Small Cap Value Report (Fri 18 Nov 2022) - GLE, NAR, LIO

18th Nov '22 by Paul Scott

49 comments 7128 reads

Good morning from Paul & Graham.

Agenda

Paul's Section:

MJ GLEESON (LON:GLE) - it warns that the cancellation rate has shot up recently, which shouldn't come as a surprise to anyone. Being a low price, starter home builder, GLE should be relatively well protected from any downturn, because some buyers are expected to trade down, partially offsetting reduced demand from existing customers. Housebuilders look stunningly cheap to me, with the whole sector trading well below net tangible asset values. Hence I would see any continuing share price weakness as increasing the buying opportunity. They generally don't have any debt, and are sitting on cash piles, as well as owning huge land banks outright. So this time it really is different, even allowing for a housing market downturn.

Graham's Section:

Liontrust Asset Management (LON:LIO) (£727m) - H1 numbers are released at this fund manager, following the detailed H1 update last month. Outflows were large and with sales reportedly remaining difficult, it’s too soon to bet on the trend reversing to inflows at this time. The bounce in asset prices since the end of September has at least produced a recent uptick in AuMA. H1 revenues are slightly higher than a year ago but unadjusted profits are sharply lower as they digest the acquisition of Majedie. There is a huge emphasis these days from many quarters on sustainability, ESG and Net Zero, and Liontrust is very focused on these trends. It’s not my top pick in the sector but I do suspect that Liontrust shares, like most others in the sector, are underpriced.

Northamber (LON:NAR) (£13m) [no section below] - this tiny company has a 63% shareholder and continues to be a case study in bad capital allocation. Net tangible assets are £23m and they remain locked up in a business that is inherently unable to earn an economic return. Perhaps some day, the assets will be released and put to good use, but who knows when that might be? Today’s full-year results (FY June 2022) reveal the company has made a fresh operating loss on £66m of empty revenues. Northamber has not made a meaningful operating profit since 2005: if markets and economies were efficient, a company like this would have released its assets to more productive use a long time ago. [no section below]

Explanatory notes -

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timarr

18th Nov '22

RE: Legal & General (LON:LGEN)

Strong statement....most encouraging. Risks around LDI seem to be falling away...

Not sure there were ever many. L&G had no direct exposure and tons of liquidity anyway. If the bond crisis had persisted the UK would have been bust so it was always going to be a short-term liquidity issue. No doubt there was some arm twisting from the BoE behind the scenes.

The recovery today is in part due to the Solvency II reforms announced by the Chancellor yesterday. These have long been flagged, but will allow insurers to release investment into properly productive assets and increase returns.

I've been happily buying Legal & General (LON:LGEN) and Aviva (LON:AV.) for a while but they still look cheap to me, noting that rising interest rates bolster their income at the same time as recession will see a spike in claims, albeit many of them dubious.

Monty Carlo

If we start discussing the finer details of Solvency II here I suspect we will be treated as guests who have outstayed our welcome...

I was never too concerned about Legal & General (LON:LGEN) from an LDI perspective, as I explained back in October for those who wish to revisit.

As has since become clear, combine too much leverage in a pooled fund structure with a one-way gilt market and you get fireworks.

The real fault lies in some LDI managers and pension consultants putting too much reliance on historic market behaviour to model their potential collateral requirements. And no....I am not being "Hindsight Harry" here, it doesn't require a PhD to observe that QE has distorted the UK gilt market and that statistical analysis of previous yield jumps was not fit for this purpose. I don't have much sympathy for the leveraged repo crowd either - we know there are scenarios where the repo market ceases to function as we would wish.

JohnDoe2378

Positive update from Bodycote (LON:BOY) this morning, now above 50 and 200 day MA.

Could be a nice bowl forming, not sure share in this sector though would command a PE of much more than 15, especially in a bear market.

No position.

Regards.

Zipmanpeter

Re Drax (LON:DRX) - burning wood chips from SE USA to cut carbon emissions is a fraud - and a reminder of why Adam Smith wrote about Political Economy! - and it cannot last.

On the one hand the sceptics will ask if we are to burn stuff, why not cheaper coal. O n the other wing (which I support) people will increasingly ask if the same Govt subsidy money was put into energy efficiency (insulating lofts, subsidising heat pumps) and low cost renewables (on/offshore wind, solar,) and energy mgt (grids-cale batteries to shift & smooth consumption), would this not be a far more effective long term use of funds

The only lobbies to keep the subsidies to Drax going are local MPs to 'save jobs' and, short term 'keep the lights on' and government inertia.

Having been heavily burned by a sudden shift in regulation on other shares, I would steering very wide of Drax from an investment point of view - +ve momentum could change very fast with 1 change of Minister.

GreyInvestor

I did the sums yesterday. £167k average purchase price, 85% mortgage, 5.5% to 6% interest rate, 20 year repayment = something like £15,600 per annum to be paid. Average couple earning £44,100 gross. Seems like a stretch to me; a third of their gross pay, or maybe 40-45% of net pay?

Interest rates have a huge impact on affordability.....

Lucky dip

At Mello, I talked to Ed and Paul about more comments on Mid and Large caps.

My arguments is we benefit from a collective wisdom of the group as much as the comments by Paul and Graham. I read all the comments and it is very good that so many of the community here take the time to write. Thank you all and please continue!

Paul told me that he is now reviewing companies of up to nearly one billion which is great .

Michael C

I agree about the housebuilders generally and MJ GLEESON (LON:GLE) particularly because although it's a good company, it will not go bust, and it will pay dividends, there is nothing to show that the share price is not a falling knife. As I have been reminded the hard way with PayPoint (LON:PAY) this month, buying a good company which will not go bust and will pay dividends is pointless if one loses multiple dividend payments from a falling share price. I think that what I am saying is that in a market like this timing is crucial. The pundits all say you can't time the market but sometimes I think it's the only way to achieve a decent performance. And the time is not yet right to buy MJ GLEESON (LON:GLE) unless you want to try trading it for a quick 10%.

Over the nest few sessions, I will put in writing what I heard and learned and gained form the Mello.

The first session was John Lee, who said some interesting points;

He said he is fully invested most of the time unless he receives cash which he expects from the take overs (Appreciate group).

His comment about having too much cash was interesting: it is clever when you sell high but then you worry when to re-enter the market. This becomes a source of anxiety and stress , exactly opposite of what you wanted.

His holdings: In defence sector his preference was Concurrent Technology.

He has added to his holding in Anpario, Christie.

He still likes Treatt, PZC, describing them as good recovery values.

I'm now down 10% on GLE, oh well. I'm holding for the long term. The profit warning today can't be a surprise, the shares have already come down very sharply.

For the value hunters, I've just bought a decent slug of Secure Trust Bank (LON:STB). Dirt cheap and some serious shareholders on board...but DYOR, I'm an amateur.....

TheFloatingInvestor

Interesting research from Shore Capital REF: Sureserve (LON:SUR), which is again bouncing off resistance having had a decent rally last week.

Jeremy Hunt yesterday pledged in his Autumn Statement another £6bn to improve energy efficiency in homes and industry from 2025. This is on top of the £6.6bn current ongoing programme. The details are still to be set out, but we see this as a potential major positive for the social housing energy services groups long-term pipeline. Valuation: FY23 PER 7.7x.

• The combined impact of the two programmes are aimed at reducing energy consumption by 15% by 2030 and improving energy security. Full details are expected soon.

• It is not clear whether there will be any changes to the current programme, such as grants to homes, but it extends the commitment.

• We see the group benefiting from protected long-term contracts in protected sectors of gas safety compliance and energy efficiency that is not reflected in the valuation: FY23F (Sep YE) 7.7x, PER; 4.6x EV/EBITDA.

(I Hold)

davidjhill

I think with house builders you need to separate the various components that have caused the falls. This is a cyclical sector and tends to trade at price to book value rather than specific PE ratios so I find it better to look at that for context. The other thing is balance sheet. In previous downturns builders have been leveraged, now they are not. £CREST as an example now has half its value in net cash, Taylor Wimpey (LON:TW.) has circa £650m and so on. That means the usual fear of tapping shareholders at distressed prices appears unlikely this time around.

In my view builders sitting on 0.6 to 0.7 * BV is historically a trough level, whereas 2* is generally peak. At the moment in some cases we are sitting below historic trough levels. I put that down primarily to the Truss mini budget. It created gridlock in mortgages and as such cancellation rates went up and people searching for houses went down. That gridlock has now started to ease again and should continue to do so. The next market pressure is affordability and that needs some time to reset to new interest rate levels but it doesn't change the supply/demand dynamic longer term. If house prices fall in the region of 8-12% that isn't great for house builders but it doesn't justify sub 0.7* book values for businesses in net cash positions. Cost inflation is then the next issue and I believe we are past the peak on that now. look at YoY of Steel -63%, Lumber - 42% etc. Once energy costs roll over too input inflation could look benign.

Combine the above and what I expect to see is pressure on margins and overall revenues, thus lower EPS. This will likely lead to less special dividends but still quite high yields from normal divi's as I expect house builders to stay profitable just with margin contraction.

In my view I see house builders around trough levels. I think the cost inflation, house price falls, interest rate rises, margin contraction and lower divi's are factored in. What wasn't factored in was the mortgage gridlock / withdrawals. As a consequence I see a stepped recovery from here as each issue fades but will clearly take some time.

GreyInvestor - I too bought Secure Trust Bank (LON:STB) recently but I am being reminded frequently at the moment that the market knows more than I do most of the time, and the chart is giving me only a very weak buying signal - the price could easily drop 10% from here - so I have been watching like a hawk and wondering when their next reporting date is. There is no financial calendar on their website so I sent an email to the published address for enquiries saying I'm a shareholder and asking that question but they haven't replied. If they don't reply today I'm going to phone the Company Secretary on Monday.

Good idea. Stephen Cohen is no lightweight as an investor….

brads13

I think it is because bilateral double tax treaties set out the residency rules and the taxing rights of the respective countries based on the location of the entities and the type of income. And treaties override national law, unless you rip up the treaty with all the associated consequences of withholding taxes, tariffs and trade barriers. A bit like mini-Brexits all over the world and making a UK listing long term unattractive for a windfall tax of a few billion.

mojomogoz

Good to meet a number of you at Mello Wednesday and Thursday....and cheers for a few beers (I suspect I'm in beer debt to lurker Bill).

Also very good to meet our leaders Paul and Graham...keep it up...and given goings on in the evenings somewhat amazing that the show kept rolling in the morning ;)

Until next time, ciao.

jonthetourist

Us old folks got it

Persimmon increasing the cladding provision from £75 to 350 million is a bit scary for the balance sheet.

Antehelion

i'd strongly recommend doing a mystery shop for STB, I tried to create a savings account with them and was horrified at the 1990s experience. I think the numbers look good, but I wonder at what point they will cut themselves out of market share, the lean digital only startups like Atom are on a totally different level in terms of ease of use and appeal to anyone under the age of 70 (imo)

The Boon Fund

I missed the Legal & General (LON:LGEN) opportunity last month as it did trigger my buy alerts, but I passed because I was too worried of over-exposure to one industry in my portfolio; I hold Phoenix group (LON:PHNX) and they are already my largest holding, more than 10% of my portfolio.

But Phoenix has also risen so I have benefitted, so I can't complain.

On claims spike - I am thinking that we are maybe about to enter a multi-year cycle of increasing car insurance premiums, what with the rise of used car prices now baked in, as well as more claim volumes. This should encourage switching behaviour, as more customers balk at the increases at renewal. Moneysupermarket.Com (LON:MONY) might benefit. Although they will now also see another year of zero-energy-switching due to the extension of govt support after Apr23. Unless gas and elec prices collapse, which could happen in a worldwide recession. Food for thought.

(I hold Phoenix in the Boon Fund)

garbetklb

19th Nov '22

But Legal & General (LON:LGEN) & Phoenix group (LON:PHNX) don't write motor (or other non-life classes) as far as I'm aware..

Small Cap Value Report (Fri 18 Nov 2022) - GLE, NAR, LIO

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Paul Scott

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