Small Cap Value Report (Thur 19 Sep 2019) - IGG, SFE, BILB, A&B

Good morning

Let's see what the RNS has in store for us today.

Timings - writing until around 2.30pm today.

This list is final:

• IG Group (LON:IGG)
• Safestyle UK (LON:SFE)
• Bilby (LON:BILB)
• Albemarle & Bond

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IG Group (LON:IGG)

1st Quarter Results

Not a small-cap (market cap is >£2 billion), but as the share price is up 8% and it's one of my larger holdings, let's briefly discuss.

I have taken the view with this one that that regulations can't get that much more strict. Indices are at 20:1 and FX is at 30:1, for example.

Other reasons for my bullishness: 

1. Compliance costs from all the new rules and fewer trading choices for customers could make life even easier for the incumbents, by creating an environment where there is less competition and fewer new entrants
2. Professional clients are unaffected by the rules, and the spread bet companies can focus more resources on them, instead.

Let's see what this Q1 update says.

The business has performed well in the first quarter benefitting from growth in the number of active clients, and from increased client trading activity as a result of the favourable market conditions in August.

I can attest to that myself as I was taking out positions in FTSE options during August, because of the excessive volatility/fear in the markets.

By the way, with the FTSE back around 7350, doesn't it feel like nerves have calmed already, since that August fear? GPB has strengthened, too. Perhaps these are early signs of the positive adjustments which will happen after Brexit is resolved - that's just my wishful thinking!

IG's Q1 revenue was flat in June/July/August, compared to Q1 the prior year.

The regulations took effect in August 2018, so two months of Q1 last year were still under the old regime. This is very positive to me, as it suggests there was an underlying improvement (doubtless helped by all the volatility this year).

By category, the "OTC leveraged" segment (spread betting/CFDs) was flat. 

Nadex, the North American business, declined by 2%.

Meanwhile, stock trading and investments were up 9% - that's great news. This is a much lower-margin business compared to spread betting and CFDs, but I strongly believe that IG has a competitive advantage in this area and should grow much larger over time.

IG also makes the point that Q1 revenue was 11% higher compared to Q2-Q3-Q4 of the previous financial year, which makes for a better comparison since those are the periods when ESMA rules fully applied.

That's true, but let's not get too excited about one quarter's results. This business has a lot of swings with market volatility, and August this year was a particularly volatile time.

Medium term targets

IG gives us some more context for what it's trying to achieve. It is looking for 3-5% growth per annum in its core markets, and revenue growth of £100 million (to £160 million) in its "significant opportunities", by 2022.

The significant opportunities are the unusual new products and markets which it is developing and working on (e.g. expanding to regional markets in Asia).

And it seems to be clear about what it needs to do:

The driver for sustainable revenue growth in OTC leveraged derivatives over the medium and long term is growth in the size and quality of the client base, and the number of OTC leveraged active clients in the core markets in Q1 FY20 was 5% higher than in the average of Q2-Q4 FY19.

Other: IG reminds us that regulation is coming in Australia.

Guidance for revenue growth in the current financial year is unchanged.

My view: I don't need to change my stance on IG following this update, except that my confidence is bolstered.

Quantitatively, it looks great with a StockRank of 92 ("Super Stock") and customary excellence in terms of ROE, ROCE. etc.

The valuation is nice, too - forward PER of 14x as of last night, with a dividend yield of 7.5% and EV/EBITDA multiple of about 9x.

I held a position in CMC Markets (LON:CMCX) for a short while, but ditched it due to a lack of conviction (even though the valuation over there was even more attractive than the valuation at IG).

IG is the market leader and it's rare that you find a company with the biggest market share in a regulated industry, excellent quality metrics and a cheap-ish valution.

My confidence in the new CEO and her strategy is growing, and my only major worry is on the regulatory front. This is a risk that I am happy to bear, even though it is very difficult to analyse and predict what might happen years from now on that front. I competely understand why other investors might prefer to stay away and avoid that risk altogether.

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Safestyle UK (LON:SFE)

• Share price: 55p (-1.6%)
• No. of shares: 82.8 million
• Market cap: £46 million

Interim Results

Let's go back to small-cap land for a few minutes.

As anticipated, the double-glazing company Safestyle makes a "small loss" for H1 (see Paul's analysis of the trading udpate).

It makes an underlying loss of £0.8 million but also suffered non-underlying expenses of £1.65 million.

It seems rather funny to me, but one of the non-underlying items is "Commercial Agreeement amortisation".

This is the agreement that Safestyle signed with one of its former co-founders, in exchange for him promising not to compete with them anymore.

How on earth is this a non-underlying item? I can't think of anything more relevant to underlying business performance than this. If it wasn't for this agreement, Safestyle would still today be getting crushed by Safeglaze.

Thankfully, this charge was "only" 200k in the period. £300 of share-based bonuses are also treated as non-underlying.

Key takeaways

The company says that its turnaround is on track.

It says it was profitable in Q2, "with levels forecast to increase in H2". 

Pricing power has returned: business volumes as measured by frame installations are slightly down compared to H1 last year, but revenues are up over 6%. That's what happens when an aggressive competitor gets out of the way!

Outlook

We have a profit warning for H2.

If you go back to the trading update, you'll see that it was guiding for "a small profit for the full year".

But it's going to have to pay more on lead generation than it expected, and revenue hasn't quite matched up with expectations either:

The Board also expects revenue to be marginally below previous expectations, although still expects double-digit growth in H2 versus the prior year alongside continued gains in market share.  Consequently, the Board now expects a small underlying loss before taxation of c.£0.5m for the full year.

My view

I think I'll wrap this section up now. This company falls short of passing my quality filters.

It might turn out to be dirt cheap if it recovers to previous levels of profitability, but we have seen what happens to it when competition picks up. I don't see what can be done to prevent competition from heating up again, if profits start to look tasty again in a couple of years.

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Bilby (LON:BILB)

• Share price: 24.25p (-7%)
• No. of shares: 40.5 million
• Market cap: £10 million

Full year results

Bilby Plc (AIM: BILB.L), a leading gas heating, electrical and building services provider, announces its full year results for the twelve months ended 31 March 2019.

This is grim.

Trading is said to be in line with expectations.

But on top of the poor "underlying" results for FY 2019, you have £13 million of non-underlying items.

When the non-underlying expenses for a single year are larger than the market cap of the entire company, it's rarely a pretty picture for investors.

And this is another company which has a sense of humour when it comes to exceptional items.

One of the exceptionals is "impairment of accrued income", i.e. writing off revenue that it previously booked on the income statement.

I could create a business which had terrific results every year, if I was allowed to accrue income that I would never collect. And if you were willing to ignore the subsequent impairments of those accruals, perhaps you would even invest in it!

This is a low margin contractor and these FY March 2019 results show what happens when margins deteriorate at a low margin business.

Let's also note that it has taken nearly six months to get these numbers out.

Net debt more than doubled to almost £11 million, and the company has had to get a waiver of covenants from HSBC. 

The Board has "confidence of at least maintaining underlying revenues of £59 million with adjusted EBITDA of not less than £4.5 million".

We enter the new financial period having taken decisive and conclusive action to ensure that the causes of the isolated failings are not repeated. It is in light of this that I am confident that together, with our enhanced Board and experienced management, we are well positioned to drive sustainable and profitable growth.

My view - bargepole.

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Albemarle & Bond

"They've run off with our goods" - anger at Albemarle & Bond HQ

(I have a long position in HAT.)

Got to hand it to the Guardian. This is good reporting.

Guardian writers have been hanging around A&B's "Pawnbroking centre" in Oxford, and they've managed to get quotes not just from customers but also from former staff members.

Angry customers have been taking time off work to visit A&B's warehouse. If your grandmother's gold ring is in there, that makes sense.

In another article, the National Pawnbroking Association's CEO was quoted:

Ray Perry, NPA chief executive, said there were only 10 people working in Albemarle & Bond’s contact centre and they had been overwhelmed by demands for information. He said: “The industry is not impressed and we are quite angry about this. The provision made is clearly woefully inadequate and the information sent out is quite contradictory in places.”

This is of course completely unacceptable. The company has responded that it is doubling the number of phone lines and staff responding to emails.

Back to today's article, and we get some insight into the collapse of A&B:

Another former staff member said they were not surprised the company was in difficulty under Daikokuya’s ownership.

“I found that there were many Japanese executives swapping out UK natives with experience in the pawnbroking industry.

“Some of these new executives from Japan unfortunately didn’t speak English and were not familiar with the specific requirements needed to make a financial company successful.”

To be fair, A&B had been mismanaged under UK owners and executives, too. It sounds like the company never got its affairs in order.

Investments implications? For H & T (LON:HAT) and Ramsdens Holdings (LON:RFX), I think this bolsters the argument that there are specific, non-industry reasons for the recent demise of A&B. Which would clearly be positive for H&T and Ramsdens: not only do they face less competition, but there is no reason to think that the sector is facing a general downturn. Companies which operate sensibly should continue to do well, at least for now.

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I'm out of time for today but thanks once again for all your feedback, comments and suggestions.

I hope Paul is enjoying his holiday, too (Hi Paul, if you're reading this!)

Graham