Small Cap Value Report (Wed 10 Feb 2021) - WATR, SDI

Good morning! It’s Paul here with the SCVR for Wednesday.

If you want to discuss the removal of the thumbs down feature, please don’t do it here! There’s a specific thread here [link now fixed] for this issue, where you can hear the logic for why it was done, and express your opinion, if you must.

Timing – TBC

Agenda -

To start with, here’s something left over from yesterday -

Water Intelligence (LON:WATR) – 2020 Trading Update

Today’s results amp; trading updates -

Sdi (LON:SDI) – a superb trading update on the back of strong orders

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500p – mkt cap £86m

Water Intelligence plc (AIM: WATR.L) (the “Group” or “Water Intelligence”), a leading multinational provider of precision, minimally-invasive leak detection and remediation solutions for both potable and non-potable water is pleased to provide its unaudited Trading Update for full year 2020.

Performance has been excellent -

Statutory profits before tax grew very strongly by 78% to $4.2 million, which exceeded market expectations.

Last year, adjusted profits were $1.0m higher than statutory profits. So there’s a query as to why the trading update today mentions statutory profit, not the more normal adjusted profit? Ah here we are, adjusted profit is mentioned further down -

Water Intelligence profits before tax adjusted for non-core costs*, non-cash amortisation expense and share-based payments grew 49% to $5.1 million (2019: $3.4 million)
* Non-core costs include one-time items such as legal expenses on transactions

Revenue for 2020 up a healthy 17% over 2019, to $37.9m (2019: $32.4m). Remember that this understates the level of end customer activity, because some of WATR’s business is via franchisees. Does the franchise model actually work? I’m not sure about that, because WATR regularly buys back franchises, to operate itself. Suggesting that it’s not easy to make franchises work.

Green Economy Mark - this sounds interesting, it’s not something I’ve heard of before. This is awarded by the London Stock Exchange, for companies which derive at least 50% of their revenues from environmental solutions. More information is here. This makes the shares suitable for ESG investors – an increasingly important part of the market. I’m all for fund managers becoming more proactive in overseeing companies they invest their clients funds in, hence I see ESG as a very positive trend.

Being cynical, this might also provide an indication of which shares are likely to be chased up to over-valuations, from ESG fund buying, hence for us to buy in a bull market, and avoid in a bear market when funds face redemptions and become forced sellers.

Diary date – mid May for audited FY 12/2020 results. Slow, but they are audited. I’m not sure why the company doesn’t publish unaudited figures earlier, as most companies seem to do.

Net debt – $2.0m (being gross cash of $6.8m, less bank debt of $8.7m) at year end. Debt amp; cash increased by $3.2m post year end.

Outlook/guidance – nothing specific, just general comments that its markets are growing, and the group is non-cyclical. Innovation through new technology. Upbeat tone.

Unusually, there’s an expanded commentary below the main body of the announcement, which I only spotted by accident.

My opinion – I’ve under-estimated this company in the past. It’s developing a very good track record of impressive revenue amp; profit growth.

You can find an update note from WH Ireland on Research Tree, my thanks go to them for providing this essential information for us.

Its forecast for 2020 has been raised considerably, to 24.4 US cents = 17.6p – for a PER of 28.4 times – which seems fair, considering such strong profit growth has been achieved over the last few years.

Forecast for 2021 looks very modest growth, so it seems likely the company might continue issuing out-perform updates in 2021, and hence drop the PER.

Overall, I’m impressed. It looks like the company is growing nicely into what previously seemed an excessive valuation. I’m happy with the valuation now, given these strong figures, so it gets a thumbs up from me.

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151p (up 25%, at 08:17) – mkt cap £148m

Trading Update

This share stood out in MrContrarian’s early morning snapshot comment below (thanks as always for these wonderful, rapid amp; consistent posts, they help me focus on the more interesting announcements).

SDI Group plc, the AIM quoted Group focused on the design and manufacture of scientific and technology products for use in digital imaging and sensing and control applications, is pleased to announce an update on trading.

Follow-on orders have been received for its subsidiary Atik Cameras, mainly for delivery in FY 04/2022.

… the Group, as a whole, will exceed the market’s sales and profit expectations for the year ending 30 April 2021 and substantially exceed the market’s sales and profit expectations for the year ending 30 April 2022. This is also underpinned by the continued recovery of activity across all of its businesses.

Fantastic! We don’t often hear the phrase “substantially exceed”, very impressive. Shareholders will rightly be delighted with this news.

Guidance – how about this (below) for impressive, ultra-clear guidance! Things are always better in a table. No EBITDA nonsense, they’re giving us proper profit (I’m happy with adjusted profit usually, but it always pays to double-check the adjustments are reasonable).

The group is saying it “will exceed” these numbers, so expect further upgrades I suggest -

* before amortisation of acquired intangible assets, reorganisation costs, acquisition costs and share-based payments

Broker forecasts – Finncap and Progressive provide updates today, many thanks for those.

Finncap pencils in 5.5p EPS for FY 04/2021, and 7.1p for FY 04/2022, which is based on very similar adj PBT to the above numbers from the company itself, as I would expect. Therefore, there’s probably upside on these forecasts.

Valuation - I reckon we can probably work on c.8.0p EPS as the starting point for valuation, which at a current price of 151p gives a PER of 19 – not demanding, providing the higher profits can be sustained.

My opinion – a cracking update today, with lovely transparency too, giving very specific profit guidance. I just wish more companies would report to the market in this way.

My only note of caution is that valuations of shares are based on what level of profits is sustainable. The risk is that these Atik contracts might be one-offs, and hence not sustainable. Although I’ve heard that for medical devices, once a supplier is contracted to provide key parts, then they tend to be in for the duration of the product life, measured in multiple years, because essential parts are sold on quality not price.

It’s certainly looking as if SDI is pulling off that difficult trick – making repeated acquisitions, and getting them right. Whereas so many fall by the wayside, ending up wrecking the balance sheet with debt amp; intangibles, then having to restructure when the acquisitions go wrong. I’ll never forget that clown who destroyed Vislink in this way. There are numerous other examples too, of acquisitive groups that destroy shareholder value.

Whereas SDI (so far) looks as if it might be similar to Judges Scientific (LON:JDG) which created spectacular shareholder value, through a series of modestly priced but very good acquisitions. It’s so difficult to pick these things in advance. I suppose it’s more about spotting strong entrepreneurial management, and just having faith in them, rather than any analysis of the numbers. Then holding for years, and largely ignoring valuation – scary, but that’s how the multibaggers seem to work.

So far so good with SDI, hence a thumbs up from me.

The chart is going exponential below, but I’d be inclined to resist the urge to bank profits, because as set out above, the fundamentals do justify this big increase in valuation.

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