Small Cap Value Report (Fri 25 Aug 2023) - CMCX, ZED, IPEL, LOOK

Good morning from just Paul today, with it being Friday!

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 £1bn. 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 (thumbs up) – 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 (thumbs down) – means we see significant, or serious problems, so anyone looking at the share needs to be aware of the high risk.

Not much reporting today, so I’ll see if I can do a couple of backlog items as well as the main one, CMC -

CMC Markets (LON:CMCX) - Down 15% to 104p (at 08:39) £290m – Trading Statement – Paul – GREEN

A frustrating update, with limited information, and no broker notes to help me. So I have to dig through the last full year accounts to make some sense of it. The main point is that balance sheet NTAV is now above the market cap, and it’s almost all liquid assets. So this share looks astonishingly cheap for a possible recovery in due course. Providing nothing more serious is going wrong under the surface.

Zenova (LON:ZED) - Unch 5.25p (£6m) – Interim Results – Paul – RED

Loss-making tiddler. I only review it briefly below, to get something into the system here. Main point is, it’s financially distressed, and needs to be recapitalised to fund the continuing losses. Near zero revenues. Fire safety products might be interesting, but it needs to get proper funding in place first before I would go near it. 

Lookers (LON:LOOK) – Interims – Paul – AMBER

Down 15% to 104p (at 08:39) £290m – Trading Statement – Paul – GREEN

CMC Markets Plc (“CMC” or the “Group”), a leading global provider of online retail (“D2C”) and institutional (“B2B”) platform technology, today issues a trading update for FY 2024.

A strange and vague description above. It’s actually a spread betting/ CFD company, 59% owned by Peter Cruddas, so he’s in control, which can bring risk with it sometimes, as we occasionally see at companies with a dominant single shareholder.

The current financial year is FY 3/2024.

As you can see below, it enjoyed a profitability boom during the pandemic -

The share price has since lost over ¾ of its peak valuation – here’s the 5-year chart – looking very poorly now – ominous, or an opportunity, I wonder?

To get me up to speed, Graham amp; Roland’s previous comments on CMC are as follows:

25/1/23 – GREEN – 235p – TU: trading stable, in line exps. High quality, PER 11x.

13/6/23 – GREEN – 160p – In line FY 3/2023 results. Roland – fundamentals strong, good value.

27/7/23 – GREEN – 147p – TU: weak customer activity. Graham: sector looks cheap (holds IGG personally)

The above is a good reminder that we can only review the facts, figures, and forecasts as they are on each day. We’re not able to reliably predict the future! Clearly business has been slowing down at CMCX more recently. However, at some point in the future, it might pick up again, that’s usually what happens in this sector.

This is the latest – sounds like private clients are hiding or on holiday, rather than trading! -

Following the update provided on 27th July 2023, subdued market conditions have continued through August with trading and investing net revenues trending 20% lower year-on-year. August in particular has seen a more challenging environment with markedly lower monetisation of client trading activity due to a higher proportion of lower margin institutional volume.

Revised guidance -

Whilst underlying market activity has the potential to recover, should year-to-date market conditions continue for the remainder of FY24 then it is expected that net operating income will be between £250 and £280 million…

Management expectations for FY 2024 operating costs excluding variable remuneration are unchanged at £240 million. A further update on costs will be announced with interim results.

What a confusing way to report! Why can’t they just guide what the profit (before tax) is going to be? Or give a range of outcomes?

There are no broker notes available.

So I’ll have to refer back to previous published accounts to work out what today’s update means.

Net operating income – this is effectively a gross profit number, but before all the substantial overheads (mainly staff, premises, marketing amp; IT, I imagine) -

• Guidance today for FY 3/2024: £250-280m
• Actual FY 3/2023: £288m
• Actual FY 3/2022: £282m

Operating expenses - looking back at previous accounts, this looks quite straightforward, they’ve given us the two numbers needed to deduce operating profit. Operating expenses are -

• Guidance today for FY 3/2024: £240m (but it says this excludes variable remuneration – staff bonuses I suppose. £240m is unchanged from guidance given on 13 June 2023)
• Actual FY 3/2023: £234m (very large increase on previous year – why?)
• Actual FY 3/2022: £188m

Operating profit is therefore -

• Guidance today for FY 3/2024: £10-40m (excl. staff bonuses)
• Actual FY 3/2023: £54m
• Actual FY 3/2022: £94m

(staff bonuses were £16-17m in each of the last 2 years)

That’s clearly a worrying downward trend, and also a wide range of outcomes for the current year, from not much above breakeven, to about 26% below last year.

What was previous guidance? I can’t see any profit guidance in the Q1 TU of 27 July 2023. It just said that Q1 performed as expected, and that net operating income was “similar” to last year.

Interest income - this is an important point. I recall before the zero interest rate period, spread betting companies made most of their profit from finance income – pocketing the interest earned on substantial client funds. Now that interest rates have gone up substantially, and rapidly, this should result in a dramatic increase in finance income for companies like CMCX.

Indeed, the TU on 27 July 2023 made this important point -

…however weaker client activity has been offset by stronger interest income, resulting in overall net operating income tracking at a similar run rate to the same period last year. 
[NB - from previous update on 27 July 2023]

Today’s update doesn’t say anything about interest income.

Note the net interest income increased from £1m in FY 3/2022, to £14m in FY 3/2023. So it’s reasonable to assume the figure for this year will be substantially higher again. Although it seems that net interest income is already included within net operating income.

Client funds amp; assets – this sounds reassuring, suggesting that some clients have paused activity, rather than closed accounts and withdrawn their cash amp; assets -

Core KPIs including client money, assets under administration, and active clients across both the trading and investing businesses remain robust with no material change seen through recent weeks.

EDIT: Client monies are segregated, ie not shown on CMCX’s balance sheet. This is from the FY 3/2023 accounts -

Client money 
Total segregated client money held by the Group for trading clients was £549.4 million at 31 March 2023 (2022: £546.6 million).
Client money represents the capacity for our clients to trade and offers an underlying indication of the health of our client base.

Client money governance
The Group segregates all money and assets held by it on behalf of clients excluding a small number of large clients which have entered a TTCA with the firm. This is in accordance with or exceeding applicable client money regulations in countries in which it operates…

This gives us an idea of what interest income CMCX could earn on client funds. If it’s say 5%, then on £550m funds, that would be c.£28m pa – which is nearly double the finance income earned last year.

Balance sheet - this is the best bit! I’ve reviewed the last reported balance sheet as at 31 March 2023, and it’s excellent.

NAV was £374m, with only £35m intangible assets to write off. So NTAV is £339m. Better still, that’s nearly all liquid assets (including cash of £146m), and near-cash (i.e. receivables that would turn into cash within days probably).

Bear in mind that the market cap after this morning’s drop is only £290m (at 104p/share), which is 14% below NTAV (almost entirely liquid assets). That’s crazy! It’s much too cheap in my view, and being more than fully backed by liquid assets, the valuation doesn’t make any sense at all to me.

Paul’s opinion - it’s taken me almost 2 hours to pick my way through this update, because it’s unclear the way the company reports, and I’m hampered by not having any broker notes available, and also being personally unfamiliar with the company.

Clearly conditions are tough, but that’s the market generally, not anything CMCX is doing wrong, I imagine. Sooner or later markets recover, and activity increases again.

In the meantime, it looks as if CMCX is still profitable, but only just, if it only hits the bottom end of its forecast range provided today. That’s clearly not good, but it’s a volatile business, where trading activity by clients ebbs and flows – this is completely normal, not exceptional.

Reading previous accounts, it looks as if CMCX has been expanding and increasing costs. That could be reversed, if depressed market conditions continue or worsen.

Therefore, I see the deep fall in share price more recently as a potential buying opportunity, for a recovery in due course.

The best bit is that the market cap is now more than fully backed with liquid assets. That’s remarkable.

The main risks are that something might be going badly wrong within the business itself – so not just a cyclical downturn, but competitors eating its lunch. That’s the main thing to check. So the next step would be to review major competitor IG group (LON:IGG) announcements, and if they’re similar to CMCX then that would reassure. I see IGG’s share price is also soft, but hasn’t fallen anywhere near as much as CMCX, which suggests the market seems to think CMCX has some company-specific problems on top of market cyclicality being poor at present.

Overall then, I recognise that CMCX is not trading well at present, but the deep value on the balance sheet is such that I have to give it a positive GREEN view, for a recovery in share price that is now incredibly well underpinned with liquid assets. It almost doesn’t matter what trading is like in the short-term, as long as it doesn’t slip into heavy losses, since investors have more than 100% liquid asset backing of the market cap.

The other potential risk with companies like this, is a catastrophic meltdown of IT, and hedging risk. If the IT allows traders to buy amp; sell at the wrong prices, they’ll quickly exploit it to the full, and the company could bankrupt itself in days, or even hours. So you have to hope they’ve got the most robust IT systems possible.

Once markets begin recovering, it wouldn’t surprise me at all to see CMCX shares maybe even up to 100% higher than they are now. So a very credible candidate for further research I think.

Unch 5.25p (£6m) – Interim Results – Paul – RED

Fool Hardy flagged this tiddler in the reader comments here, so I’ve had a very quick (literally 5 minute!) skim of the numbers. Just to get something in the system, as we’ve not looked at it before.

Negligible revenues of £108k in H1

Loss before tax £709k in H1 (FY Nov 2022 was £2.0m loss)

It’s burned through the £1.7m cash pile in the last year, only having £312k left at 31 May 2023

Placing at 4p raised only £500k in June 2023.

Director loan recently of £350k

Warrants issued, so note this is more dilution if shares recover in price.

Paul’s opinion – the finances look distressed, so it needs to get proper funding in place before I would see this as investable. More dilution looks inevitable, and could be ruinous. Even then, if it does get proper funding, you’ve got a blue sky, loss-making tiddler with negligible revenues.

On the upside, product news, contracts, etc, sound promising, but it needs to get the financial basics in place first before I would want to delve into the product side of things.

Looks to have floated in 2021, which tells me everything I need to know!

710p (£318m) – Interim Results – Paul – RED

This one has slipped through the net, we’ve not covered it since 2019. Pity, as there’s been a fabulous share price recovery since 2020, with it hitting new highs recently.

It’s a staffing business controlled by Lord Ashcroft, with his family trust owning 56%. There was controversy over his political connections (a former Tory Party treasurer, and big donor), and Impellam winning large NHS contracts to supply temporary staff (locums). The Guardian hints there might be a connection here, which Lord Ashcroft denied.

The blue band at the top of the StockReport says that Impellam “is involved in a takeover situation”. Rummaging through the RNS list, it keeps issuing extensions to the PUSU (put up or shut up) deadline, with bid talks (not a formal bid as yet) ongoing with HeadFirst Global, a Netherlands based group. Looking at its website, HeadFirst’s numbers only look slightly larger than Impellam’s, so I’m not sure how a bid would work from HeadFirst? Would it be a merger, or involve taking paper instead of cash, or a mix? I don’t know. HeadFirst’s website says it has an investor, IceLake Capital, which is helping it fund European growth, so that could be the answer. The commentary says that Lord Ashcroft wants to sell, and had previously notified this to Impellam.

Interim Results – were issued on 21 August 2023

Impellam (AIM: IPEL) announces its unaudited interim results for the 26 weeks ended 30 June 2023.

Gross profit growth in a challenging market

I have to say, Impellam’s interim numbers look feeble for a business valued at £318m – eg

H1 gross profit up 2% to £97.6m

Operating profit before amortisation £8.3m (down 11%)

Continuing operations adj EPS up 26% to 9.6p (so looks like there’s been a disposal)

Net cash £56m (up from £18m a year earlier)

Disposals – it’s sold a big chunk of the business, Medacs (the controversial healthcare business), and other regional subsidiaries, for £104m in March 2023, funding a £60m special dividend.

Actually there have been 3 special divis paid, of 69.3p, 55.4p, and another 55.4p, between Dec 2022 and Apr 2023.

Balance sheet – has negligible NTAV at 30 June 2023, only about £12m.

Forecasts – there don’t seem to be any, so I can’t value the shares on forecast earnings.

Given that it only reports continuing operations adj EPS of 9.6p in H1, which annualises (assuming no seasonality) to about 19p for a full year, I’d put that on a PER of about 10 maybe, being generous, so I get to 190p share price as looking reasonable. The actual share price is 710p! So I must have missed something here – there must be some hidden value in the group that isn’t obvious from these interim numbers.

Paul’s opinion – based on what I’ve seen so far, this share looks wildly over-priced, given it’s a low margin operator in a tough sector that seems to be embarking on a macro downturn.

Do any readers understand why the market cap is anything like this high? Particularly given that the cash from disposals has already been paid out?

If the potential bid from the Netherlands falls through, then I could imagine this share re-rating downwards by a huge amount. It’s probably only worth about a quarter of the current share price based on my reading of the interim numbers. Although as I say, there might be something important I’ve missed, as I’ve not looked at this share for 4 years.

Hence risk:reward looks extremely poor to me. RED.

128p (£489m) – Interim Results – Paul – AMBER

Lookers plc, one of the leading UK integrated automotive retail and service groups, today announces its unaudited interim results for the six months ended 30 June 2023 (“H1″ or “the period”).

Good trading performance despite macroeconomic headwinds

I’ll keep this brief, as it’s in a bid situation, with a Canadian suitor having already increased the bid from 120p to 130p, but failing to gain much in the way of acceptances, so there’s a chance this might fall through. When that happened once before, the share price plunged, then the higher bid came through.

The 130p cash offer is recommended by LOOK management, and a shareholder vote is imminent, for 5 Sept 2023.

So this is a tricky situation, where each investor has to decide for yourself whether to hold on for the bid, which involves accepting the risk of a say 20%-ish fall in share price if the bid falls through, which seems a distinct possibility. Would the bidder raise the price again? Could another bidder get involved? Is there a risk that the bid premium might take LOOK shares too high relative to its listed peers? Who knows.

I interpret this table positively. Car dealers had a bumper year in calendar 2022, yet it’s almost matched the EPS in H1 this year too. There wasn’t any seasonality last year, with H1 amp; H2 being very similar, yet the broker consensus for FY 12/2023 if for EPS to drop to 14.2p. With 9.0p already in the bag for H1, it seems likely that LOOK could be on track to beat 2023 forecasts perhaps.

Note how finance costs are rising steeply, to £18.3m in H1 (£11.6m H1 LY) which is a worry I have for this sector, as they often use large loans to finance inventories, which is an increasing headwind.

Going concern – the “material uncertainty” is a red herring, as it only applies to what might happen after the takeover bid goes through, which is irrelevant to us, as shareholders would no longer be shareholders then! There is a clean going concern statement for the group as it currently exists (i.e. if the takeover bid were to fall through). Solvency and balance sheet look fine to me.

Paul’s opinion - trading remains robust at LOOK, which could have nice read-across for other shares in this sector perhaps?

It seems that LOOK could beat forecasts, given the strong H1 performance, so the fwd PER of 8.8 is possibly less than that in reality. Although how long will fairly robust trading remain, if (as most people seem to now be expecting), higher interest rates push us into a hopefully only mild recession? People tend to buy fewer cars in recessions, but these days many new cars are rented on personal leases, so it’s not really a big ticket purchase, if you’re paying say £300 per month for an essential mode of transport. 

The increasing squeeze on mortgages though is bound to hurt households, who might decide to keep an existing car for longer. There again, retired people who are now earning interest on their savings for the first time in 15 years might decide to splash the cash and treat themselves to a new car. It’s so difficult to predict these things, and often what happens seems to be the complete opposite of what many of us expect! That’s certainly one lesson from the last 3-4 years of chaos.

Personally I’ve banked my profits in the car dealers, as they’ve had a good run this year, and I wanted the money for other buys. Although the bid interest in the sector could continue, and they all look cheap still, so that might have been a mistake, who knows?!

I view LOOK as AMBER currently, as it looks a good business, seems to be performing ahead of expectations (for H1), but I wouldn’t want to take the risk of the bid falling through, just for a couple of pence upside.

Stockopedia