DSM: Half-year report
*Downing Strategic Micro-Cap Investment Trust plc*
*LEI Code: 213800QMYPUW4POFFX69*
*1 November 2022*
*Half-Yearly Financial Report for the six months ended 31 August 2022*
*Downing Strategic Micro-Cap Investment Trust plc** (“Company”)*
*Hunting value, enabling transformation*
*Half-Yearly Financial Report for the six months ended 31 August 2022*
The investment objective of the Company is to generate capital growth for shareholders over the long term from active involvement in a focused portfolio of UK micro-cap companies (those whose market capitalisations are under £150 million at the time of investment) targeting a compound return of 15% per annum over the long term.
The Directors of Downing Strategic Micro-Cap Investment Trust plc announce the company's results for the half year ended 31 August 2022.
*Key points*
► NAV per share of 79.68p, reflecting a decline of 6.73% since 28 February 2022. As has been well documented, world indices, in particular in the UK, have fallen heavily in that period. The FTSE AIM All Share TR declined by 14.56% over the 6 months to 31 August 2022;
► Over the six months to 31 August 2022, the share price discount has increased from 14.84% to 23.7%;
► Values of the quoted equity positions stand at a c.60% discount to consensus valuations in analysts’ reports;
► The portfolio continued to be actively managed in the period, with realisations being made alongside investments in 2 new positions;
► Strategic initiatives continued to help influence performance of the maturing portfolio;
► The investments within the portfolio are well financed for recession; and
► Cash of c.14% of the portfolio will allow the Manager to be opportunistic in challenging markets.
Judith MacKenzie, the lead manager, said:
“This portfolio of well-run, niche, smaller companies are well equipped to weather what will inevitably be a continued period of volatility. Moreover, they have strategic catalysts to deploy which should mean that their nimbleness and flexibility should help to mitigate against headwinds. As Managers, we will be opportunistic in challenging markets, and will use cash to buy and top up positions in companies we know at miss-priced share prices.”
Financial highlights *(Unaudited)* *(Audited)* *Six months ended* *Year ended* *31 August* *2**8** February* *Change*
*Assets* *202**2* *20**2**2* *%*
Net assets (£’000) *39,460* 43,059 (8.36%)
Net asset value (‘NAV’) per Ordinary Share *79.68**p* 85.43p (6.73%)
Mid-market price per Ordinary Share *60.80**p* 72.75p (16.43%)
Discount *23.**70**%* 14.84%
*Revenue*
Revenue return per Ordinary Share *0.47**p * 0.42p
Capital return per Ordinary Share *(6.17**p**)* 4.29p
Total return per Ordinary Share *(5.70**p**)* 4.71p
Ordinary shares admitted to trading on 9 May 2017 at 100p per ordinary share. Starting NAV of 98.04p per ordinary share.
*Chairman’s Statement*
*Overview*
In the six months to 31 August 2022 the FTSE AIM All Share TR was down 14.6%; your company’s NAV had declined by 6.73%. In the volatile year to 31 August 2022 the FTSE AIM All Share TR was down nearly 31% whilst DSM’s NAV had declined by 15%. That at least indicated your company’s comparative strength. Through to the end of this reporting period the DSM portfolio was, broadly speaking, level best in its competitor group. That is evidence as to why a concentrated and actively managed portfolio, with defensive characteristics, works in difficult times even when equity, particularly UK equity, is out of favour.
The further chaos of September and October has been difficult for everybody but at least DSM’s NAV has fallen less than its more growth orientated peers and has been better than its peer group. Much of its portfolio comprises well financed companies, virtually all cheap in themselves. Investment through DSM has an added advantage because regrettably, despite a comparably respectable NAV performance, DSM’s share price discount to NAV has widened significantly from 14.8% on 28 February 2022 to 23.7% by 31 August 2022 and it is around 25% at the time of writing. That is an undervalued share price. Your board is very alert to that discount and shareholder interest is a topic later in this statement.
*The portfolio*
The manager’s report takes you through the detail of this value portfolio which is suited to these difficult times and gets close manager engagement. The portfolio itself currently holds 14.6% in cash. At the interim assessment the median EV/EBITDA of the portfolio as a whole was 6.9 (against 11.5 for the Microcap universe). In a former note by Kepler, quoting work by the managers, the portfolio was at a 40-50% discount to assessed intrinsic value and currently the upside implied by the consensus of analysts’ target prices to the actual share prices of those quoted constituents covered, taken as a whole, is of the order of 60%. Take whatever view you will of market analysts, the portfolio has considerable embedded value. Added to that, there is a double discount created by DSM’s own discount to NAV. So there is a potentially large upside for shareholders. Embedded value should also provide opportunities across the portfolio for M&A (and a decline in sterling may add attraction to overseas acquirers). For shareholders the appeal lies with good companies well below target prices and your company’s discount to close – which it ought to with a redemption point ahead.
Shareholders can also feel some contentment in holding shares reflecting a portfolio of well-run small companies contributing to some key aspects of the UK.
*Shareholders’ interests*
As set out in my May statement for the 28 February 2022 year end, your board has introduced a 50% share redemption point in May 2024. That alone should be attractive to new shareholders given a comparatively well performing portfolio and share discounts currently around 25%. Although that discount widened from circa 15% at the end of FY 2022 and during the volatile and disrupted markets of late summer, we did not buy back shares. It is always a difficult judgment, but there are times when there are significant market shifts, investment company discounts widen generally, and when in terrible markets buybacks just have to be shelved. We have started modest buybacks again picking up loose stock in October, but fingers remain crossed as to whether markets are settling, buyers return, and we can help reduce the discount again.
*Presenting the company*
What shareholders will soon see, through a new website and shareholder contact, is a refreshment of how we present DSM. That is going to be not just a much better website, but with new presentations and videos, research material, more direct contact with shareholders and improved ways in which shareholders can register for the managers’ excellent investor letters and video question-and-answer sessions. There will be much more opportunity for interaction with shareholders.
I shall shortly be contacting as many shareholders as we can and if you have not already done so, I would urge shareholders to respond to that by registering on the DSM website to receive at least the six-monthly, in-depth investor letters (or email downingfundmanagers@downing.co.uk to request to be added to the distribution). The 31 August 2022 investor letter from the managers in part focused on how the managers assess risk in these tense times, as well as reviewing the leading investments.
*New brokers*
Despite a good relationship with Shore Capital, who get my best wishes, we decided to move, after five years, to finnCap who are particularly active amongst microcaps. Their research notes on DSM are now available on our current website and will be on the new website. They are informative. Kepler’s analyses are also readily available and will be on our website.
*Looking forward*
The world is going through immense disruption. The UK is hopefully recovering from some disorder. A possibly laudable intention to shake up a tired economic model has been abandoned; financing that much intended change was just not available at going rates. For that and other reasons over recent years there has been damage which will endure, and repairing the UK’s tired model, may take time. A resumption of abstinence, if not austerity, looks likely; and that’s not helpful for the country’s immediate growth prospects, or for its social and healthcare infrastructure. Can decline be avoided without much more confidence and without too much calling on ‘the kindness of strangers’? This country needs further funding and economic growth to fuel investment. An important part of that investment should be in good, well-managed, vigorous small companies that meet national necessity and growth. Your company’s portfolio matches that descriptor across important sectors. Even in troubled times it has proved resilient (hence the better performance against the market). It remains a portfolio for the future. As for funding the wider needs of the UK’s economic and social infrastructure, let’s hope for a return to stability and confidence.
In the immediate future I invite you to register for the finnCap webinar with the managers on 8 November 2022 and for the Investor Meet Company video and Q&A session with the manager on 10 November 2022 on the IMC platform to see the managers’ latest views on what the portfolio is achieving, company by company, and join in the Q&A sessions. That should enlighten this portfolio of captured value in companies undergoing transformation.
As always, my thanks go to board colleagues, to the managers, Judith MacKenzie and Nick Hawthorn, and to the admin, CoSec and support team.
*Hugh Aldous*
Chairman
1 November 2022
*Investment Manager’s Report*
*(Written **26 **October 2022)*
I wouldn’t normally be specific about the date that this report was written, but the fast-moving geopolitical dramas of 2022 dates narrative with surprising haste. Therefore, it seemed relevant to allow the reader to understand the context of our thoughts against what was happening at this time, acknowledging it will be very different in even a few days. This is counter-intuitive for us, as long-term investors. A recent conversation with a fellow investor raised the question “If the stock market was to shut tomorrow for two years, and you had a choice of companies to hold – what would you hold?”. It’s a good test of conviction in a portfolio, but also a sound lesson in ignoring the news and the politics. It was easy for me to reach the conclusion that I would hold the DSM portfolio. While quietly acknowledging to myself that it would be a pleasure not to have the volatility of herd-like market behavior bounce the valuations around on a daily basis. But it is that volatility which also provides opportunities! In short, we have a portfolio that we would like to hold for the longer-term as they are companies with relevance, competitive strength and an ability to drive their own catalysts. We will use market volatility to pick up stock when we believe that stocks are being mispriced. And we will ignore the background noise.
Concentrating on what you know, without having to guess the minds and motivations of a government-led economy, is cathartic. We know there is a recession looming (I suspect we are in it), we know it’s going to be horrible for the consumer, we know about energy prices, we know world debt levels are too high, we know it’s not going to be the short sharp recovery that some had hoped for.
We believe therefore that investing in companies that have their own clear catalysts for value creation, with unburdened balance sheets and a clear moat, builds a defensible portfolio in these times. We also believe that buying value means you should mitigate some of the trauma from multiple compression, allowing us to be fixated on the earnings element within our investments. Being realistic, we think flatlining earnings will be a good outcome over the next year or so. We are not searching for super-heroes. We aim to have created a portfolio of companies with sustainable business models, their own catalysts to deploy, that have been acquired at sensible multiples of earnings. History would tell you it’s these smaller companies that can rebound quicker once the environment returns to stability.
As we said in our August investor letter, we continue to focus on margins, balance sheets, the ability to pass on inflationary input costs and self-help catalysts. We update this with a focus on the main contributors and detractors of the last six months.
*Activity in **the p**eriod*
This was an active period for the Trust. £1.9m was deployed in the six months in three new positions whilst we added to three existing positions. In the period, £4.3m was realised from five portfolio positions, realising a gain of £988k.
This included a £1.6m sale of Volex Plc, realising a gain of £1.0m. Profits were also taken in Ramsdens Holdings plc where the position was modestly trimmed, realising £1.4m and a gain of £197k. Meanwhile, gains were also taken in Hargreaves Services Plc, allowing a gain of £229k to be taken on a realisation of £648k. The one detractor from the realisation gains was Venture Life Group Plc, which we began selling during the period due to a lack of confidence in management. We took advantage of a rise in the share price over the period and post the period end the position was sold in full, generating proceeds of £662k, crystalising a loss over market value brought forward of £189k, which resulted in a loss over cost of £1.1m.
Post the period end, a provision of £1.0m was recognised against the investment in Real Good Food plc, reflecting the continued challenging trading due to macro headwinds and the requirement for funding of up to £2.5m in order to fund initiatives to create a more sustainable business for the longer term. Through our board seat, we continue to monitor this position closely in light of current trading.
The main movers in the period are highlighted below:
*Portfolio Gainers*
*Equals Group Plc* +£378k unrealised gain (or 30.2% rise in share price). This reflected continued strong trading through new customer acquisition, which led analysts to upgrade forecasts in the period. Their first half revenues were up 86% to £31.1m, in line with guidance. They should therefore be on track to deliver over £10m of EBITDA on £64m of sales. Transaction values on the FX platform grew from £1,091 in Q1 2021 to £2,189 in Q2 2022. In the quarter to September 2022 this growth has continued with revenue for the period of £13.3m, a 55% increase on the same period last year. Trading momentum is strong, and we believe that there is some possibility of upgrades, however we will be very happy with the company making its forecasts.
*Ramsdens **Holdings plc *+187k unrealised gain in the period (or 14.0% rise in the share price). This reflected the confidence, which was subsequently played out, in the foreign exchange trading improving since Covid. Since the period end, the company announced a positive trading update, with FX back to pre-pandemic levels. Meanwhile, although we are cautious over an extrapolation for 2023 of the positive jewellery performance in the current year, which is up around 40% to £26m revenue, we have to acknowledge that the work that management have done on this side of the online solution has yielded direct results. Demand for pawnbroking loans grew during the year. The loan book had increased by over 40% to £8.6m (FY21: £6.1m), which is above the pre-pandemic loan book of £7.7m at 31 March 2020. Precious metal buying volumes increased throughout the summer, aided by the high gold price and increased footfall. Revenue was up more than 50% to approximately £16.0m (FY21: £10.3M), returning to pre-pandemic levels. We believe that this is a well-run, defensive business that should be resilient during the coming 12 months, whilst improved by ‘self’ help measures to improve efficiencies to target the online target markets.
*Centaur Media* +£134k unrealised gain (or 4.5% rise in share price). This reflected our belief that this multi-faceted media and IP business has a greater valuation than that of its constituent parts. In simple terms there is value in the separate businesses (‘Econsultancy’, Influencer Intelligence’, ‘MW Mini MBA’ and ‘The Lawyer’). The first stage in that value realisation is the growth to 23% EBITDA margins by 2023. That deadline is now in sight and the company is on track to achieve these margins, meaning that the likelihood of a double-digit free cash flow yield is eminently achievable. The recent interims showed growth across the four key brands mentioned above, of 11%. In line with Centaur's strategy, the higher quality revenue streams of premium content, marketing services and training and advisory now represent 78% of group revenue. It has had a really well-defined self-help plan that it put in place a couple of years ago to get to 23% EBITDA margins noted above by 2023. And it’s more than likely to do that – that translates into a 16% FCF yield, complimented by £14.2m on the balance sheet.
*Portfolio Detractors*
*Volex plc *-£1.2m unrealised loss in the period, (share price down -7.4%). The investment contributed negatively as the market ascribed a lower multiple to its earnings, which otherwise grew strongly in the period. This de-rating was more severe than other comparable companies which we think is unwarranted given the quality and structural growth drivers of the Group. The market has likely been focusing on potential margin compression and declining consumer revenues. However, we think that with supply and input cost pressures now easing, margins hopefully have troughed. The consumer business may be hit by weaker like-for-like customer revenues, but given its pricing advantage, we see this as an opportunity to win a share from new customers. There remain compelling revenue growth drivers in electric vehicles and datacentres which we do not believe are priced by the market.
*DigitalBox** Plc* -£811k unrealised loss in the period, (share price down -22.6%). This reflected the general market sentiment and derating of media and advertising companies generally and was not pertaining to any fundamental trading at DigitalBox. As we mentioned in our August Investor Letter, DigitalBox is exposed to consumer driven ad-revenues. Advertising budgets tend to be viewed as discretionary and when consumers stop spending, businesses reduce their ad spend to reduce costs. However, we think that the company’s digital only and mobile optimised model is an attractive place to be. Yields matter too and spend will always be channelled towards content which demonstrates a good return. Digitalbox demonstrates very strong yields indicating that they produce in-demand content. The business had a record first half, delivering £1.9m of revenue versus £4.1m for consensus this year, which looks achievable considering that revenues are traditionally second half weighted. We are similarly positive on cash flow and think that net cash could end the year at over £3m, versus a current market cap of only £12m.
*National World plc *-£805k unrealised loss in the period, (share price down -36.5%). National World has been affected by weaker sentiment towards publishing businesses. Regardless, the business performed admirably through the period, generating almost 70% of its consensus EBITDA for the full year. We think there remains considerable scope for cost savings across the business as the management team continue modernising the print business. The business has around 50% of its market cap in net cash, which provides a significant amount of confidence through these more uncertain times.
*Strategic initiatives undertaken in the period*
A lot of what we do goes on behind closed doors and is not appropriate to attribute to companies directly. What we can say is that we have been active and busy across the portfolio including;
► Engaging with boards and management teams re potential for strategic exits over the coming months to maximise outcomes for all stakeholders;
► Undertaking interviews for new board appointments;
► Engaging on ESG issues with boards and management;
► Attending board meetings of investee companies as a board member and as observers;
► Assessing the opportunity for merger and acquisition activity in specific investments;
► Engaging with Remuneration Committees re salary levels and Long-Term Incentive Plans;
► Discussing the wider market with merger and acquisition advisers, specifically what the sentiment of private equity is, and where international companies are looking to consolidate or enter into the UK.
*Outlook*
As I said at the start, we will continue to focus on a portfolio that we are comfortable with for turbulent times. We will ignore the background noise – we know this is going to be one of the most challenging macro-economic environments for at least a decade. We will also pick up stock in companies we know well at discounted prices when the markets are irrational. We are long term investors, and this will be a time to be opportunistic and buy some quality companies who will appreciate steadfast shareholders to work through the coming turbulence. Our ability to engage and facilitate catalysts in our portfolio has, in past experience and cycles, managed to yield non-index correlated returns, and we would expect that to continue to be the case.
*Judith MacKenzie*
Head of Downing Fund Managers and Partner of Downing LLP
1 November 2022
*Investments*
As at 31 August 2022
*As at*
*31 August*
*202**2* *As at*
*2**8** February*
*202**2* *Market *
*Value*
*(£’000)* *% **of*
*Total *
*Assets* *% **of*
*Total *
*Assets*
Real Good Food 10% Loan Notes^1 3,284 8.32 6.19
Flowtech Fluidpower plc 3,273 8.29 7.92
Hargreaves Services plc 3,266 8.28 10.09
Centaur Media plc 2,948 7.47 6.54
Fireangel Safety Technology plc 2,505 6.35 6.28
Volex plc 2,470 6.26 9.98
Ramsdens Holdings plc 2,366 6.00 7.80
Digitalbox plc 2,299 5.83 7.39
Synectics plc 2,152 5.45 4.91
Real Good Food 12% Loan Notes^1 1,829 4.64 4.08
Adept Technology Group plc 1,666 4.22 5.16
Tactus Holdings Limited^2 1,633 4.14 3.79
Equals Group plc 1,620 4.11 2.88
National World plc 1,484 3.76 4.97
TheWorks.co.uk plc 566 1.43 -
Norman Broadbent plc 297 0.75 1.23
Venture Life Group plc 269 0.68 1.98
Norman Broadbent 10% Loan Notes^1 205 0.52 -
Real Good Food plc 120 0.30 0.40
Other 251 0.64 -
*Total investments* *34,503* *87.4**4* *9**1.59*
Cash 5,007 12.69 8.82
Other net current assets (50) (0.13) (0.41)
*Total assets* *39,460* *100.00* *100.00*
1 Unquoted. Stated inclusive of the fair value of unpaid interest income.
2 Unquoted equity.
All investments are in Ordinary Shares and traded on AIM unless indicated. As at 31 August 2022, DSM held investments in 17 companies (28 February 2022: 15). Details of the equity interests comprising more than 3% of any company's share capital are set out below.
As at 31 August 2022, loan note principal represented 9.37% (28 February 2022: 7.29%) of total assets and the total of loan note principal and interest represented 13.48% (28 February 2022: 10.27%).
The table above includes net current assets of £4,957,000 (28 February 2022: £3,618,000) that are also disclosed in the Statement of Financial position.
*Background to the investments*
(unless otherwise stated, all information provided as at 31 August 2022)
*AdEPT Technology Group PLC (AdEPT) (**4.22**% of net assets) *
*Cost: £**3.83**m. Value as at **31* *August** 202**2**, £**1.67**m*
*Background*
AdEPT is one of the UK's leading independent providers of managed services for IT, unified communications, connectivity, and voice solutions. AdEPT's tailored services are used by thousands of customers across the UK and are brought together through the strategic relationships with tier-1 suppliers such as Openreach, Vodafone, Virgin Media, Avaya, Microsoft, Dell, and Apple.
AdEPT functions as an aggregator of telecoms services providing a smoother, integrated service to corporate and government organisations. We were attracted by the high operational gearing and recurring revenue streams at attractive margins. Communications and technology have converged over recent years and that is only set to accelerate into the future, and AdEPT is well placed to benefit from this trend.
*Update to the investment case*
► *Cash generation in line with management expectations*
► *Commitment to de-gear through continued focus on cash generation*
► *Secured several important new contract wins and renewals*
► *Share price does not reflect the quality of recurring earnings*
► *Reinstated the dividend*
*Progress against investment case*
AdEPT issued a trading statement in September 2022 which reported that cash generation for the year to date is in line with management expectations and the group is making progress on its strategy to strengthen the balance sheet.
The quality of earnings is reflected in recurring revenues from a customer base that includes local government, education and SME. We have been frustrated with the malaise in the share price that does not reflect the quality of these earnings. Deals in the sector have been executed on 10-14x EBITDA whilst this business lingers around 6x EV/ EBITDA for the current year. We feel that this is probably due to the gearing within the business which was year-end net senior debt of £29.4 million after payment of the initial consideration for the Datrix acquisition. However, AdEPT generates strong cash conversion – 108% of EBITDA turned into cash last year – and has historically done so, enabling a pathway to de-gear the business over the medium term. Showing confidence in this cashflow, the company reinstated a modest dividend at 1p per share.
Organic growth has also been challenging to demonstrate. However, with the declining fixed line business now less than 10% of revenues, this will become less of an issue. A commitment to reduce debt whilst stopping any M&A activity will allow the company to prove the quality of its earnings and cash generation from its existing asset base.
*Centaur Media PLC (Centaur) (7.47% of net assets)*
*Cost: £3.58m Value as at 31 August 2022, £2.95m*
*Background*
Centaur Media is an international provider of business information, training and consultancy, creating value through premium content, analytics and market insight within the Marketing and Legal segments. Centaur operates under several flagship brands, namely The Lawyer, MW Mini MBA, Influencer Intelligence and Econsultancy, with the latter three brands forming part of their marketing arm, XEIM.
*Update to the investment case*
► *Value in the Flagship 4 brands which are the key drivers of organic growth*
► *Double-digit free cash flow yield is eminently achievable*
► *Higher quality revenue streams now represent 78% of group revenue*
► *Spend in the sector tends to be volatile in recessions*
► *Net cash balance of over £14 million*
*Progress against investment case*
Centaur is a multi-faceted media and IP business that we believe has a greater valuation than that of its constituent parts. There is value in the Flagship 4 brands which management consider to be the key drivers of organic growth: (‘Econsultancy’, Influencer Intelligence’, ‘MW Mini MBA’ and ‘The Lawyer’). The first stage in that value realisation is the group’s Margin Acceleration Plan which aims to raise adjusted EBITDA margin the growth to 23% and increase revenue to more than £45m by 2023. The company is on track to achieve these margins, meaning that the likelihood of a double-digit free cash flow yield is eminently achievable. The recent interims showed growth across the Flagship 4 key brands of 11%. In line with the group’s strategy, the higher quality revenue streams of premium content, marketing services and training and advisory now represent 78% of group revenue.
Advertising and marketing spend tends to be volatile in recessions. We believe that there is some defensiveness as revenues tend to be resilient as clients tend to choose Centaur for strategic, long-term spend, to protect their businesses. This is evidenced in the company being able to implement structured customer price rises to help mitigate the inflationary environment.
Centaur continues to maintain a healthy net cash balance of over £14 million. Cost controls have been maintained through clear operational and financial steps taken to reinforce the resilience of the business, such as strong negotiation with suppliers and flexible reward structures to retain and recruit top talent. We expect to see the continuation towards the 23% margin accretion in the full year results, along with the benefits of operational gearing and the possibility of corporate activity, from a shareholder list that welcomes and drives such activity.
*Digitalbox PLC (Digitalbox) (5.83% of net assets)*
*Cost: £1.13m. Value as at 31 August 2022, £2.30m*
*Background*
Digitalbox is a 'pure-play' digital media business with the aim of profitable publishing at scale on mobile platforms. The business generates revenue from the sale of advertising in and around the content it publishes. Its optimisation for mobile enables it to achieve revenues per session significantly ahead of market norms for publishers on mobile.
*Update to the investment case*
► *Increased advertiser demand for high-quality audiences on mobile*
► *Consistent earnings upgrades*
► *Strong and attractive inventory*
► *Management incentivised and have ‘skin in the game’*
► *Cash available to complete value enhancing acquisitions*
*Progress against investment case*
The group’s most recently published results for the first six months of 2022 highlighted increased advertiser demand for high-quality audiences on mobile continues to fuel session values. Entertainment Daily session traffic was up 46% and The Tab up 57% in the period.
The group successfully generated earnings upgrades through the year, particularly in Q4, aided by the strong digital ad market. The group’s strong performance has not all been market driven and management deserves credit for building a scalable operating platform and for investing in content that has considerable value. Digitalbox’s inventory remains hot property and this is reflected in market-beating yields.
*Equals Group PLC (Equals) (4.11% of net assets)*
*Cost: £1.19m. Value as at 31 August 2022, £1.62m*
*Background*
Equals Group is a technology-led international payments group augmented by highly personalised service for the payment needs of SME's, whether these be FX, card payments or via Faster Payments. Founded in 2007, the group listed on AIM in 2014 and currently employs around 265 staff across sites in London and Chester.
*Update to the investment case*
► *Significant revenue growth*
► *Record adjusted EBITDA*
► *Return to statutory profit*
► *Strong balance sheet *
*Progress against investment case*
Equals issued strong results for the six months ended 30 June 2022, and a positive update on Q3 trading. Management reported record revenue and EBITDA, cementing a successful transition into cash generation and, ultimately, a return to the first statutory profit since 2018.
The business has embarked on a three-year investment cycle into platform, connectivity and compliance which, alongside an operational pivot towards corporate customers, has enabled the business to go from strength to strength.
After a strong H1, trading in Q3-2022 has continued to be robust, despite global economic uncertainty and inflationary pressures, with strong growth over the same period last year. There continues to be an increase in fee-based revenues to complement the group’s transactional and FX revenues, which is part of the overall strategy for diversifying and de-risking earnings streams.
*FireAngel Safety Technology Group PLC (FireAngel) (6.35% of net assets) *
*Cost: £5.73m. Value as at 31 August 2022, £2.51m*
*Background*
FireAngel designs, sells and markets smoke detectors, carbon monoxide detectors and home safety products under the FireAngel, FireAngel Pro, FireAngel Connect, AngelEye and SONA brands.
We were attracted to FireAngel because of its dominant share of the UK fire safety market, with products that are endorsed throughout Europe. We also saw an opportunity from changing legislation that we believe FireAngel will benefit from. Legislative guidance is for the purchase of smoke alarms with a 7– 10-year lifespan, and we are already beginning to see a replacement cycle on the installed base in more mature markets.
*Update to the investment case*
► *Revenue ahead of the board’s expectations*
► *Macro supply issues restricted a much-improved performance*
► *Significant progress on development of a new generation smoke alarm*
► *Post the Trust’s period end, the board cautioned on the full year expectations due to macro influences**Progress against investment case*
FireAngel’s latest interim results for the six months ended 30 June 2022 reported revenue up 15% to £25.6 million which was ahead of the board's expectations. Despite a backdrop of macro supply issues which restricted a much-improved performance from the group, both half year revenue and underlying gross profit were the highest since H1 2017. Additional highlights in the period included sales of 1.4 million units as supply constraints eased, up 40% from 1 million units in Q1 2022, which was the highest volume per quarter since Q4 2019, and international sales, up 55% to £8.4 million.
FireAngel had some ‘self-help’ measures to implement which has allowed it to improve margins despite the headwinds. Gross margins in the quieter H1 were 21.9%, and these were achieved despite low availability of higher margin products and strong input price pressures. Planned mitigations against inflation and volatile input prices began to improve performance from mid-Q2 2022 and the company delivered gross margin of c.26% in the six months to the 30 June 2022, leaving it well positioned for the historically stronger second half of the year. At the end of the reporting period, the group had £0.7 million of cash and £4.5 million of debt, whilst the undrawn Inventory Discount Finance (IDF) facility had capacity of £4.1 million. Since the period end, FireAngel have announced that they will not meet market expectations for the full year, as the effect of currency headwinds combined with input pricing overrode the benefit of the margin improvement initiatives. Although this was disappointing, we see that this can be mitigated by hedging, and continued push through of price increases.
FireAngel has made significant progress with its project to develop a new generation smoke alarm alongside its German partner, Techem. This is a paid-for project that will yield some exciting international opportunities in the coming year. It is pleasing to see that despite some very challenging headwinds, management actions have continued to allow the company to make operational and financial progress.
*Flowtech Fluidpower PLC (Flowtech) (**8.29**% of net assets) *
*Cost: £**2.60**m. Value as at **31* *August** 202**2**, £**3.27**m*
*Background*
Flowtech is a value‐added distributor of hydraulic and pneumatic consumables into a wide array of sectors predominantly in the UK and Ireland. The group is a leading UK player in this space, with pre‐Covid revenues of over £110 million, and it sits between much larger global manufacturers and a highly fragmented and localised cohort of smaller distributors. The company’s high service levels, broad stock offering and exposure to maintenance, repair and overhaul markets were key attractions, and these attributes facilitate Flowtech’s relatively high gross margins of over 35%.
*Update to the investment case*
► *Solid trading performance in H1 2022*
► *Re-structuring should provide a more scalable operating cost base*
► *Post-Covid revenue recovery has played out as expected*
► *Evidence that the group is taking share from peers*
► *Net debt increased to almost £20 million to fund inventory investment*
► *Expected to unwind somewhat in H2*
*Progress against investment case*
Flowtech achieved a solid trading performance in H1 2022, with revenue up 4.8%, improvement on gross margin to 36.3%, and underlying EBIT at £4.3 million. Management reported that inflationary pressures were offset by cost savings and productivity improvements.
Flowtech has been a post-Covid recovery play, and this has played through in revenue terms. The business is now investing in its e-commerce platform which will allow it to better target existing customers and open up new revenue opportunities. From a margin perspective, we think that there are gross margin tailwinds, and the effects of the ongoing re-structuring should provide a more scalable operating cost base which can deliver improved drop through on revenue growth. While the net effect of these will be diluted by higher operating costs, we still believe that the effect will be accretive to margins overall.
Cash flow is likely to be weaker this year as the business has had to re-invest in inventories post-Covid. At the interim period, net debt had increased to almost £20 million, from £15.4 million at the full year. Inventory levels increased by £11 million over the twelve-month period. This has reduced headroom to just over £5 million which may ordinarily be concerning as we would expect working capital to continue to expand as the business grows. However, we expect the opposite here since the crux of the opportunity is for management to begin improving the cash flow profile of the group by improving inventory turnover. If trading conditions were to deteriorate materially, management can take rapid action to improve headroom by slowing or stopping re-investment. We saw this through Covid where the business generated an accounting loss but over £10 million of positive operating cash flow. The banking facilities were recently renegotiated and therefore do not present a current refinance risk for the business.
Management has a job to demonstrate reasonable top line growth combined with improving margins and payback from e-commerce investment. Working capital efficiencies should be well within their grasp to execute once trading conditions normalise. We remain confident and view the equity as significantly mispriced.
*Hargreaves Services PLC (Hargreaves) (**8.28**% of net assets) *
*Cost: £**2.65**m. Value as at **31* *August** 202**2**, £**3.27**m*
*Background*
Hargreaves is a diversified group delivering key projects and services to the industrial and property sectors. The Distribution and Services division aims to generate sustainable profitability through operations across the energy and infrastructure sectors in the UK, Europe and Asia. The Property and Land division aims to generate value through the development and/ or disposal of the companies’ significant land bank which includes planning for residential, logistics and industrial space.
*Update to the investment case*
► *Strong FY results*
► *Expect divisional margins to be robust*
► *Strong balance sheet*
► *Potential reduction in trading opportunities in the German commodity business*
► *Numerous strategic catalysts available to unlock value*
*Progress against investment case*
Hargreaves reported strong results for the year ended 31 May 2022 and has developed a strong platform from which to create value for shareholders. Revenues in Hargreaves Land are predominantly earned from developers of housing, commercial and industrial space. In our view, the structural demand drivers for space are well documented and relatively certain. Moreover, Hargreaves is not flooding the market with land from its landbank – the release of phases at Blindwells will be slow and steady. Pricing should improve, both as the estate becomes more established, increasing prices for later phases, but also with general inflation. In Hargreaves Services, there are contractual mechanisms in place to pass through inflationary costs. Management has navigated onerous contracts in the past and have been careful to avoid these issues in the future. For this reason, we also expect that divisional margins should be robust.
There are a few moving parts in cash this year, particularly with the deployment of Services assets onto HS2 and the lockup of significant levels of working capital in the German associate. The group is free from any bank debt and held net cash of almost £14 million at the year end. In addition, there was an outstanding loan to the associate for £15 million, of which £12 million had been repaid post year end which should be added to that cash balance.
We think that there are two scenarios which could play out from here. Firstly, trading opportunities in the German commodity business could become less plentiful, driven by lower and less volatile commodity prices. This would require less cash in that business and hopefully mean that excess cash could be returned to Hargreaves and passed through to shareholders. Or secondly, trading opportunities remain ample for the associate, and this requires elevated levels of trading collateral. Either way, it looks like consensus is wrong since analysts have forecasted a mean reversion in earnings but no return of cash. Although the timing is uncertain, a cash return for Hargreaves’ shareholders must be inevitable and given all trading is back-to-backed, relatively risk free too.
We remain positive on Hargreaves’ prospects, driven by numerous strategic catalysts to unlock value, including from the renewable asset portfolio which management expanded on at the capital markets day. There also remains plenty of opportunity for consensus to be wrong and with risk to the upside.
*National World PLC (National World) (**3.76**% of net assets) *
*Cost: £2.**62**m Value as at **31* *August** 2022, £**1.48**m*
*Background*
National World, another new addition to the portfolio, is a reverse into the regional publishing assets of the old Johnston Press, the third largest newspaper publisher in the UK. The business is highly cash generative and unencumbered by legacy assets typical of other large publishers. This leads to improved cash generation and that cash flow can be re-invested into content and a digital transition which will offer more opportunities for growth and higher margins.
*Update to the investment case*
► *Strong results in H1*
► *Increased developments to transform the business for growth whilst driving operational efficiencies*
► *Restructuring generating significant cost savings*
► *Difficult consumer environment reducing advertising demand*
*Progress against investment case*
National World’s latest results for the six months to 2 July 2022 demonstrated a strong H1 despite the uncertain economic environment. The group has invested in digital content and increased development to transform the business for growth whilst driving operational efficiencies to offset the economic headwinds. Re-skilling the workforce in producing more original content that can be monetised and increasing automation will also increase efficiency as the business transitions.
There is some caution around the second half as consumer spend and ad revenues continue to be squeezed, and newsprint and wage inflation is still high. We think that there is much more cost saving potential as the business transitions to digital and away from legacy print cost structures which could mitigate near-term revenue pressures. While there is caution over H2, in the first half the business generated 68% of the £8.7 million full year EBITDA expectation. It has £22.2 million of net cash and thus an enterprise value of around £20 million. The trading environment remains difficult with the prospect of a further slowdown in the UK economy. Despite the challenges, increased investment in the development of its portfolio of digital sites and commercial opportunities and the tight management of the cost base will support future profits and cash flow. At this stage, the board expects the business will perform in line with its expectations.
*Norman Broadbent PLC (Norman Broadbent)** (equity, loan notes and interest, **1.2**7**% of net assets) *
*Cost: £0.**62**m Value as at **31* *August** 2022** (including loan note interest)**, £0.5****m*
*Background*
Another new addition to the portfolio, Norman Broadbent (NBB) is less than 2% of DSM but Downing client funds now hold an influential stake of almost 20% of the equity. NBB offers a bespoke mix of high‐quality Search, Interim Management, Research & Insight, Assessment & Development solutions. A recognised but historically uninspiring brand, NBB has market presence but had struggled to gain scale. However, it is profitable, modestly cash generative, and provides a platform for growth. After executing a turnaround in 2017 and a return to stability, Downing and other strategic shareholders recently refreshed the Chair and CEO positions, having identified a strong ‘buy‐in’ team to take NBB to the next level of organic and inorganic growth.
*Update to the investment case*
► *Strong revenue growth and net fee income in H1*
► *Highly experienced management team with a proven track record*
► *Business well positioned for growth*
► *Director share purchase*
*Progress against investment case*
In its H1 results, Norman Broadbent reported revenue was up by 28% to £3.96 million, Net Fee Income (NFI) increased by 20% to £3.30 million and positive EBITDA of £55,000, with considerable forward momentum.
The group is also growing headcount significantly, with very high calibre individuals in key markets. Despite the challenging economic backdrop, management remains confident in the shape and position the business is now in to deliver sustainable and accelerated growth in both NFI and EBITDA in H2 2022 and beyond. Director share purchasing is also a positive sign and gives us confidence in the prospects for the group.
*Ramsdens Holdings PLC (Ramsdens) (**6.00**% of net assets) *
*Cost: £**1.90**m. Value as at **31* *August** 202**2**, £**2.37**m*
*Background*
Ramsdens is a growing, diversified, financial services provider and retailer, operating in the four core business segments of foreign currency exchange, pawnbroking loans, precious metals buying and selling and retailing of second hand and new jewellery. Ramsdens does not offer unsecured high-cost short term credit. Headquartered in Middlesbrough, the group operates from 157 owned stores within the UK and has a growing online presence.
*Update to the investment case*
► *Strong performance as trading conditions normalised*
► *Gross profit significantly improved*
► *Quality management team*
► *Strong balance sheet conservatively managed*
*Progress against investment case*
Ramsdens produced a strong performance in H1 of 2022 as trading conditions began to normalise. Profit before tax was £2.2 million compared to a £0.1 million loss in the same period the year prior. Gross revenue increased by 51%, Jewellery retail revenue was up 62%, the pawnbroking loan book at the period end was £7.5 million as customers returned to normal spending habits and required short term cash flow assistance, and foreign currency exchange improved as international travel restrictions eased, driving a significant increase in gross profit to £3.4 million.
While Ramsdens is a consumer facing business, its diversified model has proven resilient, and we expect that a tighter consumer environment will continue to drive strong business growth for the pawnbroking segment. This is also likely to be replicated in precious metals purchasing, which is growing from a relatively low base, where consumers are likely to dispose of unwanted items to boost cash flows. Jewellery retail and FX may find the operating environment tougher, but we think that there is still some recovery trade to play through here, and scope to benefit from consumers trading down.
Margins should be stable, and we think that there is upside as the business continues to benefit from operating leverage and investment into cross-selling and a more scalable e-commerce platform. We don’t expect any shocks in terms of cash flow – this is a cash generative business and investments are small and incremental. Similarly, outside of lease liabilities, the business is conservatively managed with little bank debt – of a £10 million revolving credit facility, only £1.5 million was drawn as at March, and this facility extends through to 2024, so no near-term refinance risks. Overall, we think Ramsdens is a relatively lowly priced company given the quality of management and defensiveness of the business model. We expect that it will continue to prove a solid store of value through economic uncertainty.
*Real Good Food PLC (RGD) (equity, loan notes and interest, **13.26**% of net assets) *
*Cost: £**5.17**m. Value as at **31* *August** 202**2** (including loan note interest), £**5.23**m*
*Background*
Real Good Food is a food manufacturing business specialising in cake decoration (Renshaw and Rainbow Dust Colours) in the UK, USA and Europe.
*Update to the investment case*
► *Business has gone through material turnaround*
► *High debt levels*
► *Challenging conditions for consumer facing business*
► *Efficiency measures to take out costs*
*Progress against investment case*
Real Good Food is, optically, in a tough position, operating a consumer facing business, with a discretionary product. It has a structurally low margin, high commodity, and significant (unionised) labour input, and has a high level of debt. Firstly, the debt is predominantly shareholder debt – hence, we are not dictated to on an attitude to gearing from a third party. Secondly, as the company announced for its first half, a good percentage of cost increases have been passed through the chain. Thirdly, management has been working hard to take cost out of the business.
However, it would be naive to think that these mitigating factors can override very challenging macro headwinds and we expect these to continue. This has been confirmed in a recent trading update in September which stated that operations have continued to be impacted by daily supply shortages and erratic deliveries of key ingredients. There has been hyper cost inflation; the cost of sugar has doubled, and costs overall are about 30% higher. For the first five months of the financial year to 31 August 2022, volumes were 29% down on the same period last year, and 16% lower than the pre-Covid benchmark (FY20). The group has been increasing prices and reducing costs to partially mitigate the fall in volumes but is currently incurring losses at an EBITDA level. As a result, negotiations with customers are being accelerated to address the widening gap caused by cost inflation.
The group is in advanced discussions to secure an additional £2.5 million of funding to support the restructure. Existing loan note holders have pledged £1.0 million and a new asset-backed facility of circa £7.5 million, comprising a term loan of £2.3 million and circa £5.0 million invoice discount facility, is under discussion, underpinned by robust asset security and the recovery plan.
The recovery plan is well defined and includes significant price re-sets with customers and circa £3.2 million of overhead cost savings to take the business back to profitability. Successful implementation of the plan is expected to return between £2.0 million and £4.0 million in EBITDA under current market conditions. Several price adjustments have already been agreed with major customers. Management reiterated a ‘hunker down’ attitude and we believe that those companies capable of hunkering down in challenging direct consumer facing markets will do very well on the other side. Indeed, one of RGD’s aggressive competitors has recently gone into administration, which should provide an opportunity to increase market share.
Overall, we remain positive on the company’s prospects, despite what is obviously going to be a tough demand and cost environment in the immediate future. Our economic interest lies predominately in the loan notes, and we are focused on ensuring that this value is not permanently impaired and that the business is positioned to repay these plus premiums at a later date.
*Synectics PLC (Synectics) (**5.45**% of net assets)*
*Cost: £**3.98**m. Value as at **31* *August** 202**2**, £**2.15**m*
*Background*
Synectics is a leader in the design, integration and support of advanced security and surveillance systems. The group has deep industry experience across gaming, energy, urban transport, public space and critical infrastructure projects. Its expert engineering teams work in partnership with customers to create integrated product and technology platforms, proven in the most complex and demanding operating environments.
*Update to the investment case*
► *Covid recovery reorganisation yielding positive results*
► *Latest financial results demonstrate significant turnaround in performance*
► *Strong order book*
► *New contract wins*
*Progress against investment case*
Synectics has seen the impact of its reorganization through Covid continuing to yield financial return. Over £2 million of annualised cost savings were taken out of the business, leaving a leaner, more efficient structure that is highly operationally geared. Recent interims saw a substantial profit turn-around, booking profit before tax of £0.5 million versus a loss of £0.8 million in the previous year. This was accompanied by a healthy order book (at the end of May 2022) of £29.6 million. We like how Synectics measures its order book – these are real signed orders; not pipeline orders. The cash of £4.2 million (at end of May 2022) was higher than anticipated and complements no bank debt and a £3 million undrawn facility.
New contract wins over the course of the last six months include those in the oil and gas and infrastructure markets. These are all solution-based contracts at good margins. We are confident that the business can grow from here. While a recovery in the Asian gaming market may take longer, the US is returning strongly, as is investment in oil and gas which we had written off in our original thesis. This is a business which used to generate over £80 million of revenues when the oil price was strong.
In the last few months, the company readdressed the incentive plan for management – crudely put this means that management need to reach a base EPS of 17.2p before any pay out and would receive a full incentive at 24.36p EPS (starting hurdle of 11.87p). Reading this through, we believe that a fair and modest price-earnings ratio is 12-15x for this type of company – therefore implying 292p/365p per share (before valuing cash). The current share price of around 120p is therefore significantly undervaluing the future value of the business in the eyes of the board.
*Tactus Holdings Limited** (**Tactus**) (**4.14**% of net assets)*
*Cost: £**1.00**m. Value as at **31* *August** 202**2**, £**1.63**m*
*Background*
Tactus is an unquoted UK business which supplies own- and third-party computer hardware, including laptops and notebooks and customised gaming PCs.
*Update to the investment case*
► *Executing growth strategy in education, budget IT and gaming verticals*
► *M&A strategy progressed well, bolstered by £40 million funding round*
► *Recent consumer weakness and overstocking reducing revenues and profits*
► *Sentiment weighing on consumer multiples *
► *Cost/synergies focus to maintain margin against macro headwinds*
*Progress against investment case*
Tactus’s trading has been affected by the consumer slowdown. Device sales in particular have slowed, a function of excess stock in the market and reduced consumer appetite. The B2B segment has performed well, and the management team are looking at how they can capitalise on the strong demand here. While revenues are behind expectations, margins have been robust as management are focusing on cost savings and efficiencies post several acquisitions over the course of the last twelve months. Weaker players are exiting the market, and this bodes well for Tactus’ market position over the medium and longer term as the consumer inevitably regains confidence in due course.
*TheWorks.co.uk** PLC (**WRKS**) (**1.43**% of net assets)*
*Cost: £**1.12**m. Value as at **31* *August** 202**2**, £**0.57**m*
*Background*
The Works is one of the UK's leading multi-channel value retailers of arts and crafts, stationery, toys, and books, offering customers a differentiated proposition as a value alternative to full price specialist retailers. The group operates a network of over 500 stores in the UK & Ireland and an online store.
*Update to the investment case*
► *Strong financial performance in FY22*
► *Total revenue up 46.5%*
► *Balance sheet strengthened*
► *Positive pattern of trading*
*Progress against investment case*
The Works recently reported strong underlying sales driven by solid progress against its strategic objectives, careful management of supply chain, and increased consumer demand post COVID-19. Total revenue at £264.6 million was up 46.5% compared with FY21, and two year like-for-like sales were up by 10.5%, with positive growth both online and in stores. Two-year total gross sales were up 12.7% and this performance plus improvements made throughout the year to operations and proposition helped offset the impact of external headwinds.
The group’s online performance has gradually improved, and management continue to be encouraged by store sales, which comprise the significant majority of revenue and have delivered positive LFL sales growth since June. This has all been supported by the ongoing evolution of The Works proposition, including a strong performance of its improved 'Back to School' range. The company has also reported significant growth in their books category, driven by their increased representation of front-list authors including Julia Donaldson and Richard Osman.
*Venture Life Group PLC (Venture Life) (1.98% of net assets)*
*Cost: £**0.80**m. Value as at **31* *August** 2022, £0.**2**7**m*
*Background*
Venture Life is a leader in developing, manufacturing and commercialising products for the self‐care market, which we have followed for some time through our ownership in other funds. We think the business has reached an interesting juncture with significant growth prospects.
*Update to the investment case*
► Strong revenue growth
► Momentum building post acquisitions
► Post period end trading in line with management expectations
► Supply chain challenges continued in 2022
► Concerns over governance led to exit
*Progress against investment case*
Venture Life issued results for the six months ended 30 June 2022 and reported strong trading figures. The group reported that the acquisitions made in 2021 are now fully integrated into the business and have delivered growth as expected in the first half of the year and have contributed to improved gross margin percentage. Whilst operating cash conversion (before working capital movements) has been high, management has continued to invest in inventory to ensure it can supply customers. The supply chain challenges experienced in 2021 have continued into 2022, in terms of both cost and availability, particularly impacted by the significant increase in energy prices. That said, price increases put through during the first half of the year have gone some way to mitigating the supply side cost increases.
We believe that the next 12 months will continue to present challenges in the uncertain and volatile global environment for some of these consumer-led products that Venture Life sell. This, combined with some concerns over the governance of the company which we were not able to influence, led us to exit our position post period end.
*Volex PLC (Volex) (**6.26**% of net assets)*
*Cost: £**0.99**m. Value as at **31* *August** 202**2**, £**2.47**m*
*Background*
Volex manufactures complex cable assemblies and power cords through a global manufacturing base for a wide variety of industries. Following a turnaround and portfolio repositioning, the business has shifted away from lower margin, commodity products and has been growing sales in high structural growth sectors such as electric vehicles and data centres.
*Update to the investment case*
► *Strong Q1 trading, in line with management expectations*
► *Some consumer headwinds but exposure is more defensive than others*
► *Cost headwinds should be easing post results*
► *Structural growth drivers in place*
► *Net cash flow likely to be lower as management invests for growth *
*Progress against investment case*
Volex reported in its latest trading update that trading has been strong in the first quarter of its financial year to end June 2022, and in line with management’s expectations.
Our concerns around revenue were predominantly concentrated on the consumer electronics division which predictably grew strongly through Covid, but we feared might see a contraction as consumers are squeezed. While this concern has not abated completely, we take comfort from several points. Firstly, the consumer business is predominately concentrated in white goods, and we think this is more defensive/ less discretionary than other consumer electronics. Secondly, Volex is predominately in the value end of the market and would benefit from consumers trading down. Thirdly, Volex’s market position as the lowest cost producer in Turkey, and the opportunity to roll this through other sites, could result in market share growth even if volumes to individual customers do decline.
On balance, the revenue risk within consumer, even in a tighter macro environment, should not prove too significant. Elsewhere, structural growth drivers remain in place. Data centres were weak last year as product certification and supply chain issues delayed the roll-out of next generation 400Gbs cables. Volex also invested heavily to develop an active cable, an entirely new product for the business, which will increase customer wallet share and drive significant growth over the medium term (average selling price of an active cable is 7x that of passive). Electric vehicle growth continues from a low global base, so we ex