Small Cap Value Report (Mon 6 Sep 2021) - HEAD, WJG, BLV, SPSY, PCIP

6th Sep '21 by Paul Scott

57 comments 10389 reads

Good morning, it's Paul & Roland here with the SCVR for Monday.

In between exploring the Senglea and Burgu areas of Malta over the weekend, I also took a look at interim results from Headlam (LON:HEAD) - not a current holding of mine, but something I would like to buy back into, when funds permit. So there's a section on that below, to get you started today.

Mello Monday is back today, at 6pm - details here.

Agenda -

Paul's Section:

Headlam (LON:HEAD) - my review of the recent interim results, to supplement Roland's review last week. I'm impressed with the recovery to pre-pandemic levels, plus the very strong balance sheet (with net cash, and freehold property) could attract a bidder maybe? Still seems good value to me. Although the commercial sector remains subdued, and there is a new competitor Likewise, set up by former HEAD leaders.

Watkin Jones (LON:WJG) (I hold) - a frustrating trading update that sounds reassuring, and gives lots of detail on developments, but says nothing specific about performance versus market expectations. A research update from Progressive says that today's update reinforces confidence in forecasts.

Pci- Pal (LON:PCIP) (I hold) - very strong organic growth in mainly recurring revenues. However, all the additional gross profit has been consumed by considerably higher admin costs - although this was flagged as a deliberate policy to help accelerate growth. I ponder the bull & bear points.

Roland's Section:

Belvoir (LON:BLV): an excellent set of figures from this estate agency group, boosted by rapid growth in revenue from sales and mortgage broking.

Spectra Systems (LON:SPSY): strong numbers and excellent cash generation from the banknote authentication specialist. But I’m struggling to get a clear picture on growth.

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.…

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Boon

6th Sep '21

Indeed! bank note circulation is increasing.

Also in Europe (data up until first week of 2021): https://www.statista.com/stati...

The statement about breakthrough in polymer tech, being able to compete against the likes of De La Rue (LON:DLAR) is interesting; not quite sure I understand it fully, so will read more about it later today.

Overall, I am expecting FY21 EPS to probably come in 12-13c instead of the 11.8c forecasted currently.

It has a stronger pipeline of "new tech" than any time in the last few years, so historical multiple range (17-27x) doesn't really apply, this should trade at 25-35x, IMO.

Solid moat of tech, good revenue visibility, exciting portfolio of growth opportunities, good balance sheet.

I therefore see potential for the shares to realistically re-rate up to around 280-300p, and that's why I'm happy to hold; a good 75% potential uplift. In the meantime, getting 4%+ dividends that is secure due to the long-term revenue visibility of the company and its decent balance sheet.

(I hold)

timarr

Hi herbie

I used to use notes all the time but have not been to an ATM for over a year now, I'm sure I'm not alone.

Me too but sadly for us I suspect our ATM based contributions to the UK's banknote circulation have never been that significant.

The same trend is evident elsewhere. Eurozone for instance:

It's a general trend, not something specific to the UK. The reasons for it are complex, but regardless banknotes will be around for a lot longer than I'm likely to be a shareholder in £SSPY.

Stocks123456

Deferred tax is just a provision to recognise the likely CT payable in the future, based on tax balances now. If the tax rate in the future has been enacted then that rate can be used. Hence the 23% rate sounds fine in this case.

Lucky dip

what is said here really is that the market is irrational at times! some it for sure is due to market makers actions.

shanklin100

Fairly unusual for any company, £spsy in this case, to highlight that it has a product which is better than its two main competitors. If this is not what they really meant, i cannot see why they mentioned them in the RNS.

Wilbraham

Interesting chart! Puzzled that the blue line shows steady annual growth yet the yellow lines show huge fluctuations, down and up, in 'notes in circulation'. Eg the fall from €1400bn to €200bn over 2008-12 with steady increase thereafter. Anecdotally, my friend in Ibiza always told me that pre-GFC, Germans would turn up on the island with suitcases stuffed with notes to buy second homes, until this tax evasion was stopped. But it's hard to understand who would be hoarding currency now - most public-facing businesses surely will hold just enough for immediate needs. I remember vaguely considering in March 2020 withdrawing a daily £200 for several months and burying in the garden, but this was driven by imminent talk of meltdown and authorities imposing -ve interest rates on bank deposits (which I thought applies in a couple of countries?).

Back to Spectra Systems (LON:SPSY) and £DLAR surely what is more important is the velocity of circulation of notes? Hoarded notes shouldn't deteriorate but money passing between grubby hands does eventually. With businesses in Western countries accepting no-surcharge card payments for just a £2 cup of coffee, and many Eastern nations having leapfrogged the card system altogether in favour of mobile payments, I don't understand who is spending/circulating so much cash. Long-term, plastic notes should need replacing far less frequently than paper, so I'm rather negative on Spectra Systems (LON:SPSY) prospects once their target markets have completed the switch to plastic. Not to mention the threatened central bank digital currencies, which I thought are already being trialled in some China cities.

BnB

The most interesting revelation was the increase in gross margin to 76%. It's a good rule of thumb in the USA, where such growth companies abound and I do the majority of my research, that margins in excess of 75% are considered healthy. I am with you on a preference for positive earnings or cashflows. That deficit (and a less sexy sector than cybersecurity) is what is holding the valuation back from matching the likes of Darktrace (LON:DARK) and its US counterparts. But my estimation is that positive earnings or cashflows for the same growth and margin profile would probably double the valuation, or even triple it with a Nasdaq dual-listing. I plan to attend the Investor Meet on Wednesday pm.

Rusty2

I've looked in Euro notes and it seems a lot is either outside Europe or is in store. Retail transactions using cash is falling, up to 2019 it was around 6% fall per year, I expect 2020 it fell even more as many switched to card payments. So if there is less money going through the banks then does that not effect £SSPY ?

I'm also have read that the BoE is counting old notes such as £5 and £10s which are no longer legal tender, in it's figures for banknotes. Europe has issues new notes in the last year so it could be an issue there as well. I can see there will be some doubling up until all the old notes are out of the system.

rmillaree

Was watching an interesting interview with the theranos whistleblower at the weekened where he was told in no uncertain terms by the hedge funds et al who they were pitching to get money from that any forecasts with regard to sales should really be double what they actually expected to achieve as all the dishers out of funding that matter simply take company estimates for sales and use half the figure as a starting point - seems like everything is on steriods when it comes the good ol US of A. Note this one bods comments may not reflect reality he may just have been telling a good story in this regard

I work in electronic payments so, sadly, I know far too much about this.

There are multiple reasons for the increase in cash in circulation. For the dollar and the euro a lot of it is dollarization effects where they're used as hard currencies in countries with unstable governments and high inflation. There's also a movement for people to hoard cash - with interest rates at zero then it's not a major issue to do so. And, of course, for person to person payments cash is still king (although in Sweden and Denmark even that has been largely replaced by electronic payments).

Outside the major currency zones the amount of cash used in transactions is still increasing, although the total number of transactions is increasing faster - the difference being the increase in electronic transactions. Also, of course, banknotes get lost and destroyed - although polymer notes decrease the latter effect.

Beyond that you have the potential rise of CBDCs - essentially fiat cryptocurrency - which will also start to eat into banknote useage. That's a long story in its own right.

So overall there's no question at all that the production and usage of banknotes globally will start to decline soon. But "soon" is hard to define and the idea that the world will suddenly stop using banknotes in the next few years is just wrong. £SSPY will have plenty of time to develop its business and, for all we know, could end up with a larger share of a shrinking market.

timarr

Hi Tim, I never said banknotes will stop in the next few years. But it is certainly declining in the west. Even in less advanced countries the switch to cards or mobiles is gaining ground. Yes less advanced countries are still using cash. Apparently money withdrawn from ATMs in the UK last year was down 30%.

My understanding is that £SSPY deals mainly with retail money, so if the money is abroad or in store then it will not go near a SSPY system. So yes they are in a declining market, especially as they are based in western countries. It's good they are branching out into other areas away from banknotes.

My understanding is that £SSPY deals mainly with retail money, so if the money is abroad or in store then it will not go near a SSPY system.

I haven't looked at this recently but a lot of SSPY's business is based around banknote security features - which are used in central bank production processes and are then used in checking when they're circulated back through the banks. Mostly that looks like Central Bank customers rather than retail ones.

I think the main risk here is customer concentration, rather than banknote decline.

There's a difference with forecasts in a fundraising or IPO of a private company - which can and will pitch heat to get your much-needed injection of cash - as opposed to quarterly guidance from a market-listed firm. In the latter example, you can spot a missed forecast or disappointing guidance on any growth stock chart from a mile away - just look for the big drops. These are a regular event, even for the likes of Amazon, which disappointed only last month. And for that reason, guidance has to be prudent and achievable as much as it is ambitious and attention-grabbing. It's a fine balance.

Logical David

Many thanks Paul for asking Jack if he will do a write up because I bought back into Sylvania Platinum (LON:SLP) towards the end of August based on its technicals.

ie, 78% retracement in its share price.

Stochastic had dipped below 20 and was starting to rise.

MACD blue reference line was about to cross over the red signal line.

smilingmickey

Thanks for your thoughts Roland.

I have held Spectra for several years now.

I still am not sure how they have managed to regularly increase their profits each year since I invested at well below £1! In terms of products they sell, advantges they have, and so on they are very secretive. Not many turn up to their meetings!

What I am sure of is that Spectra possesses considerable IP which they use to generate much of their growing profits and do not employ many people, smart scientists aside. Brown University (from where the MD qualified) is where they seem to be sourced from.

I surmise that much of their banknote authentification know how, may be developed using the very strong relationship they have with one central bank with whom they appear to have an externally funded continuing research contract.

I surmise that they hope to profit from the move to the use of longer life bank notes, using the IP they hava developed, to increase their market share by selling bank note substrates.

The subsidiary mentioned in the RNS was (I believe) spawned by the MD a couple of years ago. It is developing a product in the entirely different field of medical instrumentation. Since it is majority owned by Spectra one assumes that should it produce a commercially successful product (a blood plasma viscometer) much of the returns will be shared in some way by Spectra shareholders.

I like the fact that the Company holds a considerable cash pile, generates lots of cash and has been paying a consistently rising strong dividend for several years.

Harry Hindsight

Going from a update software on your PC/MAC to a cloud or internet based system is the way to go for the service providers. I use Evernote which did the same thing and functionality dropped - but have not found an alternative yet. Change is hard to assimilate to the best computer on planet earth (inside your skull).

InvestorLiam

Haha I see! Yep, I know that feeling all too well.

Appreciate the response buddy!

abtan

Spectra Systems (LON:SPSY) (I hold)

Thanks for the write-up Roland and to all those who made interesting Spectra contributions today.

One of the things that originally put me off buying Spectra Systems (LON:SPSY) was the promise of revenues many years in the future.

So I decided to go and read annual reports several years prior and (most) things did indeed turn out as the company predicted they would.

So when I read announcements such as today's:

incremental $500k new contract win (with Dr Pepper- $50b market cap), which drops straight to profit, and;
Secure Transactions EBITDA is lower due to higher development costs, which will increase future profit levels;

a) I believe them, and b) it gives me optimism for the future.

---

Further observations from today include:

H2 revenues will be quite similar to H1 due to a drop in Covert Materials revenue,
Annual cash generation is looking decent @c.£6m, 10% of the market cap,
the company bought back just over 1% of its shares (and I hope they continue to buy back shares.)

I remain wary about the share price reaction when revenues eventually don't grow for a period, but overall I remain reasonably optimistic.

Here are some more granular details for any interested, though please note the H2 numbers are my own.

Cheers

Belvoir (LON:BLV) (I hold)

"Deferred tax is just a provision to recognise the likely CT payable in the future"

I must admit to being confused by this.

I was under the impression that deferred tax is literally a past tax expense on the P&L that hasn't been paid yet.

So the current £1.9m deferred tax on the balance sheet is the cash the taxman is expecting to receive in the near future on profits generated over the last 12-18 months.

What has this got to do with 2023 tax rates?

The Belvoir's CFO seems quite competent so I don't doubt that she knows what she's doing, but I don't really understand it.

Any further help on this - from any tax experts out there - would be most appreciated.

7th Sep '21

Thanks for your write-up today Roland.

I remain a big fan of this company (probably because I hold) and am quite surprised by the drop in share price today.

The biggest takeaway for me was the underlying progress of the Nicholas Humphreys (NH) acquisition (completed end of March 2021):

This added £808k of additional revenue in 3 months.
Very basically, assuming the company's c30% operating profit applies = £250k of additional operating profit (in just 3 months.)
Annualised = c£1m
For prudence let's assume that this drops to a more reasonable £0.8m per year
The business cost £4m to buy.
This seems like an excellent return (so far) and ties in with what was announced at the time of acquisition.

If there was 1 negative I could see, it was that 3 NH-now-Belvoir-Corporate-Owned Offices generated £724k of revenue, whereas 17 NH-now-Belvoir-Franchised-Offices generated £84k.
Unless I'm missing something that seems quite a poor return from so many franchised offices. I am hoping that it's just a timing issue.

---

On the point of extending the 24 years of profit growth, I have a feeling that the company will either:

Sell the recently acquired NH offices, which look quite profitable, or;
Buy the growth.

The company currently generates c £8-£8.5m in free cash flow per year, which should be more than enough to keep the acquisitions flowing and profits rising.

To be honest given the highly recurring revenues, and what I see as pretty secure c.£5.5m operating profit, which should trade at a high multiple (this estimates excludes any Sales gross profit, which was £2.5m in FY20), I'm quite surprised the share price isn't higher than the current c£93m.

But of course, I am biased and I imagine that I am probably being overly optimistic. Nonetheless I do hope that the growth continues.

Thanks again.

Small Cap Value Report (Mon 6 Sep 2021) - HEAD, WJG, BLV, SPSY, PCIP

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Paul Scott

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