Small Cap Value Report (Thu 27 May 2021) - AUG, BLV, FIF, XLM, CAY

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

In case you missed it, I added new sections on Gym (LON:GYM) and De La Rue (LON:DLAR) yesterday afternoon, so here’s the link to yesterday’s completed report.

Timing – today’s report is now finished.
I’ve got some spare time, so am going to write up my top 10 personal portfolio holdings, and the rationale behind each one. You’ll be familiar with all the names, as I gush about them here! I’ll post a link here to my top 10 holdings report once it’s done later today. OK, here it is!
Link to my top 10 holdings as of today.

Agenda –

Paul’s Section:

Augean (LON:AUG) (I hold) – Morgan Stanley says it is considering a possible offer for this recycling company.

Belvoir (LON:BLV) (I hold) – another strong trading update from this estate agents franchise business. Broker forecast increased considerably. Still looks good value, even after doubling n price in the last year. How much of the trading out-performance is temporary though, due to stimulus from Stamp Duty holiday?

Finsbury Food (LON:FIF) (I hold) – positive trading update yesterday, but lack of broker research hampers me from digging any deeper. Looks good value still.

Roland’s Section:

Xlmedia (LON:XLM) – a disappointing trading update from this online publisher, warning of a continued decline in the Casino business. Revenue guidance has been reinstated, but the market doesn’t seem impressed.

Charles Stanley (LON:CAY) – this venerable wealth management firm has a bulletproof balance sheet. Today’s results look reassuring to me, although the company’s exposure to interest rates means profits suffered last year.

(I hold)

248p – mkt cap £248p

Statement re Possible Offer

This statement has been issued by Morgan Stanley Infrastructure Inc. -

Response to press speculation regarding Augean plc (“Augean”)

Morgan Stanley Infrastructure Inc. (“MSI”) notes the recent press speculation regarding a possible transaction involving Augean and confirms that it is in the preliminary stages of considering making an approach to Augean regarding a possible offer for the entire issued and to be issued share capital of Augean.

There can be no certainty that an offer will ultimately be made for Augean, nor as to the terms on which any firm offer might be made.

My opinion – here are my notes from 1 March 2021, when I reviewed Augean’s accounts for FY 12/2020, concluding that the shares looked cheap. Although ongoing uncertainty exists over a large disputed landfill tax assessment from HMRC (which has been paid, but Augean is claiming it back).

I imagine bid talks could boost the share price today, although it has risen almost 20% in May so far. This share has done tremendously well over the last 3 years.

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(I hold)

233p (pre market open) – mkt cap £82m

Belvoir Group PLC (AIM:BLV), a leading UK property franchise group, provides the following update on current trading ahead of the Group’s Annual General Meeting to be held at 10:00 a.m. today.

Ahead of Expectations

Another strong update today -

The Board is pleased to report that trading during the four months to 30 April 2021 was exceptionally strong and materially ahead of management’s expectations, with substantial revenue growth across all three markets…

… the Board confirms that the Group is trading significantly ahead of mnagement’s [sic] expectations for the year ending December 2021.

• Key underlying income stream (MSF) up 22% on 2020
• Lettings MSF up 12%, but the stand out number is +81% for residential property sales
• Demand fuelled by recovery from lockdown, and Stamp Duty holiday (extended to Sept 2021)
• Financial Services division also strong, up 24%

Outlook –

Our entrepreneurial franchisees and advisers are very focused on maximising the opportunities from such a buoyant property market. The level of activity is expected to remain strong until at least the end of June, at which point the benefit of the Stamp Duty holiday is reduced by 50%, and probably through to the end of September when the Stamp Duty holiday ceases. In such unusual times, it is difficult to predict what might happen thereafter, but it is quite possible that the pent-up demand will not all be met in that timescale, and the tapered approach to the tax break will avoid a cliff-edge, such that the property market remains busy for most of the year.

Broker update – Finncap helpfully updates us this morning – all its research is freely available on its own research portal, or via Research Tree.

Big increases in forecast EPS are issued today -

FY 12/2021: 20.6p (up 19%) – a PER of 11.3

FY 12/2022: 19.5p (up 8%) – a PER of 11.9

Note that a drop in earnings next year is presumably modelling the unwinding of Govt support, which seems prudent.

My opinion - a smashing little company, which has been performing very well for a while now, and also demonstrated great resilience during the pandemic. Therefore it’s a better company now, and proven to be a safe investment in a crisis.

I find the valuation appealing.

Edit: I see the price has opened up about 5% at 240p. It still looks good value.

The StockReport has much lower broker forecast figures, so expect the StockRank to improve further when the latest broker forecasts feed through, usually in the next few days.

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I’ve crudely amended the EPS forecasts on the graphical history below. What an excellent track record, especially on EPS growth. Surely this justifies a PER higher than 11 or 12? -

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(I hold)

91p (up c.8% today) – mkt cap £118m

Trading Update – from yesterday

Finsbury Food Group Plc (AIM: FIF), a leading UK speciality bakery manufacturer of cake, bread and morning goods for both the retail and foodservice channels, today provides an update on trading for the current financial year, ending 26 June 2021.

Ahead of expectations update yesterday – but no information is provided about what those expectations are –

Trading in the second half of the financial year has been strong and the Board now anticipates that Profit Before Tax for the full year will be no less than £15.0m, ahead of current market expectations.

The strong trading, in a period that has been impacted by Covid-19 throughout, has been driven by improving volume performance and the benefits of the Group’s operating brilliance program which has resulted in improved line efficiency and lower waste throughout the Group’s bakeries.

Dividends – being reintroduced, but no indication of the amount.

Broker forecasts – nothing that I can access. I can’t tell you how frustrating it is, when companies fail to ensure research gets out to private investors.

Valuation – FIF made £7.2m adjusted profit before tax in H1, and £7.4m unadjusted profit before tax in H1. It’s not clear from today’s update whether the £15.0m full year guidance relates to adjusted, or unadjusted numbers.

It implies £7.8m or £7.6m profit in H2, up a bit on H1.

Stockopedia shows £10.0m after tax profit for FY 06/2021. Assuming about a 20% tax charge, then that’s equivalent to £12.5m pre-tax profit, so well below the £15.0m guidance today. This implies about a 20% upgrade in guidance today – very pleasing.

My opinion - I’d like to get some more accurate information at some stage.

Overall, I like FIF as a value share that looks priced at bargain basement levels. An efficiency drive seems to be working well. In the back of my mind, I wonder if it might become a takeover bid target?

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I’ll got through the FY 06/2021 numbers in full, when they’re published in Sept 2021. Looking back a year, it seems we’re likely to get the next trading update in mid-July.

Stockopedia classifies FIF as: Consumer Defensives – Balanced (not sure what that means) – Small Cap – Super Stock

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50p – market cap £133m

AGM Trading update

Digital performance publisher Xlmedia (LON:XLM) hit a purple patch from 2016-2018, but has struggled to regain that form since then.

XLMedia’s business model is built around informational websites which earn commission payments by generating signups for advertisers.

Historically, the business has been focused on the online gaming sector, but current management are working to reduce this dependency after more than 100 of the firm’s casino sites were hit by a Google penalty early in 2020.

Today’s AGM update provides an insight into progress this year, which appears to be somewhat mixed (my bold):

“We have made a solid start to 2021, supported by a good performance in the Personal Finance and European Sport verticals. This, alongside our recent acquisitions in US Sports vertical, continues to partially offset the ongoing weakness across our European Casino assets.

US Sports betting: XLmedia acquired the US website Sports Betting Dime for $26m (£18.5m) in March 2021. Shareholders contributed with a £20m placing and £3m open offer.

Integration of the SBD website and a previous US acquisition (CBWG Sports) is said to be “progressing well”. These businesses are expected to “add materially to Group revenue for the current financial year”.

Casino: Management expects revenues “to decline further in 2021”. Further cost-cutting is targeted to try and stabilise the situation.

This decline is expected to be “partially offset” by improving performance in European Sport and North American Personal Finance.

Revenue guidance for 2021: The company has resumed guidance and expects to generate revenue of $65m-$70m in 2021. It’s hoped that over time, margins will return to levels “last experienced in 2019”.

Stockopedia actually shows a thumping statutory loss for 2019:

But I’ve looked back at the company’s adjusted figures for 2019 and these show an underlying operating margin of 33% in 2019. That would certainly be a decent achievement, in my view.

Today’s revenue guidance is below the consensus shown on Stockopedia, so it looks like a revenue warning. However, I think that what’s actually happened is that guidance was withdrawn for a while.

XLMedia’s house broker, Cenkos, has reinstated forecasts today, after withholding them as recently as April. Interestingly, Cenkos’ revenue forecast for 2021 is just $64.9m, at the very bottom of XLMedia’s guidance range.

Cenkos is forecasting adjusted earnings of 2.7 US cents per share this year, which I estimate puts the stock on around 23 times forecast earnings. A significant improvement is expected in 2022.

My view

XLMedia doesn’t break down its different operations into reportable segments, so we can’t see how much revenue comes from each area. This leaves us guessing as to how dependent the business is on revenue from its Casino websites.

In my view, XLMedia shares look fully valued at this level. I wouldn’t be prepared to bet on growth in US sports betting outpacing the company’s declining Casino business.

More generally, I would be reluctant to invest in companies which use this business model. Digital performance marketing is an area where I have some experience, and I know that it’s not easy to generate good quality, durable earnings.

A ranking penalty or even just a small tweak to Google’s algorithms can reduce website traffic to a trickle, overnight. Reversing can be difficult. In my experience, traffic rarely returns to historic highs.

However, this kind of monetisation model is increasingly mainstream in the online publishing sector, as revenue from display advertising declines. Magazine publisher Future (LON:FUTR) and most national newspapers use affiliate links heavily in their online content, to generate revenue from free-to-view material.

This raises potential concerns about editorial integrity and conflicts of interest. Consumers don’t seem too bothered by this at the moment, but this could change, as might Google’s stance. This isn’t a business model in which I’d choose to invest.

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355p (-1.4%) – market cap £192m

Final results

This asset manager is one of the oldest firms on the LSE, with a history that can be traced back to 1792. It specialises in providing “holistic wealth management services to private clients, charities, trusts and institutions”.

Today’s results cover the 12 months to 31 March 2021. Let’s take a look at the key numbers.

Business performance was strong, as I’d expect, with an increase in AuM and net assets:

The only point I’d make here is that average FuMA (funds under management or administration) fell slightly to £23.2bn (2020: £24.2bn). This is said to be due to market disruption.

Lower average FuMA and the impact of interest rate cuts combined to cause a significant fall in profitability for the year:

• Revenue stable at £171.2m (2020: £173m)
• Underlying pre-tax profit down 10.9% to £17.2m
• Reported pre-tax profit down 22.5% to £13.4m
• Underlying earnings per share down 15.8% to 26.4p
• Cash balances up 12.7% to £105.4m (2020: £93.5m)
• Final dividend of 9p, total dividend up 33.3% to 12p

The company says that the decline in underlying profits was mainly due to a 69% fall in interest income due to lower interest rates.

It’s rare these days to see a company that generates a material part of its profits from interest income. But Charles Stanley’s outsized cash balance means that interest income is material for this business.

The fall in interest income caused revenue at the group’s core Investment Management Services to decline, despite higher fee income. Revenue rose in each of the group’s two other divisions:

Divisional performance

One big challenge for asset managers in recent years has been pressure on margins from lower-cost passive funds. Charles Stanley appears to be managing this situation quite well.

IMS: The group’s core IMS discretionary fund management division, which generates more than 85% of revenue, has reported an improved total revenue margin since 2019:

• 2019: 0.67%
• 2020: 0.75%
• 2021: 0.77%

Higher operating costs (probably IT for home working?) pushed down the overall operating margin for this business from 15.8% to 13.5% last year. But I don’t see anything to be concerned about.

Financial planning: This business is being scaled up and remains loss making due to higher staffing costs. However, performance improved due with revenue up 15% to £10m and operating loss reduced from £5.1m to £4.1m.

Revenue per financial planner was £338k, so I’d guess this could be a profitable business if it can achieve sufficient scale.

Charles Stanley Direct: The company’s lower-cost online platform saw equity trading activity rise by 62% last year. However, interest income fell by 71.4%, from £2.1m to £0.6m.

As a result, revenue from this division only rose by £0.1m to £9.6m, despite a 40.7% increase in assets under administration.

I’m surprised by Charles Stanley’s dependence on interest income. I wonder how much of this (if any) is interest earned on client cash, rather than the company’s own cash pile?

Profitability

Underlying vs reported profits: Charles Stanley’s underlying pre-tax profit is 28% higher than its reported pre-tax profit. When I see a differential like this, I like to look at the adjustments to see which measure of profit I want to use.

Here are the adjusting items from FY21:

In my opinion, many of these adjusting costs could be considered regular costs of doing business. Although I might accept restructuring charges, amortisation and impairment charges are clearly annual events. In my view they form part of the company’s underlying performance.

Profit margins: Measured on the company’s preferred underlying basis, Charles Stanley’s underlying profit margin fell from 11.7% to 10% last year.

On a statutory basis, operating profit margin fell from 10.3% to 8.3%.

As a financial business, return on equity might be a more appropriate metric. My sums suggest this drops out at 8.5% for the year. Not stunning, but in line with past years:

My view

I’m intrigued by Charles Stanley’s exposure to interest income and would like to understand more about this. But on balance, today’s numbers look solid to me and do not seem to suggest any cause for concern.

As far as I can tell, the company is maintaining its market share and not losing out to cheaper alternatives. In a bid to attract lower net worth/cost conscious investors, the company plans to launch a new “simplified advice” service this year, too. This will offer services such as model portfolios and execution-only dealing.

Would I buy the shares? I’m aware of the tailwind provided to fund managers’ AuM by the strong rally we’ve seen over the last year. But Charles Stanley does not seem overly expensive to me, especially given that its £105m cash balance covers more than half the £188m market cap.

The stock yields 3.3% based on today’s results and trades on a multiple of around 18 times statutory earnings. That doesn’t seem unreasonable to me, for a long-established business such as this, with a bulletproof balance sheet and insider ownership (the chairman owns 25%). I’m left with a positive impression of this business.

Stockopedia