Small Cap Value Report (Mon 25 Feb 2019) - ALY, PFG/NSF, FIF, QTX

25th Feb '19 by Graham Neary

34 comments 11168 reads

Good morning!

I hope you are all feeling refreshed and energetic. Plenty to chew on today.

Today's report includes:

Laura Ashley Holdings (LON:ALY) - update on media speculation (re: takeover)
Provident Financial (LON:PFG) - response to offer by Non-Standard Finance (LON:NSF)
Finsbury Food (LON:FIF) - interim results
Quartix Holdings (LON:QTX) - final results

Laura Ashley Holdings (LON:ALY)

Share price: 3.76p (+16%)
No. of shares: 728 million
Market cap: £27 million

Update on media speculation

We discussed Laura Ashley last week, and my conclusion was:

"Not worth dabbling in this until there is a sale/liquidation planned, as the brand seems to be dying a slow death under current management."

Three business days later and the company is suddenly at the centre of takeover speculation!

The Sunday Telegraph reported over the weekend that Michael Flacks "is to approach Laura Ashley's Malaysian controlling shareholders in the hope of taking it private and reviving it".

Today, the Chairman of LA says that no approach has been made and also that "as major shareholders, we have no intention of divesting our shareholding".

The group of controlling shareholders is centred around Khoo Kay Peng and his MUI Group (Malaysian United Industries), with c. 60% of the shares.

Speculating on takeovers is very difficult, in my experience. In this instance, a takeover bid has not yet been made and the controlling shareholders are indicating that their stake is not for sale. So we have some fairly obvious reasons for caution.

A controlling shareholder is always a huge roadblock when it comes to getting a change of direction, e.g. see French Connection (LON:FCCN) which should have been transformed many years ago. My comments last week were on the basis that the current controlling shareholders might some day want to move on.

Buyer background check - Looking into the background of the rumoured bidder, I see that he does have a track record in this sort of activity and so the rumoured bid is probably not just a publicity stunt.

In 2012, he led…

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Trident

25th Feb '19

IG Group (LON:IGG)

Always tricky to read those holding RNS's right, but it looks like Standard Life have acquired 5%. If so, a mild bit of encouragement someone sees value there?

Gromley

Reach (LON:RCH) results and Trading Updates are normally very boring and predictable – slightly less so this morning I think.

Earnings

The trading statement on 14^th December told us to expect performance marginally ahead of expectations for the year. This spooked the analysts to reduce their forecasts for the year (the ‘tradition’ is that the Q4 trading update guides to performance ‘ahead’ or ‘slightly ahead’.)

In fact, results came in at underlying operating profit of £145.6m (vs updated consensus of £140.3m) and adjusted EPS of 39.2p (well ahead of any forecast during the year).

Adjustments

There are adjustments galore and in fact the statutory results show a loss (-41.0p / share).

The significant adjustments being impairment of intangible assets. Now one can engage in the philosophical debate about whether these are ‘real’, more importantly though I would say that if you take the view that they should be included, they should in fact be spread over several (future) years.

The adjustments all seem reasonable to me, although it is frustrating that they accrued yet more costs for potential payouts on the historic phone-hacking issue – could there yet be more to come?

Dividends.

Full Year dividend increased 5.9% maintaining a dividend yield above 10% (at the current price).

This was largely as expected and whilst many would say that such a high dividend yield is a sign of ‘distress’; if you actually look at the cashflows the dividend looks secure.

Net Debt

Here’s a puzzle – in the 14^th December update they told us that they expected net debt to be c. £55m impressively down on the £81m at the half year. Now they tell us it was in fact £40.8m as at 30^th December.

Obviously that’s a positive, but I would really like to understand where they got an extra unexpected £14m of cash inflow in the last two weeks of December. (A Christmas present from a long lost great aunt?)

The pace of debt reduction is no doubt impressive, but I suspect this snapshot is somewhat flattering.

Overall

Quite a lot to like here imho, but I doubt this will be turning point for market sentiment (Share price down c.75% over 5 years).

The statutory loss will probably be enough to allow the market to continue to consider this as a dog.

Incidentally, I was writing an article on Reach over weekend examining why I think even the StockRanks are overly pessimist here, I decided that in fact it was too boring.

I will though just give this snapshot :

Reach has a moderate Piotroski F-Score of 5 out 9.

Three of the tests that it fails are :

Is the company making a profit?
Is it more profitable than it was last year?

Both of these tests are failed because of the impairment of intangibles mentioned above. I don’t in fact consider either of these to be really ‘fails’.

Also :

Is the company's long term debt reducing or stable?

This is a fail due to the fact that they raised new Long Term debt to fund the N&S acquisition, however, again as noted above it seems pretty clear that the debt trajectory is downwards.

These “one-offs” will take until this time next year to drop out of the numbers, but in the meantime, I believe that Reach has a higher quality than currently reflected in the StockRanks.

For the time being I remain a relatively content if frustrated holder here (despite the lack of price momentum meaning it doesn’t fit my current profile) but I don’t necessarily expect any major change in sentiment soon.

EDIT : It just occurred to me that I had meant to clarify that I was commenting on the results on the assumption of pre-knowledge of the overall situation - there have been quite a few discussion on Reach previously. Anyone though coming to this 'fresh' should consider the key 'bear case' that revenues from the traditional business are in secular decline and that so far growth in 'digital' is not sufficient to cover these reductions in any reasonable timescale.

CliveBorg

Thank you Gromley, for a really excellent and very clearly laid out report on Reach.

sharw

Centamin (LON:CEY)

apa apa - the £+code will not work unless you put a space after it.

The SCVR does not usually cover holes in the ground be they oil or minerals.

Luthrin

"So although print is clearly a declining business I can see them at net cash levels exceeding £100m in the next 2 or 3 years and would expect pension deficits to be significantly reduced. Indeed, if yield curves do start to steepen eventually then that reduction could be fairly dramatic."

This sort of sentiment has been expressed on Stockopedia about a number of companies with large pension deficits over the past year. The prospect of rising discount rates and the recent stalling (and even reversal in some parts of the UK) of life expectancy improvements would certainly suggest that pension liabilities won't look so onerous in the near term at least. However, I haven't seen any concerns articulated regarding what I view as a material threat in the medium term to companies with large defined benefit obligations, even if their schemes are presently in surplus: the growing likelihood over the next fifteen years or so of a step change in expected human lifespan due to the availability of anti-ageing therapeutics.

This is a subject that I've been following for well over a decade, and back when I first started looking at it, anti-ageing research was a backwater that few serious scientists would ever consider navigating, with those brave individuals who did pursue a career in the field finding themselves plagued by a lack of funding. However, over the past three years or so this has all changed (breathtakingly so) and there is now a wall of money finding its way into age research and towards companies seeking to commercialise anti-ageing therapies. Some obvious examples are Calico with its $2.5bn funding from Alphabet and AbbVie, Unity Biotechnology and Jim Mellon's Juvenescence, but there are now numerous smaller startups in this space and the number is growing by the month.

Mellon isn't short of gushing enthusiasm on the subject: "This is the biggest money fountain idea that Al and I have ever seen. The longevity business has quickly moved from wacky land to serious science, and within just a couple of decades we expect average human life expectancy in the developed world to rise to around 110" [1]. Of course, it's always wise to remember that Mellon is talking his book, and as with the dotcom era, an awful lot of investors are going to lose an awful lot of money in the coming stampede if his predictions regarding sector growth come to pass.

All the same, the investment madness we witnessed with the dotcom gold rush didn't undermine a fundamental underlying truth: that the Internet was going to radically change our lives and reshape the commercial landscape profoundly. And so it may likewise be with the nascent longevity industry, where progress and investment is being driven by a greater scientific understanding of the biological mechanisms that underlie ageing.

Personally, I don't see this as an imminent threat to companies with substantial pension labilities. The first anti-ageing therapeutics are likely to be senolytic compounds which are now entering clinical trials and aren't expected to be on the market until at least 2022 (these drugs are targeted to clear senescent cells from the body, which are now implicated in many age-related conditions [2]). However, my concern is that as this emerging field gains more prominence, investors' perceptions of the risks attached to large DB scheme liabilities will be reflected in market valuations. As an example of how this is beginning to permeate institutional awareness, Barclays Private Banking recently released a report titled 'Beyond 100' ("breakthroughs in bioscience could increase life expectancies and help people live fitter, healthier lives for much longer than we thought possible"). And the Longevity Leaders Conference in London earlier this month was sponsored by Legal & General and Prudential, with the latter supplying a booklet for attendees with the title 'Prepare for 100'.

As a consequence of the above I no longer invest in companies with DB scheme liabilities which are disproportionate to market cap and profitability. The risks relating to a marked increase in human longevity are still relatively remote at present, but I believe those risks are increasing as each year passes and I sleep a little easier knowing that my portfolio isn't exposed to this particular dynamic.

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[1] The quote is from Mellon's book Juvenescence (co-authored with Al Chalabi). As an introduction to ageing theory, therapeutic targets and many of the companies in the sector, it's not a bad place to start.

[2] The following Nature article gives a highly readable overview of senescent cells and why we might want to eliminate them: 'To stay young, kill zombie cells'.

Pantastic1

Woodford has 'lost the plot' in the last couple of years, and (in my eyes) is compounding it here.
I personally intend hanging in there with PFG. I firmly believe the board WILL get their act together to bring the Company back to better days.
Fund managers have too much power in this type scenario these days. They think they own the world, and everyone else is wrong.

davidjhill

It's a very interesting topic and I enjoyed your commentary, so thumbs up from me.

However, in a similar manner to AI it is one that has all sorts of potential implications/ramifications to every company, and not just those with current final salary type pension liabilities. I don't think anywhere near enough is known to avoid/not avoid or change valuation perceptions of businesses on the back of this yet. Typically company valuations adjust 6-12 months ahead of events whereas I believe we are 5+ years away. Not least that we don't know how Governments will react should life expectancy take a sudden jump up. Extended life expectancy has historically been highly correlated to a reduction in younger generation numbers, and many developed economies are already seeing a negative gap opening up between birth and death rates. If that were to continue I would expect to start seeing retroactive pension legislation at some point, extending the age at which private pensions can also be drawn. Not least because Governments will come under increasing pressure to ensure a viable workforce to maintain GDP and standards of living (not withstanding AI disruption potential of course).

Reach closed its final salary scheme 10 years ago. Given the length of time to build entitlement I'd say that it's probably only those enrolled 20+ years ago that have a material impact. It wasn't the most healthy profession either so I'd be inclined to take the view that life expectancy of those enrolled back in the 70/80/90s is also lower. Therefore, I'm relatively happy to take the view that any large jump in life expectancy passes this particular scheme by.

I'm not complacent to pension risks by any stretch but the cash generative nature of this business currently leads me to consider that any deficit will reduce dramatically over a 3-5 year view irrespective of yield curve. If I am right the shares should massively re-rate, but I will watch closely and if the facts change so will my investment thesis.

dealtn

Longevity is a truly interesting subject, and from a finance perspective my own view is that (unconscious?) herding has created an asymmetry where many more investors, including institutions, see the negative risks, with respect to pension liabilities, than those who see the opportunities with respect to their (potential) mispricing. My portfolio reflects my view that this asymmetry is wrong so I have "skin in the game" and, in general, don't see companies with pension deficits as "uninvestable" (although many fail to make the grade on other criteria).

Life expectancy is arguably falling, and definitely is in some demographics. At the minimum the expected increases in longevity that have long been talked about, and "priced in" are not being met. However the investment "industry" acts very much like a slow oil tanker in changing its direction.

I am sure there will be a number of substantial medical discoveries over the years that will prove to be life extending, yet these will take many years to discover, test, and bring to market, though I concede many may already be along that timeline as we speak. As a counter we also have the very real issue of decreasing effectiveness of current drugs, and in particular antibiotics. You can also add lifestyle choices, and obesity "epidemics" into the ring as offsets to the life increasing discoveries in the field of science.

The truth is it isn't really possible to model with a great deal of accuracy what predicted life lengths will be over the medium to long term.

However the reality is that most, though not all, companies with historic pension "issues" aren't particularly exposed to the long term. The majority of schemes are now "closed", and effectively in run off, and have agreements in place as to how the deficits, should they exist in terms of cashflow outcomes as opposed to current discounted valuations, are financed and resolved.

It is probably the case that positive, and negative, impacts on life expectancy will, as well as being currently difficult to know, and model, have significantly greater bearing on the youngsters of today (and the currently unborn) than they do on the currently retired who are drawing their pensions, and even those still working but members of schemes currently considered problematic by the investing community.

JohnEustace

Regards longevity, I have seen research that says one of the key determinants of a long and healthy retirement is having a decent pension to draw on.
So I would want to understand the lifespan of those more fortunate people drawing the final salary pensions and not just look at the overall population numbers.

AnonymousUser192020

Indeed, but all these factors are allowed for in the actuarial valuation. This 'client thoughtpiece' describes the process; it's essentially the same for private sector schemes https://www.barnett-waddingham.co.uk/media/filer_public/0f/c7/0fc7f48d-9ace-43dd-8913-e86881d46ebe/25092018_choosing_mortality_tables_briefing_v1.pdf
Some actuaries will also fit tables by reference to postcode analyses and similar geo-demographic data.

Bear in mind also that many closed final salary schemes are looking to hedge their liabilities, including longevity risk, and will aim to have offloaded their liabilities, eg through buy-out or buy-in with an insurer, long before the last pensioner has popped their clogs.

I haven't read up on the anti-ageing research but sense it's possibly a 'day after tomorrow' issue. The timescale for getting new drugs to market is typically many years. If these are indeed effective then they pose potentially huge ethical issues (eg impact on social security and healthcare systems) far wider than the pension scheme impact. Should we be shorting the insurers? Also, again showing my lack of reading, I'm unclear whether the claimed benefits apply to clapped out old pensioners or just to youngsters whose cells haven't been too damaged yet. And will they be affordable?

I expect we'll find 'personalised medicine' (based on individual genetic make-up) a similar concern.

Interesting topic, though!

xcity

The big issue with Reach (LON:RCH) is that it is a declining business in a declining industry. And it takes over similar businesses when they reach the point of no return with current owners to the immediate detriment of its balance sheet. And there's a cloud of nasty events that could bash it further. It's full of things investors don't like, especially growth. So a low rating is guaranteed.

This is also the positive side. Looking at long-term outcomes, the city usually undervalues companies in decline and overvalues companies in growth industries. Will the high cash flow be sufficient to give a good ROI before the inevitable happens?

Without knowing the management at all, it is my impression that they know what they are about and they're not likely to suddenly develop delusions of grandeur by using the cash flow to take over a growth company. Just return the winding down cash to investors. OK by me, but not risk free.

"I personally intend hanging in there with PFG. I firmly believe the board WILL get their act together to bring the Company back to better days."
Woodford had discussions with Provident Financial (LON:PFG) management in the past which reassured him that they were on top of things and were going to rebound. He then bought more when many investors were selling. Events seem to have indicated otherwise and I'm not surprised that he feels that management is the key issue and is happy to support a management he is happier with to take it over.
I hold neither but his support for the bid seems entirely rational to me (whether its right or wrong is another matter & you obviously believe it's wrong, though I'm not sure what evidence you'd use to support that).

gbjbaanb

Anti-ageing will be more and more researched.. .but, I doubt the resulting technology will be for you and me, it'll be for the already rich who can afford the pills or whatnots that will be priced accordingly. So I'm not too bothered about pension liabilities being a problem for quite a long time. Ask me again in 20 years, its that level of even initial sight of problems.

As for those on DB pensions - most of them were closed in the 80s, and all those getting them would have been smoking and drinking in smoky clubs and pubs (you kids probably don't remember) and so life expectancy of the recipients will be relatively low by modern standards.

I thought Reach was a property business with a side-line in printing. Even that is just being run for fun while they get more into online publishing and advertising.

Alexgedla

There is no evidence at all that active outperforms passive as a style. And yet the fees remain materially higher. Funds will flow away from active for the time being

Beginner

I see the offer allegedly values Laura Ashley Holdings (LON:ALY) at 2.75p a share:

https://www.bbc.co.uk/news/business-47356386

I would be very surprised to see many takers at that price.

MichaelFBS

Hi Graham

Finsbury Food (LON:FIF).

Thanks for a great report. I do, though, think you are a little harsh on Finsbury Food (LON:FIF). It nigh on 10 bagged from market lows in 2009 to late 2016, which is not bad for a cake maker. Though now only 6 bagged since December 2008. I personally made a 60% ish return between March 2014 and December 2016.

It is on a very undemanding PE of around 6 and a yield of 4.5%.

I don’t hold and probably won’t buy but boring can sometimes be good!!

Regards

Michael.

Thank you for the responses to my comment on the emergent longevity industry - insightful and challenging viewpoints which emphasize why I value the Stockopedia community so highly.

mojomogoz

If you are going to heavy weight longevity breakthroughs at broad population level then best also put in downsides...say demise of Western hegemony due to collapse in value in of dollar due to unsustainable deficits which obviously takes down supplicant countries in Europe in a new sinocentric world.....

Smorgasbord of big macro risks to choose from.

Cos have a good record of muddling through. Longevity is a small risk relative to broad economic health. If we remain first world a longevity risk solutions will need to be forthcoming as not only private pension fund at risk. There is approx £11tr of unfunded pension liabilities in the UK with the majority owed by government in some way or other - >5x GDP (approx £2.05tr)

I'd bet on longevity risk sorting itself out in a factor sort of way (might sink individual companies)...but seek a hedge against the country doing an Argentina

cig

26th Feb '19

If there was a shift change in longevity, “unsustainable” deficits could be voted away by legislatures noting that the legacy arrangements didn’t anticipate this major development and are thus void. Pensions are not immutable laws of nature.

Small Cap Value Report (Mon 25 Feb 2019) - ALY, PFG/NSF, FIF, QTX

Laura Ashley Holdings (LON:ALY)

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Graham Neary

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