Small Cap Value Report (Tue 9 July 2019) - RM, SIS, ADT, BEG, PAM, EHG, SYN | Graham Neary

9th Jul '19 by Graham Neary

47 comments 10782 reads

Good morning!

A very busy morning in terms of the supply of updates. I will need to be very tactical about this!

I'm not covering all of these, but am mentioning them for completeness:

RM (LON:RM.) - interim results
Science in Sport (LON:SIS) - trading update
AdEPT Technology (LON:ADT) - final results
Begbies Traynor (LON:BEG) - final results
Premier Asset Management (LON:PAM) - trading statement
Elegant Hotels (LON:EHG) - update on Hodges Bay Resort
Synnovia (LON:SYN) - final results
Robert Walters (LON:RWA) - trading statement
Finncap (LON:FCAP) - final results
Young & Co's Brewery (LON:YNGA) - AGM statement
Knights Group (LON:KGH) - final results
K3 Business Technology (LON:KBT) - interim results
Renold (LON:RNO) - postponement of AGM
Sports Direct (SPD) - offer update re: GAME Digital (LON:GMD)
ClearStar Inc (LON:CLSU) - trading update

Elsewhere, in big-cap land, Ocado (LON:OCDO) shares are up more than 6% on the back of interim results. Bloomberg reported that short interest ticked up recently, so there might be a few bears licking their wounds this morning.

Please note that your suggestions make a difference - I will allocate more time to stocks which you have suggested.

Thanks,

Graham

RM (LON:RM.)

Share price: 259.5p (+2.6%)
No. of shares: 84 million
Market cap: £218 million

Interim Results

This educational group says that it is #1 in the UK, in the markets in which it operates, and it has major international activities, too.

Its three divisions are:

Resources - curriculum and other resources for schools and nurseries. It distributes 50,000 products, of which it has designed 4,000.
Results - "global high-stakes e-assessments". Processing exam scripts.
Education - software, services and technology. Outsourced IT and digital platforms.

Paul and I have covered this from time…

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andrea34

9th Jul '19

Knights Group (LON:KGH) please. The results look SMASHING! Revenue £52.7m+51% (15% organic growth), underlying EBITDA £11.3m+51%, underlying EBITDA margin maintained at 21.5%, underlying PBT £9.8m+104% & EPS 11.88p+55%. I particularly like (1) strong cash conversion of 115%, net debt of £14.1m which is £3.7m lower than expected, and increased average fees per fee earner by 22% to £131,000

jonesj

Please could you consider Begbies Traynor (LON:BEG) as a candidate for analysis Graham ?

This is a counter cyclical business with a good dividend and seems to be generating some organic growth now, in addition to a number of small acquistions. Founder managed.
I hold.

RichardK

Amino Technologies (LON:AMO) reports interims with t/o down 16% but gross margin, profits measures and cash both up following some restructuring, and expects FY to be in line.
I sold most at a loss, partly for tax reasons, at the end of the last financial year and am considering buying more. I would welcome views.

Richard

Graham Neary

Morning frederick, thanks for the suggestions. Yes, I will try to cover both of these.

I appreciate all the suggestions - I'm happy to allocate more time to those stocks which are in high demand. Always a tricky balancing act but I'm doing my best.

Cheers

Graham

Hi jonesj, yes I will be looking at Begbies Traynor (LON:BEG) today.

Thanks

Graham

Aislabie

I suffered a brief heart attack re my Scientific Digital Imaging (LON:SDI) holding where you noted that there was an update on their takeover of GAME Digital (LON:GMD) . Much relief to find that it is Secured Property Developments (OFEX:SPD). !

xcity

I like the list, even without comments on all of them.

Zipmanpeter

Request for Renold (LON:RNO) - If I had not been burnt by other recent events (eg the collapse in Non-Standard Finance (LON:NSF) shareprice), I would be tempted to add here here as I already hold.

Renold (LON:RNO) are now quite deep into a multi-year global restructuring plan that IMHO had had seemed to be going well. The RNS is very clear that the Board think 'the overstatement of profit has arisen from the intentional mis-statement of the financial reports at a local level ' and is a limited issue driven by 1 locality and limited in scope - its size is very specifically quantified; so if it proves to be wider, their credibility will be shot. They could have been much more bland.

Consequently a 20% reduction in share price for a claimed 5% drop in profits seems harsh.

JohnEustace

Re Elegant Hotels (LON:EHG),

In the Year End results on Jan 15th "Hodges Bay Resort & Spa, which we operate under management contract, opened in December 2018. This hotel is one of the best properties on the island of Antigua. As the Group's first full management contract, and its first operation outside Barbados, we intend to use this as a template for further expansion in the region."

Today, however, "Hodges Bay, which was originally due to open in July 2017, remains incomplete due to ongoing issues with the construction of the property, which are outside of Elegant Hotels' control. However, Hodges Bay was being operated by Elegant Hotels on a partially open basis.
The Company confirms that, although the operating term of the management contract has not commenced, it has now received a termination notice in relation to the management contract. The Company disputes the validity of this termination notice and intends to take all action necessary to preserve shareholder value."

If I were a holder I wouldn't be best pleased with that. Perhaps Luke Johnson will explain it all in his next Sunday Times piece.

Re Renold (LON:RNO) although that is what the board may think, perhaps the restatement is a wider issue than they are aware of. Just look at Patisserie Holdings (LON:CAKE)

mojomogoz

RM (LON:RM.) results look decent with some factors creating distortion for onlookers which perhaps drives a below deserved valuation:

1) On going turnaround story whereby revenues have often fallen as they deliberately exit business areas but margins and profits have grown. They are pretty much at the end of this now so top line is pointing up rather than down (note, acquisition of Consortium Group couple of years ago boosted top line)

2) Tough UK school environment weighs on revenues but they again grow overseas which has been a persistently impressive feature. Maybe one day UK schools wont be as tough and will offer some upside too.

3) Debt position has increased from year end. This looks like timing difference and significantly the result of new business acquired and the timing of reported versus cash income. Second half always produces more cash

4) Adoption of IFRS15 explains some of 3 boosting revenue and profit for first half

5) Although quite small business it is quite mature and at first sight complex with 3 different divisions

6) Big acquisition of Consortium a couple of years ago pushed up debt from bet cash. This was thrown in with RM Resources. Mainly UK focused resources and equipment for schools (no1 in UK now). This has created integration costs and cuts so a bit of headwind there. Its over half of revenue so perhaps creates angst. That said, margins have significantly strengthened over few years and now stand at near 14% on this business.

I've invested for the last few years. Its done well without shooting the lights out. I feel it has been relatively unrewarded for its achievements - eps growth and strengthening margins with strong growth in areas, particularly international, offsetting tough UK. Management have had a lot to do and have done it well combining both cost cutting and investment in different areas to make a better whole.

Its hard to say that it will do spectacularly in next 2-3 years and I flirt with view that I could go for something more exciting. However, valuation is undemanding, top line growth looks like its appearing with turnaround past and mgt have clear view on how to go after opportunity. So another double over next 3 years looks possible from combo of top line, margin strengthening and valuation moving higher.

And with a cleaned up and much leaner business in the UK they will be in a good position to surprise more meaningfully if spending in UK education market picks up. Obviously it will at some point (unless we are now de-emerging country) but RM mgt aren't sitting around waiting for the day.

Overall, its a stock that isn't going to excite many people...and therein is perhaps the surprise.

The danger? The mgt team have shown high competence and ability to do a lot of things at once and understand where to grow and where to prune. Losing them or them their mojo would be negative.

SundayTrader

I hold Amino Technologies (LON:AMO), but am struggling to understand how well they are doing as a result of the restructuring. Underlying cash flow looks good, with amortisation twice the spend on capitalised development costs, so I am continuing to hold.

Ned Kelly

Interesting Q1 update for Riverfort Global Opportunities (LON:RGO) only 11 days after 2018 finals. They seem to be overcoming the legacy issues associated with the company and are profitable in Q1 '19.
I hold

Trident

I notice on K3 Business Technology (LON:KBT) that they have raised their comparative figure for capitalising software development from circa £1m to £1.7m.

Whilst some of the trends for K3 Business Technology (LON:KBT) have improved I used to be worried in the previous management order that capitalising software development was running aware from the costs of the exercise they set them themselves in terms of moving to more own IP in their software offerings.

Of course there are some tax advantages in capitalisation, but I think a more coherent way would be off-set these off against each other to understand the net movement. But such transparency leaves less scope for fudging. I am not saying this is the aim of the new management, but it does become an easy recourse if business strategies become harder to justify down the line.

I think this may have been touched on the more recent PI World presentation video.

Star8

Re RM
Another cogent and perceptive article by Graham.
One comment on a item that was not mentioned is the large increase in the Pension deficit. This is due to the drop in bond yields ( i.e bond prices rising) which automatically increase Pension Liabilities. This will reverse if / when drop bond prices drop. However the company could come under pressure to increase its pension contributions if the large deficit remains and in any event it is likely to act as a drag on any large dividend increase.

I too interested in Mercia Technologies (LON:MERC)

I've got a half full position in the stock. The reasons not full position:

1) Looks like they will want to raise more equity for investment purposes sometime this financial year. They have not shown enough evidence yet that they make good with the capital so they are valued at meaningful discount to NAV (and then throw in embedded asset management business and cheapness widens) so equity raise is dilutive.

2) Recent syndicated round into portfolio company Oxford Genetics of £6.5m of which Mercia only committed £0.4m. This is out of keeping with their normal approach whereby they are the lead investor in each round (they still own 33.3% but down from c.40%). This could be indication that they are being canny with their cash...or it may be an indication that this company is approaching a stage whereby exit might be considered.

3) Its a tricky position to negotiate optimally now balancing short term and long term value creation. Putting own capital in to grow and nurture businesses is the best long term. However, lack of outside capital participation will keep valuations low. So could raise cash and dilute short term or seek external finance more which if done before a business really takes off will be dilutive. Or could sell one of the performing companies for a nice uplift in valuation and cash injection. This will get investor attention and no doubt boost valuation relative to NAV but is not optimal long term value creation either!

4) Woodford owns 25%. Note, Susan Searle who departed as Chairwomen early this month is also on the board of Woodford's Patient Capital.

5) The woes of Allied Minds (LON:ALM) and IP (LON:IPO) have likely deflated sentiment to the area greatly. Mercia is much more conservatively and better managed IMO but it takes time to earn kudos.

6) They wrote off £4m investment in Smart Antenna during the year so denting what would have been a more impressive £8m portfolio valuation uplift spread decently broadly indicating general good performance. Part of the reason for the write off is that Mercia was unwilling to inject more capital given an abrupt manufacturing change driven by the needs of big client. Would they have supported with deeper pockets?

So I'll probably keep my half position rather than go full until the path above is more clear. I'd guess that they would choose to raise equity...but the Woodford thing seems to put a bit of a block on that. Tricky situation for them to navigate short term and there's got to be a danger that someone with deeper pockets and/or higher rated paper decides that they could make a cheeky bid for Mercia...I'd likely make money from my 30p purchase price but it would be very annoying and I'm not going in full on the speculation of 25% bid premium when I see the longer term upside as much better....

...overall, makes me feel that they need to clarify where extra cash is coming from pronto and on balance they are probably best to realise it through sale of portfolio company.

Who to compare against. I reckon people will tend to think IP (LON:IPO) but I think Draper Esprit (LON:GROW) is more interesting. Neither work terribly well. IP Group is an unmanaged crapshoot cluster-f IMO whereas Draper Esprit invest in much later and different area.

From a theoretical perspective I see long Mercia and short Draper as a great pair (I wouldn't put it on though as too much underlying valuation uncertainty). Draper have enjoyed great valuation uplift in companies that they own typically a significantly lower stake than Mercia do. Draper are in the faddy sort of VC-PE plays that gets the crowd excited. The game of incremental raises pushing valuations ever higher. If you've got a genuine big winner then this can run and run...but most winners aren't that big and not every company can succeed. When there's a crowd of money chasing after hot-ish names it can lead to mediocre companies being overly funded. I don't know this is Draper but I look at their communication and what they hold and I feel there is a danger (...or they may be one of the few good bigger VCs).

By comparison, Mercia take big stakes in smaller and earlier stage companies. This leads to more conservative valuation uplifts over time. The losses and write-offs tend to come earlier.

IMO Draper (and IP) are much more at risk from broad market and financial condition effects (note the all important eurodollar market is currently stressed and all sorts of bad things are appearing as a result). IP have already experienced regular disappointment on lots of early stage cos they've floated on AIM. Draper doesn't have any listed companies (I don't think anyway) so all private. But the exit route is probably flotation as the companies are too big and too niches to be easily acquired. This contains much valuation risk. On balance I think that Mercia's valuations are likely to be higher quality than Draper.

Another very important factor for Mercia is that they generate >£10m revenue per year mainly from underlying fund management business. They are not quite at cost breakeven but close. Whereas Draper and IP consume capital. Draper generates fee income of c.£6m despite having NAV approx 8x higher. Mercia's income underpinned by £400m 3rd party funds (VC, debt, EIS).

Overall, I see Mercia as a stock that will have meaningful upside surprise as portfolio cos mature given the very conservative valuation uplift so far but where Draper is at risk of downside surprise.

The Stockopedia system choice of Secured Property Developments (SPD) over the intended Sports Direct International (SPD) is interesting. Is there a way to distinguish between them when doing the short form of £ before the ticker?

If Mercia Technologies (LON:MERC) takes big stakes in smaller and earlier stage companies, then I don't understand why this is a higher risk play than Draper Esprit (LON:GROW) and perhaps this is why Mercia Technologies (LON:MERC) trades at a greater discount to NAV...?

RM (LON:RM.)

Hi Star, thanks for mentioning the pension issue, that is something I might have included. G

Ha, thank you for pointing that out! G

Small Cap Value Report (Tue 9 July 2019) - RM, SIS, ADT, BEG, PAM, EHG, SYN

RM (LON:RM.)

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Graham Neary

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