Small Cap Value Report (Fri 20 Mar 2020) - ZIRP And No QE, FUTR, CMCX, FOXT,TRCS, CTO

20th Mar '20 by Graham Neary

125 comments 11909 reads

Morning folks,

Some updates this Friday:

Future (LON:FUTR)
CMC Markets (LON:CMCX)
Foxtons (LON:FOXT)
Tracsis (LON:TRCS)
Tclarke (LON:CTO)

Timings: finished at 14:40.

Central Banks to the rescue - Zero Interest Rate Policies (but no QE)

Perhaps I shouldn't complain, since this news may have helped to erase some of the losses on my long FTSE trade.

Let's just spend a few moments reflecting on the latest act of monetary desperation.

The new Governor of the Bank of England, Andrew Bailey, has presided over the second emergency rate cute in a week.

Already this month, former Governor Mark Carney erased the two 25 basis point increases he made in 2017-2018 by announcing a 50 point cut in Base Rate.

That decision brought us back to the all-time low of 0.25%.

It's not enough, and the new Governor wants an even more extreme stance to deal with the Coronavirus-related financial panic.

From the Bank's statement:

Over recent days, and in common with a number of other advanced economy bond markets, conditions in the UK gilt market have deteriorated as investors have sought shorter-dated instruments that are closer substitutes for highly liquid central bank reserves. As a consequence, UK and global financial conditions have tightened.

At its special meeting on 19 March, the MPC judged that a further package of measures was warranted to meet its statutory objectives.

The result: a cut in the interest rate to a fresh all-time low near the zero bound, at 0.1%, and £200 billion in additional QE.

"When all you have is a hammer, everything looks like a nail" - this is my analysis of the BoE's decision-making process. They are able to cut rates and buy bonds, and so that is what they do whenever the financial markets are scared.

If we weren't already near the zero bound of interest rates, I am certain that they would have cut rates by at least 25 basis points. Maybe even by 50.

But the Bank is not yet ready to announce zero or negative interest rates. Can you imagine the public reaction when they do that?

It can't be too long before they capitulate. Remember that the ECB is stuck at minus…

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smatthews1

20th Mar '20

Hi Graham, first of all your reports are currently very valuable right now, so very much appreciated and thank you for your time.

Could I ask, maybe for a future post, if there is a chance you could breakdown how you would forecast any down turn in future trading and cash burn on a basic level, appreciate each company needs to be treated individually, but given that there are so many changing dynamics at the moment this is proving to be quite tricky.

For example, just this week alone we have heard support from the government in the form of 3 month mortgage holidays, reduced business rates, deferred TAX bills, guarantees, interest free loans and now they are willing to pay up to 80% of wages and no limit to the business's that require help. Absolute unimaginable and extraordinary times.

Which leaves me begging the question, how on earth do you factor all of this lot in to future projections?

Stay safe, have a great weekend.

xcity

In my view there has always been a gaping chasm in the benefits system - if you are a very low earner then your lifestyle perhaps doesn't change too much if you lose you job as the gap between benefits and job income whilst growing is not massive.

However, if you earn a little bit more the sudden drop in income is a massive hit and if you have been prudent and put by some savings you will only get minimal help.

All the discontinuities in payments are problems plus the non payment issues like eligibility for free prescriptions etc. Moving to a single integrated system should have been a good first step if the Treasury/Osborn hadn't ruined its implementation by making people initially worse off.

And every waiting period makes the system dysfunctional. It's always a risk for someone established on benefits to take a job when employment may be intermittent. Zero hours contracts likewise.

tic_tac_toe

does this help?

judywil

21st Mar '20

The HL app is great - very simple to see your portfolio and sell and buy

Hot Socks

Don't think the govt had much choice but to pay at least some of people's wages for all the reasons you give. They will have to do the same for the self-employed shortly.

But covid 19 is a supply side as well as a demand side issue. Paying those who cannot work may maintain demand to some extent but it won't replace supply at all. More demand than supply = inflation? Or at least inflation for those things that people can still afford to buy while in lock down.

afaics most people, including investors, are vastly underestimating the scale of this situation

The original plan, being followed by a number of governments as well as ours, was effectively to delay spread (so there was some chance of letting the NHS cope), let the virus run through the less vulnerable part of the population and isolate the vulnerable so that they avoided infection until herd immunity was achieved. It had the big advantage of a built in endpoint to the crisis and also the lowest economic cost. And the huge disadvantage of a very large number of deaths, most in a a period of months.

That became politically untenable and so they switched to suppression. This minimises the number of deaths in the near term but doesn't do much to reduce the total number of deaths in the absence of an effective treatment, vaccine or the virus waning spontaneously. And it pretty much maximises the economic hit. I've not seen anyone suggest that a vaccine could be ready in less than twelve months. It's going to become harder and harder to manage and behaviourally I see little possibility of a tightening and loosening of restrictions. This approach probably increases the risk for the vulnerable population (even if it is only through isolation of a virtually unlimited time). German estimates still have 80% of the population getting infected at some point.

I don't know which plan was best, but the government appears to have been governed by advice on both. I don't believe the government had any political choice but to switch plans given the media and the preponderance of European countries (and WHO) going for the suppression approach. If we have an effective treatment in less than a year, it was clearly the right decision. If we don't find a successful vaccine or treatment in less than three years (maybe two), we will have done a lot of economic damage with nothing to show for it.

From an investment point of view, the second plan implies that virtually all companies (and their debt) have no value, in the absence of support from the government. Their assets will have little value either, so balance sheets aren't as critical as they might be in more normal circumstances. But cash won't be worth anything either, so selling doesn't help much. Gold is better than cash (can't be printed), but not by much (a medium of exchange has no value in the absence of exchange). The value of any of these will depend on government action (and the actions of other governments).

We appear to be lucky with Boris/Rishi. Corbyn/McDonnell would have used it as an excuse to nationalise virtually everything with no compensation (I can imagine them enjoying party meetings in Revolution Bars); May/Hammond would have been very loath to spend money on the scale required.

Actions so far appear to indicate a desire to maintain the economy in a state to bounce back quickly when the crisis is over - and thereby supporting many businesses who would otherwise be bankrupt fairly quickly. I would be unsurprised to see a moratorium on debt repayments at some point. But they have also shown some willingness to nationalise (railways) or take large equity stakes (mooted for airlines) as a price for the rescue; I would expect the latter approach to be limited to large companies in selected industries.

The spending on laid off workers is substantial and ultimately underwritten by the printing press. By reducing the value of the pound in everyone's pocket it effectively spreads the cost of the crisis to the whole population rather than only those who have lost their employment. I approve.

But it is very hard to calculate what a share might be worth when so much depends on decisions the government hasn't even thought about yet.

More demand than supply = inflation? Or at least inflation for those things that people can still afford to buy while in lock down.

Inflationary, but with a possibility of no inflation. Demand will be lower (less money to spend, greater anxiety about the future, asset values down). Oil price already halved, other raw materials down too (demand down, fairly rigid supply).

peterg

22nd Mar '20

One of the key points about supression is exactly that it aims to reduce the total number of deaths by increasing the options for treatment, by minimising overload of health service. That is likely to be a major effect.

Rusty2

Yes that's true apart from food. Will imported food prices rise as we import quite a bit from countries such as Spain but much of that is closed down, so there could be shortages. Less flights so difficult to import goods and prices will be higher. If farms here have staff shortages then our own produced food could rise in price also.

Depends on what you call major. NHS capacity will be overwhelmed in either case. As will all health services. Health staff are clearly particularly vulnerable through quantity of exposure and stress impact on immune systems - see China and Italy data. Vulnerable patients are most likely to die; lengthening the crisis means that isolation throughout becomes harder and their infection risk rises. Lengthening the crisis also means a longer period of other conditions being less treated and a higher death rate from them. The big health gain is for the less vulnerable who are more likely to be able to access full treatment whenever they catch it.

China's coping in Wuhan was not only based on a total enforced lockdown, but also on being able to import very large numbers of health staff from elsewhere in the country.

I agree that health service will be overwhelmed whatever route is chosen, but it makes a lot of difference to survival rates if they are overwhelmed by a factor 2-5 or by a factor of 20-50, or more.

Only if everything else remains equal. The published model has no endpoint for suppression and assumes NHS capacity is entirely related to IC, ventilators and coronavirus impact.

What you should be looking at isn't extent of undercapacity but the total quantity of cases whose needs can't be met. It's quite hard to model the shape of that curve with suppression (and not exactly easy with doing nothing). And you need to build in a decline in staff capability after a period of overworking. If you've ever worked in any of those environments you will know that you can only keep pushing and pushing for so long before people start dropping like flies. I believe that the postulated difference in total deaths is exaggerated in the absence of a cure, early vaccine or spontaneous waning. I don't think that there was any choice other than switch to suppression, but I'm not confident it will make a substantial change to total deaths, though I do believe it will reduce the number of deaths in the less vulnerable.

I saw on the news last night the NHS now has 8,000 more beds, and 20,000 extra staff, as has use of private hospitals, so that changes the picture somewhat.

Hopefully hospitals now the flu season is passing will have slightly less pressure also and it was a mild winter.

I'm watching what happens in Italy, I think their cases will start to level off in a week or so.

Certainly good news, and clearly there are and will be more improvements, as hospitals rearrange themselves and, hopefully new equipment arrives. However, total NHS beds, prior to this, are 142,000, so while 20k more is very welcome it's not going to produce a fundamental change. Ultimately the things that will are a improved understanding of how to treat patients, possibly including use of existing drugs, and ultimately a vaccine.

I agree it is not enough but it will help, also intensive care should be increased significantly, we only had about 4,000 beds in the NHS. Some operations have been cancelled, so that should free up some beds also. Italy is just about coping but their problem is it's mainly in one area, at least in UK it seems more wide spread.

dtg46

Xcity's analysis of past events seems to me to be about right however they do clearly show a lack of consistency of approach.... And that continues, sun on Wednesday doom on Sunday. With that in mind and the feeling that the Government is constantly merely responding to the latest pressure group gives me no confidence whatsoever it is possible to make a reasonable prediction of short or medium term share prices (or run a business!) The 80% under-righting of salaries is far too great and will delay necessary adjustments. It is clearly unfair on those required to continue to work including NHS staff and in addition it will also significantly encourage pressure on the existing lower skilled self employed by allowing heavily subsidised moonlighters to enter that world.

As far as investing goes maybe for once investing will truly be a long term matter only for those with strong stomachs, nerves and finances. Like all wars this one will eventually accelerate change so look to companies with real intellectual value, skills or competitive advantages as the Government bumbles its way through. Finally remember equities are high risk/rewards instruments and at present the risks and rewards are pretty extreme so diversify your risk.

dscollard

Tomorrow looking grim again.
ASX down 8% , FTSE futures -6 5%, US has hit limit down on futures so frozen. Japan is down over 7% , gold is weaker while the Dixie keeps going higher

Greenback cash is still king for now

Mnomis

23rd Mar '20

Chris, if you look at their valuation metrics in 2007 (height of a bull) vs now (when been hit by FCA), I think you will re-consider. Buying a share at a reasonable valuation that can do +40% revenue in a global recession sounds like a winner to me ...

John McArthur

22nd May '20

Graham,

Regarding your commentary on Tracsis:

"...Tracsis made an acquisition that cost c. £16 million in cash, using its reserves."

No, they didn't. As was made clear in the March RNS Tracsis bought iBlocks with £12.5m of cash, issued them another £1.5m of stock and also gave them the value of their own net current asset balance sheet which was basically the cash and debtors they were already sitting on. The net outgoing of cash was £12.5m not £16m leaving in excess of £12m as cash reserves.

"It might cost up to an extra £8.5 million in contingent consideration over the next three years. Excluding the company's other cash flows since July, the Tracsis cash balance has therefore reduced to c. £8 million.""

Your numbers are wrong and the reference appears to suggest that the deferred contingent consideration is somehow a burden on the existing balance sheet. It isn't. As with just about every Tracsis deal, the contingent element is self funded from the profit generated by the newly acquired entity and payable as a profit share. If it ends up getting paid (which I sincerely hope it does) then Tracsis will be reporting an additional >£10M of profit and paying back £8.5m of this to iblocks. The deferred element is therefore irrelevant to Tracsis’ going concern/financial strength position. I do wish analyst’s would get this right – we’ve made 14 acquisitions to date and they all follow the same general structure!

"It's also possible that Tracsis could borrow, if it had to, in order to get through this situation."

Yes, that is true but there is no ‘situation’ to get through given the business has ample reserves and the larger point you fail to mention is that in 13 years as a PLC (which started well before the last financial crisis) the business has raised just £4m from public markets and never had a penny of debt. I would suggest raising debt or equity would be a formality if the company needed to (it doesn’t!) but in the meantime it has no debt to service which is in stark contrast to many other companies on AIM.

"It would be far easier, however, if last week's acquisition could somehow have been postponed."

This is a trite comment made with the supposed benefit of hindsight. The specific timing of our last deal (March 10th, the day before the Chancellor's budget) was deliberate and designed to avoid a potential risk that has been brewing for many years that relates to Treasury’s increasing dislike for entrepreneurs relief.

As it turned out the Chancellor did indeed change ER which now significantly reduces the benefit to company owners on disposal (effective March 11th). Had we waited/deferred the transaction, not only would we have created a huge amount ill with management - potentially killing a great transaction completely - but we would have also have had to pay the extra cost related to the changes in tax legislation to the tune of several £m (unsurprisingly, entrepreneurs are not going to accept less cash in their pocket due to a delay caused at the request of the buyer).

Rather than lament poor timing, Tracsis should be applauded for getting this deal done, and utilising surplus cash to acquire another very profitable software company in their target domain. Even with the benefit of hindsight we wouldn’t have changed anything about the deal or the timing.

I hope this clarifies.

Regards
John

22nd Jul '20

As a quick follow-up to my previous post from 22nd May Tracsis put out a trading update RNS on 9th July.

To anyone who follows this business, I would draw your attention to the following:

- Cash balances have risen to £16M since the acquisition of iBlocks which was announced on the 11th March. This reinforces the long held view that the business has excellent cash generative revenue streams.

- The year end revenue guidance is now circa £46M which management allude to being £10m less due to the impact of Covid. 2019 full year revenue was £49M so had Covid not happened the business would have been on track to deliver £56M (>15% growth on last year). A sub 10% hit on revenue this year seems like a very good outcome given the obvious impact to UK transport and a widespread cancelling of most summer events within the UK.

- The technology side of the business continues to trade 'very well' with revenue underpinned by 'high levels of recurring software revenue'.

Regards
John

Small Cap Value Report (Fri 20 Mar 2020) - ZIRP and no QE, FUTR, CMCX, FOXT,TRCS, CTO

Central Banks to the rescue - Zero Interest Rate Policies (but no QE)

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Graham Neary

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