Small Cap Value Report (Thu 25 March 2021) - FNTL, MCLS, JDG

Good morning, it’s Paul amp; Jack here with the SCVR for Thursday.

Timing - who can say?

Agenda -

Paul -

Fintel (LON:FNTL) – the new name for SimplyBiz – resilient results from FY 12/2020. Balance sheet still weak, but improving. Looks quite good overall.

Mccoll’s Retail (LON:MCLS) – bumping along at breakeven, terrible balance sheet with tons of debt – I think the shares could be worthless on a conventional basis, but we’re in a crazy bull market, so anything could happen. Very high risk

Judges Scientific (LON:JDG) – brief mention of the results, but let’s start a discussion about 100-baggers, and how we can spot the next JDG? Please chuck your ideas into the pot, in the comments.

Here are a few catch-up items to start off the day

Fintel (LON:FNTL)

207p – market cap £200m

When I saw that Jack had put Fintel on our google docs which we use each day to collaborate on the SCVRs, I thought it was a typo for Findel. Wrong! Turns out this is the new name for SimplyBiz – an acquisitive group of professional subscription services companies – e.g. outsourced compliance for financial advisers.

I’ve always liked the business model (it makes sense to pay a relatively modest fee to outsource very specific amp; complicated regulatory work), high margins, and recurring revenues at this group. Although its over-stretched balance sheet put me off in the past. Also, I didn’t fully trust the numbers, and wanted to see more of a track record established.

Fintel (AIM: FNTL), the leading provider of fintech and support services to the UK retail financial services sector, today announces its audited consolidated results for the twelve months ended 31 December 2020.

As you can see from the financial highlights below, this business is now battle proven, in that it has survived covid amp; lockdowns with barely a scratch. That’s impressive, and I think we should consider paying more for companies like this, which have proven they can cope with a serious economic and organisational dislocation.

In particular, I generally want to invest in companies that have proven they don’t need to dilute shareholders in a crisis, with an emergency placing. These are important risk factors that many investors forget about.

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Valuation – adj EPS of 11.3p and a share price of 207p gives a PER of 18.3 – not cheap, but for the reasons mentioned, I think that can be justified. Also earnings should improve in 2021, lowering the forward PER.

Outlook – there’s evidence of the PRs being let loose on this announcement maybe a little too much! E.g. the added descriptions above “Resilient, Stable, and Solid” before each bullet point – designed to mould our thinking – this reminds me of those Mamp;S food adverts in a Nigella-esque voice (“succulent” potatoes, “plump” plums, etc) – I’ve been reading this RNS in the same internal voice, which has amused me. This is what 3 months lockdown has done to me – reading RNSs in comedy voices.

Anyway, for Fintel’s outlook section, I’ve switched from Nigella, to a more aggressive, Wolf of Wall Street type male voice, in my head, as I read this -

The strong start to the current year is marginally ahead of the Board’s expectations. Our strategic plan is being implemented efficiently and at pace. We therefore remain confident that the company is in a robust position to achieve its full year ambitions, and is moving forward with real agility.

We are Fintel.

Whoop! Yeah! Awesome!!! I think they missed out some additional punctuation. I much prefer: We. Are. FINTEL!!!!

OK, back into serious mode.

Balance sheet - most of the lines on the balance sheet have remained very similar from end 2019 to end 2020. The stand-out mover, is non-current loans amp; borrowings, which has reduced substantially from £37.7m to £29.7m. That’s exactly what I was hoping to see – i.e. meaningful debt reduction to a more reasonable level.

Given the resilience of the business in 2020, and this debt reduction, I’m much more relaxed about the balance sheet. Deleting the huge £105.4m of intangibles, NTAV is still negative, at £(30.7)m, a £6m improvement in the year. However, given the capex-light nature of this (people) business, and reliable recurring revenues, with customers paying up-front, then this balance sheet structure looks OK to me. It’s not ideal, but neither is it a deal-breaker.

Dividends – a weak balance sheet usually means a modest dividend yield, and that’s indeed the case here. Shareholders are to receive 2.85p, yielding 1.4% – not much now, but a progressive dividend policy is to be adopted in future, so divis should rise over time. If they can combine that with further debt reduction, then it’s good.

My opinion – I’ve only covered the basics here, there’s lots more detail in the announcement.

Overall, I think it’s good – as you can see below the quality metrics are very good, dark green, i.e. towards the top end of the market overall.

Valuation metrics are mostly middling, amber. For colour-challenged people, please note that the length of each bar is also the measure, the larger the bar, the better. So you don’t need the colour coding to understand these graphics – i.e. the colour-coding is triggered by the length of the bar, which everyone can see.

My conclusion is that Fintel looks a good quality business, probably priced about right.

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As with many other shares recently, the share price has been strong. In this case though, I think it’s reasonable, although personally I wouldn’t chase it any higher than the current level, which looks a fair price. Charting/momentum traders might take a different view. Remember I’m not trying to predict short term share price movements here, I’m thinking more in terms of fundamental valuations.

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32p – mkt cap £37m

I last looked at this convenience stores business a year ago, reviewing its accounts here for FY 11/2019, concluding that the equity looks worth nothing, due to a very weak balance sheet, and the low likelihood of meaningful dividends ever being paid again.

This week it announced 53 week results to 29 Nov 2020.

Key points -

• Very impressive LFL sales growth of +12.0% (local convenience stores benefiting from lockdowns)
• However, a much lower gross margin (23.9% vs 25.9%) eradicated the benefit of higher LFL sales
• Adjusted profit is just above breakeven, at £1.1m
• Net debt of £89.6m remains a problem, and has only slightly fallen from £94.1m a year earlier.

Current trading amp; outlook -

• LFL sales still decently positive at +8.8% for the 15 weeks to 14 March 2021
• But, gross margin trends similar to last year, i.e. down, so again that would eliminate the benefit of higher sales. People are buying lower margin products in lockdown.
• Expecting margins to normalise after lockdown, but (not stated) presumably that also means sales growth would drop back?
• Cautious for the year ahead, with tougher LFL sales comparatives, and Govt support measures phasing out (a £9.4m benefit in FY 11/2020).

Bank facilities – £100 RCF and £67.5m term loan were revised to give more covenant headroom, and extended to Feb 2024.

Dividends – none. It wants to resume divis at an affordable level, but deleveraging is needed first – the bank facilities prohibit payment of divis until leverage is below 1.75x (EBITDA). Personally I can’t see that happening without a big placing to mend the balance sheet.

Balance sheet – looks very weak. NTAV is negative £(139.7)m. It’s going to need a big placing at some point, to prop things up. Or a CVA. Or both more likely.

My opinion – this looks ultra-high risk to me. I don’t see any value at all in the equity, because the business is not making a profit, and it’s difficult to see how it will do so in future. Particularly when business rates support is phased out.

That leaves the issue of how it will repay the hefty bank debt?

Hopefully McColls might be able to trade its way out of these financial difficulties, because convenience stores are very useful to the people they serve, and who work there, and of course they’re very good unpaid tax collectors – it’s probably better overall for HMRC to let them pay the VAT amp; PAYE/NICs late, than force it into administration and foot the bill for all those unemployed staff..

As things stand though, I think anyone holding this share should be prepared for the possibility of a 100% loss at some stage. Why take that risk?

There again, towards the top end of a bull market (arguably now – the signs are all around us, it feels just like 1998-99 to me, but with no constraints now on central bank/Govt behaviour, so this could run amp; run), crazy things happen. Tiny market cap companies that just might survive, can be speculative multi-baggers, if you catch a wave of muppet buying – look at what happened with Gamestop. Not my approach at all, but I’m just flagging the reality of a toppy market. Hence you would be insane to short anything right now, even if it does look bust. Anything could happen with the MCLS share price. It could go anywhere. Fundamental value of the equity, is zero, as things stand, in my opinion.

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6200p – mkt cap £393m

Final Results

Judges Scientific (AIM:JDG), a group focused on acquiring and developing companies in the scientific instrument sector, announces its final results for the year ended 31 December 2020.

Skimming over the numbers, as with many companies, it’s taken a bit of a hit from covid lockdowns.

Adj EPS is down 20% to 177.2p – a PER of 35.0

Outlook -

· Effects of pandemic still being felt but signs are positive, and our sector is adapting;
· Recovery in order intake still in progress.

Acquisitions – two more have been made – that’s the raison d’etre of this group, it’s made a long series of shrewd acquisitions, and funded them mainly from internal cashflows.

100-bagger – JDG has been a stunning success in the last decade or slightly more, which has been a major multibagger. In fact, skimming over the long-term chart, this has been approximately a 100-bagger from the lows after the financial crisis in 2009. Quite remarkable! I think this justifies some discussion, so we can look back, and see if the signs could have been identified? I’m angry with myself for being fully aware of the company all the way along, and doing nothing as it 100-bagged. How could I have been so stupid? So it’s time for some reflection on that.

I wonder how many investors have held continuously since then? If you have, then post a comment, and if we believe you, will be interested to hear why you bought amp; held that long to achieve a 100-bagger?!

I can remember Richard Crow (aka CockneyRebel) banging the table about this one, when it was about 100p, saying it had a lot of potential. It wasn’t obvious from the numbers at the time, at all, but looking back, this has been all about a clear strategy, and good execution. Looking back, it wasn’t a wild speculative stock, it had a sensible, quite conservative strategy, to buy cheap companies in niche products with good margins, often family owned.

I danced around the edges of this share for years, usually complaining that I liked it but it was too expensive! The usual thing.

Was there a way of spotting JDG might be a 100-bagger in advance? One reason I can think of, is not financial. We saw David Cicurel present at Mello, several times, many years ago. I remember he explained a crystal clear strategy to buy cheap, but high quality small businesses in the medical instruments sector, e.g. where the owners wanted to retire. There were no particular synergies, he explained (I can remember snippets from his presentation in my head, c.10 years later). The acquisitions would be funded by modest bank debt, which would be rapidly repaid from the earnings of the acquired companies. He went on to do just that, numerous times, and has created massive shareholder value. He richly deserves a comfortable retirement, having helped so many people.

My current favourite investment book, 100 Baggers, by Christopher Mayer has heavily drawn on many other investment books, which he does reference, so it’s not plagiarism as such. It’s a useful summary of lots of important investment books, which saves me a lot of time, so all good.

In it, he identifies the common traits of 100-bagger shares. JDG does fit that model very well – e.g.

• Owner/manager with a lot of skin in the game (big personal shareholding) – David Cicurel meets that criterion
• Great capital allocation – especially making shrewd, and sometimes transformative acquisitions, at the right price – that’s exactly what JDG has done – you want an owner doing this, risking their own money, not a hired hand
• High ROCE – yup, JDG has those high quality scores, all dark green:

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Then above all, the biggest component of a 100-bagger, according to the book, is patience – sitting back and letting compounding work its magic.

Ignoring drawdowns – i.e. taking no notice of market gyrations, and holding forever, regardless of short term losses from market price movements. OK, who can actually do that in practice?! It’s incredibly difficult.

For a start, you can’t be geared, and I don’t think it’s humanly possible to do that with a large shareholding, hence the 100-baggers are maybe small initial positions that you forget you even own? (the “coffee can” portfolio idea, of tucking away the share certificate under the bed, and checking it in 10 years’ time to see what happened, very much appeals to me).

All very interesting. Looking back then, there really were signs that JDG might become a 100-bagger. Above all, it seems to be all about backing the right management. So difficult to do though. So easy with hindsight! That’s very much what Warren Buffett says in his shareholder letters too – backing the best people, and just letting them get on with the job.

Thinking about all the above, I’m definitely interested in adapting amp; improving my own investment approach, to stop thinking about short term numbers amp; sentiment, and instead think longer term, and more about the key points above.

I hope that’s useful amp; interesting, just thinking out loud really, as I continue my fascinating learning journey in the investment world, every day.

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