Small Cap Value Report (Tue 21 Dec 2021) - EMR, GMS, TON, INS

21st Dec '21 by Paul Scott

101 comments 10196 reads

Good morning, it's Paul here. Today's report is now finished.

Agenda:

Paul's Section:

Empresaria (LON:EMR) (I hold) - a positive trading update, saying it is "well" or "materially" ahead of market expectations. Combine that with a lowly PER, and a weak share price, and I think there's upside here. Sector read-across could make this an interesting area for fresh buys possibly?

Gulf Marine Services (LON:GMS) (I no longer hold) - news of 2 contract wins, at (unquantified) higher daily rates, confirms the bull case. EBITDA guidance is unchanged. Positive outlook also confirmed from higher daily rates, and higher utilisation. Limited capacity in this capital-intensive sector. Lots of tailwinds here, which should enable the company to pay down its vast debt pile. High risk, but an interesting special situation.

Titon Holdings (LON:TON) - brief comment (no section below) - only £12m mkt cap. Results for FY 09/2021 are quite good - £1.1m profit vs breakeven LY. Very strong balance sheet, with £4.8m net cash. Outlook - supply chain issues & costs rising (passing these on to customers). Korea remains subdued. It's too small to interest me, but looks one of the most sensible micro cap investments I've seen lately - so could be worth investigating further if you delve down this low in market caps.

Instem (LON:INS) - brief comment (no section below) - H2 China market update - contract wins, but no figures provided. Many thanks to subscribers Michael Tee and BnB who have left helpful comments below, in the comments section. I had a quick look too there, and concluded that this looks a potentially interesting (although not cheap) share.

Brief market comment from Paul

This morning looks like the opposite of yesterday, because futures are up strongly due to a big rally in the US overnight, so the FTSE 100 is forecast to open up 88 points (writing this at 07:00).

I've raised a small cash war chest, and will be deploying the whole lot (with some gearing on top) first thing this morning. My reasoning being that all the evidence seems to be pointing towards an imminent climax of covid cases (omicron being so contagious), then herd immunity within just a few weeks - which is seemingly what's happening in South Africa, who seem to be about a month ahead of us, with…

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Doug2b

23rd Dec '21

BnB - I will try again in 3 parts:

BnB - tech is generally expensive again at the moment, so yes you probably would find nothing that is tech/new economy/or just popular that would currently generate a tangible surplus relative to MCap that is attractive.

There certainly have been tangible surplus qualifying tech opportunities in the past, from around 2009 to 2011, Apple was very attractively priced. It was the share buy backs once factored in that made Apple compelling back then. I did not buy Apple back then for the simple reason that I did not look closely at share buy backs and share issuing. My approach was more naive in those days. Having said that 12 year SIPP returns to April 2021 were verified by the DT as 17x, i.e. 1,600% over 12 years.

Of my 4 compounding double periods, by far the longest has been the last one, it has taken me from c2016 to double my holdings. This is the period when my investment skills have been much better than the prior periods, but alas, UK facing everyday stocks have had a tough 5 to 6 years. The upshot of that is that the under valuation of my holdings is now quite extreme, likewise the over valuation of most tech/new economy/or just popular stocks is equally extreme.

Tech opportunities will come back and I will be open to some of them when they do, those that offer me long term tangible equity growth at a cheap price, but right now, these sectors are the wrong place to be.

Fundsmith and SMT have had a much stronger last 5 years than me, but both are comfortably behind me over 12 years - for Fundsmith they began just over 10 years ago but are about half my SIPP returns for the same period. But, although both of thes funds are ahead of me over the past 5 years, their average tangible surplus relative to MCap is typically between 1% and 2% - hideously over priced, whereas my holdings have a tangible surolus of around 10% - chronically under priced.

That is a dramatic difference and my holdings are not static, they are growing their tangible equity rapidly, my favoured house builder has tripled its tangible equity in just 9 years, if that is not growth then I don't know what is.

Of my 4 SIPP compounding double periods, by far the longest has been the last one, it has taken me from c2016 to double my holdings for the fourth time. This is the period when my investment skills have been much better than the prior periods, but alas, UK facing everyday stocks have had a tough 5 to 6 years. The upshot of that is that the undervaluation of my holdings is now quite extreme, likewise the overvaluation of most tech/new economy/or just popular stocks is equally extreme.

Fundsmith and SMT have had a much higher returns than me over the last 5 years, but both are comfortably behind me over 12 years - for Fundsmith they began just over 10 years ago but are about half my SIPP returns for the same period. But, although these funds are well ahead of me over the past 5 years, their average tangible surplus relative to MCap is typically between 1% and 2% - i.e. hideously over priced, whereas my holdings have a tangible surplus of around 10% - i.e. chronically under priced.

That is a dramatic difference and my holdings are cetainly not static none growth businesses either, they are growing their tangible equity rapidly.

My favoured house builder has tripled its tangible equity in just 9 years, in addition to paying substantial dividends, my other holdings offer much the same, if that is not value growth then I don't know what is.

Rusty2

Housebuilders are very cyclical, I remember back in 2009, most were nearly bankrupt, shares were extremely low, so buying them then, would have brought huge returns in the next 5 years but the last 5 years you have been outperformed by Fundsmith, which has a fairly average performance, judging by funds performance tables. Most of Fundsmith is invested in US stocks, so not really comparable to the UK market. If there is a recession you don't want to be holding housebuilders shares.

BnB

The longer the post, the more likely for it to disappear. Very rare for that to happen with something of this length, for example.

I’ll respond further a little later. And do t be put off by the glitch. This is a good community.

It’s good that you have a methodology that’s working so well for you. But we all have different motivations for investing. For most people it is to achieve positive returns after inflation. For many here it will be achieve the highest risk-adjusted returns, often with specific reference to a relevant benchmark. I picture you in this category, I hope accurately. For me, after a lifetime of business-building, with all the risks and rewards that entails, I simply want to enjoy this phase of life as owner of the very highest quality enterprises on the planet in established sectors with secular growth - the Fundsmith approach - or category definers in disruptive or burgeoning sectors that potentially define the future - the SMIT model.

This does not preclude finding undervalued names. A good example and a great investment has been Schneider Electric. But Microsoft and its peers haven’t been cheap in 10 years and if I had waited for an outstanding value entry I’d have missed out on the 200% return that has been the reward for holding for under 3 years.

I suspect that you care about returns more than I do. And I care more about what the future looks like and how I can own a part of it. As it is easier to be wrong about the future than to model past performance, and certainly riskier to pay the price for duration assets, you’ll probably outperform me. And that will validate your approach. Where I would take issue is in the description of, let’s say, Microsoft as expensive, just because it fails your particular test. Often, these category winners look very good value in retrospect. Now, if I could just avoid the losers ;-)

Rustbucket - Bellway, Berkely and Redrow were not in trouble in 2009. A genuine recession would cause me to re-evaluate all my holdings, but we are not in a recessiona and PMI data will give a clear early warning of an approaching recession.

Yes, thanks for that advice.

I agree the discussion is sensible and thinking.

timarr

But, although these funds are well ahead of me over the past 5 years, their average tangible surplus relative to MCap is typically between 1% and 2% - i.e. hideously over priced, whereas my holdings have a tangible surplus of around 10% - i.e. chronically under priced.

Excuse me for asking - but what is "tangible surplus"? I don't think I've ever heard that term before.

Apologies if you've explained it elsewhere.

BnB - take for example ScS, which Stockopedia seems keen on, so am I, in fact it was a Stockp... vlog on the LSE bb under ScS which drew me here.

Sofas and carpets, not really a growth sector and generally over supplied, often big premises - hence hideous business rates, lots of smaller local non-listed discount suppliers. Tough to make a good profit in this sector, not really on anyone's radar. But ScS, caught ouy initially by Covid, decided to invest heavily in their website and online offering, refused to issue shares to do so.

In YE July 2021, they came storming back, generating tangible equity worth c30% of their current MCap, and they bought back some shares as well. This year will be quieter due to last year's post covid bounce and some supply chain constraints, but even if this years equity growth is around 2/3 of last year, the balance sheet impact over the 2 year period is quite mind blowing.

Very much a Peter Lynch scenario, find a business in an unexciting sector, asector that has often struggled to produce decent profits and so is 'off the radar'. But find the business that is greatly out performing within the sector, producing remarakble results.

Because the market is not watching, you have time to take a postion and benefit, this is rarely possible in popular sectors. This is not a bet on what ScS might do down the track, this is betting on the horse after it has already passed the winning post!

“this is betting on the horse after it has already passed the winning post!”

Terrific analogy.

But SCS shares are flat over 3 years. EBIT is forecast to fall 10% over the next two years and earnings to collapse so badly that PER will go from 8x today to 20x in ‘23. EV/EBITDA stays as flat as the revenues. You are seeing something that I do not - and I say that as self-criticism, not to undermine your case.

I have a lot of admiration for those who can see the potential in such situations. The ROOCE is first class. On the other hand the growth rate and operating margins don’t pass my tests for a business with enduring competitive advantages. Once the investing profit has been made, you’re off looking for the next win. That’s not my concept of business ownership, even if it makes you the more successful investor.

There’s a sense in which I am being self-defeatingly “purist” in my approach and you would be justified in levying that charge. But when an expensive purchase kicks on for decades with no further effort required, then it feels pretty good.

Enjoyable discussion.

24th Dec '21

BnB - important to view ScS in terms of what happened in the year to July 20 - hit by Covid and major investments in the online offering.
The subsequent equity build up last year was huge. The fact that earnings this year and next will be lower is not important. ScS is still expected to generate tangible equity growth this year which is c20% of its MCap and the same again next year. Surely the penny must drop for you now, this is astounding value accumulation relative to what you are being armed to pay! This is the overriding metric as it is what is generated for shareholders relative to their outlay.

The tangible surplus is the average annual net growth in tangible equity over the past 4 years, added to the forward dividend yield. This sum is then expressed as a % of the current market cap.
Long term tangible equity growth and the yield are the real wealth generated by a business for its shareholders. Expressing the sum of these two as a % of the current MCap is the most reliable metric for predicting forward medium to long share price growth as it highlights shareholder wealth generation and crucially, how much you are paying for that wealth generation.

I see the value and the likelihood of a good return but it does not necessarily make me want to buy the company. That will seem obtuse but we have different objectives. You have an accountant’s/analyst’s eye for value and risk management, I have an entrepreneur’s eye for markets and growth. I’ve built a portfolio of, to me, the world’s most interesting companies, many of which are never cheap. There’s a continuous process of refinement as selections disappoint or new possibilities arise, but my hope is for the annual churn to decline progressively. If I succeed in this endeavour, then I won’t have to worry about individual management, or the economic cycle*, or black swans - I just let progress do its thing.

No doubt you will outperform in investment terms because the “penny” will likely never drop for me! But that doesn’t stop me wanting to learn and I appreciate your observations.

* apart from a wary eye on inflation and its affect on duration assets

abtan

Scs (LON:SCS) (no position)

Hi Doug

I've written enough about Scs (LON:SCS) so don't want to delve further, though I thought it might be worth sharing this very old (2008) article on the company:

https://www.theguardian.com/bu...

All the best

abtan - clearly ScS was in a very different position in 2008. Today ScS is sitting on a sizeable and rapidly growing cash pile. The current strength and growing asset base of ScS reminds me of the position and extreme under vauluation of Dart Group (now Jet2) at the end of 2012. I did more than double my money on Dart Group, but I made the mistake of selling much too soon. Jet2 today does not offer anthing like the value growth on offer in 2013

25th Dec '21

FAFDM - the above screen does cover most of my current holdings, inc LGEN and BWY, as well as many others that I don't regard as investable, many dozens of others in fact, but that is okay. I only ever view screens as a starting point, to highlight possible candidates. If such a screen were to highlight just one or two possible candidates each year that I might otherwise of overlooked, then that is of great benefit.

Small Cap Value Report (Tue 21 Dec 2021) - EMR, GMS, TON, INS

Brief market comment from Paul

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Paul Scott

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