Small Cap Value Report (Thu 14 Oct 2021) - MMH, XPS, NXR, BMS

Good morning! It’s Paul amp; Jack here with the SCVR.

Mello Results Show – is this afternoon, starting at 1pm. More details here. Interesting sessions lined up. Some people say, oh the shows are too long, but I tend to have webinars playing in the background, and zone in amp; out, depending on what interests me. The presentation from Onthemarket (LON:OTMP) (I hold) should be interesting – we had a good debate about OTMP in a recent SCVR, with bulls and bears offering their opinions, we very much like 2-way debate here at the SCVR.

A suggestion to presenters – keep mentioning the company name. Often people say, “they”, or “this company”, etc, and I have no idea what company they’re talking about!! Or the name is said quickly amp; indistinctly, and I don’t catch it. Names need to be said clearly, and give the ticker too. Maybe I’m starting to go a bit deaf, as everyone seems to be mumbling these days?! Schools should start doing elocution lessons again. How is it that they can have kids in for 10+ years full time, and yet many of them leave seemingly incapable of speaking or writing clearly? Then people wonder why they’re not attractive to employers.

Agenda – to follow

Paul’s section:

Marshall Motor Holdings (LON:MMH) – material acquisition (c1/3 of market cap) for this car dealer. It’s a hot sector right now with surging profits, so we might see more consolidation going forwards.

Norcros (LON:NXR) – a positive trading update for H1 is out today. It’s a bit vague on supply chain issues/inflation, but does say it’s confident to raise full year guidance (not stating by how much though). I have a stab at valuation, as no broker notes are available. Still looks reasonable value, but remember the giant pension scheme amp; S.Africa risk are a big headwind for valuation of this share.

Braemar Shipping Services (LON:BMS) – this shipping broker (hot sector) upgrades its full year FY 02/2022 profit guidance by 15%. Seems modestly valued on a forward PER of 9.7, before today’s upgrade. Might be worth a closer look for value investors.

Jack’s section:

Xps Pensions (LON:XPS) – pension scheme administrator and consultant. Recurring revenues, recovering conditions, a good dividend, and potentially attractive long term organic growth profile. But there’s a question over how fierce the competition is and how well it can protect margins. Overall, looks interesting.

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.

242p (pre market open) – mkt cap £189m

Acquisition

MMH is buying Motorline, a car dealer chain which has 48 sites, and 1,500 staff. I mention this because it’s a sizeable deal. Motor dealerships are having an unprecedented bonanza this year, due to supply constraints causing a shortage of vehicles, thus buyers are bidding up the prices of second hand cars in a way I’ve never seen before. Hence lower volumes, but huge profits, for car dealers.

Although I note from both the websites of Cazoo (ludicrously over-valued on a US listing) and Motorpoint (LON:MOTR) (I hold) both have a reduced number of cars for sale. A couple of days ago, they both had an identical 2,734 cars available online. That’s down from about 3,300 which both had available a couple of months ago. Cazoo’s gullible US investors have been sold the yarn that it’s doing something unique, disruptive, selling online. It’s complete nonsense of course, everyone’s selling online, and most buyers want to see amp; test drive a car before buying it, and Cazoo doesn’t have any genuine buying advantages, so there’s nothing much to disrupt. But it does have a huge marketing budget. According to VTU’s CEO, that is its only actual advantage! (see his last webinar).

All that cash has to go somewhere, and MMH is spending £64.5m (that’s about a third of its market cap, so a major acquisition) on buying another dealer (although the target has £20m cash itself, so £44.5m cost, if we offset that cash).

This is interesting, and we should expect more deals. With brimming cash reserves from super-normal profits this year, we should expect a wave of deals, buying up smaller chains of car dealers, and maybe someone will start consolidating the big players too? Hence I remain of the view we’re in pole position for private equity deals, holding shares in this sector. My sector pick remains Vertu Motors (LON:VTU) because it’s highly prioritising digital things, and is the only player in the sector which is trading below its own NTAV, which doesn’t make any sense at all to me.

VTU recently announced a resumption of buybacks, and divis. Lots of companies are keeping divis this year small, to avoid criticism of shareholders benefiting from taxpayer support measures such as business rates relief, furlough, etc. However, it’s looking deeper into the numbers and ascertaining the large dividend paying capacity which is more revealing. That’s the way we can today buy the big dividend yields of the future, which is what I’m focused on.

Remember that most of these companies are also brimming with freehold property, which has alternative use value in many cases, and is likely to be attractive to private equity buyers. I’m amazed we’ve not had takeover bids already, given how much cash PE has sloshing about. Maybe they’re focused on tech companies instead? It’s only a matter of time before someone spots the value amp; surplus assets in car dealers, in my view.

It will be interesting to see broker forecasts for MMH once they’ve crunched the numbers for the acquisition. Motorline only traded a bit above breakeven in 2020, but no doubt is more profitable now, and there sound like plenty of synergies to improve profitability as part of a larger group.

As a value/GARP investor, I find motor dealerships as a sector highly attractive right now. It’s a rare beast – obvious value, right under our noses, hiding in plain sight!

MMH share price is up 8% today, showing that the market likes its use of spare cash to make an acquisition. I think we can expect more of this from other sector shares too, providing an obvious catalyst for upside moves.

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309p (up 6.5% at 08:24) – mkt cap £249m

Trading Update

Norcros plc (“Norcros” or the “Group”), a market leading supplier of high quality and innovative bathroom and kitchen products, will announce its interim results for the 26-week period ended 3 October 2021 on 11 November 2021. In advance of this, the Group is providing the following trading update.

Revenue in H1 looks excellent, well up on both covid, and pre-covid comparatives -

Group revenue for the 26 week period is expected to be approximately £200m (2020: £135.3m; 2019: £181.2m), 49% higher on a reported basis than the COVID-19 impacted prior year (2020) and 18% higher than 2019 on a constant currency like for like basis.

UK and S.Africa (a significant part of Norcros) both doing well.

Net cash - looks robust, despite outflows for inventories amp; divis -

The balance sheet remains very strong with net cash of approximately £1.0m (pre-IFRS16) compared to net cash of £10.5m as at 31 March 2021. During the period the Group has replenished inventory levels and paid the prior year declared dividend.

One of the things I like about Norcros, is that it’s made a series of good acquisitions, without running up a ton of debt. In fact, it seems to have done that lovely thing that Judges Scientific (LON:JDG) so successfully demonstrated – making cheap acquisitions, and paying for them from internally generated cashflows, which created stunning shareholder value at JDG.

H1 profit guidance -

… excellent performance, and we expect to report an underlying operating profit in the first half of the year of no less than £21m (2020: £12.8m, 2019 £17.4m).

That’s usefully up on both comparison years. I’d prefer companies to report underlying profit before tax (PBT), not operating profit, because IFRS 16 has messed up operating profit and EBITDA numbers, moving some of the cost of leases into finance expenses (complete nonsense of course, IFRS 16 needs to be scrapped asap).

Supply chain – the burning issue at the moment, along with inflation, which present serious risks to investors. If only we knew which companies are going to suffer, and which ones are feasting on bonanza profits – it’s incredibly difficult (impossible I’d say) to predict.

Norcros today says -

As previously referenced, supply chain challenges, increased energy costs, inflationary cost pressure and a normalisation of consumer spending patterns mean that uncertain market conditions are likely to prevail during the remainder of the financial year.

Notwithstanding these factors, and based on the excellent first half performance and the Group’s strong revenue momentum, we expect underlying operating profit for the year to 31 March 2022 to be significantly ahead of the board’s previous expectations.

It’s fine for companies to tell us the obvious, that the future is uncertain, but we now need more detail too. Or, as Norcros has done above, guidance for the full year. Just leaving it hanging, with an uncertainty message, is not good enough, because that just provokes some investors into selling their shares – understandable, if companies are not prepared to commit to clear guidance.

I’m increasingly coming round to the view that some management teams seem to have a good grip on their business, whereas others don’t. It’s at times like this, with multiple challenges, when we see which is which.

Norcros seems to be in the good grip group.

Valuation – we don’t have access to any updated broker analysis, unfortunately. That’s an oversight on the part of Norcros, which has a big private investor shareholder base. The company really should make sure at least one broker publishes notes via Research Tree.

Using Stockopedia’s broker consensus forecast of 32.1p, we need to adjust that up for today’s “significantly ahead” update. What might that mean? Maybe 35p+? But how much of that is one-offs, relating to unusually strong demand (people revamping homes using money saved last year from aborted holidays amp; going out)? Also, might NXR be benefiting from supply shortages, and raising prices? We’re not told, there isn’t enough detail in today’s update.

My opinion -

Bear in mind that NXR has traditionally always been on a low PER, because the market marks it down for;

• Huge pension scheme amp; risk/deficit payments, and
• Political/economic risk from operations in South Africa

To offset those risks, NXR has a strategy of making acquisitions of businesses that don’t have these issues, which over time dilutes the problems. That justifies a slow upward re-rating of the shares, which has been happening.

Note that NXR also pays a well-covered divi, yielding about 3%.

I’ve always liked this company, as a modestly priced, decent business. The large pension scheme does put me off, now that the PER has risen to about 9 (it was more attractive when the PER was about 6). I don’t see a lot of scope for it to re-rate much more, and big pension schemes can put off potential bidders for the business.

Overall though, given the strong performance announced today, this share certainly doesn’t look over-priced.

The StockRank is very high too, which I find reassuring.

Note that Norcros is unusual in that it’s held onto all the gains from the “everything rally” from Oct 2020′s good news on vaccine development. Whereas many other smaller caps have given up some of the gains, in profit-taking/panic, particularly in the last few weeks. That tells me NXR has committed shareholders, rather than day traders flitting in amp; out -

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271p (up 9% at 09:30) – mkt cap £87m

Trading Update – ahead of expectations

Braemar Shipping Services Plc (LSE: BMS), a leading international Shipbroker and provider of expert advice in shipping investment, chartering, risk management and logistics services, is pleased to make the following trading update for the current financial year.

I like it when companies put the key message in the title of the RNS, as that draws our attention to out-performers. I wonder if they would include the words “profit warning” in the headline, if performing badly? Probably not, is my guess!

Underlying operating profit for H1 (6m to Aug 2021) expected to be £6.9m (H1 LY: £5.6m). No comparison with 2019 is provided, which would have been helpful to show a pre-pandemic year too. I’ll have to check now, to make sure they’re not hiding a deterioration in performance vs pre-covid. They’re not! H1 pre-pandemic (6m to Aug 2019) was u/l op profit of £3.7m.

Full year guidance - nice and clear -

The overall trading environment for Braemar continues to be positive and the board now expects to report underlying operating profit* for the year to 28 February 2022 of £10.8m (2021: £8.9m), 21% ahead of the prior period and 15% ahead of the board’s previous guidance.

That seems a decent level of profits for a company valued at £87m.

Historical profits are a bit zig-zaggy (to use the technical term!), with this not looking like a growth business. Although the commentary today refers to a new growth strategy.

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Dividend – interim divi of 2p. Note that BMS used to pay out much larger divis, but they were cut in 2017, and suspended during the pandemic. See the divi summary page here.

Broker – changed to Investec. I blow a raspberry at that, because Investec don’t let us pond life see any research notes, so might as well not exist, as far as private investors are concerned.

Also, Braemar is too small to matter to Investec, so I don’t understand how this decision makes sense.

Diary date - 3 November, for H1 results (to Aug 2021)

My opinion – I don’t know much about this sector, which as we are very much seeing now, is subject to cycles and extreme volatility. That said, with some companies saying freight rates having risen up to 10-fold, it’s natural to assume that as a middleperson, Braemar should be seeing bumper profits. I’m a bit surprised it hasn’t upgraded more today.

Stockopedia is showing a forward PER of only 9.7, which is before today’s upgrade, so it looks sufficiently cheap to be worth readers maybe taking a closer look for yourselves, if you are attracted to low PER shares. It can be good to look at shares which are simultaneously valued on a low PER, but putting out favourable trading updates amp; raising guidance. That’s a nice combination, which can be a prelude to upward share price moves, if the rising profits are sustainable.

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Share price: 140p (pre-open)

Shares in issue: 205,151,471

Market cap: £287.2m

XPS is the only UK pensions specialist listed on the LSE Main Market. It advises more than 1500 pension schemes and administers pensions for over 930,000 members. Services include things like pensions and investment advice, administration, corporate advice, covenant advice, and GMP equalisation. It works with pension schemes ranging in size from less than £20m in assets to multi-billion pound pension funds and it charges fixed fees for most of these services, making for more than 90% recurring revenues from its long-term client base.

This pure focus on the UK pensions market could make for quite a scalable business model as these scheme can be very large, and XPS has a proprietary tech platform already in place to deal with them. Revenues are recurring and non-cyclical, coming from risk-averse customers who make decisions on who to partner with very careful, and are likely quite slow to change their minds.

XPS is developing a good track record of revenue growth now.

And the valuation looks intriguing, with a forecast PEG of less than 1x and a forecast dividend yield of more than 5%.

Trading update

• Organic revenue growth for the six months to 30 September +10%
• Pensions Actuarial Consulting +7%
• Pensions Investment Consulting +26%
• Pensions Administration +9%,
• SIPP business revenues were down 1% year on year, reflecting the reduction in the bank base rate.

The strong Investment Consulting growth relates to high client activity levels in the face of regulatory change, and new business wins coming on stream.

The National Pensions Trust (‘NPT’) business has continued to perform well with revenues growing 49% year on year, thanks in part to a faster than expected recovery in asset prices. Assets under management within the NPT business are now above £1.2bn.

XPS won both ‘Actuarial and Pensions Consulting Firm of the Year’ and ‘Investment Consulting Firm of the Year’ at the recent UK Pensions Awards, whilst also being highly commended in two other categories, including ‘Pensions Administrator of the Year’.

The pipeline of new business opportunities has grown significantly and has returned to pre-pandemic levels, with new business success across all business lines. This is expected to support growth in FY23 and beyond.

In line with the continued growth of the business, XPS has agreed on a new £100 million revolving credit facility and accordion of £50 million for a term of four years from October 2021, with a one-year option to extend. This new RCF replaces the previous £80 million facility which was due to expire in December 2022.

The group now expects to deliver higher single digit revenue growth for the full year. This will be accompanied by some additional investment in headcount and associated costs to drive the Group’s mid-term growth in light of increasing demand. It remains on track for financial performance for the full year to be in line with expectations.

Paul Cuff, Co CEO commented:

As the UK returns to some normality, we have seen this reflected in our new business pipeline, which has continued to strengthen and is now at pre-pandemic levels. We have had some significant new wins over the period which will contribute to continued growth in FY23 and beyond.

The revenue growth we have seen reflects the strong market position we have, as a high-quality provider of all the services the UK corporate pensions market needs. The recognition we recently won at the UK Pensions Awards further enhances this market position.

XPS will report its half-year results on 25 November 2021.

Conclusion

This looks like a fairly interesting situation: a company with a strong market reputation investing for growth, with 90% recurring revenues from long-term clients. I wonder if competition is an issue here, but XPS certainly seems to be in good standing. I’m not sure how much pricing power a firm like this might have. While it is scalable, it’s also possible that margins could come under pressure.

Directors have been selling, but the outlook appears favourable and the group pays out an attractive dividend yield, while the PEG figure suggests we can expect solid progress in earnings per share over the next year or two.

XPS is positively geared to regulatory change and the backdrop here also looks positive. I could see decent scope for growth for a company like this. More interesting than I initially thought it might be, certainly worth a closer look at the prospects here.

Near term growth beyond FY21 looks a little pedestrian, but in the longer term there seems to be a decent opportunity assuming it can protect or grow its market share and maintain margins.

Checking back, the balance sheet looks quite weak however, with 77% of total assets coming in the form of £205m of intangibles. That’s a negative tangible asset value of £56m. This is a shame, I would hope for more here. Current assets do cover current liabilities but the balance sheet is very light, so that’s something to bear in mind.

Stockopedia