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

6th Aug '21 by Paul Scott

43 comments 8648 reads

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.

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…

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Paul Scott

6th Aug '21

Very interesting, thanks Effortless Cool!

Trident

Did anyone notice the Debenhams television adverts recently?

Honey Badger

I would also recommend the We Crashed podcast series on Wondery, chronicling the WeWork saga. The last episode is an interview with Prof. Scott Galloway, who forecast WeWork's demise. He's a brand expert, entrepreneur and NYU professor who is excellent on the world of tech and explores many of the themes discussed here in his own weekly podcasts.

Andrew Ross

The update from #IXI IXICO would be interesting to cover I'd think. Would be interested in people's take on its prospects.

Effortless Cool

Hi SurreySteve,

Cenkos have put a note out this morning in respect of the latest Venture Life (LON:VLG) acquisition. They haven't updated their forecasts yet, however, saying:

"We anticipate, in line with previous years, Venture Life providing a trading update for H1/21E in the coming weeks and therefore will update our forecasts at that time, consolidating both this acquisition and the recently announced acquisition of BBI Healthcare".

fwyburd

I've been advising and investing in UK Tech start-ups for nearly a decade now. Whilst very high risk, the SEIS/EIS regime here in the UK makes it very attractive so long as you choose wisely. My favourite one is Onfido, which has pioneered online identity checking for banks and employers. It now employs nearly 500 people and has annual recurring revenues of over $100m with customers across Europe and the US. It's doubling revenues every year with a gross margin above 80%.

I invested in them in 2014 but have sold down via secondary placings on a couple of occasions (too early as it turns out) but still retain a decent stake. Sadly for the UK, it is likely to list on the Nasdaq early in 2022 and will be valued north of 10X revenues so likely to be a Unicorn ($1bn valuation). However, the story of their founder (21 years old when I first met him in 2013) being one of the youngest tech entrepreneurs involved in a Unicorn is a great plaudit for the UK regime for tech entrepreneurs. However, as ever, we seem incapable of holding on to these companies here and they end up listing in the US.

Cheers

Francis

PS: I had a fractious conversation with someone here a while ago about the age of CEO's and how experience was key (I disagreed). The conversation was about Alex Dacre CEO of £MRL being under 30 when he started Marlowe. Marlowe's shares have risen from around £1 when I first invested to £7.50 today. Onfido's CEO had no business experience at all yet has built a Unicorn in 8 years and the shares have risen 20X and at IPO it will be 40X.

CamRaid

I like Sdi (LON:SDI) for that same reason. Integration into the group is key for any acquisition. SDI have proven their ability to make this work.

In terms of management capability and ambition to grow by acquisitions. I like Eenergy (LON:EAAS) too. They have Ric Williams as CFO who was the M&A Partner at Delloite. The CEO Harvey Sinclair has executed a buy and build model before. The leadership team is very top heavy for a business of this size and shows their ambition. Take a look at https://eenergyplc.com/leaders...

They focus on private schools at present and the transfer towards LED lighting.

However, they could easily work in so many other areas such as hospitals, care homes, offices, etc..

They can also target other energy savings other than lighting.

The model builds recurring revenue on medium term contracts up to 5 years. It has reached breakeven and I think it will push on from here.

I think Eenergy (LON:EAAS) is one to watch.

sharksmouth

Hi Paul

Your comments in your report with regard to freight concerns are apposite. Each day, there are a growing number of company reports that highlight this issue.

As investors, we all should be very wary about the negative impact of increased worldwide freight costs, shortage of capacity in the market and the concomitant delays to supply chains.

Having semi-retired now, I have over 35 years experience in worldwide logistics and I have never ever seen anything like what we have in today’s market.

The British International Freight Association (BIFA) issued the below report on 21 July which outlines many of the issues faced. It makes for uneasy reading.

https://www.bifa.org/media/4664699/bifa-container-market-overview.pdf

The Chinese market in particular is fraught with danger. Freight rates from China to the UK that were approx. $1800 - $1950 per 40’ container in November 2019, are today exceeding $19500.
And for UK importers, this is just the port-to-port freight cost. They also will have to pay any pre-carriage costs in China and the landed /delivery charges in the UK.

I know of several smaller scale UK importers of mid-value products, with not enough pricing power or margin in their products, that have ceased trading.

In my view, the major shipping companies are price “gouging” on a scale never seen before and the governments around the world are showing little or no concern. For example, Maersk, the biggest shipping line in the world, highlighted in their Q1 result in May that:-

A.P. Moller - Maersk had an exceptionally strong start to the year, with strong earnings and growth momentum across all our businesses in ocean, port services and logistics. The company benefitted from strong demand in a market still influenced by the pandemic and significant disruptions in global supply chains. Strong demand coupled with significant operational challenges such as bottlenecks, lack of capacity and equipment shortage in global supply chains drove freight rates up significantly.
Overall in Q1, EBITDA increased to USD 4bn from USD 1.5bn year on year and EBIT to USD 3.1bn from USD 552m compared to same quarter last year, while revenue improved by 30 pct. to USD 12.4bn. The results reflect the high volumes, which are up 5.7 pct., significant increases in freight rates of 35 pct. and lower bunker fuel prices, leading to an EBITDA in Ocean of USD 3.4bn compared to USD 1.2bn in Q1 2020, and an increase in revenue to USD 9.5bn from USD 7.2bn.

As a result of the above, I have exited some positions with exposure to the problems that I felt uncomfortable with (e.g. Tandem / UPGS) and will bide my time waiting for the dust to settle before reviewing.

Finally thanks Paul for all the work that you put into the SCVR. It is very much appreciated.

Good weekend all.

SundayTrader

Hi Paul

I will be interested in your thoughts on the update from Aferian (LON:AFRN) - I have held this for a number of years and it has prospered overall. There was a setback a few years back when they decided to get out of the manufacture of set-top boxes, and concentrate on the software side of the solution - on the face of the numbers, the fruits of this are now starting to show. The Stocko numbers make it look undervalued at first sight - you will have noticed a low PEG ratio. However, there is a big gap between the adjusted and the reported profit numbers, and the ratio of capex to operational cash flow looks a bit on the high side to me, considering the capex must be all software.

This is a B2B business, servicing smaller and mid-cap television companies - as with many such companies, the size of the growth opportunity is difficult to assess for the investor unfamiliar with the industry. On the face of it, there should be room for their growth by acquisition strategy.

Hi SundayTrader,

Thanks for your thoughts on Aferian (LON:AFRN)

I noticed that the bulk of sales is still hardware (with embedded software), so looks like they've just outsourced the manufacturing, which would tie in with inventories being low (as the manufacturer presumably holds any stock, or it goes direct to the end customer possibly?). So am not sure I particularly believe what they say about being mainly a software business now. Recurring revenues still looks small.

It's very difficult to assess the future potential for AFRN without knowing who all their competitors are, what strengths & weaknesses it has relative to others, etc.

I remember a few years ago, there was a consistently profitable business called Vislink, making specialised cameras, related to TV, and over a couple of years it was just snuffed out by the competition. So I do worry that competitive strengths can disappear quite quickly in this sector.

Amino/Aferian does have a good long-term track record though. I recall it used to be cash rich, and paid very generous divis for quite a while, so looks like strategy has changed a lot now, focusing on acquisitions instead.

Regards, Paul.

sharw

Paul - re Aferian (LON:AFRN) you say "It's very difficult to assess the future potential for AFRN without knowing who all their competitors are, what strengths & weaknesses it has relative to others, etc".

Here is the slide pack from the presentation: if you look at slide 20 the competition is shown. There is only one end-to-end competitor and that is TiVo part of $2bn. MCap Xperi(NASDAQ: XPER).

At a previous presentation there was this in the Q&A:

Q5: Who are your major competitors and what do you estimate as your current market share in devices and software?

It is worth listening to the answer here - you need to click on the Q&A tab.

mojomogoz

Venture Life (LON:VLG)

It seems obvious to me that expected £5.04m net profit for 2021 is going to have a massive downgrade. I think people haven't put together the obvious pieces here...and getting to 2022's £5.13 will assume heroic profitability improvements

2020 will be an unusually profitable year for existing pre 2021 acquisition businesses - big seeming one-off China order (that they've back-pedalled on future 'massive' value since) and hand gel sales for covid (that they never really detailed adequately plus moved around some element in reporting to make it look like 'brands' were suddenly very profitable as opposed to their profits that traditionally come from 3rd party production).

What have they added? Well they are not really clear on that as for BBI they report adj EBITDA at £2.6m and for Oncology Support they report gross profit of £1.2m....we have no idea where those figures net out to in terms of net profit. Note that in 2020 gross profit for VLG was nearly £13m but net profit was only £2.4m (and that was a boosted year IMO).

Obvs the broker and company will give a run rate 2021 net profit figure expectation when they announce (ie assuming they owned the new businesses for full year)....but that is likely to be well short of £5.4m.

What odds the price touches 50p?

IMO I think this company has abused PIs. I've been vocal saying this as I think there's been quite a lot spivvy cheerleading of it by PIs talking their book without looking at the simple available facts. That is rather unedifying IMO (not targeted at any poster here today)

Lincoln Green

'Money Week' magazine is now delivered in a recyclable envelope, very good, but I just arrived home and found my recyclable envelope delivered with nothing in it!! Well I suppose it saves me from recycling the magazine. Funny how you miss something when it is not there. I hope the rest of my weekend is not as empty!

JCPr

Thanks Mojomogoz for your unequivocable comments on £VLG. I formed my own opinion on Venture Life (LON:VLG), right or wrong, and haven't noticed any spivvy cheerleading.

I've tried to dig out some numbers from the annual report in the gap between finishing the day job and beertime.

They attribute £3.6m of sales to their hand sanitiser range DISINPLUS and they attribute a £1.2m increase in the sales of Dentyl mainly to their Chinese partner.

They reported the revenue from 'customer brands', so basically the outsourced manufacturing, as going from £13.5m to £15.2m.

So a quick back of an envelope calculation gives their own brand revenue (incl acquisitions) increasing by £3.5m. So £5.2m of revenue increase probably isn't attributable to one-off increases in sales in 2020. Of the sanitiser and Chinese sales it is probably reasonable to assume 2021 levels won't be zero. 50% still gives £2.4m. The same logic attributes £2.4m of 2020 sales as one-off increases.

Given that and the other acquisitions this year I don't find the 2021 forecasts as presented by Stockopedia that implausible.

We'll see.

Phuntt

https://podcasts.apple.com/gb/...

Hey Paul (& others who might be interested) I listened to a great interview of Billion Dollar Loser’s author on above link at the weekend. Really detailed description of the history and mistakes of the company. Made me want to read the book so good to hear another unvarnished recommendation from you. Think I’ll give it a read…

Brilliant podcast here: https://moneyweek.com/investme...

This covers many of the exact themes we've been discussing here today. Highly recommended.

Tortoise investor

Do you have any view of how shipping brokers like Braemar Shipping Services (LON:BMS) are affected by the current problems? Do they make more profit or do their margins get squeezed due to price rises from the shipping industry?

mark1308

7th Aug '21

Why ?

back2value

As a general rule, if shipowners are earning well, so are shipbrokers. Companies such as BMS are doing very well this year, because the container and dry bulk sector earnings are at levels unseen since the crazy pre-Lehman bankruptcy days of 2007 & 2008. The freight indices are very healthy, which means commission earnings are a lot higher. In stark contrast, the tanker market remains depressed with many ships earning below breakeven rates, but this doesn't take much cream off what is a booming market for dry cargo.

Separately, in response to sharksmouth, I can see why the logistics industry might see the current exceptional profits of container operators as "gouging", but when you average out their earnings through the cycle, physical ocean shipping is still a thin-margin, high risk and VERY capital intensive business, requiring enormous investments in ships and infrastructure even when earnings are negative. When container rates are where they are today, consumers never stop to think about how incredibly cheap freight has been for so long. Without the opportunity for profit at some stage in the cycle, no-one would make the huge investments needed to have such an efficient supply chain.

B2V

8th Aug '21

Hi B2V

Fair comments with regard to the need for shipping owners to invest to ensure an efficient supply chain. The under-investment over many years has been a major factor in leading us to this point.And having worked for many years in the logistics industry I know all about wafer-thin margins.

The gist of my comment was merely to highlight to others the current issues faced by importers from an investment point of view.

We need to be mindful that when companies, such as Flowtech above, report in fairly benign terms "that they are addressing the short-term challenges presented by supply chain issues and inflationary pressures" the reality of the situation is somewhat different.

In my view the days of sub-$2000 freight rates from China to the UK will never be seen again. And many businesses will have to revise their supply chain strategy accordingly to maintain their margins and in some cases, for them to even continue. Price inflation is inevitable.

As mentioned I have exited several positions, not wishing to learn of the degree of these difficulties at the time of the next company report.

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

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Paul Scott

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