Weekly Commentary 18/10/21: The Eagle has Crash Landed

With the FTSE 100 reaching 7235 last week, the index finally seems to have broken out of the trading range that it has occupied since May. The index’s all time high is 7,903 reached in 2018. ITM, the hydrogen company raised £250m through an over-subscribed placing at a 16% discount.

There’s still plenty to worry about though: Brent crude rose to a 3 year high of $85 per barrel and an index tracking Chinese junk bonds hit 24% yield last week, up from 10% in June, as contagion from Evergrande spread to the rest of the Chinese property developers.


THG (formerly The Hut Group) shares fell -32% last week following a Capital Markets Day that was supposed to contain “no material new information”. The pre-recorded presentation was light on numbers, so it’s hard to be certain what triggered the fall. There was a negative report published by Mark Hiley at The Analyst. But the FT also reported investors were spooked by SoftBank not exercising their call option on THG’s Ingenuity subsidiary, in addition there have been concerns about related party transactions . Following the share price fall Steve Clapham has done this 16 minute YouTube video on the 10 adjustments that the company makes to Adjusted EBITDA, which he suggests are “red flags”.

I think of the list above, I’d be most concerned about the related party transactions, which refer to a property deal done by the Chairman/Chief Executive/Founder Matt Moulding. THG sold property to Matt Moulding for £215m including the £139m of assumed debt and Moulding paid the balancing item £76m. He didn’t pay cash though, he paid THG £76m in shares. In fact, he didn’t pay with shares that he owned, instead he paid with shares that he was entitled to under THG’s option scheme, rather than receiving those shares, they were cancelled. Now that the share price is hovering around £3, the price he paid for the property has fallen to c. £45m – and the deal means he benefitted financially from THG’s falling share price, though of course he also saw hundreds of millions of pounds wiped off the value of his holding in THG.

Most company management understand that when the company does well, both shareholders and management benefit. However, some management take more of a “heads I win, tails you lose” mentality, and engage in related party transactions, which risk losing the confidence of their shareholders.


Another company that has related party transactions and has been targeted by a negative research report is Adler, a German property company. Their share price is down -60% this year, and they published a brief statement attempting to refute Fraser Perring at Viceroy’s short selling report.

Though much smaller than Evergrande, Adler are still sizable owning 70,000 residential apartments in Germany and owes c. €10bn of debt. It’s remarkable that property companies like Evergrande and Adler are imploding at a time when long bond yields have been so low, Central Banks continue with QE and there has been unprecedented fiscal support for businesses. The tide is only just beginning to go out, and already we can see some of those that have been swimming naked.

The other reason to highlight Adler (which means “eagle” in German) is that I, and many others, have known for some time that the accounting was, to put it delicately, “less than conservative”. I haven’t verified all of the claims in the short selling report, but what I do know is instructive. I first looked at the company in 2014, when management were buying property “at below the market price”, and then immediately marking up the value using their own model assumptions about what the “market price” was. When I asked management who was selling property to them “at below the market price” they responded that they had signed Non Disclosure Agreements, so couldn’t tell me. Management were adamant that their own models valued the property correctly, as opposed to the price that they’d actually paid in the market.

Similarly Adler also bought another listed company, called ESTAVIS, which was trading at a c. 50% discount to book value, and whose 1-year bonds were signalling distress, trading at a yield of over 10%. When the deal completed, rather than value ESTAVIS at the discounted priced that they paid for the shares (ie the market price), Adler management wrote up the value on their balance sheet to “book value”, ie almost double the price that they’d paid.

Given how strong the German property market has been in the last few years, it could well be that optimistic model valuation assumptions have proved correct. Yet the shares have failed to benefit from the tail wind (instead down -75% in the last 3 years). The Viceroy Research note suggests not just optimistic valuation assumptions but even more dubious related party transactions have been going on too. We can see from SharePad’s “Financial Health metrics” that there are reasons to be cautious: I don’t think I’ve ever seen a Beneish M, earnings manipulation score so high. Note too that analyst “buy” recommendations outnumber “hold” and “sell” recommendations.

Investors should remember that research paid for by the company is not independent. Such research can still be useful, it highlights the investment case that companies would like to make to investors. But it should come with a health warning “caveat lector” – let the reader beware.

This week I look at four trading updates from Argentex, Calnex Solutions, Capital and Sanderson Design Group. Argentex has returned to its strong revenue growth trend, though it hasn’t published a cash figure. The latter three all seem to be going from strength to strength, but of them I think that Capital, hiring out equipment in the unloved mining sector, is the most attractively valued.

Argentex H1 September Trading Update

This forex company put out a trading statement for their H1 which ended in September. I have a soft spot for this business because theoretically if banks served their corporate customers well it shouldn’t exist; but they don’t, and it does. Revenues for H1 September are expected to be +33% to £15.7m. Full Year they were down -3% FY to March 2021, so that return to revenue growth is pleasing. FX transaction turnover has increased by +67%, which suggests either considerable margin pressure or significant change in mix. Historically Argentex has reported a roughly 50/50 split between spot and forward trading revenue. Spot is lower margin, but the risk profile is much reduced as they receive the cash almost immediately. The average tenor of forward contracts was less than 5 months at the March year end.

Cash vs profits Unlike most trading statements, this company has the annoying habit of not putting their net cash figure in the RNS. The company must know how much cash they have in the bank at the end of September, so I’m intrigued why they don’t share the figure with investors. At the FY results in March net cash was £38m, down £10.8m versus the prior year. Cash from operations was minus £4.1m.

Roughly 40% of that £10.8m decrease last year was customer balances falling, and 60% (ie £6.2m decrease) was investment in new offices and dividends to shareholders. When a company reports good profits (Argentex FY 2021 PBT £7m and RoCE 23%) but falling cash it is worth being a little cautious, and asking yourself if the cash will eventually arrive. The largest negative items in the FY 2021 cashflow from operations were £8.6m decrease in payables and £3m decrease in derivative financial liabilities. Cash for investing activities was also negative £3.9m. There’s not much explanation around that, but I’m assuming that the higher margin forward contracts tie up the company’s cash.

Equals Trading Update The fintech payments group that started life as FairFX, also reported a trading statement for their Q3 (July-September). They reported a +62% increase in revenues to £12m (Q3-2020 £7.2m), and up by a third versus Q2 this year.

Valuation Argentex shares are trading on just 6x PER March 2024F, and 1.6 Price / Sales for the same year. Revenue growth is forecast to be +28% next year and the year after, so the company looks very good value if that’s remotely achievable.

Opinion There was a share overhang as the previous co-Chief Exec, Carl Jani, stepped down and sold his 12% stake into the market over the last 3 months. The removal of that overhang was supposed to be a catalyst for the shares to begin outperforming, but despite the +33% revenue growth in the trading statement, the shares haven’t responded.

I think the concern must be over the cash, so I’d like a better understanding on that, I can’t see a management presentation from this year on Investormeetcompany or PIworld though.

Calnex Solutions H1 to September Trading Update

This company supplies telecoms testing equipment to network operators, network providers and other systems suppliers. It came to market in October last year at 48p, valuing it at £42m. Maynard wrote about the company here, highlighting positives such as: a track record of profitable expansion; the founder Chief Executive Tommy Cook has a 31% shareholding and; a competitive position based on in-house technical research. But he also digs into the numbers and finds some inconsistencies with provisions and depreciation policy pre-floatation.

Raising Expectations Calnex management feel confident enough to say that revenue and profits for the Full Year ending March 2022 should be materially ahead of previous expectations. They don’t however feel confident enough to tell us what those expectations were. SharePad shows revenue falling -4% for FY March 2022F to £17m, before resuming double digit growth in the following year.

EPS FY March 2022F was previously forecast to be 3.8p, rising to 4.2p March 2023F.

It’s pleasing to see a company beating expectations after a recent IPO, but I think we need to be a little cautious. The growth rating that the shares trade on implies that many investors were already expecting Calnex to beat expectations of declining revenue. Plus, it could be that the increased revenue this year is merely bringing forward demand from next year. Assuming that EPS for March 2023F is +10% higher than forecast, that puts the shares on a PER of 21x. That seems reasonable given the high-quality metrics from SharePad (see below).

Opinion Maynard notices the resemblance of Calnex to AB Dynamics, whose shares are up 13x since their IPO in 2013. Both companies make testing equipment for household-name customers involved in a major global industry that’s undergoing significant change. I think this requires some background research on the potential size of their market, and whether Calnex can sustain their competitive position, but at first glance I like the risk / reward ratio. Below is Stock Whittler on Twitter’s annotated SharePad charts:

Sanderson Design Group H1 to 31 July

This wallpaper and design group that used to be Walker Greenbank, reported strong results with revenues +48% to £58m and statutory PBT £4.9m versus a loss last year. Net cash excluding leases was £15m, up £11m vs July last year.

I wrote about the company’s FY results in May. They were badly hit by the pandemic, and didn’t benefit from people spending time DIY renovating their homes because if you’re going to put up wallpaper at £80 a metre, you’re likely to pay a professional to do it. So SDG was hit hard by the first lockdown, though fortunately the shares have recovered strongly in H2 last year and now H1 this year.

The company has a number of licencing agreements with the likes of NEXT and Wedgwood but also foreign retailers like Sangetsu (Japan) and Williams Sonoma (USA). License Royalty Income was £2m, or 3.5% of H1 group revenue, but there’s little cost attached. Hence, the benefit drops straight through to the bottom line, and contributes significantly to EBIT margin (10% forecast FY Jan 2022F) and PBT (£11m forecast FY Jan 2022F).

Valuation Forecasts are for mid-single digit revenue growth in 2023F and 2024F. The shares are trading on 14x March 2024F, for a company reporting CROCI of 21%. Perhaps we should be a little careful with that ratio though: the company’s cash from operations at £18m was 3.6x higher than net profits, because it enjoyed positive working capital movements FY to Jan 2021. That’s likely to reverse at some point, probably this year or next. ROCE was a more pedestrian 6.6% for the same FY period.

Opinion The shares suffered a violent sell off during the first lockdown, falling below 30p. They have now recovered to close to the peak valuation of 240p a couple of years ago. I like SDG, but I’m reluctant to pay such a full price now. The chart over the last couple of decades shows the share price can see some vicious drawdowns, so I think I’d put this on my watchlist and try to time my entry point better.

Capital Drilling Q3 Sept Trading Update

This mining equipment hire company focused on Africa announced Q3 (July-Sept) results, with revenue +75% vs Q3 last year to £62m and +13% sequentially vs Q2 this year. This figure was the best Q3 since the company was founded more than 10 years ago, and at the H1 results presentation they put up a slide titled “Strongest Demand Environment in a Decade”. The group is increased FY guidance on anticipated revenues for 2021 to $220-225m (previously $200-210m).

As the company has achieved greater utilisation rates of equipment, margins increased to 20% at H1, as the chart below from the company shows. This is a cyclical business is a cyclical business though!

Valuation The mining sector is almost as unloved as the banking sector, so you would expect this company to trade on attractive valuation multiples. The PER is 8x March 2023F. The share price has barely moved since May, despite raising expectations twice this year. That may just be a reflection on the sell off across mining stocks and small caps since the froth came out of the market. The FTSE 350 Industrial Metals and Mining sector is off -12% since its peak in mid May.

Opinion The shares look good value. Both Mark Simpson and Leo, are fans. One concern they flag is that in cyclical companies management can often invest at exactly the wrong point of the cycle (ie at the top, just before it all goes wrong). They point to management’s skin in the game (Jamie Boyton, the Chairman owns 12% and Brian Rudd owns 10%), plus an investment banking background means the company should understand the capital cycle well. Following the results, the company released this short interview with the Chairman, so readers can judge for themselves. I think unlike SDG it’s not too late to take position, so I may buy some, but haven’t done so yet.

Bruce Packard

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