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It is coming up on a year since our launch. We are not bounded by quarterly reporting and while some may choose to update people on a meaningless date or only when it’s time for a victory lap, we are choosing to update you now when there is no shortage of fear in the market, leading to plenty of opportunity.
While we are not attempting to achieve short-term gains and are focused on the long-term returns, we understand that it is just not satisfying when the market seems to be telling you you’re wrong every day and portfolios aren’t up as much as you would hope. We recently published a blog around the illogical behaviour of investors, particularly on AIM, discussing our thinking around mindsets and playing your own game. To avoid repeating all of that, it can be found here (https://mhmembers.com/if-aim-is-a-casino-can-you-beat-the-house/) for those that have not yet seen it.
As we update the watchlist each day, we monitor the theoretical returns of the ideas as if you had invested the same amount, say £1,000, in each idea at publication. The IRR (Internal Rate of Return) is the key return metric and as at today, under this illustrative scenario, you would have generated an IRR of 6.2% (without factoring in frictional costs). Just a few weeks ago at the end of Dec-22, this IRR was almost double at 12.1%, exactly highlighting the issue with short term price movements. Did the value of our ideas really change by that much across the board in such a short period?
For comparability we could assume that instead you were a completely passive investor and invested the same £1,000 in the index at the close price on the day each of our ideas was published. In this case, your IRR today would be:
AIM All Share: -13.0%
FTSE 100: 7.3%
Please see the table sent via email of the ideas published to date, ordered by their value growth, as well as the premia to Thesis and Margin of Safety prices.
Disclaimer: Past performance is not a guide or guarantee of future performance.
Source of numbers: relevant stock exchanges, Google finance, Moulton Harrox calculations and estimates
TABLE SENT VIA EMAIL
With only a few months since launch it’s been what many might consider a tough market – the war in Ukraine, rampant inflation, a Truss premiership, a brief relief rally followed by more inflation fear and finally Silicon Valley Bank collapsing. Against that background, the performance of some of the investment idea share prices would suggest that the market is screaming at us that we are wrong.
While we are not entirely displeased with the positive overall performance (particularly relative to the indices) and are well on the way to achieving our target of generating sustainable returns at least in line with inflation, the current share prices do not in any way reflect our view of the underlying value of the companies on the watchlist. All of the watchlist ideas continue to provide excellent opportunities in our opinion, some obviously more so than at publication given reduced share prices without a commensurate reduction in underlying value.
Since launch, our Ideas for Research (pre and early revenue companies) have been posted without thesis prices as there isn’t the level of data required for reasonably accurate, or indeed any, near-term cash flow forecasts. However, we believe that it would be helpful to give some idea of the potential we see for each to aid decision making. We have, therefore, now updated the watchlist to include thesis and margin of safety prices based on necessarily high level but conservative assumptions. The Ideas for Research discussion boards have been updated with our valuation thoughts for each current idea and these are re-produced below under the summary for each idea.
While these are earlier stage / turnaround companies and are clearly high risk, we obviously believe them to have a better than a 50:50 ‘coin toss’ chance of success. For the margin of safety prices, therefore, we assume a 40% probability of the risk scenario across the board along with of standard 15% margin of safety discount to the risk weighted expected price. As these companies progress, they will be published as full memos as per previous ideas ‘moving up’ if the thesis plays out, or transparently removed where not.
We are also excited about our pipeline of ideas. We have just finished, after several months, a more detailed screening of the US and Canada (over 5,000 companies) alongside the years of investment in the UK and European screens. We believe that there are some hugely interesting ideas coming up. However, ahead of membership renewals we wanted to note how the cadence of memos will change going forward.
Memos will continue to be published monthly until there are 25 ideas on the watchlist (including Ideas for Research). The watchlist will then be maintained at 25-30 ideas and we will switch to a ‘model portfolio’ approach. At the point we reach 25 ideas, everyone that has joined to date will have had at least 12 memos published within their membership year in addition to Ideas for Research. New memos will then likely be between 3-4 per year while we closely monitor 25-30 companies and at that point, we genuinely believe there aren’t enough great new ideas to publish monthly, and would only dilute the opportunity pool.
We have also had feedback that the model portfolio approach is useful to members as an indicative guide to portfolio sizing and timing to take advantage of anomalous market movements, of which we have already seen so many in our first months. The model portfolio will then be broadly ‘one in one out’ with 25 companies and up to 30 if there are exceptional new opportunities while current ideas are still maturing and reaching their full potential.
Additional feedback from prospective members also suggested that the membership fee was not high enough to attract our target member audience, did not reflect the value of the offering and didn’t differentiate it from the myriad of share tip sites out there. We have taken heed of that advice and while removing the need for invite codes to make it easier for new members to join, we have increased the membership fee to £500 (+VAT). All founding members that joined before the end of 2022 will, however, retain their £250 (+VAT) renewal rate – we greatly appreciate your early and hopefully ongoing support.
We would be extremely grateful for any further suggestions on improving the offering and experience. The discussion boards are relatively quiet other than our company and news updates. We would like to understand your thoughts on what more value-added interaction might be. Is there a better form of updates than the discussion boards? Is it helpful to post more Ideas for Research ahead of full memos being published to allow for your research alongside ours? Would it be useful to organise calls for discussion? The Suggestions Box discussion board is available for a public airing of views on improvements.
Given our long-term approach, the c.10 months we’ve been publishing ideas is nowhere close to providing a representative sample of hit/miss ratios and returns, particularly due to the number of micro-cap opportunities with gyrating share prices. While the discussion boards and update memos contain ongoing updates on each of the companies, per our blog referenced above, we thought it would be useful to provide a brief consolidated update on each of the ideas on the watchlist with our view on noise and short-term swings vs. underlying performance and value. We welcome all alternative perspectives on these.
Q3 results were strong with ongoing growth across the business, including mobile money that forms a core part of our investment thesis. Key cash flow figures were broadly in line with our forecasts for the year, though net debt is higher given the timing of spectrum payments which have been move heavily weighted to this year than anticipated, with Nigerian 5G spectrum being the biggest factor. Noncash finance charges (predominantly FX translation losses) impacted EPS and the market did as expected and focused on that ‘negative’ headline. We remain focused on cash flow and continued strong growth, particularly in mobile money.
The share price was starting to trend towards reflecting its true value but short-term economic outlooks have brought it back down again despite the company delivering a strong 2022 performance and having opportunistically acquired an additional US asset at well below previous price expectations. We will update our memo and forecasts following Q1 results and publication of the treatment charge for 2023, but our view that this is a monopolistic business with strong management and good growth prospects is unchanged.
We recently updated our memo following the full year results which were well ahead of our estimates. While we didn’t see Liz Truss coming with her impact on the housing / mortgage market leading to more muted volumes in 2023, we believe our long-term thesis is fully intact as the business successfully executes its growth strategy within a favourable market structure while allocating capital with thoughtfully.
There has been no news flow on Costain since our recent memo publication and so there is little to update on our investment thesis. As we await the next results it is oddly nice to have an idea’s share price drifting upwards, although the greater visibility of the company makes the value disparity a bit more obvious.
There has been almost no movement in the share price, but the dividends keep on coming to stave off inflation vs. holding cash, record quarterly revenues keep being achieved with new royalty partner investments and they secured £100m funding (up from previous £55m facility) from Fairfax Financial Holdings Limited with warrants issued at a price of 45p, (vs. the current c.33p) reflecting the strategic nature of the partnership. Fairfax, like us, believe there is significant upside in the share price that the market has not yet recognised. The story here perhaps just isn’t exciting enough for the trading community, but this company is quietly going about its value generating business.
Headlines around the level of insolvencies coming through following the COVID ‘ban’ would, in kinder markets, probably have had a greater impact on the current share price. Having attended the AGM and results presentations, we have seen first-hand how bullish management are about their prospects and we have recently seen a number of new hires. Again, there has been little in the way of news flow, but the share price has been moving slowly in a positive direction to close the gap on our view of fair value.
The company recently issued a trading update stating, “Given the continued sales growth, a strong orderbook, benefits of the cost reduction and efficiency programmes, and the successful recovery of cost inflation on raw material and energy, the Board is confident the current trading momentum will deliver revenues and underlying operating profit for the full year in excess of market expectations”. This has only been modestly reflected in the share price. They have also recently announced a Capital Markets Day (on 10 May), which companies tend to organise when they have positive things to say and are in a good position to not just execute their strategy, but demonstrably show the results of their efforts. We continued to be impressed with management and look forward to future successful growth from their operational improvements and further acquisitions.
Record revenues in 2022 while making significant investment in expanding their facilities and declaring ordinary and supplemental dividends. An effective global monopoly business trading at <5x 2023E EBIT with strong cash conversion that it is investing in growing international markets and new products, all while paying out significant dividends, apparently just isn’t interesting enough for a short-term focused market when it is expected to achieve ‘just’ flat results in the coming year. For the patient, this management team is a safe pair of hands and at some point, the weight of cash it produces should be more than enough to tip the scales of the share price in a positive direction. In the meantime while we wait, at the current price, it is paying out an 8% dividend yield.
The company issued FY 22 results broadly in line with our forecasts, but Q1 23 results highlighted a more uncertain short-term outlook, in particular in their ‘commodity’ business of Global Paper. Pricing increases more than offset volume declines in consumer and corrugated and the long-term theses for those segments remain intact, but the more cyclical Global Paper segment was impacted more significantly by customer destocking. The main issue for the market, however, was that management did not provide guidance for the full year 23. Highlighting its inability to think independently with analysts not having the company do their work for them, the shares were instantly marked down. While the results and short-term outlook are indeed more difficult and uncertain, the relatively rational market structure and long-term demand outlook, aided by the switch of plastic to paper packaging, leave our view of the company and the opportunities ahead of it relatively unchanged.
Early Bird Radar
We have written much about the share price being impacted by the ineffective board, which unfortunately has not improved under the new Chairman in the way that we had hoped in the original thesis. The Azerion contract dispute was clearly a set back and poorly managed by the board but we still don’t believe that the long term value proposition of the business isn’t worth multiples of the current price. It does feel like the bad news has now been factored into the price but there will remain the overhang of a potential further equity raise in the absence of the board clarifying the Azerion situation and proving they are capable of intelligent corporate finance. The newly appointed CFO should certainly help in this regard and for the first time in a while the management team are appearing in public and trying to spread the word about the enormous potential. Our most frustrating idea to date and a difficult hold, but the prize still remains to be claimed.
Harland & Wolff
The Chairman, CEO and CFO all recently bought shares at c.15p, with the CEO having previously bought shares at c.24p in Nov-22. The FSS contract win clearly jump started the share price but it has drifted somewhat over recent weeks. The market doesn’t seem to quite believe the £900m backlog, revenue targets and cash flow breakeven points the company has disclosed. We believe the FSS contract win will lead to additional pipeline conversion, particularly following the £77m investment into the shipyards which we now understand will come predominantly from external sources (£65m from government grants, Navantia, the MoD and landlords) rather than be funded by the company. An expanded £200m finance facility is due to be signed off in Q2 23 to aid bid conversion on bigger projects and everyone seems to have forgotten the potential value of the IslandMagee project which is likely worth a premium to the market cap all on its own. We are looking forward to following what we expect to be the continued revival of this business.
The valuation here is unfathomable but for it being on AIM. The delayed news flow on the Mozambique acquisition closing (one of the longest I have ever seen) and the short-term production delays from the ‘weather proofing’ of the mines in Madagascar has led to the share price continuously drifting with no regard for the value being built. We believe the company has one of the lowest cost operations globally, can continue to expand production at the lowest cost and is now quickly ramping up production to globally significant levels to meet obvious demand. It is also profitable even at current production levels allowing it to finance future growth from its own resources and moderate external debt financing. We are awaiting the full year results after their March year end to update the memo, which will reflect lower production in the near term given the delays, but we expect little change in our long-term view of the value of the business.
Our latest idea and they announced results in line with expectations so there is little to add at this point. However, in the results they provided guidance for 2023 and it is key to point out that revenue accounting as they switch from 15 to 18 month print cycles will make this year look worse in Marketing Services than it should, but it won’t impact cash flows and they expect to retire $100m debt in 2023. There’s a melting ice cube narrative around the company but our thesis, and the opportunity, is that the hidden SaaS business will start to emerge and alter that narrative.
Ideas for Research
Since our last update, the company raised £55m from Susquehanna, acquired a profitable diagnostics business as it begins to build out that division to take advantage of the Affimer platform and most importantly, published AVA6000 trial data that strongly suggests its revolutionary chemotherapy platform works better than even the company expected (and is therefore potentially worth billions). The share price reaction? A modest 24% increase from when we posted the idea. It seems to us that the market either can’t or won’t do the work to understand that further Phase 1a cohorts to find a maximum tolerated dose and an updated Phase 1b trial design will accelerate market commercialisation and aren’t the delays that simple headlines suggest. The share price recently began to move towards a valuation based on a reasonable chance of success, but as is often the case with AIM, the share price had increased into the Science Day with the shares then ‘sold on the news’. So the share price is currently in the hands of the traders as we patiently wait for trial results to highlight that the chances of success are higher than currently being attributed, especially given preCISION is a delivery platform not a new drug.
Valuation assumptions: Doxorubicin generated annual sales of $1.4bn in 2022. If AVA6000 is better than standard Dox it should become the standard of care ‘overnight’ and take 100% of the market, and even more, extend the market as treatment will be available to more patients than could not tolerate standard Dox. To be conservative we assume that AVA6000 captures just 75% of the current market and apply a 6x multiplier to the revenue to reflect a discounted patent lifetime and manufacturing costs. Given the already ‘blue sky’ valuation this implies we assume no value at all for the rest of the preCISION platform or diagnostics. For a risk price we simply assume zero for maximum conservatism in the margin of safety price, assuming all platforms fail.
Another baffling valuation based on the Songwe Hill asset alone, let alone the value of its 42% stake in HyProMag (via its Maginito subsidiary) which is building rare earth recycling plants based on proprietary technology. Songwe Hill, as an ex China source of rare earth metals is a strategically important asset and the current market cap of c.£30m reflects just 6% of the $559m NPV, completing excluding any value from the Pulawy separation plant whose definitive feasibility study is still ongoing. While the environmental permit for Songwe was received in Jan-23, the ongoing delay to the mining licence issuance has investors on edge and the company required a modest £3.5m fundraising at 12.5p in Feb-23 to fund ongoing projects, despite CoTec effectively providing funding at 27p. CoTec are also increasingly vocal about the value they see in Maginito (where they have invested £1.5m for a 10% stake) and are planning 3 new North American plants in addition to the UK and German plants currently underway (with €3.7m of grant funding in Germany). Indeed, the CEO of CoTec recently stated in an interview that each plant had a capex requirement of $15m for an NPV of $80m – pretty decent returns. There are increasing market expectations that the Songwe Hill asset will be sold once the mining agreement is finalised in order to focus investment on the recycling opportunities. Given the amount going on at MKA, this recent presentation provides a good summary and useful background.
Valuation assumptions: We assume that if Songwe is sold to another operator to develop we might achieve a valuation of 15% of the $559m NPV. We then add the value of the company’s 90% stake in Maginito implied by CoTec’s recent investment of £1.5m for 10%. In the risk scenario, we assume just 5% of the Songwe NPV.
I have rarely seen a CEO so confident in their convictions and the future direction of their business. In many cases, such confidence can be a sign of trouble ahead and an attempt to mask underlying underperformance. In this case, however, he is delivering (even over-delivering) against his targets having shown exemplary behaviour over the past 18 months to sacrifice short term revenue and the share price for long term value creation. For those that haven’t already, I encourage you to watch some of the videos posted in the discussion boards alongside the news release. We are excited to see in detail what the new micro-betting B2B product will be, but in the meantime this idea is completely off the radar of the market. It has tiny volumes traded daily and its market cap of C$10m is barely above its cash balance of C$9m (as at end Sep-22), despite it being on track to breakeven in the coming months ahead of a potentially transformational new product launch.
Valuation assumptions: In the 9 months to Sep-22 the company has expenses of C$1.96m, which equates to C$2.6m on an annualised basis. With the company expecting to breakeven on a monthly basis in H2 23 and given its rate of top line growth, it doesn’t feel unreasonable to assume that the business can easily scale to C$2.5m EBIT or C$1.5m in a risk scenario in fairly short order. We apply multiples of 12x and 8x in the thesis and risk scenarios respectively. We of course believe that the company has the potential to greatly exceed these numbers, but even at these levels we highlight how absurd we think the current valuation is if you believe in the business model and the management team.
A more recent addition to the watchlist and they held a capital markets day in Feb-23 confirming our initial investment thesis. We await news on progress and additional information in order to publish a full memo, but with the company trading on <4x 2023E EBIT with new US states coming online this year, we believe there is a good margin of safety in this turnaround story.
Valuation assumptions: The market consensus is £9m EBIT for 2023 and we assume a single digit multiple of 9x for this asset light and growing business i.e. the market re-rates upon recognition that the business has successfully recovered and re-positioned itself. For the risk price we assume £8m EBIT in 2023 at an even more modest 6x multiple.
A hugely interesting concept with all the ingredients of a successful proposition, but they just don’t seem to be able to get it off the ground in a visible timeframe. The business update in Jan-23 was so lengthy and incoherent, lacking a focused proposition, that it led us to remove the idea from the watchlist. We note, however, that during its time of the watchlist the company reached a share price of 14.8p (and intra-day even higher), a 111% premium to the publication price, highlighting how there is clearly money to made in short term trading if you have the time and ability. We will, of course, continue to monitor this idea in the case that it does start to make the progress that we originally hypothesised.
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