Weekly Commentary 17/01/22: When you’re underwater…

Bruce looks at risk management, and how to react to the discomfort of your positions being underwater. Plus 3 stocks that updated on progress last week: Equals, Franchise Brands and Frenkel Topping.

The FTSE 100 was up +1% to 7554, driven by banks and oil companies which have enjoyed a strong start to 2022 (BP and Barclays both up +17%, closely followed by the rest of the sector up >10% since 1st Jan). This contrasts with Nasdaq 100 which is now down -5% since the 1st of Jan, and the S&P500 is down -2.2%. Bitcoin was trading around $44K and the VIX was at 18. Meanwhile Cathy Wood’s ARKK ETF is now down -15% since the start of this year, so the sell-off in her innovation stocks has been accelerating. The gold price has been flat, but rhodium has spiked up +28% in the last two weeks to over $15K per ounce, which should be a helpful tailwind to Sylvania Platinum.

There are a couple of high profile players who look to be timing sales of their businesses to take advantage of the current market conditions while they last i) TPG IPO that Marc Rubinstein wrote about here and ii) Ken Griffiths of Citadel Securities (a subsidiary of his Citadel hedge fund) selling a stake to Sequoia. We could be at a “Blackstone moment”, because the private equity fund timed its IPO perfectly to take advantage of frothy market conditions just before the 2007-9 financial crisis.

A couple of weeks ago I talked about my three best performing stocks. I should also mention that I sold Hostelworld at a loss last year – losing 29%. I bought the online booking platform just before the pandemic, so my timing could not have been worse. Valuation didn’t play a role in my sell decision – I think the price is fair, reflecting a wide range of outcomes. There’s a good chance it could still fall sharply if Covid continues. Annualising the H2 loss suggests that their cash would fall by €19m in the next 12 months vs €25m cash at the end of December. But except for the last 6 weeks of 2021 (Omicron) bookings were recovering, so I can see the argument for a bounce as Omicron recedes. Now that I’ve sold, the risk for me is that they rebound strongly in 2022 and I’ve timed BOTH my buy and sell decisions badly.

To me it’s important to recognise the discomfort of being underwater, take the loss and then move on. I’ve just finished Guy Hand’s book, and he says his greatest mistake was not cutting his losses with EMI, and the subsequent court case against Citi. He couldn’t bear the thought of it all being for nothing, he wanted there to be a direct connection between time and money put in and return achieved. Unfortunately investing (and life) doesn’t always work like that.

I spend my Saturday mornings at a frozen lake outside Berlin, where I and others do 3 rounds of breathing exercises and then jump in the ice cold water for 5-10 minutes. We then hang around afterwards to chat and drink tea. Some people suggest the cold water helps the body’s immune system to reduce inflammation, though it’s hard to do a proper scientific trial into any health benefits. Unlike a pill or an injection, you can’t do a double-blind trial to separate out the placebo effect, because those taking the placebo as a control (ie not going swimming in cold water) will obviously know that they’re in the control group! The others do seem to have a healthy aura, perhaps that’s simply because they’re a self-selecting sample who generally make other healthy lifestyle choices as well?

An alternative theory is that it is psychologically healthy to acknowledge discomfort. It’s the opposite of addiction, which is about trying to avoid pain which ends up worse than whatever you’re trying to block out. Far healthier to acknowledge discomfort (perhaps even intentionally seeking it out) and then move on. For investing that means running your winners, and cutting your losers.

If you’re interested in a more extreme version of this attitude, then I recommend checking out the World Record Holder for under ice swimming, who is called Amber Fillary. She has a crowd funding page for her next challenge (she has swum 70m in freezing water under ice, but would like to break the 100m barrier). Amber needs the funding because there are some associated costs, for example registration fees to Guinness World Records*, setting up safely and filming to verify the record.

I haven’t written up Frontier Development’s profit warning in detail, when the shares fell -20% last week. The computer games company has revised down revenue guidance for FY2023F as a result of a delay to their Warhammer Age of Sigmar game. On first glance the share price fall looks like an over-reaction to a decision by management to focus on quality rather than hitting a deadline to please the stockmarket. But I am a little concerned that management didn’t give themselves enough lee-way, especially after the disappointment of Elite Dangerous: Odyssey. So with the shares down -60% in the last 12 months, if I held, I would be tempted to recognise the loss, and revisit the investment case in 3 months’ time.

This week I look at Equals, where the recovery in revenue growth continues, Frenkel Topping the specialist asset manager that is acquiring litigation cost expertise and Franchise Brands, where its Metro Rod plumbing franchises are reporting strong growth and B2C franchises should recover in time.

Equals FY Dec Trading Update

The fintech and payments company that I mentioned last week as a pick for 2022 put out a trading update, with FY Dec 2021 revenues up +52% to £44.1m. Q4 vs Q4 2020 was even stronger +96% to £15.3m. They have £13.2m of cash, up +65% vs Dec 2020. They also say that the first couple of weeks of this year have started strongly.

They have done well to adapt to the changed market conditions, being hit by the lack of travel. In H1 2019 Currency Cards (ie pre-paid cards to be used abroad by people traveling) and Travel Cash revenues were £5.1m and £1.2m respectively, versus Group revenue of £13.6m (or 46% of revenue). In H1 2020 they managed to sustain group revenue at £13.8m, while Currency Cards and Cash fell to 22% of revenue. International Payments +71% to £8.2m picked up the slack last year. One thing I should mention is that in SharePad the historic charts containing turnover look squiffy, because Equals changed the way it reports revenues (gross vs net). The historic figure of over £200m is the number that they reported at the time, but is not comparable with the current figure, hence distorts the chart.

Runrate One calculation that you can do is the weekly run rate of Group revenues (ie £15.3m of revenues in the last 13 weeks of the year = £1.18m revenues per week). If you extrapolate that Q4 2021 run rate for the whole of 2022F by multiplying £1.18m by 52 you reach £61m versus SharePad’s £43m broker forecast. There’s a couple of days delay as new broker forecasts are fed through the system and appear on SharePad, but I think that it’s safe to say the pressure on forecasts is upwards. Add to this that Equal’s RNS says that Currency Cards and Cash fell to 5% of revenue in the most recent Q4. But at some point they expect it to contribute £8.0m, which was the FY 2019 amount. That recovery to £8m could be material to revenue growth on its own. In other words, although revenue growth was up +52% last year, there’s probably more to go for in 2022F.

Judith Mackenzie at Downing Fund Managers made the investment case here. She thinks there’s at least 80% upside to the current price. Of course, it’s not unknown for fund managers to talk their own book!

Ownership Crystal Amber own 20.6% and their fund is in run off over the next couple of years. So potentially there’s a large seller. Pembar Ltd, Ashley Levett’s British Virgin Islands vehicle that has owned a stake since before the IPO in 2014 owns 13.9%. JO Hambro owns 7.7% and Schroders 4.8%. Downing’s stake is not large enough to be a disclosable stake at the moment.

Valuation At the time of writing SharePad was still showing forecasts of £43m for 2022F. The broker forecasts aren’t freely available on Research Tree. But given my run-rate calculation, I don’t think investors need them. The stock is trading on 2.2x annualised Q4 run rate revenues, and should enjoy operational gearing as more revenue goes through a fixed cost base. So I can see where Judith Mackenzie is coming from with her 80% upside.

Opinion I like the story, and should have bought at the start of last year. One caveat though is that banks and firms like Equals will say that their forex “dealing profits” are not taking proprietary risk on their own balance sheet, but are customer transactions. Which is true, but customer transactions themselves can be a volatile figure on a relatively fixed cost base and SharePad shows that Equal’s historic revenue growth rate has not been a constant. In 2018 revenues were up +68% to £26m, 2 years later they fell -6% in 2020. Over that time the share price fell 87% from 150p to 20p when that decline in revenue expectations happened, yet another reminder that operational gearing amplifies returns in both directions!

Frenkel Topping Acquisition

This fund manager that specialises in helping clients at times of financial vulnerability announced a small acquisition and a trading update. In practice what the firm does is help people following life changing injuries by providing expert witnesses, maximising the amount their clients are due and then helping to invest the money in structured annuities for their long term needs. It’s an interesting niche, with 99% client retention, but also limited market size.

History There was a formal sale process in 2017 which failed to find a buyer, followed by a botched acquisition (National Accident Help Line NAHL). They then raised £12m in 2019. I wrote about the history in more detail last May. More recently they’ve been making small acquisitions of specialists in the Personal Injury / Criminal Negligence areas: Forths (expert witness firm), A&M Bacon, Partners in Costs and Bidwell Henderson. The last 3 are specialists in litigation costs, the acquired companies allow Frenkel to build better relationships with both law firms and Deputies to the Court of Protection, keeping track of claims occurring across the country.

Acquisition They’ve now bought Cardinal Management Ltd for £10m total consideration in cash (half of which is an earn-out). Cardinal works at the NHS’s Major Trauma Centres helping patients access welfare, legal, rehabilitation and financial support. Cardinal had FY revenues of £900K and PBT of £300K.

Outlook They also said trading is “inline” with expectations. FinnCap their broker, is forecasting FY Dec 2021F revenues of £16.9m and EPS of 3.1p. The broker has raised expectations for FY 2022F and FY 2023F following the acquisition, giving EPS of 4.4p and 5.3p respectively. Meaning a 15x PER ratio FY 2023F. I’ve done a table comparing FEN with the other asset managers, sorted by size, showing that FEN is the smallest and least profitable on a Return on Equity (both recent and 5 year average).

Management said in this presentation that they see themselves as a “growth stock”. Of course, if “value” had outperformed “growth” over the last 10 years, they’d probably say the reverse!

Shareholders Christopher Harwood / Harwood Capital owns 23%. IPGL, Michael Spencer’s vehicle, owns 14.8%. Hargreave Hale 8.1%, Gresham House 5.7%. The percentage not in public hands is 40%.

Valuation The group is transforming itself, to become more vertically integrated by acquiring specialist advisers. However this does mean that it’s less like an asset manager, that would be valued on a percentage of AUM, and more like an advisory firm which has to constantly find new customers. To be clear, I think the expansion is the correct strategy, but it may not drive the re-rating that management believe they deserve.

Opinion Impax continues to do well, enjoying £2bn of inflows last quarter to take AuM to £41bn, versus £3.6bn AuM when I bought in 2016. Frenkel Topping will never see that kind of growth, but it should also prove defensive in a downturn because of the low-risk nature of the investments, which are tailored for their customers who need a secure future income stream. So not only will the assets not fall in value as the much hyped ESG green energy sector, but also they won’t see the outflows because Frenkel Toppings client retention is so strong.

Franchise Brands FY Dec Trading Update

This dog hotels to drain cleaning, plumbing and pumps franchise released a trading update saying that FY Dec Metro Rod (c. 2/3 of revenue, but lower gross margin) franchise system sales grew by +24% last year to £50.4m. System sales is the total sales of their franchisees of services to third-party customers, which for Metro Rod drives a Management Service Fee (MSF) of 22.5% to FRAN.**

The group had £9m of cash at the end of Dec (up from £4.9m net cash Dec 2020). I presume that they mean net cash – but the RNS doesn’t actually make that clear, so something to double check when the results are released on 3rd March. They are targeting run-rate revenues of £100m and adjusted EBITDA of £15m by the end of 2023F.

They comment that the supply and install division of Willow Pumps (1/4 of revenue, but higher gross margin) has taken longer to recover, I think because it’s driven by housebuilding, and the delays related to construction.

B2C Division The B2C division (1/8 revenue, but also higher gross margin) has attracted 57 new recruits in 2021 (v 58 2020). The B2C division was hit heavily in the first lockdown in April 2020, they furloughed 85% of their people back then. But I would expect franchises like Barking Mad (dog hotels), Chips Away (car dent repairs) and Oven Cleaning to benefit as part of the trend of people quitting their 9-6pm office jobs, and working for themselves which has become a feature of the pandemic. At the H1 last year, Stephen Hemsley the Exec Chairman said the B2C franchisees were back to paying full fees.

Azura Platform FRAN management also point to the acquisition of Azura, a franchise management software system developer they bought for £1m in November last year. Metro Rod was a customer of Azura since 2018, and the idea is create a common technology platform (that “platform” word again!) across all its businesses. They are investing heavily in systems, a further £1.5m over the next 3 years hoping that this will generate operational gearing (ie growing revenue on a fixed cost base).

Valuation This share looks expensive on 30x P/E and 16x Price/Net Tangible Asset Value partly because earnings will be held back as they invest in their computer systems. On a 3x Price/Revenue basis it looks more reasonable, though not cheap. It’s the former Domino’s Pizza management, so I would expect it to do well over the long term. If they achieve the target £100m (vs £49m FY Dec 2020) that would put them on 1.5x revenue.

For comparison, Water Intelligence is on 56x PER, 6x Revenue and reports Negative Tangible Book Value.

Opinion This is on my watch list. I was rather hoping that management might stumble at some point, giving me the opportunity to buy in at a depressed level – so far that hasn’t happened, the shares were up +54% in the last 12 months. If it does as well as Dominos Pizza UK then I’ll regret not paying the full valuation.


* The history of Guinness World Records came about in the early 1950’s when Sir Hugh Beaver, Managing Director of the Guinness Brewery, got into an argument at shooting party in County Wexford about the fastest game bird in Europe and failed to find an answer in any reference book. He had the idea for a Guinness promotion based on the idea of settling pub arguments and invited the twins Norris (1925—2004) and Ross McWhirter (1925—75) who were fact-finding researchers from Fleet Street to compile the book of facts and figures.

** This is further complicated by the FRAN network has two types of system sales: National and Local accounts. In the case of National accounts Metro Rod bears the credit risk, whereas for Local the franchisee bears the risk.

Bruce Packard

The author owns shares in Impax AM

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