Small Cap Value Report (Mon 7 Oct 2019) - DUKE, RFX, BOOM, ANG, GHH

Two factors do not appear to have been clearly pointed out so far:

First: Real Estate prices are cyclical, moving from Buyers to Sellers' markets over periods of about 25 years. There are cycles within cycles, moving from the developed world to individual countries to individual regions. So one has to judge where one is in the cycle for where one wants to buy. In North America prices have surpassed the peak of 2006-7 but in South America there are some great opportunities. 

Unfortunately few of us have the time to shop, invest or settle in those areas.

Second: Property with a mortgage is a leveraged investment just like one in the stock market and if you buy at the right time the underlying asset is fairly stable. The fact one can live in the asset if it drops in value helps.

So then it comes down to a question of cash flow. How much mortgage debt can you service? If you have tenants you can service more.

You could take the house out of the equation and ask would you be prepared to borrow, say, £100,000 at a low rate of interest to invest in shares. Younger people may find this hard to believe but at one time you could get tax relief on interest borrowed for any purpose. At the time tax rates went up to almost 100% when the investment income surcharge was taken into account and it was often the case that persons on high earnings would borrow money, get tax relief on the interest at their top rate of tax and hope to secure a capital gain which was entirely free of tax at the time. It is not something I would do at the present time as the £100,000 borrowed could become £60,000 in short time but, of course, if it came off it would be a good idea.

I've always thought of any houses I've owned as investments. There are massive regional variations but where I live in Norfolk renting seems cheap to me compared to buying. We sold our house last year as prices had got 'silly' (they may yet get 'sillier'). This has freed up lots of cash for investing. We're now renting a very nice house on a long term secure lease and I reckon the landlord is grossing about 2 to 2.5% pa. Happy to take the other side of that trade.

At age 70 I had to payout my previous mortgage on my home but found I was able to remortgage at a fixed rate for 5 years at just over 2%. This seemed a no- brainer to me rather than taking the money out of the market. Effectively the mortgage money is now in a Fundsmith ISA earning 17% plus so far, so will pay it off when the 5 year fixed term is up.

On buying a home versus investing, I think that this country's obsession with bricks and mortar has been damaging to the UK economy. On top of which we have continual government meddling. Help to Buy etc.

Hi Graham, Your question about Home Equity v Stock Market Equity has generated a huge response, and rightly so.   I've faced a similar decision recently, as I was in a position to pay a significant part of my mortgage early.  I had 10 years to run and faced the decision: do I pay it off, or do I keep investing?

One source that I found really useful when thinking about this was a series of articles by "Big ERN" on his blog https://earlyretirementnow.com.  He's done a lot of research into the "sequence of returns risk", and how the sequence of returns affects your actual return over time.   His worked examples are extremely detailed.  He also discusses the merits of paying off the mortgage early.

As a quick example, say you choose to pay off the mortgage early, so pump as much free cash as you can into that goal.  You're mortgage free, maybe 10 years earlier than planned.  Is that a better scenario, than pumping all your free cash into the stock market and running the mortgage out for the full term?  If you go with option 1 then you've potentially lost 15 years savings, PLUS all the compounded returns.   You also start investing 15 years later, and although you may now be in a position to invest more cash, you have less time left to benefit from the compounding effect.  The risk due to the sequence of those returns is also greater because you have less time left to invest. 

Inflation also plays a serious part here.  Although the interest rate may fluctuate, the amount you owe will not be affected by inflation.  In fact that amount will become less significant over time.  By investing alongside the mortgage, inflation works in your favour, as your returns should benefit from inflation, whilst your mortgage amount remains unaffected.

If you fancy a podcast that provides and good summary of this subject then he appears on the Choose FI podcast - this one discusses sequence of returns risk https://www.choosefi.com/035-sequence-return-risk-early-retirement-now/ .

"Do you carry a large mortgage while also building a stock portfolio? Or would you prioritise building home equity first, before venturing into the financial markets?" Graham, I think the answer to this comes down to your appetite to risk. Considering you can borrow money for next to nothing at the moment, this lends itself to carrying a large mortgage. It doesn't look like interest rates will be moving north anytime soon. If interest rate rises worry you, for peace of mind you could always take advantage of a 10 year fixed product. I notice you can get fixed rates at 2.3% on a LTV of 75%. Considering you are still a young man it seems sensible to have the capital work for you in the markets rather than have it tied up in property. Its really a question of opportunity cost. Personally, I think you'd be crazy not to take full advantage of the low interest rate environment and use it to your advantage.

I purchased my first property in 1995, having deliberately decided they looked too expensive in 1990.
I liquidated my Investment Trust holdings to have a 26% deposit.
The mortgage was about 2x income and I put together an Excel spreadsheet & adjusted the numbers until it showed the mortgage being paid off in 5 years. Which is exactly what I did.
I then went back to stock market investing from 2000, having had no exposure during the life of the mortgage.

With hindsight:
1 The property purchase was well timed.
2 I was much too conservative in paying off the mortgage, when I should have being doing a combination of paying off the mortgage and utilising PEP allowances. With the way I did it, I missed PEP allowances and missed the 1995~2000 stock market returns.
I did just fine from 2000 onwards, avoiding tech stocks and investing in breweries etc.

The situation now is slightly more complex, a a couple have 2x £20k ISA allowances, plus the opportunity to avoid a lot of 40% tax with a SIPP (£40k per annum ?). So it would need a good 6-figure income to live, fully exhaust these tax allowances and still have some left over to pay down the mortgage.

Hi Graham,

I would strongly recommend an offset or flexible mortgage to buy your property, rather than a traditional repayment mortgage. An offset or flexible mortgage can save you a fortune in mortgage interest payments over the years. It might also make it easier for you to combine stock market investment with the purchase of a property.

Interesting question posed by Graham about whether it is best to pay off the mortgage or used the money for investing. I think the comments accurately reflect the fact that this is best considered on a case by case basis and the answer is different for different people, depending on their circumstances. I would suggest that a key consideration is whether you are confident that you can outperform the markets through investing in shares over the long term.

Graham, the best advice I can give regarding property and equity is to make sure you can go to sleep at night without worrying about the roof over your head. The security of each of our incomes, and the people we need to support with that income is different for each of us, so it's very much a personal decision.

I've never been one for taking massive financial risks, and have always split my money evenly between the stock market, the family home and any investment properties.

At the moment, I'm thinking we could well be due a significant property correction and a stock market correction, due to years of low interest rates and various national and international risks, so having a large pot of cash at the moment suits me fine, offset against my mortgage, while I wait for the black clouds to either clear or play out.. Yes there is an opportunity cost, but I gain flexibility to take advantage if there are any significant falls.

On the house v stock I used to live in a pretty nice house and rent out an apartment both on LTV averaging about 45%. In the last year we sold the house and remortgaged the apartment to 90% which we not live in.

I am using the excess capital to put into the market in quarterly intervals over 6 years (1 of which has elapsed so far) to ensure I avoid timing issues (in theory.)

I have gone minimalist in my thinking and imagine spending my later years traveling full time without any property living off bond/dividend income.

I regularly had to report to my wife on how I was paying down the mortgage. So that influenced my take, and it was generally my natural inclination to do that versus playing the market, on which I had a patchy record.

Arguably the lower interests rather justifying deferring pay down for market opportunities should encourage an appropriate amount of spare earnings to be allocated to mortgage pay down, whilst the opportunity exists.

However, I was on a definitive salary, with certain occasional material variations in my own business, so if your business is 100% making investments on your personal account, then it would be harder calculation to make perhaps as to where you place allocations of capital.

With respect to home equity vs stock market equity - my story comes from a rather different time. I had a total of three endowment policies linked to my mortgage, and when the first two of them matured I used them to pay off a chunk of the mortgage without thinking about it   too much. The third, for £20,000 or so, matured in the spring of 2009 just as the credit crunch bear market was reaching its bottom. I was pretty certain that the bottom had been reached and so instead of paying off my mortgage entirely I invested the £20,000 in equities. This decision was well justified, and within three years I was close to doubling my investment.

Who can say where the FTSE will go from here? I agree that under most potential scenarios it should rise appreciably, but if a Corbyn government is elected then I hate to think what will happen.

Graham, the starting question is: is your home really an investment and how would you measure the return?
Robert Kiyosaki (Rich Dad Poor Dad) has made a career of thinking of a home as part of your investment thinking but I think he is wrong unless it really has to be part of your income planning.
For many people (well, including me!) a home is not a tradeable investment, it is quite a different part of my life. I do not intend to move if the value goes up or down, any “sell” signal being largely unrelated to value. I do not (cannot!) live better if the value goes up unless I take on debt, which I have no intention of doing while in healthy retirement, and if the value goes down - so what, if you can afford the debt.
The “return” , if you can call it that, is the immense enjoyment of a home that is mine ( after many years of sharing it with the mortgagor !).

Hi Graham, on the equity v bricks debate I am terribly risk averse. My own personal story is that I bought my house in 1999 with a mortgage. Modest income and modest mortgage. I was very financially aggressive in paying down my mortgage (then @ 6.3% interest rate) and paid off the mortgage in just over 8 years. Whilst over that time I invested a small amount in funds and an ISA my primary focus was becoming debt free.

I'm reaping the benefits now. In 2009 I met who has become my wife. She is not earning and now I have to support 3 of us. Thankfully by personally being mortgage free I have a little more flexibility as some months have seen unexpected expenses mean monthly income < monthly outgoings (beyond my control which is a frustration because I'm very prudent with my own personal expenses when needed). My wife had and still has an apartment on a mortgage which she lets out. Over the years this has been a constant surprise of unexpected costs and rent free periods (since my wife doesn't have a job (health issues) I cover these, sometimes significant costs). I've pleaded with my wife to sell the apartment since it is a net loss generator but since it is in negative equity (even after 10+ years) she won't do this.

If I remember correctly didn't it say in the book "Rich Dad, Poor Dad" that property is not really an asset because it has ongoing maintenance and costs, whereas a true asset generates value without taking value away from you?

Since I cleared my mortgage I've been able to focus on my ISA and generated some notable % returns in recent years. Being mortgage free helps me since when I have surplus cash I can fund investments, when I don't have surplus cash I have less outgoings to help me make ends meet.

I was interested in the £DUKE PrimaryBid offer. However on attempting to make a payment two different debit cards were rejected as 'not being debit cards'. I called PrimaryBid's support line and was told their systems did not correctly recognise Lloyds Bank debit cards (nor my Starling debit card).

I wonder if the low retail take up of the £DUKE offer via Primary Bid is at least partly explained by their poor IT systems?

Hi Graham, home equity v stock market is an interesting question. Putting money into buying a home means you are pegged to the property market which isn’t as volatile as the stock market. This has its benefits.

I’ve also built up a small portfolio of buy to let flats. When I initially purchased property the gross yield on offer was 7% and this would drop to a net yield of around 1-2%. However, as time as gone on, the gross yield has increased to 15%. In addition there has been capital appreciation. I’m sure there are shares which have done particularly well over the past 15 years. But a lot more diligence is required to be undertaken and when things do go wrong, the impact can be significant.

Overall though, I believe a balanced investment approach is required rather than 100% in property or stocks. 

A bit of a dumb question but is there a place I can purchase a FTSE option for a specified strike price?
I am wanting to hedge my exposures, but I do not want to place a short.

£AGFX (FX service provider) trading update today. Revenues up 45% yoy. Recent IPO, founders own lots of stock, IPO proceeds used to support growth, couple of interesting small-cap investors involved (Amundi / Gresham House). Profitable every year since formation (2011 I think), and good rates of growth. Very competitive sector but plenty of short-term tailwinds. Interesting comparator to Alpha FX / Record.

A trading update from Franchise Brands (LON:FRAN) today indicating an encouraging start to the second half of the financial year. They have also acquired WPL Group Holdings Ltd (Willow Pumps), a pumps and drainage company, in a cash/shares deal. It strikes me as a slight change in direction but it seems to have been well received by the market.

Hi Graham

Ramsdens Holdings (LON:RFX) / H & T (LON:HAT)

If you have time today I'd be grateful if you could give your take on recent events in this area.

Ramsdens have issued an in-line TU today and note:-

"The stores acquired from The Money Shop have performed well and the Board continues to appraise acquisition opportunities in this highly fragmented market. The widely publicised recent collapse of one of the Group's largest competitors has again highlighted the importance of our outstanding and highly-trusted customer proposition."

H&T acquired the pledge books of A&B (probably at a discount but this wasn't disclosed) and took over a big chunk of The Money Shop.

Do you have any insights into why these two appear to be doing well when the sector in general seems to be having problems.

Phil

Hold both (didn't expect them to be on the acquisition trail but pleasantly surprised)

Interesting announcement from Air Partner (LON:AIR) ahead of tomorrow's interims. Air Partner (LON:AIR) to partner with NGS an international emergency response company as preferred emergency air charter supplier. Although emergency air charter is not new to Air Partner (LON:AIR) it is nonetheless a positive development as the company seeks to diversify the range of services provided.

A good update from Ramsdens Holdings (LON:RFX) with £0.6m added to cash balances. Slightly more nuanced that H & T (LON:HAT) but still very positive. "Compare and contrast" to borrow a phrase from school exam papers. Any thoughts you have Graham to add to your previous commentary would be appreciated.

Good morning!

There's a solid update out today for H1 (6m to 30 Sept 2019) from £IGP  (in which I hold a long position).

It's a turnaround situation, under new-ish management, who stripped out costs & moved it into positive cashflow. Important because it should not now need to raise any more funding.

I met management  earlier this year, and think they're very backable - CEO has a good track record of developing small software companies. His main reason for joining IGP (and also my main reason for buying shares in it), is the astonishing quality of its clients - US Govt Depts, major global companies & banks. A lot of revenues are recurring, so if it has a breakthrough in winning more orders, then the operational gearing could be exciting. As always though, there are no guarantees this will work out, and the company has had false dawns in the past, under old management.

This morning's trading update is in line with expectations, saying;

Revenues for the six months ended 30 September 2019 are approximately 5% higher than last year. This is in line with expectations and reflects a strong end to the half with orders received from both new and existing customers resulting in revenues of £4.4m (2018: £4.2m).

We are also pleased to report that continued tight cost control has resulted in a positive operating cashflow during the period with cash balances as at 30 September 2019 totalling £5.2m compared to £3.2m as at 31 March 2019.

The stand-out number there is cash, which has risen £2m in just 6 months. I reckon this probably means one or more big contracts might have been won near the end of H1, hence cash up-front, and and likely to feed through into H2 revenues, possibly?

Note that it has £4.7m in convertible loan notes, costing 8% p.a., so paying down some or all of this debt from the £5.2m cash pile would make sense, saving up to £380k p.a. in interest costs. That would also remove potential future dilution, if the shares really do take off (conversion price is 68.8p, well above current 34p share price)

I've put a call in to the company, to query the high cash balance, and some other questions.

A lot of its earnings are recurring, and in US dollars. So nice protection from Brexit & forex issues.

There seems to be an H2 trading bias. No outlook statement is given today, so I presume they're in line.

All in all, a nice potential turnaround situation I think. DYOR as usual.

Regards, Paul.

P.S. Azalia Trust recently increased its stake to 29.7% - always nice when a major shareholder increases to almost the maximum allowed without triggering a takeover bid (30%)

Intercede update is out this morning. Not too much detail, but things seem to be progressing ok. 

My morning smallcap tweet: Construction destruction at SIG

Totally (LON:TLY), SIG (LON:SHI), Local Shopping REIT (LON:LSR), Deltex Medical (LON:DEMG), Time Out (LON:TMO)

Totally (TLY) wins two contract extensions. £10.6m to Sep 2020 and £6m from April 2020 to March 2022. F/C FY20 rev is £120m.
SIG (SHI) construction mkt weakened further in UK & Germany. Warns significantly lower profit than its prev. expectations. Also selling Air Handling and Business Solutions divs for £230m tot. Will return majority of cash not used to cut debt ie up to ~£60m.
Local Shopping REIT (LSR) Duncan Soukup coup takes effect following cash return. He becomes Chair and an independedt NED appointed. 3 directors leave.
Deltex Medical Group (DEMG) FD left on Friday. He is thanked.
Time Out (TMO) placing of up to £17m at 127p, a nil discount. Cash for continued investment in roll-out of Time Out Market and to reduce debt.