Small Cap Value Report (Fri 26 Feb 2021) - SLP, AVAP, VARE, JUP, DOTD

Morning, it's Jack here with the SCVR for Friday. Paul's a little busy today but might be able to pop on later. If you have any suggestions on what to cover please do leave a comment.

There were some intriguing companies pitched at this week’s Mello Bash. Stephen English did a great job with Intercede, which Paul also owns, and Bruce Packard pitched Sylvania Platinum (LON:SLP) , which I hold. Simon Thompson has covered this PGM producer recently, raising his target price to closer to 200p. It’s also been tipped in the Momentum Investor newsletter.

At this rate, if you stopped your postman in the morning for a chat (socially distanced, of course), he or she would probably end up tipping SLP as well before wishing you good morning.

The stock has had a remarkable run of late, pushed ever higher by surging Rhodium spot prices. SLP said in its recent corporate presentation that increases to its basket price are being driven by Rhodium and Palladium. While Rhodium makes up just 12.7% of SLP’s prill split, it is currently responsible for generating some 60% of revenue.

Source: Interim Results FY21 Corporate Presentation

With autocatalyst industrial demand set to recover, minimal price elastic supply, and a lagging demand response, prices can go higher still. Rhodium was below $3,000 in January 2019 but hit a new record of $17,000 at the end of December 2020. Today, the spot price is closer to $24,000.

It’s worth remembering that Stephen English had some timely words of caution at Mello around the sustainability of these prices. There are always two sides to the argument.

But more and more we are seeing this narrative of a ‘commodities supercycle’ beginning to take root. Is there something to this, or is it just noise? It doesn’t mean you should go mining mad if that’s never been your strategy, but for more sector agnostic investors it presents an interesting portfolio allocation question.

It would be great to get people’s thoughts on this part of the market, and commodities in general - even if that view is you continue to stay away and focus on areas you know better.

Agenda:

Avation (LON:AVAP) - half year results from this commercial passenger aircraft leasing company

Jupiter Fund Management (LON:JUP) - net outflows but good underlying results from a modestly valued, dividend paying asset manager

Various Eateries (LON:VARE) - thoughts on a Leisure sector roll out vehicle helmed by heavyweight management team

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Jack's section

Avation (LON:AVAP)

Share price: 122.5p (+1.66%)

Shares in issue: 62,669,942

Market cap: £76.8m

Avation (LON:AVAP) is a commercial passenger aircraft leasing company. Its unaudited interim financial results for the six months ended 31 December 2020 are out today, with a chunky $60.5m loss before tax due mainly to impairments.

Highlights:

• Revenue and Other income down by 6% to $63.3m;
• Impairment loss on aircraft of $46.7m;
• Expected credit loss on receivables and accrued revenue of $12.9m;
• Loss before tax of $60.5m;
• Loss per share of 97.9c; and
• Net asset value per share is $2.38.

These are rough results and some substantial writedowns for what is just a £75.5m market cap company. In fact, compare that to the enterprise value of £759m and you see AVAP has a big net debt position. This debt is probably asset-backed by aircraft to a degree, but it’s still a figure that makes me cautious.

The Z-Score is also flashing, picking up on this large amount of liabilities and a relative lack of liquid assets.

The tone sounds fairly stretched, although no doubt management will be hoping to squeak through with a close eye on vaccine rollouts. AVAP is ‘focus[ed] on preservation of liquidity and cashflow’. And it really does need to focus on liquidity.

Rent deferrals of $25.9m have been provided to airline customers. Loan repayment deferrals of $31m have been obtained from secured lenders. An agreement has been struck with bondholders to extend the maturity of its 6.5% senior notes to October 2026, and capex and dividends have been temporarily suspended.

The pandemic related disruption to the airline industry has clearly impacted aircraft valuations. These impairments are largely related to aircraft leased to Philippines Airlines, Virgin Australia and Braathens who have all been subject to formal or informal restructuring processes.

This impairment loss dominates the financial result. But is this as bad as it gets? The company says it is unlikely that there will be further significant writedowns and that the underlying business remains profitable.

Conclusion

AVAP reports a loss before tax of $60.5m. It also reports unrealised losses, aircraft impairments, and expected credit losses of some $67.5m. These are non-cash, although the latter will at some point become cash. If you strip them out as one-offs then there could be an underlying profitable operation.

The group generated $24.9m in net operating cash flows, although it looks to be a very capital intensive business even in normal times. When net debt was steadily rising and free cash flow was negative, the group opted to increase dividends to shareholders. It’s not a combination I tend to trust.

But the share price was doing well before Covid, so perhaps there is an underlying growth story here.

The risks now are considerable though, even with light at the end of the tunnel. AVAP does have assets, but it also has over $1bn of debts, meaning net debt to assets of 77%. That’s high, and the cash flow characteristics in more normal conditions are not attractive.

It could be a high risk, high return recovery stock if you can get comfortable with the financing. The bond extension is a positive, and there will be acquisition opportunities assuming conditions normalise. But there’s a lot going on in these accounts and, given the material risks, I’ll move swiftly on.

Jupiter Asset Management (LON:JUP)

Share price: 296.6p (+1.58%)

Shares in issue: 457,700,000

Market cap: £1.4bn

Jupiter was established in 1985 and has grown to be a leading specialist asset manager through high conviction, active management.

The group now offers a range of actively managed strategies available to UK and international clients including equities, fixed income, multi-asset and alternatives. Assets under management (AUM) are at a record high of £58.7bn after its acquisition of Merian in 2020.

It’s got great StockRanks and has an attractive 6% forecast dividend yield.

Cash generation and returns on capital are strong for asset managers, but this profitability is attracting competition and many are seeing margins come down. This is leading to a period of consolidation. It’s a key industry dynamic to bear in mind.

Today the group updates the market with its year end results.

Results for the year ended 31 December 2020

Highlights:

• Acquisition of Merian introduced £16.6bn of AUM on 1 July 2020.
• 70% of mutual fund AUM above median over three years.
• Ended the year with AUM at a record high of £58.7bn.
• Underlying profit before tax increased by 10% to £179m but statutory PBT down by 12% to £132.6m, after exceptional acquisition-related costs.
• Underlying EPS largely unchanged at 28.7p per share. Statutory EPS was down from 27.5p per share to 21.3p per share.
• Ordinary dividend held at 17.1p per share and a special dividend of 3.0p per share proposed. The total dividend for the year was 20.1p per share, representing 70% of underlying EPS.

If you take the underlying EPS figure of 28.7p, that makes for an FY20 PE ratio of just 10.6x. That looks good value.

There are some flies in the ointment, but on the whole this looks like a reassuring performance given the valuation, with AUM increasing, a useful acquisition, and a special dividend. The latter can be quite a nice sign of a shareholder-friendly culture.

AUM of £58.7bn is actually some 37% ahead of last year, and the total dividend of 20.1p is 18% ahead.

The Meridian acquisition is ‘transformational’, expanding Jupiter’s product range, building scale in some areas (such as UK equities and Fixed Income) and expanding investment expertise in others (such as alternative strategies, private assets investments and gold and silver). The institutional client base and international footprint in key markets like China have been expanded.

But Jupiter also says that ‘more time is needed to stabilise flows from certain products’. That’s probably a point to look into further as there were outflows from Merian funds. These were offset by synergies but I would still keep an eye on potential further outflows.

In total, net outflows at Jupiter were still high at £4bn. Hopefully future growth opportunities outweigh these.

Conclusion

Similar to Polar Capital Holdings (LON:POLR), Jupiter looks to offer good value with its 6% forecast yield and reasonable forecast earnings multiple. Profits have been coming down over time but this year, after stripping out acquisition costs, the group has bucked that trend on an underlying basis.

The brokers aren’t mad about it and have JUP as a consensus hold, but they have been consistently inching up their earnings forecasts after that initial Covid lockdown adjustment.

Looking at the five-year chart, it does look as though there is scope for a more sustained rerating if conditions continue to improve - especially given assets under management have never been higher.

The trend in net outflows is something to bear in mind. Merian strategies saw outflows in the second half but Jupiter says there has been a shift in momentum though and anticipates a pick-up in net client flows in the future.

These asset managers are fantastically cash generative but the high returns continue to attract competition. Passive funds are an ever present threat, and the profitability ratios for Jupiter show declining metrics across the board.

Here’s the operating margin, but you’ll see the same trend for ROCE, ROE, etc.

Continued M&A is probably required if fund managers want to stay ahead of this.

The group’s focus on specialist strategies is a key point, as margin compression is a feature of the industry. If you are happy with those industry dynamics and believe stock markets are more likely to recover rather than fall, then the current valuation looks attractive to me. As always though, DYOR.

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Paul's section

Various Eateries (LON:VARE)

Share price: 87.94p (+0.5%)

Shares in issue: 89,008,477

Market cap: £78.3m

I was looking at Various Eateries (LON:VARE) last night, so here are my initial impressions.

Formats (Coppa Club & Tavolino) - nicely fitted out, but the only thing that really stands out is the "igloos" at the site near Tower Bridge. I wonder if this is the site sold by Tasty (LON:TAST) (I hold) for a couple of million a while back, just before covid I think? Menus seems very ordinary, all the usual stuff: pizzas/pasta, burgers, etc. So high margin, cheap ingredients mostly. Photos of the food & prices look unappealing to me, but haven't tried them in real life. Hence very much "me too" formats, with no particular innovation or point of difference, is my first impression, but I reserve the right to revise that view after renting an igloo next time I'm in London & restrictions have been lifted.

Figures - 52 weeks to 27 Sept 2020 recently published (yesterday). Obviously loss-making due to lockdown, so we can look through the P&L. Business interruption claim is very interesting, and helpful. Part payment of £2.5m received from insurer, balance not yet quantified or booked into accounts. So could be good upside here potentially maybe?

Balance sheet - OK, but not strong. c.£23.5m IPO (net of costs) monies are in receivables, so that will have since turned into cash, but there was £12.4m in loans from related parties to pay off. Lease liabilities are hefty, so I wonder what the lease terms are, if agreed pre-covid, they could be expensive.

Opportunity - lots of competition disappeared, and plenty of opportunities (over 1,000 sites available, mgt says in PIWorld interview) at lower rents, with long rent-frees. So this is definitely a good time to be expanding. But I think plenty of other people have the same idea.

Management - founder, Hugh Osmond well known, and Chairman, CEO & CFO all have strong sector experience.

Overall - the valuation looks nuts to me. £78m market cap, for a me-too type of business with just 11 sites, is absurd. So this float has definitely been pumped up on the reputations of management, not on fundamentals. Looking at the format & menus, I don't see anything particularly special, so why would I want to pay £7m per existing site for it?

It's all about roll-out potential though. But why pay £78m for this, when you can buy far more advanced Fulham Shore (LON:FUL) for £91m? That also has experienced management, and I think more distinctive formats.

The other thing is that VARE has mainly London sites, which may struggle to get back to former glories, if lots of people continue working from home, we don't know yet.

Therefore my conclusion is that VARE is wildly over-priced at the moment. You often find that is the case with new floats, where people are buying into the reputation of management, rather than the fundamentals of the business.

DotDigital (LON:DOTD)

163p - mkt cap £487m

Interim Results

Dotdigital (LON:DOTD) is an 'SaaS' provider of omnichannel marketing automation and a customer engagement platform. It announced its Half Year results for the six months ended 31 December 2020 ("H1 2021") yesterday.

There's a short video here from PIWorld.

Note there will also be an InvestorMeetCompany webinar on 4 March, at 10:30. It’s so good to see many more companies engaging with these online platforms, to communicate properly with private investors. All companies should be doing this. Why would PIs want to invest in any company that doesn’t engage with us?

The H1 financial highlights look good - decent growth -

My main concern here, which we’ve discussed before, is that the revenue growth seems to be coming almost entirely from increasing spend by existing customers. ARPC is up 20%. Organic revenue is up 22%. This implies that new customer wins are only slightly more than offsetting customer churn. That puts a question mark over how much actual growth is happening, in terms of winning new business? Not enough, I would suggest.

Adj EBITDA margin is high, at 37%. That’s £10.5m in H1. Although this is an inflated figure, because the company capitalised £3.1m into intangible assets in H1. So the real world cashflow is £7.4m in H1, if we make that essential adjustment.

PBT (continuing ops) is up 9.3% to £7,139k in H1, that’s 25.3% of revenues - indicating this is a high margin, quality business.

Adj diluted EPS is 2.19p in H1, if we double that for a full year we get 4.4p, giving a PER of 37 - certainly not cheap, but we’re in a tech boom, where often very high, even irrational valuations are given to growth companies. In present market conditions, I don’t see a PER of 37 as being wildly excessive. It all depends what future growth can be produced. If revenues really start to motor upwards, then this share could be cheap. I just don’t see enough organic growth to justify chasing it any higher, personally.

Balance sheet - is bulletproof, with £27.6m in cash, with no interest-bearing debt. Some of this cash is clearly surplus, so DOTD has plenty of scope to make acquisitions, and could even sustain some debt, given its high level of high margin recurring revenues. It would be nice to see management get cracking with an earnings accretive acquisition.

Research notes - both Finncap & N+1 Singer have published update notes that can be viewed online, at Research Tree. Thanks for those. N+1 Singer has a lower EPS forecast of 3.9p for FY 06/2021, and 4.1p for NY. That implies an H1 weighting to profitability, since H1 has already achieved 2.19p. If those forecasts are hit, then it means EPS will have barely moved in 4 years - which does put a question mark over things. A growth company that’s not growing earnings. Does it matter? Probably not that much, markets aren’t really focused on profitability, it’s growth at any price that seems to be exciting tech investors the most.

My opinion - as usual, this is mainly a review of the figures, and I’m happy with them - this is a high quality, cash generative business, with a very strong balance sheet, and even paying small divis.

It’s up to you to assess the products, competition, and future potential, that’s outside the scope of what I do here. It’s always looked promising, and still does. The Shopify and Magento connectors sound interesting. Maybe DOTD might become a bid target, for a larger software group with the firepower to really scale it up?

I think it would need to demonstrate faster organic growth, in terms of new customers (not just generating growth mainly from selling more to existing customers). Imagine what the share price would be if new customers really started rolling in, on high margins, at say 50%+ p.a. growth rate? It would quickly get into the billions, rather than £500m market cap, if that were to happen.

In the meantime, you can justify the current valuation, on a profit/cashflow basis. It’s not cheap, but not excessive either, given current buoyant sector valuations.

Overall, DOTD continues to look interesting, in my opinion. I very much like growth companies which throw off lots of cash as they expand, as opposed to cash burners that might eventually break into profit, which make much riskier investments, as so many fall by the wayside.