Small Cap Value Report (Fri 23 April 2021) - FUL, PHTM, BOOM, REC

Good morning, it's Paul and Jack here with the final SCVR for this week.

Timing - today's report is now finished.

Agenda -

Paul's section:

Fulham Shore (LON:FUL) - strong trading in first week of re-opening. Upbeat about the future. I like it, but it's looking fully or over-priced.

Photo-me International (LON:PHTM) - a big rise in profit guidance, thanks to a surge in activity in Japan, driven by Govt action. Looks worthy of a closer look, but I still find it impossible to value, due to uncertain long-term outlook for photobooths, and lack of divisional breakdown of other activities.

Audioboom (LON:BOOM) - good revenue growth, but it's only just reached breakeven. >£100m market cap is factoring in a lot more growth. Definitely not my type of investment, but I bounce around ideas as to why it might appeal to speculators in a bull market.

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Jack's section:

Record (LON:REC) - ongoing fee pressure in core Passive Hedging product but growth in (smaller) higher margin products and good inflow momentum from this outsourced currency manager.

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Paul's Section

Fulham Shore (LON:FUL)

16.0p (pre market open) - mkt cap £99m

As with so many shares at the moment, I’m very surprised the valuation of FUL has run so high, before it’s even properly re-opened. Yes, it’s likely that the company and other hospitality companies are on the cusp of a bonanza, as newly freed customers want to enjoy eating & drinking socially again. But does that really justify the price now being c.50% higher than before covid? Maybe people think it does, I’m just asking the question, and can’t see it being reasonable myself.

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I have to laugh, as less than a year ago, I remember quibbling over buying at c.6.5p, thinking it was too expensive! If only I’d had a crystal ball back then.

Re-opening step 2 - for hospitality this meant outside spaces only, happened on 12 April, only 11 days ago. Therefore, FUL giving us an update today, suggests they’ve traded really well - companies are usually eager to get good news out fast, whereas bad news takes longer.

So I’m pretty sure this update is going to be good, without even having read it yet!

Trading Update

The Board of Fulham Shore (the "Board") announces the following update on trading, as well as an update on new restaurant opportunities.

Current operations -

As of today, Fulham Shore has re-opened 70 out of its 72 Franco Manca and The Real Greek restaurants for various combinations of al-fresco dining, delivery and collection services. The restaurants' terraces are operating as much al-fresco dining as possible. Currently, 37 out of the 52 operational Franco Manca pizzeria and 16 out of the 18 operational The Real Greek restaurants have outside tables.

A reminder that FUL has done well from delivery & collection over the pandemic, which could be a reason why the shares have up-rated? Possibly investors might be thinking that the pandemic has made the business better, by developing its takeaway and delivery channels?

First week’s trading - has been excellent, being ahead of the comparator week in 2019 (since 2020 not comparable due to lockdown 1). That’s remarkably good, since no indoor seating was available. It must vary a lot from site to site, e.g. the Real Greek in Bournemouth has a large outside terrace, whereas the Franco Manca in Islington only has about 3 small tables outside on the pavement.

Pent-up demand is very much in evidence, and in my view, likely to increase as the weather becomes warmer -

These trading results were achieved without any inside seating and our colleagues in the restaurants deserve great credit as demand has far exceeded the number of seats available at peak times.

New sites - this could be another reason why FUL shares are expensive - that it is actively seeking out new sites to expand, boosting future profits (if they chose the sites well, and don't over-pay). As we know, and the company has previously indicated, very attractive deals are currently on offer from landlords, desperate to fill empty units. There’s another benefit at the moment too -

Many of the restaurant locations we are seeing are available as a result of insolvency events and, as a result, are typically pre-existing fitted units. Sites of this nature have a lower opening cost to the Group compared to shell units. We therefore expect a reduction in the Group's average capital expenditure per new site in the short term, and that this should improve our return on capital.... The Group continues to be presented with a number of excellent potential retail locations, almost on a daily basis.

They're spoiled for choice, which is a wonderful position to be in. In my experience, retail/hospitality that can expand in times of widespread business failure, often sow the seeds for a highly successful business in the future. Because they can pick up good sites, for a song, in a recession. Landlords often also give long rent-free periods, and capital contributions (reverse premiums), which can make expansion self-funding, i.e. requiring little to no capex once the landlord contributions are netted off.

Outlook -

The Board believes that the next few months may be the most exciting in the Group's short history and looks forward to opening our restaurants fully once permitted and capitalising on the property opportunities that are being presented to us.

I think they are right to be excited. Businesses that have survived the lockdowns intact, and have funding available for expansion, are set for a very buoyant period of trading, in my view.

The game-changer (we hope) is the successful vaccinations programme. The latest UK data on that looked highly encouraging, with less than 3 dozen confirmed cases of vaccinated people being hospitalised from covid, out of 74k between Sep 2020 to Mar 2021. Providing no disastrous mutations occur, then it seems possible we might have seen the last lockdown, but let’s not count our chickens. That’s what the stock market is clearly thinking, otherwise valuations wouldn’t be this high. Plus, the Government is saying that amended vaccines (to take into account mutations) are already being worked on. So it seems likely we’ll get booster jabs in the autumn/winter, and probably as a matter of routine every year in future.

My opinion - it’s all good, and as I’ve mentioned many times here over quite a few years, I really do rate FUL as a decent business, with good restaurant formats that are nicely differentiated (as opposed to the “me too” pizza/pasta offerings from e.g. the Kayes, and others who still seem stuck in the 1990s).

For valuation purposes, I’m increasingly using peak earnings pre-covid as my starting point, then checking for (and adjusting if required) for any dilution during the last year from placings. A higher number of shares, means lower EPS (earnings per share).

FUL did a smallish fundraising, and its share count seems to have gone up from 583m to 619m currently, up about 6%. So 16p per share today, is the same valuation as 17p before the fundraising, not a huge difference. And of course armed with more cash, the business is arguably worth more after a placing.

I think peak earnings valuation method is more reliable than looking at broker forecasts, which still seem to be all over the place. Many brokers seem to be far too pessimistic in recoveries, as they are at the moment, which provides us with some nice opportunities, especially in smaller caps where research is thin on the ground and can be difficult to obtain.

Another way to value shares is on an EBITDA multiple. I was reading a report, suggesting that private equity deals in the hospitality space are typically being done on about 11 times EBITDA. FUL produced £7.8m in EBITDA in its last pre-covid results FY 03/2019, giving £86m enterprise value. The market cap is £99m currently, so allowing for a bit of debt on top of that, EV would be well over £100m currently. However, the valuation just about stacks up if you factor in a year or two’s growth in profits.

Personally, I’m pretty disciplined about my buying prices. Hence I just won’t overpay for anything, which does mean missing some opportunities in a bull market. However, it also means (usually!) avoiding gut-wrenching losses, when valuations reset to more rational levels in a market correction. Value investors don't tend to panic sell in a correction, whereas momentum traders do, because they use stop losses - that makes the corrections worse for the more speculative shares. The 1987 market crash happened because of automated sell orders, for example.

There is scarcity value for hospitality sector shares, which could also explain why prices are high currently.

Who knows where the FUL share price could go? It seems a market driven by optimism, momentum, and speculation. Sooner or later though, that kind of market runs out of steam, then valuations reset to be more driven by fundamentals.

For what it’s worth, I think FUL shares look (at 16p) valued at the top end of what can be justified by fundamentals. If you look at the long-term chart, it has traded sideways for long periods of time, after becoming over-valued in the past, and that's the trouble when you buy after a long rally - you could be buying at or near the top, and then sit on losses for a long time afterwards.

Overall, I really like the fundamentals of this business, but the shares look fully or over-priced to me, hence are not of interest.

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Photo-me International (LON:PHTM)

69.6p (up 6%, at 09:31) - mkt cap £263m

There’s been a positive market reaction to this update (up 6%), so I’ve moved it up our running order.

Here are my notes previously from March 2021, when I reviewed its FY 10/2020 results & outlook, concluding that it was impossible to value this share because we’re not given a breakdown of performance by division. Also, profit guidance from PHTM of £9m profit before tax (PBT) for FY 10/2021 seemed lacklustre for the valuation.

Trading Update

Photo-Me International plc (PHTM.L), the instant-service equipment group, announces an update on the Group's trading position.

This is for FY 10/2021, and it sounds positive -

In the first five months (ended 31 March 2021) of the 2021 financial year the Group performed better than expected, driven by stronger than anticipated trading momentum in Japan due to an increase in applications for the My Number card, the Japanese government's social security and taxation photo identification card scheme….

Consequently, the Board has revised its expectations for the financial year ending 31 October 2021 and is pleased to announce that it now expects to report revenue of between £190 million to £200 million (previously £175 million) and profit before tax of between £15 million to £19 million before exceptional items (previously £9 million before exceptional items).

Outside of Japan, trading in the period was in line with the Board's expectations. The Group's multi-country restructuring plans to improve profitability are on track to complete at the end of April 2021 and vaccination programmes continue to provide encouragement…

It goes on to say that covid uncertainty continues, and is important because France is “a major contributor to the Group’s results”, plus threats of renewed lockdowns in Japan and Germany. My feeling on that, is that the EU seems to be starting to get its act together, belatedly, with vaccination programmes, according to figures in a recent press article I saw a few days ago. Hence hopefully these issues could be temporary.

My opinion - this is a big upgrade in profit guidance, from £9m previously, to £15-19m today. I think that is good support for a share price that has bounced strongly this year.

My problem remains, that I don’t know how to value this company. In a way, today’s upbeat reinforces that problem - Govt action in Japan has spurred increased activity of PHTM’s photo booths, but how long will that last? Is it temporary, or permanent?

Will the newer activities (laundry machines, bank self-service kiosks, fruit juicing machines) be able to make up for likely long-term decline in photo booths? Might photo booths last longer than we think? So many uncertainties.

Overall then, this is a very nice update today for holders of the shares, with a big increase in guidance.

The long-term chart below is interesting. It had a much higher peak during the tech boom in 1998-2000, when it spiked up to 375p, which is just off the page on the left. I can also remember this share being as low as 10-12p several times. So it has a long history of crashing in price, when people write if off as old economy fag butt type of share. Then it surprises with its resilience & cash generation, and there’s a burst of excitement, it multi-bags, then drifts back down again. Hence I think this is a very nice share for traders, if you are good at market timing!

This time around, could this share have legs up to 100p? I think that looks possible. Especially if it reinstates divis at some point, and if the re-opening news from France is good later this year. The burst of activity in Japan is worth investigating - if that is likely to continue, then it could be happy days for PHTM shareholders.

Overall, it's quite interesting, and more interesting after today’s update, but I still have no idea how to value this share, so declare myself neutral.

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Audioboom (LON:BOOM)

695p (up 5%, at 10:58) - mkt cap £109m

Trading Update

For background, I reviewed AudioBoom’s FY 12/2020 results here. Reading through those notes to refresh my memory, the 2020 figures showed a reduction in losses, and a not very good balance sheet. But the outlook statement did look interesting, with >80% of FY 12/2021’s revenues already booked in with advertisers. Speculative, but not a complete basket case, was my conclusion just over a month ago.

Today’s update - remember this says revenues, not profits (or losses in this case) -

Revenue expected to be significantly ahead of current market forecasts

Audioboom (AIM: BOOM), the leading global podcast company, is pleased to announce that it has continued its strong sales momentum, with signed advertising bookings for the year now representing more than 95% of the recently upwardly revised market forecast for revenue in 2021.

In light of this continued strong trading and the prospects for the months ahead, the Board now expects that Audioboom will generate revenues significantly in excess of the current market expectations for the year and an increased adjusted EBITDA.

That does sound encouraging.

More detail is given, saying that revenues are being driven by content creation. That’s fine, but content costs money to create.

Revised forecasts - many thanks to Allenby for providing us with an update note today. This shows a 10.5% increase in forecast revenues to $41.4m.

Adj EBITDA rises from $51k, to $118k - so it’s more than doubled from diddly squat, to diddly squat. Adj PBT is forecast at $18k - about the same as one person doing a minimum wage job.

It’s valued at over £100m.

OK, it’s not fair to value a company on a breakeven year, the question is whether it can scale up and become profitable in future? Then the company might become valuable. Adj profit of $1.0m is forecast for 2022.

My opinion - Audioboom is now generating meaningful revenue growth, which is clearly good news. But its gross margin is low, so there’s not much operational gearing, which is the bit that makes growth companies exciting.

There are so many podcast platforms, that I don’t think users particularly care which platform a podcast is on, and ads are annoying.

If this is the (long-awaited) start of exponential growth, then this share could get exciting though.

In buoyant stock markets like this, there are lots of new entrants, who open trading accounts, and generally go for growth companies, often story stocks. Because these companies are often loss-making then you don’t have to worry about crunching any numbers, or valuation, and you just buy anything with a good story and a rising chart. There’s nothing wrong with that, in the euphoric bull phase of a market, and people can make a lot of money quickly. The trouble is, when the music stops, it’s a long way down for shares where the fundamentals don't support the share price, once sentiment turns negative.

Hence for me, personally, I tend to avoid this type of share. Having said that, we’re in a lovely euphoric bull market, so there’s money to be made, if you can get out before things collapse, which could be a long time, who knows? A few of these small, speculative companies could do well, longer term, but most don't.

BOOM is now at breakeven, so hopefully it shouldn’t need to raise more equity, or not much % dilution if it does. Therefore it’s a much more sensible-looking share than say a couple of years ago, when it looked doomed to failure.

Overall, it doesn’t appeal to me, but if you buy into the growth story, and think it can become decently profitable in future, then who knows, it could do well? >£100m market cap is already factoring in quite a bit of success though.

This is the type of share where some investors buy a basket of similar shares, knowing that most won’t work too well, but one might become a monster success. A perfectly valid strategy, especially if you can de-risk things by top-slicing on the way up & running the balance at nil cost. Although American stock markets are a much better hunting ground for investors with that approach.

Note the 3-year chart below - the market has clearly decided this share is going places, so well done to holders. Nobody ever went bust by top-slicing a bit, after that kind of move.

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Jack’s section

Record (LON:REC)

Share price: 78.5p (pre-open)

Shares in issue: 199,054,325

Market cap: £156m

Record (LON:REC) is a leading currency and derivatives management firm, with assets under management (AUM) for pension funds, foundations, and other institutional clients worldwide. The group’s services include Bespoke Currency Hedging, Currency for Return, and additional currency solutions and consulting services.

It is notable for its Quality metrics.

The business was established in 1983 by Neil Record who previously worked at the Bank of England. He is currently the chairman and biggest shareholder, with nearly 30% of the business - but he did sell 4m of shares last September, so it’s possible he might be looking to reduce his stake over time.

It has grown over the years by hedging for corporate and institutional clients, with mandates including the world’s first stand-alone currency hedge in 1985. So there is a precedent for innovation there.

Since 2009, it has been diversifying its range of products and services in response to fee pressures in its Passive Hedging segment.

Actual asset management is experiencing margin compression, so I’m curious to see whether an outsourced currency manager occupies a more resilient market position, or if it will end up suffering similar headwinds. It looks like the latter.

The Group has four principal reporting lines:

• Dynamic Hedging, where Record seeks to eliminate the impact of negative currency movements on elements of clients' investment portfolios but participate in the positive movements;
• Passive Hedging, where Record seeks to eliminate fully or partially the economic impact of currency movements;
• Currency for Return, in which Record enters into currency contracts for clients with the objective of generating positive returns; and
• Multi-Product, where the client mandate includes combined hedging and return-seeking objectives.

Fee pressures aside, this does have some of the hallmarks of a quality compounder, due to the high margins, large market, and presence of a founder-owner. It’s also a high Ranking Financials stock that could play a useful role in a diversified portfolio.

The shares have been very strong recently and, as with many stocks at the moment, there has been a strong rerating here. Record was just above 30p back in September 2020 and now it is approaching 80p.

The forecast PEG is just 0.5 though, which is a promising initial sign.

Q4 trading update

The group reports two distinct periods: the three month Q4 and the twelve month FY21 that this caps off.

AUM grew by 7.4% in the quarter and by 37% for the year to $80.1bn (£58.1bn), including net inflows of US$9.7bn.

In terms of quarterly progression in AUM across the group’s products:

• Dynamic Hedging was up 16.3% to $9.3bn,
• Passive Hedging was up 6.2% to $61.5bn,
• Currency for Return was up 8.3% to $3.9bn,
• Multi-Product was up 6.2% to $5.2bn, and
• Cash & Futures was stable at $0.2bn.

We can see that Passive Hedging strategies are responsible for 76.8% of the total $80.1bn AUM (compared to 77.6% in the preceding quarter). This is where the fee pressure is.

Dynamic Hedging and Multi-Product are higher margin, so a step up in growth here is something to watch out for. And it does look like, over the twelve month period, inflows were encouraging in this regard.

Diversified AUM net inflows in the year of US$2.1bn into Passive Hedging, and across our higher-margin Dynamic Hedging (US$6.6bn) and Multi-Product (US$1.0bn) strategies.

Most of the segments (barring Cash & Futures, again stable at 0.2%) also had quarter-on-quarter inflow growth. Record enjoyed inflows of $4.9bn over this three month period ($3.7bn of which came from Passive Hedging), so it looks like there is healthy demand for its services.

The group closed its Dynamic Macro Currency and Global Macro strategies to focus resources in higher growth opportunities.

Client numbers grew by +17 (24%) to 89 in the twelve months and by +10 in the last quarter alone.

The group has also set up a new EM Sustainable Finance fund, which is expected to launch in the current quarter and will have an initial size between $200m and $500m.

This product has been developed in collaboration with one of the largest wealth managers in Switzerland, and offers higher margins, product diversification benefits. Record intends to actively increase its presence in the fast-growing ESG and sustainable investment market.

Leslie Hill, Chief Executive of Record plc, commented:

Whilst the growth to date has broadly been across our core suite of currency products and services, inflows into our higher-margin products including Dynamic Hedging and Multi-Product have changed the revenue mix, reducing the dominance of our lower-margin Passive Hedging products over which we expect to see continued fee pressure in the future.

Conclusion

There is some succession planning going on but it all looks like it’s being carefully managed ahead of the event.

Can you maintain an edge in forex? That’s a question. At the more passive end of the spectrum business looks tough but this is a huge global market and my initial hunch is that there is scope to continue adding value for more active clients and with innovative products.

This requires an ongoing and significant shift in AUM into higher margin products with a brighter future. If it can continue this shift then there could be an opportunity here, but it will need to attract a lot more AUM in order to really move the dial.

But the group is well positioned with a robust balance sheet, long-standing and strong client relationships, and an experienced team. So if it can seize the opportunity then I imagine this could be an extremely scalable opportunity.

So it’s worth checking out in a little more detail, even after the strong share price run, although at these prices you are now relying much more on future growth than existing value.