Weekly Commentary 15/11/21: Gold fails to glister

The FTSE 100 rose +0.8% towards 7,400 before dipping back slightly on Friday to 7,353. That was a better week compared to the Nasdaq 100 and S&P500, down -2% and -1% respectively. However, the FTSE outperformance has mostly been driven by a weak pound, which fell to 1.34 to the dollar, as currency markets reacted to the BoE’s unwillingness to raise interest rates. Bitcoin remains strong, up +7% last week to over $66,000 suggesting that risk appetite remains in the more frothy areas of the market (crypto, meme stocks) despite Elon Musk very publicly selling some of his Tesla shares.

Vaccine Rally Last week marked the one year anniversary since the vaccine was announced. Over 7.3billion doses have been administered in the last 12 months across 184 countries, according to Bloomberg. There are some excellent “sector” features on SharePad, including the ability to sort by best performing FTSE 350 sector over any time period you care to chose. The table below reveals that the Transport sector has been the best performing (+121%), followed by Industrial Metals & Mining (+56%) and Oil & Gas (+49%) since the vaccine was announced. Longer term, the Oil & Gas sector is down -29% in the last 10 years, as investors have thought more about sustainability and environmental concerns.

Interestingly the Industrial Metals sector has been weak recently (-14% in the last 3 months) presumably because investors have worried that China could be heading for a hard landing in their property sector. I was also slightly surprised that banks were not one of the top 5 best performing sectors, but they were in sixth place (+26%).

Another conundrum is the relatively disappointing performance of the Precious Metals & Mining sector (+22%), as the commodities themselves have been weak. Gold at $1,827 per ounce is actually down -2% versus a year ago, silver is flat and platinum is up +22% to $1,060 per ounce (but flat since the start of 2021). For all the talk of inflation, precious metals have not performed well. This, plus the US 10y bond yield at 1.5%, suggests that there are many investors (rather than just Central Bankers) who believe inflation really is transitory. Or perhaps markets are just inefficient?

Best Of The Rest Last week BOTB came out with a terse “in line” trading statement, saying that customer acquisition costs had stabilised, and that trading is “consistent” with management’s revised (ie lower) expectations. The shares responded by rising +5% on the morning of the RNS, Many on Twitter appear to blame management for the disappointment of the last 6 months, so I think it’s only fair to point out that the shares have increased in value 21x over the last 10 years. My feeling is that as long as there isn’t another profit warning, this share should once again reward patient HODL’ers. H1 results will be in January next year.

Similarly M Winkworth, the estate agent franchisor said conditions remain strong in the UK property market, and their shares were up +5% following the RNS. Interestingly they said that London rentals have seen a resurgence of interest and there’s been a reversal of the trend to move out of big cities. Rental prices outside of prime central London have recovered to pre-pandemic levels, while prime central London prices are back to within 10% of pre-pandemic levels. FY Dec revenues should exceed management forecasts and profits should be “materially higher” than expectations. This suggests that the Purple Brick’s profit warning in the prior week was stock specific. Cake Box also reported strong H1 to Sept with the share price +5% last week. I haven’t written about CBOX below, but if you are interested I’d refer you on to this site where it’s covered in detail.

Stocks covered Below I look at Argentex H1 results. FY Mar 2022F forecasts have a strong H2 weighting though, so we could yet see disappointment in early 2022, otherwise the rating looks very attractive. Renold appears to be the opposite situation, following a strong H1, FY expectation look likely to be beaten but the low rating < 9x Mar 2024F PER reflects poor profitability and a huge pension deficit. Bank of Georgia is even cheaper, trading on < 5x 2023F, and remains highly profitable (RoE 26%) though some investors consider a Georgian bank outside their comfort zone, despite it having a Premium Listing on the LSE for the last 10 years. Plus Volex, where I think the risks are to the downside.

Argentex H1 to September

This foreign exchange company had already announced headline figures in a trading statement a month ago. So revenue +33% to £15.7m was exactly in line. Administrative costs growth was ahead of revenue at +37%. I don’t think that’s a problem, it’s not reasonable for management to match hiring costs with revenue growth each 6 months. They say that it takes 18 months for new hires to make a meaningful contribution. There are now 1,241 client trading accounts, up +27% y-o-y, and I’d imagine that is also a good lead indicator for continued revenue growth.

It does mean that the margin has fallen to 29.9% (vs 31.4% in the prior year) and so statutory H1 PBT growth up +24% to £4.2m has lagged revenue growth. Cash at the bank, net of amounts owed to clients was £23m, a £3.2m increase versus March this year. Cash generated from operating activities was £8.4m positive in H1 (vs a negative £4.1m FY March 2021), as large negatives from an increase in payables seen in the last year reversed.

That’s important because the shares have de-rated (as shown by forecast turnover vs price to turnover above). I had wondered if the concern was cash as i) they hadn’t given a figure in the trading statement ii) there was a diverging trend between cash (down -£0.3m) and profits (a healthy £4m increase) seen last year. If cash and profits are going in opposite directions, it can indicate that profits are being boosted by non-cash accounting adjustments, but following H1 results we can see that’s not the case here.

Outlook The other concern was that competition from the likes of Wise, Equals and perhaps even banks using their lending relationships to discourage customers from switching to AGFX could mean that the outlook was difficult. But management said in last week’s RNS that they have increasing confidence in a sustained return to growth. There was a heavy H2 weighting in revenue last year (H1 2020 £11.8m vs H2 2020 £16.3m) as long as we see the same trend this year, AGFX should achieve the £37m revenue FY Mar 2022F (implied FY y-o-y growth of +32%) and EPS of 8.1p. Management confirmed on the call that they think a 40% H1 vs 60% H2 revenue split is normal, because H1 contains Easter and August where not much happens. By contrast, H2 contains December and March year ends, which clients like to trade ahead of.

With SharePad it’s relatively easy to verify (or not!) management’s assertion, using the “Quarterly” button at the bottom of the “Financials” tab. The c. 40/60 H1/H2 revenue split was true of FY Mar 2021, but much less pronounced the year prior to that with the split being 48/52 in FY Mar 2020.

Applying the same revenue split as FY Mar 2020 revenue would imply that FY Mar 2022 revenue comes in at £32.7m (ie £15.7m / 0.48 =) so a 12% miss to FY revenue consensus forecasts of £37.1m. Given the hiring and new office expansions, EPS forecast of 8p would likely see a much bigger hit.

Conference Call Management did break out the impact of movements in client balances on the call, reassuring that the business was cash generative £5.6m H1 Sept 2021 vs £4.8m FY Mar 2021. They said that their Amsterdam office was already contributing to revenue, even ahead of receiving approval for a regulatory licence. The Australian office is likely to receive approval next financial year (ie FY Mar 2022). They also mentioned that rising interest rates should be positive, because at the moment they hold £23m of cash that doesn’t earn any interest. One slight negative was that they ignored my question and there were a number of other people on Mark Simpson’s small cap Discord channel who complained that their questions went unanswered. This suggests to me that management are wobbly about the demanding FY consensus growth expectations.

Valuation The shares are trading on 1.65x FY March 2024F revenue. Deducting £23m of cash from the market cap (which may not be the right thing to do because they need a healthy cash balance to reassure counterparties and regulators) suggests a cash adj PER of just 5x in FY March 2024F. Or another way to think about valuation, is to assume that they do warn on profits, and only achieve 6p of earnings in FY Mar 2022F, which would put the shares on 15x post warning multiple.

Opinion The chart looks very unappealing, so I’d been expecting some disappointment. It is certainly possible that comes in H2. But I bought some shares on the morning of the results based on the optimism of the management commentary. If they do miss revenue forecasts, I’d reappraise how much I trust management to deliver what they say they can, so my position sizing is cautious at the moment.

Renold HY Sept Results

This supplier of industrial chains and related power transmission products announced constant currency revenue +22% to £95m and statutory PBT more than doubling to £6.2m. As a consequence of the improved profitability net debt has fallen by 47% to £14m. The order book, at £72m Sept 2021 vs £47m Sept last year, is at a record high.

They made a small acquisition Brooks, in April this year, though with revenues of £1m, which has slightly flattered the revenue growth. Although the business claims to be precision engineering, the low single digit EBIT margin and RoCE suggest this is a business that lacks a “moat”.

Pension The group has an enormous pension deficit of £100m, versus a market cap of £74m. The deficit on the balance sheet is a net number, with £151m of plan assets and £254m of liabilities at the FY – suggesting that the deficit will be sensitive to changes in the discount rates or other assumptions. In H1 last year this resulted in a £17m negative “below the line” item in “Other Comprehensive Income” (ie not in the p&l.)

If bond yields increase, and all else stays the same, this has the potential to reduce the deficit. However, in the most recent half year the present value of obligations increased because inflation assumptions rose faster than discount rates. Companies rarely fail because of their pension deficit. So during the pandemic, management were able to negotiate with trustees a £2.8m reduction in payments to the pension fund. But now normal contribution levels have resumed with a £2.4m payment deducted from the cashflow statement (but not taken through the p&l). Management say that cash pension costs are sustainable, having remained consistent at approximately £5.5m for several years – though investors should note that the company is not reintroducing a dividend. While the deficit is unlikely to cause the business to fail, shareholders are clearly behind pension fund beneficiaries when it comes to payouts. The large deficit will also make it difficult to raise money to fund growth, in my view.

Broker forecasts FinnCap have been appointed joint broker, earlier this month, alongside Peel Hunt. Sometimes this can mean that a company is looking to raise money, in this case I think the pension deficit rules that out. Presumably they’ve engaged FinnCap because the broker is prepared to make research freely available to amateur investors.

So FinnCap have resumed coverage with FY Mar 2022F £192m revenue, implying forecast +22% growth for the FY. For the following years revenue growth drops to a far less exciting +4% Mar 2023F and +3% Mar 2024F. That converts to 3.7p EPS and 4.0p Mar 2023F and Mar 2024F respectively. That suggests the shares are trading on 8.5x PER Mar 2024F. But don’t forget the pension deficit!

Opinion SharePad shows that RoCE has failed to reach double digits since 2015. I’m trying to avoid low profitability, indebted companies with large pension deficits. The shares have bounced strongly already, up +166% YTD, so they are no longer in “deep value” territory. Renold may have further to run over the next 6 to 12 months, but longer term the low profitability and high pension deficit put me off.

Bank of Georgia Q3 September

This London-listed, Tbilisi headquartered, bank reported strong Q3 results, supported by a rebounding Georgian economy (GDP +9% in Q3) and remittance flows from Georgians working overseas. Revenues were +26% Q3 vs Q3 last year in local currency (Lari) terms. The bank is currently reporting 26% RoE for both Q3 and 9M 2021, and a RoA of 3.3%. The high level of profitability has meant that the Equity Tier 1 ratio has recovered to 12.8% vs 9.9% last year, despite loan growth +14% y-o-y.

Net Interest Margin (ie the difference between what the bank earns on loans and other assets versus what it pays on customer deposits and other funding) was 5.0%, up 30bp versus the previous quarter. For contrast Lloyds was 2.5% and NatWest banking NIM was 1.62% at their interim results.

Valuation BGEO looks expensive relative to UK banks, as it trades on a 1.4x premium price to tangible book ratio. However, that premium rating is reflecting the banks superior track record of loan growth and profits (SharePad shows the last 4 years 18% avg RoE, versus the next highest bank Lloyds’s 7% RoE). On a 2 year forecast, BGEO shares are trading on 5x 2023F PER, versus 9x PER for HSBC and NatWest.

Purist would balk at me using a PER ratio to value banks, but I’m sceptical that price/tangible book has helped investors in UK banks for the last 10 years. The key, in my view, is to think about whether returns are sustainable (they were clearly not for UK banks), whereas BGEO enjoys a roughly 30% market share in a concentrated market, with a Central Bank more focussed on financial stability than trying to introduce more competition. The long-term trend in RoE (chart below) is encouraging.

Opinion I’ve held the shares for a decade. There is some near-term risk that the 30% level of vaccinations among Georgians means we see more economic disruption over the winter, but the bank has come through the worst of Covid without blowing up. This suggests that the double-digit loan growth of the last decade has not been reckless. Over the next few years I’d expect loan growth to slow (management target +10% y-o-y, down from +20% a few years ago), and some decline in RoE towards 20%. But I think a re-rating to at least 10x earnings is more than possible.

Volex H1 to 3rd Oct results

Volex reported revenue +45% to $293m and statutory PBT +22% to $25m. The supplier of power cables has grown rapidly by acquisition, so it’s rather disappointing not to see an “organic” growth figure. Last financial year they bought DE-KA, a Turkish power cord manufacturer for $60m, and they’ve announced three more acquisitions in North America, two of which were post period end. Following the completion of Irvine, Prodamex and TC acquisitions net debt is expected to rise to $35m. It should be noted that Volex like to report net debt without including lease liabilities, which is understandable, but it’s worth remembering lease liabilities are $18m (so net debt of $53m on a statutory basis) to make sure that you’re using the correct net debt figure when comparing to other companies.

Last set of results Volex enjoyed the benefit of a tax credit (which they included in “underlying” EPS). For this H1 the tax rate remains low, with an effective tax rate of 11%. Cashflow from operations was affected by a large -$19m negative working capital movement, so that cash from operating activities was $7.3m versus $17m profit after tax. Receivables at $125m or 43% of sales looks high.

In the past management have said that they are able to pass on costs of material (eg copper) to customers, however there’s been a hit to the gross margin down to 21.3% versus 25.1% H1 last year, caused by a combination of timing (time lag to pass on costs to customers), foreign exchange movements and acquisitions. The operating profit margin also fell to 9.3% (v 10.3% H1 last year). That may be temporary, but it’s disappointing that the bull case was based in part on margin expansion, and in reality the ratio is going in the wrong direction. Hence the shares fell -12% last week but are still trading on 18x Mar 2023F.

Adjustments I don’t find the accounting for this acquisitive company straightforward. For instance, there are 19 items listed on the cashflow statement to get from “profits” to “net cash from operations”, including a $2.6m benefit from the forgiveness of a PPP loan. They’ve included this $2.6m as an exceptional gain in the p&l, offset by other adjustments (share based payments, acquisition costs, goodwill amortisation). I’ve been thinking I should look more closely at various companies’ share based payment disclosure, and Volex strikes me as such a company where a detailed reading of the notes in the full Annual Report might reveal something worthwhile.

Outlook Management point to their order book and are confident of delivering FY Mar 2022F market expectations. They point to Electric Vehicle sales trebling y-o-y, to $45m or 15% of group sales.

Opinion The shares have ten bagged in the last 5 years, but I think that the risks are on the downside. Given the low margin nature of the business and the mid-teens RoCE I’m doubtful that investors will ever reward this business with an earnings multiple above 20x. Debt funded international acquisitions from Turkey to the USA are likely hard to integrate, and I’m not convinced that such a geographically diverse company can enjoy the synergies management seem to believe are there. So this could go wrong if revenues disappoint.

I’ll avoid.

Bruce Packard


The author owns shares in AGFX and Bank of Georgia.

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