Small Cap Value Report (Wed 20 Nov 2019) - TPFG, CRL, BAR, AGFX, RFX, IDP

It's a busy day in RNS-land. I'll probably work through the afternoon to cover as much as possible. 

This list is final:

• Property Franchise (LON:TPFG)
• Creightons (LON:CRL)
• Brand Architekts (LON:BAR)
• Argentex (LON:AGFX)
• Ramsdens Holdings (LON:RFX)
• Innovaderma (LON:IDP)

---

Property Franchise (LON:TPFG)

• Share price: 156.65p (+3%)
• No. of shares: 26 million
• Market cap: £40 million

Trading Update

Please note that I have a long position in TPFG.

This is a very pleasing update. 

TPFG is a franchisor of estate agent brands, e.g. Martin & Co. It can be compared to Belvoir (LON:BLV).

The successful franchise model has resulted in an admirable track record of high returns and cash conversion. To help demonstrate this, I'd note that TPFG gets a QualityRank of 99 from Stocko (BLV isn't bad either, at 85!).

The best counter-arguments versus these shares have been:

• they operate in a low-growth, mature industry
• the tenant fee ban and other regulatory threats
• the potential for a bear market in property.

This update should help to allay some of these fears.

Firstly, trading is in line with expectations. I can see forecasts for EPS of 14.6p this year, and 15.3p next year.

Secondly, franchisees appear to be doing well when it comes to letting income: they earned nearly £6 million in lettings revenue last month, which is a new record. The success of franchisees should in turn benefit TPFG, as franchisor.

This new record comes despite the introduction of the tenant fee ban over the summer.

TPFG reports that tenant fees were previously responsible for 16% of lettings revenue. This income has very quickly been replaced, partly through growth in the sheer number of tenants but also through "shifting the burden of cost" over to landlords.

Following this success, TPFG advises that it expects to achieve "full mitigation" of the tenant fee ban by June 2020, earlier than expected.

My view - I like this stock. It's simple and easy to understand, generates lots of cash despite not deploying very much capital, and enjoys some diversification across estate agent brands and local geographies. There is also the potential for its subsidiary Ewemove to gradually take a bigger share of the property market pie, by taking an original approach.

The overall StockRank is 97 and it passes 5 screens (for dividends, free cash flow, quality, and value). So this is a share where both my view of quality, and the purely quantitative approach, are in agreement.

There is always going to be that fear of a bear market in property. 70% of TPFG's royalties are derived from lettings activity, which is more consistent, so hopefully it would sail through a downturn without too much too pain!

---

Creightons (LON:CRL)

• Share price: 49.1p (-2%)
• No. of shares: 63 million
• Market cap: £31 million

Interim Financial Report

Please note that I have a long position in CRL.

This has been the talk of the town since Mello, where it wowed the crowd (or so I heard - I was giving a speech somewhere else at the time!)

For background, the CRL share price has been very excited in recent weeks. It was around 38p at the start of this month, and then rapidly shot up toward the current levels, with the help of the appearance at Mello.

I've been a shareholder since early last year, and am now sitting on paper profits of over 100% - lucky me.

It was originally a value play. I all too frequently make mistakes when "value" investing, but in this particular instance, the market has decided that it agrees with me.

Let's check the headline numbers from this report:

• revenue +6.3%
• gross margin improves to 42% from 38% - very good.
• operating margin improves 100bps to 7.7% - good.
• interim dividend maintained

Property purchase

Last month, CRL bought the factory it uses in Peterborough from the company Chairman, at a cost of £3.8 million. This was fair value, according to an independent valuation.

The main trading subsidiary, Potter and Moore, will now pay the £350k annual rent to Creightons PLC, rather than to the Chairman.

Operational leverage

Sales growth is reported to have been driven by the private label division (i.e. contract manufacturing for retailers).

Management have very deliberately driven the gross margin higher, by making a variety of strategic choices, and I'm really impressed by their focus on this metric.

On the other hand, distribution and administration costs have risen at a faster pace than sales, and this has held back operating leverage in the short-term. If these costs had been kept flatter, then the increase in operating profit would have been spectacular. 

Even so, the increase in operating profit is a very reasonable 30%. 

For future periods, I would like to see distribution costs and administration expenses rising at a slower pace than sales growth. If that happens, then we could indeed see spectacular increases in operating profit.

Degree of Operating Leverage

Here's how I calculate operating leverage: gross profit / operating profit.

For H1 last year, CRL's degree of operating leverage was about 6x. This means that all else being equal, a 1% increase in sales could translate to a 6% increase in operating profit. A 2% increase could translate to a 12% increase, and so on.

We actually got a 6.3% increase in sales, as mentioned already, and this translated to a 30% increase in operating profit. The improvement in gross margin helped to offset the increase in overhead costs. The company didn't quite live up to its degree of operating leverage, but it still did extremely well.

ROCE

The strong performance by Creightons on this metric is one of the things that originally got me interested.

It's a little bit tricky for me to do a ROCE calculation, since the March 2019 balance sheet is reported on a pre-IFRS 16 basis, while the September 2019 balance sheet is on a post-IFRS 16 basis. Ideally, I would take the average of these two balance sheets, to calculate average capital employed.

To save time, I'll simply use the September 2019 numbers - this won't be perfect, but should give us a ballpark figure.

According to my calculations:

• Return on Tangible Capital Employed is approximately £1.8 / £13.6 = 13% in six months.
• Return on Total Capital Employed is approximately £1.8 / £14.9 = 12% in six months.

Stockopedia reports annual capital employed of 23%.

So earning 12% - 13% in six months is about right. I'm glad to see the company maintaining its usual standards here, with very admirable returns.

Conclusions

The company is making a presentation at 2pm today, with the help of PI World (whose broadcasts are always excellent, by the way!). This will definitely be worth a watch.

Long-term, I don't know if this will be a "hold forever" type of stock for me. I originally got involved for the simple reason that it looked way too cheap, relative to its quality, and now it's a "bagger" for me. Maybe I should be happy with this outcome, and not look for any more?

One of the reasons to consider selling is that dilution is a bit of an issue: there are 10.3 million share options outstanding, which is 16% of the existing share count. There is no doubt that staff are highly motivated, but there is also no doubt that this is a lot of potential dilution! Diluted EPS for H1 has only increased by 14.4%, i.e. at a much slower rate than the increase in PBT, because of this possible dilution.

But selling your winners is a cardinal sin in investing. Dilution worries aside, Creightons haven't put a foot wrong. If they keep building on this momentum, with strong ROCE plus some sales growth, we could see wonderful increases in profits in the years ahead.

I haven't decided what to do with my holding yet, but am in no particular hurry to do anything. It's hard enough to find a winner. When I find one, I don't want to let it go too quickly!

---

Brand Architekts (LON:BAR)

• Share price: 162.5p (-11%)
• No. of shares: 17 million
• Market cap: £28 million

AGM Statement

This one was previously known as Swallowfield (SWL).

It's another cosmetics company. It is currently focused on brand-building in the beauty space, having sold its manufacturing business. The brand portfolio can be viewed on its website at this link.

This update is bad news:

• UK conditions are "difficult"
• International sales affected by US tariffs on China-sourced products

It then says:

"We expect both the UK and international sales will return to growth in the second half of the year, underpinned by the complete management focus on our brand business following the disposal of contract manufacturing, new product developments and improved UK distribution for our key brands."

Fair enough. But if management are pre-emptively willing to take credit for improving the company's performance in H2, then why not take some of the blame for a disappointing H1?

This statement will serve to bolster the view that the brand portfolio isn't particularly high-quality. I'm familiar with the fish hair product, for example - it doesn't stand out strongly from the crowd, but it's ok. Ratings on Amazon are good.

Value investors should be all over this one, since it has nearly its entire market cap in cash, after making that disposal over the summer. Net cash as of 31 August was £24 million. And the remaining activities earned an underlying operating profit of £3.6 million last year.

What the company plans to do with the funds is of utmost importance. Acquisitions are apparently on the cards. 

My view - There is no doubt in my mind that this company should prove to be worth more than the current market cap. But management will need to use the funds wisely. Are they up to it? It remains to be seen.

If the executives had a bigger stake in the outcome, I'd almost certainly want to participate in this with them. For now, I'm comfortable on the sidelines.

---

Argentex (LON:AGFX)

• Share price: 167.8p (-3%)
• No. of shares: 113 million
• Market cap: £64 million

Interim Results

This FX business has been listed only since the summer, and it's my first time looking at it today.

It's confident of meeting expectations - it would truly be a shame to deliver a profit warning at this early stage!

The outlook for the business remains strong. Uncertainty surrounding the General Election and Brexit is leading to a positive trading environment for our business model, which takes no market risk or house positions. As expected, our corporate clients continue to seek certainty around the outcome of the UK General Election and Brexit. Irrespective of what form either may take, it will provide those clients with an ability to plan ahead again, leading to increased trading volumes.

Shouldn't the spread betting companies be doing well, too? With the general election, and then Brexit to be resolved, there are many reasons for corporates to seek advice, and many reasons for individuals to want help, too (or to enjoy speculating on the outcomes).

AGFX was previously structured as an LLP (a partnership) and says that it provides "tailored FX advisory and execution services" (emphasis added by me).

Browsing its website, and how it talks to prospective customers, it strikes me that the business model involves plenty of human contact. This would confirm the "tailored" nature of its advice, and the critical importance of its partners and senior employees, in managing client relationships.

You can see a list of sample clients and read client testimonials here. Sources of revenue should be diversified, with >900 active clients.

My view

FX is big business at the moment, and we've now got a fair selection of FX-related companies on AIM to choose from.

Unfortunately, I find it hard to distinguish between them all. This is not good - it means that I feel unable to predict which ones might be able to outcompete the others. I'm also concerned that some of them might be "people businesses" which ought not to be rated at a high multiple.

Nearly two years ago, I invested in Record (LON:REC) on the basis that it was "too cheap". Thanks to its recent share price recovery, and taking dividends into account, I've lost very little money on that investment. But it still hasn't matched my expectations. So I don't feel confident when it comes to the FX brokerage business.

For what it's worth, the P/E multiple here is in the region of 20x, depending on how you measure it. 

Good luck to all holders. I would be interested to read if someone think that this is the FX share to invest in, rather than any of the others.

---

Ramsdens Holdings (LON:RFX)

• Share price: 201p (+8%)
• No. of shares: 31 million
• Market cap: £62 million

Share price movement

I see that the Ramsdens share price fell over 10% since Monday, and has been recovering today.

The company is trading in line with expectations and confirms that it  does not offer "unsecured personal loans nor high-cost, short term credit loans as defined by the FCA".

Perhaps I should have mentioned this in my recent coverage of H & T (LON:HAT) (disc: long). Ramsdens doesn't have to worry about the FCA review of H&T's unsecured loans, because Ramsdens doesn't offer that product. Ramsdens mostly does FX, retail and pawnbroking.

Share can fall for strange reasons. Even when a company has done nothing wrong, its valuation can be affected by the fortunes of its peers

I continue to be an admirer of RFX, even though I actively support its biggest rival.

---

Innovaderma (LON:IDP)

• Share price: 63.5p (+1.6%)
• No. of shares: 14.5 million
• Market cap: £9 million

Launch of new Skinny Tan "Choc" range in Superdrug

IDP is switching the narrative away from recent boardroom developments (departure of the founder and sale of his shares) and back towards the product offering.

The innovative new range will add five additional SKUs to the existing 58 and will feature 'milk choc' and 'dark choc' versions of the self-tanning whip and instant tan melt. 

Apparently it smells great and offers a "deep golden tan".

The launch was covered by Metro, Daily Mail, etc, as various models/"influencers" made an appearance at the event in London.

A nice bit of publicity for the new products, which are exclusive to SuperDrug.

---

Out of time for today - thanks everyone.

Have a great evening.

Graham