Small Cap Value Report (Wed 30 Nov 2022) - IGR, MUL, LINV, KETL

30th Nov '22 by Paul Scott

84 comments 7585 reads

Good morning from Paul & Graham.

Agenda

Paul's Section:

IG Design (LON:IGR) - H1 figures look good, but the outlook is only for about breakeven for FY 3/2023, so I'm publishing the first part of this section to alert readers to this point - caution needed! The rest of this section is now up. It could be an interesting turnaround, especially if input costs fall in future, but so far there's not enough evidence to convince me. Plus there's bank refinancing risk to consider.

Strix (LON:KETL) - drops about a third today, on a profit warning. I raise several concerns over the historic accounts, so this share gets a thumbs down from me.

Graham's Section:

Mulberry (LON:MUL) (£150m) - disappointing numbers from this luxury handbags and leather goods company. It swings to an H1 loss and also suffers a large cash outflow as it builds up a large pile of inventories, betting on a big festive season. Expenses have ramped up across marketing, technology, and expanding the store network. It’s an ambitious plan and hopefully it will pay off over time with improved revenues and operating margins. We’ve seen false dawns here before and I believe that Mulberry should allow itself to be taken over by a larger group who can run it profitably. The shares are currently priced at a level where I think buyers would be interested, but it’s not clear if Mulberry’s major shareholders would be willing to let go.

Lendinvest (LON:LINV) (£113m) - the property investment platform and lender confirms its H1 numbers and leaves its expectations for the current year unchanged. It no longer expects any improvement in PBT for this year, but it thinks that the issues are temporary and that it can get back into a strong growth trend in FY 2024. I’ve reviewed its key numbers and am disappointed that it hasn’t already securitised more of its portfolio, in order to reduce its own leverage. As things stand, it remains very highly leveraged and I’m concerned that its balance sheet would not be able to withstand a few more heavy blows.

Explanatory notes -

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bensummers

30th Nov '22

no for me it is the wrong time to buy. You can't keep upping prices forever - everyone is feeling the pinch including rich people. I think a lot of people are sheltering in those 'blue chip' stocks and it is a false sense of security.

BnB

everyone is feeling the pinch including rich people

Where is your evidence for this assertion? The nature of inflation is to disproportionately affect those of limited means. The genuinely wealthy are relatively untouched. Even today, employment opportunities and wage rises for highly skilled professionals - one (rather poor) definition of “rich” - are red hot.

This “pinch” you refer to is not showing up in the sales figures of LVMH and Hermes, Ferrari and Porsche. One of the reasons is that genuine luxury businesses constrain supply such that demand almost always exceeds their sales objectives. This protects margins and volumes. Bernard Arnault is the second richest man in the world. Think like him or simply ride his coat-tails!

Mark L.

The directors' dealings section is useful feature of Stocko. Companies are obliged to issue an RNS for every directors trade. Trouble is this swamps newsflow with (mainly) trivial trades such as DRIP investments. It would be nice to get alerts say for major trades e.g. £>50K worth.

epo001

Of Paul's 5 opinion bullet points, the first 2 can be de-emphasised because of 0% corporation tax? Point 4 I don't really follow, isn't capex good if it helps the business?; though declining, free cashflow is still positive. Debt? Yes, too high. Dividends? Could get cut.

I think this share is in the doldrums now and am going to cancel my 70p limit buy because I think it may get cheaper, especially if the big holders decide to reduce. Hindsight as always is wonderful, I should have sold in January when I was in profit.

MichaelFBS

I follow Jake Taylor @farnhamjake1 on Twitter and when I get the time listen/watch the Value:after hours podcast. Jake recently (I think yesterday) launched Journalytic and while I have only just signed up, it does look like the service I have been looking for and have tried to solve previously with a blog, OneNote, Evernote etc but never with great success.

Anyway as I thought it might be of interest to readers here.

It can be found at

https://journalytic.com/

Kind regards

Michael

mojomogoz

Late to catch up today and I see its a Strix (LON:KETL) day on the board - got no view on that but will take a look given the battering! Ouch

I see a couple of comments on System1 (LON:SYS1) which is a bit of a let down too. I know it had people interested back a while but that's cooled. People sceptical here. I'm interested in any further pro or con comments people have?...

I note that this half year cash generation poor they have net capitalised £600k of software development (they don't normally) plus net working capital draw on cash as they met payables and had net increase in receivables (to be expected with their move to data services?)

I don't have a view other than something could be very good or bad here...bit of a brainjuicer to work out (my biz model knowledge here is low at mo...wondering whether to look).

Boon

If the Mulberry (LON:MUL) product is good, and the brand has pricing power, then I'd argue that it is the best investment. As all they need to do is crank up the branding investment and marketing. And those are not rocket science.

Tanglands

lendinvest

My limited knowledge of this market place and the companies structure, is that their funds borrowed, are fixed , in that daily they require an interest payment, but the deals they fund for their clients, have a shelf life, 12-18 months. So cost of capital is fixed but income is based on constant tread mill of new deals to ensure that all money is “ placed” in the market. This menas their model is like a hamster on a treadmill, every deal that redeems needs to be matched with a new one to ensure the funds are constantly,earning to pay the cost of borrowing. So interest rates, although a concern, are not I would suggest the biggest.

NeilS

Coincidentally, I have been amazed at how well shares in a fund called GAM Luxury Brands has held up despite goings on in China and of course the Russia situation. (I hold)

I just looked quickly at Strix (LON:KETL) for first time - one I have avoided as didn't make sense in past. Some Qs and points:

1) Is there potential for debt covenant stress here? Its got to be at around 2.5x ebitda and above (particularly depending on how adjustments are taken)

2) I don't feel their narrative re what's gone wrong on revenue side makes a lot of sense. They are basically saying that covid zero has bitten them as people can't work and make stuff. IMO to date manufacturers/exporters have been able to negotiate this. Local and central govt is very aware of the need for maintenance of these sectors and the forex they bring in particularly as the domestic economy struggles with real estate very sick and infrastructure non productive (both grossly bloated part of GDP and so the pain is acute). It seems more realistic that something additional is happening -> my guess is that the kettle market must be v exposed to the inventory de-stocking we're seeing + which might be exaggerated by appliance makers perhaps over ordering parts like those that Strix supply when supplies were tight relative to exaggerated demand + strix is in a very narrow vertical so no chance to diversify out of it (I know they've diversified thro acquisition etc so my analysis is flawed)

3) Does 1 and 2 above put some pressure on capex plans. They way to make profit and keep covenants sweet would be to not spend so much on capex. Is this a positive or negative if they do that?

4) I have not view on their patents and their importance or defensibility thro superior production knowhow. However, the rather mad dash for growth thro other channels and acquisitions might be explained by concerns of impact of patents coming off? I'm not 100% sure where their capex goes but if into kettle switches then that could be they think they need automation to defend market share when more competition comes on after patent expiry and/or the need to invest in other products.

5) I was quite frustrated not to be able to find a regional split of sales easily on the company. But I suppose its near all China and then the finished product made by OEMs sold on. I was looking to see how much China is the end market for the products their parts are used in. Massive tea drinking country. With covid zero and quite harsh personal finances going on there I could imagine a fall in demand for appliances like kettles or water purifiers etc. Any views or data on that?

The above is quick very partially informed analysis. I'm interested in feedback and/or to be put right on matters

Hello re D4t4 Solutions (LON:D4T4) - why has it got so much cash?

Hoarding over the long term? On a quick look it doesn't look like a company making cash in excess of reported earnings.

1st Dec '22

But all the brand equity at Mulberry is concentrated in one label, which makes for a much riskier proposition, not to mention that the management at LVMH is evidently vastly superior. Compare Kering, whose revenues are virtually all from Gucci, to LVMH to see how this plays out over time. Sure, it could be a good trade over the short term and if a bid comes through. But I’m investing on a 10 year horizon.

jimbr

In fairness the management team did purchase 0.322m shares in the October rights issue at a cost of £0.37m. That counts for something Id say.

illiswilgig

D4t4 Solutions (LON:D4T4)

Hello Mojo. On the nail. As usual.

It's an intriguing one. And a relatively recent buy for me. Not sure that it has got so much cash. Yet. It’s cyclical and growing. Which makes it hard to judge the level of excess.

Net cash jumped from £11m at March year end to £26m at end of Sept.

Post period end a special dividend of 12.5p returned £5m.

I expect a similar cycle is underway through H2 as cash outflow covers costs while invoices raised towards year end are not received until after Mar23 (H1 FY24).

Caused by transition of the business from:

Legacy hardware sales to a software business
3^rd party IP to higher margin own IP
Perpetual licences to ARR licences
Increasing sales of new products through partner channels (Pegasystems/Teradata)
and as if that wasn't enough the Pandemic caused a shakeout/pause of customer base and growth.

All of which tends to obscure progress made within the business. It’s this lack of visibility which has made me wary of the shares, though I like the new management, product and the market opportunity. At the same time the shares are not cheap.

The relationship with Pegasystems/Teradata is powerful but not ideal. Standalone products that can be marketed directly have been developed. API, cookie-less data option, Cloud implementation released and recently an app launched on the Salesforce platform. An experienced sales/marketing team has been acquired/brought in-house for the direct sales channel – all of which will increase costs in the short term, but places the company in a much improved position in the medium/longterm.

I like that the transition of the business and the market opportunity are being funded from the legacy business and is already profitable with plenty of cash backing. Probably enough to allow an acquisition if one presents, though they say thats not the case at the moment and are focusing upon their product development and launches.

But not cheap. I guess it all depends upon whether you like the management, products and market opportunity? I do, but not at any price – so I’m hoping for some weakness to increase my holding on current progress,

cheers

Mark

Thanks Mark. I don't know its history well and haven't read much.

I felt cautious on Bill Bruno instinctively when he joined. Nothing particularly wrong with him as a person but he seems a real sales sort of guy (the kind that will be positive and push on no matter what) and that felt a little at odds with a business that (from my unknowledgeable position!) seemed to be going through a rather technical and protracted transition and maybe needed something more conservative at the helm for a little bit. It's not a strong view just a vibe and if I'm wrong about where they are or on who Bill is then Mr Bruno could be the very right guy for the job. Just one of those intangible feel things...that are often wrong.

A more generic doubt I have is around their products and how they are positioned to sell them (again I emphasise this is poorly/partially informed). Do they have 3 products or 1? I kind of feel that unless they are selling one core product then they are ducking and diving around what companies need/want rather than hitting the main vein. Rolling out bits and pieces of solution rather than the solution. That makes me think that they have product that is reactive and therefore ultimately they will do a lot of defending around rather than product that is leading and continually makes its own case in use...so selling itself. We know that once IT systems are in place they tend to be sticky regardless of true necessity or essentialness as its becomes hard to change...but if you aren't holistically burning the path forward then you are always going to get chipped hard on price or what you provide for the price. A hard downturn or an innovative solution (independent or embedded in something else) could push down hard on their prospects? Or clients just drift away over time. Do they show real pricing power? Have the migrated and raised prices without significant client losses (numbers as much as value tho latter more important particularly if they cleaned out dead wood clients)?

The app/partnering with Salesforce (I believe it means they are in the ecosystem and that other 3rd party marketers on the platform might now sell them on to end users. rather than Salesforce selling them?) - I kind of see this route as okay to test and develop new product at low cost before you have the sales force and channels in place but a weak way to sell established core product. Again pushes my concerns re how well positioned their products is.

The own vs 3rd party IP thing confused me a little as to why it is so meaningful in terms of short run margin. Again probably my lack of knowledge (not deep dived) but it makes me feel anxious about where they are positioned with clients.

The above is all drive-by banalysis that is picking holes. It shows my dissonance in looking at them and maybe not getting it...plus having a reaction to Bruno (that could be very unfair)

2nd Dec '22

Oooh, Errr, Mojo!

Interesting, Based upon that I've no doubt that you are better off to keep on driving

For me? That's given me plenty to mull over. It's certainly not without it's issues. But then what is? Despite that it might still be an opportunity, at the moment they seem to be making good progress but I'm still not totally decided one way or another and will be watching continued progress closely.

As for Bruno. If you've not already done so I recomment that you - do not - listen to his podcast or look up an image. It will only serve to reinforce your preconceptions?

I've watched/listened...I don't dislike...I specifically wonder whether he's what they need...are they ready to sell like he wants? Do they need and integrator and base builder preparing the ground more for a growth push? If they are ready to push on the sales front then he's the type of guy.

Overall, my views are weakly held. The case just jangles in my mind rather than congeals.

Bill Bruno’s LinkedIn profile hits all my “businesss bollocks bingo” tests. He is “humbled by his appointment”, “passionate about data” and asks us to “reach out to him”. Textbook fail.

Haha. There can definitely be a culture difference and personally I put it down to that and that he's a sales guy (from other side of pond!). TBC I like the guy (he's defo got a sense of humour too)...its more about the company and where its at and whether he is the experience and skill set D4t4 Solutions (LON:D4T4) needs or is ready for...

...so I say all this fishing for someone to give me a comprehension of why D4T4 is the right biz at right time...not trashing at all -> I can see there could be something here. But I've laid out some of the (partially/poorly informed) things that hold me back. Maybe there's a presentation that answers a lot of this? (I did watch something this year)

Zorbatheleek

7th Dec '22

£KETL "No corporation tax payable - why? Are the profits real?" ... I believe the company is based in the Isle of Man therefore an offshore jurisdiction that has no corporation tax

Small Cap Value Report (Wed 30 Nov 2022) - IGR, MUL, LINV, KETL

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Paul Scott

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