Small Cap Value Report (Fri 29 Oct 2021) - BEG Red Flags, MTW, GYG

Good morning, it’s Paul amp; Jack here, with the SCVR for Friday. There’s hardly any relevant news today, and I (Paul) have to pack up my airBnB and move to a hotel in Funchal now, so will sign off for the day. Have a good weekend everyone!

Agenda -

Paul’s Section:

Begbies Traynor (LON:BEG) – Q3 Red Flag Report, interesting improvement, but rise in CCJs augurs badly. I broaden this into another ramble around topics like inflation amp; supply chains.

Gyg (LON:GYG) – bid talks with major shareholder are off, with a reasonable explanation given. The company confirms it shouldn’t need to raise any fresh equity funding, despite uncertainty over contracts.

Jack’s Section:

Mattioli Woods (LON:MTW) – wealth manager that has recently made a few acquisitions. The group reports revenue growth amid uncertain conditions. There are some signs of a decent company, one that can potentially continue to grow, but it looks fairly valued for now.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover trading updates amp; results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it’s anybody’s guess what direction market sentiment will take amp; nobody can predict the future with certainty. We are analysing the company fundamentals, not trying to predict market sentiment.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed – please be civil, rational, and include the company name/ticker, otherwise people won’t necessarily know what company you are referring to.

145p (pre market open) – mkt cap £220m

Q3 Red Flag Report amp; further rambling from Paul

These reports from insolvency practitioner Begbies Traynor are always an interesting brief read, so worthwhile for all readers to have a look.

There’s actually some good news this quarter – with a sizeable (14%) fall in the number of companies in significant financial distress, compared with Q2 -

…This fall can most likely be attributed to rising corporate revenues as pent-up customer demand has fuelled a boom in consumption and allowed some companies to improve their short term debt position, whilst improving cashflow. Whilst this has eased the immediate threat to many companies’ survival, there is uncertainty if these trading patterns will continue.

Outlook – Begbies flags up some of the challenges that lie ahead. Begbies doesn’t mention the ending of the rent moratorium, in March 2022, which could potentially tip many companies over the edge, with rent arrears becoming punishable with evictions again. Although there is talk of the Govt introducing an arbitration system.

Unfortunately, considerable challenges lay ahead for UK businesses, including constrained raw material availability, rising inflation, labour availability, spiralling energy prices and rising COVID rates, combined with a winding back of government COVID support measures that could yet impact failure rates in Q1 2022 and beyond.

Rising CCJs – an ominous sign -

CCJ’s are often a bellweather for future insolvency and the latest data paints a gloomy picture. Official data shows there were 9,101 CCJs lodged against companies during Q3 2020, rising to 21,769 during Q3 2021, a 139% uplift. This acceleration in CCJ’s was also evident between Q2 and Q3 2021 with a 51% increase.

The latest official figures show that court activity is picking up as creditors, become more aggressive in chasing debts.

Sectors – this surprised me. We hear every day about struggling retailers amp; hospitality companies, but they’re not particularly high on the most distressed sectors list today from Begbies -

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My opinion – given what’s happened, with the pandemic, and some disruption from Brexit (although in reality Brexit has been nothing approaching what we were pre-warned would happen), then I think the Govt support measures for business and households have worked brilliantly. Nothing like this has ever been done before. Also the whole lot has been funded on magically invented new money (QE) so the illusion of high Govt debt is just that – an illusion. I’ve yet to find any mainstream journalist that understands QE, so they’re generally still peddling the myth that Govt debt is high. Govt debt is actually quite low, by historic standards, once you net off QE (Govt debt owned by the Govt [the Bank of England]). Also it’s very cheap to service. So there is absolutely not any kind of crisis, or even problem, with Govt debt.

I heard a remarkable statistic in the Budget – that (the OBR, I think) was expecting unemployment to peak at 12%. That has now been revised down to a peak of just 5.2% – which is pretty close to full employment. Astonishingly good.

Who would have thought the recovery would be so strong, as it turned out, it was a V-shape? Hats off to Rishi Sunak, his policies have worked a treat, so credit where credit is due.

Supply chain disruption seems to have sent UK small cap investors into a complete meltdown. Yet it’s temporary. Christine Lagarde said yesterday that supply problems will ease in 2022, although not as quickly as previously expected. It will take a “good chunk” of 2022 for the private sector to resolve the issues, she says. But, she says the new factories to build more computer chips are being built, as are the new ships needed to increase shipping capacity.

She dismissed ideas about “stagflation” returning, commenting that there’s no sign of stagnation – essential for stagflation to happen, and that economies are strong, with good growth.

Black amp; Decker CEO - I watched an interesting interview with the CEO, on CNBC. He said supply chain problems are a big problem, with previously $300m of finished goods in transit in normal times, having swollen to $800m right now, with lots of product stuck in the flotilla of ships at anchor outside Los Angeles.

He also indicated that $1bn of extra costs (materials, labour, transport) would be added to its existing $16bn costs, all of which will be passed on to customers in price rises. That remains the crucial issue – passing on increased costs to customers. That’s what will determine which shares are the winners amp; losers in our market too.

He mentioned that Black amp; Decker is trying to re-shore production back to the USA, by automating factories, instead of using cheap labour abroad. Bravo, long overdue generally, I would say.

Reinforcing my point that we are seeing both cost push, and demand pull inflation at the moment (I know one reader strongly disagrees with me on this, but that’s fine, it’s a debate and we enjoy all sensible discussion here, with all rational views welcomed) – Black amp; Decker said they are experiencing “tremendous demand”, which is partly why they’re struggling to match supply with demand. Plus of course, you can only pass on price increases to customers if there’s strong demand, and people are prepared to pay up, and have the money to do so.

What happens in 2022 then? It seems to me that inflation is likely to continue rising for a while, but as supply chain problems ease, then it should logically moderate again. Remember that inflation requires continuous rises in prices, otherwise it declines once one-off spikes in prices annualise. We saw that in recent years when sterling lurched down, triggering a short term rise in inflation to about 5%, which promptly subsided the following year. So there is recent evidence to support the theory that inflation should be transitory (i.e. maybe a 1-2 year phenomenon), but nobody knows for sure.

Going back to the Begbies report, I see insolvency risk as more of a problem for smaller businesses. Most of the listed companies we look at here, are in robust financial health, and at little to no risk of insolvency. There are still some that need to raise fresh equity, and if interest rates do rise, then that could put them under increased pressure. But for the time being, overall I’m seeing current issues as probably temporary. For that reason, I’m becoming increasingly bullish about small caps, given that we’ve had something like a panic sell-off recently. It looks like a good time to be sniffing around for bargains, and putting fresh cash to work, possibly, where good companies have been sold off for no good reason.

EDIT: Just to clarify, what I’m thinking of, in terms of buying opportunities, is companies that have put out positive recent trading updates, with no problems flagged, yet their share prices have sold off say 20-40% in recent weeks. That removes the guesswork. A good example is Sanderson Design (LON:SDG) (I hold) which put out excellent interim numbers recently, with a good outlook statement, yet its share price has slumped, possibly triggered by a Telegraph journalist writing some nonsense about it looking over-valued (which it wasn’t). That’s an obvious buying opportunity, unless of course there’s always the risk that something might have gone wrong in the background that we don’t yet know about. End of Edit.

I think a lot of the recent falls have been illogical, and seem to me more like traders panicking about losing their profits, rather than any long-term impairment of company valuations. Prices move on little volume, and people sell shares for all sorts of reasons, often completely unconnected with the performance of the company in question.

Who knows, it’s all educated guesswork, and I could be wrong, as always!

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Bid talks with major shareholder Harwood Capital (run by renowned investor Christopher Mills) are off, but it sounds amicable.

Harwood’s statement is here

GYG’s statement is here – which goes into a bit more detail, including some uncertainties over contracts, and it reassures on the financial position -

…the Board believes that the Group can generate sufficient cash to meet its working capital requirements and repay its borrowings as they fall due. As a result, the Board does not believe that it will need to seek additional funding from shareholders in the foreseeable future to maintain operations or to meet its obligations .

In the meantime, the Group continues to build its forward order book position, the superyacht market remains on a strong growth trajectory and the Board reiterates its confidence in the medium to longer-term prospects of the business.

My opinion – reading between the lines, it sounds as if Harwood might be back with another offer, once the uncertainties have been resolved. The trouble is, in the past I found Harwood whipped away the upside for itself, with a lowball bid for a decent company I was a small shareholder in, a few years ago. So whilst they’re very shrewd stock-pickers, they look after number 1, leaving limited upside for other shareholders, which is why I don’t follow them closely any more.

GYG shares are small amp; illiquid.

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Share price: 810p (pre-open)

Shares in issue: 50,571,600

Market cap: £409m

Mattioli Woods is a specialist wealth and asset management business providing pensions and wealth management services.

The group recently completed the acquisition of Ludlow Wealth Management, which expands its presence in the North-West. This follows the acquisitions of Maven Capital Partners and Richings Financial Management. The Mamp;A activity is driven by MTW’s medium term goals of extending the group’s existing investment proposition and adding scale, distribution and product to its client proposition.

You can see the group is expected to be significantly larger through its revenue forecasts:

There has been a general trend of broker EPS upgrades here and the stock is rated as a Strong Buy.

AGM update

There’s no numbers here, just an AGM statement from management. Slim pickings today.

It says:

In September, we were pleased to report revenue growth for the year ended 31 May 2021 despite the continued economic uncertainties that persisted throughout the period.

Market stability and investor confidence are showing signs of improving, despite the wider economic uncertainty, with net inflows into the group’s investment and asset management services ahead of the equivalent period last year. The number of new clients on-boarded in the first four months of the financial year exceeded the prior year, thanks to existing client referrals and business initiatives including virtual seminars during the pandemic. That means the pipeline of new business enquiries is outperforming the prior year.

Along with underlying growth in its core pensions consultancy and administration and investment management segments, total organic growth is in excess of 10% in the first four months of the year.

The financial performance of the acquired businesses are in line with expectations and a final dividend of 13.5p per share (2020: 12.7p) will be proposed at today’s meeting, making for a proposed total dividend for the year of 21.0p (2020: 20.0p).

Outlook -

The further easing of lockdown restrictions and continued roll out of the COVID-19 vaccination programme are supporting improved investor confidence and we expect the increased client inflows and new business enquiries seen in both the prior and current financial year to continue. Current trading is in line with management’s expectations and we remain confident that we are well positioned to secure future growth, both organically and through further strategic acquisitions, which will allow us to continue to deliver sustainable shareholder returns.

Conclusion

This is not a stock I follow but, clearly, Covid has impacted numbers over the past year or so.

MTW has generated a reasonably good StockRank over time but there has not been much in the way of share price progression over the years (although there has been a rerating from the 2020 lows).

Shares in issue have been stable over time (barring the past year), the group is cash generative, a rising dividend is being paid, and there’s a net cash position, which all point to a sensibly run company. MTW seems to make quite a lot of small acquisitions judging from the cash flow statement, and revenue and profits have been rising fairly steadily.

The group generates fairly stable revenue from a large fee base, which is good, but on the flip side, a fall in NAV could really dent profitability at some point. This could be an under the radar stock, quietly going about its strategy, but I’m wondering what the shares need for a serious rerating.

FY22 and FY23 EPS are forecast to be 51.4p and 61p, which would suggest the PE falling from 15.8x to 13.3x. It seems reasonable, but not enough to get excited about in my view.

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