Small Cap Value Report (Tue 12 Oct 2021) - CLX, OTMP, MNO, FCCN, DLAR

12th Oct '21 by Paul Scott

69 comments 9844 reads

Good morning, it's Paul & Jack here, with the SCVR for Tuesday.

Today's report is now finished.

Agenda -

Paul's Section:

Onthemarket (LON:OTMP) (I hold) - solid interims, although the profit comes mainly from adjustments. Balance sheet, and cash position look fine. Good recovery from last year's downturn, with H1 revenues up 46%, and profits ahead of expectations. I see speculative upside here. It's a bit of a special situation, not a value share.

French Connection (LON:FCCN) - a final look at this company, now the recommended bid at 30p looks likely to happen. I've sold out at 29p, since in my view a higher competing bid is unlikely. Figures are academic now, but aren't too bad - a small underlying loss, helped by taxpayer support measures. FRC investigation is unhelpful, but doesn't seem to have put off the bidders. I wouldn't want to hold for 1p more, with that risk hanging over me.

De La Rue (LON:DLAR) - in line with expectations trading update, for both profits and net debt. Looks cheap, but beware the enormous agreed cash outflows to address the pension scheme deficit.

Jack's section:

Calnex Solutions (LON:CLX) - comes across as a classy operator with a sustainable growth opportunity supported by several underlying trends. The valuation looks high in the short term, but it is worth considering the longer term growth prospects here.

Maestrano (LON:MNO) - provides rail networks with an automated railway inspection solution. The company is winning new clients but has still yet to turn a profit. Management expects to reach cash flow breakeven in the next six months, so it could be worth monitoring, but it's still early days for this risky micro cap.

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 are analysing the company fundamentals, not trying to predict market sentiment.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the…

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1James1n1

12th Oct '21

De La Rue (LON:DLAR) - Paul, thanks for sharing your thoughts on the company, but I was struck by the repeated use of the, "in line with the Board's expectations" terminology.

What are those expectations? They are unstated and I could not immediately see them from previous announcements. Are the boards expectations the same as market expectations? Whichever way, the conpany could and should do far more to be clear in its communications with company owners and potential investors.

JohnEustace

Re Diversified Energy (LON:DEC)

The article's here. I got out when it was 10% down. Been falling like a stone - I'll start rebuilding when it seems to have found a floor.

"Old oil and gas sites are a climate menace. Meet the company that owns more of America’s decaying wells than any other.

There are hundreds of thousands of such decrepit oil and gas wells across the U.S., and for a long time few people paid them much mind. That changed over the past decade as scientists discovered the surprisingly large role they play in the climate crisis. Old wells tend to leak, and raw natural gas consists mostly of methane, which has far more planet-warming power than carbon dioxide. That morning in Ohio we pointed our camera at busted pipes, rusted joints, and broken valves, and we saw the otherwise invisible greenhouse gas jetting out. A sour smell lingered in the air.

To Rusty Hutson, it smells like money.

Hutson is the founder and chief executive officer of one of the strangest companies ever to hit the American oil patch and the reason for our four-day visit to the Appalachian region. While other oilmen focus on drilling the next gusher, Hutson buys used wells that generate just a trickle or nothing at all. Over the past four years his Diversified Energy Co. has amassed about 69,000 wells, eclipsing Exxon Mobil Corp. to become the largest well owner in the country. Investors love him. Since listing shares in 2017, Hutson’s company has outperformed almost every other U.S. oil and gas stock, swelling his personal stake to more than $30 million."

Diversified Energy (LON:DEC) hedge about a year out.

davidjhill

but that's what the naysayers have been saying for ages. Why would anyone go.....etc etc but they do and they are succeeding! Primarily because they offer not dissimilar enquiry rates at a much cheaper cost. My guess is that's why the major house builders are doing exclusives with them as they are very margin focused.

Onthemarket (LON:OTMP) have 13,300 advertisers, Rightmove (LON:RMV) is 19,000 so actually the difference in terms of agents and listings is not that big

For me Rightmove (LON:RMV) is there to be competed against. If you look at ARPA Rightmove (LON:RMV) takes about 8* what Onthemarket (LON:OTMP) does. So the reality is they are a great cashcow that agents dislike. The equilibrium price will be somewhere in the middle. That's ultimately potentially bad for Rightmove (LON:RMV) and good for £OTMP.

You might not get why they are starting to succeed but once a business is able to double marketing spend and still make operating profits which Onthemarket (LON:OTMP) are then you have a major competitor player in your space if you are £RMV. Of course Onthemarket (LON:OTMP) still have to continue executing but medium term I would rather own them than Rightmove (LON:RMV)

why? - because prices will come down so Rightmove (LON:RMV) look primed for falling revenues over the medium term given market dynamics and at 38* earnings it won't take much for a chunky fall. Whereas if Onthemarket (LON:OTMP) continue along current lines they can raise volumes, revenues and re-rate. Risk/reward looks far better to my lens. Of course you may just choose to avoid the sector entirely.

Paul Scott

Hi James,

Are the boards expectations the same as market expectations?

Every time I've asked companies this question, the reply is always yes (not specific to DLAR, just generally). So I think we can usually view mgt & market expectations as the same.

I think the reason can sometimes be that brokers don't usually provide half year forecasts, so it's not technically correct to refer to market expectations for a half year, since there aren't any. Although personally, I don't see why companies can't say something like this -

"Performance in H1 is consistent with full year market expectations, which we expect to meet"

(and then include a footnote to stipulate what market expectations are, including revenue, adj PBT, and adj EPS. Plus EBITDA if they must. All too often I find companies quote EBITDA, but miss out market expectations for EPS, which for me is the most useful number).

The lack of consistency is really annoying actually. We shouldn't need to pick through trading updates trying to work out what's actually going on, what they've omitted, etc.

Regards, Paul.

??? If you were sitting at 50p per therm a year ago a half decent FD could have quite easily hedged energy requirements out for 2-3 years. So the fact they didn't was either because it made their business unprofitable or they were overly focused on margins. (As the big energy companies have shown - they did exactly that (big tick to them) whereas the newcomers were cutting prices in the hope that prices would stay stable. ie the business was long term not viable.

Same for large energy industrial users. An FD can quite easily hedge but my guess is they chose not to because it impacted margins and of course because Gas had very low volatility over quite a long period of time. ironically you can hedge cheaply in times of low volatility and very expensively in times of high volatility. Reality is that the companies that chose not to hedge gambled with the company (wittingly or unwittingly).

And that is the point about corporate resilience.......as investors we should prefer companies that are not going after every last drop of margin at the expense of resilience and management should be incentivised to prioritise resilience over short term profitability. A well run company will do that and those that don't we should avoid as investors, because at any given point they might well wipe out our capital.

An example of a company that learnt its lesson well in that regard was Somero Enterprises Inc (LON:SOM) which over-leveraged and nearly went bust in recession. Now they retain a strong cash buffer so they can ride out recessions but also give money back to shareholders when they exceed it. As a consequence they have performed well and are resilient. Holding cash is the same as hedging really (it is an insurance). It doesn't generate any return but it protects the business long term.

What we shouldn't accept are companies asking for bailouts based on their focus on margins over resilience. Covid was a bit different - that was a forced government closure but inflation, interest rates, commodity prices etc are all part of the common cycle of the economy.

marigold

The country is falling apart for sure. Shortage of everything.

Agreed - the CEO is on Investormeet next week so will check in on that. I believe the growth primarily comes from an increased ARPA as agents take more product. Rightmove (LON:RMV) is around £1200 and Onthemarket (LON:OTMP) is £188 so there is plenty of space for Onthemarket (LON:OTMP) to double revenues and still be much cheaper to agents.

ezlifeme

Hi Marigold - I think the start of GB PLC going to the dogs was Concorde's last flight!

mammyoko

This, from the 202o annual report?

'The manufacturing process is a mixture of contract manufacturers in China and Malaysia, and in-house manufacturing'

',Focusrite Pro, Novation and Ampify) hardware and software products are all designed in the
UK and assembled in China and Malaysia.'

'The Group relies on a small supplier base, concentrated in China and Malaysia, to deliver products on time and to the Group’s required quality and ethical standards'

Fears that shipping costs are going to reduce profits in the same way as Gear4music Holdings (LON:G4M) .

Hi cwatson,

Hi Paul, does that mean you have sold out of your position in Renold (LON:RNO) ?

No, I'm very keen on Renold (LON:RNO) and topped up on recent weakness. So as you imply, that does break my usual rule of avoiding big pension schemes. With Renold, it seems fairly steady at about £5m p.a. cash contributions into the pension scheme, which it's managed to pay in without needing to raise any fresh equity (dilution).

In this case, the big pension scheme provides leverage for equity. So I see the pension deficit as quite helpful, in that it suppresses the market cap to such a low level, that further improvements in trading would feed through entirely to equity, thus giving a bigger % share price rise than if there were no pension deficit.

That's completely inconsistent with what I wrote above about avoiding pension schemes! lol. I think Renold is the only exception though.

Thanks Paul for your reply and I agree entirely. Perhaps its a topic for a future Sharesoc campaign...

gus 1065

Hi JohnEustace.

Thanks for the link to the Diversified Energy (LON:DEC) article. The cynic in me suggests much of it was written to an agenda rather than as an objective piece of investigative journalism but can’t argue with a quarter of a billion pounds being knocked off the company’s market cap for impact. Shares finished at about 102p (about 20% down) so well off the day’s lows of about 94.5p and what look like a few biggish buys going through towards the close (not mine LoL!). One positive I did pick out from the article was that Diversified Energy (LON:DEC) appear to be on the right side of the local state regulators in terms of fulfilling their decommissioning obligations but they’re definitely in the cigar butt end of the oil business so it’s never going to be pretty.

Gus.

raggedtp

Yep, Tharisa (LON:THS) seem really solid to me. Wish I had bought more in the recent dip! Net cash of $48m now and internally funded growth coming. Can't see why it's not back to 150p yet.

Wilbraham

I was out all morning and came back mid--afternoon to a 20-25% fall in my Diversified Energy (LON:DEC) holdings. I read the RNS and comments here and was close to making a top-up in the late 90's. Then I read the full Bloomberg story and decided against and may trim if there's a meaningful bounce. What influenced me was:-

1. Bloomberg is one of the most respected and influential financial reporters, not a shady shorting outfit like Muddy Waters. I'd say that 75% of the article is targeted at the company and the rest at ''the system''.

2. Clearly the company has been in discussion with Bloomberg for some time, yet they still produced this highly disturbing article.

3. Some 25-30% of equity is held by blue-chip UK institutions - AXA, M&G, Schroder, Blackrock, Aberdeen. In this increasingly ESG-conscious world I just can't see them, or their end-clients, being happy about these revelations. The 28m shares traded today is just a small part of their collective holdings. It wouldn't surprise me to see bale outs by one or more of these holders over the next few weeks.

4. The rate of well retirements/cappings, although meeting contractual undertakings, looks far below what is really required. Surely if a well is never going to produce at a commercial level it should be retired sooner rather than later? Comments on ADVFN suggest the financial retirement reserving policy (''financial engineering'') may be inadequate, particularly if states tighten up their requirements.

5. ''If something seems too good to be true, it probably is!'' In hindsight, MPT tells us it's cloud-cuckoo land to expect an 11% annual dividend without substantial risks to capital somewhere down the line.

6. The concept of a company operating in the biggest financial market globally, with US management, choosing to list in the UK has always seemed a something of a red flag.

It's weird, but whenever I've allowed a quoted company to creep above 2x annual expenditure it tends to come crashing down following some ''unknown unknown'' (aka poor DD). BUR, DTG, DNA, IQE and now DEC all fall into that category. Indeed just at the weekend I was beginning to think about top-slicing DEC but I'm a terribly slow learner!

MiserableJacktPotato

I mean, Bloomberg knocking an oil company, who'd a thought it?

Environment | Bloomberg Philanthropies

PS Just caught up with Cathie Wood's epistle from 2 October. Somewhere around the middle she mentioned (no specific reference to DEC of course) that US banks and institutions are already reducing their lending to fracking companies and similar 'dirty' industries. I wouldn't underestimate the influence of the ESG movement.

Indeed, in the UK there's a new requirement for larger pension funds to report annually on their climate-related risks, all of which is likely to hasten disinvestment from these sectors https://www.willistowerswatson... The direction of travel seems pretty clear to me.

Hi Wilbraham.

Fair comment on the Diversified Energy (LON:DEC) situation. The ESG trend is certainly gathering pace, growing from a fringe of specialist ethical funds a few years ago into the mainstream and Diversified Energy (LON:DEC) is an obvious potential casualty of this trend. The counter case, of course, is that by bringing a large group of old wells under a single umbrella the problem is arguably better managed and supervised than it might otherwise be if left in the hands of a large number of independent operators. Oil industry spokesman Malcolm Graham Wood makes this point in his commentary today:-

https://www.malcysblog.com/202...

Interesting to see how this plays out.

18th Oct '21

Diversified Energy (LON:DEC) appears to be clawing back some of its losses after last week’s Bloomberg article. Currently 112.4/.8p about 19% up from last week’s low.

28th Oct '21

Diversified Energy (LON:DEC) in line trading statement released this morning for QE 30/9 (commendably prompt).

https://www.investegate.co.uk/....

Record production and a lot of focus on their good ESG corporate citizenship in the commentary, no doubt still sore from the recent Bloomberg article. Not sure they’ll ever be on Greta’s Christmas card list but they’re in a seemingly profitable niche of monetising and hopefully clearing up other people’s cast offs. Shares now back up to about 117p, within touching distance of the level pre-Bloomberg hatchet job.

Small Cap Value Report (Tue 12 Oct 2021) - CLX, OTMP, MNO, FCCN, DLAR

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