Small Cap Value Report (Wed 15 Feb 2023) - GATC, PIER

15th Feb '23 by Graham Neary

37 comments 5705 reads

Good morning, Graham here. The RNS feed is light on news so I'll leave it there for today. See you tomorrow!

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.

Graham's Section

Gattaca (LON:GATC)

Share price: 90.5p (pre-market)
Market cap: £29m

Paul normally covers this one but I’ll take a quick look at it this morning.

Gattaca is a STEM recruitment business with an uninspiring financial track record:

CtMhZuhlvCBklKvzovT_fUw5k_bDuEhoogszHLsuqTP2bj52AjwEMZDrX6yNITtTS-EyuhzRSiSdjukMAPhCB7rJQ6f24wDi9D4qSpGg1h9z5VVIw08bgsL9i6bv-AKvVzjQw55eJqHfYkdawEQ_8H4

The main attraction with these shares seems to be the strong balance sheet, rather than its financial performance.

Here are the key points from today’s trading update, which relates to the six months ended January 2023.

Although it doesn’t explicitly say so, this is a profit warning, and analysts have downgraded forecasts

H1 net fee income +5% year-on-year to £22.7m
“Core sectors” seeing double digit growth, weakness elsewhere.
Permanent hiring shows “signs of weakness since the turn of the year”.

Net cash rises to £21m as of January 2023, vs. £12m in July 2022, thanks to the collection of receivables (N.B. this is not a measurement of profitability).

CEO comment highlights the weakness in permanent hiring:

As we enter the second half, we are conscious of softening in some external sectors, and perm is likely to be impacted by a level of restraint around hiring, shifting candidate sentiment and, as such, slightly…

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Roger Baron

15th Feb '23

Corero Network Security (LON:CNS) (Ihold) today announces that Lionel Chmilewsky, the Company's Chief Executive Officer, has resigned to pursue other opportunities! Any thoughts?

Monty Carlo

The question with Babcock International (LON:BAB) is whether you can get comfortable with the debt level and the pension deficit, plus the liabilities they may incur when they mis-price a long-term contract with pretty tight margins.

There are ongoing disposals to further reduce the debt & you would hope the pricing environment for assets they need to dispose of would be firmer than in recent years?

S&P upgraded them from BBB- to BBB, stable back in December. They survived the LDI debacle, but the pensons scheme(s) reduced their inflation hedges to avoid selling risk assets.

If you can get a handle on their liabilities (some are lease related), then it is cheap relative to BAE Systems (LON:BA.) and Qinetiq (LON:QQ.)

However, it really would help if some of their brain-dead employees didn't glue back on the heads of plastic screws they over-tightened on a nuclear sub recently. Talk about shooting yourself in the foot.

Rusty2

Hargreaves Lansdown (LON:HL.) , not sure what is happening, the shares were up 8% this morning but are now down 9% on the day. I can't really see anything in the RNS.

Lochinver

Hi John. Can i ask if you own any shares in Peabody (BTU) ?

mikebianchi

I hold and well down agree jam tomorrow update totally agree but look out a couple of years and things may be quite different, shortages are well forecast and according to some we are sleep walking into an era of significant metals price rises or at least I hope so.

colin1862

I was short on Peabody Energy (NYQ:BTU) and got stopped out yesterday and was wondering why so thanks for explanation!

The RNS looks positive to me. I don't understand why price fell.

The Boon Fund

What company? This comment doesn't seem nested to the original comment - bug?

Gattaca (LON:GATC), it was an IC tip and Robbie Burns mentioned it, lets hope he got out before today.

I've only done a quick skim on Hargreaves Lansdown (LON:HL.), but it looks like the long term metrics of the company (AUM, customer numbers, etc) were all mediocre? I'd love to hear Abtan's view on this, as I know he has been tracking HL for a while!

On a 16x PE and 15-20x FCF it doesn't strike me as particularly good value unless the growth continues.

cdm1

Leon positive as usual, despite the setbacks. https://www.directorstalkinterviews.com/jubilee-metals-group-plc-results-on-target,-despite-south-african-power-situation-video/4121105773 Jubilee Metals (LON:JLP)

"Hargreaves reports a 31% jump in HY profit before tax as
an increase in the number of its active clients overshadowed a
drop in the assets managed by the company
** Co reports HY 2022 profit before tax of 197.6 million
pounds($238.92 million) compared to 151.2 million pounds a year
ago.

** Says revenue for the period also rose 20% to 350 million
pounds ($422.70 million)"

Well clients were up, assets though were down, not surprising, as many PIs moved money out of shares.
They are also set to gain from higher interest rates, which they get on clients cash balances.

I can see why the shares were up 8% initially, then they fell around 16% which seemed quite surprising, now have recovered somewhat to -5%.

BnB

Well I did warn him - although ultimately this dog will probably reward traders in an indiscriminate bull market.

threeputt

Robbie isn't in it and hasn't been for some time, I actually did a better job of trading it than he did at the time lol

Well, he was in it when I warned him last Friday!

Phil117

This is an interesting one. There are solid bull and bear points to made. In the former camp you obviously have their market leading position, the relative stickiness of their customer base, their balance sheet strength and solid FCF generation. But in the latter you have:

1. The fact that their Net Customer growth is now pedestrian. They seem to be solidly in the 'cash cow' rather than 'growth' stage of the BCG matrix

2. The fact that their cost Inflation depending on your point of you and to steal a line from founder Peter Hargreaves is completely out of control. We "now expect FY23 Underlying Cost Growth at top end of the guidance range (c.11.5%)". Note further that even though their revenue will be up almost 40% from '19 to '23 their Operating Profit is essentially flat over the same period owing to ballooning costs. No wonder the margin has dropped double digits

3. A completely different competitive environment from when HL originally disrupted the market. You have the likes of AJ Bell, Interactive Investor, etc, offering much cheaper dealing and custody, for what is essentially a relatively similar product

4. The fact that their bacon has been almost completely saved in H1 by the rise in interest rates and the consequent massive boost to revenue from the higher interest on cash deposits. But on p.9 of the Investor Pres they imply that the most recent increases in base rate have been entirely passed through to depositors. So presumably this one-off step change is now done. And indeed on p.12 they seem to imply a lower revenue margin from Cash deposits than originally forecast

All in all I must admit that I find myself in the sceptic camp. I buy the relative stickiness of their AUM and customer base. But I struggle to see what the massive increase in cost over recent years has achieved. Charitably you could argue that it has been necessary to defend their market position. But if that is the case then it's not as good a business as it was before owing to the competitive environment. Less charitably and to build on Peter Hargreaves' recent press comments the spending has been wasted. I certainly think that their ambition to become a hybrid wealth management provider will be a very difficult trick to pull off. It's notoriously difficult to provide bespoke or even semi-bespoke advice at a reasonable price and in an automated way. And then if you look at their near term revenue lines I struggle to see where any growth is expected to come from. Share dealing volumes look like they peaked during the pandemic and are unlikely to return any time soon. Custody / fund fees are largely flat. Interest on cash is the one-saving grace but this is self-limited from here as touched on above, presumably owing to competitive pressure and the risk of regulatory interference. The risks to the downside are obvious then: continued competition forcing a further step down in custody and trading fees. More investment in marketing required just to stand still. And further squeezed margins as costs continue to grow double digit. I see the only potential catalyst as A. a bid from a (foreign) rival looking at establishing a leading, turn key UK retail brokerage. Possible of course but obviously a totally exogenous event and impossible to predict B. the new CEO taking Peter Hargreaves' advice and taking an axe to costs in the pursuit of a leaner strategy. And yet I believe he is committed (at least for now) to following the original strategy. All in all then is it any wonder that Mr Market is not happy. Perhaps it's a prime opportunity for an Activist Investor to shake thinks up?

abtan

Hargreaves Lansdown (LON:HL.)

Hi Boon

I have indeed had quite a thorough look at today's results, though I missed the earnings call and am waiting for the recording before coming to a final conclusion.

Overall though, I was quite impressed:

Assets Under Management have been creeping up since the year end (in June 2022);
(Note that Assets Under Management have gone up every year since 2004...until FY22 - a remarkable record.)
New clients onboarded in the period are quite young (37 years old);
New clients each brought in just under £20k of new funds in the period;
Client retention rates are still +90%;
(The new tax year is almost upon us, so that's another possible £20k per person to come - it's a never-ending stream of income for the company, even if client numbers did stagnate).
Interest income has increased even faster than I was expecting;
The company has now disclosed their expectation of maintaining a 1.65% return on client Cash Under Administration (CAU.)
If CAU falls, then the hope is that transactional revenue will increase to offset some of the lost interest income;
The Active Savings product has been great at keeping customer funds within the HL ecosystem, ready to be deployed when sentiment improves.

There's lots to like.

Having said all that I sadly do not hold at the moment because:

I saw the company put up client ISA and SIPP interest rates at the beginning of January, thereby removing a major source of income for them (though the 1.65% NIM mentioned above provides some clarity here); and
I think the strategic investment costs relating to improving the platform will increase faster than revenues for the next couple of years.

On point 2. above, I actually think that the company is doing the right thing and as a customer I look forward to being able to participate in IPOs, fund raises, etc... over the next few years...but I fear that the share price might stagnate for a while as a result.

It's such a remarkable business that I'd probably be quite content to buy and forget; I can't see how it won't do well in the long run.

Hello Phil, thanks for your very detailed response.

I don't hold any Hargreaves Lansdown (LON:HL.) shares but I do use their platform. I agree there is a lot of competition now and I use IG group (LON:IGG) most of the time, HL are too expensive especially on US shares. I will be moving most of my account to other platforms this year. HL I will only use for funds and other investments that are not available on my other platforms.
Re the cash deposits, this is cash in accounts such as ISAs, SIPPs and Share accounts, they have now increased the rates by about 1%, top rate I think is 1.70%, but you only get that on the top tier, not on all your cash. I would have thought they earn higher rates than that, so don't really understand about it has all been passed onto the depositors already, the higher rate was only paid on 9th February, 2023. I can get instant access rates of around 3%. I think what they mean the recent rises have now been passed on, as they have increased the rates, and it looks like rates won't be rising much more.

The increase in rates is welcome but won't stop me moving, the cash is for buying shares but did build up last year, but I will be looking to invest more this year, probably mostly in the US markets.

Hargreaves Lansdown (LON:HL.) service is a lot better than some of the cheaper competition though.

timarr

RE: Hargreaves Lansdown (LON:HL.)

Yeah. What he said.

Clearly there are challenges ahead, and the excess investment in the platform now required is a direct failure of past and current management. Still, it's being addressed.

Going forward it will be harder to grow, no doubt, but it's going to be hard to shift all of those lovely fee paying customers who are very happy with the service they're getting. Meanwhile we can see that the shift between low interest rate and high interest rate environments can be smoothed out due to interest payments, something I'd always doubted.

Others here have put forward decent bear points so I won't reiterate them, there's no magic bullet to making money, but it's hard to see how they can't continue to be successful and profitable going forward. What it isn't going to do is shoot the lights out, the days of rapid growth are behind it.

chris2021

Sylvania Platinum (LON:SLP) (I hold). Share price tends to track very closely the platinum Spot price.

Small Cap Value Report (Wed 15 Feb 2023) - GATC, PIER

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Gattaca (LON:GATC)

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Graham Neary

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