Small Cap Value Report (Tue 19 Jan 2021) - BOOT, APTD, COG, QTX, SDRY, WJG

19th Jan '21 by Paul Scott

103 comments 13088 reads

Good morning, and welcome to Tuesday's SCVR, written by Paul & extra sections from Jack, since it's too busy for me to handle everything on my own.

Inflation & interest rates again

What an interesting discussion yesterday about the risk of inflation returning. Everyone seems to be commenting on that at the moment, I saw a very good article in the Telegraph this morning on the same topic, and thought to myself, oh dear I hope the Stockopedia subscribers don't think I plagiarised it. That's unavoidable though, when you're covering current topical themes. I remember a city broker friend once wrongly accusing Graham of plagiarising his blog, because they both happened to comment on bond yields on the same day! I had to gently intervene and point out that nobody had ownership of any macro topic, and we're far too busy to read other peoples' blogs, when we're frantically trying to prepare content to a deadline for our own! We're all friends again now, I'm pleased to say.

I enjoy thinking about macro topics, but just for the avoidance of doubt, see myself as an enthusiastic amateur on that topic, not any kind of opinion leader! It's interesting trying to work out how the world around us works, especially at times like this, when strange stuff like QE is happening. Also, I feel having a general overview of macro economics is vital to put share prices into context - are they cheap, or expensive? That depends on what's likely to happen next to the economy.

Russell Napier

My thanks go to subscriber Michael Prince who added a comment yesterday pointing us towards a podcast by Grant Williams, called The End Game Ep.5 - Russell Napier (you can find it by searching for the title or the name, on whatever podcast system you use). I was gripped by this long podcast, and concluded that Russell Napier is a brilliant commentator/economist.

I also found a more recent podcast from MoneyWeek where Merryn Somerset-Webb interviewed him badly - constantly interrupting & talking over the end of his sentences. Pity, as she's usually very good, but should have just kept quiet to let the interviewee speak, who after all, knows a lot more than she does, and has more interesting things to say. Pity, as she usually talks sense, and I normally respect what she has to say.

Indeed, as…

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Stocks123456

19th Jan '21

Hi Gromley

So how do we end up with a credit to the P&L (not a charge)?
Thanks

MiserableJacktPotato

Gromley

So how do we end up with a credit to the P&L (not a charge)?

Because last year - they wrote down the "rights of use" asset - the asset that balances out the rents that have to be paid in the future against the profits they might make from those assets.

So that loss (taken last year gets reversed in the current year)

It can be confusing, until you get your mind aligned to how it flows. Maybe this will help?

	Without prior write-off	With prior write off
Rents Actually Paid (cash)	-80	-80
(Reduction in future rents liability)	80	80
Reduction in Rights of use asset	-80	-80
Reverse PY RoU previously write-down	NIL	40
Impact on CY P&L	-80	-40

Essentially in FY20 they 'booked' some of their future rental costs as an exceptional loss. in recognition of the expectation that the stores in question cannot deliver the gross profits required to cover the rent.

So they took a loss in FY20, "pre-booking" the losses they will make in future years.

It's "kinda" okay so long as they can cover the negative cashflow.

Not sure if that makes it clearer?

Tommy H

Hi John

Sorry a late comment, it would seem at the moment that things all move up ahead of the results, we get the results which read well to me considering all going on, especially the continued buying back of debt and reducing interest costs, and the SP goes down.

This for me is a long term hold, so as I am up on the original price even after the drop today I find it frustrating, but at the same time I was not looking for a trade exit, or even to admit that I have the ability to buy/sell quickly on temporary peaks, as this is the second time in a few months that Premier Foods (LON:PFD) has done this, gone up and come back down that is.

Tommy

CamRaid

Hi Abtan,

I always like a good discussion and a differing opinion so please don't think I am trying to convert you or convince you that I am right. I am just sharing my opinion.

Yes you are right that there is a 1% management fee but compared to the overheads required to service this and the high interest rates enjoyed by investors the fee is negligible. To be a financial success they need to keep pedalling.

"All additional comments on loans being one-offs (for refurbishments, machinery, CBILS, etc...), no-one going back to the institution that originally lent to them and having to go through the under-writing process for all additional loans, applies to ALL lending institutions."

Yes I agree that this applies to all lending institutions. However, not all lending institutions were floated as a multiple of revenue claiming to be a technology company. The issue is the product is transactional and not necessarily a repeat product by the nature of it's structure and it's term.

Take a look at Ally Financial in the US. They roll out high volume products to a mass market. Car loans, mortgages, etc.. The renewal rates will be high. What is even better is that they fuel this in the main by low cost deposits from savers. Look at their share price graph and there are tips they will hit $90. Take a look at https://www.dataroma.com/m/comm.php

Funding Circle is a bad idea that is badly run. I can't see it making money. If anything short it.

Put your money in Ally and thank me in 12 - 24 months. :-)

Gerrymac

Paul,

I find it hard to get my head around the large number of companies that are over valued given that they show no proof of profits and on the converse Boohoo and ASOS who both produced excellent results last week have dropped circa 10%+ in a week.

Great buying opportunities but didn’t make sense to me.

abtan

Funding Circle Holdings (LON:FCH)

Hi Camraid

No offense taken at all. I'm enjoying hearing a different view to be honest. And just to reiterate, I don't hold, though I remain curious.

Ally Financial - I just took a quick look. Everything does indeed seem to be going in the right direction. I never look at tips (ever since owning Avanti Communication in a past life) + it seems like a mammoth company to research, so sadly I think I will pass. Best of luck with it.

Back to Funding Circle Holdings (LON:FCH) ...

The 1% annual fee - you're correct, it's tiny, unless they continue to build originations, in which case it's an amazing passive income stream and could one day cover their OPEX.
I get the impression that it's not just that you don't believe in what the company does, but more that you think it's overvalued. I personally cannot tell.
If they do indeed have a phantom net cash position - i.e more cash on their balance sheet than their market cap, and they are EBITDA positive going forward, then the valuation is completely incorrect and it is undervalued. We shall see.

Cheers again

20th Jan '21

That is interesting. Can you explain where the phantom cash is likely to come from?

Nick Plantman

Is it just me or did you not addLON:WJG to this report?

PLS1nve5t

It's probably just you :-) currently it is showing as the last section of the report, just after Superdry - you could try doing a refresh <F5>

In the last annual report (link here, page 35) there is a section on SPVs - Special Purpose Vehicles.

These have been set up to allow institutions access to blocks of Funding Circle Loans.
Before institutions can buy these:

Funding Circle Holdings (LON:FCH) needs to buy loans,
place them on their balance sheet,
consolidate them into one product,
sell them on.
Agreements are already in place with institutions before step 1.

However, there is a short period between Funding Circle Holdings (LON:FCH) buying those loans (step 1.) and then selling them onto the institutions (step 4)...which is when covid happened.

As far as I know:

Funding Circle Holdings (LON:FCH) are insisting that their exposure is minimal.
institutions have still bought the loans as previously agreed, but Funding Circle Holdings (LON:FCH) will have taken a FV hit.
You might have noticed in the Trading Update a few days ago that the company only referenced "Income" not "Revenues". It's because the latter includes the loss on these FV adjustments. Sneaky.

To summarise:

The Stock Report is showing Funding Circle Holdings (LON:FCH) has a lot of debt on it's balance sheet:
However, this isn't taking account of the SPV's currently sitting on it's balance sheet, which have likely been sold by now:

Note the £319m net equity position above and that the market cap today is £318m.
Additionally Funding Circle Holdings (LON:FCH) insisted last year that their exposure was minimal

I hope the above is clear.

If it's true and a large £300m net cash position does appear on its balance sheet in the near future (i.e. they have more cash than their current market cap) AND they are EBITDA positive, then I'm more likely to be interested.

Until then, I'll just need to wait.

Cheers

riosurfer

Paul - ref your comments on deficits and Stefanie Kelton's book

From the London Sschool of Economics blog on its website: "In The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy, Stephanie Kelton dispels six key myths that have shaped the conventional understanding of deficits as inherently bad, instead arguing that deficits can strengthen economies and lead to faster growth. This book is a triumph, writes Professor Hans G. Despain, shifting normative grounds of government spending away from the false and unproductive idea that deficits are irresponsible and ruinous towards the productive political activity of deciding which spending programmes should be prioritised"

This book is claptrap. Don't be fooled Paul! The BoE can "create" money as long as investor ascribe value to the money created. When that value falls, the BoE has to create more, and more, and more....

I lived in Latin America for many and saw the tragedy of the Kelton attitude play out many times over.

It a superficially alluring option. Just "create" money out of thin air! But ultimately a road to ruin.

That is really interesting. Thanks for sharing.

Thanks Gromley for taking the time to set this out so clearly. I need to get up to date with lease accounting! So in summary are you saying that it is the increased expectations of future economic growth that has changed here (and therefore the ROU asset), not the lease liabilities? So its a double benefit for investors ie a positive outlook and a reduction in losses now.

Sorry - limited time to respond right now, so I'll try to expand on this in due course.

But essentially I think you've read my comments the wrong way around (possibly because I - or the topic - was unclear).

In very short form - they booked some losses that are proper to this year in last year's accounts.

So they are now presenting results that make them seem more profitable than they really are - cashflow will be worse than the P&L.

I have probably left that unclear, but I'll be back.

To be, somewhat incorrect, but concise : they are (legitimately) overstating their profits.

No, I understand you, it's an accounting adjustment therefore the cashflow will be worse than the profit. Thanks!

21st Jan '21

Yes that bit's right.

I don't think it is a double benefit for investors however - unless perhaps - they can renegotiate the rents down to meet what they can now make from the leases.

Abtan,

Thanks very much for this. You have really got me thinking about this.

I invest in Naked Wines and one of the factors I liked about it (I got in at 220p) was the marketing could be stopped at anytime and reduced to a level that serviced existing customers rather than trying to acquire new ones. It is a subscription model with more frequent and lower value purchases but a similar principle could apply to £FCH. This would make the business instantly profitable.

Your concept of this hidden cash amazes me. There have been rumours that Starling bank could buy FC but the rumours had scorn poured on them due to the market cap of FC. This could make the transaction achievable.

Do you have more thoughts on this?

23rd Jan '21

Hi Camtab

It is indeed an interesting scenario.

First, sorry I'm not sure I fully understood the Naked Wines (LON:WINE) comparison.

Second, I didn't know that Starling Bank were looking for a company to buy - interesting.

From a very quick read, it looks like their focus is on European expansion. Given the recent closures of the French and Dutch Funding Circle offices, I'm not sure the company would therefore appeal to Starling.

Also keep in mind that £FCH might now be EBITDA positive. Let's say EBITDA for FY21 comes in at £10m and let's use a reasonably low x10 multiple = £100m

+ at least £200m cash if those SPV's have indeed been removed from the balance sheet and we prudently assume some write-downs

= £300m

This seems like a low end estimate.

From a look at the last Companies House records, it doesn't look like Starling has this sort of money lying around. FY20 was a good year for them though, so maybe they might be able to raise funds for a cheeky bid, I've honestly no idea.

It will certainly be interesting to see how this pans out though.

Cheers and have a nice weekend.

WDWombat

24th Jan '21

The QTX block was sold to a single investor, the Buffetology Fund. The company stated that they were approached by the fund in December. Finncap suggests this might be equivalent to an historic (Dec 2020) p/e of around x30 and a forward p/e of closer to x50 (there are apparently additonal costs in the US this year expected to crimp profits). The history has been of very high returns on capital which may go some way to explaining what looks like a very expensive deal for the buyer and a very good one for the seller?

Small Cap Value Report (Tue 19 Jan 2021) - BOOT, APTD, COG, QTX, SDRY, WJG

Inflation & interest rates again

Russell Napier

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Paul Scott

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