Small Cap Value Report (Wed 22 June 2022) - VTU, CHH, SYS1, UPGS, IQE, MCRO

22nd Jun '22 by Paul Scott

45 comments 8247 reads

Good morning! It's Paul & Graham again today - the new normal, now Jack has moved on to a job in the city. Hopefully he'll let us know how he's getting on!

Grim market conditions continue for now, but we're finding bargains almost on a daily basis, for your watch lists, or brave purchases that could be the multi-baggers of the future. It's the work done now, which I think will lay the foundations for the next period of out-performance. The only thing we don't know, is the timing.

Mello show tomorrow - this one's free, and the content looks interesting, from 12:30. I tend to put on my bluetooth headphones, and then wander around doing other things whilst listening to webinars, which is a good use of time.

Agenda -

Paul's Section:

Vertu Motors (LON:VTU) (£189m) (I hold) - strong trading continues, although the company is coy about raising guidance again, due to consumer uncertainty. It says supply of new cars is expected to gradually improve in the coming months. Exceptionally cheap value share, strongly asset backed too. CEO previously said sector consolidation is inevitable, so prospect of a takeover bid looks high.

Micro Focus International (LON:MCRO) - amongst the top fallers today, it's rapidly approaching small cap territory from the wrong direction. The ultra-low PER indicates that something is badly wrong, which it is - a $3.65bn debt mountain. This looks precarious, as a result. The business itself looks decent, but equity seems at risk of being engulfed by the higher-ranking debt holders. A special situation, only for experts who know what they're doing, I would say.

Graham's Section:

Churchill China (LON:CHH) (£154m) - This year’s AGM statement guides for year-on-year improvement in 2022, with the company experiencing record demand. The trends in hospitality remain positive and this bodes well for Churchill. Against that, I have some concerns that inflation may affect the company’s margins and profitability in the medium-term. Real profitability may not reach pre-pandemic levels until this situation has normalised.

System1 (LON:SYS1) (£36m) - this advertising consultancy announces that future distributions will be made in the form of share buybacks or tender offers. While this won’t be to everybody’s taste, I think that it signals intelligent leadership. When combined with the announcement of a one-off tender offer, I think this company is showing excellent shareholder…

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ACounsell

22nd Jun '22

Appreciate this is a macro comment and not small cap specific but an announcement from one of my European holdings £UMI illustrates the problems facing companies and the shift to a 'greener' economy. Also politicians are encouraging business investment but where is the incentive for companies when short termism in the financial markets hammers the companies share price:

LONDON, June 22 (Reuters Breakingviews) - Investors in Belgian’s Umicore UMI.BR have sent a worrying message to heavy corporate spenders. The 8 billion euro chemicals and battery-materials supplier on Wednesday lost more than a tenthof its market value after pledging 5 billion euros https://capitalmarketsday.umic... outlays over the next five years. The capital expenditures, roughly double what analysts expected according to Refinitiv data, are supposed to help the group meet rising demand for electric-vehicle batteries and their component materials. Chief Financial Officer Filip Platteeuw said at an investor event that Umicore could potentially raise equity to pay for the investments.

It’s a cautionary tale for carmakers, renewable-energy companies and other industrial groups that are also on the verge of an investment splurge to fund the move away from fossil fuels. Umicore reckons the new capex will help it to more than double revenue by 2030. But investors seem to be ignoring those long-term benefits and focusing on the near-term pain. Umicore’s shares are down 30% in a year. Its enterprise value is less than 8 times 2021 EBITDA. The lesson is that ramping up spending in a bear market can be costly. (By Liam Proud)

There may be a read across for large oil & gas players as well as the miners who are aiming to ramp up investment in renewables. Their prices are down significantly today too though it is difficult to disentangle the causes. Take your pick form short termism, inflation, falling oil price, looming UK recession, war in Ukraine, slowdown in China - perfect storm anyone but there must be buying opportunities somewhere!

Nanotrader09

Doesn't the yield depend on when you bought though? E.g. you bought when the yield was 3% but the share has tanked so the yield is now 7%. You are still "only" getting 3%!

Bouden54

Liontrust Asset Management (LON:LIO) As a fund manager, share price performance heavily correlated to equity markets - so will recover when markets recover. No idea when that will be, but doesnt necessarily mean we have to wait a long time - sentiment can change pretty quickly. If markets get a sense that US inflation is heading back down then we could see a big rally IMO

rmillaree

K3 Capital (LON:K3C)

Apologies bit of a rambling post this one - hey ho i aint done much rambling recently

I think the thing is with part people businesses should one expecting to pay any more than 10 * earnings ever?? . Even though they say they are more than a people business facts are i suspect the peeps that know the business inside out could easily depart and set up in direct competition and make good inroads into the "profitable stuff" that this company does. It doesnt even have to be someone internal - another company happy to be slightly cheaper than K3. I have so often seen these business types go off the rails quick when it all goes wrong - presumably the egoes at the top as soon as things are tough they may be looking to find something less tough - presumably if they dont get chomping payrises they may be tempted top lok at waht can be had elsewhere.

I am probably being over cautious but as soon as i hear the term "exeptional" used with regard to current trading - as K3 have done. I immediately take them at face value and presume we should not be expecting the current exceptionality. Ok the outlook is fairly positive at present but if they didnt see rersults as being "exceptional" as per the dictionary definition why use that word? . Personally i think this word is perhaps used too often in updates - but when it is no sour grapes later on if results arent repeated you were warned !

It appears to me that sellers aren't selling based on fundamentals

With current market cap 172 mill and expected net profit ye 31/5/2023 of 16.5 mill It seems a nice hold IF you are comfortable with the people element and possible "peak earnings now" risks. The company does not strike me as being obviously undervalued though so its no surpise to me that peeps may sell despite the fundamnetals being what they are - decent chance to "revalue" when/if they continue in upward trend ref results but at present there is enough question marks to make me not presume a return to highs should be expected until they deliver higher profits and no bad news. I think its reasonably obvious we should not be expecting "market froth" that has existed previously to return anytime soon.

Ref worry about shares being cheaper tomorrow i dont think anyone knows - i would say i had not noticed till today that dividend yield is now 6.6% - i suspect until they have some bad news i would be surprised to see this one go below 200p and would guess that 6.6% yield may be enough bribery to limit chances of further declines from where we are now until peeps worry about the next update. Must admit if i did hold this share i would be watching like a hawk and quick to ditch if the newsflow turns for the worse.

simoan

RE: Vertu Motors (LON:VTU)

Maybe it’s just me, but when I read trading updates I’m always looking for the dog that’s not barking. We all know pretty much where interest rates are heading to combat inflation and that the splurge of spending on cars in the past few years has been fuelled by ultra cheap contract finance.

Surely much higher car finance costs driven by higher interest rates, at a time when consumers food and energy bills are increasing must greatly affect car sales, regardless of availability? For me, availability as mentioned by Vertu Motors (LON:VTU) is now largely irrelevant. Affordability is everything and cars will become much less affordable going forwards.

All the best, Si

Revs8

True but I bought the 2 mentioned above at less than their current price.

I don’t disagree but what more can companies do to reassure investors? They report past figures that are above expectations and tell us that forecasts profits look good.

There appear to be many companies who are not yet seeing the downturn that investors are pricing in and maybe won’t?

In the case of K3 Capital (LON:K3C) they might actually see more business in a downturn. Photo-Me International (LON:PHTM) are growing their launderette business rapidly. Not a discretionary spend.

At some point I hope the better companies will start to differentiate from ones who should have gone long ago.

Camtab

If anyone is interested in Record who announced good results yesterday but missed the Company meeting today II thought I would just pass on a few notes. The meeting was attended by Leslie Hill CEO and Steve Cullen FD. I really like Leslie in particular she is transparent, keep things simple and clear which is a big tick for me. There was a bit of talking over one another which I hope isn't a sign of competition or bad will. It looks to me like it is a good management team. Brief remnder

AUMe +4%, Revenue +38%, Op Margin +7% (31% - big one for me!), Basic EPS +64% at 4.52p putting them on PE of 16 times. Final div 1.8p +57%, Special Div 0.92p +104%. The Board like to deliver a dividend of 70 to 90% of earnings. The investment summary is this is a growing business as they diversify from Foreign Exchange hedging to other asset classes with a growing dividend. Whilst they never say never they do have enough cash and cashflow to deliver their plans as they exist at the moment.

They have three main development pillars. 1) Modernise. A lot of their software and tech had fallen behind and they have spent much time catching up. They believe they have made good ground with introducing the cloud, better tech and new software. Software is getting cheaper. They have a budget for constant development. 2)Diversification. As were, was a currency niche. Hard to make progress of any form in this niche given commoditisation. Whereas used to sit down as a sales team discuss potential attractive ops, they now allow the customers to lead their product ops. Diversifying out across asset class, geography and staff. Pillar 3) Continue to work on succession plan. Leslie believes she has the right people in the right roles now and has to ensure they keep them.

That lead to a question as to whether the company is prepared to allow the savings scheme for staff to dilute the share holding. Steve answered they had always bought through the market and didn't have any plans to change this. Although they do have the freedom through their articles to issue up to 5% if needed.

Leslie explained her targets through to end 2025. She said these are based on real opportunities and not just numbers picked at leisure. She expects revenue around £60m (currently around £25m) and Op Margin 40%. So that would bring in profits of £24m (my estimate) with no impact on share numbers as enough cash. Currently in the £7 to £8m range. So this is a significant growth story if you believe the management.

A question was raised about the current rocky situation and how it might affect the company? Leslies response was diversification is being planned for that purpose. They also use hedging to reduce issue. Steve added that the underlying client portfolios are well diversified in 2020 when markets fell 20 to 25% their portfolios fell around 7%.

They talked about current clients in relation to how they work with them. But clear they have good long term relationships. 42% of the clients of the clients have been with them longer than 10 years. A further 18% have been with them more than 6 years. Their top ten clients represent about 73% of management fees covering 4 different product categories. So I would say still work to be done here.

Their Passive hedging product represents 35% now of management fees. In 2020 that was over 50%. At the same time dynamic hedging has grown from 17 to 29%. Currencies for return from 9 to 16% and multi product has fallen from 22% to 20%. Clearly progress is being made to higher margin products.

So how is inflation going to affect them. As a business their main cost is salaries and to keep staff they will have to keep up with inflation was my read so that 40% margin may be a bit hopefull!! Very hard to pass that on. That said they are growing the business, they don't have legacy issues other fund managers may have. They have now launched the German Municipal Fund and whilst it has taken time they believe it will grow quite fast. They are looking at a Sharia type investment with a client which is interesting.

My view for what it is worth. I have decent holding and won't be selling. Hope someone gets something out of this.

yiannos1

Just have in mind that the Chrysler group was one of the best performing stocks during the last inflationary cycle.

Vertu is a growing company with serious people that manage it and deliver returns for its shareholders.

Looking (deeply) at the balance sheet , the company will use another £35m for the next three years for buybacks and thus cancellation of its shares.

Adding to that the dividend will grow to at least 2p per share, making the total returns to its shareholders ( plus buybacks )of around £60m for the next 3 years.

This is an amazingly cheap share and I will continue buying.

Snazzytime

hi Camtab

Record (LON:REC)

Thanks for your very useful summary.

I also watched the presentation and agree that there was much talking over each other. Additionally the sound quality was poor with an off putting room echo and much banging of coffee cups on the table (too close to the mics) so it was hard to pick up what they were saying at times.

For some reason Leslie was determined to answer questions as the presentation continued with the result that it became a hotchpotch of a presentation (skipping and missing many slides) interspersed with answering questions in rather random fashion. All very ad lib and most unsatisfactory.

They need to sort this out and revert to the standard pre-prepared company presentation style of CEO opening remarks / CFO financial review / CEO Strategy / Q&A's.

Despite all this I am positive about the company's prospects in pivoting to higher margin asset management products. Their prospects look encouraging, much in line with Graham's comments on here yesterday (I hold).

Actually, it was amazingly cheap when I bought at 22p and it wasn’t discussed on this blog. I get the discount to NAV but that didn’t stop it tanking last time.

Sorry but I don’t understand how the rest of your reply relates to the point I was making about affordability and the loss of cheap finance. I know people who don’t have two halfpennies to rub together driving round in new cars. Something has not felt right about this for ages and some kind of car finance mis-selling scandal down the line would not surprise me at all.

peterg

Yes, and no! You're only getting 3% on what you paid, but you are getting 7% on what you could raise by selling. It's the latter I'd be more likely to take into account in deciding should I stay or should I go. That's what you need to compare with alternative homes for the, reduced, cash now

Greedo

I guess it also depends if you DRIP.

Your reinvestments would yield 7%.

Paul Scott

Hi RDHowarth,

I don't know much about Berkeley group (LON:BKG) but had a quick look at its accounts this morning. Outlook said something like, nowithstanding all the macro uncertainties, we're in a great position. Very strong balance sheet. Explicit about future shareholder returns. One number jumped out at me, about (sorry this is from memory) £8bn in build-out gross profit. I've not seen housebuilders disclose that figure before.

Historically, periods of higher inflation saw nominal house prices go through the roof. This time, house prices are starting out at a historically high price to average income level. So that might drop, offsetting the nominal rise in average incomes (remember incomes are rising about 7% nominally p.a. right now).

In the last 2 recessions, housebuilders almost went bust, as they had to write down land values, and had problem levels of debt. That's not the case now, some are even holding net cash, or very little debt.

Overall then, I struggle to see house prices dropping much, if at all. There's such a shortage of decent housing. Also, personally I don't believe bank base rates are likely to get anywhere near the inflation rate, so depressed housebuilders shares could turn out to be decent investments from here, if my theory is correct!

Regards, Paul.

Surrey Steve

I too listened to the IMC presentation given by Record (LON:REC) which I hold.

I thought that Leslie's confidence had grown since previous presentations and while acknowledging that they skipped around a bit, they seemed keen to answer all the questions in a very open manner which should be applauded. I think that the dynamic with Steve works well and they work well together as a team. I did not pick up any contradictions, just an appetite to explain.

The stating of their targets for FY25 gives a useful underpin to the detail on how the strategy has changed since Leslie took over,

GN100

Nanotrader. This argument gets aired regularly. Historic yield is almost irrelevant - it's boasting points down the pub. If the SP has dropped, all things being equal, then ergo - you must have an increase in yield. Now you reassess the share, could I get a better return elsewhere. Your choice, stay or go. The reverse applies - the SP rises and the yield drops, and now you have a capital profit. You reassess the share, could I get a better return elsewhere. Again, your choice. Take the capital profit and look for a better home for the money or stay.

Of course, it's not quite that simple in real life. Emotion (kill that!) comes into play plus your view of the future of the share. Happy investing!!

Boon

You can't say Photo-Me International (LON:PHTM) has been disappointing after the TU and expectation upgrade. It went from 70p before to now 77p. Granted, it overshot to 84p but you have to ignore that, unless you were actively trying to sell right after the results. Market volatility will be a fact in these crazy markets, both up and down.

I'd argue that PHTM is still too reliant on photobooths for profit. I know Paul mentioned like c30% EBITDA from laundry operations that is fast growing. However, that 30% number I believe is from last FY (until Oct21).... when photobooths did almost zero revenues. I'd argue that the HY22 results, with the photobooths revenues surging, will probably see laundry at c.15-20% of total EBITDA.

Metatron

If you are on Linklin there is a good 25 min podcast on Photo Me 'The Private Investor' with Mark Atkinson.I am a holder as the CEO has put millions into the business recently and although 79 yrs old his CV is worth respecting

Bagash

Paul, buybacks are fine as long the bought shares are canceled. Putting the in the treasury to reward to Board, later on, serves no benefit to the ord shareholders!

23rd Jun '22

Hi Bagash, I think that the context is critical.

If the shares are simply bought and given to management then I agree wholeheartedly with your comment.

If there is a well thought through equity element to senior management remuneration which both helps to retain key executives and aligns their interests with other shareholders then I think that the holding of shares in treasury is useful. Doing this can prevent shareholder dilution (cash is paid out effectively rather than shares) and can be used to support the share price during periods of weakness/undervaluation.

I put Record (LON:REC) share purchases in the later category.

Small Cap Value Report (Wed 22 June 2022) - VTU, CHH, SYS1, UPGS, IQE, MCRO

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Paul Scott

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