Small Cap Value Report (Fri 27 May 2022) - LSL, BLV, PMI

Good morning! Friday’s SCVR is being prepared for you today by Paul.

Agenda - very little news today, so I’ll look at LSL, then do a few backlog items, so you’ll still get a full report by 1pm. As it’s so quiet, I suggested Jack takes a well-earned day off from SCVR duties!  

LSL Property Services (LON:LSL) – this reads like a slight profit warning, with potential for another one, reading between the lines. Scrutinising current market forecasts, I think they’re too high, and need to come down by perhaps 30%? That takes the valuation on a PER basis from cheap, to not so cheap. Net cash  has increased a lot. Overall, I’d want a bombed out valuation to attract me to buy an estate agent in current macro conditions. So it’s not for me.

Belvoir (LON:BLV) – today’s report is turning into an estate agency special! An in line update from this lettings-focused, acquisitive business, with an excellent track record. Thumbs up from me, again.

Premier Miton (LON:PMI) – sorry this took me so long, but I’ve had a good rummage through interim results from this fund management group. Good results in H1, but clouds on the horizon for H2, as AuM fall, due to maket volatility amp; redemptions. Excellent divi yield may not be fully sustainable at this level. Key risks are top staff leaving, but they get most of the spoils already. Overall, I think it looks good, with a nice yield, and potential upside on the share price once markets settle.

Rishi Sunak sounds uncannily similar to Tony Blair doesn’t he?! I had to double-check that it wasn’t Blair giving the speech in Parliament yesterday lunchtime. Not just because they soundalike, but also because the policies of big state intervention are also alike. A windfall tax on oil amp; gas companies’ excess profits is set to raise £5bn p.a., and doesn’t seem to be a one-off, although Sunak says it will have a sunset clause. It’s linked to increased investment allowances, which seems a neat idea. I’m not keen on retrospective taxes, but we’re in a tight corner. 

It would be interesting to know how other countries are dealing with high energy costs. Sunak’s proposal to link electricity prices to the cost of production, rather than being pegged to the price of natural gas, seems a good idea.

What surprised me most, was the extent of grants to households, targeting the poor, which I think is only fair, given that energy (and food) are a high element of poor households’ spending, so their inflation rate is reckoned to be nearer 11% than 9% (or maybe even more)? Benefits have only been upped by 3.1%, so that’s a yawning gap. Whereas inflation for middle class households is nearer 7% (source: an economics professor on the news), and pay rises will be in the same ballpark, so potentially little to no squeeze on middle class households? Hence why I think share price falls may have been seriously overdone for some companies, giving us a buying opportunity, possibly? Decent quality retailers amp; eCommerce businesses look way oversold to me, so my dogs from last year could be the recovery shares this year (or next), possibly? Especially if they start to attract takeover bids.

Since 2008, and the discovery that QE works rather well, Governments have become much more interventionist. The scale of Sunak’s household support packages yesterday was far more than I imagined they would do. This follows on from massive State support over covid. So that makes me think this current downturn may not be anywhere near as bad as bears might imagine, due to forthcoming Govt action. Share prices are already down so much, and with big Govt stimulus now happening, we could be near a bottom maybe? I’m starting to think we’re definitely nearer the bottom than the top anyway for share prices, so I’m going into tentative buying mode now.

On the flip side, this could just be another bear market rally, nobody knows.

There’s no doubt company earnings are under pressure, in cyclical sectors, so plenty more bad news to come. cmpeckham made a great point in the reader comments here, saying that broker forecasts need to come down a lot, as they look way behind the curve. I completely agree. That said, share prices are anticipating profit warnings, and the falls seem to be be moderating – e.g. Hostmore (LON:MORE) (I hold) warned on profits yesterday, which shouldn’t have been a surprise to anyone, and the share price only fell 14% – suggesting that the market had anticipated it largely. It’s now looking remarkably cheap, for a self-funding roll-out of 3 distinct formats. By my calculations, MORE could be a 3-bagger in maybe 2 years, if the economy amp; inflation settle down (based on revised broker forecasts for c.10p in 2 years, and a PER of c.15).  What’s not to like about that? The profit warning wasn’t a bad one, and they seem to be on top of the issues. It could get worse still, but if you’re not going to sell regardless of the share price, just hold for 2+ years, then barring some absolute calamity, there’s only upside. People obsess too much about short-term paper losses I think. If you decline the low market price, then it should recover over time.

I also noted pent up buying in many other interesting small caps yesterday, e.g. Luceco (LON:LUCE) up 11% on no news. There’s a wall of cash on the sidelines, and some of these rallies are so quick, that if you dither, you miss it. People are losing nearly 1% per month due to inflation, by sitting on the sidelines. So that cash has to get back to work, at some point, which I think could fuel a strong rally – which seems to be what’s happening in the USA. Although I can’t help also feeling, that with so much bad news still to come with company earnings, it might be too soon to have seen a definite bottom put in, but nobody knows, as that’s purely down to sentiment.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review 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.

345p (down 3% at 08:13)

Market cap £362m

Trading Update (AGM)

I’ve always thought of this as an estate agent, but the company’s own description reverses the order, emphasising its associated property services first, and then its estate agency in the last paragraph below. That sounds a bit, well, estate agent-ish! (a bit like PR companies, they can’t help themselves, and usually put a bit of positive gloss onto everything in RNSs) -

LSL is one of the largest providers of services to mortgage intermediaries and mortgage and protection advice to estate agency customers, completing around £41bn of mortgages in 2021. It represents around 10% of the total purchase and re-mortgage market with around 2,900 financial advisers. PRIMIS was named Best Network by Money Marketing in their 2021 awards and Best Network, 300+ appointed representatives at the 2022 Mortgage Strategy Awards.  

LSL is one of the UK’s largest providers of surveying and valuation services, supplying seven out of the ten largest lenders in the UK, employing around 500 operational surveyors, and performing over 500,000 valuations and surveys per annum for key lender clients. It was named Mortgage Surveyor of the Year at the 2021 Mortgage Awards with Money Age.  

LSL also operates a network of 225 owned and 128 franchised estate agency branches.

These are the main points in today’s update -

Revenue for Jan-Apr 2022 is £104.5m, in line with last year (2021 said to be “buoyant markets”)

Conveyancing delays -

Our Estate Agency and our Direct-to-Consumer Financial Services businesses were naturally affected by residential pipeline conversion rates which remained extremely slow across the market principally due to the continuing industry-wide capacity issues in conveyancing.  

This resulted in a 9% reduction in Estate Agency Division revenue largely driven by a fall of 16% in residential exchange income. Fall-through rates remain at normal levels, meaning that the residential sales exchange pipeline now stands at nearly record levels, having increased by over £4m since the beginning of the year.

Cost inflation - mainly energy, and staff costs.

“Proactive management” of costs, so “only a modest impact on profitability”.

Net cash of £30.4m at end April 2022, vs net debt of £(7.8)m a year earlier – a striking improvement.

Outlook - now expects FY 12/2022 profit “slightly behind” 2021, whereas previous guidance was “broadly at the same level”.

That doesn’t sound much different to me! Although I would prefer numbers, rather than having to work out the nuances in their commentary.

This sounds like a possible profit warning in the pipeline -

We have yet to see clear evidence of a sustained improvement in residential pipeline conversion and should the current slow conversion rates across the market persist or fall throughs increase, then more significant pressure would be placed on profits in our Estate Agency Division and to a lesser extent in our Financial Services businesses.

I don’t understand this point below – surely if H1 was so strong, then there would be an H1 bias, not an H2 bias? This same wording was in the 2021 results outlook comments -

As previously reported, the split of H1:H2 profit in 2022 is expected to revert to a more typical profile with a skew to H2, after record housing transactions in H1 2021.

Valuation – the StockReport shows a fairly modest forward PER of 8.9, but it’s vital that we inspect the trend of broker forecasts to see if they’re realistic. In this case, there’s been minimal reduction below, so I reckon these forecasts could be too high, in a more troubled macro environment. That’s reinforced by the cautious comments in today’s commentary from the company. So expect forecasts to reduce, they’re behind the curve I think! That’s an important point for all shares we look at right now – reasonableness test the forecasts always, as lots may be too high right now.

.

Here are Stocko’s historical graphs, with my comments below -

.

Note that in graph 2, the very high 2021 profit was exaggerated by a £29m gain from disposals, on top of a 40% increase in underlying operating profit.

This exceptional profit (on disposals) seems to have been adjusted out of the normalised EPS in graph 3.

Since the company tells us today that 2022 is now expected to be slightly below 2021, and there’s risk to the downside I would say from their other comments, then I think 2022 forecast EPS needs to come down from 38.4p consensus, to well below 30p. To be safe, if we pencil in 25p for this year, then at 345p per share, the PER would rise from 8.9 on the StockReport to 13.8 – demonstrating why it’s vital to not rely on forecasts right now! We have to sense check forecasts, which usually means reducing them, given uncertain macro conditions.

My opinion - it’s not cheap after all, so I don’t see any attractions to buying right now, once I’ve adjusted the forecasts to something more realistic.

Estate agents generally don’t tend to be good investments I’ve found, unless you happen to buy very cheaply in the middle of a crisis, when they look vulnerable to going bust.

Taking the long-term chart of LSL below, it’s basically gone sideways from 2010 to 2020. The more recent burst of excitement in the share price seems to be dissipating. Combined with a wobbly outlook, and broker forecasts currently being too high, then I think this share looks vulnerable to drifting down to the 250p level, which it seems to gravitate towards long-term. There is a dividend income, and with net cash, that should continue.

It also depends on your view on residential property prices. They’ve been boosted in the pandemic, but with interest rates rising on mortgages now (although still incredibly low by historic standards), maybe the market could struggle?  There again, in periods of high inflation in the past, property ownership has been one of the best places to be, long-term. Even in the depths of previous recessions, there were still plenty of people moving house. So I don’t know, anything could happen, but for me the valuation is not attractive right now, with all the uncertainty.

.

.

260p

Market cap £97m

Trading Update (AGM)

Belvoir Group PLC (AIM: BLV), a leading UK property franchise and financial services Group…

Following on nicely from LSL above, this is another estate agent.

We very much like this share here at the SCVR, as it’s developed through sensible acquisitions into a larger, and more profitable business. On top of that, its core lettings business has proven very resilient in downturns (e.g. during covid), due to the defensive nature of its business – people still need houses to live in, whatever the economy is doing, and LSL earns a pretty reliable income stream from lettings, and is further insulated by a low-risk income from franchisees.

Hence it’s a lovely combination of self-funded growth via acquisitions, and stability.

The company appeared in person at Mello this week, which seems to have triggered some buying. I’ve not met them myself, but mgt seem really grounded, and experienced, when I’ve viewed them on webinars.

Current trading -

The Board is pleased to report that trading during the four months to 30 April 2022 is in line with management’s expectations. Group revenue is up 14% on the same period in 2021, with the property division up 8% and the financial services division up 20%.

Within this, strong demand for re-mortgages has more than offset falling demand for new mortgages.

Lettings income up 4%

Sales income down 11%

Lettings is far more important, with a ratio of 78:22 lettings:sales income

2 acquisitions done so far this year

Outlook – nothing specific said about the full year, but there’s a nice summary of the business model, and its strong track record -

“Belvoir has a proven track record in delivering growth built around a resilient business model underpinned by a significant recurring and reliable lettings revenue stream, and a successful acquisition strategy that has facilitated its diversification into estate agency and financial services. A long-serving and experienced management team has ensured that all acquisitions, 10 since 2015, have been successfully assimilated into the Group. 

“The Board remains confident that its business model and growth strategy present a strong investment case for shareholders and deliver enhanced value for all our stakeholders.”

My opinion – positive. I’ve followed this company for years, and often been tempted to buy some. As you can see below, the long-term share price showed no progress for years, but then suddenly re-rated during the pandemic, as people appreciated the defensive nature of its business, and the progress made.

The big increase in share price has held firm since, despite the bear market we’re now in, and I think that’s justified by the strong fundamentals.

Given the excellent long-term track record, I think there’s a strong case for having BLV as a buy amp; forget long-term holding. It looks a much better bet than LSL for example, with more scope for growth, and less cyclicality due to the emphasis on lettings – which means much less downside risk than with LSL.

So it’s another thumbs up from me for BLV.

Although in the short term, a PER of 14.5 probably looks high enough.

If I like the fundamentals of a particular share, then I check which Stock Screens it has passed. This is a useful way of finding new stock ideas, which share similar characteristics. BLV qualifies for 2 Stockopedia screens:

Benjamin Graham Deep Value Checklist, and

Buffettology-esque Historical Growth Screen

.

.

123p (up 9% at 12:39)

Market cap £195m

It’s been a while since I’ve looked at a fund management company’s shares, Jack normally covers them. However, given current problematic market conditions, I thought it would be interesting to review the figures amp; commentary.

I tend not to invest in this sector, because the companies mainly exist for the benefit of the employees, who get the bulk of the rewards. Also they can, and often do, jump ship to competitors, or set up on their own, hence earnings cannot be necessarily relied upon. Plus, clients funds are often fickle, and tend to also jump ship if returns become negative, or lag behind – which happens for sometimes medium term periods, however good your track record or strategy is.

Half Year Results

These numbers are good -

Adj profit before tax of £14.6m in H1, up 23% on H1 LY, so that annualises to about £28m full year profit, as I don’t think there is any seasonality to fees charged.

The commentary explains that the main driver of profit is assets under management (AuM), with Miton earning an average fee of 0.65% of AuM.

Falling AuM – this is the key driver of profits, and in current market conditions, obviously AuM is now falling, due to markets falling (and most of Miton’s AuM are invested in equities).

AuM was £13.9bn at 31 Dec 2021, has since fallen to £12.5bn at end April 2022 – a drop of only 10% this YTD, which strikes me as good! I wish my portfolio was only down 10%, – mine’s actually down 28% YTD, but of course that’s due to concentration (or my incompetence, depending on how harsh you want to be! Thought I’d get that in first, before the usual culprits snipe at me!)

Redemptions – my main area of concern. I remember in the bear market of 2000-3, which the current situation reminds me most of (explosion of a tech bubble), that funds saw big withdrawals, and often became more-or-less forced sellers of many illiquid small caps, which killed valuations for a long time (but laid the ground for a fantastic recovery from 2003 onwards). Miton’s net client inflows of £359m in H1 LY has now reversed into net client outflows of £401)m in H1 this year. Not good, but it’s only 2% of opening AuM, so that’s not enough to make Miton a forced seller of equities. It could probably absorb some or even all of that from dividends and bond coupons received. I’m very relieved about this. Although a protracted bear market could change that.

Dividends – interim divi is flat at 3.7p. A prior year final divi of 6.3p has just been paid, and a final of about the same seems to be forecast for this year – that looks a stretch to me, if H2 sees a decline in profits. So I would plan for the possibility of future divis being trimmed somewhat. Even so, the dividends are the main attraction of this share, although we could also see a nice capital gain over time, from the current depressed share price..

The dividend policy is stated as paying out 50-65% of adjusted profit after tax.

A positive aspect of the business model, is that it doesn’t need much for capex, having hardly anything in tangible fixed assets. This enables it to pay out most earnings in divis.

Balance sheet - is adequate, with about £32m NTAV once we’ve written off intangible assets, which are just meaningless book entries.

The market cap is about 6x NTAV, so you’re not buying an asset-backed business, you’re buying future cashflows amp; divis – which is heavily dependent on clients leaving funds with Miton, so dependent on fund manager performance, and the best fund managers being attracted amp; retained.

Market commentary – there’s nothing unexpected in this, it just talks about all the macro amp; market issues we already know about.

I only put an asterisk next to this comment – this is so true, and is a massive challenge for all of us -  

As we look forward, the long-term implications of current events remain unclear. Investors are pondering issues such as energy security, global supply chains, energy transition, increased defence spending and the end of quantitative easing. Above all, a generation of investors has never had to worry about investing in an inflationary era.

Staff remuneration - most of the money does go to the staff – £9.8m fixed staff costs in H1, then £9,5m variable (i.e. bonuses!), is about double what shareholders get £9.3m divis paid (from the cashflow statement). You might expect me to launch into a rant about how terrible this is, but actually it looks fine to me. Staff are doing all the work. Shareholders are just providing a relatively small £32m NTAV asset base, which is needed for regulatory purposes, and general financial stability. Getting a c.8% dividend yield (on the much larger market cap), just for providing capital and nothing else, looks perfectly reasonable to me.

My opinion - this looks quite good to me, especially the divis. Even if you allow for a soft patch due to current equity market turmoil, Miton’s funds seem to be holding up well, due to them being diversified. Some clients inevitably panic, and cash out in market downturns, which is a shame, because that’s when they should be adding, not selling! And they tend to put in the most money at or near market highs. That’s why I think investment funds should really be closed ended, and then just have the shares tradeable, as that insulates the fund manager from having to make forced selling decisions, which of course was what caused Woodford to blow up – putting highly speculative rubbish into an open-ended fund, was doomed from the start, in hindsight, and shouldn’t really have been allowed.

I’d like to find out how much of Miton’s funds are open ended, hence riskier, and what percentage are closed ended? I know they’ve used clever hedging strategies in the past too.

Also, the staff amp; key management don’t seem to have much skin in the game (there’s a 5% employee trust holding, but major shareholders are otherwise other fund management companies), which is a worry, as what would happen if the best people decided to leave amp; set up in competition?

Just adding the numbers in my head, Miton seems to have paid very roughly 45p in divis since listing in 2017. Not bad in 5 years, especially as that included the pandemic. So buying the shares now at 123p looks a sensible move for long-term income-seekers who are happy to ignore short term market volatility. Plus I reckon you could see a 50% capital gain on top of that, with patience. Not bad!

.

.

Stockopedia