Small Cap Value Report (Thu 8 Aug 2019) - BUR, ZTF, WATR, ELCO, BUR (rebuttal), VTC | Paul Scott

8th Aug '19 by Paul Scott

77 comments 12148 reads

Good evening/morning, it's Paul here.

To manage expectations today, I'm on the afternoon shift, so estimated completion time of this report is c.6 pm. As usual, I'll update it in sections as I go along. It's a quiet day for small caps news anyway. All done now (17:36)

Burford Capital (LON:BUR)

Yesterday was so dominated by BUR that I didn't get round to looking at many other things. Hence today's reports starts with some catch up items, written by me late on Weds night. Incidentally, I really liked Graham's coverage of Burford on his own website, here.

Another thought occurs to me. It might be that the share price could bounce from here, but will it get back to previous levels? I doubt that, because now it appears (according to MW) that profit is mainly coming from aggressively anticipating the future cashflows from only 4 big cases, then that casts considerable doubt over the sustainability of future profits. That in turn means that a much lower multiple of earnings should be used in valuing the company.

Taking that into account, means that I suspect Burford shares could eventually settle permanently at a lower level - maybe 500-1000p? As Graham points out in his article, given that Burford appears to recognise future profits aggressively, then we should possibly be valuing it at a discount to published NAV, not a premium? It depends on how you look at it.

Interestingly, the Stockopedia computers were negative on Burford, before the recent share price collapse. On 4 Aug 2019, when the share price was 1425p, the StockRank here was very low for a (at that date) £3.1bn company;

That has since dropped to 18, as the momentum has obviously dropped this week.

Nobody is claiming that the StockRank system is infallible - it couldn't possibly be, as no system can predict the future. However, I've noticed that ignoring low StockRanks is often a costly mistake - many of my low StockRank personal holdings have done really badly in the last year. With hindsight, if I'd played it safe, and stuck to higher StockRank positions, I'd probably be a lot happier and wealthier than I actually am now. Ho hum, we live & learn. Or maybe that should be: live and make the same mistakes…

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xcity

8th Aug '19

One other thing struck me when reading your Burford Capital (LON:BUR) comment is that the impact of aggressive accounting of future profits on top of substantial expansion creates an interaction which makes things look much, much better than they really are. How will the numbers look when the music stop?

I don't remember MW addressing this and it's too late for me to attempt to work it out (not sure I have enough understanding of the way they work it anyway), but I think I'd need to attempt to model this if I were considering an investment here.

dmjram

From conversations yesterday, the base assumption on the stock seems to have been that Burford needed cash only to fund new cases and that in steady state mode i.e. not taking on new business it would be cash generative.

We really don't know what the position is if it's been aggressive in taking profits and case success has a low batting average but with the potential for "jackpot" returns on a small % of those taken on. Could be the equivalent of a bad bank impaired loan book run off and not the steady stream of cash realisations. Need to see what Burford has to say in relation to the specific points raised. Too much uncertainty at the moment.

MrContrarian

My morning smallcap tweet: Xeros washes hands of legacy laundry biz

Xeros Technology (LON:XSG), Intelligent Ultrasound (LON:MED), S&U (LON:SUS)

Xeros Technology Group (XSG) gets shot of most of lossmaking legacy US laundry business. Sells majority of its Hydrofinity US commercial laundry customer portfolio of leased machines for $109k. Already written down to nil.
Intelligent Ultrasound (MED) £6.25m placing and token open offer at 10p (a nil discount) for ScanNav dev and marketing.
S & U (SUS) H1 trading: "Transaction volumes and quality improvement, particularly in our motor finance business, are expected to be reflected in the pace of profits growth over the full year." In line? Who knows?

andrea34

Paul, I would argue that Water Intelligence (LON:WATR) deserves its 'toppy valuation' rather more than Zotefoams (LON:ZTF) where the latter is showing considerably more pedestrian growth.

Mark Tughan

Morning Paul,

Arrow Global (LON:ARW) announces interims this morning. Good progress all round is how I would superficially summarise. They used to be one of the most shorted stocks on the whole market but this seems to have fallen from 12.4% to 7.9% now, and the SP has moved from lows of 167 (roughly at the short interest peak) to 266p now (pre-opening).

With the Burford Capital (LON:BUR) story at the forefront of many investors minds, this could be an interesting one to follow. There was never a big splash of a short dossier but the short interest was huge (higher than the currently leader Kier (LON:KIE) at 11.9%) and the funds involved in Arrow Global (LON:ARW) considered very serious players. Will the shorters renew their interest or is this the end of this short attack? Will Arrow Global (LON:ARW) continue to deliver? My sense is that the shorts are unwinding slowly but surely, trying to avoid a squeeze.

Management themselves expressed frustration at the short interest when questioned at a capital markets day I attended (because I hold and was worried and wanted to see and hear from management in person), but their response was rather along the lines of "it's frustrating but it is what it is and we're going to just get on with delivering real results and a growing dividend". It seems (to me at least) that this is working. By contrast, from my reading of some of the excellent commentary on Burford Capital (LON:BUR) so far (here and elsewhere), Burford Capital (LON:BUR) has some legitimate and serious questions to answer and it will be interesting to see if it's response is similar to Arrow Global (LON:ARW), or defensive, sniffy and possibly litigious. I'm worried that it may be the latter.

I'm not sure what the catalyst was (if any) that saw the Arrow Global (LON:ARW) short interest peak and then start to decline. Maybe they just achieved their aim - to profit from an overvaluation as they saw it at the time. 460p to 167p is a result - mission accomplished.

Arrow Global (LON:ARW) is now commanding a StockRank of 69 and yields 5.1% on 2019(f) dividend of 13.8p. This will be it's 6th year as a dividend payer, with increases every year. I'm continuing to hold.

jonno

Morning Paul
Understandably Burford Capital (LON:BUR) is the big news story at present, but the interim results from Vitec (LON:VTC) look interesting. Trading in line with expectations but it appears in a period of transition with a 2nd half weighting that was flagged up at the last prelims. However debt at £108m appears high. Next year with the summer Olympics and US Presidential elections is anticipated to provide significant growth although Mr Market usually has trouble looking beyond today let alone 12 months ahead.

The excellent coverage of small caps by you and Graham is thoroughly appreciated. The Burford Capital (LON:BUR) situation is compelling. I have much sympathy with those that hold the stock having bought at much higher levels and have to deal with the current conundrum.

Martin Verlaine

re Burford. I am not surprised at accounting issues coming to the fore but in rather large spades. This type of opaque accounting is meat and drink to the shorters. I have always taken the view that this type of company depends on success in larger and larger cases and one bad outcome would upset the Apple cart. To me the rating has always been way ahead of where the specific corporate risks imply. It should be. This is a sector that is vastly overrated to me and a definite no go

FREng

I would welcome a view on £VTC too. It was a recent purchase by Lord Lee, written up in the FT a couple of weeks ago, and he seems to do pretty thorough due diligence.

oaktree

I too am coming round to making sure there is a high Stockopedia ranking being a necessity or certainly very wary if its not.

Thanks Paul for the additional comment today on BURFORD , it would appear to be solvent which is my main worry as Im a holder of the fixed interest bonds. Believe it or not I hold a fair bit of cash due to global uncertaintly and wanted some where SAFE and interest bearing to park my money! lol How I missed that the CFO is the wife of the CEO is beyond me.

We'll know more once the company issues its report, but surely if we think its solvent and its a big IF.......then the fixed interest stock must be a BUY at current levels?

You can buy the 5% maturing in 2026 for £81.
The 6.5% maturing in 2022 at £85. Not long to wait!

IMHO
(Im talking my own book up here!)

The problem with Burford Capital (LON:BUR) solvency is that with the high rate of expansion what is solvent now may not be solvent in 2 or 3 years. And that's irrespective of the accounting practices.

Fair point re Buford Capital xcity. Its a worry for sure. Plus why they seam to keep asking for money. Those days must be gone now..........Don't like how they are so big Cap wise and still on AIM.

"Don't like how they are so big Cap wise and still on AIM"

Like a shiny roller on the forecourt at Dodgy Dick's

Nick Ray

Nobody is claiming that the StockRank system is infallible - it couldn't possibly be, as no system can predict the future. However, I've noticed that ignoring low StockRanks is often a costly mistake - many of my low StockRank personal holdings have done really badly in the last year. With hindsight, if I'd played it safe, and stuck to higher StockRank positions, I'd probably be a lot happier and wealthier than I actually am now.

The Stock Rank rating of Burford Capital (LON:BUR) is interesting. Its low Quality Rank is largely due to its low Piotroski F score (the other Quality factors are reasonably good) and the low F score is mainly because it has very poor free cash flow. It is showing good ROE but not actually generating any cash. (This is a key part of the MW report but was not exactly a secret.)

What is interesting is the difference between "playing it safe" and being aggressive. If you look at only stocks which have made better returns than 80% of their peers over the last year you find that the F score is not very important in finding these over-performers. Short-term momentum is one of the best metrics for this.

But if you ask what is important to avoid the 20% of stocks with the worst returns over the last year then the F score becomes one of the strongest discriminators, and short-term momentum tells you not very much.

The problem of course is that the "playing safe" screens also tend to avoid really aggressive out-performers. If markets are efficient then my best bet is to play it safe - I would get the same returns but with much less volatility. If markets are not efficient - or I believe that I can find inefficiencies - then I can gain a benefit. But if I cannot do this consistently then I am likely to get similar returns to the "play it safe" strategy but with greater volatility (good years and bad years.)

Trident

As Theo Paphides used to rather crassly say, poor trading trading is like a a cancer. You get some time to sort things out, and get treatment. Cash crises are like a heart attack. they can kill you in minutes.

A realistic shareprice grading for Burford Capital (LON:BUR) stock could mean having to go to finance markets at the worst time, or ask shareholders to double down at the worst time.

Not a particularly good place to be.

Nick

Please will you remind me how to display the component values that make up a rank for a specific company?

Reacher

Burford has issued a response to the Muddy Water dossier:

https://www.investegate.co.uk/burford-capital-ltd--bur-/rns/response-to-short-attack/201908081245314390I/

On the old site you need to put BUR (or the stock of interest) into a portfolio and then view its ranks. You can then click on a rank and you will get a pop-up showing the make-up of the rank.

Alternatively view the stock report. Then use the "breadcrumb" at the top to get a view of the stock in a list of the stocks in the same sector and again click on the rank. What doesn't work is to click on the rank info from the stock report itself.

Not sure how this has changed on the new site. Last time I tried it wasn't working at all.

Or if you are really desperate you can cheat by typing in an HTML path explicitly, but you lose the pretty formatting.

So for Burford Capital (LON:BUR) you could use:

https://www.stockopedia.com/ajax/composite_rank/ratios._QualityScore_zz/LON:BUR/

to get the Quality Rank components. It looks ugly and loses the little bar graphs but contains the data.

Small Cap Value Report (Thu 8 Aug 2019) - BUR, ZTF, WATR, ELCO, BUR (rebuttal), VTC

Burford Capital (LON:BUR)

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Paul Scott

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