Small Cap Value Report (Weds 21 April 2021) - JOUL, 95% mortgages, CARR, AIR, SYS1, NEXS, HSP

Good morning! It's Paul & Jack here with the SCVR for Wednesday.

Timing - today's report is now finished.

I had a couple of nice surprises, when recently booking a hire car online for a trip to see family. It turns out that 3 of my driving licence points have expired, so instead of having 6, I now have 3 remaining! Or in shares parlance, "broadly in line with" a clean licence. Also, it turns out that I'm 52 years old, whereas I've been telling everyone I was 53. Many thanks to Thrifty car rentals for spotting this anomaly. So I've gained not only a more relaxed journey up to Cheshire, but also an extra year of life. Not bad for a few minutes work on the internet!

I think we're seeing a bout of profit taking - lots of smaller cap stocks seemed to drop back a similar amount yesterday in particular. That makes sense to me - prices have run too high in many cases, in my opinion. I trimmed back some of my geared positions, as it's not a good idea to go into a downturn highly geared. Also, I tend to go through my list of positions, and periodically top slice the ones that have done well, or look over-priced, or ditch them completely where my conviction is low.

The coffee can idea (in 100 Baggers book) is great, but it's not compatible with using gearing.

Agenda -

Paul:

Joules (LON:JOUL) - comments on the secondary placing yesterday - founder Tom Joule top-slicing his shareholding a bit. No discount, and an honest reason given for the sale - take a bow Peel Hunt!

Overview of the new 95% mortgage guarantee scheme.

Carr's (LON:CARR) - solid interim results. Outlook sounds positive. I like this - looks good value, for a resilient business.

Air Partner (LON:AIR) - issues a "Reach" (i.e. PR) update re its private jet division. Quite interesting.

System1 (LON:SYS1) - An upbeat trading update, has pushed shares up 25% today. Potentially interesting, although I have some quibbles with the way they adjust profit!

Jack:

Nexus Infrastructure (LON:NEXS) - good growth in the group's early-stage electric vehicle charging business, but work to do at its more established (and much bigger) civil engineering division.

Hargreaves Services (LON:HSP) - special situation. Ex coal miner now focusing on industrial services, with an outperforming brownfield land joint venture in Germany and an improving cash position.

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Paul’s Section

Joules (LON:JOUL)

(I hold)

240p (up 3%, at 08:41) - mkt cap £266m

My heart sank yesterday afternoon (13:00), when an announcement from this owner-managed fashion brand came through - a proposed secondary placing (i.e. a partial sale of the founder’s shareholding). The share price immediately dipped, but when the deal was successfully completed, recovered. This morning it’s actually risen, so looks like this deal has been expertly handled, and well received. A few key details -

• 5.25m shares proposed to be sold (111.24m total in issue, so this sale is 4.7% of the total - not a lot really for a placing)
• The selling shareholders are founder Tom Joule, and family trusts
• Tom Joules shareholding: before - 26.5%, after - 21.8% - so he remains a major shareholder
• Accelerated book build, as is usual, conducted by broker Peel Hunt - these are usually a done deal by the time they’re announced, and the result was announced less than 2 hours after the first announcement
• Result - all the 5.25m shares were sold, priced at 232p - no discount, so clearly there was good demand from Instis & HNWs (high net worth individuals)

Reason given for the partial disposal by the founder - terrific stuff! Finally, an RNS that is truthful about the reason for a disposal (none of this "to satisfy institutional demand" rubbish -

This proposed sale is aimed at achieving greater portfolio diversification on the part of Tom Joule and the discretionary trusts. Tom Joule last sold shares in Joules in 2016.

My opinion - this was handled very well I think. Getting the shares away in full, and at zero discount, is impressive. That’s encouraging because it suggests there were backed up buyers not able to buy in size in the market, who were keen to pick up blocks of shares when offered.

Personally, I don’t have a problem with founders trimming their stake. Tom Joule going from 26.5% to 21.8% means he still has a very substantial amount of skin in the game, and I don’t begrudge him top-slicing his holding. Some people are suggesting that worries about Capital Gains Tax being increased might be driving the recent spate of founder sales. That and buoyant stock market prices of course.

I am awarding the SCVR inaugural order of merit, to Peel Hunt, for their clarity, and honesty, in providing the reason for the sale as being the founder wanting to achieve greater portfolio diversification.

Usually brokers use that awful (and untrue) statement that a secondary placing is being done in order to meet institutional demand. We all know that isn’t true, so stop using it everyone! I am delighted to see Peel Hunt break the mould by providing the true reason for the founder selling some shares.

Here is your award, I know you’ll treasure it!

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95% Mortgage Guarantee Scheme

Click on the title above to see the Gov.uk announcement from 2 days ago, re the launch of this scheme. This looks significant, and could be a good catalyst for renters becoming buyers of residential property, given that the difficulty in raising a deposit is the main impediment, especially for younger people.

Key points are -

• Up to £600k property price
• Taxpayer guarantees the 95% mortgage
• Can fix rates for up to 5 years
• End date (if it’s no extended) is 31 Dec 2022
• All homes, not just new build (so much wider in scope that Help To Buy scheme)

How it works -

The government will provide lenders with the option to purchase a guarantee on the top-slice of the mortgage. In other words, the government will compensate the mortgage lender for a portion of the net losses suffered in the event of repossession. The guarantee will apply down to 80% of the purchase value of the guaranteed property.

The guarantee will be valid for up to 7 years after the mortgage is originated, evidence shows that loans are unlikely to default after such a period has elapsed.

My opinion - this seems likely to unlock the housing market, since lenders generally withdrew 95% mortgages after covid struck in March 2020. New 95% mortgages using this scheme are now available.

I imagine this could have good read-across for many companies involved with the housing market (estate agents, housebuilders, building supplies, home improvements, interior furnishings, etc). We'll have to put on our collective thinking caps to determine how it might pan out.

So it sounds bullish for our investments in those areas.

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Carr's (LON:CARR)

148p (up c.8%, at 10:10) - mkt cap £136m

Interim Results

Carr's (CARR.L), the Agriculture and Engineering Group, announces its Interim Results for the 26 weeks ended 27 February 2021.

"An improved H1 performance in a challenging environment"

The financial highlights section has grabbed my attention, this looks good -

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I particularly like the big reduction in net debt, I’ve highlighted above.

Also a modest increase in adj EPS strikes me as good, considering the last year H1 period would have been just before covid started having an impact. Therefore this looks a resilient business.

The statutory figures above are very little different from the adjusted numbers, giving me confidence that the adjustments are small, hence reasonable & don’t need investigation.

I like this bit -

• Engineering adversely impacted by low oil prices and travel restrictions in H1 but expected to be significantly better in H2. Order book now stands at £44m, increased by 19% since year end and order intake now improving.

Outlook section says -

A continued positive performance is forecast across the Agricultural divisions together with an improved second half in the Engineering division as the impact of COVID-19 begins to recede and its order intake continues to increase.

A programme of simplification and standardisation is forecast to improve performance over time.

Trading since 27 February 2021 has been positive and the Board's expectations for the current financial year remain unchanged.

What are expectations? The current financial year is FY 08/2021. Edison has issued an update note this morning, forecasting a 2.5% rise in adj EPS to 12.2p for this year, rising to 13.0p next year. That's a PER of 12.1, dropping to 11.4 - good value in an expensive market.

There must be H1 seasonality, since it has already achieved 8.2p in H1 - probably due to higher sales of oil in the winter? I’m guessing there, but it rings a bell. Looking at the divisional breakdown, the bulk of the group profit comes from animal feeds, which is surprisingly high margin at about 20%, I would have expected that to be more competitive, and hence lower margin.

The engineering division makes a very small profit (only £0.9m in H1), could that be an opportunity for future earnings growth, if more business is won & profits rise?

Note that broker consensus forecasts have come down quite a lot. Could this provide upside opportunity in the coming years as covid retreats we hope?

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Balance sheet - a quick check here. Overall this looks strong, but with quite a few unusual items in there, e.g. a £7.8m pension scheme asset, Associate & JV assets, significant non-controlling interests. All of which would need checking out before committing money here.

So overall, a big, and quite complicated balance sheet. But the bottom line, is NAV of £136.6m , less intangibles of £40.6m, gives a very healthy £96m NTAV.

It’s a capital-intensive business then.

Stockopedia gives it positive quality scores for ROCE & ROE, but not for the low operating margin. I think that might be because of pass-through revenue though, as the main animal feeds business actually produces a high profit margin of 20% as mentioned above.

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My opinion - I think this looks good.

A decent business, at a reasonable price - so a nice share for value investors.

To find other shares like this, click on the image below (taken from the StockReport), as CARR qualifies for the John Templeton Bargain Screen, although looking at the shares chosen by this screen, nothing jumps out at me as worthy of further digging.

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Air Partner (LON:AIR)

76p (up 6%, at 12:24) - mkt cap £48m

This is a “Reach” announcement, i.e. non-regulatory, PR type announcement.

It says that customer activity in its private jets division are picking up, in the UK & USA, with deposits & bookings up.

AIR’s JetCard product allows customers to buy jet flying hours up-front, at fixed rates, then use them on a flexible bookings basis. Sounds good.

This is an interesting point that I hadn’t thought of before -

The US private jet market is one vast, domestic market so it has not been subject to the types of restrictions and national lockdowns that we have seen in the UK and Europe. As a result, the skies have remained open and we have seen sustained private leisure flying from high-net-worth individuals in the region…

The pandemic has really shone a light on the benefits of our JetCard product: for those who are able to reserve private flying hours in advance, it offers unparalleled flexibility and access to a private jet at very short notice. This means it is proving very popular among customers who want to know they can travel easily and safely when lockdown restrictions lift."

My opinion - I thought I had some AIR shares in my portfolio, but they’ve gone, so I must have sold them on a pruning of my positions, which happens from time to time. Pity, as this looks quite good, and the chart suggests that it might be overdue a surge like everything else has seen in the last 6 months?

There could be a trade in this, anticipating it having another go at getting to 100p perhaps?

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System1 (LON:SYS1)

238p (up 25%, at 12:35) - mkt cap £30m

A quick comment on this minnow’s trading update today.

The following relates to FY 03/2021 revenues:

• H2 good - up 8% on H2 LY.
• H1 was bad - down 26%
• Full year down 11%

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That’s not bad, a decent recovery in H2.

How about profits?

We expect to report a pre-tax Adjusted Profit (which excludes impairment, share-based payments, government support, bonuses, loan interest and certain provisions) of some £2.9m for the full year (FY 2019/20: £2.0m).

I think that’s taking adjustments beyond breaking point! Share-based payments, and bonuses especially, are payroll costs, so can’t just be ignored! Also loan interest is an undeniable cost, why would we ignore that? As for Govt support, it depends what was received, so I’d want to see the detail on that.

Therefore I’ve not got enough information to rely on the £2.9m figure, and it looks overly buffed up for me to want to take it seriously. Let’s see what the full numbers look like in due course.

Liquidity - sounds OK

The business continued to generate cash, ending the period with £6.5m cash net of debt versus £4.2m at the previous year end.

Looking to reinstate share buybacks, but not divis. That’s odd.

Outlook - discretionary spending is going to be increased, and headcount has already been increased from 128 to 147 in H2.

We plan to remain profitable and to continue to generate cash in the 2021/22 financial year, notwithstanding that we are targeting revenue growth to be at least matched by the rate of cost growth as we prioritise scaling our automated predictive products.

My opinion - neutral. I’ve always felt there could be something interesting with SYS1, but the shares are too illiquid to make me want to get more closely involved. Historical performance was very erratic too, so it's difficult to have confidence in the company's ability to generate consistent profits, or stellar growth. All a bit too much like guesswork for my appetite.

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Jack's section

Nexus Infrastructure (LON:NEXS)

Share price: 176p (unchanged)

Shares in issue: 45,400,765

Market cap: £79.9m

Nexus Infrastructure (LON:NEXS) is a provider of essential infrastructure services, utilities connections and smart energy infrastructure. It’s got three businesses:

• eSmart Networks - FY20 revenue of £2.2m (1.7% of total). Smart energy business created in 2017 providing electric vehicle charging and smart energy infrastructure. Also developing the delivery of renewable energy connections and on-site extra high voltage electrical infrastructure.
• Tamdown - FY20 revenue of £85.8m (67.5% of total). Civil engineering business providing specialised infrastructure and engineering services to the UK housebuilding and commercial sectors. These include earthworks, building highways, substructures and basements, installing drainage systems, and high-rise construction.
• TriConnex - FY20 revenue of £39.1m (30.8% of total). Utilities business that designs, installs and connects gas, electricity, water, fibre networks and electric vehicle charging infrastructure on new residential developments.

You might expect a company involved with essential infrastructure to have defensive characteristics but Nexus’ profitability has declined in recent years, and 2020 saw the dividend halted as well as a big step up in capital expenditures.

And, while the Z-Score of 2.87 is borderline safe, the group’s F-Score (which measures trends in financial health) is much weaker. It all points to Nexus having had a tough couple of years.

Trading update for the six months ended 31 March 2021

All three of Nexus’ businesses are active on site and winning new business. The group expects to deliver revenues of £63.9m for the period (H1 2020: £84.2m), ‘in line with the base case’ set out in its June 2020 placing.

The group's total order book stood was up £2.1m year-on-year and up 6.9% on 30 September 2020 to £301.6m on 31 March 2021.

TriConnex (utilities) has performed well, delivering both revenue and profit growth. The order book increased by £5.5m to £190.9m and is up 4.6% year on year. H1 revenue was up 5.8% year on year, delivering a gross margin of approximately 30%.

eSmart Networks (smart energy) has seen revenue increase by more than 150% year on year. The order book has also increased substantially, up by £8.4m to £12.2m. That’s a good start, albeit from a small base.

The business says it is establishing an impressive client base in the electric vehicle charging, industrial electrification and renewable infrastructure sectors.

Tamdown (civil engineering) has seen turnover significantly down in the period after a difficult FY20. There are green shoots here and the business has grown its order book from £92.5m at the year end to £98.5m.

There's cash and cash equivalents of £25.6m (31 March 2020: £19.7m) and net cash, adjusting for borrowings of £10.7m (31 March 2020: £8.7m) on the balance sheet.

Conclusion

While the utilities business might have some slightly more defensive characteristics, it is eSmart Networks that is of real interest with Nexus. The growth looks attractive here, but this bright spot is darkened by the poor performance at Tamdown.

How expensive is it to build out a nationwide electric charging network? I’m drawn back to that spike up in FY20 capex. There could be a lot of hard work and spending ahead of Nexus in order to build up the infrastructure, but no doubt this is potentially a big, long term opportunity for the group though.

I wonder if further down the line a spin off might be on the cards? In these markets, an early stage electric vehicle charging provider could probably be valued at £80m by itself. With Tamdown and TriConnex together generating FY20 revenue of £124.9m, you could argue that at a market cap of £80m, you are not paying much at all for the eSmart growth potential.

Directors took up a fair amount of shares in the June 2020 placing and M.T. Morris owns 22.26% of the company. Large director holdings don’t guarantee long-term success, but they do suggest a degree of alignment with shareholders.

This is important as management can destroy the value of your investment through wasteful capital allocation. But if they themselves hold shares, they are less likely to do this. And it looks like how capital is deployed at Nexus might be particularly important in the years ahead.

More detail is required before forming more of an opinion here, but eSmart Networks is an obvious point of interest. The company's interim results will be announced on Thursday 20 May 2021.

Hargreaves Services (LON:HSP)

Share price: 331.51p (-2.5%)

Shares in issue: 32,311,606

Market cap: £107.1m

‘Hargreaves Services is a diversified group supporting key industries within the UK and South East Asia.’

That sounds like an odd mix. But the plot thickens - Hargreaves Services (LON:HSP) was until recently a coal mining company (it ceased all mining activities in July 2020).

The group’s business segments are Services (materials handling, mechanical and electrical contracting services and logistics, as well as specialist earthworks for major infrastructure projects) and Hargreaves Land and Hargreaves Services Europe, which owns an investment in a German joint venture, (HRMS - focused on the development of brownfield sites for both residential and commercial purposes). Services is the larger of the two.

So we have an ex coal miner that now provides industrial services in the UK, has a brownfield land development joint venture in Germany, and also has operations in South East Asia.

Trading update

HSP notes improved trading from its German JV and a ‘material improvement in year end cash position’.

It looks like Hargreaves’ investment in the German JV HRMS is increasingly important and trading here is exceeding expectations following extensive work to reduce costs and improve operational efficiency at its subsidiary.

The board now expects its JV contribution to profits ‘to be materially greater than current market expectations.’

The Group's Distribution & Services business continues to trade in line with expectations, as does its property development business. Delays to the mobilisation of HS2 are adversely impacting Specialist Earthworks but performance in both Production & Distribution and Industrial Services has been improving.

I’m wary of any kind of dependence on HS2, so the group’s exposure to this much-delayed project is a point to consider.

Another point is this outstanding settlements situation, which looks to have been resolved:

The Board can also report that it has now concluded final account agreements in respect of all C A Blackwell Legacy Civils contracts. Other than retentions for defects periods, all cash has now been received. These settlements have resulted in a £2.2m exceptional charge, consistent with the previous accounting for these contracts.

Overall though, the tone is positive. This paragraph is eye-catching:

In recent weeks, the group has experienced material cash inflows due to working capital reductions. As a result, the Board now expects that year end cash balances will be substantially higher than market expectations. The only debt the Group will carry at the year end will be leasing debt, which will be lower than expected due to the deferral of capital expenditure within Specialist Earthworks into the following financial year as a knock-on effect of the delayed mobilisation of HS2.

HSP now expects a consolidated net cash position as at 31 May 2021.

Conclusion

The material upgrades at the German JV sound promising and the revised broker earnings per share forecasts put HSP on a forecast FY21 PE of about 14x.

Clearly, the company has a story to it and so historical results are presumably not indicative of the future trading profile. This type of special situation can present an opportunity, but you do need to put the work and due diligence in.

Is it worth the time investment?

There are some initial pointers that suggest further work is justified. Directors have been buying stock in recent months and Stockopedia is picking up on a number of positive data points via the StockRanks.

The StockRank itself is up 17 points in 30 days, and all the other individual Ranks have been rising.

The momentum indicators are strong across the board, so the market is picking up on something too. So, on balance, this unfolding situation could be worth spending a little more time on.

The board expects to provide a further update in early June following the end of the financial year on 31 May.