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Small Cap Value Report (Mon 12 June 2023) - NETW, AO., STAF, FUM, LTG, RWI, OMG

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Good morning from Paul amp; Graham!

Today’s report is now finished.

Weekend podcasts went up as usual through the main podcast channels, or here on the web. I tinkered with the format to include lots of reader comments, but it doubled the length to over an hour, so I might need to re-think that! Apologies for the poor audio quality on part 2, I’m not sure what went wrong, but I’ll invest in a new microphone this week. Do spread the word, if you think they’re useful. I’m amazed anyone is listening, given how awful small cap markets have been for some time. Still, bear markets lay the groundwork for the next bull market, and valuations are looking very cheap!

Also I updated my SCVR summary spreadsheet yesterday (a quick reference tool), see below in reader comments for the link (not for sharing outside Stockopedia please!) 


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.

What does our colour-coding mean? Will it guarantee instant, easy riches? Sadly not! Share prices move up or down for many reasons, and can often detach from the company fundamentals. So we’re not making any predictions about what share prices will do.

Green – means in our opinion, a company is well-financed (so low risk of dilution/insolvency), is trading well, and has a reasonably good outlook, with the shares reasonably priced.

Amber – means we don’t have a strong view either way, and can see some positives, and some negatives. Often companies like this are good, but expensive.

Red – means we see significant, or serious problems, so anyone looking at the share needs to be aware of the high risk.



Summaries amp; Quick Comments Idox (LON:IDOX)

(backlog) – unch. at 69p (£310m) – H1 FY23 results – Roland – AMBER

A solid set of half-year numbers from this software group, with good cash generation and evidence of improving profitability. Near-term growth forecasts appear quite modest though, I think the share price is probably up with events. (More detail below)

Renewi (LON:RWI)

(backlog) – unch at 510p – FY23 results – Roland – AMBER

A fairly flat set of results from this European recycling group, but with many moving parts underlying the headline figures. I see the appeal of the group’s ambition, but question its ability to create shareholder value. More research needed – for now, I’m neutral. (More detail below)


Network International Holdings (LON:NETW)

Update price later – CVC takeover off – Paul – AMBER

Not a share we cover here, as the mkt cap is about £2bn, following a bid approach announced on 17 April 2023. The potential bidding consortium (CVC, and Francisco Partners) today announce that they won’t be bidding, with no reason given. That’s likely to trigger a sharp fall in share price today, as the bid premium evaporates.

EDIT: many thanks to BnB who points out in the comments that there’s a higher bid at 400p from Brookfield , which I hadn’t spotted. Apologies for that.

This company does payments services in the M.East amp; Africa. I note it has a high profit margin, but doesn’t pay divis, and has a weak balance sheet. So not the sort of thing I would probably be interested in, even if the market cap was within our range. Although the revenue growth does look impressive, so maybe more of a growth company, than value. It’s interesting how a lot of the private equity bids happening at the moment are for structural growth companies, and larger small caps or mid caps. Also prices being paid seem quite high, so there seems to be a valuation gap between the public market, and the private market, for growth companies. Could be bullish for the markets maybe?


AO World (LON:AO.)

£401m (69p pre-open) – Frasers partnership – Roland – AMBER

Retailer Frasers (LON:FRAS) (main shareholder: Mike Ashley) has acquired an 18.9% stake in online electricals retail AO World at a share price of 68p, which is in line with Friday’s close. This appears to be a purchase of existing shares, so not an equity raise.

The two companies plan to work together, with Fraser Group benefiting from “AO’s valuable know-how in electricals and two-man delivery, helping us to drive growth in our bulk equipment and homeware ranges. In turn, AO will have the opportunity to benefit from Frasers’ expertise and ecosystem.”

We’ve long been bearish on electrical retailer AO World here at the SCVR – and mostly with good reason. The shares trade 80% below their 2014 IPO level and the business has never really made a profit.

However, the company has a 32% UK market share in major domestic appliances and is now focusing on its domestic market, rather than trying to expand internationally. Founder John Roberts is also in charge again. I think there’s a chance this could become a sustainable and modestly profitable business.

Broker forecasts have been rising steadily, albeit from a very low level:

However, with the shares trading at 20x FY24 earnings, I think the valuation is well up with events. I note Stocko’s Momentum Trap status. For now, I’m staying on the sidelines.


Staffline (LON:STAF)

Unch at 35p (£57m) – AGM Trading Update – Paul – AMBER/RED

This is a very low margin recruitment amp; training group, with a poor track record.

It reassures that trading for FY 12/2023 remains in line with expectations, with an H2 weighting, which it says is the historical trend. Early signs of organic growth.

Liquidity – “substantial financing headroom”, and “benefits from its interest rate cap”.

Outlook – confident in medium to long-term (hence more cautious on short term? “mindful of ongoing macroeconomic headwinds”), and planning on increasing market share.

Paul’s opinion – it’s not a good business – absolutely tiny profit margin, which comes mainly from adjustments. Weak balance sheet. Why would anyone want to invest in this, when there are several other much higher quality, decently profitable staffing groups at attractively low valuations? Possible upside on STAF if major shareholder bids for it, I wonder? If STAF can increase its profit margin, then on c.£1bn of revenues, that could be meaningful. But that £1bn includes contractors wages, which are pass-through. So real revenues are better viewed as the £83m gross profit. It’s such a competitive market, supplying agency staff (mainly blue collar), that increasing margins is likely to be very difficult, with nothing to differentiate staffing companies, and customers on the ropes financially because of macro difficulties. It’s not of any interest to me, but good luck to holders. Also note substantial dilution, which was necessary to keep it afloat – 34m shares in 2017, 162m now! So there’s no point in drawing lines on the chart, or hoping for EPS to return to previous highs, when there’s been so much dilution. I’m surprised the StockRank is high, so maybe I’m missing something?


Futura Medical (LON:FUM)

Up 24% to 53p (£153m) – FDA Approval - Paul – RED

As MrContrarian says, mentioning this company always triggers a wave of innuendo, so maybe we can keep that brief, if at all, in the comments section? FUM makes a product that claims to help with erectile dysfunction. Although a quick look at review sites shows that the product doesn’t work at all for many people, and when you allow for probably lots of positive reviews being fake, the alarm bells are ringing here. 

Paul’s opinion - What happens next? Dusting down my crystal ball (which is badly chipped and opaque!)  I reckon it’s probably a flurry of positive RNSs about strong sales in the coming months, rising share price, insiders quietly bank their profits, then a lack of repeat sales (because the product doesn’t work) causes a profit warning further down the line. So I would be very careful to avoid this share. As always I could be wrong, but I’m highly sceptical about this share. And of course readers can mystery shop the product for yourselves.

FUM has a long history of generating heavy losses, on zero revenues. So the share price rests entirely on hopes for this product launch. That’s what makes it so risky, as the product doesn’t seem to work. 


Learning Technologies (LON:LTG)

Down 2% to 99p (£780m) – AGM Statement – Paul – AMBER/GREEN

LTG, the provider of services and technologies for digital learning and talent management…

“With a step-change in the scale of our business following the successful integration of GP Strategies, our broader offering provides a platform to capture a greater proportion of the circa $100 billion, and growing, addressable market in digital learning and talent management.

In a challenging macro environment we continue to see moderate business momentum in the first half of 2023 supported by a healthy sales pipeline. Our strong balance sheet will enable the Group to make select accretive acquisitions in due course that fit our long-term strategy.

Doesn’t sound madly exciting, but macro conditions are tough, so it’s probably not realistic to be expecting gangbusters growth right now.

Graham reviewed its FY 12/2022 results here in April, but wasn’t happy that the outlook comments slipped out a profit warning.

This share used to command a high PER, being seen as a glamour, growth stock. It’s now down to a value share rating, which reminds me a bit of RWS Holdings (LON:RWS) which we looked at last week.

Despite recently lowered broker forecasts, the historic graphs below still look terrific – strong earnings trend amp; growth, but graph 4 shows a plunging PER, now down to only 11.5x forward PER – which could be a buying opportunity maybe?

Balance sheet – is weak. As at Dec 2022, NAV of £426m includes intangible assets of £561m, giving NTAV of a horribly negative £(135)m. There’s too much bank debt for my liking too. So it concerns me that management today claims to have a strong balance sheet (when it clearly doesn’t!), with scope to make more acquisitions. If the economic cycle gets worse, and demand falls, which it might as I could see training being something many employers might cut to save cash in a tough economy. In that possible scenario, do shareholders really want to see LTG running up more debt on more acquisitions, at this stage in the cycle? I don’t – I’d much prefer to see the company paying down debt, so it could comfortably get through a recession. It’s expanded fast in the past, so I’d say this is a time to be more cautious.

Paul’s opinion – I don’t know enough about the company to give a strong view either way.

Bull points – I like the low PER, high margins, and strong historic growth track record.

Bear points – I very much dislike the balance sheet, which is weak, and has too much debt. Forecasts have been reduced steadily in the last 3 months, so clearly the outlook has been deteriorating. Question mark over how AI might affect the company?

Overall, it looks interesting, I’ll go with AMBER/GREEN.


Oxford Metrics (LON:OMG)

102p (£133m) – IMC webinar notes – Paul – GREEN

As it’s quiet for news today, I listened in to the interim results webinar at 10:00 today, on InvestorMeetCompany. Very good it was too. I reviewed its interim results here, late last week, which impressed me. OMG was on my runners up top share picks for 2023, and I’m very pleased with progress, even though the share price is down 5% YTD. Good fundamentals eventually pull up the share price.

I jotted down what struck me as the key points in the webinar, so this is not comprehensive -

CEO amp; CFO struck me as clever, hands-on, down-to-earth entrepreneurs – exactly what I look for (this is obviously subjective).

H1 revenue growth of 70%

Full year visibility in the bag, already have orders in hand.

Very encouraging sales pipeline.

Well placed to deliver ahead of expectations for FY 9/2023.

Previous Ramp;D spend has driven growth. Focused on increasing addressable markets with new products.

Staff increased to 170 total, with 20 added in Ramp;D.

Entertainment is biggest growth sector for end users, £11m H1 revenues, up 178%

Asia is biggest region, 43% total revenues (biggest country within, is Japan).

Valkyrie high end cameras are in strong demand.

Vicon’s main 2 competitors are Qualisys (Europe), and Optitrack - happy to compete against them, know we can win when head-to-head, as Valkyrie cameras have better features, so maintained/enlarged our market share.

AI – “we’ve been in it for years”.

Cash pile £63.6m, almost half market cap! Mgt sound sensible – not letting it burn a hole in their pockets. CFO said he’s maximising interest received, but won’t take risks, and needs to keep flexibility for Mamp;A pipeline. “See myself as a custodian” of the cash pile – good, he is!

Question about buybacks/special divis? CFO replied that cash primarily ear-marked for acquisitions. Might do a tender offer, if can’t deploy the cash on deals.

Mamp;A pipeline is good – valuations are now coming down to more sensible levels. Must be the right targets, at the right price, and earnings accretive. Must stack up as of today, without making assumptions about illusory synergies. It sounds to me as if the risk of management blowing the cash pile on something bad, is low.

There’s a short 4-minute H1 results video here.

Paul’s view - the webinar further improved my view of this share, and I really do want to get some into my portfolio at some stage. My main worry is the single-product risk – valkyrie cameras are doing great now, but is that sustainable?

I’ll reach out to the company, and see if they want to do an audio interview with me.


Roland’s Section: Idox (LON:IDOX)

Share price: 68p

Market cap: £310m

Half-year results (8 June)

As it’s a quiet day for news, I’ve scrolled back to last week to take a look at half-year results from Idox. This is an AIM-listed software business that specialises in information management solutions for public sector clients and asset-intensive sectors.

Public sector products include software for planning and building control, environmental health, licensing, and elections. In the private sector, the firm’s focus is on facilities management and engineering information management.

Results in the past have been somewhat inconsistent, but investors with good timing may have enjoyed a double bagger over the last few years:

I notice Paul was fairly cautious when he looked at the AGM update in March. Do last week’s numbers justify a more positive stance? Let’s take a look.

“The business continues to perform well and in line with the Board’s expectations.”

Financial summary: the headline numbers from these results appear to be fairly healthy:

  • Revenue up by 8% to £35.8m

  • Recurring revenue up 7% to £21.2m (59% of total)

  • Operating profit up 16% to £4.9m

  • Operating margin: 14% (H1 FY22: 13%)

  • Adjusted earnings from continuing operations up 10% to 1.33p

These numbers give me a trailing 12-month return on capital employed of 9.5%. This means that both operating margin and ROCE continue the positive progression seen over the last few years:

Cash flow and debt reduction also seem to support a positive story:

  • Net cash at the end of the period was £1.1m, versus net debt of £6.7m at the end of October 2022

  • Free cash flow for the half year was £12.6m (H1 FY22: £7.0m), excluding acquisitions. Idox renews many of its annual contracts during H1, so cash flow is typically weighted to the first half of the year.

One possible concern is that the balance sheet shows a negative tangible net asset value of £22m, due £91m of goodwill from previous acquisitions. This means there’s no asset backing if things go wrong. But given the group’s low working capital requirements (many clients pay cash up front), I wouldn’t rule out the stock on this basis alone.

Overall, Idox’s latest accounts look healthy enough to me. Although profitability doesn’t seem all that good for a software business, it’s certainly acceptable, in my view.

Trading summary

Management commentary provides a flavour of the group’s client base and product offerings across its three (recently reorganised) divisions:

Land, property amp; public protection: revenue rose by 22% to £21.5m, accounting for 60% of total revenue. Wins included multi-year contract extensions from customers such as The City of Edinburgh and Wolverhampton City Council.

A number of new councils also signed up to use Idox Cloud services.

Assets: revenue rose by 5% to £7.2m, driven by stronger sales of engineering information management (EIM) and facilities management (CAFM) systems. Sales of Transport and iFit solutions (not sure what they are) were down.

Communities: this business provides software used for elections in the UK and Malta, in addition to a range of products including grant databases and health services.

In the absence of any major elections, divisional revenue fell by 19% to £7.2m. But Idox (rightly?!) expects 2024 to be a much busier year for UK elections.

Outlook: the company expects full-year results to be in line with expectations. According to Stockopedia, broker forecasts suggest adjusted earnings of 2.8p per share this year, up from 2.44p per share last year.

However, this rate of growth isn’t expected to continue into FY24, with earnings forecasts almost flat for next year, at 2.85p per share.

Roland’s view: I don’t see too much to dislike in these results. Idox has moved to a net cash position and is slowly increasing the proportion of recurring revenue in its results and its profit margins.

On the other hand, there are a lot of moving parts here, with an extensive history of acquisitions and no solid asset backing on the balance sheet.

The valuation also looks up with events to me. Idox is not an especially high margin business and my sums suggest the shares are trading with an EBIT/EV yield of just 3%.

This translates into a forecast P/E of 24, which looks high enough to me given the modest rate of growth forecast over the next 18 months:

I’m going to give Idox an amber view, as I think the good news is already in the price at current levels.


Renewi (LON:RWI)

Share price: 510p

Market cap: £407m

Preliminary results for y/e 31 March 2023

“The Group continues to trade in line with market expectations for FY24”

This is another backlog item – this acquisitive recycling group published full-year results at the end of May, so I thought I’d take a quick look to see what had changed since Jack last covered this stock in the SCVR one year ago – a period that’s seen the shares fall by 25%.

What it does: Renewi says its ambition is to be the “leading waste-to-product company in the world’s most advanced circular economies”. A big – and potentially valuable – ambition.

The company says it handles 14m tonnes of waste each year, of which 89% is recycled or used for energy recovery. Its two largest markets are the Netherlands and Belgium, which generated 88% of revenue last year. The UK is next biggest, accounting for around 10% of revenue.

Markets served include construction, healthcare, plastics, glass and electronics. The company has deals with some corporate clients to supply recycled materials – e.g. recycled liners for Electrolux fridges.

Results summary: these results cover the 12 months to 31 March 2023 and are in euros, reflecting the group’s business mix.

Headline numbers suggest a fairly flat performance, at best, last year:

  • Revenue up 1.2% to €1,892m

  • Underlying EBIT down 1% to €132.9m (FY22: €133.6m)

  • Statutory after-tax profit down 12% to €66.6m

  • Basic earnings per share down 15% to €0.79

  • Adjusted net debt up 23% to €370.6m, reflecting an acquisition

  • Net debt to EBITDA increased to 1.8x (FY22: 1.4x)

  • Operating margin: 6.4%

  • Return on capital employed: 8.6%

The company says it faced lower recyclate prices and cost pressures from inflation over the last year, but was able to mitigate these through cost savings and customer price increases.

This may be true, but these numbers do seem a bit underwhelming to me. Although operating cash flow rose slightly to €188.4m, capex rose from €78m to €115m and the company also spent €53.5m on an acquisition. I estimate free cash flow of just €8m, excluding acquisitions.

The increase in net debt reflects this cash outflow, but Renewi’s return on capital of 8.6% makes me wonder how much value the company is generating, over and above its cost of capital.

I think the extent of the adjustments applied to reach the underlying EBIT figure also highlights some of the risks facing this business. Items excluded from last year’s underlying results included:

  • Loss on disposal of portfolio companies (€5.5m)

  • Restructuring gains (+€3.7m)

  • Favourable reassessment of UK onerous contract provisions (+€27.1m)

  • Release of legal provisions in Belgium (-€15.1m)

  • Cost of ineffective cash flow hedges (-€0.9m)

  • Reversal of prior year impairments (-€2m)

  • Amortisation of acquired intangibles (+€5m)

In total, excluding these items added 11% or €10.6m to underlying pre-tax profit last year, lifting pre-tax profit from €93.1m to an underlying figure of €103.7m.

It probably won’t surprise you to learn that I think most of these are regular costs of business that should be included in the group’s statutory profits. But I think they also highlight significant regulatory and legal risks that – perhaps – come with the territory in this highly-regulated yet fast-evolving sector.

Trading commentary: Renewi says it is continuing to make good progress on its target of adding €60m of additional EBIT by FY26, “with €20m delivered so far”. Given that underlying EBIT was flat last year, I’m not sure when this increase was delivered.

Management say they’ve completed €60m of capex and that the recovery in the “Mineralz amp; Water” division is ongoing.

However, while recycling rates are increasing, competitive pressures appear to be growing too. In the Netherlands, Renewi saw lower volumes, due partly to “increased pressure from secondary disposers”. As a result, the company is focusing on higher-margin volumes.

Outlook: FY24 trading is said to be in line with expectations and management expects to restart dividend payments this year.

Broker forecasts on Stockopedia suggest earnings of €0.82 per share for this year, pricing the stock on just seven times forecast earnings.

Roland’s view: Recycling and reuse are obviously important and fast-growing areas. But these conditions don’t always translate into businesses that can reliably generate value for shareholders.

In fairness, I think there are quite a lot of moving parts here. I would need to do further in-depth research into Renewi’s individual operations to understand the opportunities (and risks) that might exist.

For now, my view is that this business is moderately leveraged and not especially profitable. I would argue that the low price/earnings ratio is probably a fair reflection of recent and expected performance.

I note that while Renewi’s net fixed assets have remained stable over the last six years, the company’s book value per share has fallen. Again, this makes me question how much value this business is creating for its shareholders:

For these reasons, this isn’t a stock that interests me at this time. But I can see that Renewi could have medium-term potential as its capex starts to deliver results.

I’m going to give the shares an amber (neutral) view – also echoed by the StockRanks:

Stockopedia


Source: https://www.stockopedia.com/content/small-cap-value-report-mon-12-june-2023-netw-ao-staf-fum-ltg-rwi-omg-969539/


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