Small Cap Value Report (Tue 29 Sept 2020) - NCYT, SNG, CLIN, SCS, DOTD, MAB1

Good morning, it's Jack here with Tuesday's SCVR.

I'm interested in quite an exciting announcement from Novacyt SA (LON:NCYT) so without further ado let's dive in!

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Novacyt (LON:NCYT)

Share price: 565p (+20.9%)

No. shares: 70.6m

Market cap: £331.4m

(I hold)

Launch of COVID-19 antibody test and New UK DHSC Contract.

I’ve been wary of buying stock in companies that attach their name to the ongoing COVID pandemic but with Novacyt Sa (LON:NCYT) it seems that the transformational trading figures are already in the bag and the market is perhaps slow to acknowledge that.

This is an international specialist in clinical diagnostics whose business now sees unprecedented levels of demand. The group’s recent half year update was extremely strong and the outlook for the rest of the group’s financial year is impressive.

Jumping back to that statement:

• H1 2020 sales of €72.4m and EBITDA was €49.4m, resulting from the sale of the Company's market leading PCR COVID-19 test, and
• Visibility of orders for the Company's COVID-19 product portfolio suggests H2 2020 performance on track to exceed that of H1 2020

That sounds to me like more than €100m of FY20 EBITDA vs a £220m market cap at the time (£330m now) off which you can knock c£15m of cash (and probably more by end of year)

There are a couple of companies right now where it seems as though the market is struggling to price in a COVID-related transformation that the company has explicitly guided towards and NCYT is one of them (LoopUp, for example, is another - last covered by Paul here).

Anyway, NCYT has two separate updates today.

Launch of COVID-19 antibody test

NCYT has launched a new assay (ELISA: enzyme-linked immunosorbent assay) test for the detection of IgG antibodies to SARS-CoV-2 derived from plasma and serum samples.

This test complements NCYT’s existing COVID-19 product portfolio and allows clinicians to differentiate between active and prior SARS-CoV-2 infections in patients.

Novacyt has the manufacturing capacity to deliver more than three million ELISA antibody tests per month initially and is working with its manufacturing partner to ensure this can be increased.

Graham Mullis, CEO, commented:

We continue to strengthen our product offering in COVID-19 testing as demand continues and we are delighted to launch an antibody test. We believe an antibody test plays an important role in aiding the diagnosis of COVID-19, as well as increasing our understanding of the disease through screening of populations for infection rates and immunity.

UK DHSC contract

A member of my family unfortunately experienced the UK COVID testing debacle first hand, having contracted the virus a month or so ago. Safe to say - back then at least - there was a dire need for additional testing capacity. Presumably that is still the case.

So no surprise that this second announcement regards a new contract with the UK Department of Health and Social Care (DHSC) for instrument platforms and COVID-19 testing kits.

The DHSC needs Novacyt to ‘support the urgent requirement for COVID-19 testing of patients in the NHS’ as well as provide training and maintenance services for the q16 and q32 instrument platforms.

More specifically, it concerns NCYT’s ‘q16 and q32 Rapid-PCR instrument platforms, exsig® COVID-19 Direct kits and genesig® SARS-CoV-2 Winterplex kits’ and marks the second major contract awarded by the DHSC to NCYT’s Primerdesign division during the pandemic.

The contract is split into two phases. Phase One:

• Phase one has an initial fixed term of 14 weeks with the potential to extend supply by a further 10 weeks.
• This first phase of the contract will involve the deployment of 300 PCR instruments, related kits and support services with a minimum value of £150 million for the first 14 weeks.
• Based on this initial period, a further £100 million of revenue could be expected for the subsequent 10 weeks, however volumes can be varied up or down subject to certain notice criteria given by the DHSC.

Phase Two:

• The second phase of the contract, which is optional, allows for the provision of up to 700 additional PCR instruments, related kits and support services, as well as additional COVID-19 products from the Company's portfolio where required.
• Depending upon the uptake, phase two of the contract could generate considerably more sales than the first phase.

Conclusion

The testing announcement sounds exciting.

Even before this, though, NCYT’s H1 2020 trading figures and H2 forecasts were very encouraging for a small cap biotech company. Anything beyond that, such as these announcements, is a bonus.

I think NCYT is halfway through a considerable transformation. The trick will be in ensuring the revenue generated from this COVID spike can be used to develop products with longer term market opportunities.

The share price chart tells a story.

There is the risk that once we move on from this pandemic, NCYT’s business dries up. Everything management has said so far suggests the team is planning for this eventuality and making the necessary investments in R&D for a profitable life after COVID.

There are a couple of blue-sky stocks in this space floating around with £300m+ valuations. Maybe they are the real deal but I feel more confident about NCYT as it looks to already be walking the walk with its strong trading figures.

Even if NCYT didn’t bring out these new products such as Winterplex and just continued along its existing trajectory, I still think that’s grounds for a higher valuation based on its H1 figures and H2 forecasts.

The new contract provides further reassurance that NCYT is the real deal. That sense appears to be backed up from a more quantitative, fundamental perspective by the StockRanks:

Not only is it reassuring, it sounds very exciting from a shareholder perspective.

I’ll come back to this one at a later date as there’s plenty more work to do but I’ll move on for now and, with the shares up more than 20%, it’s safe to say NCYT has impressed the market.

Synairgen (LON:SNG)

Share price: 175p (+7.7%)

No. shares: 149.4m

Market cap: £242.8m

Shares are up today on two announcements for this COVID-related respiratory disease treatment company: interim results and a managed access program with Clinigen.

Interim results for the six months to 30 June 2020

Synairgen (LON:SNG) has numerous ongoing studies around possible COVID treatments, with at least one patent in the works and discussions ongoing with regulatory agencies to establish approval of its SNG001 as a viable treatment.

It is also investing in its supply chain to ensure any finished products can meet market demand.

In terms of financials:

• SNG raised c£14m in March to fund its initial COVID-19 related activities,
• R&D for the six months was £4.47m as it scaled up various clinical trials,
• The loss from operations was £5.08m (30 June 2019: £2.21m loss)

Investors with more insight into healthcare trials and this part of the market in general might be able to spot the winners early but I’m not in that camp right now. I wish SNG all the best but I'm generally waiting for signs of transformed cash flows and profits.

SNG was founded by a trio of University of Southampton Professors - I’m sure it’s a legitimate enterprise with considerable expertise but tests are ongoing and the company makes a loss for now.

At present, operating losses are increasing (albeit on the back of increased R&D spend) and SNG raised a net £13.22m in March and spent £4.63m in operating cash flow in the six months to 30 June.

That seems a reasonable amount of breathing room but there is still plenty to do before SNG’s treatments are approved and monetised.

Either its products hit the market or things take a little longer and it might be tempted to raise more cash, particularly given the transformed share price. Another equity placing would be at a share price nearly treble the previous round.

Synairgen and Clinigen sign Managed Access Program

SNG has also announced a Managed Access Program with Clinigen (LON:CLIN) for its inhaled formulation of interferon beta. This is SNG001 in Synairgen’s statement.

To recap, interferon beta (IFN-beta) is a naturally-occurring protein that plays an important role in orchestrating the body’s antiviral response. Synairgen's SNG001 is a formulation of IFN-beta-1a for direct delivery to the lungs.

There is growing evidence that low levels of IFN-beta is what makes at-risk patients ‘at-risk’. Viruses such as COVID have developed methods of suppressing IFN-beta production in the body, so SNG is testing to prove that adding exogenous IFN-beta to such patients ‘greatly reduces viral replication’.

So far, SNG has found that SNG001 increases the chances of a rapid recovery with a marked reduction in breathlessness and troublesome coughs.

The Phase II trial of SNG001 in hospitalised COVID-19 patients was conducted across nine NHS trusts in the UK and was adopted by the NIHR Respiratory Translational Research Collaboration, who gave it Urgent Public Health status.

Now CLIN has signed a MAP to get SNG001 into UK and EU hospitals. The group’s CEO comments:

We are working with a number of companies who have products being tested against COVID-19 and are very pleased to be working with Synairgen to make this highly promising COVID-19 treatment available internationally. The early study results demonstrate that SNG001 may have a vital role in helping hospitalised patients recover more quickly from the disease.

It sounds like promising stuff and this is some useful external validation of SNG’s treatments - but the difference between SNG and NCYT is that the latter is already reaping the financial benefits of approved products that are hitting the market.

SNG has money, is spending on R&D, and appears to have real potential in its treatments. Revenue is non-existent though and so, as an investor with no edge here, it’s just a little too early for me.

SCS (LON:SCS)

Share price: 210p (-4.6%)

No. shares: 38m

Market cap: £83.6m

Scs (LON:SCS) is a perennially cheap sofa retailer with a perennially strong StockRank - so why the reluctance to rerate?

A quick look at the Financial Summary shows steady, profitable growth since 2016. It is also extremely cash generative.

Despite the strong cash generation and high returns on equity, SCS has a number of strikingly cheap relative valuation measures.

Obviously lockdowns have muddied the water for most retailers. SCS has its preliminary results out today so let’s see what shape it’s in.

Preliminary results

• Results ‘significantly impacted’ by the pandemic, with all stores and distribution centres closed from late March to late May
• Gross sales -19.5% to £268.1m, with delayed sales despite strong post-lockdown demand (due to reduced deliveries) having a ‘material impact’ on gross profit and EBITDA
• Gross profit -20.2% to £119.6m and underlying EBITDA -63.5% to £7.2m; underlying EPS down from 30.3p to 2.6p
• Underlying cash flows from operations up from £24.1m to £39.5m
• Government support of £8.4m has been recognised

Perhaps the collapse in underlying EBITDA is what has disappointed the market, particularly given that shares have gained c45% since July.

That aside there are signs of operational resilience.

Order intake was down just 5.9% for the year despite two months of absolutely no operations. Meanwhile online sales jumped up 13.6% to £19.1m. Current trading shows order intake up some 45.8% on a like-for-like basis for the first nine weeks of the new financial year.

The wider mood music is subject to change of course. A second winter lockdown sounds quite plausible. In fact, SCS itself says sensibly:

Year to date trading has continued to exceed the Board's expectations, but we are mindful of the developing situation with COVID-19, and the potential impact on the wider economy.

The world is much changed heading into SCS’s key autumn trading period, with consumer confidence finely balanced and the prospect of a closed down Job Retention Scheme at the end of October.

Conclusion

If you assume we will return to more normal living conditions in the medium term then SCS is probably still cheap. The group is trading at less than gross profit, although it has a relatively low operating margin and operational gearing may have spooked some investors.

The adoption of IFRS 16 also temporarily affects the clarity and comparability of accounts (not that that’s SCS’s fault), with an added c£135m of lease liabilities now popping up on the balance sheet.

Obviously 2020 is a bit of a write off for retail park operators like SCS. What matters are the longer term prospects and whether or not the company has the financial strength to weather short term turbulence.

On that point, I note the group’s track record of steady growth, its high levels of cash generation, and the cheap valuation.

If you were to assemble a basket of cheap retail and leisure stocks, SCS could certainly play a role in that kind of diversified recovery play.

But it’s been so cheap for so long, would the rerating be meaningful? I suspect this share is too cheap but it has remained stubbornly anchored to its IPO level for years now.

Assuming a return to normal conditions in time, SCS could easily be north of 300p if the market viewed it differently. In the short term I can’t see much in the way of catalysts that might change perceptions and drive a rerating, but perhaps patient shareholders could do well in the long term.

Dotdigital (LON:DOTD)

Share price: 144.5p (+4.0%)

No. shares: 297.9m

Market cap: £414.06m

Dotdigital (LON:DOTD) operates an integrated digital marketing platform that appears to be well regarded by the clients that use it. It’s been on the watchlist for a while as a promising software candidate.

Valuation is always a concern when it comes to successful, growing, software-as-a-service companies and a quick look at the Growth & Value box shows DOTD does indeed come with a premium valuation:

It’s the classic QM software trade-off: expensive valuation for recurring cash flows, high profit margins, and high returns on capital.

Today DOTD has announced its inclusion in the UK Government’s G-Cloud procurement initiative - it’s a short announcement but is additional confirmation of the quality of DOTD’s product and is as good a reason as any to take a closer look at what seems to be a promising UK software company.

The UK Government's G-Cloud initiative is a procurement framework and online platform from which public sector organisations can buy services without needing to run a full tender or competition procurement process. The fact that DOTD makes it onto the platform is probably good for business and testament to the quality of its product and reputation.

Per the company:

Key influencing factors in the approval process included the Group's recent ISO 27001 certification, world class uptime, availability of 24/7 global support and continuous development of a resilient and scalable global cloud infrastructure that exceed the needs of its customers. ISO 27001 is the leading international standard for information security management.

Conclusion

Not much substance in today’s statement but a worthwhile update that reinforces the view that this is a company worth investigating in more depth at some point.

As above, DOTD is not cheap - but not many successful and growing SaaS companies are. What matters is the rate of growth, management execution, possible moats or barriers to entry, and the scale of the market opportunity.

We can see DOTD is generating attractive compound annual growth rates:

Its integrated marketing automation platform looks like it has the potential to form some sort of barrier to entry or moat based on proprietary client data and the bundled services it offers. As for scale of market opportunity - you would have to think the opportunity in digital marketing is pretty big.

That leaves the quality of management as an additional area to investigate but on the whole, DOTD ticks a few boxes. If only it wasn’t so expensive! Well done to holders so far.

Mortgage Advice Bureau (LON:MAB1)

Share price: 722.6p (+1.0%)

No. shares: 52.1m

Market cap: £373.2m

Interim results are out for this network for mortgage intermediaries.

Mortgage Advice Bureau (LON:MAB1) essentially provides its 150 mortgage intermediary firms (known as ‘Appointed Representatives’ or ARs) with support and services. It’s a franchise style model based on long term contractual strategic partnerships with these ARs.

Most of the group’s revenue comes from:

• Procuration fees from lenders on the arrangement of a mortgage,
• Insurance commissions from MAB1’s panel of insurers, and
• Client fees paid by underlying customers for received services.

MAB1 actually appears to receive all of the revenue first. It then returns to ARs their share of revenue on a weekly basis, which they use to pay their advisors.

This makes for quite a cash generative, capital light business model and enables MAB1 to return quite a lot of its profit to shareholders in dividends.

The Ranks clearly pick up on its Quality:

The group has grown profits considerably over the past five years, it pays out healthy dividends, its earnings are backed up by cash flows, and it generates high returns.

2020 earnings are set to take a hit though and MAB1 is now valued at 23.5x FY21 expected earnings per share.

The PEG ratio of 1 suggests it is fairly priced.

Interim results

Highlights:

• Revenue +4% to £63.5m (although this includes £6.1m of revenue from First Mortgage, acquired in July 2019)
• Gross profit up 22% to £17.2m
• Adjusted PBT +6% to £7.9m
• Statutory PBT down 15% to £6.1m

The difference between adjusted and statutory profit is mostly from a loan write off and loan provision totalling £1.7m and £0.5m of Government grant income in H1 2020.

MAB1 has turned in quite a resilient performance at the operational level at least, with the number of advisors remaining stable, gross mortgage completions up 8%, and market share of new mortgage lending up 17% to 5.9%.

Post period end the group has seen new mortgage applications at record levels and has announced Australian Finance Group as its new joint venture partner in Australia. The group has also acquired a 40% stake in Meridian Holdings Group.

And then there is the introduction of ‘MAB Later Life’ - a new proposition in partnership with a leading integrated provider of later life lending products.

All in all, there are a few initiatives here that could provide decent growth.

Conclusion

It looks like an attractive business model gaining share in a large market.

Franchise networks like this can be cash generative and operationally resilient in tough conditions and that seems to be the case here.

I’d perhaps be hoping for a more enticing valuation than 23.5x FY21 earnings.

That said there’s plenty to like here on a long term view. The group is cash generative, has a net cash position, and is growing market share and making acquisitions while others are presumably struggling.

MAB1 does say that current trading is strong and expects adjusted profit before tax for the full year to be significantly ahead of the market's current expectations.

It is optimistic on the outlook and has a couple of growth initiatives on the go including acquisitions, joint ventures, and new products addressing new areas in the mortgage market.

A good business that is perhaps fairly priced for now at 722.6p given ongoing macro risks... But that view might prove to be churlish in time of course, given MAB1’s resilience, high returns, and large addressable market.