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Small Cap Value Report (Wed 5 Oct 2022) - Macro, VTU, PCF, KETL

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Good morning from Paul amp; Graham.

Agenda - 

Paul’s Section: 

Starts (below) with some macro/markets general commentary.  I should emphasise that these are all ideas that I pick up on my travels, from a wide network of experts. So I’m not trying to set myself up as a guru, but instead am really just regurgitating amp; summarising all the various good ideas amp; views that I think are the most interesting, and credible, that I’ve picked up from the best sources in my network. 

Vertu Motors (LON:VTU) - I’ve completely re-written this section, after originally dropping a clanger by reviewing an old trading update by accident, doh! Interim results look good, and it now expected to beat (very modest) full year expectations, due to good trading in Sept, and the benefit of recent Govt help on energy bills, and lower NICs. Balance sheet is superb. Even taking into account the known bear points, this share still looks remarkably cheap to me.

Graham’s Section:

PCF (LON:PCF) (£7.5m) – this stricken challenger bank announces that it continues to explore options to raise “growth capital”. If it doesn’t get it, it might engage in various disposals or “other options” to deliver value and certainty to shareholders. It’s scary language as management continue urgently looking for external help. They also announce today that PCF will cease any new lending activities, and will also look to cut their corporate overhead costs. In the main section, I review some of the warning signs (there weren’t many) that the wheels were about to fall off this company, and conclude that the existing equity should be assumed worthless. Balance sheet equity was £41m in March, giving hope of a recovery, but ongoing losses have spooked the new management team and it’s impossible to predict the dilutive terms of any future fundraising deals.

Strix (LON:KETL) (£255m) – a £38m acquisition is announced by Strix, with the help of a £10m equity placing and a debt refinancing. I’m starting to wonder if the market might be overly pessimistic about this one. When I covered it in July, I thought that it was fairly valued at a PE of 12x, given its short track record when it came to acquisitions (and also its financial risk). But the PE is now in the single digits, the dividend yield looks attractive, and today’s acquisition appears to make lots of strategic sense. Could the risks be fully priced in?

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.

Paul’s Section: Macro/Market Comments

There seem to be a few glimmers of light at the moment –

US markets (which drive the direction of ours) have staged another rally - but is it another bear market rally, or a turning point? No idea! Although commentators in the US are pointing out that inflation seems to be peaking, which could then take the pressure off the Fed raising rates much further, which in turn should be good for equities. So there does seem to be some logic in stock markets looking forward to finding a floor, perhaps?

Set against that is apparently a now falling property market in the US, much higher mortgage rates, and the likelihood of company earnings coming under pressure.

Higher interest rates usually mean lower PERs for equities, and for the first time in many years, some bonds are actually looking quite reasonable alternatives to equities, especially if you think (as I do) that interest rates might only be spiking up, and could come down again next year if inflation subsides (as forecasters seem to think it will, but they’re usually wrong).

Over here in the UK, we’ve seen an impressive rebound in sterling, from a low of about $1.04, to about $1.14 in a short space of time. A reminder that the vast majority of huge trading in forex markets, is speculative. Sometimes markets smell blood, for whatever reason, and trigger a spike down, as has happened recently with sterling. The rebound this week takes off a fair bit of strain, and is good for inflation (see last week’s review here of the outlook from £NEXT – which emphasised that the strong dollar is inflationary for 2023).

Lastly, the wobble in the Gilts market, caused by derivatives used by pension schemes (who would have thought that posed a threat to financial stability?) was quickly snuffed out by the Bank of England, which only used a small fraction of its reported £100bn (not £65bn) maximum firepower. Gilt yields in the UK are now very similar to those in the US, so this looks to have been another storm in a teacup. Sorry to disappoint those who like to constantly talk the UK down! (and isn’t it nice to see them with egg on their faces, as their predictions of doom fizzle out!)

Put that lot together, and things seem considerably more settled than they were a week or two ago. Although to me, things at the moment do have a whiff of 2007-8 about it – when a housing market crash in the US triggered the Great Financial Crisis, when enormous derivatives trades went badly wrong (caused by unforeseen risk from asset prices suddenly falling). Sound familiar? Recently we’ve had multiple asset classes crash (shares, bonds, property,  crypto). There are bound to be casualties from that in the financial system, where gearing and derivatives multiply the losses. So I’m actually quite worried about the macro picture now. 

I don’t know where the next crisis is going to come from, but it does feel as if we could be entering a problematic phase. Back in 2007-8, it was the sudden failure of big players in financial markets (Bear Sterns, AIG, then Lehman, and others) which caused a domino effect, where counter-party risk in the financial system caused everyone to retrench. Before that, other financial crises have also happened when a major player suddenly collapsed. People are talking about Credit Suisse looking wobbly right now.

On the upside, everyone knows what to do this time, after the experience gained in 2008. Governments amp; regulators have to move fast, and contain any problems with key institutions – forcing them to merge or refinance, giving guarantees, etc. The reason 2008 got so bad, was because they were so slow to act, to shore up the system.

Maybe if we get into another financial crisis again, we can be reassured that the people in charge know what to do this time to nip problems in the bud?

Financial crises usually start with something completely unforeseen. Although I think the stability of the Eurozone (with funding Italian deficits in particular looking a weak point) could be the next target of speculators.

I reckon it may not be long before we’re back at zero interest rates, and deficits funded by QE again, once inflation has moderated as supply chains ease. If that turns out to be right, then there are numerous equities today that could do seriously well in future, and be valued much more highly if interest rates do return to zero.

Personally, I don’t think QE is likely to ever be seriously unwound. Look what happens every time they try!  (they quickly have to abandon it).

If you think the opposite, that higher interest rates are here to stay, and could go higher, then equities could have further to fall. It will certainly be interesting to see how things pan out. Fascinating, albeit painful times. No matter how confident the delivery of their comments, forecasters/economists  are only guessing. They don’t have any better idea than you or I, as to what will happen in future. Actually, some of them might even be worse at forecasting than us, because they’re locked into some dogma or other.


Friends amp; family tend to ask me for a second opinion when arranging mortgages etc (the fools!). Obviously I can’t, and don’t want to give advice. It’s more about talking people through the options, then armed with the facts, they can decide. It’s very tricky at the moment. A close friend is looking at remortgaging from a 2-year fix that’s coming to an end in about 6 months. The old rate was crazily low, not much about 1%. The new rate quoted by a broker/adviser who has screened the market, for both 2 and 5 year fixes, is about 5.0-5.5%, on a fairly low loan to equity mortgage (about 40%). We discussed the options, and my feeling was that it seemed unwise to fix into a rate so much higher than before, when mortgage markets are currently a bit haywire. I looked into discounted rates, which were much more competitive, but with that option we run the risk of not having protection if interest rates really rocket.

Everyone’s situation is different of course, and the ability to meet higher payments (if rates do soar) is important. We could cope with a short term spike in interest rates, so we’ve decided to probably go for discounted, rather than fixed rate. But that might not suit other people. For the moment though, we’re not doing anything. We can wait until next summer when the current rate ends, when I suspect/hope better deals might be available, because inflation is forecast to have fallen significantly by then.

I can see why journalists amp; people on Twitter were joking that the main topic of dinner party conversations in polite society has now become when does your fixed rate mortgage expire?! So people are dividing into the smug, and the panicking.

Vertu Motors (LON:VTU)

46.5p (up 7% at 08:28)

Market cap £160m

Interim Results

Right, let’s try this again, reviewing the correct announcement this time!

Vertu Motors plc, the automotive retailer with a network of 160 sales and aftersales outlets across the UK and a sector leading online presence, announces its interim results for the six months ended 31 August 2022 (“the Period”).

Full year profits anticipated to be ahead of market expectations

Here are my notes from reviewing the interim results (not comprehensive, just what struck me as most important) -

H1 revenue £2.0bn, most of which is pass-through value of the cars.

Gross margin of £223.7m (I tend to see this as being more like revenue) – almost identical to H1 LY.

Costs rose substantially (mainly salaries), so adj PBT fell from £51.8m H1 LY, to £28.2m H1 TY (this year), but this is not a surprise, it’s as planned due to LY numbers being a one-off due to pandemic effects. Adjustments are small, and mostly share options costs.

Basic adj EPS 6.5p in H, so nearly all of the 7.5p full year forecast has already been made.

Net tangible asset value per share is strikingly high, way above the share price, at 71.2p (working shown in the notes) – this is very unusual, and marks out VTU as the sector bargain for asset-backing.

Share buybacks – Vertu has bought back 2.9% of all its shares in the last 6 months – impressive.

Divis – interim of 0.7p. Finals tend to be bigger. Forward yield is about 4%, covered multiple times.

Outlook – moved from “in line” last time VTU reported, now to “ahead of market expectations”. Driven by good trading in September, plus H2 benefit from Govt support for energy costs, and reduction in NICs.

Strong acquisition pipeline.

Costs are a key focus, especially energy. Installing solar power, capital cost, but good payback c.4.5 years. This is very interesting, and we’re seeing other companies report the same thing as a self-help measure, and good for the overall energy crisis, if companies produce more of their own energy on-site.

Vehicle shortages expected to continue “well into next financial year”.

Agency model – this is a key concern about the dealership model, as it might damage their future profits. VTU says Mercedes is the first one moving to agency model (no haggling on price, manufacturer owns the stock) from Jan 2023 and VTU expects no change in profitability. Although doing a bit of googling, other manufacturers have said the move to an agency model is being done to strip out distribution costs – which does suggest that dealership profits could be harmed by the move (but not all manufacturers are changing to this new model).

Balance sheet - very strong. NAV £340.0m, less intangible assets of £107.5m, gives NTAV of £232.5m. The market cap is only £160m, so really you’re getting part of the business for free, if you buy at the current share price. Although with commercial property prices now falling, maybe the freeholds might be worth less now?

Cash is £85.9m, and note interest receivable is now coming back. That’s mostly offset by interest-bearing debt of £68.1m.

The commentary mentions the possibility of taking out mortgages on its freeholds to raise cash for acquisitions. Pity they didn’t do that when mortgages were cheap. Maybe not such a good idea now?

Pension scheme – this is interesting. The scheme benefitted by £8.2m from a reduction in measurement of liabilities (due to rising bond yields). However, its assets fell by more, £12.2m. Therefore we need to be careful in assuming that pension deficits at other companies must be falling due to higher bond yields. We need to watch this area closely, and I’m not comfortable investing in companies with big pension schemes, due to the uncertainty in this area.

Cashflow statement – very straightforward. The operating cashflow generation has been spent on acquisitions, capex, divis and share buybacks, leaving cash little changed. That’s fine.

My opinion – that all sounds fine to me. To summarise -

Bull points:

  • Trading well, now above expectations.
  • Revised (up) broker forecast still looks low.
  • Very low valuation – forward PER of only 5.5 (on modest forecasts)
  • Decent divis of 4.4%, and 4-times covered by earnings.
  • Share count falling, due to buybacks.
  • Balance sheet very strong, including many freeholds, and shares trade at discount to NTAV.
  • Sector consolidation likely – takeover bid?

Bear points:

  • Reduced profits inevitable, when vehicle supply returns to normal (but that’s already in the forecasts).
  • Electric Vehicles – less servicing, and customers might buy direct from manufacturers in future?
  • Agency model could be a potential threat to profits?
  • Property assets might have fallen in value recently, due to higher interest rates.
  • Impact on earnings from higher costs, esp salaries amp; utilities.
  • Wafer thin profit margins, although note that the biggest contributor to gross profit is high margin aftersales (e.g. servicing, repairs)

Overall, I continue to see VTU shares as a particularly good value share. Strongly asset backed, with a low PER and decent divis on top. So this is attractive to value investors.

Stockopedia also likes it – look how high the StockRank is (below – chart below the share price chart) -


Graham’s Section: PCF (LON:PCF)

Share price: 2.25p (pre-market)

Market cap: £7.5m

This is below our normal £10m cut-off, but I think it deserves an update as this is one that I previously covered in some detail. It’s also a stock that I previously owned.

You can read my final SCVR report on it here (from April 2020). I also wrote a detailed overview on my own website here (November 2021).

In summary, this looked like a fast-growing, high-performing challenger bank with a lot of potential. But over the last few years it has suffered a vast array of problems, many of which were self-inflicted (although the impact of Covid hardly helped them).

Most shockingly, the problems included “members of the finance team, under instruction, manually adjusting certain accounting entries for both financial and regulatory reporting purposes”. In other words, we may have been analysing falsified numbers from this company.

Some of the recent events here are:

  • May 2022: early-stage takeover discussions with Castle Trust Capital Plc. “Under the terms of the possible offer, PCF shareholders would have a small minority position” in the combined group.”
  • June 2022: interim results to March 2022 show a pre-tax loss of £7.5m as the company’s expenses increase and its lending book reduces. Balance sheet equity falls from £49m to £41m.
  • July 2022: the major shareholder injects £1.5m at the low, low price of just 5p per share (9% dilution).
  • August 2022: PCF starts selling defaulted receivables to a specialist.
  • September 2022: Castle Trust Capital says it does not intend to make an offer for PCF.

This brings us to today. With the Castle deal no longer on the cards, PCF wants to let shareholders know what it is planning to do:

The Company continues to be engaged in its objectives of seeking to raise further growth capital despite the difficult market backdrop whilst separately continuing to explore other transactional options, be that by way of business, operational or asset sales or other options to give greater certainty to, and maximise value for, shareholders.

In my view, this is the sort of language that tends to precede a fire sale, or worse. The problems at PCF must run very deep. Even with £41m of balance sheet equity (as of March), it feels unable to continue without external help.

Indeed, current management have decided they need to slim down and stop lending:

…the Board of PCF has taken the decision, with effect from today, that it would be prudent for PCF Bank to suspend any new lending activities until further notice. The business will also accelerate a review process of its operational structure with the intention of further reducing its cost base.

My view

From my perspective, there were only a few, mild warning signs that all was not well at PCF.

  • In the good times, PCF had raised equity at a substantial discount to its prevailing share price. They seemed unnecessarily eager to raise funds.
  • The acquisition of a company providing asset finance to the media industry looked like a distraction and a high-risk investment.
  • There were some signs of deterioration in the lending portfolio in December 2019.

The wheels subsequently fell off – to the great harm of many private investors.

Still, at least former CEO Scott Maybury is doing well. On his LinkedIn, he describes his current occupation as “retired”.

Where do PCF shares go from here? Unfortunately, for anybody still holding them, I think we have to presume that their value is zero. They might not be worthless, but the positioning of management clearly indicates that additional capital is needed (and is not yet forthcoming).

And in the meanwhile, the company is suffering from much higher expenses and a much smaller lending portfolio than it originally planned for.

Castle Trust Capital looked like a suitable buyer, and it had a long time to review the opportunity. In the end, they walked away. I wonder what they saw that put them off?

Additionally, the decision to cease lending will send a signal to customers that the bank is not in great shape. This could have longer-term reputational implications.

I’m very curious to see the final outcome. Maybe there is still hope, if the company can raise enough funds to cover its higher expenses for the next year or two, while it sorts out its problems? But hope is a dangerous thing.


Strix (LON:KETL)

Share price: 123p (-4%)

Market cap: £255m

This company reported its interims in September, showing a £4m reduction in H1 revenues (to £50.7m) and an increase in net debt to £61.3m.

The last time I covered this (July 2022) I said that it would definitely be worth keeping an eye on its balance sheet, as debt was growing to fund a highly ambitious growth strategy. The company has been seeking to double revenues by 2025, and is pulling out all the stops to do this.

As a reminder: Strix provides kettle safety controls to a huge proportion of the global population (it claims to have 56% value share of the global kettle controls market). But in order to turbocharge its growth prospects, it has been branching out to water filtration, water purification, and various appliances.

Today, it announces a £10m placing, at 115p:

  • 10% discount to the prevailing share price.
  • 4% dilution for existing shareholders.

Dilution at this scale doesn’t tend to arouse much anger among shareholders, especially if it’s for a good cause.

The purpose of the placing is to help Strix buy a company called Billi: see its Australian and UK websites.

The acquisition will cost £38m, and so the placing only helps to part-fund it. The rest of the funds will be borrowed through a new term loan.

Debt refinancing

Strix’s current £80m RCF (revolving credit facility) has been given a new tenor of 3 years, plus two 1 year extension options, i.e. the banks are potentially happy to keep this facility open for up to another five years.

In addition, Strix is taking out a new £49m term loan with a tenor of three years. Unlike the RCF, this one needs to be paid down gradually over time.

It feels like a lot of debt to take on. But for context, Strix’s H1 2022 operating profit was £12.9m. Full-year operating profit in 2020 was £33.7m. Its cash generation has, I think, usually been quite good. The banks will have run the numbers, of course, and must believe that a £130m debt load is manageable.

Strix says that net debt to adjusted EBITDA will peak at 1.9x this year and reduce to 1.4x by the end of next year. By the standards of some other companies, that debt multiple could be considered modest.

Strategic Rationale

The acquisition “changes the earnings profile of the Group, accelerating growth plans for the Water amp; Appliance categories”. Medium term targets – presumably including the revenue target – are now expected to be reached in advance of the 2025 timeframe.

Billi’s products include a range of water systems, high-tech taps and accessories. Like me, perhaps you’ve noticed that high-tech taps are all the rage now!

Here’s some of the explanation from Strix around why it’s making this acquisition:

Billi is benefitting from structural market and ESG tailwinds including increasing focus on water filtration, a reduction in single use plastics and a focus on energy consumption from heating water which is aligned with Strix’s sustainability goals

Opportunity for further organic growth driven by increased residential sales, new product development particularly in sparkling, internationalising Billi’s revenue stream through Strix’s global footprint, cross selling Strix products into commercial applications and growing aftermarket sales

Identified efficiencies across Billi’s product lifecycle through utilising Strix’s Chinese operation to improve procurement, using Strix filters in Billi products, consolidating the marketing group and rationalising the store estate

My view

This acquisition gets the thumbs up from me. I say this nervously, as I’m aware of the pitfalls that come with Mamp;A. But the strategic rationale makes a lot of sense to me, and I would view this as a highly complementary acquisition that fits in well with what Strix has been trying to achieve in water filtration and appliances.

As for the financial aspects of the deal, you could of course argue that the risk profile has increased and that the shares need to be priced lower, to reflect this financial risk.

However, I don’t think we should be too surprised at today’s news. Strix has been clear about its growth ambitions and has not been shy to use debt to achieve them. If anything, I think we should be relieved that they decided to at least use some additional equity to help pay for the deal.

They are paying around 4x Billi’s expected EBITDA this year, which sounds reasonable (it depends on how much EBITDA converts into net income, but a 4x EBITDA multiple can hardly be considered extortionate).

Finally, I think it makes sense that the Strix share price is lower today, to reflect the issuance of new shares at 115p. The company’s recent lack of growth is a concern, and I must acknowledge that its falling share price indicates that investors are worried. The stock is down by almost 70% from its peak in September last year:

But I’m intrigued as to whether the market is overly concerned about the situation here, and might have served us up a value opportunity? The Stockopedia Value Rank is 89, and the dividend yield has become rather fat:

Certainly there are risks, and I wouldn’t bet my retirement on this stock. But has it possibly got too cheap at this level?



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