Small Cap Value Report (Tue 3 Dec 2019) - RFX, GYM, MERC, BOO, BLCC

Good morning, these are on the menu today:

• Ramsdens Holdings (LON:RFX)
• GYM (LON:GYM)
• Mercia Asset Management (LON:MERC)
• Boohoo (LON:BOO)
• Block Commodities (OFEX:BLCC)

Finished at 4.55pm.

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Ramsdens Holdings (LON:RFX)

• Share price: 202p (+1%)
• No. of shares: 31 million
• Market cap: £62 million

Interim Results

Good results from this major pawnbroker.

Let me give you a quick recap of the two major differences between this one and H & T (LON:HAT) (where I have a long position).

1. RFX is associated with Northern England, Scotland and Wales, while HAT's home turf is London.
2. RFX's business is heavily weighted towards foreign currency exchange (there is a clue in its ticker), while HAT is more focused on the traditional pawnbroking segment.

I like both companies, and I admire RFX's very strong return metrics. If I had been invested in RFX rather than HAT recently, I would have avoided the FCA investigation into HAT's personal loans business.

That said, I have a lot of conviction in the strength of HAT's pawnbroking business, and I look forward to the effect that a rising gold price will have on this. I can't muster the same conviction in RFX's foreign currency service. So HAT is my personal favourite.

Let's take a look at these results.

• FX did well, despite less than favourable conditions ("consumer uncertainty created by Brexit and the weakness of sterling has continued to impact the demand for holidays"). 8% more currency was exchanged, and the margin improved so FX income increased by 15% to £8.4 million.

Note that despite the company finishing the period in a net cash position, it says that it did use its credit facility over the summer to hold stocks of foreign currency. I wonder how much foreign currency risk is involved?

• Pawnbroking loan book is 14% higher and interest income, net of impairment is 16% higher at £4.3 million. Note that this is little over half the income from FX.
• Jewellery retail revenues are up 22%, but the mix of items sold had a lower margin, so gross profits only increased 11% to £2.6 million.
• Gold buying profits were up 57%, or 35% if you exclude a one-off scrapping of old, slow-moving stock. Excluding that one-off sale, gross profits were £3.5 million.

In summary, all the main segments are doing ok. There is some diversification between revenue streams, but foreign currency exchange remains very important.

New stores - RFX has been growing its store estate over the past couple of years, and says the new stores "continue to trade well". Benefits from merging with certain bits of the defunct Money Shop have "flowed through as expected".

All of the older stores (123 of them) are reported to be profitable on a standalone basis. The total number of stores is now 160, with another 3 set to open in H2.

Outlook - "solid start" to H2, and confident of achieving expectations.

My view

There's nothing to dislike here.

Browsing the StockReport, there is a mighty StockRank of 97, i.e. not many companies screen better than this.

It is arguably undervalued at a forward P/E multiple shy of 10x, and a P/BV of less than 2x (using the balance sheet value reported today). Companies with an ROE of c. 18% are usually more expensive than this.

I'm tempted to pick up a few shares in it, but I already have enough exposure to the sector and nothing has really changed since yesterday. The only difference is that we know Ramsdens continues to execute well on its strategy and is currently problem-free. That isn't usually a leading news story, but the SCVR is a place for good news as well as scandal!

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GYM (LON:GYM)

• Share price: 260.5p (-2%)
• No. of shares: 138 million
• Market cap: £360 million

Small Box Format Rollout

This expanding gym chain has two snippets of news for investors today.

1) It's rolling out small gyms, which PureGym did last year. These small gyms enable it to open up in smaller towns which don't have the population needed for a larger site.

2) its new credit facility is for £70 million, which is bigger than the one it replaces and is said to be on improved terms. So the banks are comfortable with GYM as a borrower.

My view - I very briefly held shares in this one, and occasionally feel a pang of regret that I didn't have the conviction to hold on. As the linked article states, the fitness industry just keeps on growing, needing more and more sites to keep up with the demand for gyms. There is plenty of competition for GYM but it appears to be holding its own.

If you're happy to pay up a forward PER of 20x today, this might look cheap in 2-3 years.

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Mercia Asset Management (LON:MERC)

• Share price: 28.3p (-11%)
• No. of shares: 303 million
• Market cap: £86 million

Proposed Acquisition & ABB to raise £30 million

Half-year Results

This is a VC/Private equity'private debt company, focusing on the regions outside London. See comments in the thread below for some excellent analysis by readers.

I began coverage of this one in July, and noted the discounted share price (32.6p, at the time) versus the NAV (41.6p, at the time).

NAV has now crept up to 42.3p, and the share price is lower, so the value "disconnect" is now even wider.

Eagle-eyed RNS watchers will have noticed that Mercia appointed N+1 Singer as joint broker last month, to work alongside Cannacord.

In general, investors aren't supposed to know about major corporate transactions before they've been officially announced. But companies do have to announce when they hire a broker, either as a replacement for their current broker or as an addition to what they've already got.

This can be a terrific clue that the company is working on something - and it has proved to be the case in this instance.

Mercia is raising £30 million at 25p. Half of this is to fund the acquisition of a private equity business, and the rest will be used for broader investment purposes (i.e. for the existing portfolio and for new opportunities).

It sounds like the existing portfolio would have been starved of funds, if not for this fundraising. Those are less-than-ideal conditions for an early stage investor to find itself in!

At least there is a promise that future fundraising won't be needed:

The Board currently expects that the net proceeds of the Placing will fully fund Mercia's investment pipeline and "evergreen" the balance sheet with future investments funded from periodic portfolio cash realisations.

My view

There is a lot of detail to wade through in these two announcements, and I've got bogged down in all the text. The rationale for today's acquisition, for example, lists 11 reasons why the company is buying this private equity business.

The bottom line is that I agree this share is likely to be undervalued, given that it reports net assets per share of £128 million as September.

But there are some factors we might want to think about:

1. Raising money at a discount to NAV has the unfortunate side-effect of reducing NAV per share. The large discount both to prior NAV and to the prevailing market price suggests that there might have been a struggle to raise funds: why did investors not want to fund it at the existing NAV, or at least at the price in the market?

We could speculate that the second broker was brought on board only when it was realised that the first broker was not able to get the job done by itself.

The lack of investor interest could be a sign that there is great value to be had here, if you are willing to be a bit contrarian.

2. Mercia's own portfolio (not the portfolios it manages for others) is still quite heavily concentrated. The top 5 investments account for 49% of total value. The largest investment is in nDreams, a company that makes virtual reality video games. Others are OXGENE (gene therapy) and Warwick Acoustics (audio products).

These direct investments are now worth over £100 million, according to Mercia's balance sheet. Valuing them is not exactly hard science but I think that updated values are based on third-party valuations in the latest funding rounds (or the miserable share price, in the case of Concepta (LON:CPT) - Mercia owns 22% of that).

Overall, this strikes me as a nice value play. And investment vehicles are some of my largest individual positions, so it's the sort of thing that I like to invest in.

But to get involved, I need a lot of evidence that the investment process works. Until I can see some hard evidence that the investment process at Mercia has a strong tendency to work, I'll remain merely an interested observer. Let's see how their portfolio performs over the next year or two.

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Boohoo (LON:BOO)

• Share price: 307p (+2.5%)
• No. of shares: 1.2 billion
• Market cap: £3,561 million

Trading update

Strong trading at this old favourite, including the successful integration of Karen Miller, Coast and MissPap.

Performance is "comfortably in line with expectations" - maybe we can get a performance beat?

It's a successful, growing, online business and the market loves it. People are paying nearly fifty times earnings despite the slowdown in growth at the core Boohoo brand. An impressive valuation.

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Block Commodities (OFEX:BLCC)

• Share price: .006p (-14%)
• No. of shares: 4.8 billion
• Market cap: £300k

Final Results

This is just a bit of fun. I thought I'd mention this, as it has every possible red flag.

• agricultural activities in Africa
• incorporated offshore in Guernsey
• formerly on AIM; relegated to NEX
• applying blockchain technology to agriculture
• wants to start making cannabis investments
• never made a profit
• material uncertainty that it can continue as a going concern

If you offered me £10k of lotto scratch cards or £10k of BLCC shares, I'd take the scratch cards!

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Sorry for the slow service today - there were some distractions. I'll be here bright and early in the morning. Cheers!

Graham