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Companies: SIXH, ABDP, AXS, AMPH, ALU, AEP, AVG, AVON, CAR, CHH, DSCV, DOTD, FRX, FLO, FCRM, GTLY, G4M, RAD, GHH, GHT, HDD, BOOT, IOF, LLOY, MPE, MAB1, RE/, RNO, RBN, SEE, SXX, SOLI, SOM, SCE, TRT, TRI, VANL, VEL, VCP, WIL, ZAM, ZOO, ZYT
Small-cap quantitative research - Quality screen refresh + 10 quality focus stocks
by N+1 Singer, 26 Oct
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Wilmington | Gresham Technologies | Avon Rubber | Churchill China | Zytronic | Dotdigital Group | Mortgage Advice Bureau | Gateley | Fulcrum Utility Services | Van Elle | AB Dynamics
"We have refreshed the quality style screen some ten months from its inception at 7
February 2017, according to the same criteria although with one threshold marginally
relaxed. The screen was applied as at the close of business on 24 October 2017. This
resulted in 25 stocks being selected, effectively being the “best” quality 5% stocks in our
universe according to our criteria. While the time since inception is rather extended,
there is a slow turnover of constituents due to the reliance on historical data. As before we focus on a smaller selection of 10 stocks, which are either under coverage or well-known to our analysts, and provide brief summaries and financials on pages 6-10. These are listed on this page to the right.
On a weighted basis, the screen outperformed the main small-cap index by c.13pp with
marginal outperformance of the microcap index. On a unweighted basis, the screen
outperformed small-cap by 7.6pp but modestly underperformed microcap. Our focus
stocks performed better than the style screen overall. Notably strong performances
came from GB Group (not rated, up 47%), dotDigital (Corporate, up 43%), Zytronic
(Corporate, up 42%) and Kainos Group (not rated, up 40%). We discuss the performance
in more detail on pages 2-3.
More detail can be found on page 3, but the quality screen requires a combination of
high returns on sales and capital coupled with low financial leverage and strong cash flow conversion. To select 25 stocks this time, we had to relax the cash-flow conversion threshold marginally, otherwise, all thresholds were unchanged.
Despite the extended interval since inception, there were only nine leavers and joiners,
which we list on page 5. We have focussed on 10 stocks of which 5 are new, namely
Churchill China (where we have just conducted a successful site visit with investors),
Fulcrum Utility Services, Mortgage Advice Bureau, Van Elle and Wilmington."
Gear4music (G4M)
H1FY18 encourages on all fronts | Panmure Gordon & Co, 23 Oct
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"H1FY18 EBITDA of £717k is ahead of our forecasted £571k. Whilst the quantum of the profit ‘beat’ in G4m’s seasonally less significant trading half is immaterial per se, the significance of the positive surprise should be well received by the stock market as; (1) it confirms that G4m has demonstrated the good discipline of successfully navigating a period of elevated investment into its customer proposition and supporting infrastructure, whilst simultaneously delivering profitability and continued strong revenue growth above consensus expectations; and (2) management’s credibility around profit guidance continues to strengthen, a highly prized characteristic in a high growth company making the considered significant investments required to secure its increasing market presence at scale. KPIs remain impressive, showing continued progress. Operational execution is strong, with numerous ongoing initiatives (e.g. the launch of a US$ website) to support future profitable growth. We note management’s outlook commentary regarding “continuing momentum”, and confidence around unchanged guidance for the FY18 out-turn, suggesting a good start to the key-for-annual-profits H2 period. Reiterate BUY and 920p TP, reflecting H1’s operational, financial and strategic progress, with much more to come.
Pre-reported revenue growth of +44% to £31.2m; gross margin edged down 160bps to 25.0% (reflecting principally tactical and strategic investment in the customer proposition); EBITDA margin of 2.3% demonstrating leverage of the overhead and marketing cost structure (when considering the £621k y/y fall in EBITDA can be wholly explained by the £700k strategic cost investment in the two new European DCs); Balance sheet remained strong with cash of £4.1m (post the £4.2m growth capital raise in May 2017) available for further tactical and strategic investment, albeit the overall position is net indebtedness of £3.7m, reflecting mainly £5.3m of long-term debt associated with the purchase of a new HO in H1 (with the relocation now successfully completed). The operational/trading KPIs remain impressive, showing further progress e.g. active customer number growth strong +43%, conversion rates increased to 2.84% (vs. 2.38%), and margin-rich own-brand sales growth of +60.6%. The other key standout for us in H1 was the accelerated pace of technological development i.e. the critical benefit of G4m’s bespoke e-commerce platform is the ability to deliver technical change and innovation at pace, with 247 technology releases/website/systems developments released during H1. "
Machinations
by finnCap, 27 Oct
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600 Group | Acal | Accsys Technologies | Aggregated Micro Power | Alumasc Group | Anglo-Eastern Plantations | Avingtrans | Capital Drilling | Carclo | Fenner | Flowtech Fluidpower | GLOBAL INVACOM GROUP | Gooch & Housego | Hardide | Iofina | M.P. Evans Group | R.E.A | Renold | Robinson | Solid State | Somero Enterprises | Surface Transforms | TRANSENSE TECHNOLOGIES PLC | Trifast | Van Elle | Velocity Composites | Zambeef Products
"Highlights this quarter -
Economics: Generally, the data points to modest growth continuing, with a more positive trend in PMI surveys suggesting decent m manufacturing momentum over the next six months. Currency weakness continues to be a double-edged sword for U K manufacturers, with exporters gaining competitiveness while input prices have risen. There has recently been a divergence of sterling’s performance against the euro and the USD. Those in commodity or competitive product areas may well have seen margin erosion, while many in intermediary goods have already passed on price increases to their customers. With low unemployment, the prospect of tighter labour markets post-Brexit and public sector pay caps starting to come off also signals the potential for some labour inflation, long absent from the UK industrial scene.
Topic of the quarter: We believe that powerful macro and sectoral pressures will drive further significant changes to the manufacturing supply chain over the next few years. We investigate some of these pressures, with the move to outsource suppliers to low- cost centres, like China, now seeing a slight reverse flow with some restoring to shorten complex and often inflexible supply chains. We see systems technology facilitating greater supply-chain control and efficiency. Brexit will present challenges to the UK supply chain with price and time to market barriers likely to rise, presenting challenges to the UK’s highly integrated and time-sensitive supply chain. Slick distribution infrastructure and greater information sharing with suppliers are likely to prove winning strategies in optimising logistics and gaining stock efficiencies.
Sector valuation: The industrials sector has continued to exhibit strength, with small-cap industrials outperforming by 2 % on last year and larger cap industrials by 17%. Currency and improving economic data have been a positive for the sector. While some other sectors have seen a pick-up in profit warnings over recent months, industrial technology companies have announced generally positive or in-line trading updates that have helped to drive the small-cap Industrials to an EV EBITDA of 8.4x and a P/E of 16.7x with the traditional small-cap discount narrowing."
Sirius Minerals (SXX)
750kt binding offtake agreement signed | Liberum, 26 Oct
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"Sirius has announced it has signed a 750kt binding offtake agreement for the supply of POLY4 with Wilmar International, for use and resale exclusively in South East Asia. The agreement takes Sirius binding offtake agreements up to 4.35mt and is a significant step towards achieving its target of 6-7mt of agreements, needed to deliver Stage 2 financing. Having South East Asia's largest agribusiness group make a major investment
in POLY4 (c.$110m per annum) is another incremental endorsement for the product which has now gained acceptance from major consumers and/or distributors in North America, China and South East Asia. BUY.
Offtake agreement a positive signal for POLY4 demand The agreement is for Sirius to supply polyhalite over a 7 year period, with sales ramping up to 750kt per annum. The pricing mechanism being used is consistent with existing offtake agreements, meaning the price is in the $140/t to $150/t range based on the formula using current nutrient input prices (vs. our modelled $125/t price).
For us, the agreement looks to be further evidence of the 'pent-up' demand for chloride-free potassium - i.e. an offtake agreement of this size to one customer is not going to be entirely substitution of SOP, SOPM or Kieserite. A significant part of the demand is likely to be due to demand for chloride free potassium and magnesium units that could not otherwise be satisfied. This is a positive signal as to the size of the polyhalite market as it indicates a preference to substitute MOP potassium units for POLY4. We have noted in previous research, around 30-40% of the MOP market might be substitutable into polyhalite, most likely in the bulk and compound NPK's.
Binding agreements pushing towards target levels Sirius now has 7 binding, take-or-pay agreements totalling 4.35mtpa (at their peak). Major agreements have been struck in North America (1.5mtpa), China (1.5mtpa) and now South East Asia (750ktpa). Smaller agreements have also been struck in South America (ex-Brazil) and North
America. This geographic distribution implies a significant opportunity still exists in South America, where the sulphur content of POLY4 would be valued highly and where Sirius is yet to sign a major deal.
In order to deliver stage 2 financing by the end of next year, the company intends to take binding agreements up to 6-7mt, which will form the basis for the Stage 2 debt financing package."
Seeing Machines (SEE)
Seeing stars | finnCap, 24 Oct
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"Driver Monitoring Systems (DMS) are becoming a core element in the next generation of vehicles, initially augmenting drivers’ abilities but eventually underpinning a safe migration to vehicle autonomy. Last month, Euro NCAP (the European body responsible for vehicle safety ratings and testing) identified a DMS system as a key criterion in its stars classification system; from 2020, if an OEM wants a five-star rating for a new model, it will need to have a good DMS solution on board. Time is tight; it takes three or more years to design and start producing a new vehicle model and Seeing Machines is a clear market leader, with its Fovio solution already in production and actually on the road with GM. This will certainly sharpen the focus for the dozen OEMs currently working with the technology.
Technology can be its own worst enemy; the growing use of smartphones and improving semi-autonomous vehicle capability will lead to much higher levels of distraction on the roads; drivers switching off when they simply can’t afford to yet. To deal with this, automotive and transport regulatory, rating and investigative bodies around the world have begun to issue new recommendations for DMS as an integral part of new vehicle designs; both Euro NCAP and the US NTSB are recommending imminent deployment of advanced DMS technology.
DMS will help to reduce the obvious risks associated with the migration to AV. Technology is not yet at a level where a vehicle can cope with all of the issues encountered on the road and effective DMS is essential to a safe co-pilot function to ensure that drivers remain sufficiently engaged and/or ready to re-assume control as and when required.
Seeing Machines’ Fovio technology is backed by years of real-world experience and data gained from use in the mining industry - in some of the harshest environments on the planet. That technology has been approved and adopted for use by the likes of Caterpillar and General Motors while its rivals remain in the lab. As OEMs have to make a rapid decision on design-in of a DMS system, we foresee even greater demand for Fovio over the next few years. "
Zoo Digital Group (ZOO)
Here to stay | finnCap, 25 Oct
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"Over the last 18 months, ZOO has enjoyed strong growth thanks to the success of its ZOOsubs, and more recently ZOOdubs, cloud software platforms, together enabling ZOO’s localisation services. The focus of this note is to examine the sustainability of this positive trend.
Headroom and tailwinds – we estimate total spend on localisation (for OTT services) is $0.7bn and is expected to grow at 14% CAGR over the next four years, driven by the global uptake of subscription streaming services. This implies that ZOO only has a 5-10% share of a $0.17bn subtitling market and a negligible share of a larger dubbing market, worth $0.55bn. More broadly, we note the wider localisation market (reflecting all physical and digital sale and rental models and broadcast TV) has been valued at $2bn in Europe.
Strong customer base – all six of Hollywood’s largest film studios are customers, as are major TV broadcasters including ABC, NBC, CBS and HBO. In addition, ZOO also counts Netflix, Amazon and Apple as customers. We believe that this breadth of coverage across content owners and distribution platforms is a key asset for the company as it positions ZOO in an ideal position to benefit from industry growth.
Strong service offering – ZOOsubs scores well in competitive analysis testing, offering both breadth of services (i.e. multiple languages) and service quality. This is a key differentiator as service providers typically suffer a tradeoff between the two. For ZOOdubs, customer traction is a better indication of validity; to this end, since the September launch, ZOO has received follow-on orders from its first customer and also earned industry recognition. "
Henry Boot (BOOT)
Value being evidenced | finnCap, 23 Oct
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"The strong trading seen in H1 has continued into H2 to the extent that management now expects FY 2017E to be materially ahead of expectations. We have upgraded our FY 2017E EPS by 16% and highlight that, assuming no change to the economic backdrop, there remains upside to both FY 2017E and subsequent forecasts. We reiterate our view that our sum-of-the-parts analysis is well evidenced by both company and external transactions, supporting our 398p target price.
Hallam Land Management’s sales in the year to date represent 2,048 residential units up from 1,609 last year. We estimate Hallam will obtain permission for and sell 53,000 units from a total potential 84,000 units in its land holdings over the next 15 years. This generates a value today of 322p per share.
The Prime Minister recently announced an extra £10bn for the Help to Buy scheme. This will help support housebuilders’ confidence and desire to continue to buy land.
The Aberdeen Exhibition Centre contract is on track but unit sales within the Chocolate Factory at York are now complete, ahead of the original end date target of mid-2019. Our sum-of-the-parts include 43p per share for this division.
Management expectations for FY 2018 remain unchanged reflecting the possibility that, while some work has been pulled forward, the opportunity pipeline is being replenished and some deals may still complete this year.
We estimate 322p per share of value from the land division, 69p from investment property, 43p from the largely pre-let and presold development work and then a net -36p liability from the Construction, Plant Hire and PFI businesses, overheads and net debt and pension deficit. "
Lloyds Banking Group (LLOY)
Confirmed indecent excess capital generation power | AlphaValue, 25 Oct
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"The group released a solid set of results showing resilient operating trends no longer obscured by litigation and conduct charges. In this context, excess capital generation accelerated further, leading to an enhanced full-year guidance. While management confirmed the benign impact of IFRS 9, it announced inflated Pillar 2A equity requirements.
Third quarter results came out at £1,470m, corresponding to an impressive 15.3% RoTE. With limited impact from non-recurring items (notably litigation and conduct charges), the underlying RoTE is very closed, at 15.6%.
Revenues were up 8% YoY driven by net interest income (up 12% over the period) boosted by the first integration of MBNA. On a pro forma basis, the NIM remained broadly stable (+2bp) while the quarter saw a resumption in loan book growth. Other income was perfectly stable over the period. Management expects the NIM to remain stable in Q4.
The group enjoyed further efficiency gains with perfectly stable operating expenses over the quarter. The MBNA is processing well and will be completed ahead of schedule.
The cost of risk almost doubled from a low and unsustainable basis, driven by a single name, but the full-year guidance of a below 20bp cost of risk has been maintained.
In a context of stable RWAs, the group enjoyed accelerated excess capital generation. The fully-loaded CET1 ratio increased by 85bp over the quarter to 14.9%, falling to 14.1% after dividend accrual. Management now expects capital generation of between 225bp and 240bp for the full year. It disclosed its IFRS 9 impact estimate: a benign 10bp to 30bp impact before transitional arrangements. On the negative side, it mentioned inflated Pillar 2A requirements (up from 2.5% to 3.0% for the portion to be covered with equity). However, according to our estimate, this reduces the valuation by only 5%. "
Victoria (VCP)
Acquisition of Serra | finnCap, 24 Oct
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"Victoria has agreed to acquire Serra, an Italian ceramic flooring manufacturer, for a cash consideration of up to €56.5m (£50.4m).
Serra manufactures and sells ceramic flooring both domestically and via export, mainly into Continental Europe but also the US and the Far East. In the year to December 2016, Serra achieved revenues of €28.2m and an EBITDA margin of 37% – more than double VCP’s existing c.14% margin.
€36.5m is to be paid on completion (expected December 2017) with the remaining €20.0m payable over four years contingent on Serra achieving pre-determined EBITDA targets. Assuming the full amount is paid, this values Serra on a trailing EBITDA multiple of 5.4x. Incumbent management will remain in situ for a minimum of four years post-completion.
Strong strategic rationale for the deal includes 1) a presence in the largest flooring category globally; 2) a platform off which to consolidate other European ceramics operators; 3) geographic and currency diversification with c.40% of group earnings post-deal from outside the UK, creating a useful hedge to UK macro; 4) an immediately earnings-enhancing transaction pre any cost synergies; and 5) an attractive valuation with management demonstrating its ability to acquire high-quality, high-margin, hard flooring businesses in Europe at multiples in line with previous target levels.
We raise our EBITDA margin forecast for FY19 from 14.5% to 15.7% and for FY20 from 14.7% to 16.0%, and we now forecast 3- year adj. EPS CAGR of 18.2% compared to 13.4% pre-deal. Net debt/EBITDA remains sub 2x on a pro-forma basis. Our assumptions conservatively exclude any revenue and cost synergies once Serra is part of the larger group.
Increase in price target from 530p to 750p (18.9x FY19 adjusted EPS). While this is proportionally greater than our increase in forecast earnings, it recognises: 1) the likelihood of future acquisitions in ceramic flooring; 2) potential synergies post the integration of Serra that existing forecasts exclude; 3) scope for further upgrades from existing manufacturing and logistics restructuring (1% increase in EBITDA margin = 12.5% increase in net profit); and 4) management’s track record of meeting or exceeding expectations. "
Gear4music (G4M)
Ready to rock | Edison, 23 Oct
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"While revenue and customer KPIs continue to grow robustly, Gear4music (G4M) is preparing the next stage of expansion. The first half saw the start of the planned investment associated with the May placing, the new head office structure, and the move to a positive contribution in the two European hubs. It ends with the launch of the US$ website opening a new front in a larger market, and the company strongly positioned for the key pre-Christmas season.
After a first half focused on expected investment and positioning for the next stage of expansion, G4M reported strong interim revenue growth of 44% YoY to £31.2m with pre-tax profit at break-even. Margin pressures have been well managed and, as planned, significant investment has been laid down ahead of the key second-half trading period. KPIs are ahead across the board and the two European hubs have ended the period profit-positive.
From UK origins, G4M has progressively developed strategies to penetrate wider markets. Its development to date has been marked by phases in which fund-raising rounds for investment have preceded step changes in expansion. The May fundraise of £4.2m (net) is associated with the current investment stage, including key management hires and the new headquarters, and G4M has now announced the launch of its US$ website, opening a new front in a significantly larger market.
Given the strong customer KPIs, we expect H218 revenue growth at similar rates to H1. We expect currency-based margin pressures to abate, while administrative costs should settle from 24.9% in H1 to 22.6% for the year, in keeping with FY17. As a result, we leave our profit forecast unchanged, in line with guidance.
The share price reflects the strong growth expectations associated with significant market share gains. Short-term P/E and EV/EBITDA multiples remain top of the range of currently profitable pure-play online retailers, against peers that are more established in international markets outside Europe. G4M’s current share price implies seven years to reach market share of 6% in mainland Europe. Achieving that one year earlier would imply 1094p. Alternatively, overlaying a 1% share of the US market developed over the next 10 years would be equivalent to a share price of 949p. The two combined would be equivalent to a share price of 1258p."
