Small Cap Value Report (Mon 12 Sept 2022) - BKS, SRC, SPSY, MTEC, AXS, ARC

Good morning from Paul & Graham - suitably refreshed from his holidays! Today's report is now finished.

Normal service resumes here today, I'm pleased to say.

Weekend podcast went up as usual, or is available on podcast services (just search for "Paul Scott small caps").

Agenda - 

Paul's Section -

Beeks Financial Cloud (LON:BKS) (I hold) - a reassuring, in line with (previously raised) expectations, trading update for FY 6/2022. Also BKS reveals the identity of an impressive recent client win. Outlook comments are buoyant, with a "record sales pipeline".  This share is tricky to value, but the accelerating organic growth, mostly recurring revenues, and positive outlook, reinforce my belief that this share looks like a long-term winner for patient investors.

Spectra Systems (LON:SPSY) - I crunch the interim numbers, and come away impressed with the high profit margin, strong balance sheet, and generous divis. It's a very small company, but has numerous projects in the pipeline, any of which could be transformational if they scale up. Hence blue sky upside, on top of solid fundamentals - that's an attractive risk:reward stating point in my view. Worth a closer look I'd say.

Accsys Technologies (LON:AXS) - a catalogue of problems from this specialist wood products maker, which is struggling to ramp up production. Sluggish production in Holland, hampered by high gas prices as well as production gremlins. Its new Hull factory is also seeing delays & question marks over viability (due to gas, again). Only its US JV is progressing well, but won't be producing until mid-2024. Pity, as products are in demand. Overall, it looks too difficult to assess, and I'm worried about more dilution.

Graham's Section:

Sigmaroc (LON:SRC) (£310m) - this quarrying company announces interim results and also a JV with the industry giant ArcelorMittal. The deal is impressive in terms of the association that’s been formed, but I’m curious as to how the JV will negotiate pricing with its primary customer (ArcelorMittal) who will also be a 47.5% shareholder. As for the interim results, they show promise with good profitability and an upbeat trading statement, although the balance sheet has a significant degree of leverage. Overall I find this a perhaps risky and complicated, but nevertheless an interesting stock for us to keep under coverage, especially considering the inflation theme which exerts great influence over SigmaRoc’s revenues and costs.

Made Tech (LON:MTEC) (£44m) - this company focuses on digital transformation for the public sector. Revenues are growing at an excellent rate, approximately doubling each year, but statutory profits remain elusive. This looks to me like a labour-intensive, low-margin business that would be more appropriately owned by its employees, rather than external shareholders. However, external shareholders were happy to pay £70m for less than 50% of the shares at last year’s IPO. It wouldn’t surprise me if employees eventually bought it back for a pittance.

Arcontech (LON:ARC) (£11m) (+5.7%) - previously announced contract losses result in lower year-on-year revenues and profits at this software company, in line with expectations. PBT of £760k is generated from turnover of £2.8m. With over 90% of revenues being recurring in nature, the company has the confidence to increase its final dividend. Additionally, the Chairman says they are “well placed to make up some of the lost revenue during the current year”. It’s worth noting that Arcontech shows £6m of cash on its balance sheet, i.e. more than half of its market capitalisation. The underlying business does not appear to be going anywhere very quickly but it’s easy to argue that this is priced in at the current valuation. The shareholder register is also worth a look: insiders are well represented, plus some well-informed private investors.  [No section below]

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Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review 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 are analysing the company fundamentals, not trying to predict market sentiment.

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), and make your own investment decisions. 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.

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Paul’s Section:

Beeks Financial Cloud (LON:BKS) (I hold)

143p (pre market open)

Market cap £94m

Trading Update

Beeks Financial Cloud Group plc (LSE: BKS), a cloud computing and connectivity provider for financial markets, is pleased to provide an update on trading for the year ended 30 June 2022…

Client win - this strikes me as significant, as a major reference customer - more detail is in the RNS -

…confirm that the first customer for its newly launched Exchange Cloud offering is ICE Global Network (IGN) part of ICE Data Services, a division of Intercontinental Exchange (NYSE: ICE), the world's largest exchange group and owner of the New York Stock Exchange.

Trading Update - this looks fine to me -

Beeks has delivered a record trading performance in the year, delivering growth on the prior year and in line with upwardly revised market expectations.

The Group has exited the year with Annualised Committed Monthly Recurring Revenue of over £19.3m, growth of 40% on the prior year, providing a strong basis for further growth in FY23.

I was discussing recurring revenue stats with another SaaS company the other day - PCI- PAL (LON:PCIP) - who explained the importance of annualised recurring revenues. For anyone not familiar, it’s a forward-looking indicator on revenues, that shows what the base level is (assuming no client churn, which is usually low at this type of business) for the coming year. Then there’s usually some additional growth on top of that, for new contracts won. Hence we can use ARR as a sense check for broker forecast revenues in the coming year.  Stockopedia is showing £24.7m consensus forecast revenues for FY 6/2023, hence £19.3m ARR suggests that 78% of the new year’s revenues should already be in the bag. That’s appealing visibility for investors.

Results date - “early October”, for FY 6/2022 results.

Outlook - sounds encouraging -

"The success of Proximity Cloud and Exchange Cloud have contributed to a fantastic trading performance in FY22 and we enter the new year with a record sales pipeline and confidence in our ability to continue to capitalise on the significant opportunity ahead."

My opinion - this remains one of my favourite long-term holds. It’s tricky to value, because it’s a rapid growth company, not a value share. Hence I feel that over-analysing the historic numbers is missing the point. It’s the acceleration in growth, and the niche nature of what it does, that interests me.

For customers, security, and reliability, are absolutely key, and it’s taken Beeks c.10 years to develop its reputation and technical capabilities. Whilst that could be replicated by a well-funded competitor, it would probably take years before customers would be willing to trust it to deliver faultless service. Hence I see considerable intangible value in Beeks shares, and barriers to entry. Customers are very sticky, once signed up.

Management has spoken before about reaching a tipping point, where contracts are now scaling up. Large organisations tend to dip their toe in, with an initial contract, then once it’s proven, scale up to larger contracts.

Everything looks to be on track, and with a record pipeline, I reckon the forecast for FY 6/2023 looks set at a beatable level. Hence there should be little risk of a profit warning.

Beeks shares have held up relatively well in a nasty bear market for small caps. It seems to trade in a range between 125-200p. I’m more interested in the longer-term picture, as it seems obvious that Beeks is going to be a much larger, and more profitable company, in future. It just requires some patience, and nothing bad happening. So far, so good!

I’ve seen more bearish commentary on BKS shares, but think it misses the point, but it’s always good to consider bearish opinions, if only to double-check that the bull case holds water, which I think it does.

It's too early stage to have a decent StockRank. So the StockRank system asks us sternly, are you absolutely sure about this?!

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Spectra Systems (LON:SPSY)

162.5p (up 2% at 08:59)

Market cap £62m

Interim Results

Spectra Systems Corporation (the "Company"), a leader in machine-readable high speed banknote authentication, brand protection technologies, and gaming security software, is pleased to announce its interim results for the six months ended 30 June 2022.

These interim numbers look good, and the company says that H1 figures are in line with its (previously raised) expectations.

Revenues were up 15% to $9.27m in H1.

It’s a high margin business, with adj PBT of $3.7m.

Overheads look strikingly small, so it looks as if SPSY is run on a shoestring, hence the high net profit margin.

Adj EPS fell 7% to 6.2 US cents, due to a much higher tax charge vs H1 LY.

Shares seem illiquid, often with a wide spread, e.g. only 13k shares traded so far today which seems unusually low for a £62m mkt cap company, on results day. So it could require patience to buy or sell in any size.

Balance sheet - is very good . $25m NAV turns into $18m NTAV. This includes $18m cash - boosted by a one-off large up-front cash receipt from a customer, of about $3.9m.

Cashflow statement - note the big divis being paid, plus smaller share buybacks. Again, cashflow was boosted by the $3.9m increase in deferred income (cash paid up-front by customers).

Outlook - sounds good -

"The Board therefore believes that the Company is on track to achieve record earnings and meet market expectations for the full year."

My opinion - the bumper 6.2% dividend yield may not necessarily be sustainable, given that some of the cashflow is one-off in nature. Although the $18m cash pile looks way more than necessary, so the company probably could continue paying big divis from cash reserves, if it wished to.

The most striking thing from reading these interim results is that SPSY seems to have lots of potentially interesting activities underway, including large contracts in the pipeline. Indeed, I know several shrewd investors in this share, who have told me that it’s a small company, where a number of development projects could prove transformational if they come off in scale.

In the meantime, it’s cash generative, and very soundly financed, so you get the best of both worlds - blue sky upside, but without the risks of cash burn, placings, etc.

I’d like to know how sustainable existing profits are? I.e. what proportion of earnings are repeating, and what are one-offs?

With its very low overheads, SPSY looks almost like a development company, where I imagine a team of boffins working on products & services in a lab, with a very lean overhead - e.g. sales & marketing costs were only $478k in H1. This is not a criticism, by the way! If it can throw off loads of profit & cash from a small team, then that’s attractive - although could be dependent on a few key people, possibly?

Overall, I’ve only scratched the surface of this share, but have seen enough to make me intrigued. I can see why several of my shrewd investor friends have congregated in SPSY shares, this looks an interesting company, so do have a read of the commentary with today’s results, which is the most interesting bit. There's also a note from WH Ireland available on Research Tree, thanks to them. 

I’ve crunched the numbers, and am reassured that side of things looks OK. The PER is about 16, and the yield about 6%. Doesn’t look expensive, given all the interesting development projects in the pipeline.

An amazing bull run began in 2016. StockRanks smile kindly on this share too -

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Accsys Technologies (LON:AXS)

75p (down 16% at 11:03)

Market cap £155m

Trading Update

This update hasn’t gone down well, with a 16% drop in share price today.

This update covers the first 5 months (to 31 Aug 2022) of FY 3/2023.

Accsys, the fast-growing and eco-friendly company that combines chemistry and technology to create high performance, sustainable wood building products, provides the following update regarding recent trading and the status of its strategic growth projects further to its last update on 30 June 2022.

Key points -

Strong demand for Accoya wood product, above production capacity. Strong order book.

Revenues flat at 39m Euros - BUT this is volumes down 24% due to plant shutdown, offset by higher prices.

Energy (gas) price is an issue - adopted surcharge to “help the group manage the cost impact”.

Problems with 4th production line now resolved, but will take 2 years to reach full capacity (why?!)

New plant (Tricoya product) in Hull, being built with a consortium, is also over budget, and behind schedule. Gas prices also an issue. Funding issues. Evaluating all options.

USA JV plant construction - progressing well. Due to commence production mid-2024.

My opinion - I can see why the share price has been poorly performing.

The big problem with Accsys, is that it seems to be expensive, time-consuming, and problematic to scale up production.

On the plus side, the products seem genuinely good, with key advantages (e.g. longevity) over traditional wood, and are in demand.

If it can resolve the production issues, and get higher volumes flowing, then this share might do well. If not, then the share price could remain bogged down.

It’s also clearly leveraged to what happens with gas supplies - good upside if Russia backs down over its invasion of Ukraine, or potential big problems if the situation escalates.

AXS’s last reported balance sheet had good NAV, but it’s very top heavy with fixed assets - emphasising how capital-intensive this business is. A fundraise was done to top up the coffers with 20m Euros in May 2022. Reading that announcement, the funding structure looks complicated, with convertible debt, restricted cash, etc.

The share price is near the March 2020 pandemic lows, but the share count has risen from 118m in 2019, to 207m now. It’s vital to always check the number of shares in issue, before comparing points on the chart. I suspect that probably won’t have been the last fundraise.

Overall then, this is a complicated special situation. There are too many unknowns (e.g. price/availability of gas, production delays from new factories, funding for new factories, possible need for more equity placings) for me to be able to reach a conclusion on this share. Overall, I can see the potential for the product, but so far this share has been a frustrating example of how difficult it is to ramp up production of innovative, but complicated products. I think I’d rather stick to investments where revenue can be scaled up quickly, cheaply, and easily. AXS is very much the opposite of that. It could come good in the end though, who knows?

The StockRank system toyed with AXS when momentum was good, but has since gone cold on it -

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Graham’s Section:

Sigmaroc (LON:SRC)

Share price: 48.6p (+2%)

Market cap: £310m

This acquisitive quarrying company announces a joint venture with steel manufacturing giant ArcelorMittal (you can find its StockReport here). SigmaRoc will invest around €20m and will own 47.5% of the newly-formed company, whose purpose will be to produce vast quantities of lime. The main customer of the new company will be ArcelorMittal, and it will also be supplied with heat energy recovered from a nearby ArcelorMittal plant.

This initiative looks to be an impressive sidebar as SigmaRoc collaborates with a vastly larger company on an apparently equal footing. However, ArcelorMittal will be a supplier, the primary customer and also a 47.5% shareholder of the new company, so I’m not sure how this new company is going to be able to negotiate pricing with ArcelorMittal, so as to ensure strong returns for SigmaRoc investors. I see a lot of potential for governance issues. But hopefully it works out well for SigmaRoc, which has been transformed by deals made over the past year and has an apparently insatiable appetite for more deals!

Interim results are also announced today, with key highlights being:

• Revenue £247.1m, +17% on a pro forma basis
• Underlying PBT £29.1m
• Actual PBT £18.6m
• Cash (30 June 2022): £46.4m

I’m not going to bother printing EBITDA here because it doesn’t make any sense to me as a metric in this case.

I also don’t think we need to concern ourselves with a direct comparison against 2021 figures, because the company has changed beyond recognition after a reverse takeover that occurred in 2021.

Let’s skip ahead to the upbeat outlook statement:

Trading in the early part of H2 2022 has started well, with the Group benefitting from its broad end market and geographical diversification. Demand remains good both for housing and infrastructure, as well as for industrial minerals. The Group has successfully dealt with various supply chain and inflationary headwinds in H1 2022 and has continued to do so into H2 2022, with particular focus on energy costs and continuous operational improvement initiatives.

My view

In summarising this company, I’m immediately drawn to the balance sheet where I find that it has total assets of £866m, or £511m if you exclude the intangible items. Against that it has total liabilities of £415m.

In other words, net tangible assets are less than £100m. That’s a deep discount to the latest market cap, but perhaps the valuation gap has been partially closed by inflation?

I’d also note that the credit facility led by Santander is not charging a very high interest margin, suggesting confidence from lenders, and that leverage ratios are said to be within Sigmaroc’s “target range”.

I suspect that management have many different moving parts to keep track of, both operationally and financially in terms of balance sheet management.

From an economic point of view, this is likely to be a good stock to monitor when it comes to inflation trends: can the sale prices for construction materials and other raw materials outpace input costs? The chart isn’t screaming bullishness yet:

Overall, as you can probably tell, I have mixed views on this one. But I’ll keep an eye on it for future developments.

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Made Tech (LON:MTEC)

Share price: 29.9p (-2%)

Market cap: £44m

This is “a leading provider of digital, data and technology services to the UK public sector”. You can review its service offering here.

The company’s IPO was in September 2021, at 122p per share.

It has had a rotten share price performance so far, down by over 75%:

I’ve just looked up the prospectus, to find some details about how this one came to market. It turns out that of the 70 million shares which changed hands at the IPO, only 12 million of these were new shares (i.e. shares sold by the company to raise new funds).

The rest of the shares which changed hands - 58 million of them - were sold by existing shareholders.

This is definitely something to watch out for in an IPO: is the company raising funds for growth, or is the point of it to let existing shareholders get out?

In the case of Made Tech, it appears that the main point was to let existing shareholders get out, with gross proceeds for them of around £70 million, in exchange for less than half of the company. An impressive result, considering that Made Tech’s entire revenues for FY May 2021 added up to just £13m!

But it was sold as a growth story, with revenues approximately doubling each year.

Today’s annual results continue the theme:

• Revenues +120% to £29.3m.
• Gross Profit +125% to £11.3m.
• Adjusted PBT £2.3m (vs. a loss in FY 2021).

“Sales booking” and “contracted backlog” have also more than doubled, but these metrics are based on work carried out several years into the future so I wouldn’t get too bogged down in the details of numbers.

The main point, clearly, is that the story of a very high revenue CAGR (compound annual growth rate) is intact.

We also get a positive adjusted PBT, which is an improvement, but the statutory result is in fact a loss - there are “share based payment expense and related costs” of £2.4m, which wipe out all of the adjusted PBT.

Let’s check out revenue per employee, to see how efficient the company is at turning its headcount into sales.

At the beginning of the financial year, the company had a headcount of 235. At the end of the year, it had a headcount of 478. Let’s make a very rough guess that the average headcount was 350. By my calculations, that makes revenue per person for the year of around £85,000.

I have the impression that Made Tech’s employees are highly skilled (i.e. commanding good salaries). So with revenue per person of around £85k, it’s little wonder that there isn’t much money left over, after paying salaries and covering all the other costs of the business.

(To see how a high-quality company performs when you apply this metric, do it for Games Workshop (LON:GAW) and you’ll find that revenue per person is around £160k.)

It could be argued that the benefits of increased headcount at Made Tech haven’t been felt yet, and that the increased revenues to be delivered in future years will feed through to more positive financial results.

But the annualised revenue run rate is now reported to be around £40m, as of August 2022. If we apply the company’s year-end headcount to that figure, we again get revenue per person of around £85k. It looks like it might be difficult for the company to make big improvements to this metric.

Outlook

The company is purely focused on public sector work and is confident in its ability to steer through political change:

We are mindful of the recent changes within government and the potential impact of this may have on our public sector clients. However, our high level of order bookings, significant proportion of contracted revenues and the embedded and long-term nature of our client relationships and contracts give us confidence in our prospects for the coming year and beyond.

The “levelling up” agenda provides opportunities to expand regionally, and Made Tech has made new hires in Scotland, Newcastle and the Midlands.

My view

As you can probably tell, I’m not keen on this one as a potential investment.

It’s being sold as a play on the “digital transformation” industry, where there is secular long-term growth, but I’m not sure how investors are going to make much money here. As shown by the revenue per person metric, the work appears to be labour-intensive and from a shareholder perspective the overall margins look poor. At what scale would this company be able to earn meaningful profits?

I also note that the company’s employee retention rate collapsed to 73% from 86%, and no explanation for this was given. Given how crucial its employees are to the business, an explanation would have been helpful.

Finally, the company’s statutory loss would have been bigger if it hadn’t capitalised nearly £2m of product development costs.

Stockopedia’s algorithms describe this one as a “Sucker Stock” and I also can find few attractions here from an investment point of view. Some of the air has been taken out of the valuation, but I can see it deflating further: