August 2021 Portfolio Update

On the whole August was pretty boring with precious little in the way of updates and naught but a single trade. One long yawn until, oh yes, Best of the Best decided to deliver an astonishingly destructive profit warning. Following the theme of operational gearing gone wrong they announced that profits for the year would more than halve, on a much smaller drop in sales, and indicated just how little control they have over their destiny. The key points to learn, for me, are that I should be much more active in trimming back big winners and that when high growth starts to flatten I should be looking for the exit.

Fortunately, while the BOTB debacle has probably reduced my annual return by 6-8%, which is undeniably painful, the incident is far from terminal. A fair level of diversification and strong performances from many other holdings have allowed me to scrape a positive return of 2.3% for the month to leave me at 15.1% up YTD. Hopefully this strength across the board will continue in the Autumn as corporate investors return from their holidays and start gearing up for that Christmas bonus. After such a volatile year I could certainly do with a bonus to make the winter more bearable.

Risers: STAF 25%, VLX 17%, BUR 17%, RWS 14%, LUCE 14%, GAN 13%, CLX 13%, KNOS 12%, DX. 10%, AFX 9%, SCT 8%, GAMA 8%, UPGS 7%, SDG 6%, BOO 5%, CCC 5%, MNZS 5%, K3C 4%, DRV 4%, BLV 4%, SPSY 3%, G4M 2%, SLP 1%

Fallers: CAML -1%, GAW -1%, CMCL -2%, CER -2%, CLG -3%, TM17 -5%, GMR -6%, FXPO -21%, BOTB -57%

Purchases

None.

Sales

Belvoir Group Sold at 320p - 100.0% gain

This top-slice of my Belvoir position is simply a risk mitigation exercise. I happen to believe that this is a very well run company but any business can hit a speed-bump and it's unwise to become too exposed to any large position. This goes against the thesis of running your winners perhaps, and finding the next 100-bagger, but in every case where I've let a position become too large it has come back to bite me. Sure I'm a bit sore from Best of the Best but if nothing else I should learn from this painful experience. Hence I've cut back this holding by an eighth as the price remains very strong.

Announcements

Belvoir Group

As expected Belvoir has continued to trade very strongly (exceptionally even) due to the buoyant property market. This has driven high levels of growth in both the property and rental divisions with half-year revenue up over 40% compared to both 2020 and 2019 (on a like-for-like basis). The key concern is that this performance is unsustainable and in some respects that's true. The housing market needs to return to more normal transaction levels and it appears that this is happening in a controlled fashion as the stamp duty holiday is gradually removed. Off-setting this are the recent acquisitions of Nicholas Humphreys and the Nottingham Building Society mortgage business. Both of these fit neatly into the roll-up strategy being pursued at Belvoir and are immediately earnings accretive. As such the group continues to trade well ahead of expectations set at the start of the year. (Update)

Team17 Group

This is barely an update in that the group is trading in-line with expectations. The bigger question is whether someone will make a bid for the company given how hot the games development sector is at the moment. That would be a surprise but not wholly unexpected. (Update)

Ferrexpo

These H1 results are pretty impressive at first glance with revenue up 74% and profits up an immense 165% (from $250m to $661m). In fact they're pretty amazing at second glance with strong cash-flow putting the group into a net cash position of $213m and allowing for a tripling of the interim dividend. Considering the hefty debt load in place just five years ago this is an excellent turnaround for the balance sheet. Still it's worth noting that iron ore prices doubled year-on-year, dominating sales growth, and that these frothy prices are already moderating. This process is likely to continue as new supply comes on-line and demand reduces as governments wind down their pandemic stimulus. Still the board believe that a higher base level will remain and that the company is in a position to command a price premium. The reason behind this is that Ferrexpo produces high-grade (62% and 65% Fe) pellets that can be fed directly to blast furnaces. They are also moving towards even higher grade (67% Fe) direct reduction pellets that reduce carbon emissions and allow for the production of "green" steel. This focus on pellets drives capex decisions and by the end of Q3 all of the pelletiser lines will have been upgraded to boost output. So the outlook for H2 depends on how increased production balances against the forecast price decrease of ~10% implied by the futures market. My feeling is that if prices remain near this level then Ferrexpo will continue to generate high FCF allowing it to fund growth capex, without recourse to debt, and to return cash to shareholders. In the longer term their focus on carbon-reducing pellets makes sense and they should be able to sell into whichever markets are demanding this commodity. For more colour it's worth watching the results presentation since it covers all of this in some detail. (Results)

Caledonia Mining

Another miner and another set of excellent results (despite the headwind of a falling gold price). Operationally Q2 hit a new production record of 16,710oz, taking H1 production up to 29,907oz and more than making up for a poor first quarter. Even better production in July hit 5,995oz which puts the mine on track to hit guidance for 2021 and is a huge step towards the target of 80,000oz for 2022 and beyond. Now if the new production level is sustainable, which it should be now that the Central Shaft is fully operational, then there's a chance that this years guidance could be beaten. That would be nice. As it is the all-in sustaining cost of $933 per ounce is lower than projected ($985 to $1080) and should fall further as production rises given that most of the mine costs are fixed. This leaves a decent margin with even a lower gold price and helps explain why adjusted EPS is up 70% to 62.6c, on a 31% rise in revenues. Cash generation remains strong with net cash from operating activities up to $12.7m leaving the company well able to pay a higher dividend and cover capex costs. These will be reasonably high over the next six months as the solar project ramps up, for completion in April 2022, but will reduce in future periods. It's a shame that the Glen Hume asset didn't meet requirements, leading to a $3.5m write-off, but I'm glad that the board aren't throwing good money after bad. I remain impressed by the management here but it's important not to get carried away given that this is a single asset company operating in Zimbabwe! (Results)

Best of the Best

Well this is a kick in the teeth and make no mistake about it. Foolishly I trusted management when previously they said that they hoped to see customer engagement return to normal levels. Maybe the clue was the fact that they didn't state what "normal" might be. Anyway the big problem is that customer acquisition costs have sky-rocketed due to social media (i.e. Facebook) costs increasing by up to 60%. Since the total marketing budget hasn't changed this means less ads and 40% less new customer revenues. Is this the right approach? Should BOTB just increase its budget and take the lower margin? It's hard to know as these new customers were generating 20% of total revenue with this fraction now down to 10%. This means that existing customers are providing 90% of total sales with their engagement down, due to Summer and end of lockdown, but not catastrophically. This is all well and good but the problem is that BOTB is very operationally geared - much more than I had thought. With costs mostly fixed the 15% drop in sales translates into a 57% drop in profits. OMG. I suspected that the forecasts for moderate growth this year were rubbish but not to this extent; this update slashes the forecast by a hefty 62%. Clearly the business was an astonishing lockdown winner with higher revenues and lower acquisition costs leading to massively inflated profits. Anyway there's no point crying over spilt milk after such a profit warning. I don't think that the business model is broken but with increased competition it is certainly "normalising". (Update)

GAN

I must admit that I thought that this year would be a strong one for gaming shares with exposure to the unlocking of US states. However it may be a case of it being better to travel, rather than arrive, since this has been a volatile sector recently. Still GAN continues to make strong operational progress with 11 real money gaming launches in the year-to-date and significant progress made integrating the new sportsbook engine into their B2B platform. As an outside observer GAN appear to be successfully positioning themselves as a go-to partner for large gaming operators which should, in time, pay dividends. That said the stand-out performer in Q2 was the B2C segment with revenues up 68% neatly off-setting flat B2B revenues. This rather validates the acquisition of Coolbet back in January with this new business outperforming all expectations so far in addition to smoothing group revenue volatility. Sadly the group isn't yet profitable at the bottom-line, although gross margins remain high and stable, as investments in talent and technology are growing in line with sales. As a result forecasts indicate a solid loss this year followed by a much smaller one in 2022 and profitability in 2023. Looking at the change in these forecasts over time it seems that this date has been pushed out, which would explain the share price weakness, but equally this could go the other way given momentum in the business. For H2, GAN expect continued strong performance from the B2C segment (particularly in Latin America and Northern Europe) as well as from their B2B segment as they gain new client wins in major markets. In addition they indicate that profitability metrics will improve as revenues scale up. Overall I'm happy with progress and look forward to the rest of their financial year. (Results)

Calnex Solutions

This is a simple in-line statement with the first quarter seeing strong trading and good order levels. Usefully the company has not experienced any negative impact from the global semiconductor shortage which is encouraging. That's it for now but hopefully we'll see a proper trading update before the interim results in late November. (Update)

UP Global Sourcing

This is a fine, if understated, full-year update. From a numbers perspective revenue and PBT will come in ahead of the market consensus which is excellent news given the disruptions of the past year. This means that EPS will be up 25-30% to around 10.5p with analysts currently estimating 13.8p for 2022. This will include a full year's contribution from the recently acquired Salter business while the core order book is currently ahead of this time last year. The biggest challenge right now remains shipping with retail customers being prioritised ahead of stock purchases (directly for the group I presume). This is a concern but management at UPGS have shown themselves able to deal with challenges before and I have valid reasons to trust their operational capability. Still it is an unwelcome headwind and I can see why the board aren't rushing to upgrade expectations. (Update)

Burford Capital

I must admit that I lose the will to live a little whenever I see a Burford announcement. It's not that they're bad, far from it, but the level of detail is punishing and I'm not sure that I wish to take the time to understand it. That's where the opportunity exists, of course, but equally it's taking forever for anyone to spot this theoretical opportunity! At the top-level this half-year period was relatively quiet, with pandemic related delays still featuring, although high levels of commitments and deployments were achieved. This means that actual asset realisations have been subdued leading to a profit of around $20m for the period, ignoring the impact of non-cash accruals, which is low considering the full-year forecast of over $200m (although these forecasts receive no guidance whatsoever from management). If you include the non-cash adjustments, which relate to compensation expenses in a moderately technical manner, then the company will report a loss. With this in mind I can't see the shares exactly surging in the coming months despite Burford appearing to provide ever-improving prospects from its volume of funded cases. One day this company will prove its worth - I hope. (Update)

Clipper Logistics

These are pretty knock-out results from Clipper, after a subdued few years, with profits up 34% on a revenue increase of 39% to £696m. It's hard to put an exact figure on the EPS though because there's quite a gap between the basic value of 21.3p and the underlying basic EPS of 13.1p. I need to look at the reason for this difference but more importantly cash generation remains strong (up 44% to £87m) with net debt falling from £45m to £17m. From an operational perspective the pandemic has created a permanent shift to online shopping which has driven record volumes for CLG with multiple new contract wins. The company has clearly benefitted from this change with a significant expansion in both headcount and estate size deemed necessary to cope with demand. In the new financial year trading remains strong, and in-line with recently upgraded guidance, with the prospect of yet more new contract wins as clients appreciate the value of its services. It's this exposure to the unstoppable rise of e-commerce, and the necessity for existing retailers to maximise sales in this channel, that draws me to Clipper as a company with a significant growth runway. The business model is proven as are the management team. However the group is expanding into Europe and perhaps the US which adds execution risk. European logistics is expected to be a high growth area in the future, and the group is already operating successfully on the Continent, but I do wonder whether stretching the board to cover North America is sensible. Still that is why we pay them the big bucks. (Results)

Computacenter

This is a rather unusual trading update in that analyst engagement (or rather the lack of engagement) has forced the company to make an unscheduled announcement. The problem is that many of these analysts have made no changes following the strong July update and so their forecasts are lagging the Board's expectations. As they point out the previous H2 was very strong, making growth challenging, but even a flat performance would see them 10% ahead of the market consensus. For sure there are headwinds, which is always the case, but the company sees tailwinds also from their momentum, order backlog and history of acquisition. So there is all to play for in the second half of the year. (Update)

Disclaimer: the author holds, or used to hold, all of the shares discussed her

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