Small Cap Value Report (Mon 12 Sept 2022) - BKS, SRC, SPSY, MTEC, AXS, ARC

12th Sep '22 by Paul Scott

44 comments 8440 reads

Good morning from Paul & Graham - suitably refreshed from his holidays! Today's report is now finished.

Normal service resumes here today, I'm pleased to say.

Weekend podcast went up as usual, or is available on podcast services (just search for "Paul Scott small caps").

Agenda -

Paul's Section -

Beeks Financial Cloud (LON:BKS) (I hold) - a reassuring, in line with (previously raised) expectations, trading update for FY 6/2022. Also BKS reveals the identity of an impressive recent client win. Outlook comments are buoyant, with a "record sales pipeline". This share is tricky to value, but the accelerating organic growth, mostly recurring revenues, and positive outlook, reinforce my belief that this share looks like a long-term winner for patient investors.

Spectra Systems (LON:SPSY) - I crunch the interim numbers, and come away impressed with the high profit margin, strong balance sheet, and generous divis. It's a very small company, but has numerous projects in the pipeline, any of which could be transformational if they scale up. Hence blue sky upside, on top of solid fundamentals - that's an attractive risk:reward stating point in my view. Worth a closer look I'd say.

Accsys Technologies (LON:AXS) - a catalogue of problems from this specialist wood products maker, which is struggling to ramp up production. Sluggish production in Holland, hampered by high gas prices as well as production gremlins. Its new Hull factory is also seeing delays & question marks over viability (due to gas, again). Only its US JV is progressing well, but won't be producing until mid-2024. Pity, as products are in demand. Overall, it looks too difficult to assess, and I'm worried about more dilution.

Graham's Section:

Sigmaroc (LON:SRC) (£310m) - this quarrying company announces interim results and also a JV with the industry giant ArcelorMittal. The deal is impressive in terms of the association that’s been formed, but I’m curious as to how the JV will negotiate pricing with its primary customer (ArcelorMittal) who will also be a 47.5% shareholder. As for the interim results, they show promise with good profitability and an upbeat trading statement, although the balance sheet has a significant degree of leverage. Overall I find this a perhaps risky and complicated, but nevertheless an interesting stock for us to keep under coverage, especially considering the inflation theme which exerts great influence over SigmaRoc’s revenues…

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Howard Adams

12th Sep '22

Hi Raleigh4343

I hold ITM Power (LON:ITM) AFC Energy (LON:AFC) and £CWR .... all are very volatile share prices so not for the faint hearted.

I have invested in them in their early extremely volatile days but exited (lost money) and kept away from them for quite a while.

It might interest some that ITM Power (LON:ITM) reports 14/9, Ceres Power Holdings (LON:CWR) 22/9.

I perceive that in the longer term there will be value in the Hydrogen market.

I also have invested in and watch some North American (US & Canada) Hydrogen companies $PLUG $FCEL $BLDP to list but three. As I do with some European companies Powercell Sweden AB (PCEL) and NEL ASA in Norway (NLLSF).

But, it is an emerging sector and although large government investments are being injected into it, share prices are really volatile.

For those interested in the UK Hydrogen space, ITM Power (LON:ITM) AFC Energy (LON:AFC) & Ceres Power Holdings (LON:CWR) do three quite different things. Which is why I hold a small amount in all three.

ITM Power (LON:ITM) is in effect building a Hydrogen power station as well as building and selling power cells.

Ceres Power Holdings (LON:CWR) is in effect a Hydrogen technology company, it form relationships with large organisation to partner with them to create Hydrogen technology based products whereby the big partners then distribute these products into their big customers bases.

AFC Energy (LON:AFC) has now began to focus on targeting Hydrogen technologies such that they aim to replace 'off grid' diesel/petrol generators. Such as the generators used on large building projects.

If any are interested to dig deeper I recommend searching YouTube and watching various vids. from these companies, and other sources, to gain an appreciation of the sector.

I sense the strength for this market will be supplying energy to big transportation, think ships, planes, large trucks and trucking fleets. Replacing off site fossil fuel generators, think data centers, building projects, emergency backup facilities. Pure play Hydrogen power plants supplying a defined campus, or feeding into a grid.

As you can see I am bullish on it, but think it will be a bumpy ride and probably requires a level of knowledge to have convictions to hold through volatility.

Regards

Howard

Paul Scott

Thanks abtan, that's really excellent extra detail, thank you!

The sensors contract struck me as very large. Presumably that's likely to be lower margin?

Thanks again, Paul.

Indie

Hugely interesting and helpful. Thank you, Howard

BnB

Re Made Tech (LON:MTEC) - A more nuanced view (than Graham’s)

Time will tell on profits of course but gross margins are robust in the region of 38% and operating margins should eventually approach those of direct competitor Kainos (LON:KNOS) at around 18%. Given they operate in the same market and with a similar range of services why would it not - given solid execution?

Graham, I think you've overestimated the wage claims of a high proportion of the staff. Recruitment this year has a high proportion of "academy" hires, who are data gatherers rather than data analysts, trainee coders rather than experienced programmers - ie relatively cheap and with a higher margin per employee than you have assumed. But the question remains whether profits will emerge. If they are not visible today, then logically recruitment must be running well ahead of deployment, which bodes well for meeting FY23 objectives - you did acknowledge this possibility.

One of the keys to higher margins and profits is to develop their own IP - which is already underway and would account for the capitalised £2m development costs. So this is an area to watch.

I also believe there is a time lag in restoring margins per employee to pre-Great Resignation levels. An erosion of workforce that has been endured by all IT employers this year, and to which you alluded, means hiring replacements at higher wages to work on projects sold on a lower cost basis - this will reverse more profitably in due course.

The business is obviously still investing (in people) for growth and that will hit profitability. But the runway for expansion is considered by experts to be huge (>20% CAGR in DX through 2030). Whether Made Tech is a winner remains to be seen but I have channel checked their satisfaction levels and tested some of their work myself and been pleasantly surprised.

I used to outright own a competitor in this field (Government DX) for more than a decade and all I have further to say is that we found it deeply rewarding as a sector - as have investors in Kainos, or, on a totally different scale, Accenture. In the end, they are all software houses riding an unstoppable wave of technological progress. But Made Tech, reflecting its inherent uncertainties, is substantially cheaper on any measure!

Hi BnB,

Graham wrote the section on Made Tech (LON:MTEC)

Regards, Paul.

abtan

Spectra Systems (LON:SPSY)

"The sensors contract struck me as very large. Presumably that's likely to be lower margin?"

Highly likely, though hard to confirm.

I imagine with gross margins regularly in excess of 65%, there should still be a large enough buffer for a sizeable portion of the revenue to flow through to the bottom line, even at reduced margins.

Annual revenues are currently c$18m. That one contract, even though it's relatively short and possibly on a lower margin, should take revenues closer to $35m-$50m, at least for a couple of years.

Sorry Paul. I’m multitasking watching the tennis from last night.

Raleigh4343

Many thanks for such a great reply.

MetalMaid

Many thanks for another great podcast Paul. Like so many others - I really enjoy listening to your thoughts and catching up on the events of the week.

Although it is not a small cap, I was wondering if anyone had any opinions on Adidas shares. They seem good value to me at the current price for a quality business with very good management and an obviously strong brand / moat. Such a strong brand should be able to navigate the current inflationary pressures well. Being so global should also remove some risk when compared with more domestic businesses. I see the share price decline down to external factors that will not persist forever. I think as a buy and hold share this entry point is starting to look very attractive.

As I am not subscribed to Europe on Stocko I can't see the Adidas stock rank etc. I have subscribed to the UK and the US as I have a lot of holdings in both regions. However, I think it would be a great idea if Stocko allowed say 2 or 3 searches a month outside of your subscription region. I am sure there are others that would really benefit from this (say once you make your pick on your account - then the shares would be open for viewing throughout the month on your account). There are sometimes one or two stocks that I would like to be able to analyse on Stocko but it would not be worth the additional subscription fee for the extra region. Personally, I think this would make what is already a great service even better. Anyway, just a thought as I look at my locked-out page on Adidas shares.

cheers

Matt

Re Adidas - but would apply to Nike, Puma etc as well

The problem that faces these successful brands is that they are heavily dependent on China for growth and thereby are experiencing several problems, including:

Slowdown in the Chinese economy reducing discretionary spending

Lockdowns reducing footfall in physical stores

Consumer boycotts related to statements concerning Uyghur forced labour-derived cotton from brands trying to appease western consumer tastes

Consumer nationalism favouring local brands Anta and Li Ning (see boycotts)

These are all however powerful brands and prices today look like a good long term entry even if they might fall further if USA goes into recession. The trends driving their success are not going into reverse.

vprt

This comment is under review

Some very good points BnB, many thanks.

You're quite right about China as its their largest growth market. It currently accounts for about 22% of sales. However, this also means they are well diversified elsewhere (the other 78% of their business is showing 'nearly' double-digit annual growth in every other region - North America being the lowest growth rate, but still at 9.1%). Also, many of the China related issues could be viewed as temporary with still very good future growth over the next decade. Especially for large established western brands as they seem to benefit hugely from natural demographic changes. The Chinese middle class will imo be far larger over the coming years and the thirst for western brands is part of their modern culture - I don't think the push back towards consumer nationalism will be too much of an issue. I suppose this is where one has to take a view. The last quarterly update showed a 16% decrease in revenue from China. In my opinion this decrease is down to external factors that are out of the control of the company and so this performance is reasonable imo given the huge number of headwinds in that region.

Great businesses can't always outperform every year. If we base our investments on all future revenues etc, then short term headwinds like these can create to a good entry point for the patient investor. I would rather take a view today and buy the shares while the revenues are down a bit and the pe ratio has come down a lot. I do not think these current global issues will last for many years and at some point I expect them to be back to record earnings and at that point when the numbers are better the fickle market will re-rate on a higher multiple. But one has to have the view that these Chinese and global issues won't last for many years.

One other point is what one's opinions are on athletic fashionwear; will this continue to grow in popularity (this is not guaranteed as fashion tastes are always changing).

I have not looked at Puma as I don't like the brand. I like Nike a lot but compared to Nike it appears you are getting a far 'cheaper' valuation with Adidas. Nike has 25% of the sports apparel market - while Adidas has about 15%. I don't know why Nike deserves such a large premium. From my research Adidas appears to be growing their margin and revenue better than Nike - and this appears to have been the trend for some years. Also, the direct to consumer model should increase margins in future years for both Nike and Adidas.

All good points and I would be a buyer of all three at these levels - instead I'm already a holder of the three as a basket of athletic stocks. Nike gets a premium rating because of its market leadership first and foremost and its more consistent track record of eps growth and higher ROCE and because, well, USA!

Adidas looks like the value option but it has underperformed peers so perhaps for a reason. My bank has recently moved to Hold and I note the CEO has been ejected.

JASVFS

Thank you Howard, I agree with your last 3 paragraphs. I can't resist a small small cap and we hold Getech which is currently transitioning from solely supplying clever software programmes to mining and oil companies, to include Hydrogen storage and expertise. Japan and Germany seem more convinced about Hydrogen use but interest is growing here too now. I shall research the 3 you've mentioned with a view to investing.

Graham Neary

13th Sep '22

Made Tech (LON:MTEC)

BnB - thanks very much for sharing your perspective on this! You're right that MTEC has cheapened a lot already (e.g. it's cheap-ish on price to sales now, and a lot cheaper than something like Accenture). If margins per worker are better than I perceived, and if they further improve, then my concerns might already be priced in. Best of luck if you are a holder! Regards, G.

wolfspirit

vprt - thanks for pointing that out - stockopedia really should be on top of this or at least frame a reason why they show a divergence.

Samsgrandad

Heiq (LON:HEIQ)

Early stage company with very interesting IP principally in textiles announces interims today. Milestone payment for HUGO BOSS stake very useful, deal with LYCRA company too. I'm hoping the price is at the bottom, I bought a small stake today. Worth a look.

Dragon

I notice that have still not changed £RDSB to Shell (LON:SHEL) in transactions.

Thanks Graham. Time will tell if my faith is justified but Made tech’s profits are certainly lagging revenues today so I respect your concerns

TamzinPiworld

15th Sep '22

Made Tech (LON:MTEC) Thanks for all the comments Graham and BnB. There is a management webinar today 16.9.22 at 12 noon for you to ask further questions and make your own judgement. Register here.

Small Cap Value Report (Mon 12 Sept 2022) - BKS, SRC, SPSY, MTEC, AXS, ARC

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Paul Scott

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