Small Cap Value Report (Fri 6 August 2021) - Books, FLO, AFRN

Good morning, it's Paul here with the SCVR for Friday.

Today's report is now finished (slow news day)

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover trading updates & results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it's anybody's guess what direction market sentiment will take & nobody can predict the future with certainty.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research) - don't blame us if you buy something that doesn't work out. Reader comments are welcomed - please be civil, rational, and include the company name/ticker, otherwise people won't necessarily know what company you are referring to.

Agenda -

Paul's section:

2 good book recommendations for you (as it's quiet for news today)

Flowtech Fluidpower (LON:FLO) - in line trading update from earlier this week. Looks OK, but nothing special.

Aferian (LON:AFRN) - interim results from earlier this week, looks OK, nothing especially good or bad in the numbers.

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Book recommendations

It’s quiet for company news today, but I’ll do some catch up items from earlier this week, so we should still have a useful report up by lunchtime.

In the meantime, I’ve just finished an excellent audiobook, which you might find interesting. It’s called “Billion Dollar Loser - The Epic Rise and Fall of Adam Neumann and WeWork”, by Reeves Wiedeman.

It’s the riveting story of how the charismatic, ambitious Neumann managed to bamboozle many venture capitalist investors into repeatedly funding (at ludicrous valuations) the meteoric growth of WeWork, a real estate company offering flexible shared workspaces. Hubris took over, as Neumann grew the business at breakneck speed, throwing commercial viability out of the window. Softbank alone invested over $10bn into WeWork, believing the brazenly false story that it was a tech disruptor, when in reality it was just a badly run real estate company. It all unravelled when the scrutiny relating to its failed IPO attempt revealed the truth that was hiding in plain sight.

I think this book is a timely warning about the excesses clearly evident in the market for tech shares, and other bubbles (such as Bitcoin, SPACs, etc). I suspect many more IPOs (especially in USA) are likely to unravel, as it becomes clear that so many shares floated as tech disruptors & stellar growth plans, simply don’t have viable business models. $UBER springs to mind, and there are many more. How about Deliveroo (LON:ROO) in the UK? That’s a bunch of guys on bikes, that doesn’t make any profit, valued at £6bn, similar sort of thing.

Another good book, from the last tech boom, is “boo hoo - a dot.com story from concept to catastrophe”, by Ernst Malmsten. Some of you might remember boo.com - it was an early eCommerce website from Sweden (nothing to do with Boohoo (LON:BOO) (I hold)). Boo.com raised & burned through a lot of cash, before collapsing when the tech bubble burst in early 2000, and backers pulled out.

The parallels between the tech boom now, and the tech boom from 1998-2000 are uncanny. Conditions now are far more extreme than they were back then, which amazes me, as I didn’t expect to see anything like the 1998-2000 TMT (tech, media, telecoms) boom/bust again. Amazingly though, the financial memory is surprisingly short, and the next generation comes through and makes all the same mistakes again, with massive QE adding fuel to the fire of asset mis-allocation & inflated valuations.

That said, amongst all the over-priced hyped up tech shares, there are also some serious winners, which is why people get so excited looking for the next one. Softbank for example made billions from a small early investment in Alibaba.

I think it’s only a matter of time before we see some more crashes of shares in over-hyped, loss-making companies, masquerading as valuable businesses. Hence I feel this is a bad time to be over-paying for jam tomorrow companies, in the hope of future profits, when there’s no clear or logical route to a level of profitability that would justify the high valuation. WeWork is a great example of this risk. Charismatic founders seem to be particularly dangerous, with WeWork resembling more a cult, than a company, in its heyday. The quotes from Neumann are actually hilarious in places, as he became more detached from reality, so this is an entertaining book which I think subscribers here will enjoy.

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Flowtech Fluidpower (LON:FLO)

130p - mkt cap £80m

Trading Update

This announcement was from Tuesday this week. We didn’t cover it on the day because it’s only an in line update, and it was a busy day with more important things to cover.

AIM listed specialist technical fluid power products supplier Flowtech Fluidpower plc (LSE: symbol FLO), announces the following unaudited trading update on its performance for the six-month financial reporting period ended 30 June 2021.

Company’s summary -

"We continue to make good progress with all aspects of the implementation of our long-term strategy and remain focussed on addressing the short-term challenges presented by supply chain issues and inflationary pressures."

So many companies are reporting supply chain & inflation problems. It’s becoming quite a worry. How long will it take to sort out these issues? Nobody knows. The trouble is, when there are shortages of anything, people’s response is to stock-pile, thereby worsening the problem because that desire to increase inventories leads to further increases in short term demand. Eventually supply increases, inventories are unwound again, so demand subsides, and everything balances up again, it’s just the timing that is unknown.

I’m worried that we could see many companies reporting supply difficulties (and hence a hit to profits) in H2 this year. So it might make sense to trim a few positions, and keep some powder dry for bargain purchases. Or just ride it out for the long-term, these things are so difficult to predict sometimes it’s not worth even trying.

Key points -

• Revenues - increased, but not fully recovered to pre-pandemic level
• Selling prices increased, passing on higher costs
• Plans underway to: unify under one brand name, digital agenda, and improve operational efficiency

Overall -

The above factors combine to a position where at half-year end our profitability is slightly in excess of our expectations.

Net debt (excl. Leases, incl. £0.8m deferred VAT) - £13.3m (down from £14.6m a year earlier, but up £1.7m in last 6 months - said to be due to increased working capital as revenue recovers)

Outlook - is in line - but some uncertainty -

Current trading remains encouraging; however, it is difficult to assess both the likely short-term demand from our customers and any ongoing and widely experienced disruption in our supply chain. We will continue to invest in the key areas we have highlighted above. Overall, we expect our FY2021 result to be in line with market expectations.

Diary date - 7 Sept 2021 for half year results to 30 June.

Valuation - in line with expectations might sound OK, but we need to check whether those expectations have already been lowered. As you can see below, the forecast EPS for FY 12/2021 (the darker line) has been greatly reduced, by about half, creating an easier benchmark to meet.

The company then has to double earnings, to achieve FY 12/2022 earnings, which could be difficult.

For this reason it’s rather difficult to value this share. If it achieves next year’s forecast of 11.6p, then the PER would be a reasonable 11.2. But do I really want to base my investment on the assumption that it’s going to double EPS from this year’s forecast of 6.17p? I think that’s a bit too risky for my personal taste.

My opinion - the share price has done well in the last year, and now looks fully priced in my view. I’m not comfortable with the assumption that 2022 earnings are likely to double. Although that would only take it back to historic levels (see graph 3 below), so maybe it’s possible?

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Aferian (LON:AFRN)

149p - mkt cap £125m

Half-year Results

Previous name: Amino Technologies (AMO)

Aferian plc (LSE AIM: AFRN), a software-led global media technology company that delivers modern TV experiences, announces unaudited results for the six months ended 31 May 2021 ("H1 2021").

Company summary -

2025 Strategy driving earnings enhancement

Note that Aferian reports in US dollars.

A few key numbers for H1 -

• H1 Revenue $45.3m (up 19% on H1 LY)
• Adj Profit before tax (PBT) $4.7m (up 21%)
• Adj basic EPS in US cents: 5.05 (up 3%)
• Adj EBITDA of $8.3m in H1, but $3.5m development spend was capitalised, so I would adjust EBITDA down by this amount to reflect real world cashflows

Why the difference between PBT up 21%, and EPS up only 3%? The share count has risen, so has the tax charge of $803k this H1, versus (33)k last H1

Balance sheet - NAV is $101.9m, less intangible assets of $100.5m, leaves NTAV of only $1.4m, which I think is adequate in this case, because it doesn’t need a lot of capital (note that inventories are very low, at just $2.87m).

Checking note 14 in the last Annual Report, the intangibles mainly relate to acquisitions, so Amino has been on an acquisition spree, and risks getting a top-heavy balance sheet if it does any more acquisitions (as indicated in the commentary) without raising fresh equity. So I suspect it might need to dilute shareholders further, if any more meaningful-sized acquisitions are done. The alternative is taking on more debt.

Cashflow statement - not very good. Operating cashflow in H1 was negative at $(1.0)m ($4.2m positive in H1 LY)

Spent $3.5m on development spending, and $4.9m on an acquisition.

Raised cash of $12.7m in a new shares issue, and $6.9m in increased borrowings.

Just under $2.0m was paid out in dividends.

Overall that increased the gross cash to $17.0m, less $7.0m in borrowings, means net cash of $10.0m, so a comfortable liquidity position, although negative free cashflow in H1.

Outlook - all self-explanatory so I’ve copied it -

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Valuation - Thanks to Finncap for putting out an update.

Adj EPS is forecast at US 12.4c FY 11/2021, rising to 14.7c next year. Converting into sterling at 1.39, gives 8.9p and 10.6p

PERs are 16.7 and 14.1

My opinion - it looks reasonably-priced, if broker forecasts are achieved, and it says that the current year is trading in line.

So probably priced about right, based on the numbers.

The investment case would be all about researching the company’s products & services, and seeing if you can get excited about the future potential or not. I don't have a view on that.

I’m about to watch the recent interim results presentation on InvestorMeetCompany, so will hopefully learn more about the company from that. It’s not a sector where I feel that I have any insights, so am not likely to add this to my portfolio, but good luck to holders.

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Note that the StockRank history has been messed up by the recent change of name unfortunately.

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