Small Cap Value Report (Tue 25 Sep 2018) - NXT, PKG, CMCX, RDL, SUS, SWL

25th Sep '18 by Graham Neary

40 comments 10283 reads

Good morning - this feels like one of the busiest days of the years for company news. Three shares I own have made announcements, plus a very long list of others.

The list finished up as:

Next (LON:NXT)
Park (LON:PKG)
CMC Markets (LON:CMCX)
Ranger Direct Lending Fund (LON:RDL)
S&U (LON:SUS)
Swallowfield (LON:SWL)

Next (LON:NXT)

Share price: £55.64 (+8.6%)
No. of shares: 140 million
Market cap: £7,773 million

Results for the Half Year ending July 2018

(Please note that I currently hold NXT shares.)

This half-year report is a long document. But it's not a long list of random and disconnected statistics - far from it. It's truly a narrative that shows you how the business has performed and how management are planning for the future.

Future MBA degree courses (maybe current ones) should use Next's investor results presentations as the material to demonstrate successful leadership:

how a retail business survived the move online
how to communicate with the outside world
how to plan for change
how to manage costs, margins and cash flows

Perhaps I'm getting carried away. Next itself will admit that the future is highly uncertain and that it faces major cyclical and structural challenges. The "endpoint" of so much change in retail could yet turn out to be bleak for Next and its shareholders (including me!)

Next shareholders are enjoying the twin benefits of a company that A) reports in a detailed manner, and B) reports punctually.

Even in a bear-case scenario, these detailed reports will at least help to us to understand what happened and why. We will know which assumptions turned out to be false. We will see the trends that led to failure. There are so many small-caps where their stated reasons for disappointing leave so much unsaid.

Secondly, note that these are half-year results forJuly! The average small-cap with decent financial controls is a month behind. One of the surprising benefits of big-caps is how quickly they can get their numbers out, compared to small-caps.

Let's consider some of the main features of these results:

Total full-price sales up 4.5%, total sales up 3.9%…

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Aislabie

25th Sep '18

Premier Technical Services (LON:PTSG) reported very strong results today and a firmly positive outlook (I hold). The problem is that this excellent operating business is producing some alarm for shareholders because of the adjustments to EBITDA which reduce net income to an unsatisfactory level.
EBITDA is, far too often, a modern corporate fiction and its use is now almost a warning sign in many company annoucements.
In PTSG there are two large adjustments:
- there is a reserve for £1.0million for contingent payments in regard to acquisitions. I approve of this kind of structure (from the buyers point of view) as it keeps valuable assets engaged and probably lowers acquisition costs. BUT when a company is specifically stating that acquisition is part of its business plan this is not an adjustment - it s a regular cost. This also applies to the restucturing costs (£0.3milion) and the amortisation of goodwill .
- then there is the cost of share based payments to Directors and employees (£1.1million). This is particularly uncomfortable because not only is the amount significant in the context of a £4.4million pre-adjustment profit but amazingly the awards are based on a percentage of EBITDA ! This makes doubly important for management to squeeze as much as possible into adjustments. Rewards to management are expenses not ajustments.
The share price has dropped today so perhaps shareholders are recognising that they may not see the benefit of PTSG's undoubtedly excellent business. This is a great shame and again opens up the question of what is a fair split of earnings and when is EBITDA going to be patrolled.

gsbmba99

1H results from Mortgage Advice Bureau (LON:MAB1) today. You can find the presentation here: https://investor.mortgageadvicebureau.com/wp-content/uploads/2018/09/MAB-Investor-Analyst-Presentation-Interim-Results-2018-FINAL.pdf

Biggest impact I see is the continued development of the "product transfer" market. Product transfers are new mortgages with existing lenders (usually swapping one special rate at conclusion for another, hence why it's also called "rate switch"). Product transfers have only become available as advised transactions in the past 18 months. Product transfers do not form part of UK Finance's gross mortgage lending estimate of £260bn(ish)/year. Product transfers attract significantly lower comissions (about 20bps as opposed to 30-40bps for new mortgages). Product transfers do not attract insurance commissions at the same prevalence as new mortgages hence why protection grew at a slower rate. About 25-30% of product transfers are advised as opposed to 70%+ of new mortgages. MAB currently aiming at advisory fee pool of £260bn x 70% advised x 30-40bps PLUS £200bn x 25-30% advised x 20bps.

Overall though, the continued opening up of the product transfer market is potentially significant because it raises the lifetime value of a customer if you can advise them every time their special offer comes to an end as opposed to every time they move house. Along these lines, MAB are also positioning themselves to provide advice on "later life lending", a nascent market which may feature more heavily in the future.

Worth remembering that about 50% of MAB's growth in advisers is their appointed reps growing organically. The business model suggests that gross margins (MAB share of appointed rep commissions) could continue to fall gently on lower share of commissions as advisers grow organically or as larger advisers join the network. The company hopes to offset any gross margin dilution through scale benefits. All of the compliance functions provided to appointed reps scale with activity but other costs do not.

Costs to develop the Midas PRO system are expensed. If you want to exclude share based payments from EPS, you will have to do it yourself because the company doesn't report an "adjusted" number. Diluted EPS would have been 0.8p higher had they done so (£430k/52.78m).

Graham Neary

"Gromley-adjusted" - I look forward to seeing this included in future financial analyst exams!

paraic84

It might be worth a quick mention of the Labour Party policy proposals to require companies to share 10% of their equity with employees: https://www.bbc.co.uk/news/uk-politics-45621361

Better employee ownership is often associated with various benefits and there are some investors that actively look for share ownership among employees as a good sign of engagement of the workforce. However, based on the limited information available in the media there are a number of questions about how these precise proposals would work in practice - e.g. who would they take the 10% from, what about companies based overseas or who don't pay dividends, why would a company want to issue dividends if the Government would take most of it away...

I flag this not to be political but just as another thing to keep in the back of our minds as investors. The opinion polls still show the Conservatives and Labour are fairly even and we saw how the Tories lead narrowed quickly at the last election. If there were indications of a fresh election then I imagine investors may be more nervous than in 2017 and I note a lot of utilities stocks are trading at lower than historic valuations probably in part due to Labour's re-nationalisation plans. (Although whether a Corbyn government could get their proposals through the Commons let alone past Labour Peers is another matter).

There are a lot of political risks right now to be mindful of - although a poor outcome of the Brexit negotiations is obviously the most immediate.

WarrantStar

Hi Graham
I would just like to point out that the "QUALITY" graphic that is showing at the end of the piece on Park (LON:PKG) is the wrong one. It seems to be a copy of the one for Next (LON:NXT) .

SundayTrader

Graham

Surely that is the Next (LON:NXT) quality statistics that you have inserted into your section on £PKG?

Thanks for pointing that out, I fixed the error.

langley59

I would propose WH Smith (LON:SMWH). Similar to Next (LON:NXT) with their gradual move from stores to online they seem to be transitioning from High Street to Travel quite successfully and have clear and informative updates.

Julianh

Good afternoon johnsmith68
You asked about companies that tell it like it is. Here is another candidate.
I attended the Games Workshop (LON:GAW) AGM last week and had some time talking to the finance director and the CEO after the AGM. The things that struck me were:
1. they really enjoy their work
2. their objective is to make a success (even more of a success) of Games Workshop (LON:GAW)
3. they don't care about the share price. Unlike many boards of directors they don't seem to be interested in managing the share price (usually in order to boost the value of their stock options and 'long term incentive plans'. As a result they don't spend much effort on communicating with shareholders (e.g. they are not interested in investor presentations)
4. their results announcements are clear and to the point, relatively free of jargon and all the adjustments to the results that other boards use to encourage investors to buy the shares
5. I experienced them as refreshingly honest
6. recent history has shown them to be very good at growing Games Workshop (LON:GAW) (revenue and profits) as well as engaging their customers in their hobby. And they were honest enough to suggest that future growth is likely to be slower than it has been over the last two years
7. they like to promise only what they are really confident that they can deliver. So the history of overdelivering against market expectations should continue
8. if and when they hit problems they will be honest and open about these problems too
As you can see, I was very impressed. This doesn't mean that their share price will continue on its upward trajectory and they didn't promise that. But I left feeling that:
1. the business is in very safe hands
2. At the moment they are cautiously optimistic

gus 1065

I agree with ISAallowance that Burford Capital (LON:BUR) produce some excellent and clear reports on the business. By coincidence I’ve just received by email invitation to an investor day in November with the offer of attendance in person or via video link. Details below, registration via the company website.

——————

As previously announced, Burford Capital will host a Capital Markets Event for investors and analysts on Monday 12 November 2018. Burford's senior management team will present on Burford’s business and its growth opportunities as well as the scope of the broader legal finance market.

The event will commence at 3pm London time (4pm CET / 10am EST / 7am PST).

Investors and analysts will be welcome to join in person, subject to venue capacity. There will be a live webcast of the event for those unable to attend in person.

—————

On the subject of timely/detailed reporting, I’ve also been impressed by Sirius Minerals (LON:SXX) even though they’re presently reporting on little more than a hole in the ground. Even the bad news, when it comes such as the recent construction budget overruns, is clearly and succinctly set out.

Gus.

Trident

Paraic84

You should have a look at the Philip Aldrick column (page 41) of The Times. This explains that this proposal is a stealth tax on big companies by superficially looking an Employee style share scheme. 'The employee gets the first £500 of any dividend arising from these shares, with the Govt collecting the rest. Labour estimates that this will yield £2bn per year of inclusive dividends'

Effectively then it is a tax grab of dividends income by the State. In my terms it is a form of nationalisation of shares. Would have a big impact on investor confidence, pensions etc.

An example Aldrick gave was Royal Dutch Shell pays $16bn per annum in dividends, and has 8400 staff. Therefore in theory each staff member would be entitled to £14,500 each pa. But because of the £500 employee entitlement the State would get the balance of £14,000.

Be very scared, the crocodile has smiled!

davidjhill

Looking at Next (LON:NXT) today and their very good results prompted me to revisit N Brown (LON:BWNG) by comparison

They look very cheap. Finance services division loan book (much like £NXT) dwarfs debt so that my estimated NTAV is circa £300m vs a market cap of £400m

If they close the stores and remove the £3m p/a loss attributed from these we are looking at EPS of 23-24p from next year.

So NTAV makes up 105p of the share price : they pay a 10% divi ; pension is in surplus and have earnings of 23p

I must be missing something - surely they are worth closer to 250p (ie. 6* earnings plus NTAV which also equates to a 6% divi) ?

JohnEustace

I imagine Royal Dutch Shell (LON:RDSB) would follow in Unilever's example and propose a complete move to the Netherlands. In fact this proposal might swing sentiment towards approving the Unilever move. Although that will be a jump into the Dutch withholding tax net.

For the rest, a switch away from dividends and towards share buybacks seems the obvious first counter move. Failing that just reinvest the money in growing the business and stop paying any dividends. Or get taken over by a US company or reverse into one.

In any case Labour stand no chance of seeing the £2bn a year they think this will raise. Plenty of fee income in it for the merchant bank advisors though.

Gromley

LOL. Thanks Graham, I shall await the steady flow of royalty payments then.

Back to Learning Technologies (LON:LTG) , scratching below the surface I see that the forex gain is directly related to the PeopleFluent acquisition, so it is definitely an exceptionaland there is no exposure to a exchange rates moving the other way next time.

The subsequent movement in the exchange rate between conversion and completion of the PeopleFluent acquisition on 31 May resulted in an exceptional foreign exchange gain of £3.6 million.

It further occurs to me though that those H1 numbers are actually pretty irrelevant as they only include 1 month of PeopleFluent. [PF]

We can see that PF contributed £6.3m of revenue and £0.9m of PBT and that had it been in for the whole six months revenues would have been £31m higher and PBT £1.4m higher.

As I understand it the disparity between £1.4m PBT in 5 months and £0.9m in the sixth month, relates to LTG's ability to increase the profitability of PF - they originally took the view that they could raise EBIT margins to 20% and now they believe 25%.

That is the biggest driver of the bullish outlook

Full year profit will be significantly ahead of the Board's expectations based on the upgraded PeopleFluent EBIT margin

It will therefore be interesting to see revised broker forecasts.

Based on the old estimates (and yesterday's share price) LTG has a forward PE of 54 falling to 39.1 for a PEG of 1.27

Now by no stretch of the imagination is LTG suddenly going to become a value share, but if the revised figures give a PEG of less than 1 it might get some more interest.

Disc : I hold shares in Learning Technologies (LON:LTG)

kevfle

I wonder how much those same employees will lose due to a reduction in the value of their pension funds when shares get hit by the dilution. In the end they will probably see no overall benefit.

Its got more holes than a Swiss cheese, but it would have a devastating effect on commercial confidence generally. Once you have devised a tax, you then devise a law to say that avoidance schemes are illegal and punishable by imprisonment etc for Directors and advisors.

In many ways the Tories have jumped on a companies in a tax planning punishment regime, some more legitimate than others.

A State of left or right persuasion that over commits to spending is a tin pot tyranny waiting to happen.

andrea34

I'd be very interested in any feedback that you have from your management meeting with Sigma Capital (LON:SGM) please JDW

johnsmith68

Thanks Julianh, langley59 and ISAallowance for your suggestions. I'm a nervous holder of Burford Capital (LON:BUR) and feel like I missed the boat on Games Workshop (LON:GAW) but it's on my watchlist. WH Smith (LON:SMWH) is an interesting addition to research.
I have just been watching the H1 results presentation from the very impressive Somero Enterprises Inc (LON:SOM) (I hold) on PI world (https://www.piworld.co.uk/2018/09/20/somero-enterprises-som-h1-results-september-2018/) and management here come across incredibly well - they appear honest, knowledgable and extremely competent. Cyclical risk is enormous but they're far better placed to cope with a downturn than last time around and they appear to have come out of that one stronger than before. Another one with good read across to the wider economy.

Howard Marx

davidjhill

Re N Brown (LON:BWNG) , in your calculation you are adding the assets to a multiple of profits which are generated by the assets - so in effect you are double counting.

A test of this would be for me to ask you to value British Land (LON:BLND) :

Share price = 617p
Tangible book Value per share = 920p
2019E eps = 36p

Would you value it at greater or less than 920p/share?

timarr

27th Sep '18

In fact this proposal might swing sentiment towards approving the Unilever move. Although that will be a jump into the Dutch withholding tax net.

Actually it won't, because the Dutch government have just scrapped withholding tax - it was part of the reason that Unilever (LON:ULVR) gave for deciding to move to Rotterdam - they'd have been hard pressed to get UK shareholder support otherwise. Turns out that both Unilever (LON:ULVR) and Royal Dutch Shell (LON:RDSB) were lobbying the Dutch prime minister for this, so expect Shell to be next in line if Unilever get this away.

From the perspective of the Dutch government you'd have to imagine that this is also with one eye on UK companies who might want to re-domicile to the EU post-Brexit. If so, this is the reverse of what happened after 1688, when William of Orange toppled James II and the Dutch banks and trading houses, then the most powerful in the world, moved from Amsterdam to London.

But, yes, in the event that Labour's proposed measures were enacted it would seem likely that most dual-listed companies would attempt to move overseas. You'd also expect a lot of family controlled firms to go private and some bizarre re-organisations to get below the 250 employee limit.

Unintended consequences and all that.

Small Cap Value Report (Tue 25 Sep 2018) - NXT, PKG, CMCX, RDL, SUS, SWL

Next (LON:NXT)

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Graham Neary

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