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Following continued delays of a Brexit agreement, few sectors within the UK market have remained attractive to investors despite low valuations. One sector which has continued to outperform despite the political drama has been the UK video gaming sector (henceforth UK gaming), which we are fans of. We believe a combination of sector-leading growth, strong cash conversion and timely cyclical positioning support our positive view on the UK video gaming sector.
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Revenue increased 17% to A$34.7m (Ae: A$48.4m). We note that the difference to our forecast was due to an accounting presentation change only, whereby revenues are now stated net instead of gross including capital deployed. We believe this new presentation is much more intuitive and note that, if it had not been applied, revenue was in fact in line with our numbers at A$48.2m. Gross profit, or net gain on investment, was up 23% to A$20.3m (Ae: A$19.0m). This is particularly encouraging as it shows the actual gain on the capital previously deployed. We noted in our 5 July note that our numbers were likely on the light side, so it is pleasing to see this come through. ROIC increased from 117% last reported to 135%, displaying the lucrative returns of recent settlements.
Litigation Capital Management
Following the speculation and eventual release of a short report by Muddy Waters (“MW”) on Burford yesterday, LCM’s shares have fallen to 77p having troughed at 58p in early trading. We highlight three areas where LCM’s model differs to Burford and therefore where the same criticisms should not apply. Re-iterate Buy and 140p TP.
In January, we provided a list of 11 stocks for 2019 that we believed would perform strongly with attractive catalysts that could lead to material outperformance. In this Quarterly Research Outlook, we revisit these views, analysing what has happened and how the remaining six months of the year could play out.
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Last week LCM announced its fifth case settlement of the financial period, with a net gain of A$2.7m to A$3m estimated. The case win further demonstrates the ability of Management to select and effectively execute on the right cases. Crucially, we are now confident that our FY19E gains on investments will be met.
LCM has released a positive trading update following court approval of a settlement that was initially announced in March 2019. This further supports our forecasts and demonstrates the ability to pick the cases that win. Additionally, the Company has provided an encouraging update on the portfolio and pipeline.
We believe the settlement in principle of a litigation project that was announced on 20 March 2019 will likely be confirmed on Monday 27 May, providing further positive news flow for the shares and demonstrating the attractive returns available if the right cases are selected.
We’re just over three months in to 2019 and we’ve seen a 10% UK market rally, retracing much of the Q4 decline, such is the nature of fickle market sentiment. That said, many of the issues we wrote about three months ago that were impacting markets remain: notably Brexit, trade wars, geopolitics and global monetary policy. The 2019 rally thus far feels somewhat fragile, with competing forces of optimism on a potential trade deal which could underpin the rally, against the deterioration in underlying economic data that could ultimately undermine the recent market gains. In this context, we look at what the lead indicators and the market are telling us about the industrial cycle and the stocks most exposed to various industrial trends. The Q4 derating in short cycle industrials and autos had been vicious and while these sectors have seen a more solid footing in 2019, with earnings downgrades being priced in, it will likely take a trough in lead indicators before short cycle stocks can start to perform again and re-rate relative to the market.
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Within this note we look to build upon our existing legal sector coverage of Anexo*, Gordon Dadds*, Gateley, Knights, Keystone, Rosenblatt and NAHL to include the litigation funders Burford Capital, Manolete Partners and Litigation Capital Management.
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