Small Cap Value Report (Mon 21 Nov 2022) - ACRL, TTG, TUNE, POLR, PODP

Good morning from Paul amp; Graham! Today’s report is now finished, as I want to spend some time after lunch typing up the podcast written summary.

Agenda

Paul’s Section:

Episode 21 of my weekly summary podcast went up as usual on Saturday. There were 4 mystery shares this week (being my best stock picks of the week, reserved solely for Stockopedia subscribers). So see Wednesday’s SCVR for all of these (the whole report is mysterious, apart from McBride) which are (in my opinion) the best value/GARP shares of the week.  It’s great fun recording these podcasts, and feedback from listeners at Mello last week was really positive, so I now know it’s worth creating them, and they’re not too serious, so hopefully also an entertaining amp; fast moving listen. I haven’t got round to typing up the written summary yet, that will probably have to follow tomorrow, as I have to somehow get back to Bournemouth from London today, on a rail strike day. So this afternoon could end up spending 5 hours sitting on a bus. What joy! We seem to have been teleported back to the 1970s, with another winter of discontent looming. As my mother likes to say, “I think mankind is going backwards!”

Accrol group (LON:ACRL) – an upbeat-sounding H1 trading update. After a lot of problems in the past, things now seem to be improving, with a decent level of profitability having been achieved again. Although I still have questions about the business model, so it’s not for me.

Focusrite (LON:TUNE) [quick comment] – announces today that the audit for FY 8/2022 numbers is taking longer than expected, so the date is pushed on from 29 November, to 8 December. Importantly, it also reassures that there is no change to profit guidance from the trading update on 14 Sept. It makes me nervous when companies delay accounts, as it can mean something nasty has emerged during the audit. However in this case, I think TUNE has a strong track record, and re-confirming guidance is a reassuring sign. Shares have fallen right back to immediately pre-pandemic levels, and look more sensibly priced now, so could be worth a fresh look. There is question mark over whether the large rise in pandemic profits is sustainable though? [no section below].

Pod Point group (LON:PODP) – my first review of this installer of EV charging points. The short version? It looks a lousy investment. More detail below.

Graham’s Section:

TT electronics (LON:TTG) (£256m) – excellent news from this manufacturer of electronics components. The company’s £500m defined benefit pension fund has swapped out all of its assets for a bulk annuity contract with Lamp;G. Under this contract, Lamp;G is responsible for TTG’s member benefits, removing all of the financial risks associated with pensions from TTG. The result is a £6m annual cash flow boost for TTG and an easier path to deleveraging its own balance sheet, which has been a cause for concern. I mentioned this stock at Mello last week as potentially offering a value opportunity and a share price rebound, if equity markets recover and if it successfully deleverages. Today’s news undoubtedly strengthens the investment thesis.

Polar Capital Holdings (LON:POLR) (£474m) – interim results here show large percentage declines in profitability as the company’s AuM takes another hit from outflows and from negative investment returns. The company’s exposure to the technology sector has turned into a liability as the excessive valuations in that sector unwind. While some short-term negativity is easily justified, I think this may have already been priced in as Polar’s stock now trades at a much lower level compared to last year, despite the fall in AuM being relatively modest. Dividend cover has reduced but the yield on these shares is now in the region of 10%.

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.

25.7p (pre market open)

Market cap £82m

H1 Trading Update

On track to deliver FY23 results at least in line with market expectations*  

* For the purpose of this announcement, the Group believes market consensus for FY23 to be revenue of £213.5m, adjusted EBITDA of £15.0m, adjusted PBT of £7.1m and net debt of £26.3m.

Good to see a footnote, providing details of market expectations. All companies should do this. I have heard of one broker that removes the footnote when management include it. I would name amp; shame them, but have forgotten which broker it was.

Things seem to be going well for this tissue paper company, which has had a lot of problems in the past.

…substantial growth in volume, revenue and profit

Cost inflation – there’s a strong statement here, note the use of “all”, instead of “mitigate” which lots of companies are saying at the moment -

The Group continues to demonstrate its resilience against the challenges of input cost inflation, successfully leveraging its supply position with customers to recover all additional costs in the Period.

Net debt -

Net debt at 31 October 2022 was lower than anticipated at c.£30.5m, despite a significant increase in tissue stocks…

This is expected to reduce in H2, as inventories decline.

Revenues - a large increase, which seems to be mainly through higher selling prices, and a more modest increase in volume. If companies can maintain or rebuild profit margins, then over time, inflation results in a larger business -

Revenue up 64% to £121.1m (H1 FY22: £73.7m), with volumes increasing by 14% in the Period

Market share up from 19.5% to 21.5% – evidenced by volumes increasing (as I would expect the total market to remain roughly static)

Outlook - given that it makes value-orientated products, I can see why Accrol would do well in a consumer downturn, as customers trade down to cheaper (but hardly any different) products -

The Group’s main market, the discount retailers and private label products continue to grow strongly, driven by the cost-of-living crisis.  

The Group has delivered substantial growth in the Period and the Board is increasingly confident that the growth trajectory of the business is sustainable. The volume growth in H1 FY23 is expected to continue as consumers move away from high-cost, low-value branded products in search of best-value.  

Whilst mindful of the wider economic uncertainties, the Group’s model is robust, and the Board considers the Group to be on track to deliver results for the full year ended 30 April 2023 (“FY23″) at least in line with market expectations* with net debt reducing ahead of expectations to c.1.5x EBITDA by the end of FY23 (FY22: 3.0x).  

* For the purpose of this announcement, the Group believes market consensus for FY23 to be revenue of £213.5m, adjusted EBITDA of £15.0m, adjusted PBT of £7.1m and net debt of £26.3m.

Broker expectations - there’s a difference between beating tough forecasts, and (as in this case) just stepping over a bar that’s been moved down to very low. See below how forecasts have been reduced by over two thirds for FY 4/2023 -

.

Liberum and Zeus have issued update notes this morning, available on Research Tree, many thanks to both. Liberum has £7.5m adj PBT and 1.8p EPS for this year FY 4/2023, then a big increase to £13.9m and 3.1p for next year. I’d like to be clearer why they expect such a large profit increase next year, and why that would be achievable.

If these FY 4/2024 figures are achieved then I can see that a higher share price would be justified.

My opinion – it’s looking like ACRL has finally been sorted out. Remember the history here is terrible It floated in 2016 on the basis of a bonanza in profits due to cheap input costs. That then unwound, and the company got into serious trouble, and almost went bust. Shareholders propped it up, but that means the share count went up from c.93m, to 319m now, hence the previous highs of c.150p share price are not likely to ever be recouped.

This also demonstrated the big flaw in ACRL’s business model – that it has no control over input prices, only makes a small gross margin, so then is dependent on being able to pass on price rises promptly to customers (supermarkets) that are notoriously resistant to price rises, because they themselves only make a tiny profit margin.

So the key questions to ask management are how their contracts are now structured, in terms of controlling input costs, and controlling selling prices? If they can’t match those up better than in the past, then the business model is still flawed, and hence more profit warnings would be just a matter of time.

The business model doesn’t interest me at all, so it’s not for me. Although for existing holders, at least today’s news shows that things seem to be on an improving trend. It’s difficult to see why ACRL would be a listed company, other than to take advantage of bumper profits through an inflated IPO price, when it originally floated. I cannot see any compelling ongoing reason as to why this share is listed.

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65.6p (down 14% at 09:29)

Market cap £101m

This has just dropped £16m in value on today’s update -

Trading Update

Growth in H2 (of FY 12/2022) has “slowed markedly”

Blamed on supply chain problems resulting in car manufacturers delivering fewer new EVs (electric vehicles), hence less demand for home charging points (PODP’s main business).

Govt grants for home chargers pulled forward demand, ahead of abolition at end March 2022.

Guidance for FY 12/2022 -

As a result of these challenges the Group expects full year 2022 revenues to be approximately £70m with an adjusted EBITDA loss of circa £7m.

This represents a recent slowdown as follows:

H1 2021 revenues £26.5m
H2 2021 revenues £34.9m
H1 2022 revenues £41.6m
H2 2022 revenues £28.4m (latest guidance)

FY 12/2023 guidance – also provided today is for FY 12/2023 of £85-90m revenues, so an expected recovery compared with H2 2022. It’s blaming some of the 2022 shortfall on supply chain problems, which we know are generally easing, so it makes sense that better supply should mean more installations in 2023. Supply chain issues also include restrictions on the supply of new EVs, thus causing a knock-on reduction in demand for home chargers.

Background – as this is the first time I’ve looked at PODP, I looked back to this years’ interim results, so here are my notes.

What does it do? Mainly installation of home charging units for EVs, but also commercial installations too.

Margin are is low (gross margin of 25% for H1) – so little pricing power. There are numerous providers of EV charging points, so lots of competition, although PODP seems to have decent market share of 22% in H1, helped by deals with car manufacturers. But so what, given that these are mainly one-off sales?

Recurring revenues? Very little, only £0.8m in H1, from commercial units only (there don’t seem to be any recurring revenues from installing home chargers, which is the bulk of revenues). The recurring revenues of commercial installations are only £41 per unit, which wouldn’t be enough to cover the cost of just one maintenance callout, if anything were to go wrong.

Losses - it made a £(1.4)m EBITDA loss in H1, and bear in mind depreciation amp; amortisation are quite large, so the real world (statutory) loss before tax was £(7.5)m in H1. This includes a £2.6m charge for share based payments. It infuriates me when loss-making companies dole out free shares to management. Build a profitable business first! Then get some reward for it, is my apparently outdated view.

FY 12/2023 guidance is for continuing losses in “mid-single digital [sic] adjusted EBITDA loss in 2023”. Clearly a typo, which should read: mid-single digit, I think. Does that mean percentage, or in £m’s?

88% of jobs are installed by partners.

Stopped selling in Norway, which was immaterial anyway. Norway is a mature market for EVs, which perhaps indicates there’s not much mileage in PODP’s business model for overseas? Another  reason to be sceptical of this share.

Big increase in headcount, using IPO proceeds.

Cash pile is large, but depleting: £96m end 2021, £82m at H1, expected to be £70m end 2022, and guided to be c.£50m at end 2023. Fully funded for now, but what happens longer term? More placings, at much lower prices, would be my best guess.

The big question, is whether the cash is being spent productively? I would say a resounding no to that! It seems to me the cash pile is probably being squandered on uneconomic growth.

Green credentials in the commentary – all very commendable, but if it was my money being burned, I’d want more of a focus on building profits.

Maintenance costs – I need more information on this. PODP provides EV charging points commercially, e.g. at workplaces, and in supermarket car parks. However, in my experience, these sometimes tend to be out of order. So a key question is, who pays for the callouts to get engineers to remedy faults? If it’s PODP, then the recurring revenues of just £41/site would not be enough to cover those costs.

Ownership – note that major electricity generator EDF controls PODP, with 55% ownership. So it would be interesting to know how that relationship works? Does EDF provide subsidised electricity, or any other support? Why did it float PODP? Maybe to get someone else to part-fund the roll-out of EV charging points?!

My opinion - I’ve only done an initial review here, and have already seen enough to make me highly sceptical that this is a viable business. So I reckon the most likely outcome is that the cash pile continues depleting, with nothing much to show for it, in recurring revenues or profit. It’s not clear to me how driving revenue faster would help, as recurring revenues are so small.

If PODP could demonstrate that it’s rapidly building recurring, high margin revenues, then great. But I don’t see anything at all of that kind, rather the opposite.

The economics of the business just look awful to me, so I wouldn’t go near this share. Let the institutions fund the loss-making part of the green agenda, rather than us.

This is only based on an initial review though, so I’d be happy to learn more about the company, if they do webinars, etc.

Anything connected with renewables might have been fashionable in recent years, but I think it’s really important to take off the rose tinted glasses, and instead look at the hard numbers with a cold, analytical view. On that basis, some business models might look very wobbly indeed, as PODP seems to be.

Share price: 145p (pre-market)

Market cap: £256m

There is a really positive pension-related update this morning from TT Electronics, a global manufacturer of electronic components.

We’ve discussed recently how rising interest rates are having a major impact on pension funds.

Some funds got in trouble due to their hedging practices, but on the whole rising interest rates should be great news: rising interest rates mean higher future returns on any cash which a pension fund puts to work.

This morning, TT announces a “buy-in” (see explanation by PWC): a bulk annuity contract with an insurance company under which the insurer is contractually obliged to pay all of TT’s defined benefit members’ benefits in future. The insurer in question is Lamp;G.

The contract has been bought with existing pension scheme assets, and does not require any further payments by TT:

TT will not be required to make any future contributions into the Scheme regarding defined benefit liabilities and the buy-in delivers greater security to the Scheme’s members. The Scheme’s circa £400 million of liabilities are now matched by the insurance policy, and TT no longer bears any investment, longevity, interest rate or inflation risk in respect of the Scheme.

The impact on cash flow is a £6m benefit for TT both this year and in future years.

At its most recent interim results, TT noted that the net accounting surplus for its DB pension scheme had improved from £74m to £92m, “due to increases in yields on corporate bonds in the half year causing the scheme obligation to decrease”.

Today’s news locks in those gains (although treat that £92m figure with a large grain of salt).

My view

This is a stock I mentioned at Mello last week, arguing that it has the potential to rebound very strongly if equity markets recover and of course depending on its own execution. Underlying trading has been very strong, its order book has been growing, its costs are being passed onto customers, and yet its share price has halved over the past year.

Its balance sheet has been a point of concern: net debt was £142m as of June 2022 (including leases). However, the company has guided that its leverage multiple will reduce from 2.4x to its target range of 1x – 2x by December 2022.

Today’s pension deal surely makes that job much easier, reducing financial risk and adding strength to the view that this stock offers a value opportunity:

We should hopefully receive many more examples of good news along these lines from company pension funds in the months ahead.

Share price: 470.5p (-0.4%)

Market cap: £474m

I looked at Polar’s FY March 2022 results back in June.

Today we have the interim results up to September.

AuM Movements

• AuM falls by £3.3 billion to £18.8 billion (down 15%).
• Of the £3.3 billion fall, negative returns accounted for £2 billion.
• The rest of the fall was made up of outflows: customers pulled out nearly £0.8 billion, and there were £0.5 billion of fund closures.

I’ve noted previously that 75% of Polar’s funds (currently £14.1 billion) are open-ended in nature, meaning that customers can pull out their money at any time and receive the fund’s NAV.

Flows into open-ended funds like this are sensitive to short-term investor sentiment and the changing popularity of particular investment themes.

Over the last six months, Polar’s huge Technology Fund has seen big outflows: £569m to be precise.

This fund currently has £3.7 billion of AuM, down from £4.4 billion six months ago.

It has suffered from weak performance over the past two years, which tends to go hand-in-hand with outflows:

Polar Capital Global Technology Fund’s performance has improved but remains well off its high-water mark due to a challenging 2021.

The Technology theme reduced from 42% to 37% of Polar’s total AuM during H1.

Elsewhere, UK and European equities are also out of favour.

Money has been pulled out of both the UK Value Opportunities Fund and the European Opportunities Fund.

The summary of events at the UK Value Opportunities Fund will be of no surprise to readers here:

Polar Capital UK Value Opportunities Fund has materially underperformed its benchmark as it has high exposure to small and mid-cap domestic companies which have been de-rated due to the weakening UK economy. The performance of the benchmark (FTSE All Share) has been driven by oil and resources.

Regarding UK and European equities, investors have been “cutting exposure to these two regions significantly.”

Funds doing better include the outperforming Global Insurance Fund, the Emerging Markets Stars fund, and healthcare funds, but these are all significantly smaller than Technology.

Financial results

• Core operating profit £25.8m (H1 last year: £36.3m)
• Pre-tax profit £23m (H1 last year: £31.7m)
• Unchanged interim dividend 14p (paid from basic EPS of 17.7p, so not much cover).

Market comment

I nearly always find something interesting to read in fund manager commentaries. For example, Polar’s CEO observes that bond indices have recently been declining by as much as equity indices.

He notes that -

“a ‘balanced’ portfolio of bonds and equities is experiencing its worst year for at least a century”, and that “a GDP weighted world government bond index is on track for its worst annualised return since 1920”.

Outlook

Our diverse and differentiated range of sector, thematic and regional fund strategies where 73%, 87%, 86% and 93% of our AuM is in the top two quartiles against peers over one year, three years, five years and since inception, our improved distribution capability and significant remaining capacity gives us confidence that we will perform for our clients and shareholders over the long term.

My view

Overall, I still have a positive view on Polar due to its specialisation in strategies which should do well over the long-term (technology, insurance and healthcare are its three largest strategies).

The size of the Technology strategy is admittedly a headwind to performance as the technology bubble bursts, so timing an investment in Polar isn’t easy: who knows when the NASDAQ will find a bottom?

I certainly don’t know if we’ve reached the lows yet, but I do suspect there is plenty of value to be had here: the Polar share price is almost 50% lower than the high price it reached of c. 900p in summer 2021.

In June 2021, AuM were £22.8 billion. Polar discloses today that its AuM, as of 11/11/2021, had recovered to £19.2 billion.

So between June 2021 and November 2022, Polar’s AuM is down by only 16%.

Operational leverage has worked in reverse and has hurt the company’s profitability, but it will start working positively again whenever markets bottom and inflows resume.

So for me, this is another good value share in the fund management sector.

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