Small Cap Value Report (Tue 29 Mar 2022) - TMG, DRV, SUS, XLM, LTHM

Good morning! It's Paul and Jack here, with Tuesday's SCVR. 

Agenda -

Paul's section:

Mission (LON:TMG) - final results are out for this marketing company. Signs of impressive profit growth are a plus, but the balance sheet is cause for concern and companies in this sector are vulnerable to clients tightening the purse strings when the economy slows.

Driver (LON:DRV) - a profit warning from this construction and engineering consultancy. Immediate changes seem to have arrested the problem but the jury's out on whether this share is simply too small to be listed or worth a punt at the current price.

Jack's section:

S&u (LON:SUS) - I hold - a strong rebound following exceptional FY21 conditions. This is a well managed operator that thinks long term and prioritises its shareholders, yet the stock is neglected by the market and trades on a single-digit multiple of forecast earnings. The group is investing for growth and, while the general macro outlook is mixed, I would expect it to fare better than most.

Xlmedia (LON:XLM) - turnaround continues and the shares are up this morning. The business model was badly hit in 2018, so I have reservations over the robustness of earnings. The US sports betting market could be a very lucrative opportunity and the shares appear cheap, so I can see the bull case, but I’d need to have more confidence in the stability of this opportunity.

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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.

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Paul's section

Mission (LON:TMG)

Share price: 61.3p (up 12%, at 09:42)

Market cap: £56m

Background - At times like this, when everyone seems to be worried about the economy slowing, and maybe even going into a recession, then a marketing company is probably the last sector I’d want to invest in. As they rely on discretionary spending from clients, marketing companies can be expected to be one of the first costs to be cut, when clients are strapped for cash.

We last looked at TMG here in Sept 2021, when Roland reviewed 2021 interim results, so I’m getting up to speed reading that now. As Roland commented back then, TMG’s performance has been mixed, and the shares always look cheap. Long-term it’s not been a great investment.

H1 returned to profit (after a covid smacking), and there’s an H2 seasonal bias to bear in mind.

Roland also pointed out that revenue includes pass-through items, such as the cost of TV advertising for clients. Hence the adjusted margin is higher than it might appear.

Roland also flags that acquisition-related payouts are a form of debt, which increased 6/2021 net debt from £3.9m to £10.9m. This is the beauty of checking previous SCVRs, which pick up on points like that, which are easy to miss.

As usual with marketing companies, we have to be extra careful to spot fluffed up figures & commentary - they can’t help themselves usually, and in a way it would be disappointing if they didn’t put a decent amount of spin on their own performance, talking things up!

On to today’s news -

Final Results

The MISSION Group plc (AIM: TMG), creator of Work That Counts TM, comprising a network of 17 Agencies delivering real, sustainable growth for its Clients, is pleased to announce its final results for the year ended 31 December 2021.

Sustained improvement in revenues and profitability resulting in FY21 results ahead of expectations and 2022 has started well

Reinstatement of the Group's progressive dividend policy

I’ve reformatted the bolding above, to highlight the key points.

The financial highlights table (above) shows impressive profit growth, with lots of P&L measures to choose from. But why no percentages? Adj PBT is up 525% for goodness sake, surely a marketing group should be showing such an impressive statistic in the highlights? And bolding it! Also, where are the more meaningful pre-pandemic comparisons? Lots of companies are including those in the highlights tables at the moment. So far, TMG gets a D minus for marketing its own numbers! And that’s generous.

The balance sheet has been an issue before, so I’ll look at that next.

Balance sheet - is very top-heavy, with £99.0m of intangible assets, which is goodwill relating to acquisitions. Strip that out, and NTAV is negative, at £(5.5)m, so strong it is not. Although people businesses don’t generally need much in the way of tangible fixed assets.

As I would expect, the other main items on the balance sheet is a large receivables figure of £40.5m (money invoiced to clients but not yet paid), and £37.3m in payables (the other way around - so money invoiced by suppliers, and not yet paid by TMG). There’s a £10.3m net surplus in working capital, “net current assets”, which includes £6.1m of cash (most companies tend to window-dress the year end cash balance, so I wish accounting standards would be amended to require disclosure of average daily cash & net debt).

A stand-out positive is that total “Acquisition obligations” was only £3.3m at 31 Dec 2021, which is much lower than £8.5m a year earlier. So TMG must have paid out the difference, £5.2m in cash or shares, relating to previous acquisitions, during 2021. I can confirm that from the cashflow statement. This is probably why “bank loans” have shot up - which totalled £5.0m a year earlier, and was a £16.4m non-current liability at 31 Dec 2021 - that’s a large increase in bank debt, which might concern some investors, given the wobbly macro economic outlook.

Overall then, this is not a strong balance sheet, which is not a concern now, but would become a worry if the economy tanks in future.

TMG has a history of running up too much debt, making acquisitions in the good times - it came quite close to going bust in the 2008 financial crisis, I recall.

Cashflow statement - is not good. As I suspected, there’s a large cash outflow (£6.7m) relating to payments for acquisitions.

Also it looks like favourable working capital movements during the pandemic in 2020 reversed in 2021, which is to be expected, so is not a cause for concern.

Dividends of £2.1m were made, which looks unwise to me, since it’s been funded from increased debt.

I like to invest in businesses that throw off embarrassingly large amounts of cash. TMG uses its cashflows to make acquisitions, so it all boils down to whether management are any good at doing acquisitions or not. The trouble is that marketing businesses are all about people - so why would anyone want to sell a successful marketing business that is providing them with a nice lifestyle? Retirement maybe, but then what’s left, if the founder leaves? The business might wither on the vine. Hence an acquisitive marketing business strikes me a rather risky business model.

Outlook - positive-sounding, but no figures -

OUTLOOK

· Trading in 2022 has started well and in line with Board's expectations.

· Group remains at the forefront of opportunities across our markets and since the year end have confirmed the acquisition of Livity, the youth focused creative consultancy.

· Confident that MISSION is well positioned for future growth and will continue to make further progress against its strategy in the year ahead and beyond.

My opinion - as you’ve probably gathered, I’ve talked myself into avoiding this share.

I don’t like the sector, and think it’s particularly vulnerable to an economic downturn.

The balance sheet has too much debt, if we are going into a downturn.

There’s little dividend-paying capacity, so the yield doesn’t look sustainable to me.It may have started 2022 well, but there’s got to be a risk of a profit warning later this year, if the economy does nosedive, so why take the risk?

As you can see from the long-term chart below, the shares tried to put on a spurt from 2018 to 2021, but are now back down to where they were 8 years ago.

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Driver (LON:DRV)

Share price: 29.5p (down 24%, at 12:16)

Market cap: £16m

Trading Update & Board Change

Driver Group plc (AIM: DRV), the leading global professional services consultancy to the construction and engineering industries, providing multi-disciplinary consultancy services including expert witness, claims and dispute resolution services, today provides an update on trading and details of a Board change.

It’s a profit warning, due to under-performance in 2 regions - with commendably clear guidance -

Driver Group has had a difficult second quarter (ending 31 March) with results during the period impacted by a combination of a problematic loss-making contract in the APAC region and an unexpected drop in revenues in the Middle East region.

The EuAm region has continued to perform well and provides a solid platform upon which to build for the future, but the drag effect from the APAC and Middle East regions means that underlying* Group profit before tax for the half year is expected to be between £300,000 and £500,000 against £1.0m in the corresponding period last year.

Action taken - an operational review has identified £1m cost savings in the problem regions.

Outlook - “significant improvement” in H2 profits expected, as the restructuring is starting immediately.

Net cash is currently £3.9m, plus £5.0m available bank facilities. That’s down from £6.5m at 30 Sept 2021.

Director change - the CFO has resigned, which is a little unsettling.

My opinion - I’m not terribly familiar with Driver. It looks too small to be listed, and hasn’t demonstrated growth in the last 6 years, so I’m struggling to see why anyone would want to own this share. Divis are also lacklustre. Maybe a larger rival might bid for it, which could provide some upside.

The last balance sheet was excellent, with NTAV of about £18m, now above the market cap (of £16m).

The share price fall looks overdone to me, and I like the fact that action has been taken to restructure, and improve H2 results. Although that’s likely to involve exceptional cash costs (making people redundant, closing offices, etc).

Overall though, at 30p per share, I think this might possibly be a falling knife worth catching. But it depends on factors outside our control (whether existing holders decide to sell or not). Hence I’ve no idea what level the shares are likely to bottom out at, that’s unknowable. In situations like this, it can make sense to make a small initial buy, and then buy more if it keeps dropping. Or, just wait to see where it bottoms out instead. I reckon there could be a 50% gain in this, as a trade, with a (say) one year view - not to be sniffed at (if I’m right, which might not be the case of course, nobody can predict market prices with certainty!). So it might be worth a punt.

Expect the StockRank to fall from its current level of 64, as the new data feeds in.

Singers have withdrawn forecasts today I see.

As the chart below shows, DRV shares have a long, and undistinguished track record -

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James Latham (LON:LTHM)

1220p (down 6% at 12:58)

Market cap £244m

Trading Statement

James Latham is one of the UK’s largest independent trade distributors of timber, panels, and decorative surfaces. We supply products to a broad range of customers, from contractors and merchants, through to designers and makers.

Today we get a year end trading update for FY 3/2022.

This is the whole update below, reformatted by me into a list, and as always, it’s my bolding of keywords -

Revenue for the year to 31 March 2022 remains strong and is anticipated to exceed £370m compared with £250m for last year.

Cost prices have continued to rise throughout the year which is a major driver of the increase in revenues, and there are no signs currently of price weaknesses.

Volume growth has slowed and gross margins percentages are now returning to more normal levels, as expected.

Supply chain issues have continued, with shipment delays and congestion at the ports, and this has been exacerbated by the events in Ukraine and its effect on Russian ships and ports.

We are still maintaining higher than normal inventory levels and using our extensive network of suppliers to ensure that we continue to provide a high level of service and product availability for our customers.

Overheads are facing inflationary pressures especially with increases in fuel costs causing an increase in vehicle costs per tonne delivered. We continue to monitor and control our overheads closely.

The Company's balance sheet and cash balances remain strong.

The Board plans to report the Company's preliminary results for the year ended 31 March 2022 on 29 June 2022.

That’s all useful information, but trading updates are primarily to inform investors how profitability is performing vs market expectations. This is notable by its absence.

I suppose we have to assume it’s in line with expectations, whatever they are!

There’s a useful note from SP Angel available on Research Tree, but it’s more a summary, and with only historic numbers, no forecasts.

Looking back at its interim results to 9/2021, LTHM is a pandemic beneficiary, with shortages meaning it has been able to raise prices considerably. That resulted in bumper H1 profit (before tax) of £34.1m. Pre-pandemic, the company was making c.£7-8m each half year, so this is a massive boost to business in the short-term, but obviously won’t last forever. It reminds me of the bonanza car dealers are also enjoying. It’s fascinating how supply chain disruption has clobbered many companies, but has enabled others to laugh all the way to the bank.

Balance sheet - I’ve checked back, and LTHM has a fabulous balance sheet, although in H1 all the profit got sucked into rising working capital, with surprisingly weak cash generation. Expect cash to balloon once market conditions normalise, and the excess working capital turns into cash.

What will LTHM eventually do with its excess capital? The controlling family seem super-prudent, which is a good thing. I note they did pay special divis in 2005 & 2006, so I wonder if we might see something similar next year? Note below how LTHM continued paying divis throughout the pandemic, another beauty of a very strong balance sheet. There’s no dilution either, with the share count remaining at 20m

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Valuation - pre-pandemic, EPS peaked at around 63p. It’s likely to be way higher than that this year, but I wouldn’t value any share on a one-off trading bonanza.

If we assume profit eventually settles back down at 63p, which might be too pessimistic, then 1220p per share currently gives a theoretical PER of 19.4 - not exactly cheap.

Although an allowance needs to be made for surplus working capital, which I think could be up to about a quarter of the market cap, so that would bring the PER down to about 15 - which looks much more reasonable.

My opinion - I very much like this company, it’s a firm favourite here at the SCVR, as a well-run company, and a value share. There’s a reliable yield, but it’s only about 1.8%, so not terribly exciting, but with the prospect of a windfall special divi at some stage.

The current valuation looks fair, but not cheap.

The problem with companies like this, enjoying a profits bonanza, is that we know it’s going to end, the only question is the timing. Then reported figures will show a negative trend, which might cause downward pressure on the share price. So I think it’s important not to get get too carried away with bumper trading, and chase the valuation too high.

The StockRank reflects this - great quality & momentum, but value is middling -

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A very attractive long-term chart below - it’s been a 15-bagger since the start of this chart, although the company has been listed since 1986, and in existence for over 200 years! Still with plenty of Latham family members involved as shareholders and management. We like family firms here at the SCVR - they’re usually much safer hands than hired hands. Look how fragmented the shareholder base is below, with only 1 institution over 3%, the rest all being Lathams!

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Jack's section

S&u (LON:SUS)

Share price: 2,430p (pre-open)

Shares in issue: 12,145,260

Market cap: £295.1m

Preliminary results for the year to 31 January

(I hold)

This motor finance and specialist lender operates in a part of the market where ethics can be a concern, but S&U is a reputable operator that has built up good customer relationships over decades of trading.

It has also proven itself to shareholders as a reliable dividend payer with a history of profitable growth.

In today’s report, group chairman Anthony Coombs writes:

Together with Warren Buffett, the legendary American investor, we believe that shareholders' rewards should reflect the long-term view of the cash thrown off by the profits of the businesses they own. We have reflected this at S&U in a longstanding dividend approach which aims at seeing dividends twice covered.

Full year highlights:

• Revenue +5% to £87.9m (2021: £83.8m),
• Group amounts receivable from customers at year-end increased by 15% to £322.9m (2021: £280.9m),
• Group impairment charge of £4.1m (2021: £36.7m) - lower this year due to less utilisation of Covid related Jan 21 provisions, lower motor finance bad debt attrition and good collections in both businesses,
• Profit before tax up from £18.1m to £47.0m,
• Basic earnings per share up from 120.7p to 312.8p,
• Final dividend of 57p (up from 43p), meaning a total dividend of 126p (2021: 90p),
• Net Borrowings at £113.6m (2021: £98.8m), with gearing at 54.9% (2021: 54.6%).

That’s the highest level of earnings per share in the group’s 84-year history, valuing the group’s shares at 7.8x with a dividend yield of 5.2%. Next year forecasts suggest a dip in EPS to 265p, but that would still value the stock on a single-digit multiple. And it's worth mentioning that today's 312.8p of EPS is well ahead of the consensus FY22 figure of 291p.

S&U has two businesses: Advantage Motor Financing (larger, more established motor financing) and Aspen Bridging (newer, higher growth potential property loan bridging).

Advantage PBT has risen from £17.2m to £43.7m, thanks to a lower than normal £3.8m forward looking impairment charge (2021: Covid impacted charge £36.0m). This charge was £16.5m in 2020.

Remarkably, last year was Advantage’s first ever decline in profits, so it’s good to see this was shortlived and that the following year’s trading has been particularly strong. True, the results are bolstered by a much lower than normal impairment charge, but that is also a benefit of prudent assumptions made ‘in the dark days of January 2021’ and the group’s better than average loan quality.

Monthly live collections receipts reached a record £152.7m, 10% up on 2021. These collections represented an average 93.21% of due (2021: 83.26%) and the year finished on a remarkable 98.25% of due in January. They were made possible by Advantage's close and harmonious customer relations, responsible lending, the success of a new customer payment portal introduced last summer and, last but not least, by the professionalism and empathy of our customer facing teams.

Total annual collections for the year were £203.9m (2021: £180.5m) and annual net advances were also higher, at £140.9m (2021: £102.6m). Net receivables rose from £246.8m to £259.0m and S&U says it is happy with the quality of new business. 

Aspen Bridging PBT increased from £0.8m to £3.4m. The momentum is building here, and results are materially improving, underpinned by strong advances and repayments. Amounts receivable from customers is now £63.9m, up from £34.1m. There have been 369 new loan facilities made in five years, with 267 repaid and 102 remaining on live book.

In the housing market, although market transaction numbers have remained subdued, house prices generally have risen over 10% over the last year.

New products have been introduced. Loans now range up to £5m per deal as the refurbishment and small development market expands. Aspen also traded within the government's Coronavirus Business Interruption Loan Scheme (CBILS) introduced a 'Bridge to Let' product which is proving attractive to smaller developers and investors.

Outlook

Management commentary is as distinctive as ever. This from chairman and shareholder Anthony Coombs:

In times scarred by the global pandemic, looming environmental disaster and now a war in Ukraine, anyone claiming to see the future with any certainty risks appearing a charlatan or a fool.

Hence, without possessing any supernatural powers of foresight, I am at least pleased to see that my prediction last year of "a return to S&U's habitual levels of success" in 2021 has indeed now come to pass… Group net assets now stand at a record, £206.7m against £181.0m last year.

Current trends in both businesses remain encouraging, with new loans this financial year already beating budget. The group increased its funding by £50m last year in anticipation of this strong performance and a more favourable environment.

Conclusion

Good results, backed up by decades of management experience, financial strength, and good returns to shareholders. The valuation remains modest for what is a good and growing company. The lack of liquidity and a general lack of interest from institutional investors means that these shares will likely continue to fly under the radar, but as long as earnings grow then the prospects are positive.

It has been a difficult period. First Covid, then its economic and social aftermath, and now the war in Ukraine. But S&U has emerged from it all in a stronger position, which is the hallmark of a quality operator. 

What’s more, there is plenty of scope for ongoing growth. The group has used the pandemic period to set in place a raft of operational improvements which are making both Advantage and Aspen more competitive. New finance products have been introduced, sales channels diversified, both brand and digital marketing embraced, and customer communication automated and made more efficient.

The result is that both Aspen and Advantage have comfortably outperformed their respective markets. There is the standard of living squeeze to consider and consumer confidence remains an important variable.

Still, positive results from a company that has proven itself as an able steward for its shareholders capital and one of the longer term thinkers out there.

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Xlmedia (LON:XLM)

Share price: 30.06p (+5.85%)

Shares in issue: 262,586,405

Market cap: £78.9m

Final results for the year to 31 December

This business makes money by publishing informational websites which generate new customer sign ups for gambling, personal finance, and sports businesses.

Its turnaround strategy sees a concerted shift to more content-rich websites, which should build stronger and lasting relationships with consumers - a good move. It’s one thing to describe this intention though, and another to actually create websites that really take root. Execution risk is offset to some degree by share price falls.

Highlights:

• Revenues up from $54.8m to $66.5m,
• Operating profit up from $0.1m to $3.9m,
• Adjusted EBITDA of $17.9m (FY 2020: $12.2m)
• Adjusted profit before tax of $10.5m (FY 2020: $5.3m)
• Reported Profit before tax of $4m (FY 2020: $1.1m)
• Cash and short-term investments of $24.6m (31 December 2020: $13.9m).

The adjusted profit figure excludes loss from impairment and reorganisation costs. I’m taking that with a pinch of salt for now as I don’t know the company and am generally wary of adjustments. They can be justified, but they are also subjective and can end up complicating the very results they seek to simplify.

There has been a global operational reorganisation here, set to complete in H1 22, which should provide annualised gross cost savings of between $5m and $6m. Adjustments are understandable then, but nevertheless require an additional layer of analysis.

In terms of the group’s verticals, Sports revenue rose from $11.3m to $31.4m, Personal Finance generated revenues of $8.7m (2020: $8.4m), European Casino assets generated revenues of $23.2m (down from $31.7m), and Other legacy was down from $3.5m to $3.1m.

Over the past year, XL has clearly grown its presence within North American Sports, with coverage across the 15 states where online sports betting is legal, as well as US states and Canadian provinces soon to legalise. Two acquisitions have been integrated, while the decline in European Casino has been ‘managed’, with variable costs helping to maintain a level of profitability.

Our North American sports platform generated significant levels of online traffic across H2 2021, growing to a year-end audience of 17.8 million unique monthly users… The North American Sports season, running September through April, generated $5.7 million in 2020-2021. While the 2021-2022 season is yet to conclude, generated revenues currently standing at $38.4 million, representing a 574% year-on-year increase.

That’s a big jump in revenue, mostly from acquisitions. This could work out, but managing acquisitions tends to be a riskier way of growing compared to companies that can expand organically.

There have been quite a few senior hires too, including Caroline Ackroyd as CFO, Nigel Leigh as chief information officer, Sonja Haas as chief people officer, along with two new non-executive directors.

Outlook

Current trading for year ending 31 December 2022 in-line with management expectations. The North American Sports vertical is now a key growth driver and has seen a strong start to 2022.

Pleasingly, the business is now fully focused on expanding our portfolio of premium assets, underpinned by content-rich and consumer-centric sites, servicing high growth markets and geographies whilst delivering enhanced operating performance and efficiency.

Conclusion

The ongoing legalisation of sports gambling across the U.S is a key driver here. That’s an opportunity, but also brings regulatory risk. Take management’s comments on the declining Casino vertical (which is a different market but highlights the risk):

This vertical continues to experience ongoing trading pressures alongside expected tail revenue decline. The Group's Finnish Casino assets generated revenue of $11.7 million (FY 2020: $15.0 million), as previously highlighted, and which continue to face strong regulatory pressures and management anticipates a prolonged period of adjustment to this new regulatory environment.

More than 100 of the firm’s casino sites were hit by a Google penalty early in 2020, leading to all this change we are currently witnessing. US sports betting might share some of this risk, although it is no doubt a lucrative opportunity as well.

This remains my key concern though: the durability of earnings. There is also a lot of change going on, which heightens the execution risk. Management is both reorganising its existing operations and also strategically acquiring in US sports.

Shareholders have been caught out with this stock before, with the share price drop mirroring a fall in earnings per share.

It’s possible that XL Media’s reorganisation and strategy of acquiring US sports assets will be successful, and the shares do look cheap, assuming the strategy works out. So it could be worth a bit more investigation.

I think it’s fair that a degree of risk is reflected in the share price though. There are external variables beyond management’s control - competition, the introduction of new regulation, or even just small changes in Google et al’s algorithms - which limits my interest in the company for now. As ever, happy to hear differing views.