Small Cap Value Report (Mon 18 Jan 2021) - BEG, W7L, AUG, CPP

18th Jan '21 by Paul Scott

86 comments 10999 reads

Good morning, it’s Paul here with the SCVR for Monday.

Timing - I'm hoping to be finished by the official end time of 1pm today. There's not much in the way of small cap news. Today's report is now finished.

Lockdown restrictions

Weekend press reports suggest that the Government is aiming to start lifting restrictions in a phased manner as early as March. Dominic Raab is quoted as saying that we’ll probably be heading back to a tiered system, with partial releasing of restrictions in regions which are seeing covid subside, and vaccinations progress well.

Another vaccine is apparently in the pipeline, from Johnson & Johnson, which is a single shot apparently, rather than two. Good news.

Overall then, the news seems supportive of my current portfolio view, that retail/leisure/hospitality/travel could be getting somewhere near back to normal in April/May. After that, my view is the “roaring twenties” view, that I think we could see a big surge in consumer spending, especially amongst the middle class, who have hoarded cash in 2020, being unable to spend on the usual things like eating out, holidays, etc. Which brings me on to…

Inflation & interest rates

We all probably think we’re brilliant stock pickers at the moment, because so many shares have gone up. However, if you look more closely, “multiple expansion” is a major factor behind that - i.e. shares which used to be valued on a PER of say 13 are now quite routinely valued on a PER of 20-30. That’s a one-off gain, and it could easily reverse (mean reversion). Hence why I’m so wary of high valuations at the moment, a lot of which look very risky to me, and investors seem complacent about this risk.

I think the key driver for current high valuations is the expectation of low interest rates forever. As for inflation, people under 35 barely know what it is, because they’ve never experienced it. People under 30 think that interest rates will always be zero, because that’s all they’ve ever experienced in their lives when they become aware of financial matters (from aged mid-teens perhaps).

All this could be in for a rude awakening, if inflation rears its ugly head again. The conditions are perfect - there’s been massive money-printing in all major economies, and Governments are running huge deficits, pouring money into the pockets of households & companies, both of which…

Unlock with Email

Unlock with Google

Already have an account?
Login here

Deegee Eff

18th Jan '21

Immigration too will have had a significant dampening effect on inflation.

abtan

Funding Circle Holdings (LON:FCH) (no position)

Hi Camraid

CBILS (and PPP) were indeed the great opportunities and they flunked badly.

I was trying to go through the numbers today and I wasn't really sure what to make of them.

To make things even more confusing, it seems as though they have used an incorrect 2019 revenue number, unless I am missing something very obvious.

As for the future, I actually disagree somewhat.

The US looks like it's going nowhere, but the UK seems to be progressing. The hardest thing, as you say, is getting customers on-board, and they've done that to some degree. There will be demand in the future either from their current customers, or via referrals.

They have an automated approval process, which I believe is the first of its kind in the UK (decisions take hours, not days or weeks like traditional lenders) and if they can truly clear-up their balance sheet (a friend insists it is net cash anyway after accounting for the warehousing/ABS products) and they do truly remain EBIDTA positive, then there could be a gem here.

I, however, shall remain on the side lines.

Cheers

timarr

Hi Charlie

I'm not sure I follow your point on demand and supply - are you saying that even though we are in lockdown demand continues remotely?

No, it's nothing to do with the current situation, it's about the long term globalisation of the economy. Thirty years ago someone could earn a decent living as a semi-skilled worker in manufacturing. Now they're in competition with lots of people on lower wages in SE Asia.

Or, twenty years ago someone could demand a high salary as a software engineer in the UK, now they're in competition with hundreds of thousands of equivalently qualified programmers in India and China. Demand for those services has gone up and there's increasing specialisation, but overall the trend has been towards more competition for jobs and wages for many people have stagnated.

Wages can't increase if people can be easily replaced and if wages can't increase then people can't afford to pay more and if they can't pay more then inflation has a natural limit. That's deflationary. It doesn't matter how much money governments pump into the economy, if it doesn't end up in peoples' hands so they can spend it then it can't drive up prices.

The UK is a different matter. Raising trade barriers will force up prices. Either wages increase, decreasing profits or wages stagnate and people need to find ways of economising - which probably, but not necessarily, leads to recession. Against that we have a lot of pent up savings to be deployed and the government will pump money into infrastructure projects.

My guess is that wages will increase for the lower paid as limiting freedom of movement will reduce the pool of workers and increasing import costs will encourage more home production, requiring more workers. Company profits will probably be hit and this will be inflationary although how inflationary is hard to say. But the UK is a special case.

timarr

Laughton

"There is a lot of evidence that inflation is heading our way... one small example of this:"

Indeed! Anyone else noticed how much bigger those cardboard tubes in the middle of toilet rolls have become over the past few weeks.

Maybe that's another bull point for Accrol Group (LON:ACRL)

Thornabian

Just want to make one point, UK service sector is made up of retail, hotels, restaurants, transport, storage, IT, finance, insurance, real estate, administration and support services, professional, scientific and technical services, education, health, social work, arts, entertainment, recreation, public administration, defence and several more. (These all make up the 80% GDP)

Pure banking services make up about 6% of GDP and a much smaller portion of this is to EU companies - around 1-2%. There was never an agreement or 'trade deal' on banking services before Brexit and how regulators work together across boarders (or not so much) is still being discussed. This is improved by having the major agreement for goods in place - which is the real concern for Germany and France based on their economies.

E.g. Switzerland have just signed an agreement with us on share trading which was banned by the EU in June 2019 (27% of this was done in London so hit us most) and the EU has granted temporary access already for certain activities but the talks are ongoing until an expected agreement by March (whether this will be extended who knows?).

There is certainly a big question mark over covid and how services generally will bounce back but I think Brexit is largely a risk which has passed.

Completely agree and it is all relative because a $10bn company could be in a $200bn market or a market which is growing at 20% per year itself; excluding the company's execution on growing its market share.

Conversely, it can can be in a very mature market that needs a huge amount of Capex to even retain share (I'm thinking old Telecoms which used to be so lucrative) but a small disrupter into this market can grow very quickly (I'm thinking Hyperoptic in the Telecoms market who had a different business model to BT etc.)

The expected growth in relation to the market size needs to be realistic.

LeopoldAlcocks

Thanks timarr,

I follow you now, and agree with what you're saying.

It will be interesting to see if UK workers can demand a higher wage post-brexit. Perhaps in some sectors where jobs cannot be moved overseas because the job needs to be done in the UK, such as care work, construction we could see an uplift.

rogerh

To fellow investors in ANGLE (LON:AGL), one person last week queried the difference between Angle’s Parsortix system and a simple blood draw, as utilised by liquid biopsy companies such as Guardant and Grail. I wrote to the company about this and received the below response.

ANGLE currently has a heady Stockrank of 3, so plenty of upside potential…

There are several differentiating features between the technology and approach adopted by the companies you mention, and those employed by ANGLE.

Guardant, Grail and other larger companies focused on the liquid biopsy space analyse fragments of dead cancer cells known as circulating tumor DNA (ctDNA). They are all essentially using the same technique which is to extract the plasma which contains the ctDNA and then undertake next generation sequencing analysis. The utility of this analysis is limited to analysing DNA alone and cannot be extended to RNA or protein analysis (since it is looking at tiny fragments of dead cells). ANGLE’s patented Parsortix platform, which captures intact living cancer cells and harvests them for downstream analysis, can provide this potentially valuable RNA and protein information, which is important for informing decision making during clinical trials and treatment options in a clinical setting. Further, as we capture intact cells then, unlike ctDNA, these can be cultured for multiple uses including drug testing and we have also had key opinion leaders with breakthrough research in relation to CTC clusters which have been shown to have up to 80X metastatic potential. The liquid biopsy market potential is huge and we believe there will be multiple winners as the most appropriate technique will depend on exactly what you are trying to achieve.

Further, whilst differentiated, we do not view these approaches as mutually exclusive. The companies focused on ctDNA are all potential customers for Parsortix, since the same blood sample from the patient can be used both for ctDNA and for CTCs if Parsortix is used.

In addition, all the big liquid biopsy companies operate as service laboratories which receive and can process blood samples and analyse them, but they do not have a product that can be sold to hospitals. Parsortix, in contrast, offers (i) patented product sales and the hospitals can analyse the patient samples themselves (which is what they would prefer to do so they can retain the value of the test) and (ii) we are also now setting up clinical laboratories of our own to speed up adoption of the technology as an accelerator and demonstrator.

Richard Goodwin

Me too. Also my Sharelink also become Schwab, became Barclays

I saw a management presentation by £cpp at a Mello. They were a shower!

Harry Hindsight

Book your staycations now. Couldn't get a campsite summer 2019 (seems so long ago) and Mrs Farmer rented out her field with a portaloo and er shall we say oversubscribed. Suddenly a caravan becomes the hot investment of the century. Or how about a Campervan - but 20 mile traffic jams through A303 Stonehenge is no holiday - "are we there yet" - oh and lets not watch the 'battery indicator' :)

So that conservatory extension, loft (if can find a builder would trust with a blocked sink), Peloton cycle (nah) - no room anyway the 'gym' 'spare room' is the 'office' now. Upgrade house to the country? Nope.

Sainsbury (food Argos Bank) and M&S (website is quite good INHO) on my watchlist.

Pubs - went to a beer festival in Hackney 2019 - a million years ago. Thankfully have the photos for the grandkids album of how the oldun's used to live.

Tax - see some director outflows so Mr Sunak's plan will take 'skin' out of the game to lose another plus metric. The so called Middle Classes next.

Tax - a common them for the robber barons - buy-to-let tax no longer a benefit and with tenants at risk of losing their jobs makes it a 'sucker' game and sell then get CGT (let the govt build more then).

Inflation - ditto property with leverage. Food will benefit - already price up quality down IMHO.

Looked at China/Alibaba but "wheres Ma" - governments not good business make - but then?

NIO cars anyone - Tesla beating 0-60 in nanoseconds - but with Mr Plod's improving hand held tech and need to fund stuff - game over. Anyway we will all be in Total Recall Cab or Noddy Cars by 2030. If you can drive a nice car (sorry dirty horrible killing machine) then do so now - Best Of The Best (LON:BOTB) (got bored and sold a week back so ignore my insights).

There seems to be an investment law - the day you sell is the day it takes off. Same with Kromek - Mr Market knows how to squeeze the weak hands.

Sorry, I don't know what this mean. Golden?

Boon

Government spending/QE shouldn't be an issue as the Government can buy back the bonds and cancel them

Correct. In normal conditions. But once inflation is out of the bag, buying back more bonds will mean more newly printed money flowing to the system. Unless equal or more bonds are issued then that money has to go somewhere, causing more inflation.

You could then issue loads of bonds and suck out liquidity in the system. But that will cause prices of all bubblicious asset classes like shares, bitcoin, etc to collapse in value as people rush to sell to buy tempting bond yields. Triggering financial instability.

Once inflation gets high and cannot be tamed, there are no good options.

They don't grow/manufacturer the raw pulp that goes into their toilet rolls....! Will be the first casualty of higher raw material prices.

Gromley

My guess is that wages will increase for the lower paid as limiting freedom of movement will reduce the pool of workers and increasing import costs will encourage more home production, requiring more workers. Company profits will probably be hit and this will be inflationary although how inflationary is hard to say. But the UK is a special case.

I do think there is an interesting and perhaps serendipitous counter to this.

I don't read too much on this board or other forums I follow about the jobs crisis that is happening amongst our lower paid workers and frankly I would judge that some of those jobs won't be coming back. This could enable something of a reset.

If the "middle classes" exit the pandemic with pent up spending power then perhaps to some degree displaced "working class" former workers will step into (be forced to step into) the space vacated by "cheap foreigners".

I use stereotypes there to make the point more obvious - it is clearly far more nuanced than that. If you need to reshape the economy though , this might not be the worst time to do it.

There is a far more lengthy argument on this subject, that I have (very briefly) touched on before; but when ones get past the Brexiteer vs Remoaner narrative; the key factors will be more in depth and less obvious.

ridavies

rogerh, thank you so much for your extra research on the Angle (LON:AGL) comparative advantages versus other major competitors. I havwe been interested in this company for 7 years + after my daughter went through a very bad time with biopsies associated with breast cancer. Ditto a friend who has suffered the same recently with dramatic side effects for prospate cancer. I wouldnt wish that on anyone. This company seems to have proven itself in multiple impressive research centres, avoiding biopsies AND giving much better and flexible continuing routes to better more targeted treatment. If I get some financial return on my patient investment, so much the better - but that will be a bonus.

Stand by for cardboard tubes the size of paint cans - and 5 sheets per roll. All for the same price, naturally.

AnonymousUser465323

19th Jan '21

Hi dahokolomoki, this is true (currently) however if you watch the great presentation that Tamzin from PI World produced after their interims it seems like they are evaluating the installation of a mill to produce their own pulp and tissue and seem quite a distance along that road.

PI World - Accrol

CamRaid

Hi Abtan,

As a business they create a lot of hot air.

Historically Funding Circle Holdings (LON:FCH) have spent 50% of revenue on marketing. The global expansion has pretty much been a failure and I believe some of their overseas offices are working as brokers rather than actual lenders.

They do have an automated approval process which is slick if the deal goes through without touching sides. If there are any questions that is where the problem starts. The quality of the front line staff is dreadful. I am not sure whether they just can't pay enough or that the training is poor.

My issue with the business is the tech like valuation. There is arguably no repeat income. The loan belongs to the investor and FCH charge a platform fee for arranging the loan. The argument that customers return for another loan is somewhat unproven. Insurance companies, etc.. talk about rates of renewal. Why don't Funding Circle? The loans in the main are 3 - 5 years and historically interest rates charged have been high (up to 20%).

So why are loans unlikely to renew?

Loans are typically for a specific purpose which is often one off and does not suit other finance products. A refurb of an office would be a good example. Cars and plant and machinery are renewed more often but are better suited to HP where the asset is used as security rather than directors guarantees.

Also don't forget that returning clients still have to go through the same underwriting process. If a client does want a new loan then due to financial performance or affordability criteria they may not qualify. If financial performance has improved and debts have reduced the business may well qualify for cheaper funding via the banks.

So in short there are 2 issues with renewals. Will the client need funding and if so will they need Funding Circle, and will Funding Circle approve the new application?

Demand is another issue. CBILS is an opportunity for them to shout about improved performance but this is a one off. I would suggest most businesses that qualified have taken a CBILS or Bounce Back loan from a bank, Funding Circle or another provider. This will mean for the foreseeable future they won't need a loan. The opportunity to refinance those loans will be minimal because in most cases the rates we so low compared to normal rates.

Let's assume a business does need a loan. It is likely do to ongoing distress caused by lockdowns. The actual criteria for CBILS has not changed so they are limited to 25% of turnover or 2 X wages. They are likely capped out. Their distressed financials and existing loans will also mean they don't meet the underwriting criteria.

Beyond CBILs the same issues apply and without the government offer FC an 80% guarantee. Underwriting loans will be tough. Demand will be lower and underwriting approvals will be lower.

The next issue is investors. FC have fallen out with retail investors like us and moved towards institutional investors. Read Trustpilot. FC only send review requests to client so by that they mean people they have approved and provided a loan to. As such the reviews are skewed in their favour. However, investors have found their way there and are unhappy as are those that have been declined.

Of the existing loans prior to Covid, what will the performance be? If bad debts are high will institutional investors want to continue supplying funds? Funding Circle sold some loans to a hedge fund recently. I think bad debts will increase and investment will be harder to come by. This may means institutional investors want a higher return forcing rates even higher than they were before. This will reduce demand.

Overall I think the model is flawed. There is no repeat income to talk about and the likelihood of renewal is not the same as with revolving credit facilities, log term loans like mortgages or insurance products.

This business was overvalued on hype and hot air. The business remains full of hot air although the hype has arguably dies down.

2021 will show it's true capabilities. Income will drop significantly from 2021.

Hi Gromley

Well, ideally you'd import cheap overseas labour to do the low paid stuff and train up your citizens to perform higher value jobs, increase productivity and generate economic growth. As it stands, we'll likely see the wages of unskilled and semi-skilled workers rise for no productive benefit.

That's not a moral statement - I think raising wages at the low end and decreasing earnings dispersion is a social good. However, doing so without associated productivity increases will lower earnings and decrease profits and make us all poorer.

In addition the plan to manage the skills gap by importing talent is morally dubious. For example, should a rich country like the UK be importing medical staff from poorer countries where their skills are desperately needed? Nothing stops us training our own people other than the fact it's expensive and it's easier to poach skills from elsewhere.

But more generally, the pandemic has thrown into sharp relief the lack of scientific skills in the general community. It seems most people really don't understand what "exponential" means.

Small Cap Value Report (Mon 18 Jan 2021) - BEG, W7L, AUG, CPP

Lockdown restrictions

Inflation & interest rates

Unlock the rest of this article with a 14 day trial

About the Author

Paul Scott

86 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...