previously declared financial objectives to triple adjusted annual profits before tax to £3.3m over the three year period to 30 June 2016, with a return on capital employed (ROCE) of 20%.
In October 2015, the Board announced a new aspiration to increase the Group adjusted operating profit margin to 6.0% by June 2019. As noted above, the Group's progress against this objective is positive with adjusted operating margins increasing from 3.3% to 4.1% over the last twelve months. The Board expects further progress to be made during the second half of the current financial year and beyond.
The results have benefitted from the Board's strategy of focusing primarily on the UK, where 90% of Waterman's revenue is now generated and this focus is anticipated to continue for the foreseeable future. Waterman's long-standing relationships with blue chip companies continue to generate repeat business year on year and the Board expects this to continue whilst the UK economy is strong.
Valuation - there's still plenty of green on the StockReport in the valuation & growth section. Note that the StockRank is a perfect 100.
Furthermore, the EPS forecast for this year, at 7.8p, looks as if it might end up being on the low side. 10p EPS forecast for 2016/17 could I think end up being more like 11-12p, so that could give useful further upside, if I'm right about this.
My opinion - I'm pleased with the figures & outlook from Waterman. Obviously we know this is a cyclical business, so it's bound to suffer when the next proper recession comes along. However, from talking to the CEO it's clear that there's abundant infrastructure & commercial building work going on in the UK, for several years to come, which is likely to keep Waterman busy.
With artificially
low interest rates likely to continue for a long time, that provides a
favourable backdrop for infrastructure spending, which benefits Waterman. So I
think it's far too early to think about getting off the rollercoaster, as it
could well have a lot higher to go. I call it a rollercoaster because we know
that, sooner or later, there will be another plunge! But you could say that
about lots of sectors, this is not the only cyclical area of the economy by any
means.
RTC (LON:RTC) - good results for y/e 31 Dec 2015 from this minnow staffing group. Pre-tax profit rose from £1,018k in 2014 to £1,282k in 2015.
Basic EPS rose 33% to 7.85p, so at 80p the shares are on a PER of 10.2. There's a fair bit of debt on the balance sheet, net debt of £3.9m is about 34% of the market cap, so the shares are not looking cheap any more. A company this small should be on a discount to the sector, as it is heavily dependent on a handful of major contracts, thus making it higher risk.
Having said that, the future looks good for the time being, with a 5-year contract for providing labour to Network Rail.
If I had to pick a small recruiter, I'd prefer Empresaria (LON:EMR) to RTC, as it has a better spread of business, is on a lower PER, and is larger & hence more liquid & financially stable (not dependent on any one or two big customers, as RTC is).
It's difficult to
see much more upside from RTC, I think the big re-rating has probably now
happened. Although it has surprised on the upside in the past, with more
Network Rail work than originally planned, so who knows?
Quartix Holdings (LON:QTX) - strong results for 2015 published. Group revenues up 28% to £19.7m, and a very high profit margin was achieved, with profit before tax up 19% to £6.0m.
The valuation is much too toppy for me now, at 31 times forecast 2016 earnings.
At 352p, I suspect
the shares might have run ahead of events somewhat now, so it doesn't interest
me.
DX (Group) (LON:DX.)
Share price: 19.5p
No. shares: 200.5m
Market cap: £39.1m
(at the time of writing, I hold a long position in this share)
Interim results, 6m to 31 Dec 2015 - this is certainly an interesting one! I won't go over all the history again, as most people will already be aware I'm sure. Here is my archive of articles.
I suspected that
something wasn't quite right with this share, and the fundamental flaw was that
its big profit earner, the DX Exchange service, has seen a sharp downturn in
demand. For a largely fixed cost, subscription revenue business, that's a
disaster.
Clearly the former owner must have seen this coming, and one imagines that's why they wanted to sell it on to fund managers who were stuffed in the IPO at 100p per share. The generous divi yield was the hook to get the IPO away, but as with some similar offerings in recent years, the divi may not be sustainable.
The share price collapsed, in one of the biggest falls I've ever seen on a profit warning, dropping from 85p on 12 Nov 2015, to 23p the next day. Unusually, there was little noticeable bounce in the aftermath, with DX shares bottoming out on 20 Jan 2016, at 14.5p. A one-month bounce to about 25p followed, but the interim results have knocked us back to 19.5p.
A few comments;
DX is still profitable, but only just - it made £1.4m operating profit (pre-exceptional) for H1 this time, versus £10.1m last time - a catastrophic decrease in profitability.
There seems to be an H2 weighting to profits, which the company alludes to in the commentary, but that is dependent on the level of DX Exchange renewals in H2, from the key legal, and Government sectors.
Dividends - a 1p interim divi is proposed, payable in May 2016, subject to a capital reduction to create a distributable reserve. Management "remain committed" to a 1.5p final divi. Is that wise, in the circumstances?
Balance sheet - this buys the company more time, as it has only modest net debt of £12.3m. Although note that as DX Exchange contracts, it has an adverse working capital effect - since up-front payments from customers dry up.
Exceptional charge of £88.4m - doesn't matter, as it's non-cash - just a goodwill write-off.
Major planned capex - planned for a new central hub in the W. Midlands. This is now to be funded by a developer, rather than DX taking on the debt. Probably a good thing in the circumstances, but that depends on what the costs will be.
Directorspeak - obviously they're going to put a favourable spin on things, they have to;
Although market conditions remain difficult, we have completed the managed exit of a number of unattractive contracts and have seen our sales team start to secure attractive new contracts. In addition, we continue to make steady progress with our strategic OneDX programme including our plans to develop our new central hub.
Despite the current headwinds to the business, and with much to do still in the seasonally important second half, the Board anticipates that the Company will trade over the full year broadly in line with its expectations. We continue to position the Group for longer term sustainable growth and the Board remains confident in the medium term outlook for the Group."
My opinion - luckily I anticipated problems ahead at DX, and dodged a bullet, by selling out in early 2015 due to concerns over the sustainability of profits, and particularly because DX's profit margins simply looked too good to be true, in a low margin, ultra-competitive sector. The reason of course was that DX Exchange was highly profitable still, but very much a cigar butt. That's why the key numbers were not disclosed in results - i.e. a proper breakdown of where the profit actually came from. That also made me suspicious.
However, before getting too smug, I caught the falling knife at around 33-36p, mistakenly thinking that the falls were overdone. So that's been a losing trade to date.
None of that matters, as the market doesn't know, or care, what price any of us paid for our shares. All that matters now, is whether it is correct to buy, or sell? I was leaning towards selling, but on studying the accounts a bit more, I'm now leaning towards holding, as a seasonally stronger H2 could trigger a nice rally in the shares in late 2016, possibly. That would then be the time to exit I think.
To my mind, the business is down, but not out. I think management has some time to stabilise things, and build higher margin new business. If they manage that, and downsize the fixed costs of the DX Exchange (it should be possible to exit leases of multiple small sites by assigning them), then there could be a reasonable business remaining. We don't really know. It all depends on how management execute over the next couple of years.
If it was £100m+ market cap, I would sell without a qualm. However, at £39.1m market cap, for quite a sizeable business, maybe there is upside potential?
As always, this is a snapshot view of my opinion at this point in time, and I reserve the right to change my mind at any point.
What do readers think on this one? I would be very interested to hear your opinions, as I always say, investing is a team sport.
Disclaimer
This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.


31 comments
Positive interim statement from Waterman this morning. Revenue up, operating margin up, in line with market expectations.
http://www.londonstockexchange.com/exchange/news/m...
just as well was close approaching a 20% loss on waterman, and would have had to exit.
.... Offset by subsequent announcements that two of DX (Group) (LON:DX.) 's principal shareholders Unicorn and Hargreave Hale have reduced their combined holdings by about 10 million shares.
I note that DX (Group) (LON:DX.) put out an RNS this morning stating that the CEO and CFO (well, his wife) have jointly purchased about Stg750,000 worth of shares. Quite a sizeable vote of confidence albeit at pretty depressed price following recent mediocre earnings report. Shares are up about 9% today on the back of this.
Gus.
Not saying that the only reason for the VLK share price falling was PIs selling due to LTIP anger. You are right, the poor results did trigger a fall. Since then I personally know PIs who between them held more than 5% have sold due to not trusting the management and NEDs and the way they were structuring the reward schemes which must be contributing to ongoing weakness.
There are many PIs who hold notifiable holdings in many AIM companies, some significantly more than 5% individually....it is also the PIs who provide liquidity as the funds tend not to change their positions often. e
Even if only 5% of a small company shares were suddenly sold, it would make a mess of the share price as it would trigger all sorts of related selling.
Anyway - we agree that LTIPs and option awards etc. for senior leadership are not a welcome thing!
Private investors are key to the share price and liquidity of many AIM companies. If we got our act together collectively we could put a stop to this by simply selling the shares of any company that announces an LTIP. Vislink have really suffered as a result of PI's selling and others would too. VLK are truly shameless though. I think there are three concurrent LTIPs (or similar schemes) on the go there although hopefully they won't pay out.
Once there was downward movement in the share price, the institutions would investigate why and perhaps start to pressure the boards to remove these schemes to get PI's back on board and support the price.
Re Vislink (LON:VLK) the share price fell on 16/9/15 because its announced a loss due to restructuring costs. I thought most PIs held onto their shares so they could oppose the management? PIs have small holding in most companies, believe VLK its under 5%.
£DX "There seems to be an H2 weighting to profits"
Kiss Of Death.
I'm long DX too. In addition to being relatively cheap for the size given even modest prospects as others have said, market psychology seems to be a tailwind mid-term: the precipitous fall made everyone look for problems, and here it doesn't take much imagination to find some, so I'd expect people on average to overestimate the problems for a while (underprice the stock), in a mirror image of the usual story stock behaviour.
I am inclined to keep my position in DX open. I agree that the DX Exchange can become even nastier if the decline in volumes is not accompanied by a proportional (or preferably greater) reduction in costs (it appears that it has not been so to date). Although I like the fact that they are working on building profitability elsewhere (there was a 14% growth in the courier service and there is a mention of a new contract with Ikea), I do not like comments such as increased volumes led to higher sortation costs - to my ears it does not warrant for any improvement in margins and just puts a question mark over these more positive statements.
On the other hand, I quite like the idea of the new “DX Parcel Exchange”. The order online self-pick up service seems to be gaining popularity and InPost + Doddle should offer DX decent coverage.
All in all, I think, at least in my case (in around 21-22p), there will be a better time to exit but no major excitement ahead.
Naturally, just my raw thoughts.
With regards Waterman Group, I am deeply impressed with the CEO and CFO of this organisation. They have a superb understanding of the market, their clients and competitors and their business. The culture, the forward thinking with regards geographies and types of activity is clear and logical and has proven to be far sighted over the past few years (getting out of Russia just before they invaded Crimea - smart move).
I am happy holder here. The one cloud which prevents me from loading up is one of principle. It is the presence of the LTIP which I don't like.
In my opinion the CEO's salary and bonus of £373k in 2015 is toppy/fairish for the complexity of the organisation and the value that he clearly brings to it. However, I don't think he really needs 640,000 extra shares for getting the share price to 150p does he? Is he going to work any harder due to the LTIP? No, of course not. He's not poor by any definition and has another 8 years of profitable employment ahead of him. The CFO gets 320,000. Why?
In total, I think the LTIP would award approx. 10% of the overall share capital if the price reaches 150p by the end of 2019 so be aware that by owning these shares you are agreeing to give away about 10% of your stake in the company if it does well.
In a way you could say that if the share price gets to 150p, it's really only worth 135p to us ordinary folk as you'll be handing 15p a share over to the CEO, CFO, COO and management. It's not on, it's not necessary and it's not fair. That's about 25-30% of the upside from this point handed back without us really having a say in it....
So, on a point of principle, I will not invest in this company as fully as I would if the LTIP did not exist. We need to take a stand or it will carry on.
Re Waterman (LON:WTM) LTIP, I don't think those numbers are right. The LTIP is over 1.2m shares (CEO 640k, CFO 320k, COO 320k) and WTM have currently 30.8m shares in issue so the dilution is less than 4%. Also the share price when the LTIP plan was approved was 56p so the 150p target envisaged an almost tripling of the share price over a three year period. So to me the LTIP programme does not look outrageous.
The LTIP is 3m shares in total. The rest are for senior management which I object to less. The dilution is pretty much 10%.
The share price is utterly irrelevant in my opinion. Why should we have to give our stake in the company away to individuals who we also pay decent 6 figure salaries to?
Yes you're right, I missed the other staff element (who will earn probably considerably less than the execs) so overall looks like a 10% dilution, if the full target (150p share price for 25 dealing days) is met. The performance criterion for full vesting from the point of approval was high and would deliver significant returns to shareholders if achieved, even with this dilution. However I do accept that the closer the share price gets to the targets, the worse the deal looks for new shareholders, although this simply reflects management's success to date for existing shareholders. In any case, well worth pointing out the details here, so thanks.
I'm not keen on these types of schemes but when I looked into it a few months ago I was surprised how many companies had them, it was well over 50%, less so on the Aim. Its something to consider when buying maybe these could be flagged up somewhere? One scheme that upset many investors was Vislink (LON:VLK), since then the share price has halved. Another company I have never seen any mention of their LTIP is Finsbury Food (LON:FIF), 2 directors get 2x their salary in nil cost share options, they now have over 7m share options. IMImobile (LON:IMO) is another company with excessive share options. I hold both Finsbury Food (LON:FIF) and Waterman (LON:WTM), I sold IMImobile (LON:IMO) when I found out about the share options. Vislink (LON:VLK) I had sold before the LTIP was announced.
I think the issue here is related to the history of Waterman and many property related businesses ie they all started as partnerships and as such all profits were divied up to the equity partners. Many of these Equity partners had an enviable lifestyle as a result and many of them have remained private partnerships and thus their financial structure is well known to WTM directors. What they've not quite nailed is the fact that the Partners at flotation shared the proceeds and the quid pro quo is the new equity holders - us - want a fair share of the profits going forwards. I don't see the Waterman scheme as too egregious but it is at the top end of what I feel comfortable with, if it weren't for the reasonable and growing dividend payout I'd be very unhappy about this balance of rewards. As the target hoves into view for Directors it will no doubt concentrate their minds wonderfully , but I'm equally sure that until the LTIP vests we are not going to get any special dividend if surplus cash is sitting on the balance sheet!
Anyway as a significant holder I'd quite like them to overshoot their target
With regards DX group, having met with the management yesterday, I closed my position.
It seems to me that the document exchange business is the profitable part of the business but with high fixed costs (it costs pretty much the same to exchange 1000 packages as 5000 packages), as the volume and usage ebbs away those profits will decline rapidly. They said they would continue to run it at much lower volumes but I can't see it having more than 4 - 5 years at the very most. I suspect that there might be costs associated with exiting the business as well (leases, redundancies etc.).
With regards the rest of the business, logistics is highly commoditized and highly competitive (CityLink bust, TNT struggling etc.) and the things that the CEO was highlighting as differentiators just don't matter to me as a consumer of logistics services. I don't care if the driver is vetted or not to be honest. If it wasn't the case Amazon would be all over it, and they're not, preferring to consume logistics services than own and run logistics services.
So, we have a profitable part of the business that is in systemic and rapid decline with a high fixed cost base and what appears to be an unprofitable part of the business that's in a growing market but one that is highly crowded and with wafer thin margins...
Overlay all of this with what will be a majorly disruptive new hub build, fit and migration (and I don't really understand what that gives them except some efficiencies and you can't cut your way to growth ever) and there's risk and downside all over this.
I have sent the CEO an email with a load of questions to try to find a way to understand the way through this for them and if I get a good response I will circle back and update this but until then, it's not one I like the look of.
All my own opinions.
JDW72
DX Group
Could the big players, Fed-Ex, DHL, UPS be interested in acquiring a niche player? Since it is coming out of Private Equity this avenue may have been considered. Competition issues might stop a US company buying. Nevertherless DX picked up pieces of City Link so someone would want to pick up the remaining DX business. At what price?
I've been thinking about this too. At some point there should be further consolidation in this market. Also big players have had a reasonable Christmas, so his year probably moving from firefighting mode to business building and expanding.
But at what price? Valuing DX is beyond my area of expertise.
I cannot see the point of taking over DX (Group) (LON:DX.) . The only assets are some rented premises and some hired vans. Even management admits the core business is in decline. It may disapper entirely within a decade. DX (Group) (LON:DX.) picked up some cagework from Citylink, but not really any business. I hold here, but am in two minds whether to depart.
I don't think DX would be a match for a big group, neither the specialist segment nor the legacy lawyers business seem good fits. Probably too small to matter as well (management is not going to spend time to buy a competitor worth 0.1% of their own market cap).
On RTC: I was positive when I saw these numbers, as a long term holder. I'd also echo the idea that the profits from Gaynmede could well have pretty decent upside potential going forward; the NR contract can also provide a gateway to other projects away from maintenance and renewal, given RTC have now invested heavily in the infrastructure. As we know there are plenty of major projects - especially in one of their key regions - "The West" and "South West". Seems that a lot of the start up costs have been accounted for this year. So this coming year could well surprise.
On reliance on one or two key contracts, I can see this argument - although doing some very quick fag packet calculations, the network rail contract is maybe less than 30% of group turnover. £80-100m 5 year deal, "at the top end" (95 / 5 = £19m). Still hugely important from 2020 onwards, granted. We've also got to keep our eye on the GSS division and their attempts to replace that declining revenue - I notice that they are working hard in Qatar. Quick mention for the acquired Energy division as well, which helps with the diversification. ATA continues to do well - and again, they invested heavily in consultants here, you'd hope now that they have bedded in, that they will increasinly add value.
I have a limited experience of DX (Group) (LON:DX.) through a couple of their government contracts. They are always pretty efficient and reliable, though the Document Exchange business does seem to be very much in decline. The warm glow I feel seeing all those court summonses going out to tax evaders in that little white van may soon be no more!
More worrying though is the fact their new hub will be a drain on finances through rent. Would I be right in suggesting the figures suggest free cashflow is limited?
Personally I don't see DX going anywhere, so I would be inclined to sell. The core legal business is contracting in size and their delivery market is notoriously difficult to make money in, and DX seems to be one of the worse companies in the sector, judging from reviews I once read.
However there could be a bounce if they managed to secure some good contracts, and of course home delivery is expanding.
Hi Paul
Following the FY results to 31-Dec-15, the stock rank for RTC has increased from 72 to 97.
Also, the 2015 results reflect all the costs of start-up for the Network Rail contract but only part of the benefits, with the contract having started in May-15 and only recently reached the expected level of monthly revenue going forward.
On this basis, it seems to me the the broker estimates for the current year are likely to be very much on the low side of what will probably be achieved.
Regards, Martin
Hi Martin,
That's a really good point, I didn't pick up on that (re RTC (LON:RTC) ).
So yes, if 2016 rail contract profits are going to be higher than 2015, then the valuation could well stack up.
Although it still leaves the fundamental issue of the company being highly dependent on 1 major contract, which should be discounted in the price.
Regards, Paul.
Hi Paul
Yes, I agree that RTC need to use the Network Rail contract as a springboard to grow the business, both in rail infrastucture and in other areas. From the FY results RNS, they do seem to be picking up more of the former and are seeking to do the latter.
David Stredder touches on this a little in his Share Radio interview yesterday:
https://audioboom.com/boos/4252429-small-cap-investors-david-stredder-director-of-sharesoc-on-the-latest-goings-on-in-the-world-of-small-caps?
Regards, Martin
I have family in the legal profession. The direction is strongly towards electronic comms and away from sending paper documents by DX, though there is still some requirement. The recession meant that practice managers were vigilant in all cost areas including scrutinising their DX bills. These were being hiked automatically but those days are past.
Middle part including RTC missing?
Hi alano,
Apologies, the computer gremlins struck, after a long absence, and the report above corrupted. However, I managed to salvage it & replace the missing bits, so it's repaired now (apart from the 1 missing graphic which caused the problems).
Regards, Paul.
Hi Paul,
I thought it was gremlins.
Regards, Alan