Small Cap Value Report (Wed 15 Sept 2021) - CCT, RCDO, TPX, CAML, ELCO, HRN, DVRG, PDG, SUN, SIS, RBGP, TWD, ANP

Good morning, it's Paul & Jack here with the SCVR for Wednesday. Today's report is now finished.

It's my last day in Malta unfortunately. Although with so many RNSs to report on here, it's been more work than holiday! Mind you, waking up to this view (below), who's complaining?! (not me). And of course the weather this morning is already "scorchio!"

Agenda -

It's ludicrously busy again for updates/results today - we've already listed 14 companies on our GoogleDoc where Jack & I draft sections. So we're not going to be able to cover everything. We'll try to pick the more interesting updates (e.g. above & below expectations). If you're going to request us to look at a company in the comments below, then it helps if you explain why you think a company is worth looking at, as there's lots of other stuff competing for our attention today! By all means post your own reviews of results/updates too, we welcome that.

Paul's Section:

Ricardo (LON:RCDO) (I hold) - results for FY 06/2021 look OK, but nothing special. Balance sheet seems fine, after an equity fundraising last year. Modest divis. Overall, I'm neutral. Probably priced about right?

Panoply Holdings (LON:TPX) - a strong trading update, ahead of expectations. This share is expensive, on a high PER, but that seems justified by strong performance. Very strong order intake in particular.

Hornby (LON:HRN) - bit of a mixed trading update - strong order book (no figures provided), but as I would expect it also mentions potential supply chain problems. Overall, it's been turned around from basket case into generating a modest profit, but it's difficult to see much upside for shareholders, especially as the top 2 own 91% of the company, so minority shareholders are completely at their mercy - inherently risky.

Deepverge (LON:DVRG) - a very quick review of loss-making interims. Too speculative for me.

Pendragon (LON:PDG) - as with other car dealers, business is booming (for now). Strong full year guidance. Looks cheap.

Surgical Innovations (LON:SUN) - greatly reduced losses, due to cost-cutting. Trading around breakeven now. Balance sheet looks solid. I can't see anything to interest me here.

Science In Sport (LON:SIS) - interim results show a move into a small (adjusted) profit. Balance sheet looks OK. I think this company looks potentially interesting, but I baulk at the £106m market cap, which seems a long way ahead of events.

Rbg Holdings (LON:RBGP) (I hold) - a very quick look at impressive interim results. Upbeat outlook too. Seems quite good.

Trackwise Designs (LON:TWD) - poor interims. Clearly a jam tomorrow share, as these figures don't justify a valuation anywhere near £70m.

Anpario (LON:ANP) - interim figures don't impress. Why is this share on such a high PER, when there's little to no growth?

Jack's Section:

Character (LON:CCT) - sales continue to be strong at this toy distributor, but freight costs, port delays, and rising raw material and labour costs are impacting profitability. Management guides to at most 10% lower FY PBT, which suggests £10.8m. The balance sheet is strong and the group is well positioned to survive but near term pressures will likely weigh on the share price, which is at near all-time highs.

Central Asia Metals (LON:CAML) - copper, zinc, and lead producer with operations in Kazakhstan and North Macedonia. Results are strong and impressive levels of free cash flow are being used to pay down debt and pay out dividends. Management is now focusing on potential acquisitions. The company is doing a good job with what it can control, but commodity prices remain the key driver of performance.

Eleco (LON:ELCO) - revenue up 13% and recurring revenue up 8%. Product development continues, all funded from internal cash flows, but the company guides towards a temporary reduction in profitability over the next 18 months as the transition to SaaS progresses.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover 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 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.

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Paul's Section

Ricardo (LON:RCDO) (I hold)

420p (last night’s close) - mkt cap £261m

I dipped my toe in here a little while ago, with a starter sized position, so will be interested to see if the figures today provide confidence to expand my position, or whether it should be chalked up as a mistake and ditched.

Ricardo shares caught my eye originally because it looks a decent quality company, on a cheap-looking valuation. Obviously the automotive sector (one of its segments) is having a tough time at the moment with component shortages, so that might be having some impact on Ricardo maybe. Let’s have a look.

''Over the last eight years we have significantly diversified our portfolio and, by so doing, Ricardo is now positioned as a world-class environmental, engineering and strategic consultancy offering expertise that is supporting global green agendas.

Preliminary Results (for the 12 months to 06/2021)

The main highlights seem quite encouraging -

· The business continues to grow and we are well positioned as markets recover post COVID-19.

· Positive momentum, with H2 underlying profit before tax of £13.0m, compared to £5.0m in H1.

· All segments, except Automotive & Industrial, increased profitability on the prior year

Revenues flat at £351.8m

Underlying profit before tax (PBT) £18.0m, but large adjustments there, as statutory PBT is much lower at £3.9m

Order intake down 4.5%

Order book at year end is down 6.5% but still substantial at £293.5m. Order book data can be tricky though, as we’re not usually told over what length of time this is spread over. Companies should really provide a table, showing the order book split out for each future year.

Dividends - looking at the Stockopedia divi summary page here, Ricardo seems to have skipped the final divi last year, and reintroduced a small interim divi (at a much lower level than pre-pandemic) in early 2021.

A final divi is declared today - again at a much lower level than pre-pandemic -

Final dividend of 5.11p per share (total dividend of 6.86p per share) declared.

The divi yield works out at 1.6%, and I would expect the divis to rise in future years.

So worth having, but income is not the main reason to buy this share.

Net debt - looks OK -

Equity fund raise, together with a strong working capital performance, enabled the Group to reduce net debt by 36% to £46.9m.

Outlook - sounds OK -

As we enter FY 2021/22, we do so with a robust order book and pipeline. This is a business with a positive outlook and as a Group we continue to push the boundaries, strengthening our business for a sustainable future.

Being a services business, investors don’t have to worry too much about supply chain problems, although that is bound to be impacting Ricardo’s customers, which might have knock-on problems possibly?

Balance sheet - looks OK to me, and has benefited from an equity placing last year.

Note the pension scheme has moved into a small accounting surplus, but is still a drain on cash, with a £4.6m cash outflow to fund the actuarial deficit.

I continue to bash my head against an imaginary wall, when I have to look at pension scheme accounting, which is just so ridiculous - having two sets of figures, yet the accounting treatment requires the use of less prudent numbers, which under-state the real world deficit, and cash outflows.

The investment community is not being well served by the people who dream up accounting standards, I’m sorry to say.

Valuation - a share price of 420p is 18.8 times fully diluted EPS for FY 06/2021 - probably priced about right?

The latest forecast from Liberum (accessed via Research Tree, with thanks) is a significant rise to 31.5p, then 39.4p for FY 06/2022 & FY 06/2023 - quite punchy numbers. If forecasts are achieved, then this share would be very good value. I don’t know whether the forecasts are achievable or not.

My opinion - I can’t get excited about this, and am thinking about whether or not I should sell my small position here, as it’s a bit of a distraction, and I don’t have high conviction on this share.

The business is nicely diversified now, with good performance from other sectors, as the table of performance by division shows.

The balance sheet looks fine, with the risk of further dilution now looking low.

With economies recovering, maybe performance is likely to improve further?

Overall, I can’t decide, so will just say I’m neutral.

The chart below is quite unusual, in that Ricardo has not seen much of a rebound from the pandemic lows, whereas most other shares have recovered much better. Could there be an opportunity there to catch up maybe?

Note that the share count has risen from about 53m to 62m shares, due to the equity fundraise last year.

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Panoply Holdings (LON:TPX)

270p (up 7% at 08:51) - mkt cap £226m

Trading Update

I last looked at this software group here in July, when I reviewed its results for FY 03/2021, and came away with a much more positive impression than in the past - strong trading, good growth, and my previous concerns over dilution & balance sheet weakness had mostly been sorted out. Although the share did look very expensive at the time time at a very high PER, I felt the premium was probably justified.

There’s more good news today -

The Panoply Holdings PLC (AIM: TPX), the technology-enabled services group focused on digital transformation, announces an update on trading for the five month period from 1 April 2021 to 1 September 2021.

Trading significantly ahead of expectations

Guidance is raised -

As a result of this strong trading, the Board is raising guidance for organic like-for-like revenue growth for the full year ended 31 March 2022 to between 15-20% (from the original commercial vision target of 10-15%). The Board now expects to report revenue for the full year in excess of £77m.

In light of the growing market opportunity, and in order to execute on the substantial pipeline that has been built, the Company is investing in human capital and a single brand, but still expects to see Adjusted EBITDA margin expansion in the year.

Other points -

• £50m contracts won so far this year, +177% order intake
• Larger contracts being won, e.g. £10m 5-year deal with a utility company
• High demand

Valuation - many thanks to Dowgate for crunching the numbers for us. It forecasts 10.0p EPS For FY 03/2022, although note that this drops to 8.7p on a more prudent basis which takes into account maximum potential dilution relating to previous acquisitions. So it’s probably best to value the business on 8.7p forecast EPS, giving a PER of 31 times - a punchy rating, but that’s because the business is performing well.

My opinion - another positive update, which is reflected in a high PER.

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Hornby (LON:HRN)

41p (down 8%, at 12:09) - mkt cap £68m

To get up to speed, I’ve just read Jack’s excellent review of the FY 03/2021 results, which is here. After years of losses, this models & collectibles group scraped into a small profit for FY 03/2021. I would have expected a big boost from lockdowns, so those numbers don’t particularly impress. The share price has gradually drifted back down to where it was before the everything rally began in Oct 2020.

AGM Trading Statement

For the period from the 1st April to the 31st August 2021, sales and margins have been slightly lower than the previous year but in line with internal budgets. Trading patterns have begun to return to those experienced in pre-covid times.

On 30 July 2021, the Group completed the acquisition of the remaining 51% of LCD Enterprises Limited for a cash consideration of £1.3m.

As is usually the case in our industry; the outcome for the full year is subject to the sales rate over the key Christmas trading period. Our outstanding order book is very strong and substantially higher than a year ago, however timing is everything when it comes to Christmas and we are mindful of the potential supply disruption at the ports continuing.

That’s a mixed bag, but I think the most important point is that the order book is very strong, and substantially higher than last year. That indicates strong demand, which is the most important thing any business needs.

Supply difficulties is par for the course at the moment, and shouldn’t surprise anyway. These are temporary issues, and really shouldn’t be impacting share prices that much, because temporary problems get ironed out, and don’t matter in the long run. Unfortunately, we’re in a market where many traders/investors have the attention span of a fruit fly, and instantly react to every piece of news, often irrationally. Stock markets are meant to be for long-term share ownership, but seem these days to be more like a giant casino, with many people trying to get rich quick, and all the distortions that introduces.

For that reason, I think this is a good time to have some cash on the sidelines, so that we can pounce on heavily discounted shares in great companies, when they announce supply chain problems, as loads of companies are, and will be doing in the coming months.

My opinion - with Hornby, it doesn’t really interest me at any price. I just don’t see a particularly viable business here. Management has done well to make it modestly profitable again, from the basket case it was previously. But where’s the growth going to come from? Why is it valued at £68m, given that the last dividend seems to have been paid in 2012?

Note that the top 2 shareholders own c.91% of the shares, an unhealthy ownership structure, so small shareholders are completely at their mercy. De-listing is therefore possible in my opinion, a risk I wouldn’t want to take on.

So definitely not for me, but I wish the company well, as it’s nice to see heritage brands like Hornby, Scalextric, Airfix, Corgi, still going.

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There are loads more companies reporting, so I might just do very quick review sections now, to cover as much ground as possible, so less detail, just a general overview. Here goes!

Deepverge (LON:DVRG)

28.5p (down 6%, at 12:52) - mkt cap £61m

Interim results show revenues up, but losses increased to £(2.3)m in H1, worse than LY.

EBITDA is not so bad, as the amortisation charges are high.

Balance sheet has been strengthened with a £10m placing, so looks fine for now.

Overall, this looks highly speculative, so not the sort of thing I would be interested in. Positive commentary, as you always get with speculative shares.

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Pendragon (LON:PDG)

18.8p (up 2% at 12:55) - mkt cap £262m

Strong interim results, as we’re seeing from all the car dealership chains at the moment - they’re basking in soaring prices of used vehicles, giving them a spectacular (but temporary) boost to profit margins.

Underlying H1 profit before tax is £35.1m, and guidance for the full year is £55-60m. That’s surprising, because my sector pick Vertu Motors (LON:VTU) (I hold) guided for H2 barely above breakeven. They can’t both be right, hence I see read-across here for another profit upgrade at VTU potentially.

Balance sheet looks OK, but note there’s a pension deficit. Pendragon is unusual in that it also includes a profitable software business.

The valuation looks attractive to me.

Pendragon says it is aiming for profits of £85-90m by 2025, which seems ambitious given that this year’s bumper profits are likely to turn into next year’s tough comps.

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Surgical Innovations (LON:SUN)

2.88p (up 7% at 13:11) - mkt cap £27m

A tiny company, with only £4.2m revenues in H1. The most notable aspect of these interim results is how much costs have been reduced. Hence it ekes out a small EBITDA profit, but a small loss after tax of £(94)k. That’s much better than the heavy losses of the past.

The gross margin is low, so whilst there is some operational gearing, it’s not great.

Balance sheet looks OK, with £2.7m net cash.

Overall, the company seems to be recovering from pandemic-related reduced demand, but unless it’s able to achieve a step change in revenues & profit, then I can’t see much of interest here. Not sure why it’s valued at £27m, I wouldn’t pay a third of that price personally. It needs to develop a blockbuster product, as current size & performance doesn’t justify SUN being a listed company.

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Science In Sport (LON:SIS)

78p (up 1% at 13:23) - mkt cap £106m

This is a potentially interesting company, although a lot of upside is already priced-in. It sells sports nutrition products.

Interim results show some revenue growth, although against a soft comp, and not much growth on H2 last year.

Loss before tax of £(2.6)m in H1, but if goodwill amortisation and share options are reversed out, then it scraped into a small profit. Share options seem excessive at £1.4m charge in H1, very generous given the company isn’t yet properly profitable.

Balance sheet looks fine.

Outlook comments seem upbeat -

After record monthly sales in June, sales in July and August have performed very strongly, supported by our investment in technology and brand. Online sales have accelerated and retail sales have continued to recover. We are continuing to manage input cost inflation. While there are still challenges and uncertainties in the current environment, the Group remains very well-positioned to exceed revenue targets for the financial year. We remain very optimistic about growth prospects over the medium and long-term.

My opinion - this company looks promising, but £106m market cap seems a long way ahead of events. For the same price I could buy cash machine Scs (LON:SCS) (I hold) on a single digit PER, and with an embarrassingly huge cash pile. Why would I buy a breakeven sports nutrition business in preference to that? There again, we are in a bull market, and people cheerfully over-pay for growth in bull markets. The pain comes later.

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Rbg Holdings (LON:RBGP)

139p (up 8% at 13:37) - mkt cap £133m

On a quick whizz through, these interim numbers look impressive. It’s a legal services business, with a particularly impressive lady CEO. I took a small position a while ago, mainly on being so impressed with her presentation in a webinar, and the figures looked OK too, obviously.

Numbers today look strong, and the company’s summary/outlook is also encouraging -

"The Group has had an excellent first six months which is reflected in our revenue and profit growth. With strong demand for all Group services, we are on track to meet our recently upgraded market expectations for the full year.

While acknowledging the economic conditions continue to be volatile, we look forward to the coming months with optimism and are excited about the long-term prospects for the Group."

My opinion - I’ve not really done much work on this lately, but the figures & commentary today are enough to make me happy to continue holding a small position. I’m generally not a fan of professional services listed company, due to the inevitable conflict between remunerating the big fee earners, and outside shareholders. A lot of the legal work RBGP does is very high margin though, so there’s enough to go around. Stockopedia shows a low forward PER, and a decent divi yield.

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Trackwise Designs (LON:TWD)

245p (down 6% at 13:48) - mkt cap £70m

Looking at these figures, I see a tiny, loss-making company. If I didn’t know the market cap, I would have valued it in single digit millions, so how the market gets to a £70m market cap, is beyond me. Clearly there must be some jam tomorrow excitement baked in to the valuation. I see from the chart that the share price went vertical in Sept 2020, usually a sign of some news considered to be game-changing. It’s certainly not fed through into the figures yet, a year later.

Last year’s profit came from a negative goodwill credit, it was loss-making on an underlying basis, as it also the case for H1 this year.

It seems quite capital-intensive, with unusually large property, plant & equipment on the balance sheet, for the small size of the revenues. Also note receivables looks extremely high, I’m not sure why.

Overall, I’m not interested in jam tomorrow shares.

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Anpario (LON:ANP)

610p (down 7%, at 13:59) - mkt cap £141m

Healthy animal feeds sounds like a good area to operate in, given the damage being done with the over-use of antibiotics. The trouble with Anpario, is that it’s priced as a growth company, with all the valuation metrics on Stockopedia flashing red, but as these figures today confirm, the company isn’t really growing much, if at all.

Adj diluted EPS is down 7% to 10.88p for H1.

Strong balance sheet.

As you can see below, it’s taken 5 years just to grow revenues from £23m to £30m. Although note from graph 2 that the profit margin is excellent. It’s been a reliable dividend payer.

Unless something dramatic is going to change for the better, then it’s difficult to justify the PER of almost 30, for a company that’s not growing very much. Animal feeds markets must be huge globally, so Anpario is clearly a tiny, niche player.

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Jack’s section

Character (LON:CCT)

Share price: 600p (-13.36%)

Shares in issue: 21,379,781

Market cap: £128.3m

Character Group was founded in 1991 and designs, develops and distributes toys, games and giftware. This is a cash generative company with a strong balance sheet, a history of buying back shares, and shareholder management.

But it has also had its fair share of issues - first concerns over keeping its important Peppa Pig licence led to some volatility, followed by a sales vacuum in the Scandinavian market in 2019 caused by the failure of the region’s largest toy retailer. These events led to a huge drop in price, but the group has since rebounded.

Character sources product from China, like many companies, and so there are several well known dynamics that management must currently be facing including supply chain disruption, elevated freight costs, and wider input cost inflation.

Given the recent rise, Character’s share price is arguably as expensive as it’s ever been. While this reflects a good recovery job and returning confidence, it also means the market might be less forgiving if these pressures throw the company off course.

Trading update

The re-opening of the bricks and mortar retail sector in many markets has had a positive impact on sales and the group is seeing many of its brands outperform management expectations.

However, Character goes on to say, ‘the outcome for the full year has been affected by several factors… which have since deteriorated further.’ These factors are:

• Global logistical challenges (delays at ports, shipping and container shortages, exponential increases in freight rates, and increased costs of inland transportation in China and the UK), and
• Pressure on costs of production in China due to raw material and labour costs.

Together these have impacted profitability, and it’s uncertain when supply chain conditions will improve. After a lot of work from its teams in the UK, Scandinavia, Hong Kong, and China, Character believes it has limited the downside but full year underlying profit before tax for the year will come in at up to 10% less than market expectations.

The group reminds us that these expectations are for revenue of c.£140m and underlying profit before tax of c.£12.0m. If we subtract the maximum 10% to get £10.8m and apply a notional 20% tax rate, that comes out at about 40.4p of earnings per share and an FY21 PER of about 17.1x.

Aside from this, business continues. Development of the product portfolio for the new calendar year is well advanced and the reception from customers has so far been ‘very positive’. Order levels are strong and the prospects for a good sell through remain favourable.

Conclusion

It might not be news that shareholders will want to hear but we know many companies are trying to meet increased demand via a heavily disrupted supply chain. Tricky conditions.

Given the rough calculations above the shares look expensive by their own historical standards on a PE basis, especially after accounting for the increasing costs impacting on profits.

But there is a well-run business here, one prone to shocks, but with a relatively strong balance sheet (at the last reporting date, cash and equivalents of £35m covered all liabilities of £28.4m), that generates healthy levels of cash, and uses that cash to invest in the business, buy back stock, and pay out dividends. There’s very little debt, so all in all the group is well placed to ride out volatility. Communication to the market is clear as well.

Character expects to update the market regarding the launch of its tender offer later this month, so we might see further buybacks on share price weakness.

The group does say that conditions have deteriorated further though, so how these trends progress and just how far into profits they eat remains to be seen. So far, management has limited the impact and the team will presumably be doing everything it can in the months ahead.

Given the group’s prudent financial position I imagine it will survive the current pressures but as a neutral here, it makes far more sense to me right now to sit back and wait for further updates than to go fishing for shares.

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Central Asia Metals (LON:CAML)

Share price: 247.5p (+6.68%)

Shares in issue: 176,026,619

Market cap: 435.7m

CAML has two key operating assets, both in the lowest cost quartile, one copper operation (Kounrad, in Kazakhstan) and one zinc and lead operation (Sasa, North Macedonia). As ever with miners, your view on the company depends on your view of the underlying commodity. The outlook for copper is certainly buoyant, given the global need for wiring.

Share prices across a number of copper miners look cheap, but their earnings forecasts are underpinned by a historically high copper price. As above, there are good reasons for a strong price, but it can’t be stressed enough that should that level come down, earnings will go down with it. It reliably catches investors out.

Nevertheless, CAML has proven itself over the years as a solid small/mid cap copper producer, expanding into zinc and lead in 2017. Sasa was quite a big acquisition which saw the group take on a decent level of debt. Strong cash flows have allowed the company to pay this right down though.

With a c5.5% forecast dividend yield almost matching its forecast PER, it’s certainly worth taking a look at.

Interim results

Financial highlights:

• Net revenue +42.4% to $100.8m,
• EBITDA +51.5% to $64.4m, EBITDA margin up from 56% to 61%,
• Free cash flow +130.7% to $48.9m,
• Cash in bank up from $47.9m last December to $54.3m and net debt down from $36.2m to $10.1m, with $19.9m of debt repayments in the period,
• Early repayment of $10m corporate debt facility post period end,
• Interim dividend of 8p, up from 6p and representing 40% of group free cash flow.

A bumper period for free cash flow generation - if the group could repeat that figure for H2 then that would be a shade north of £70m in free cash flow (assuming a static exchange rate) and a price to free cash flow of just 6.2x.

Debt levels are also rapidly reducing so at some point soon the group will become net cash and the enterprise value will fall. The cash figure does include $3.6m of restricted cash.

Kounrad produced 6,214 tonnes of copper, down from 6,607 in the same period 2020. CAML says there is 140,000 tonnes remaining in this operation, so about 23 years remaining at current rates. Costs can start to rise once the low-hanging fruit has been harvested, but the group’s current position along the cost curve is reassuring.

Kounrad produced 6,214 tonnes of copper cathode during the period and sold 6,241 tonnes, generating gross revenue of $57.3m (H1 2020: $37.0m) from an average copper price received of $9,183 per tonne, 64% higher than that received in H1 2020 ($5,605 per tonne). Underlying cost inflation sees cost of sales up by 20% to $11.5m (H1 2020: $9.6m), although almost half of this increase was a consequence of increased Kazakh Mineral Extraction Tax ('MET') due to higher copper prices. H1 2021 EBITDA was $45.8m (H1 2020: $27.1m).

Sasa produced 13,807 tonnes of lead concentrate (compared to H1 2020 of 15,140 tonnes) and the River Remediation Project has been completed. The Cut and Fill project is on track and on budget for commissioning in Q4 2022.

H1 2021 gross revenue from these metal concentrates was $49.0m (H1 2020: $38.4m), up 28% on H1 2020 due to significantly higher commodity prices during the recent period. The zinc price received was on average 44% higher than the previous period at $2,829 per tonne (H1 2020: $1,964 per tonne) and the lead price 26% higher at $2,114 per tonne (H1 2020: $1,676 per tonne).

Sasa's cost of sales was up 11% to $27.8m (H1 2020: $25.1m), although 41% of this increase was currency related, resulting in EBITDA of $26.5m (H1 2020: $19.5m).

Three group lost time injuries (LTIs), no further detail given, all at the Sasa mine. CAML calls this ‘disappointing’ and says ‘lessons have been learnt from each of these incidents’.

Outlook - On course to achieve upper end of 2021 Kounrad production guidance and lower end of Sasa production guidance (which is between 23,000 tonnes and 25,000 tonnes for zinc and between 30,000 tonnes and 32,000 tonnes for lead).

Business development - this is interesting.

Management's focus on business development has accelerated during the first six months of 2021, with 18 opportunities reviewed and three discussed at length at Board level, as well as one site visit undertaken. Although there are no advanced discussions with third parties currently underway, management will continue to investigate opportunities of potential interest.

These opportunities have been in geographies including Kazakhstan, Europe, Africa and the Americas.

Conclusion

With strong demand for the metals that CAML produces, the company is in a strong position. The balance sheet is improving and some $135m of the funds borrowed to acquire Sasa less than four years ago have now been repaid. Now the group turns towards potential acquisition opportunities. As a low cost producer, it’s better placed than most to ride out cost inflation.

But so much depends on the commodity price, and continuing elevated levels are not a certainty. Management indirectly touches on this point when discussing its business development work:

Strong base metal prices have generated interest from other parties in terms of mergers and acquisitions ('M&A'). However, diverging views on long term metal outlook, that typically arise in periods of elevated near-term metal prices, have in some cases emerged and these can create differing expectations on asset valuations, making completing transactions more challenging.

So even miners have fairly divergent outlooks on commodity prices and asset valuations right now.

Putting commodity price considerations to one side, CAML does look to be in a strong position. Debt is coming down at pace, life of mines is long, free cash flow is strong, dividends are up, capital investment is ongoing, and the group is scouting out potential acquisitions.

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Eleco (LON:ELCO)

Share price: 137.9p (-5.2%)

Shares in issue: ​​83,104,650

Market cap: £114.6m

We last looked at Eleco here, and my famous last words were ‘I’ll probably do some more work into it’. Needless to say that hasn’t happened but my general feeling at the time was of a situation worth looking at more closely.

This group was founded way back in 1895, previously a family business, and has evolved much more recently into today’s SaaS (‘software as a service’) provider with clients in the architectural, engineering, construction, and interior furnishing industries.

Eleco is transforming at pace, from a product-led company to a customer-centric business focused on higher quality recurring revenues, strong free cash flows, healthy internally funded product development, and greater customer lifetime value (LTV).

The company's ‘market leading’ Elecosoft software solutions are developed by teams in the UK, Sweden, and Germany. They cover a range of activities including project management, timber engineering, asset and facility management, and cloud-based digital marketing solutions.

The Quality Rank of 98 is an intriguing figure but the valuation is pricey: a trailing twelve month PER of 39.4x and a forecast rolling PER of 29.5 suggests strong future growth is expected at these levels. SaaS companies have recurring revenues and good earnings visibility, so it’s not unusual to encounter high relative valuations, but not all SaaS businesses deserve them.

With Eleco, it is worth noting that free cash flow is often actually higher than reported earnings. Note the more palatable trailing twelve month P/FCF metric below.

The de-rating of non-growth SaaS businesses is a risk, but if you pick the right ones then they could grow to become very big indeed, so I see the attraction. Transitioning to a SaaS model does tend to temporarily depress profitability though.

Interim results

Financial highlights:

• Revenue +13% to £13.831m (+12% at constant currencies),
• Recurring revenue +8% to £7.543m (55% of total, down from 57%),
• Adjusted EBITDA +11% to £3.649m,
• Operating profit +14% to £2.366m, adjusted operating profit +15% to £2.73m,
• Basic EPS +16% to 2.2p, adjusted EPS +20% to 2.6p,
• Free cash flow -23% to £2.855m,
• Cash flow conversion down from 157% to a still strong 105%,
• Net cash up from £4.435m to £8.478m.

Adjustments exclude amortisation of intangible assets, depreciation charge and former directors' payments.

The strong revenue growth in new licence sales from Eleco’s Building Lifecycle businesses and the increase in services revenue means recurring revenue is slightly lower as a percentage of total revenue. This revenue growth should lead to a further increase in recurring revenues going forward, however.

Software - The group continues to invest in its software. Total software development spend (including both capitalised and expensed elements) amounted to £1.628m (2020: £1.623m). That’s equivalent of 12% of revenue. Software development expenditure capitalised in the period totalled £790,000 (2020: £760,000).

Transformation is now being overseen by Brigit Lenton, the incoming Transformation Director who has 20 years’ of experience. Steps include:

• The merger of Eleco's two German visualisation businesses, to be rebranded Veeuze and relaunched to its customer base by the end of the year,
• The merger of three UK Building Lifecycle businesses, due for completion in Q1 2022,
• Creation of the Northern Europe Building Lifecycle operation, which includes all building lifecycle businesses in Germany and the Netherlands,
• Expanded the focus of our Swedish Building Lifecycle operation to the Nordics region,
• Group-wide implementation of a new finance system to enable more efficient financial reporting,
• Identification of Arcon and Staircon products as stand-alone niche business areas, delivering focus and agile decision making.

Fredrik Pantze was appointed as Chief Product Officer in April to spearhead the group’s move to create software solutions based on the future needs of Eleco’s clients and to enable them to ‘make better real-time decisions’. Eleco is also searching for a Chief Technology Officer. So quite a few senior hires slated.

Software is now being sold on a subscription basis in the UK, Germany, Netherlands, Sweden and the US. The latter is a key growth territory for Eleco and the group launched Elecosoft into the Texas market as a direct sales organisation in July. The uptake in orders is expected to take time as the market presence and recognition of the brand grows. The maintenance management portfolio has also been taken into the German market.

Outlook - These projects will take time to seed but ultimately are about growth, so investors are paying a premium today for growth down the line.

The group says its transition towards a SaaS subscription model will ‘inevitably... soften revenues and profits in the short term as revenues are spread over a longer period of time and costs are added to drive growth… We therefore expect a temporary reduction in our level of profitability over the next 18 months.’

The group says ‘inevitably’ but it looks to have taken FinnCap at least by surprise. The broker has just reduced its FY22E and FY23E adjusted EBITDA forecasts by 32% and 37% respectively. They will presumably have had some guidance from management on these figures.

The broker’s earnings per share estimates now show 4.4p in FY21E falling to 2.8p and then 2.9p in the following years. While this should translate into higher customer lifetime value, lower acquisition costs, and greater revenue and earnings visibility in following years, it does raise questions over the present valuation. That’s an FY22E PE ratio in the 50s.

The company is also undergoing some major transformation projects including the digitisation of its back office systems. This should ultimately be a benefit.

Conclusion

I don’t believe a reduction in profitability was properly factored in. This is strange, as it’s known that shifting to a SaaS model depresses near-term profits while (hopefully) increasing the overall lifetime value of customers. Eleco is only part-way through this transition so it follows that near term profits might be lower.

Easy to say in hindsight I suppose, but FinnCap is paid by Eleco to produce this research so I wonder if it has taken them by surprise as well?

I’m interested in the proposition here but put off by the price and not familiar enough with the products and market to have confidence that the growth rates in c3 years’ time will be worth paying up for today.

The company is potentially attractive still, with a long heritage in its industries and a developing product suite of software services funded internally. The Quality Rank is high and the group’s cash conversion is impressive, while the net cash balance sheet is useful (although net tangible asset value appears to be negative after accounting for c£17m of goodwill and intangibles).

Revenue is forecast to continue growing. And it’s worth noting that presumably over the past year the group’s clients have faced extensive Covid-related disruption. It could be that the earnings downgrades are a red herring, with Eleco rightfully focusing on longer-term growth at the expense of shorter term profitability. The group does call it a ‘temporary’ reduction.

I remain undecided here. For now, I would either want a lower earnings multiple or higher growth rates. Reading between the lines, Eleco is asking its shareholders to be patient as it invests for future growth. The analyst consensus figures for FY21 and FY22 are presumably going to have to come down again.