Small Cap Value Report (Thu 13 Jan 2022) - ASC, CARD, CIR, CSP, QXT, SAG, FIF

13th Jan '22 by Paul Scott

137 comments 11845 reads

Good morning, it's Paul & Jack here with Thursday's SCVR.

The volume of updates overwhelmed us yesterday, but the ones we missed were just in line with expectations, and didn't move much in price. When it's busy, we focus primarily on unusually good, or bad updates, as those are the ones that move share prices.

Brief preamble - inflation

By the way, one reader comment yesterday seemed to think I'm trying to set myself up as an economic forecaster, and (rightly!) cautioned on the futility of this. Just to clarify, when I do a preamble on the market, or the macro picture, I'm just airing my current thoughts on it, driven by news, as a discussion starter in the comments section. That also sets the scene for my investment decisions. For example, at the moment I'm not going to be buying any UK shares on toppy valuations (high PERs), because that type of stock has sold off big time in the US over the last year. The UK often follows the US, hence I feel risk:reward could now be unfavourable for highly rated shares. If they were still booming in the US, then I'd be more sanguine about paying up for a growth share here.

CPI inflation hitting 7% in the USA yesterday is another key piece of news, although the market seemed to take it in its stride (already anticipated?). That level of inflation hasn't been seen in the US since 1982, so it's bound to have a big impact on many companies. Inflation, and what happens because of it, is probably the biggest single issue we need to consider right now.

Look at Accrol Group (LON:ACRL) yesterday, which issued a profit warning due to higher input costs, but saying that it would pass them on to customers, but with a delay, thus hitting short term profits. Not good enough for the market - it hit the already battered shares by another 19%. So we ignore this issue at our peril.

Whereas Portmeirion (LON:PMP) has also suffered issues with cost inflation (especially freight), but grew sales more than enough to cover it, and issued a positive update yesterday, 9% ahead of profit guidance, leading to a 13% share price rise.

How on earth do we anticipate this? It's very difficult, and I think we just have to resign ourselves to…

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Doug2b

13th Jan '22

Forterra - they are opening a new brick plant later this year. Quite rare that a genuine new brick plant is opened in the UK. The licensing and permitting is endless and takes years to negotiate. The build also takes years, you have to base the plant very near to a suitable clay source and because of the time scales, you just don't know where the house building cyle will be when the new brick plant comes on line. Oh and yes, a new brick plant is very expensive requiring years of investment.

In the UK we have to import about 15% to 20% of our bricks, mainly from Holland. There is no prospect of this production gap closing in the forseeable future, even with Fort's new plant. Bricks are heavy relative to their selling price and are therefore expensive to import, this gives a considerable pricing moat to UK brick makers within the UK market.

Fort issued c7%, just under, additional shares in 2020. Normally I would frown on this, but not on this occasion. In 2020, Fort's spend on the new plant was high. Then came Covid, none of us knew quite how deep the resulting economic disruption would be. Fort took the decision that there is a first mover advantage to share issuing. i.e. if Covid had dragged the UK into a genuine depression, then it would have been too late for Fort to issue shares and their spending commitments on the new plant would have left them vulnerable, so they issued the shares. The extra cash was not needed in the end, but they made the right call under the circumstances.

Anyway, the share issuing is factored into the TS calculation as above.

Net tangible equity increase, annual average over the past 4 years relative to MCap - 5.7%. Dividend, conservatively expected to be c3% this year. Share issuing from 2020, average over the past 4 years 1.7%. Put it all together and there is a tangible surplus currently of c7%. But the new brick plant comes on stream in H2 this year, this will increase both output and operating margins. Major upgrades on another of Fort's other brick plants also begins this year.

Basically, Fort is a buy now, despite the drain that the new plant development has made upon the business over recent years, especially as part of the high investment phase coincided with Covid. With the new facility coming online, the buy case becomes compelling.

Fort are quite obsessive about under promising and over delivering. The closer to comissioning we get the more they play everything down, but the scale of the new Desford facility relative any other brick plant currently operating in Europe is all in the public domain. Brick forward contract prices are significantly up now relative to inflation. Whether private or social or both, a lot of houses must now be built within the UK over the next decade.

MichaelFBS

Hi Peter

Campbell is not counting anything he has extracted the data from two papers prepared by medRxriv on cases of Delta and Omicron variants in Southern California between 30th November and 1st January and where the Delta variant was still dominant (the US is behind the UK, EU and South Africa (96% Omicron).

https://www.medrxiv.org/content/10.1101/2022.01.11.22269045v1

https://www.medrxiv.org/content/10.1101/2022.01.11.22269045v1.full.pdf

The papers were making comparisons between the virulence of Delta v Omicron, something that is now not possible in the UK, for example, because there are not enough cases of Delta in the population.
I accept this is one study but quite a large one and the figures are striking. I post below a screen grab of the figure for cases with Delta (complimentary to the one above).

Further a chart from his programme the day before of the number of patients on mechanical ventilation in the UK shows that though the number of cases has exploded over the past two weeks (the estimate is of some 7 million + inventions over this period) the number of patients on mechanical ventilation has remained flat because omicron infects the upper respiratory tract rather than the lungs and in addition patients are spending 3 1/2 days in hospital as opposed to 5 to 6 days.

One can monitor this oneself at:

https://coronavirus.data.gov.uk/details/healthcare

I would watch his programmes they are informative in general (in a way that MSM and Sage/government are not) but the information is relevant to what investment strategy one adopts coming out of the pandemic.

Regards

Michael.

Thank you. I will certainly take a look.

Agreed but the point is that people may look at the profit figure and say whoopee profits are back to where they were in 2019. In the case of Easyjet (LON:EZJ) £466m in 2019 but they will forget to take into account that the share count is up circa 80% and the company is more heavily indebted and therefore a very different investment proposition.

MiserableJacktPotato

You’re valuing a company that has historically grown at 40% on the figures from two years ago (ie because you’re using simple averages you’re effectively looking at the net asset increase two years ago).

Madness, pure madness.

ridavies

14th Jan '22

Hello Epsilon. Thanks for that. If it so valuable - a genuine question - why in your opinion isn't the SP movement more positive? Also quite a small IT - £95m. Any thoughts welcome

mammyoko

That's helpful advice, thank you very much

Yes, that's my thinking also

Thank you again for comments about your experience

Watchdog

Doug 2b,

Thank you for taking the time to explain how you arrive at the figure for a Tangible Surplus. I see you have some detractors who don't agree with your methodology, but I for one find it very useful to learn about different methods of valuing/assessing a company's worth as they all help to form a better perspective. There are plenty of examples from history where people (frequently politicians) have chosen to ignore evidence that is staring them in the face, simply because it does not chime or fit with their thinking, and they have been seriously embarrassed as a result. Your method seems to me to have much to recommend it and I am most grateful to you for sharing it.

Epsilon

ridavies re Menhaden Resource Efficiency (LON:MHN)

You're right this is a small Trust & hence allied to this it has a relatively high 1.25% annual management fee.

Secondly, the Trust has a confusing remit. In its own words "The Company invests in businesses and opportunities, delivering or benefiting from the efficient use of energy and resources." it's not clear from this what their investable Universe includes or excludes.

Thirdly the AIC classify the Trust as belonging to the IT Environmental sector in which there are only two other comparator companies. Menhaden Resource Efficiency (LON:MHN) has lagged Impax Environmental Markets (LON:IEM) in both the past 1 and 3 year periods;

The discount at Menhaden Resource Efficiency (LON:MHN) will be narrowed by either by an improved portfolio appreciation or by shareholder action to wind up the Trust. Clearly either of these will take time, so patience required.

I don't think anyone has a particular problem with the methodology - it works for some companies. You know, like small brick producing companies that just chug along making their products.

Here's a question for you - what do you think the copyright to Iron Man is worth?

Because Doug's method says it's worth zero. Make an Iron Man movie you can sell the rights to for years? Not worth a thing, not a tangible asset, share holders being ripped off.

BnB

Doug. Thanks for your efforts. I actually like Forterra as a business, moaty, good returns on operating capital. It only fails my tests owing to its highly cyclical nature and weak growth rate.

My concern is that your strategy to minimise risk of loss leaves you scratching around old economy companies in highly pro-cyclical sectors. This is itself a huge opportunity cost. You are thinking like an investor - I applaud that. But you aren’t thinking like a business owner.

Entrepreneurs concern themselves with market and opportunity and they seek to lock into positive long term trends. Nat Rothschild at Volex is one such individual and he has done a superb job building his conglomerate to key into megatrends like cloud computing, automation and electrification. When you buy shares in Volex you participate in Nat’s vision and this has been highly remunerative for shareholders.

Many ways to skin a cat and all that!

Dougs valuation technique is a throwback to the Ben Graham era (1950’s – 1970’s), a time when Balance Sheets were loaded with tangible assets. Ben Graham even had success with his Net-Net technique of investing in stocks whose Current Assets exceeded Total Liabilities.

However, since that era intangible assets (patents, trademarks, copyrights, acquisitions > book value etc) have grown to become the largest asset underpinning enterprise value.

https://www.oceantomo.com/intangible-asset-market-value-study/

When an ‘old economy’ stock like Forterra (LON:FORT) builds a new (tangible) plant, this is included in Dougs calculations but if for example it was expensing R/D or Sales/Marketing expenditures then these would reduce its Tangible Surplus, regardless of how much value these actions created in subsequent years.

Hence this technique has missed the shareholder value created by Amazon, Facebook, Alphabet & Tesla – remember these companies didn’t exist 30 years ago yet today are valued in excess of £4 TRILLION.. all supported largely by intangible rather than tangible assets.

The point that you make is interesting for a couple of reasons:

1. There is a Ben Graham overlap in the sense of paying c50p for every £1 worth of value, i.e. the margin of safety. Also, all value and value growth approaches tend to originate from Ben Graham.

2. The reference to price and net asssets is often made and I can see why, but actually this is not the case. Take ScS for example. That is not a business requiring a high tangible asset base at all. It has a lot of tangibles because it generates the cash asset at such an extaordinary rate relative to its MCap. i.e. the business does not need to have a high asset base at all as part of its operations, Plus500 is another example that I hold, but it does need to generate net tangibles at a hoigh rate relative to its MCap.

Facebook and Amazon have always been difficult to value. Apple I looked closeley at in 2011. I knew less then and if I had equated the sahre buy backs correctly I would have likely bought Apple in 2011. We were only a decade after the dotcome cash back then. It did at the time seem implausible that Apple would maintain its dominance for much longer in such a competitive sector at the time, but they did. But like I say if I had been analysing fully as I do now, I think that I would likely have bought Apple around 2011/12.

Tesla I currently hold a small short position, which I may enlarge of the price goes up. Tesla could gain 50% of the current global car market at industry beating margins and still be grossly over priced. A cult has formed aroud Tesla. For Tesla to justify its current price, it will need to develop usable self drive softwear in a way that nobody else can manage so that the automotive world beats a path to its door and pays a huge premium to Tesla as the worlds provider of this softwear.

Not going to happen!

See above, Volex for detailed method. It is quite logical when you see it set out.

There is nothing wrong with intangibles, there is a reason why they exist in accounting - goodwill from purchase acqusitions. But ultimately these intangible assets must generate tangible wealth if the husienss and its shareholders are to benefit, so that is what I am assessing.

Logical David

Hi Doug, your method of calculating the investability of a company and what it is valued at through its TS (Tangible Surplus) is an interesting approach and it possibly could be another method to assist investors research into which shares to invest in.

It's only a suggestion Doug, but maybe it may be worth you starting a separate forum whereby you evaluate the TS of each company which Paul & Jack discuss each day. It would interesting to see whether you TS figures show if a share is a bargepole job or whether its worth more research as a promising company with strong fundamentals.

David.

Ridavies re Menhaden Resource Efficiency (LON:MHN)

As you have identified, this is a small Investment Trust with a relatively high 1.25% annual management fee.

Secondly its remit is unclear, it is difficult to determine what stocks are within/without its Investable Universe. In the companies own words : "The Company invests in businesses and opportunities, delivering or benefiting from the efficient use of energy and resources."

Thirdly, the AIC classify the company as falling into the IT Environmental sector in which there are only 2 comparator companies. Menhaden Resource Efficiency (LON:MHN) has badly lagged Impax Environmental Markets (LON:IEM) over the past one & three years performance-wise:

Clearly the NAV discount will narrow if either the performance improves or investor action successfully calls for a wind-up. Patience is required for either of these outcomes.

jamesalastair

16th Jan '22

Sorry I missed this completely mammyoko.

I have had similar problems at least so far as it involves transfers, in this case from iweb to AJBell for my ISA (I left my SIPP with iweb). In my case some shares were left behind in the iweb account which I subsequently wanted to sell and could not as the iweb account was in limbo and frozen for 6 months (!!). The shares declined by 30% or so and iweb made good the difference without reference to the Ombudsman after they sold the shares and then transferred the cash. I also received a small sum from AJBell as they were part of the story. I think two factors were coming into play here - the existing back office systems for many brokers could not cope with the surge of business during Covid lockdowns and back office staff working from home did not help matters.

I have to say iweb have treated me well over many years which is why I decided to leave my SIPP with them. The only problem with iweb is they offer limited or even no access to some markets including large swathes of the Canadian market which is why I moved to AJBell. It turns out that AJBell are unable to offer the access they said they could in an email .... hence the modest payment. I am trying to make up the courage and patience to transfer my ISA again to a decent broker who can offer wide access to global markets. Compared to my investing friends in Australia and New Zealand, we UK investors have a very poor show to deal with.

Small Cap Value Report (Thu 13 Jan 2022) - ASC, CARD, CIR, CSP, QXT, SAG, FIF

Brief preamble - inflation

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Paul Scott

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