Small Cap Value Report (Tues 26 July 2022) - STEM, SHOE, ANCR, OTMP, FRAN, WIX, RCH, PIER, DOTD

26th Jul '22 by Paul Scott

51 comments 8486 reads

Good morning from Paul & Graham! Today's report is now finished - 9 companies, didn't we do well! :-)

Agenda -

Paul's Section:

SThree (LON:STEM) (£529m) - sparkling interim results, from this decent quality, international staffing group. The valuation metrics remain attractive. Strong balance sheet, although cashflow has been mainly absorbed into receivables. Interim Results video presentation is here.

Shoe Zone (LON:SHOE) (£100m) - another positive update, coming just a month after the last one! Profit guidance upped from £8.5m to £9.5m. Interesting that is also notes supply chains are easing, and margins improving. I think that has potential read-across for other retailers, where bombed out valuations may contain some bargains, possibly?

Reach (LON:RCH) - this took me a lot longer than expected, as it's a complicated situation. It could be cheap (if the disputed pension scheme payments reduce), or it could wither away to nothing by the time the pensions are fully funded (last reported as expected c.2027, in the 2021 Annual Report). Short term headwinds on ad spending are becoming apparent. I don't have a strong view either way, as the pension situation is so highly material, little else matters. Digital growth story has stalled too.

OnTheMarket (LON:OTMP) (£69m) (I hold) [No section below] - an AGM statement today contains nothing new. It reassures on trading so far in FY 1/2023. This excerpt might be of interest, given that it's the latest property-related company to say that the market remains healthy -

"The Group has made a positive start to FY23, and trading has been in line with the Board's expectations. Notwithstanding the well-publicised macro-economic uncertainty, the fundamentals of the UK residential property market currently remain good, with market activity remaining high and demand for properties significantly outweighing supply."

I think many property-related shares look good value right now. Property prices go up in times of high inflation, not down. It's only when interest rates go sky high that property prices are impacted badly. No sign of that being likely, real interest rates remain massively negative, so fixed rate borrowings against property, at a historically advantageous negative real interest rate, makes a lot of sense to me. So I suspect the property market might remain buoyant. Just an opinion, could be wrong, as always!

Brighton Pier (LON:PIER) Up 6% to 86p - [No section below] - a…

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lestat101

26th Jul '22

Loved Paul opting for four tins of carling over the Financial Times. Absolute class..

Snazzytime

hi Paul

Reach (LON:RCH)

Thanks for your update. Could I just query something please? You said........

'The cash contributions (which remember, are not accounted for in the profit figure, so this comes off profits) are still massive'

It is my understanding that the annual pension deficit payments do not come off profits (via the P&L account). The accounting entries are a reduction in cash on the balance sheet (and shown in the Cash Flow Statement) with the balancing entry being a reduction in the pension deficit on the balance sheet.

Hence the impact of pension deficit payments for shareholders is a loss of cash which would otherwise have been available to the business (e.g for dividends, re-investment etc). There is no impact on profits.

Have I got this right?

Snazzy

cmpeckham

"I baulked at paying £4.50 for the Financial Times this weekend (buying 4 tins of Carling instead)." Classic. I doubt that the FT have had customer feedback like this before.

The above comment comes from the section on Reach (LON:RCH) (well done for making it interesting to read someone "droning on" about pension deficits). I am not an actuary or an expert here in any way, but my guess is that the situation is not as bad as you suggest because:

(1) The accounting deficit is still meaningful. I defer to anyone who knows IAS19 etc, but I believe it is like an actuarial measure but with slightly different assumptions e.g. company's own assumptions on longevity rather than the actuary's. Do Reach state the actuarial deficit? For many companies, the actuarial deficit is smaller than the accounting deficit, not larger. Either way, the fact that the accounting deficit came down substantially over the last 6 months is meaningful information (despite high inflation increasing the level of liabilities, the higher discount rate more than compensated).

(2) The agreement reached (geddit?) on group contributions is likely to represent a worst case scenario. I know that if I was a trustee looking at Reach 5 years ago, I would have been pretty sceptical about the company's prospects and so would have demanded an aggressive schedule of contributions to protect the pension scheme before the company went belly up. My guess is that is what the current disagreement between the company and trustees is about. The company can see that the current contributions are excessive and the trustees would prefer to stick to the agreement they hammered out before. It seems quite possible that these contributions will result in a surplus, which will ultimately be to the benefit of the company.

You're absolutely right to highlight the risks, but I suspect your focus on the level of current contributions might be casting too negative a light on the situation.

TheFloatingInvestor

I like STEM and have held before. I wonder if the recession fears in Germany are playing on peoples minds with SThree (LON:STEM)

I think the staffing companies seem out of favour and any perceived head winds seem to put pay to rising S.P.

I was disappointed with the market reaction to Robert Walters (LON:RWA) decent trading results recently, and decided to exit out of staffing companies for now.

Paul Scott

Hi Snazzytime,

Yes, that's correct.

Regards, Paul.

Bouden54

Both SThree (LON:STEM) and Robert Walters (LON:RWA) down sharply - can't see any reason though and wider market looks well behaved. Possibly a bad update from another recruiter or negative broker piece?

johndenmark

Reach (LON:RCH) I sat through the analyst call this morning and the pension deficit was raised early in the Q&A. The actuarial shortfall was not revealed but the company response, to the best of my recollection, was as follows (paraphrased):

- we continue to expect the scheme to become fully funded by or before 2027 based on the currently agreed contribution schedule.

- one might infer from macro trends that it could become fully funded earlier - if so, that's obviously good, but we're not making any such assumptions in our planning.

- discussions with the trustees continue, as they always do, but it's not a major focus of attention for us at the moment.

I didn't listen to the entire Q&A , so there may have been more later on!

Silver Moon

Paul, dotDigital (LON:DOTD) just struck a chord and checking up I note that I sold my holding on this day in 2021 at 249.8 pence. Perhaps I should have bought back in yesterday! It seems to me that for the patient PI even today would not be a bad entry.

Epitychia

A large £2.6 billion pension fund with a side line in newspapers. The shares are a highly geared punt on UK and US markets. If the fund rises 10%, the shares are stupid cheap. If the fund falls 10%, the shares are worthless.

Boon

I reckon Touchstar (LON:TST) has missed the summer, and winter is coming to the transportation logistics sector. Its been a boom time for the last two years, so trading conditions would have been easy to sell more tracking units to fleets.

I don't know in the UK, but at least in the USA, there was a business sentiment survey done recently and transport logistics came out very negative sentiment, from managers in that sector. Also seen a few articles where trucking rates are coming down, so alot of truckers who bought expensive trucks last year, now idling, fuel costs up, job rates down, and struggling. In this scenario, it would be a hard sell, whether capex or SaaS subscription.

They do give a strong order book, but they don't provide order intake numbers for recent months, nor an outlook that current demand is still strong / with momentum. Reading the statements, you can see that if market has gotten softer recently, the way they've crafted the statement, might allow for that possibility.

In fact, their outlook statement is a rather veiled along the lines of "management is now focused on delivering the FY results to market expectations", or something to that effect.

There will be a lot of hedging going on in the pension fund, and a lot will be held in low risk instruments, such as bonds. Unlikely to rise or fall 10%. But agree on the wider point that there is an obvious risk in having a 2.6bn pension deficit offset by a 2.5bn asset portfolio - a small movement in either of these two can have massive impact on the deficit/surplus so personally prefer just to avoid such companies.

yiannos1

This is totally misleading in many aspects.

Just to be brief , the pension fund holds shares of not even 10% of its whole size and its performance is minimal to the overall stock market performance.

Thanks

BIACS

Thanks Timarr - I hope so too! The reply is really appreciated and its helpful to know that others have been paid as expected so that I know there is a specific problem here with my account and not a general issue with the scheme. Jefferies has confirmed to me by phone that the scheme is complete and all payments have gone out, but the custodian and broker still deny receiving anything. What a mess.

peterg

In the early 90's when interest rate were at circa 15%, a modest starter home could be had for 2.5~3.5 x annual salary.

I bought my first house in 1980. It cost about 4x my salary. To buy the same house now would cost about 30x the equivalent salary at 2022 prices. It was in an area that has probably seen higher house price inflation than many areas, but that sort of increase is way beyond effects of joint incomes. The interest rate I paid was a lot higher than people are now used to. It even briefly hit 15%. That has a lot to do with the multiple. If you are paying 1-2% mortgage rates as many were recently , it has a very big impact on the salary multiple you can afford - until interest rates rise. We could see some big shifts in house prices over the next couple of years if interest rates rise much further.

PeterG,

Fair points, well made.

Although someone tweeted a graph from the Sunday Times (which I didn't see as they had sold out at my nearby Co-Op by 2pm), which showed an astonishing growth over the last 25 years in houses owned outright - which is now c.8m homes, versus 7m homes owned with a mortgage.

Those figures absolutely astonished me.

Also remember that people buying a (say) £1m home, will probably only need a mortgage for less than half the total price, because they will have accumulated so much equity from previous houses.

Plus nominal incomes are now growing 7-10% for many professional people.

Meanwhile fixed rate mortgages can still be had for 3%.

Hence I would say the housing market looks likely to stay remarkably buoyant.

If central banks put up interest rates to say 7%+, then it's going to be carnage. But how likely is that? I reckon low interest rates & QE are here to stay. Things are very different to how they were previously.

Tommy H

Hi Biacs

I have received my payout through IWeb a while back.

TommyGood luck chasing

davidjhill

Correct yiannos1 - most people don't really have a clue about how pension schemes work in reality and also get the differences between accounting and actuarial valuations too skewed (Pauls comments above a case in point - sorry Paul, I love your work but not those comments :) ).

However, those perceptions even if not bathed in reality, get focused on and do obfuscate the real business performance so it is useful to pay attention to the sentiment.

I don't currently hold Reach (LON:RCH) but will buy back at some at some point (doesn't appear to be a massive hurry after todays news). A few things going on that I think are key share price drivers

1) cash outflow for the half year (due to divi, pension deficit and deferred consideration)

2) decline in profit due to print cost inflation. I find this odd though as it was well flagged and had driven price much lower. Numbers came in almost exactly as I expected and H2 forecasts were better, though we still have to see those come through.

3) the lack of progress on agreeing pension contributions - markets hate uncertainty.

Interestingly (tho I can't remember name of the study off hand) it has been found that investors extrapolate into the future based on what is happening today and actually don't focus properly on the future prospects of a business. This happens in good times and bad. So investors will look at Reach (LON:RCH) today and extrapolate £45m in H1 as £90m for the full year and then £90m going forward. Of course this misses many factors and assuming print inflation comes under control then future years profits could be considerably higher. Indeed the company itself has pointed to H2 being much higher than H1 though this also got lost in translation.

Anyway at a general investing level it is interesting to consider that investor psychology trait and perhaps if one invests on the basis of reversal it would have got people out of growth stocks somewhere toward the top and probably back in somewhere around now. Food for thought for me at least, as I am probably also guilty of extrapolation in my analysis. Not always but certainly sometimes, and I probably need to try and eliminate that from my investing.

Looks like an excellent deal to me but they are not buying access to the US market as they already have that. They are really buying global scale. Yes, they will get some extra US business but that's not the rationale.

The key will be to integrate the tech platform as done with Unruly and cost base will come down dramatically, plus given their self serve product offering there will be some good cross selling opportunities.

I wasn't convinced as to the value of taking on some debt to do the deal. This suggests to me that they want to retain firepower for more M&A and/or share buyback. Not a particular issue if the business can keep throwing off $150m of cash per annum but did raise a question that I'd like an answer to.

Graham Neary

27th Jul '22

I'm sorry GAW is outside the scope of the SCVR, but I have covered it elsewhere -see my Twitter.

randerson19

Investors taking a view on the cycle perhaps? Their IR website has a link to research:

Analyst coverage | SThree

Small Cap Value Report (Tues 26 July 2022) - STEM, SHOE, ANCR, OTMP, FRAN, WIX, RCH, PIER, DOTD

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Paul Scott

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