Small Cap Value Report (Tue 21 Mar 2023) - ABDP, REAT, WYN, STEM, TRST, QXT, ZTF

21st Mar '23 by Paul Scott

63 comments 9024 reads

Good morning from Paul & Graham.

Today's report is now finished. I'll put catch up items into tomorrow's report, so am working away on that now.

Banking problems are rumbling on, with the latest contagion risk apparently over who owns the bank bonds that are seemingly being potentially wiped out in refinancings/takeovers. That topic is beyond my pay grade, so if any of our banking experts have a view on it, do post a reader comment below. I might reach out to my network of experts and see what they say, so if I pick up anything useful, I'll pass it on.

Rail strikes - it seems that a settlement has been reached. So I'm wondering if any of the companies (especially in hospitality) which blamed the strikes for poor trading, will now start issuing ahead of expectations updates instead?! To be fair though, it should help the sector at least somewhat, for companies which operate in city centres anyway. (EDIT: readers are saying in the comments below that the rail strikes are not yet fully resolved, so looks like I jumped the gun here, apologies!)

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review 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 smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed - please be civil, rational, and include the company name/ticker, otherwise people won't necessarily know what company you are referring to.

Agenda

Masses of results are out this morning, so we'll work through as many as we can - we'll be doing mainly shorter sections today, to cope with the volume -

It's getting too big, so I've had to split this into two.…

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TamzinPiworld

21st Mar '23

Literacy Capital (LON:BOOK) Investment Trust will release results for FY22, 9 months to 31.12.22 tomorrow. We are hosting a webinar at 2pm, register here.

Somero Enterprises (LON:SOM) Here's the full year 2022 results presentation given by management last week with extensive questions from investors video & podcast. There's been much discussion here whether this is oversold. Stocko has a PE of 8 and a dividend yield of 12%! Management tell us all their customers are busy and they have good forward visibility. They've increased capacity at Houghton by 35%. Europe and Australia are growing nicely.

NewInvestor1972

Thanks for the detailed reply Paul, much appreciated

JohnDoe2378

Management are the key here, i back them. Noted that the integration of TPG is seemingly going well. Cautious note going forward H1 this year, hopefully just being conservative!

Roger Baron

Thanks for that Mark. Yes, Science has always been mean with divs, seeming (unfortunately) to prefer share buy backs. Can't complain though as I bought at 85.5p when my daughter was doing her university year out in industry with them. Unfortunately that's not a repeatable stock selection process!

truegent

The 12% was last year with the special div...Stocko has div of 6.73% for Somero Enterprises (LON:SOM) for 2023 ...

Andrew Ross

Not to do with any of the shares listed - but only read today that India has opened up its legal system to foreign lawyers. Reported in FT and others. Wonder if that holds any opportunities for the relatively newly listed UK-listed legal firms, Knights etc...???

Mark B

Most "investors" don't read the annual reports of the companies they own. My mind boggles over that. I wonder if reading is becoming a rare skill. :-)

davidjhill

The design was for AT1 bonds to be converted into equity if a bank breached capital buffers, not for them to be wiped out under a regulator enforced takeover, and then the equity given value.

edit: though to be clear that was the original design/intention for AT1s. I'm not referring to CS issuance specifically as I haven't looked at their prospectus in any detail and it seems these may have been a little different.

Reach (LON:RCH) Interesting announcement - I will give the CEO some credit for waiving his LTIP that should have vested in March at 43% of original full award. To be clear he has done very well out of the business whilst overseeing a disaster for shareholders but nonetheless does appear to have recognised that a vesting LTIP in his favour really wasn't appropriate. A lot of directors would not do that irrespective of how it might look.

Just my tuppence on banks following RDHowarth's great post below.

Not all Bank investments are bad - one shouldn't assume they are safer/riskier than any other investment but an investor should understand those risks.

I do invest in banks but I look for a couple of things to mitigate certain risks.

(1) The key for me is liquidity - ie the liquidity ratio. In Europe/UK there are tight rules around the liquidity ratio which mitigate risks of a run on a bank. In the US the use of this liquidity ratio is not mandatory. So I avoid US banks and others where a liquidity ratio is tight to 100%. I want to see 140-200% ideally. Then I want to see the make up of funding. I don't want to see lots of commercial funding as this can get pulled in a heartbeat. I do want to see lots of retail deposits and strong term deposits and I want to know the proportion under the government guarantee. A run on the bank is far less likely if the deposit base is covered and the liquidity ratio is high.

2) I want a strong capital coverage that is well in excess of the regulatory minimum and really 15-18%+ and then I also want to know that these "own funds" are in cash and mainly liquid assets like t-bills where interest rate risk is minimal.

If I am comfortable with both of those I then look at business model - ie who they serve and why. The more complicated the business the more risk that the assets may be subject to revaluation concerns, so I avoid.

So for me the US banking crisis that started at SVB and rolled into the regionals appeared to follow a pattern of non adherence to a strong liquidity ratio and a high weighting of uninsured and commercial deposits at risk of flight, with little industry weighting diversification. This was compounded by a very risky hunt for yield. ie buying long dated treasury bonds at cycle low interest rates; bonds which, by their very nature, are highly sensitive to IR changes.
The spillover to the CS debacle in Switzerland though was (at least in my opinion) bank specific that had been years in the making. Poor financial controls for a systemic bank is unforgivable. As a depositor why would you keep your money in a bank that admits to having poor controls? Banks are about confidence - once trust ebbs it is a runaway train that can be very difficult to stop.

SThree (LON:STEM) FY23 Q1 Trading Update given to analysts this morning video & podcast. Net fees are up 4%, in line with expectations. Contract net fees are up 8% to £82.7m, which is 81% of Group net fees. Permanent fees are down 12% this is only £19.9m revenue and reflects the trend toward Contract. In territories, Germany and The Netherlands grew 7% and 4% respectively, and represent 73% of net fees. USA was down 6%. Technology was up 8% and Engineering up 19%, while Life Sciences -15%, showing the reversal following the Covid spike. Cash is now £64m (Feb 22: £41m, Nov 22: £65m). The CEO led the success of the DACH region before he was promoted to CEO, he seems top class.

Pebble (LON:PEBB) FY22 results today, they are a provider to the promotional products industry, a much smaller 4imprint (LON:FOUR.

Revenue £134m +16%
Gross Profit margin 39.3% +2.8ppt
PTP £9.7m +4%
aEPS 5.78p +12%
Cash £15.1m
Proposed maiden final dividend 0.6p
The new year has started well in line with expectations

Management will present at a webinar with Q&A this Thursday, 23 March, 1.30pm. Register here.

ed_miller

Re: "Why don't regulators gradually just increase ordinary banks' equity?"

- Fund manager Terry Smith has answered this in the past (he was once London's top-rated bank analyst for five years running) - he points out that banks can only make acceptable profits through the use of very high leverage, which is why he never buys them.

(Fund manage Rosemary Banyard, during last week's Mello gave another good reason to not buy banks: all banks, she pointed out, operate a liquidity time bomb [my terminology] in that they borrow short (most savings deposits are instant access; most of the rest are short-notice accounts) and use the money to make term loans & mortgages etc.)

BnB

Most "investors" don't read the annual reports of the companies they own. My mind boggles over that.

I think a bit of nuance is needed here. As a shareholder, you don't need to read Microsoft's annual report to understand where the business is going, not least on account of the bombardment of comment in one's inbox, much of it extremely well-informed, from analysts, journalists and forum devotees. The same is true for multiple large caps and I can safely say, while reading all quarterly releases and studying call transcripts where appropriate, I've paid zero attention to their annual reports at absolutely no cost whatsoever to portfolio performance. As you move down the capital scale, the flow of data from outside the company shrinks relative to that coming from the statutory announcements. But one can still follow progress at the more established mid caps with keen attention to the flow of RNS/shareholder letters and the occasional analyst comment or investment article without having to read the annual report, again at no real cost to performance. As you get into small caps, where there is no supporting coverage of any kind (outside the SCVR), your comment certainly rings more true.

Michael C

davidjhill - My entire point is that it is the actual terms of the specific instrument that matter. Yes the 'original design intention' for AT1s may have been for them to be converted to equity in certain circumstances but those weren't the terms for the AT1s that have been zeroed and judging by the howls of pain and rage yesterday and today it seems that the owners of these instruments had not read the terms even though they were almost certainly professional bond investors buying from professional bond brokers!

InvestorJohn

Thanks for the heads up I hadn't noticed this

22nd Mar '23

Warren Buffet, Charlie Munger, Mohnish Probrai, Guy Spier, Joel Greenblatt , Benjamin Graham would disagree, for the active investor. I have learnt many things from these people and try to leverage their advice created over decades. Reading gives me a method to form my own opinion, without influence - and that gives me my conviction - earnt, not borrowed; which I find psychologically very powerful. Others opinions are often skewed, even maliciously to suit their purposes - so I like forming my own opinion before listening to others. I also like tracking back, to see how I miss things and that assists in my learning. I see investing as a life long learning exercise - and reading the annual report and listening to it and analysts questions is central to my process. It's also important as I have a very concentrated portfolio - and knowing what I own is very, very important to me. Deviating from the methodology of the greats makes my life more complicated than I want - so I don't.

All of which I wholeheartedly agree with - for a concentrated portfolio. It was your sneering use of “investor” to describe those with a different methodology that I took issue with. I have a portfolio of 200 names that you might describe as a “global excellence” portfolio, characterised by exceptional operating numbers, or a more diversified Fundsmith/Smithson, if you like. The portfolio performs more in line with the Quality and Growth factors than it deviates with individual company outputs, mostly because the performance of the individual names is so reliable relative to the rest of the market. You could almost argue that the studying of company reports is redundant when you have chosen to delegate the achievement of high returns on capital to management teams with the strongest track record in that regard. Meanwhile diversification all but eliminates idiosyncratic risk and makes bad apples stand out without inflicting significant damage. Choosing to own great companies for the long term is, to me, the very essence of investing, and highlights how there is more than one way to proceed with comfort.

I think many investors are not investors, they're gamblers, in my opinion, and this is my basis for the parenthesis. Many ways to heaven.

Many ways to heaven

Peace and love, brother

Caduceus

26th Mar '23

Do you have a twitter handle?

Small Cap Value Report (Tue 21 Mar 2023) - ABDP, REAT, WYN, STEM, TRST, QXT, ZTF

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Paul Scott

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