Weekly Commentary 1/11/21: The shopping trolley problem

The FTSE 100 was flat last week, drifting around 7,226. Nasdaq and the S&P500 did better, up +2.8% and +1.1% respectively, following strong results from Google and Microsoft. Apple and Amazon signalled that disruption and costs from supplying customers with physical products were rising. Facebook became Meta. Name changes should not affect share prices, but that said, it has worked for RBS! RBS, I mean NatWest, shares +38% YTD mean it’s the best performing UK bank share this year.

We are beginning to see profit warnings coming through in the UK. Last week we had James Fisher down -48%, Darktrace -17%, IG Design -43%. I’m particularly disappointed with James Fisher, because 6 months ago I observed that just buying a basket of James Halstead, Latham, Cropper and Fisher would have performed well over the last 10 years. But James Fisher has let me down.

The vaccine rally of the last 12 months has been a tide that lifts all boats, whereas in the next 6 months we could see some diverging trends. Begbies Traynor Q3 “Red Flag” report was released last Friday, citing a +139% y-o-y increase in County Court Judgements (CCJs), or +51% sequentially v Q2 this year. They say that CCJ’s are often a bellweather for future insolvency and the latest data paints a gloomy picture. The top 3 sectors they flag are support services, construction and real estate/property.

Apparently consumers are responding to supply chain problems by filling up their shopping trollies well before Christmas. By contrast, as interest rate rises may cause a market wobble, I think that investors can afford to be patient with their buying.

Non Execs What is the difference between a shopping trolley with a wobbly wheel and a Non Exec Director? Simon Laffin has done an interview on Non Execs on the PI World website, he has 3 decades of experience serving on boards (both as an Exec and non Exec). Much of what he says is common sense, for instance the LTIP awards should be capped. If an incentive scheme is paying out tens of millions of pounds, then there’s probably been some luck involved.

For balance, I should point out that Simon was Chairman of Flybe, which IPO’ed in 2010 and lost 99% of its value. The company rejected a bid in 2018 when the shares had previously been trading at around 40p per share. Then in 2019 shareholders received just 1p per share when the airline was sold in an emergency deal to a Virgin-led group. He doesn’t talk about what went wrong at Flybe, perhaps that episode has been edited out from his memory?

Instead, he talks about one lender that he doesn’t name, but as he was brought in to help rescue Northern Rock, the former mortgage bank seems a likely candidate. Rather than record a provision against weak credits, this lender capitalised the foregone interest and increased the size of the loans’ principle amounts on the asset side of the balance sheet. In the interview he is very clear that the company was allowed to do this within the accounting policy, but the consequence was that loan growth was flattered and bad debts were under-reported. The Non Execs had failed to spot this dubious accounting treatment.

My own experience of covering Northern Rock as an equity analyst was that management were aggressive with their accounting choices, but didn’t step over the line to anything illegal. In retrospect the “optimisation” of accounting profits was a sign that Northern Rock management were taking other risks (short term funding) with their business model that turned out to be more serious. Hence, if you see questionable accounting at a company, it’s worth asking what other hidden risks management are taking, that could be even more damaging.

One of the problems with Non Execs is that although their role is to represent shareholders, most of them have been selected for their corporate experience and credentials, rather than any background investing money. People who do well in corporate hierarchies aren’t particularly good at rocking the boat, asking Chief Execs tough questions or spotting obfuscation. Whereas I think many investors develop these skills after a few years listening in to management presentations or reading between the lines of text. Having retired hedge fund managers, equity analysts or even experienced amateur investors with good track records as Non Execs would improve corporate boards and decision making, in my view.

And yes, the difference between a Non Exec Director and a shopping trolley is “You can fill the shopping trolley full of food and drink, but it still has a mind of its own.” This week I look at Franchise Brands trading update, Sylvania Platinum and the mortgage conveyancing platform ULS Technology.

Franchise Brands Q3 Trading Update

This drain cleaning (Metro Rod) to dog hotels (Barking Mad) franchise business, run by the former Domino’s Pizza UK management, has said that they are confident of meeting FY 2021F forecasts. Helpfully they’ve included what expectations for FY to December 2021F are:

  • Revenue £58m (implying +18% growth v last year)
  • Adj EBITDA £8.4m (implying +27% growth v last year)
  • Adj EPS 5.43p (implying +24% growth v last year)

Longer term they also reiterated their target of run-rate turnover of £100m and adjusted EBITDA of £15m by the end of 2023.

Financials Metro Rod 61% of revenues, is their largest business and their system sales were up +32% Q3 v Q3 last year. They acquired this business in 2017 for £28m. At FY 2020 it had a network of 50 depots and 425 engineers. 90% of revenues come from Management Services Fees, which they earn from franchisees (based on 18.6% of the franchisees’ turnover).

Other Franchise Brands business divisions have been slower to recover. They also own Willow Pumps, 27% of revenue which is reliant on pubs, restaurants and also the housebuilding sector, where labour shortages and rising raw materials prices have delayed building projects.

They also have a hodgepodge of higher gross margin B2C businesses 12% of group revenue (Chips Away: car paintwork repair, Ovenclean, Barking Mad: dog hotels). The B2C businesses have been more affected by lockdowns, as they are not considered essential services. Barking Mad particularly suffers low demand when people can’t take foreign holidays, because that’s what generates demand for dog boarding. Anecdotally I’ve heard that many people have bought four-legged friends over the lockdowns, so perhaps this business will eventually come back much stronger?

Forecasts Sharepad shows a forecast PER of 26x and a Price/Revenue of 2.6x. Assuming they do achieve the revenue aspiration of £100m, that implies a price to revenue of 1.35x in a couple of years’ time.

Ownership Nigel Wray owns 23.4% of the company, and Stephen Hemsley 23.2%. Institutions on the shareholder register are RBC 14.7%, Canaccord 7% and Gresham House 5.7%.

Opinion This company has continued to grow well despite the headwinds of lockdown on their businesses. I do have at the back of my mind that a profit warning is possible if house building struggles, but so far management have coped well with the challenges.

Sylvania Q1 Trading Update

This South African platinum company with a June year end announced Q1 (ie July-Sept) revenue of $29.8m. This was down very steeply sequentially -38% (ie versus March-June Fiscal Q4) as the PGM basket price fell -29% and there were also problems at their Lesedi facility. On a y-o-y basis, revenue was down -28% and Q1 net profit was $8.6m down -59% v $21.0m Fiscal Q1 last year.

On the other hand cash balances were up +25%to $133m end of Sept, versus $106m end of June and $61m Sept last year. The explanation is that cash generated from operations was $14m plus a further positive working capital benefit of $19m. That $19m positive came from a reduction in trade debtors, as SLP receives cash from platinum concentrate that’s already been delivered and invoiced in the previous quarter.

I have worried about this in the past, with the company reporting a volatile “sales adjustment” figure in the p&l, but the cash eventually arriving does then fit with management’s explanation of a timing difference between invoicing and receiving cash payment. They do warn though that the impact of the lower Q1 ounces and pullback in the basket price will be shown in the coming Q2’s cash figures.

The gross basket price was $2,897 per ounce, versus $1,239 “all in cost 4E”, implying that even as the basket price has fallen, SLP is still profitable. Aside from the falling basket price, they also suspended operations at Lesedi due to inadequate water drainage and “increasing phreatic water levels at the tailings dam”. I had to google “phreatic” which means “below the water table”. The suspension has been in place since early August, and so far has resulted in 1,100 ounces of lost production, or 9% reduction in PGM plant feed tons.

Management has a remedial plan: hydro-mining of the affected facility began this September to reduce the water level and to resume operations. They have ramped up operations through October, and expect planned production levels to resume by this mid-November. Fortunately the Tweefontein facility is setting monthly records, and that is offsetting the problems at Lesedi.

Outlook Management reiterated their 70,000 PGM ounces annual production target (the same as last year). I think that’s important, because although the company’s revenue looks volatile, that’s driven by PGM price fluctuations which management have no control over. The South African summer is approaching, so the company shouldn’t have any issues with lockdowns in the next 6 months, but they do warn lower combustion engine car sales (due to chip shortages, which somehow don’t seem to be affecting Tesla) catalytic converters use PGMs, so that could supress the price of platinum and related metals. The other cloud on the horizon is delays buying equipment for capital projects, again due to computer chip shortage. So supply chain disruption is even being felt in the mining sector.

Opinion I’ve owned this stock for around 5 years, and like the fact that as a low cost PGM producer it should still generate profits even as the PGM basket price falls. The industry is clearly cyclical (last year SLP’s RoCE was almost 70%), but the shares are trading on 4x historic earnings and less than 2x historic EV/EBITDA. The $133m (£95m) of cash on balance sheet is a third of the company’s market cap, so that implies the depressed share price is reflecting an awful lot of bad news already.

ULS Technology H1 Sept Trading Update

This online mortgage conveyancing platform with a March year end, reported H1 revenue on continuing operations up +45% to £10.2m. November last year they disposed of a substantial business, Conveyancing Alliance Limited (CAL) for £27m in cash. Hence the focus on continuing operations, and net cash which was £23m at the end of September, down by £1m from the March year end.

The UK mortgage market H1 v H1 last year has been strong, flattered both by stamp duty holidays and a weak housing market during the first lockdown last year. So I would expect ULS to be reporting impressive revenue growth.

Divisional trends The business is split into two parts eConveyancer and DigitalMove. eConveyancer relies on winning contracts from mortgage brokers and lenders. At the moment, this is the main revenue generator with positive cashflow. The company says that eConveyancer is weighted towards First-Time Buyers, rather than home movers, hence performance hasn’t been as strong as the housing market as a whole. A couple of years ago they lost some big contracts, and were very reliant on Lloyds who are a third of the UK mortgage market and a significant part of ULS’s gross margin. The trading statement says that they are now back to winning new contracts across their channels (broker, lender and B2C).

DigitalMove The growth area of the business ought to be “DigitalMove”, which is a conveyancing workflow management platform, with electronic ID verification and digital signatures. Management say that starter packs are being completed and returned to solicitors around 60% more rapidly than using physical pen and paper. DigitalMove was launched at the start of 2020 and is still loss-making. Management are trumpeting it as a success, but to my mind the rollout of this new system appears disappointing. The company said in July at the FY results 50,000 cases had been processed, and this has only risen by 10,000 to 60,000 in last week’s trading statement.

Outlook They talk about a continued strong mortgage market, but that seems to ignore that interest rate rises are coming and stamp duty holidays will end. I’m a little bit wary, but the £23m (47% of the market cap) in cash means that management have plenty of time to get their product right.

Valuation There are no forecasts in the market. Annualising H1 revenue suggests £20m FY March 2022F revenue. While deducting cash from the market cap, suggests you are buying the operating business for £26m, or 1.3x annualised revenue.

Opinion I’m wondering if they are having trouble persuading conveyancing solicitors to use the DigitalMove product. Legal professionals are rarely early adopters of new technology, plus they may also fear that increased transparency makes them look inefficient. The older Trustpilot reviews were scathing of DigitalMove, but more recent ones seem to be improving. I own the shares, and like the cash on balance sheet, but am well aware that there are a wide range of outcomes, it could be a multi-bagger or it could be very disappointing.

Bruce Packard


The author owns shares in Sylvania Platinum and ULS Technology

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