Small Cap Value Report (Wed 17 July 2019) - Not Taking Profits, UPGS, KOOV, VLG, NICL, WOSG

17th Jul '19 by Graham Neary

32 comments 10851 reads

Good morning! This is my last small-cap report before I jet off for summer holidays at the end of this week.

Some RNS announcements to see me off:

UP Global Sourcing Holdings (LON:UPGS) - trading ahead of expectations
Koovs (LON:KOOV) - preliminary results
Venture Life (LON:VLG) - commercial update
Nichols (LON:NICL) - interim results
Watches of Switzerland (LON:WOSG) - preliminary results

At Versarien (LON:VRS), "revenues [from graphene] of any material amount have yet to be achieved". It has received its first graphene orders post-period end.

APH

Readers have been having an excellent discussion in the comments on Alliance Pharma (LON:APH).

For better or for worse, I stay away from all pharmaceutical stocks on the grounds that my time is better spent focusing on industries where I have a little bit of experience and/or expertise. Sorry about that! I strongly recommend the comments section for anyone who is interested in this share.

Not taking profits

I've had an interesting chat this morning with a friend on the subject of taking profits. We are both long-term shareholders in Burberry (LON:BRBY), and it's a significant percentage of both of our portfolios (currently 13% of mine).

Pricing of Burberry (LON:BRBY) leaves us with a problem of sorts - a pleasant problem. Do we take profits at c. 27x earnings (pre-upgrades) or do we ride it out?

Regular readers will know that as a general principle, I don't sell shares. There are many reasons for this:

frictional costs - commissions, the spread.
taxes - to avoid capital gains tax liabilities, I need to hold on to shares (your tax situation may be different).
the reinvestment problem - it creates more work for me, to find something else to invest in. This might sound lazy, but I think that minimising work is very smart!
wasted research - related to the above, it is a waste of the work done on my existing portfolio and the comfort that I've built up with my existing holdings, if I get rid of them too…

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xcity

17th Jul '19

wrt selling shares.
My observation is that I am currently standing at a substantial "profit" on ALL my share sales.
(some much higher than my buy price, others not)
I think that's trying to tell me that I should sell more.

finebone

Any comments on CAPD?

Why a 10% drop in price today?

andrea34

What's your secret?? :-( I guess you're allergic to profit warnings

abtan

Re Alliance Pharma (LON:APH)

Excellent contrasting points. Some thoughts:

With regards to prior placings, shareholder dilution and use of debt, I actually agree with you and try my best to avoid these when deciding whether to make a purchase.

In fact, Alliance Pharma (LON:APH) is one of only a few exceptions in my portfolio where I have "broken" my own rules on this. My rationale comes down to 2 things:

It is already extremely cash generative. This year it expects to exceed cash generation from 2017, where free cash flow was £22m - I imagine it will be significantly more than this given the additions to the portfolio since 2017.
With such high levels of cash generation it would not take many years to significantly pay down debt if it chose to.
On top of the cash it is generating right now, there are a couple of big plays coming in, which should increase cash generation even more.
You mentioned Nizoral (more on that below), but the big play in my mind (as I've done more research into it) is Xonvea, the licensed medicine for the treatment of nausea and vomiting of pregnancy.
If Xonvea utilisation rates within Alliance Pharma (LON:APH) 's territories get anywhere close to those achieved in Canada (56% of pregnant women used the product there in each year from 2014-2016 according to a Hardman Research note) then this product alone would be a significant cash cow. It's nice upside potential to have over the next few years.

Based on 1. and 2. above goodwill for me is irrelevant and a couple of write-downs is not to be unexpected - as long as the cash generation is good - and growing - I'm more likely to remain interested.
Local Brands. I think these are fine and look fairly static over the last 2.5 years. They alone cover operating costs and require minimum input from the company, allowing focus to be concentrated on the bigger, faster growing brands. For reference here are the revenues generated by local brands over the last 2.5 years:
H1 2017: £40.2m
H2 2017: £41.4m
H1 2018: £37.2m
H2 2018: £40.6m
H1 2019: £39.4m

The movements seem reasonable to me - some ups, some downs - with potentially a slight H2 weighting so maybe even higher sales to come in the latter half of this year?
I didn't quite understand your Nizoral point. Are you saying that at the time of acquisition Alliance Pharma (LON:APH) stated actual revenues, and then made an estimate of what their costs would be for those revenues? A bit cheeky, but nothing untoward methinks. In any case, I would expect there to be some level of assumptions when taking on a new brand. What worries me more since then, is that revenues seems to have declined since H2 2018 and I worry about the cash impact if this is a trend rather than seasonality.
The market is far too big to understand the risk of their products over the next few years. However, the growing top line, the stable margins, the desire to buy more brands and high cash generation limits the downside, leaving plenty of room for significant upside over the coming years.

MichaelFBS

Thanks Graham for your insights on selling. I feel the same but it is with the proviso that one has to be invested in really good businesses that are also really good stocks. For me finding investments is the hardest part, so I tend to hold on once I have found them.

I like to think that many of the stocks I hold come under that category and I have not sold any stock in my best companies because I think they are great businesses that I understand (some better than others) Boohoo (LON:BOO) Bioventix (LON:BVXP) Fevertree Drinks (LON:FEVR) Games Workshop (LON:GAW) Somero Enterprises Inc (LON:SOM) Treatt (LON:TET) (great podcast with Lord Lee who has 40%! of his ISA IN Treatt (LON:TET) ) and XP Power (LON:XPP).

Thx.
Michael.

hawkipa

Hi Abtan,

Many thanks for your follow up. It's extremely valuable to me to see your views.

A few follow ups to your follow ups:
Local Brands - They fell last year (FY18) so 6% was just an element of recovery that they did guide for. My fear wrt local brands is a complacency that they do do zero marketing. When I challenged on this recently, I was told that the challenge here was that the issue here was more about supply chain management and managing that. I think they missed my point. What if they did do some marketing. Would sales move materially higher? Its a diverse range of products and last year the issue was in a Mosquito product that suffered competition. As a result manufacture was stopped and they wrote down the value of that product on the b/s.

Kelo Cote - I'll paste my comments from the recent AGM I attended where this was specifically discussed:
Much of the initial discussion was regarding Kelo-cote and its potential particularly in China. The market for scar products is big and growing and whilst publicly they don't comment on individual products margins, it was implied that Kelo-Cote along with having the biggest growth last year has the biggest margin of all their products. The growth since acquisition has been compelling and underlines the point that they can add significant value to bought in brands. This is evidenced by the c67% growth in Kelo-Cote sales last year. He was cautious enough to flag that growth cannot continue at that pace going forwards.

So to be fair to them, he heavily flagged that growth would reduce this year as it simply couldn't continue at that rate of growth. The growth historically has far exceeded their expectations I think.

Nizoral - I may be mistaken, but I don't recall seeing sales numbers for Niz/Xoneva in the RNS? Only Kelo-Cote seems to be broken down? I do recall that they use see through numbers as I don't think they actually take control of sales until H2 this year on Niz. So I think I would say, its difficult to judge it as yet as J&J still handle all sales and just make a payment to them. Xoneva has masses of potential if it can replicate what has been done in Canada.
The star brands market potential looks extremely compelling to me based on the performance so far. My calculation is that the star brands potential market in c5years is over £100m of sales.

Regards
Paul

TamzinPiworld

Mello May 19: the last presentations are just coming through.

Today, Downing's James Lynch discusses cash generative business models, to enable income and growth. AdEPT Technology (LON:ADT) is presented by Ian Fishwick, also mentioned are Ramsdens Holdings (LON:RFX) and Discoverie (LON:DSCV).

Find this, and all the other Mello presentations here.

jwebster

Alliance Pharma (LON:APH)

Main positives are the steadily increasing revenues, EPS and dividends over time. Cash flow generation is strong. Pharmaceuticals is a good long term industry to be in, people will spend on healthcare, especially with the ageing population here in the West.

Negatives are the treadmill of purchasing new brands with debt and equity issuance. E.g. last year they spent £60m on acquisitions. The shares on issuance is ever increasing. In their defence EPS still rising. Currently focused on generating cash to work down the debt pile.

I always worry about firms which need to buy more to grow, as opposed to underlying organic expansion for their products.

E.g. in 2014 shares on issuance 265m and today 510m (from Stocko) EPS was 3.35 now 4.45 so double the equity for 32% growth in EPS. Also net debt 74m or so.

Other problem is last year they lost a Chinese licence, which was a set back. Their international footprint is otherwise good.

Market cap at £348m with say £143m revenues for 2019, does make it a possible takeover candidate one day, particularly if the buyer already has a distribution model, so they can cut out APH’s 87m in costs! Easy to justify a takeover premium.

I suspect this might be the real play here long term.

Graham Neary

Great stuff Michael, I am working hard to do the same as you!

Graham

Hi Mojomogoz,

Thanks for coming back. I think I have some clarity on those points that make sense to me but interesting to see whether they stand up to scrutiny:
1, The stated aim is growth both organically and acquisitively. Many dislike this model, but I have found them to be adept at it. The major purchase over recent years was a portfolio from Sinclair which was a game changer for them. That portfolio turned out in the main to be excellent and they have so far grown sales from that which was acquired. I have been cautious in the past that there isn't organic growth, but this is now being demonstrated. Kelo-Cote is a great example of a brand that was bought in and with focus the sales have literally exploded, with more to come. So in response, I think the growth is primarily driven by acquisition. However, they have proven that they can acquire a product and grow its sales markedly. Essentially, whilst the product might be tiny to a larger co. To them it can be significant so the increased focus results in greater sales post purchase.
Nizoral was funded by £30m equity and £30m debt as an eg of the financing of a purchase.

2, The write down was due to a local brand suffering competition which led to its production being ended. It was a mosquito local brand. The write down was the value on the balance sheet of it. I think sales for them was £0.7m. At the time I worried there was a complacency towards local brands as what is there to stop the same fate for other brands. However, the company believes the breadth of the product suite affords protection and in many ways they are right as they are termed local brands as a result of only being a product in a specific region eg Ashton & Palmers in the UK. I felt that this event should have acted as a wake up call to management that local brands aren't just an all weather cash cow. The 6% rise seems to demonstrate that they have not let the situation repeat.
I am comfortable with the level of intangibles as they are buying rights to make and distribute, so for me they seem like a reasonable 'tangible' intangible. For example the Niz acquisition led to intangibles increasing by £56.6m as a result of the Nizoral purchase for £60.3m (Fx movements also drove that number). But essentially, I can follow the intangibles trail and make sense of valuations. So that gives me a comfort that I understand the make up of the intangible part of the b/s.

3, Fair point. I do come back to my complacency fears here. They always point to the stability of sales and do state they are not really in growth markets and whilst they will fluctuate they will likely tread water. However, the other way of looking at is like an annuity stream with little variation. The number of products is broad so one collapse shouldn't hit too hard. Plus, all will be brands with very long heritage and proven l/t sales. The kind of thing you goto the doctor and he prescribes a cream you've never heard of before, but that will be an APH local brand. In addition, the potential of the star brands means that there is a definite tilt away from reliance here. I can envisage a time when they are just not that relevant anymore, but I don't want to get ahead of myself.

4, I'm pretty sure they have only just taken control of Nizoral. The deal was done last year but J&J only handed it over H2 19. Therefore, its not yet fair to judge them on this. This brand is a heritage brand and has lots of potential from its current position. They wanted more geography but lost out to a PE buyer. However, it is a strong brand in a good market and the other point here is doing a deal with J&J such as this gives them scope to do more in the future. This is the key in my mind as if they are as good as they are making out and see as many deals as they do, then we want them to open up deals with majors as this gives them scope to see better and better deals. My memory is hazy but one recent deal has opened up America in a small way and that is now an area of great interest.

5, The products they buy will usually already be approved. If you like they take a rounding error product from a major and then aim to re-invigorate it. Xoneva is the other end, it had approval in Canada for 40 years but not in the UK. They acquired and then sought approval. This took time, but now it is launched and is the only anti nausea product on the market. The potential for it is subtstantial. However, supply chain management is clearly a skill and they profess to be good at it and working hard to improve it. They have implemented some big cloud system that i can't remember but is apparently going to make vast IT improvements this year.

6, There is recent evidence of competition and subsequent obsolescence in local brands but it is not common. Adding balance, there is more evidence of growing sales of star brands. So it would be balanced to say that is a risk, but I'm not sure the majority could be described as weak brands. Rather the 'weaker' brands are specific geography local brands, which over time are becoming less relevant (but that is a slow process).

I was nervous at the beginning of this year as a result of a number of things, new ceo, lack of debt reduction, signs of weakness in local brands. Today, those questions have been answered for me. The other issue is the CMA. As it was described to me they had done nothing other than create and sell the drug and hadn't benefitted at all from price rises. Therefore, they believe their hands are clean. Time will tell.
The key for me at the moment is that they have reduced debt, which means when another deal comes along they will be able to rightly point out that they can reduce debt. I won't second guess M&A but I was vociferous in calling the new CEO out on when I met him. I pushed him hard on it and said the market would welcome a period of no M&A to see how the business can operate focussing on what it has rather than what it can buy and also pointed out that as a new CEO he had to prove himself. So far so good on that front for me.
Regards

Regards,
Paul

FREng

Vitec (LON:VTC) has an unusually high volume today, according to ADVFN. Almost 1.5m against a 3 month average of 43,000 according to Stockopedia, with an NMS of 300. The trades appear to be sales in the first hour today but the SP is up 40p. Has ADVFN got its data wrong?

Puzzled of Lambeth

jonesj

After a less than perfect record at holding onto long term compounders, I have also tried the "top slicing" treatment with quality long term holdings. Sell 25% if it gets ahead of itself, maybe another 25% if it goes up a lot further.
If it comes back down & nothing else has changed, I might buy back the shares sold.

Of course, what I need to do is get smarter in identifying when the business has reached an inflection point.

Re Alliance Pharma (LON:APH)

Hi Paul

Sorry, in a bit of a rush, so resorting to bullet points:

Thanks for your reply
Local brands. Interesting question regarding "what if they did market them?" What if someone else wanted to buy a few to market them?
Nizoral/Xonvea revenue calcs as follows

Total H1 Revenue = £70.3m

Star Brands £30.9m, so Local Brands = £39.4m

From Star Brands £30.9m, £13.1m (A) relates to Kelo-Cote. Balance = £23.8m

LFL sales for Star Brands up 21%.

LFL Star Brands are Kelo-Cote + MacuShield + Vamousse, so by deduction Macushield and Vamousse = £7.8m (B)

Difference for Xonvea/Nizoral = A+B = £10.0m

My understanding was that Nizoral sales were recognised as of this financial year, so given Xonvea sales were only £0.2m from 2018 (albeit only a few months worth of sales), I figured the sales this year would still be low with the remainder attributed to Nizoral (where sales would have been £10.9m in H2 2018).

A few assumptions in that last paragraph, so will be interesting to see the split of the £10.0m when they're finally released.

Cheers

monions

Vitec (LON:VTC) - interesting. Volume and price move are confirmed on SharePad. It looks like almost all the volume (~1.4m) was early on around 8.15-8.30, however, the price didn't start to move until 10am. I can check in more detail tomorrow as there will be detailed trade quantities and times available and maybe an RNS. Vitec (LON:VTC) has been in a recent downtrend, so this may be a reversal coming up.

fwyburd

Well done Graham for another great report. Have a super holiday.
cheers
Francis

Cleeve

M

I too hold some of yours indeed have held Treatt for a while and up 470% probably my best performer - where is the podcast you mention love to listen

Somebody I have sadly given up most of my profits but still think it a good stock

Sorry, just realised I missed some keys steps in my calcs owing to rushing earlier. So here is a snapshot from my notes for anyone interested.

All the figures are either published in, or calculated from, official releases from the company.

mojomogoz

18th Jul '19

Thanks abtan and hawkipa for detailed response re Alliance Pharma (LON:APH)

Here's how I feel about your response and Alliance Pharma generally (with very small position from yesterday):

Snapshot value is clear. Growth seems highly probable too.

The reason to buy in size is if believe in the growth. With APH its perhaps relevant to differentiate thinking in terms of real (cash) and altered reality (accounting) growth.

On real (cash) growth it seems highly probable, barring a large surprise event, that they produce a high level of operating cash and have the choice to invest it or pay down debt. I'd like the latter as I think that makes for higher quality platform going forward but I fear they will go for the former as that is eye-catching to outsiders and can generate a growth narrative that leads to higher multiple etc. Its also hard to 'do nothing' rather than something sort of thing for senior managers in that acquisitive buy and build habit.

As a tangental aside for hawkipa I would point out a loose parallel with 1pm (LON:OPM) here (that we've discussed before). Without going into detail and what's better or worse the current SP on 1pm has been hammered as they are consolidating and not pushing hard on growth (acquisitive or organic). Like APH they'd probably need external financing for significant acquisitions. In my way of viewing things I see the balance of probabilities being upside expectational surprises for 1pm and downside ones for APH (its not tiny company so there is some reasonably formed growth expectations partly in the price...not fully as the valuation isn't so demanding given growth and margin).

Onto altered reality growth (income statement). With £332m of intangibles on balance sheet there is significant potential for writedowns to come through income statement and distort results. The money has been spent and, as long as the debt can be brought down, I agree it doesn't really matter much. I cannot attach probability to writedown events...but I'd hazard that APH senior management may struggle to see it coming too (which refers back to point above re tidying things up). On balance, any event even if non-cash will retard valuation unless there'e out the park growth distraction somewhere else.

I think I'm probably being too cautious above. The balance of probability is that they hit 100p based on star brand growth. I would like them to consolidate and financially strengthen before pushing on harder. As a relatively distant outsider my hunch is that they have done a lot and changed a lot over a short period of time and have a diverse and complex business that is probably a bit wild and untrimmed around the edges.

My crystal ball (ha ha) says that they do hit their 100p ish level on results that look good and then announce some form of major internal investment program to clean themselves up for, say, £4-500m pa revenue target with probably some element of change in how they manage the the diverse local portfolio (they probably can't get an upfront cash buyer for that so their path is complicated). I feel that I could be a big buyer once they announce some 'new' Alliance Pharma plan and tidy up, particularly if that deflates price a little. I realise that could be higher but right now I don't see the motor as clean enough for the price on EV basis.

You are assuming it's a good thing - I'm assuming that I would have saved more value by selling other shares, if I'd only had my finger closer to the button.

And I have no idea why it has worked. I know I was absolutely certain it was the right decision at the time. No profit warnings involved (at least not until after I'd sold).

The only thing I can identify is looking actively for sales from the portfolio whereas - like most investors - I usually spend time looking for buys.

Thanks for sharing Abtan.

Small Cap Value Report (Wed 17 July 2019) - Not taking profits, UPGS, KOOV, VLG, NICL, WOSG

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Not taking profits

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Graham Neary

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