Small Cap Value Report (Tue 30 March 2021) - LOOP, MPAC, EKF, ANCR, SUS

Good morning, it's Paul & Jack here, with the SCVR for Tuesday.

Timing - today's report is now finished.

Agenda -

Paul's Section:

Loopup (LON:LOOP) (I hold) - results for FY 12/2020 are in line with expectations. A big profit, but it was all generated in H1.

Mpac (LON:MPAC) - FY 12/2020 results. I summarise key points from today's webinar. Nice company, but huge pension scheme worries me.

Jack's Section:

Ekf Diagnostics Holdings (LON:EKF) - new supply contract announcement and upgraded FY21 expectations.

Animalcare (LON:ANCR) - Covid disruption and business restructuring for this veterinary sales and marketing company.

S&u (LON:SUS) - sequential improvement in trading, 4% dividend payment, and brighter outlook for this motor finance and specialist lender.

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Paul’s Section

Loopup (LON:LOOP)

(I hold)

83.5p (up 14% at 08:10) - mkt cap £49m

There’s a strongly positive early market reaction to this cloud telephony company’s FY 12/2020 results. On quite high volume too, with 721k shares already having changed hands in the first 10 minutes of trading.

Although this does have to be seen in the context of a big disappointment late last year, when management dropped a bombshell that highly profitable trading in H1 2020 had hit a brick wall in H2. To this day, I still don’t understand what went wrong, they haven’t explained it clearly enough.

As you can see from the long-term share price chart, performance has been erratic, and overall disappointing -

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I think it’s fair to say they over-paid for a not very good acquisition along the way too, called Meeting Zone. Let's hope management don't do any more acquisitions!

Preliminary Results

For FY 12/2020.

The headline numbers are in line with the trading update on 8 Feb 2021 -

• Revenues £50.2m (H1: £31.9m, H2: £18.3m)
• Adj operating profit £9.0m (H1: £9.2m, H2: £(0.2)m)
• Net debt £0.7m

Note the huge drop off in performance from a profit bonanza in H1, to just below breakeven in H2. Why? Customers must have switched to a competing product, Microsoft Teams maybe? Or Google Meetings, Zoom, etc? LOOP seems to have retained its “professional services” clients a lot better than more casual users. So perhaps LOOP should be seen as a high-end, niche service, that seems to be used by solicitors, accountants, etc.?

Cloud telephony - this new product was launched in July 2020, and the commentary on it today sounds intriguing. If I’m reading this right, it sounds like a big opportunity. It says the “pipeline of live opportunities” has risen to £106m, assuming an average contract length of 2 years. I wonder how much of this pipeline will actually turn into revenues & profit? Watch this space.

Outlook - 2021 expectations are in line (but they don’t say what market expectations are) -

That said, we are nevertheless confident in our ability to meet market profitability expectations for the year, albeit at a potentially lower level of top line revenue

I can’t find any detailed broker research, but we do have broker consensus figures on Stockopedia for FY 12/2021, £34.2m revenues (a 32% drop in 2020), and a small loss. That sounds consistent with what LOOP says above.

Balance sheet - not great. Writing off the intangible assets (mainly worthless goodwill), arrives at NTAV of £(5.16)m.

Liquidity - it has cash of £12.1m, but borrowings of £12.8m, giving net debt of £0.7m - which looks OK, providing the cash figure isn’t an unusual peak. I’d like to see the average daily net cash/debt figures.

Overall, it looks OK, providing the bank facilities are secure.

My opinion - what to make of this? It’s very difficult to know. The company seems to be trading at a run rate of around breakeven, in H2 2020, and implied by the consensus forecast for 2021. Therefore, I think we should see the big profits for FY 12/2020 overall as a one-off spike in profit from lockdown 1, which has now subsided.

The narrative seems to place a lot more emphasis on new cloud telephony products, with the virtual meetings product almost just a sideline now?

Overall, I have no idea how to value this share! The bull case is that the new cloud telephony stuff takes off strongly - certainly the pipeline numbers seem impressive. The bear case is that the company is a serial disappointer, and the cloud stuff turns out to be hot air. There’s enough upside potential to keep me vaguely interested, so will probably sit tight on my (small) personal shareholding here. I’m not tempted to buy any more though.

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Mpac (LON:MPAC)

(I hold)

530p (down 3%, at 10:21) - mkt cap £105m

Here are my notes from 7 Jan 2021, when this packaging machinery maker gave an ahead of expectations trading update for FY 12/2020.

Full Year Results for FY 12/2020, published today, didn’t immediately bowl me over -

• Revenues £83.7m (down 5.7% on 2019)
• Underlying profit before tax £6.3m (down 16% on 2019)
• Underlying EPS of 31.4p (down 20.5% on 2019)

However, those numbers need to be seen in the context of a much worse H1 (hit by covid), then a good recovery in H2.

Equity Development has issued a new note today, and I’ve just come off an excellent results webinar they organised too. I jotted down the key points as follows -

CEO used the words “reassuring, resilience, agile”, to describe 2020 performance

ERP software system implemented, “went remarkably smoothly”

Robust order intake of £83.9m

MPAC is focused on healthcare, food & beverage markets - making packaging & processing machinery for them - resilient sectors during 2020 & structural growth markets longer term

Acquisition of Switchback in USA - delighted with performance - order intake since acquisition has been double expectations, good strategic fit, complementary products, synergies working well.

Covid has created opportunities - e.g. customers used to visit to test & sign off new machines. Now it’s all done by video, cheaper & quicker. Can’t see things returning to old ways.

Social media - increased use of this, especially LinkedIn, have good stats relative to a much larger competitor, good engagement with the sector.

Capital-light business model, 22% ROCE

Pension funds (UK one is huge) - £14m accounting surplus. Preparing for June 2021 triennial valuation.De-risking. Hedged against inflation. Partially hedged against bond yields. Well managed, de-risked as much as it can be. Ultimately working towards de-coupling.

Outlook - 2021 so far is trading in line with expectations.

Robust markets, really confident we can deliver.

More acquisitions to supplement organic growth. Have an existing pipeline of relationships which might lead to deals. Also engaged consultants to find other potential targets.

Q re organic vs acquired growth - closing order book of £55m, of which £3m relates to Switchback acquisition. £8m of the total order intake was from Switchback. The rest is organic.

Travel - delighted not to be taking 1-2 long haul flights every month, forgotten what jetlag is like thankfully! Can’t see the long haul flights returning. Need to meet & socialise with clients initially, to establish relationship, but can then maintain the relationship remotely.

Q re tax losses - these boost EPS by c.3-4p, working way through them.

Surplus land in Bucks - anything happening? No, not a priority at the moment, focused on core activities.

Competition - talked about lots of Private Equity activity, one US competitor (Promac?) highly acquisitive, has bought 40 smaller companies! Lots of consolidation.

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I find watching/listening to a webinar is vastly superior to wading through a long & complicated RNS, and it has the further benefit of being feasible whilst swinging in my hammock and soaking up some rays! Also it gives a flavour for what management are like. MPAC management strike me as open & honest, hands-on entrepreneurs. That’s exactly what I look for in small caps, nothing else matters really. They’re not flashy, quite calm and softly spoken, so my attention did drift slightly at times! Still, it wouldn’t do if we were all the same, as my Gran used to say!

Director shareholdings seem small, unfortunately, and in the past they seem to have been too keen on cashing share options. I thought the whole point of share options, was to enable Directors to build a meaningful shareholding, to align their interests with shareholders, rather than treating them like bonuses? Although to be fair the most recent option sales have been for half, probably just to meet tax liabilities.

Balance sheet - looks OK, not particularly strong, nor weak, the way I see things.

The cash pile of £15.5m looks good, but I recall the CFO said in the webinar that this is flattered by working capital movements that typically unwind partially in Q1. As always, the key numbers we need, but are rarely given, are average daily net cash/debt throughout the year. That's far more meaningful than a snapshot on the year end date alone.

My opinion - I like this company a lot. It operates in interesting, growing markets, and makes a reasonable profit margin. The turnaround has worked, and it got through the covid year in fairly good shape.

For me, the pension schemes are a worry. They’re huge schemes, and that introduces risk, although it has been mitigated as much as possible. The cash payments are currently material, so this is an important issue that can’t just be ignored.

Like practically everything else, MPAC shares have had a great run. Amazingly, the entire small caps index £SMXX is up about 50% in the last 5 months. I do worry that this has perhaps run ahead of itself, and maybe we need to see some consolidation, and retracing, in some shares?

For those reasons, I’m happy to sit on my small, long-term holding in MPAC, but am not tempted to add any more after such a strong run.

Stockopedia loves it!

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Jack's section

EKF Diagnostics (LON:EKF)

Share price: 77.7p (+10.22%)

Shares in issue: 454,993,227

Market cap: £350.3m

Ekf Diagnostics Holdings (LON:EKF) specialises in the development, production and worldwide distribution of point-of-care analyzers and clinical chemistry reagents for use in hospital and research labs, doctor's offices, blood banks and for in-field anaemia screening programmes.

It’s also a bulk manufacturer of enzymes and has custom manufacturing facilities in the USA for a variety of life science products.

In 2020, the group developed a range of COVID-19 testing products including:

• PrimeStore MTM, an FDA-approved and CE marked sample containment device that allows the safe handling, transportation and analysis of test swabs and samples, and
• COVID-SeroKlir, a leading ELISA-based antibody test from Kantaro Biosciences that provides a precise measurement of COVID-19 IgG antibodies.

So it was one of those Healthcare companies benefitting from Covid trade, but what sets this one apart is that there was already a profitable and growing underlying business long before Covid.

On that point, the major strategy aims of EKF’s core business are:

1. to continue to build its installed base of point-of-care analysers which generate an ongoing stream of revenue through the sale of proprietary consumables;
2. to supply a range of clinical chemistry reagents for use on its own and third party analysers;
3. to grow contract and partnership enzyme manufacturing business; and
4. to continue to exploit its Preferred Partnership Agreement ("PPA") with Mount Sinai Innovation Partners ("MSIP"), which allows it ‘advanced access to innovative commercial opportunities arising from certain technologies managed by MSIP.’

It sounds exciting but valuation is a concern, so the company will need to keep growing in order to justify current multiples:

Final results

Highlights:

• Revenue +45% to £65.3m,
• Gross profit +58% to £37.4m (so evidence of margin expansion),
• Adjusted EBITDA +113% to £25.5m,
• Profit before tax +180% to £15.4m,
• Basic EPS +202% to 2.45p,
• Cash from operations +171% to £13.8m,
• Net cash +88% to £21.4m,
• Maiden cash dividend of 1p per share.

These are obviously extremely impressive growth rates on the face of it, but they also price EKF at 28.8x FY20 earnings per share with a dividend yield of 1.4%. It’s a high earnings multiple but can be (and does appear to be) justified by current trading and growth prospects.

The 2.45p of basic earnings is lower than analyst consensus of 2.89p, which itself had recently been brought down from 3.6p:

I’ll take that as a sign of brokers struggling to price the temporary Covid opportunity rather than anything to be worried about. A more enduring concern is whether or not EKF can justify a premium valuation once Covid has passed.

There are signs that EKF can generate attractive returns on capital (although this has so far been volatile), so the shares are still worth investigating in my view.

The core business saw revenues fall £6.5m YoY (-14%), but EKF notes signs of a steady recovery. DiaSpect Tm grew sales by £548k (+15%), due to strong performance from OEM partners McKesson and Fresenius Kabi and Quo-Lab was up £210k (+9%) due to improved sales in EMEA and improved shelf-life of reagent cartridges.

Meanwhile, HemoControl and HemoPointH2 sales fell by £2.6m (-36%) as anaemia screening programmes were paused or cancelled and b-HB was down £847k (-9%) due in part to the fulfilment of large orders from Cardinal in Q4 2019.

EKF says that the underlying recovery has continued post period end, with tender wins in Asia and the Middle East, Africa, and the US.

Importantly, EKF has a second trading update out today announcing the signing of ‘a new multi-million dollar global supply contract’ for COVID-19 sample collection kits with its partner from the private sector. Orders will be fulfilled from EKF's production sites in the UK, Germany and the United States.

The global contract is expected to make a considerable contribution throughout the current financial year and the board is confident that trading for the year ending 31 December 2021 will be significantly ahead of already upgraded management expectations.

Conclusion

As an investor looking to earn returns from both earnings growth and multiple expansion, I do wonder if the valuation is too much right now. But then again, EKF looks like a good healthcare company with attractive growth prospects and strong trading momentum. It’s an attractive quality growth stock, assuming the longer term prospects beyond Covid are good. That’s probably the key assumption in determining whether or not today’s share price represents good value.

Quality healthcare stocks can trade at high relative valuations and continue to outperform. Ergomed is a good case in point there. This sector is responsible for more than its fair share of long term compounders.

And EKF has just had by far its most successful year to date, with record turnover and profits. This momentum continues into FY21.

The group enters the new year in an extremely strong position and is making an ongoing contribution to the fight against the COVID-19 pandemic, with strong demand for its sample collection devices driving yet more upgrades.

Meanwhile, trading in its core business is improving, and management indicates that performance for the first quarter of 2021 will be materially ahead of expectations, as will FY21 in general. It’s stellar stuff, and potentially well worth a premium valuation.

Have I missed the boat here? That’s the question I’m asking (and the answer isn’t necessarily ‘yes’). Congratulations to holders so far - I can’t see why you’d sell unless perhaps you’re concerned about post-Covid trading. For now, these are impressive results.

Animalcare (LON:ANCR)

Share price: 238.8p (-0.5%)

Shares in issue: 60,057,161

Market cap: £143.4m

Animalcare (LON:ANCR) is an international veterinary sales and marketing organisation, with operations in seven countries and exports to approximately 40 in Europe and worldwide. It focuses on bringing products to market through its own development pipeline, partnerships and via acquisition.

The group’s share price has been trending upwards in recent weeks but there are mixed signals in terms of valuation - a price to free cash flow multiple of 15.5 is good for its pharmaceutical industry peer group, but the forecast PEG of 5.0 is decidedly less attractive and Animalcare is generating some curiously low returns on capital:

The drop in profitability metrics coincides with a £33.1m acquisition in FY17. So either this was a sub-optimal purchase or today’s low metrics are paving the way for future higher returns.

In FY19, the group’s auditor noted a material uncertainty related to going concern. The FY20 equivalent note states:

The Auditor has reported on the 2019 accounts; their report was (i) unqualified, (ii) included reference to a material uncertainty related to going concern to which the auditor drew attention by way of emphasis without qualifying their report and (iii) did not contain a statement under section 498 (2) or (3) of the Companies Act 2006. The external auditor has reported on the 2020 accounts; the report was (i) unqualified, (ii) did not include references to any matters to which the external auditor drew attention by way of emphasis without qualifying the reports.

This is curious and I’d want to know more about it before investing. I can’t find any more detail at present - it’s possible this was as a result of the developing Covid situation, but I haven’t been able to confirm that. Perhaps somebody in the community knows more. I would not invest before getting to the bottom of it.

Full year results

Highlights:

• Revenue -0.9% to £70.5m,
• Underlying EBITDA -8% to £12.1m,
• Statutory PBT up from a loss of £1.6m to profit of £0.2m,
• Net debt reduced by £4.2m to £13.6m,
• Proposed final dividend of 2p per share

The group says there has been ‘significant progress in rebalancing, refocusing and defragmenting of product portfolio’. That means the company is looking to improve margins by concentrating sales and marketing resources on a smaller number of bigger brands.

This could be a good move, assuming the core brands are stronger, and could drive an improvement in returns on capital.

Clearly, trading has been disrupted by Covid but it looks like there are some company-specific issues here to be aware of too. It has recently implemented a new organisation structure to deliver more growth.

The fact that the group has been able to use this year to reduce net debt is a positive, and its focus on cash generation and conversion is reassuring. Particularly given the company’s weak balance sheet, which has a negative net asset value. This is a concern.

Animalcare has also progressed its pipeline and its Daxocox product has received ‘positive opinion from Europe’s CVMP’. This is a novel and differentiated COX-2 inhibitor for the treatment of chronic pain in dogs. The group says the anticipated launch in the second half of FY21 will represent a major milestone.

Meanwhile, the September 2020 agreement with Kane Biotech opens up near- and long-term opportunities for biofilm-targeting technologies.

Conclusion

Over the longer term, the attractive fundamentals of the animal health sector makes this worth a closer look, but the balance sheet is not strong and it looks like the company has some restructuring work to do in order to realise higher profits. And the FY19 reference to ‘material uncertainty’ remains a question mark.

Assets are dominated by £50.5m of goodwill and £43m of intangibles - Animalcare has £123m of total assets but just £34.5m of tangible assets, meaning a negative NTAV figure of -£11.9m. Cash generation and conversion are strong though, so this business characteristic helps mitigate that risk.

But Animalcare is not yet generating attractive returns on capital. It could well be that the restructuring and integration work being progressed now is setting the foundation for that down the line.

The group is reducing the number of smaller ‘tail’ or lower value products so that it can concentrate on assets with growth prospects and higher margins. In 2017, the portfolio consisted of around 330 brands which has been reduced to approximately 200 brands.

There could be some easy wins from this work. Management says the increased focus on a smaller number of bigger products has resulted in a 3.2% growth rate for the top 40 brands in 2020. There is also the H2 launch of Daxacox as a nearer term catalyst to look out for. It will be interesting to see how that goes.

Before the 2017 acquisition, Animalcare’s operating margins were around the 20% mark, so there is probably good potential in its markets. Assuming it can get back to those levels of profitability with today’s higher revenue would make for around 16.5p of earnings by my reckoning, which would put shares on just short of 15x earnings. It’s worth noting that TTM free cash flow per share is 15.4p, so that looks like a reasonable benchmark to aim for.

If you can get comfortable with the turnaround, FY19 unqualified audit statement and growth prospects here then this could be worth a closer look but there are a couple of risks being flagged.

I can’t see any director buying activity, that's always something to look for in a stock with a turnaround element to it.

S&U (LON:SUS)

Share price: 2,240p (+0.9%)

Shares in issue: 12,133,760

Market cap: £271.8m

(I hold)

S&u (LON:SUS) is a motor finance and specialist lender with two operating divisions: Advantage Motor Finance (a non-prime motor finance division, and by far the bigger of the two businesses) and Aspen Bridging (a much smaller property loan business).

Advantage lends on a simple HP basis to lower- and middle-income groups who may have restricted access to mainstream products. It remains the core of S&U, although Aspen Bridging was launched in 2017 and the group is ready to increase investment here.

One of the appeals of S&U is its attractive blend of family business / long term shareholder stewardship and its consistently high profitability metrics.

I would argue it’s rare to find this combination on the market, let alone one on a forecast PE ratio of 15x, a forecast yield of 4.43%, and with strong Ranks across the board.

The Coombs family dominates the Major Shareholders list and the minimal dilution over the past ten years suggests that value over time should accrue to shareholders.

Preliminary results

Highlights:

• Revenue -7% to £83.8m,
• Amounts receivable from customers -7% to £280.9m,
• Profit before tax -48% to £18.1m (H1 PBT: £6.3m; H2 PBT £11.8m),
• Basic EPS -50% to 120.7p,
• Final dividend -14% to 43p,
• Net borrowings down from £117.8m to £98.8m

Both divisions saw a weaker first half and a material improvement in the second half.

Advantage Motor Finance contributed £17.2m or 95% profit before tax, down from £34m. Up until Covid, Advantage had a track record of 20 years of continuous profits growth. This is a credit to the stewardship of its management and suggests that the results generated over the past year will ultimately turn out to be an unwelcome blip.

Total annual collections stood at £180.5m (2020: £196.5m), with the decrease reflecting smaller book and FCA mandated payment holidays and repossession restrictions (now lifted).

Annual net advances were £102.6m (2020: £149.0m), reflecting lockdowns and tightened Covid related underwriting. Net receivables were £246.8m (2020: £280.8m) and include IFRS forward looking loan loss provisions of £36m for the year (2020: £17m).

Customer numbers were steady at 63,000 (2020: 64,000) and the monthly collection rate against contractual due was nearly 84% (2020: 94%).

These are fairly positive results considering closed car dealerships initially led to an 80% fall in loan transaction numbers and FCA mandated customer repayment ‘holidays’ affected nearly a third of Advantage's customers.

Aspen Bridging contributed £0.8m of PBT, down from £1.2m in FY19, but this performance comes despite a first half during which the property market was effectively frozen. Some pretty dire predictions were made about the UK housing market in early 2020 and so far the outcome has been much more manageable. In fact, the second half was quite strong.

Advances for the year reached £43.5m against £31.3m and progress on product range and broker relationships has resulted in the loan book growing to £34.1m against £21.0m last year.

All this has been achieved whilst tightening checks on borrowers. Loan quality has improved over the past year, with no loans past due and no defaults over the entire book. S&U expects to double investment in this division in the coming year.

Further evidence of long-termism at S&U comes in the form of its dividend track record.

Today the group announces a final dividend of 43p per share (2020: 50p), meaning total dividends of 90p per share (2020: 120p) and a useful yield of 4.03%. I’d expect this to be higher next year.

Chairman Anthony Coombs says:

The current vaccination programme and a more coherent Government policy roadmap for Covid justify greater optimism. Many of the immediate economic consequences have been postponed, and possibly avoided by monetary policy… All this means that S&U's habitual caution should now be seasoned with ambition and optimism for the next two years.

Conclusion

S&U hasn’t come close to meaningful danger over the past year and the outlook is now more optimistic. The suppression of consumer demand and confidence is likely to be temporary and shouldn’t alter the fundamentals underpinning vehicle and property loan demand.

In fact, it could lead to a rebound in the near term and the company is well positioned for this.

Recent government measures such as the extension of the furlough, stamp duty concessions and business support measures should, along with the vaccination roll out, mean management can once again begin mapping out the company’s future growth.

On that note the team says that over the next two years its prospects and strategy will require additional funding. Post year-end S&U has put in place additional longer-term facilities of £50m on terms up to eight years, making for total committed group facilities of £155m.

The attractive mix of quality, income, and earnings growth (barring the past year, of course) make S&U an attractive candidate for a longer term hold in my view.