Interactive Investor

Stockwatch: a small-cap share with takeover potential

This speculative buy implies you think markets can avoid any major crisis in the medium term, and that the UK economy's prospects are not as bad as some fear, says analyst Edmond Jackson.

31st May 2024 11:12

by Edmond Jackson from interactive investor

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Lots of small light bulbs and one pink one

Tacit evidence of various re-ratings starting in mid-April can appear to suggest that smaller companies are poised as the next sector for UK action after the FTSE 100 picked up and the FTSE 250 index saw strength this week.

Such would be the classic progress of a cyclical market recovery anticipating better times ahead, starting with interest rate cuts.

It is also interesting this past week how, despite the US market getting knocked on inflation fears and tech jitters such as Salesforce Inc (NYSE:CRM) and Dell Technologies (NYSE:DELL), the UK market did seem to be disconnecting, falling relatively less than US indices, and yesterday rallying. Might international investors finally be recognising UK relative value, hence small-cap is a good long shot?

Obviously, there is the small matter of a potential new government or messy hung Parliament even; and despite UK business starting to “love up to Labour”, I recall the same in 1997 when John Major’s government was tired, business is recognising self-interest. And, of course, neither Russia nor the Middle East has gone away.

A relative lack of liquidity, as well as the companies sometimes being more sensitive to the cycle, are key reasons why small-cap stocks tend to lag the market and get hit more than most in a downturn.

As yet, indices are yet to suggest much radical happening. In April, the FTSE Small Cap index returned 4.0% and the first quarter saw a muted re-run of early 2022 when large, mid and small-cap performance diverged. The FTSE 100 returned 4.0%, the FTSE 250 1.6%, and small cap -1.0%, with AIM bringing up the rear with -2.3%.

Yet some re-ratings are getting highly speculative

It will be interesting to see May’s index data after what seems like a plethora of re-ratings and takeover approaches in UK mid and small-cap stocks – it becomes hard to keep up with them all on a daily basis.

Yet two examples this last week are red flags to me, and that this is becoming over-speculative in nature, driven by hopes for interest rate cuts. Even long-term serial disappointers are joining the party.

Oil & gas explorer Aminex (LSE:AEX) has shot up from 0.8p mid-April, over 2.0p since the end-April 2023 prelims showed a reduced loss of £0.9 million equivalent, down from £3.2 million. The narrative cites milestones achieved, although it has promised plenty in the near 30 years I have followed it on and off.

Thirteen years ago at 7p, I wrote: “Aminex shares have acquired a reputation for active trading [rather] than rewarding a buy-and-hold investment approach.” Despite a seemingly cheap share price, Aminex is capitalised at £84 million due to having issued over three billion shares. Well, perhaps it finally gets taken over, with the assets integrated elsewhere.

Last Tuesday, inkjet technology specialist Xaar (LSE:XAR) jumped 17% to 147p on no fresh news and in context of a sideways-volatile chart for the last two decades.

Currently capitalised at £115 million, Xaar does occasionally hit the big time with new products, trading briefly over 1,000p in 2014, although its current re-rate looks more like hopes for mean reversion after a poor trading update last November sent it down.

De La Rue does at least suggest things are genuinely getting better

I should not be cynical given another small-cap with problematic history, banknote and passport printer De La Rue (LSE:DLAR), declared in a strategic update that it has spoken with “a number of parties who have made proposals” in contest of a review that may involve business sales. It said: “The board confirms that the discussions with the relevant parties are advancing, and we expect to update further with the full-year results in July.”

Positive momentum is cited in both key divisions “with a number of significant recent contract wins and renewals”. The passport side has seen four major contracts in the past 12 months and the currency side has seen its order book jump from £137 million at end-2023 close to £300 million currently.

Despite lurching into losses only in its last financial year to March 2023, De La Rue has had a frustratingly volatile chart and at least this is one I feel comfortable applying a “hold” stance to, at 99p. Mind a still-weak balance sheet and no sign of dividend prospects if the company does remain independently listed.

Small-cap specialist Miton underlines the speculative aspect

Shares in Premier Miton Group (LSE:PMI) fell 10% near 70p yesterday, closing at 73p after the fund management group – best known for its small-cap investing guru Gervais Williams – declared mixed interims to 31 March.

Net outflows rose to £46 million from £32 million in the first half of 2023, and assets under management fell from £9.8 billion last September to £10.7 billion. That the “closing” value as of 24 May was £10.8 billion suggests outflows have continued given May has appeared to show strong performance in UK small-cap, which Miton funds have an overall weighting towards. It was also after adding £560 million via an acquisition.

Interim revenue fell 15% to £33 million, however, weighed by £2 million share-based expenses, alongside £2.5 million amortisation and £0.5 million exceptional costs (these being quite consistent features) and operating profit was slashed from £2.4 million to £0.2 million.

With administrative expenses at 82% of net revenue, it can look like another example of well-paid City workers albeit with little left for shareholders. Despite interest payments rebounding on £31 million cash at bank, a hefty tax charge left just £57,000 profit, hence negligible earnings per share (EPS).

The CEO implies retail demand for funds is linked essentially to interest rates, contending that cuts lying ahead “will support an improving environment for fund flows and asset values”.

Yet his outlook statement is vague with no guidance on numbers, instead, “it seems logical to us that the demand for savings will continue to grow as investors have to fend for themselves”.

Twinning that with high admin costs and regular, generous share-based expenses, suggests consolidation emerging among smaller asset managers and Miton as a potential bid target. Around 70% of its funds have outperformed on average since launch or tenure.

See in the table below how the operating margin has fallen progressively from around 30% to below 8% and the return on capital is even worse. The situation shouts to have costs radically taken out.

Premier Miton Group - financial summary
Year to end-Sep

201820192020202120222023
Turnover (£ million)53.452.877.794.790.274.6
Operating margin (%)29.826.012.318.516.67.6
Operating profit (£m)15.913.7 9.617.514.95.7
Net profit (£m)12.511.05.914.010.03.7
EPS - reported (p)11.910.44.09.06.12.3
EPS - normalised (p)12.111.36.09.76.22.5
Operating cashflow/share (p)16.913.03.318.711.13.7
Capital expenditure/share (p)0.64.48.40.80.20.2
Free cashflow/share (p)16.38.6-5.117.910.93.5
Dividends per share (p)10.310.57.010.010.06.0
Covered by earnings (x)1.21.00.60.90.60.4
Return on total capital (%)35.230.37.012.711.24.4
Cash (£m)21.721.538.751.247.939.1
Net debt (£m)-21.7-21.5-35.8-49.2-46.7-37
Net assets (£m)45.345.3130132127121
Net assets per share (p)44.144.887.690.080.376.7

Source: company accounts.

Lest I come across as joining the speculative party, touting a takeover, for what charts are worth Miton has since last November put in a supposedly bullish “double bottom”.

It is a reminder how asset managers are on quite a knife-edge financially for how asset flows and valuations affect their financial performance. Buying into the likes of Miton would imply you think stock markets can avoid any major crisis in the medium term, also that the UK economy does not have such bad prospects as critics claim.

Distinguished from other stocks in this piece, Miton is paying an (unchanged) interim dividend of 3.0p a share, reflecting “a balanced view of the short-term outlook given difficulties the industry has faced over the last two years”.

I find it possible to conclude therefore with a “buy”, underlining that this is speculative.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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