Thursday, 31 October 2013

A Portfolio of AIM Shares (7): Matchtech Group PLC; Brooks Macdonald Group PLC

Note: For the preliminary filters used to select AIM stocks, see

As I wrote in an earlier article (, long-term investors will prefer the steadier income streams from non-cyclical industries to the risks associated with cyclical industries. But an investor in AIM shares would be wise to select a portfolio of at least 10 stocks. And there are not many good non-cyclical stocks listed on AIM.
Consequently, I have included companies engaged in cyclical industries, recruitment and investment management, as possible components of an AIM portfolio.

Matchtech Group PLC

Engineers at the Menai Bridge, Anglesey (1868) by John Lucas, courtesy Wikipedia

Matchtech Group was founded in 1984 by George Materna as a recruitment agency for technical staff. Matchtech now claims to be the largest UK recruitment agency for engineers and the 14th largest UK recruitment agency overall. While the company has been profitable since floatation and revenues have grown by 14% per annum, earnings fell in the wake of the financial crisis and are only now returning to pre-crisis levels.
Southampton-based Matchtech listed on AIM in 2006 with a placing of shares at a price of 310p. The company's shares are currently eligible for 100% business relief for inheritance tax and the 'free float' is 50%. Materna, the founder and Chairman, owns one-third of the company. Matchtech is valued by the market at 133 million pounds and it trades on a bid to offer spread of 1.6%.
As one would expect with a company engaged in a cyclical business, Matchtech's shares (in blue) have been much more volatile than the FTSE All Share (in green):

Courtesy Yahoo, click to enlarge

Matchtech has a simple business model. It has 280 consultants (the sales force) that obtain orders for permanent or temporary technical staff from concerns throughout the UK. It recruits candidates from its websites and matches their CVs with their clients' requirements. Matchtech collects a one-off fee for permanent placements and an ongoing fee for contract placements. Over two-thirds of its income is derived from contract (i.e. temporary) placements.
In all, Matchtech had 1,600 fee-paying clients in 2013 and the largest accounted for 7% of its net fee income. Over 70% of the company's revenues come from providing technical staff to the engineering sector, leaving 29% from the rest - IT ('Connectus'), business professionals ('Barclay Meade') and 'welfare-to-work' ('Alderwoods'). Each of its four businesses is run independently, with their own management, sales force and websites. 
In September 2013, Matchtech acquired Provenis for 4 million pounds, issuing shares to that value to fund the purchase. Provenis specialises in the Oracle-based ERP (Enterprise Resource Planning) software for large businesses. Matchtech sees it as a complimentary service to Connectus's IT software. Provenis generated operating profits of 1 million pounds on sales of 14 million pounds in 2011.  
Demand for Matchtech's services is related to the number of job vacancies in the UK:

Click on graph to enlarge

The revenue, earnings and cash cycle for Matchtech is reflected in the following data:

Earnings per share pence
Revenue growth %
Net Fee Income growth %
Net Debt pounds Mn

Earnings have followed the job vacancy cycle, with an increase through 2006 to 2008, followed by a reductions post-crisis that continued through FY 2011 (the fiscal year ends in July). Since then earnings have recovered and, provided job vacancies continue to grow, are likely to continue on an upward trend. In 2013 the company made an after tax profit of 7.5 million pounds on revenues of 409 million and net fee income of 38 million.
The company's billings are over ten times its net fee income. This has significant funding implications. As the company pays contracted staff before it receives payment for their services from its clients, Matchtech must finance the difference, and this accounts for the swings on net debt (capital expenditure and other investments were negligible in this period).
Taking the last five-year period, net operating cash flow of 8 million pounds fell far short of the dividends it paid of 20 million. The sudden increase in debt in 2011 was blamed by the company on a surge of business towards the end of the fiscal year. But earnings fell to a six-year low as well. Debtor days have since improved from 53 to 49 days and profits have improved as well, though margins are still well below pre-crisis levels.
Matchtech has plenty of head room in borrowings, which are currently 32% of equity. It factors its receivables and it has a 50-million pound facility on which it is paying a reasonable 2% over Barclays Base Rate. The company's return on equity is a healthy 23%. The company has no defined benefit pension scheme to provide for. And it is the largest recruitment agency in the engineering sector.  
At an offer price of 556p, Matchtech shares are trading on a PE ratio of 17 and yield 3.2%. Unfortunately, valuation models are difficult to apply to cyclical companies.
However, the prospective investor will consider:
1. Matchtech is near the beginning of an upturn in its business and this is reflected in the recent surge in its share price. It has increased by 145% in the past 12 months.
2. The long-term market for technical staff is growing.
3. The recruitment market is easy to break into and, consequently, competition is fierce.
4. The only significant director transaction was a sale worth 100K at 502p on 15 October.
5 The acquisition of Provenis should boost the company's revenues and profits.

Brooks Macdonald Group PLC


Brooks Macdonald Group (BMG) was founded in 1991 to provide private client investment services. BMG's main source of income is derived from commissions and fees for providing discretionary management services for private clients, trusts, charities and pensions funds.

In March 2005, the London-based group placed 3 million shares at 140p a share on AIM. Since then, the value of the shares has risen tenfold as the company grew its business rapidly via acquisitions, organic growth and, after the financial crisis, rising stock markets.

BMG shares are currently eligible for 100% business relief for inheritance tax and they trade on a bid to offer spread of 4%. The company is today valued by the market at 191 million pounds. BMG has a 'free float' of 72% of outstanding shares, with the remaining in the hands of the founder CEO, Chris Macdonald, and directors.

Although BMG is in a cyclical business, it has soared, with barely a pause, through the financial crisis and beyond. This is thanks to its rapid rate of growth based on a low initial level of activity. The following graph compares BMG's shares (in blue) with the FTSE 100 (in red) and Charles Stanley (in green), which is a mature company in the same line of business as BMG:

Graph courtesy of Yahoo, click to enlarge.

Although the scale of the graph minimises the changes in Charles Stanley shares related to the FTSE 100, the investment management company underperforms in bear markets and outperforms in bull markets, as one would expect.

The spectacular increase in BMG's share price is the result of its spectacular growth in earnings, dividends and funds under management (from the 2013 Annual Report):

Click to enlarge

Past growth has come from:
1. Geographical spread via new offices and acquisitions. Since 2008, BMG has added offices in Tunbridge Wells, Edinburgh, Hale, Taunton, York, Jersey, Guernsey and Leamington Spa to its offices in London, Hampshire and Manchester.
2. Acquisitions: The largest was the 2012 purchase of Spearpoint in the Channel Islands for 32 million pounds financed with cash and a share placing. At a stroke, BMG increased its funds under management from 5 billion to over 6 billion pounds, while adding nearly 4 million pounds to pre-tax profits and access to the international market for investment services. Another, smaller acquisition in 2010 gave BMG access to property and land management. Bolt-on acquisitions have added business and staff, which now total 400.
3. Growing reputation: In a market where reputation is everything, BMG has gained the trust of 540 firms that introduce investors to the company. Last year BMG received two awards of the year for its private investor and wealth management services.
4. BMG has made a speciality of Self Invested Pension Plans (SIPPs), which has been a growth segment of its market.
5. Its OEIC funds, which are small, have performed better than their indices and most competitors.
6. A buoyant stock market, which has doubled since its 2008/9 lows, has helped to lift the value of funds under management.

At BMG's present offer price of 1450p, the shares trade on a PE ratio of 20 (adjusted for acquisition costs) and yield 1.6%. But, if Spearpoint's contribution is included on an annualised basis, adjusted earnings per share rise to 84p and the PE ratio falls to 17.

By comparison, Charles Stanley shares trade on a PE ratio of 30. And that company's profits are back where they were in 2009, and its return on equity is just 9% compared to BMG's 19%. No doubt, one explanation for the very different valuations is that Charles Stanley shares yield twice as much as BMGs.

BMG's margins are expected to fall in 2014 as a combination of IT spending, increasing regulatory requirements and the impact of the Retail Distribution Review (RDR) on commissions all work to reduce profitability. The CEO was upbeat in BMG's October release:
"We remain confident in our ability to grow funds under management and, remain optimistic about the opportunities for the Group". 

BMG's future depends more on the stock market than in the past. A continuation of the bull market will lift its income and its shares, while it is unlikely to escape the next bear market as it did the last. Investors will draw their own conclusions on the likely direction of the stock market from the following chart of the FTSE All Share Index for the period 1973 to 2013:

Courtesy Yahoo, click to enlarge

A prospective investor in BMG will consider:
1. The company is lowly rated compared to its competitors, while its earnings growth and return on equity is better.
2.  RDR is a threat to the profitability of all investment managers. BMG claims that the reduction in commissions of 5 million pounds will be offset by an equal cost now included in administration. The CEO added a warning (2013 Annual Report):
"On 1 January 2013 RDR came into force. This was a substantial change to the whole of the financial services industry with a focus on transparency of charging, greater consumer clarity and the raising of professional standards and corporate stability. These are changes that we fully support but the costs associated with increased regulation have become and remain substantial. Whilst we feel that these costs have peaked in terms of percentage of turnover, they have not been passed on to clients. This is something that we and, we believe, the whole of the industry will have to consider over the coming years."
3.  BMG has no defined contribution pension scheme to provide for. And its balance sheet is bolstered by 18 million pounds net cash, almost 10% of its market valuation. In the past five years, operating cash flow net of capital expenditure has covered the dividend 3.5 times. The company has preferred to spend its cash on acquisitions rather than returning cash to shareholders. Given the results, this is an excellent use of its funds.
4. The CEO sees an opportunity in pensions' auto enrolment:
"The growth of SIPPs continues and this is now further supported by legislative change around auto enrolment. We will be looking to launch a specific auto enrolment service later this year utilising our own funds and this will apply both on and offshore. This is an opportunity we are increasingly excited about."
5. Ultimately, BMG's future depends on the stock market. A prolonged bull run will make today's valuation seem cheap. A sudden bear market will likely cause a more than proportional drop in the share price. Valuation models help little with such uncertainty.

Friday, 25 October 2013

A Portfolio of AIM Shares (6); Nichols PLC and Advanced Medical Solutions PLC

Note: For the preliminary filters used to select AIM stocks, see

Nichols PLC

Nichols's Vimto, courtesy Wikipedia


Nichols is a soft drinks company based on Merseyside. In 2004, the company transferred its listing from the Main market to AIM, explaining that, after selling its foods business, the size of the company did not warrant the costs associated with a Main listing. Nichols has a good trading history, a high return on equity and holds net cash of 31 million pounds, 7% of its market value.

Nichols is currently eligible for 100% business relief for inheritance tax, it has a 'free float' of 73%, a market capitalization of 428 million pounds and it trades on a bid to offer spread of just over 1%. The Nichols family owns about 27% of the company's shares.

Although Nichols's brands either owned or under license, cover all main segments of the soft drinks market, except for water, its share of the UK market is only about 1%. And the total market has grown by a compound average of 3% since 2006 (British Soft Drinks Association):

Drink sales UK
Nichols's brands
Total UK Sales in
Pounds Million
% Total growth
2006 to 2012
Vimto, Panda, Sunkist, Levi Roots
30% value
Still & Juice drinks
14% value
Vimto, Weight Watchers
20% value
Fruit Juices & Smoothies
Weight Watchers
2% value
20% value
Sports & Energy drinks
(Included in carbonates and still drinks)
Extreme Energy and Sport
82% volume

From 2013 Refreshing the Nation, British Soft Drinks Association.

However, while the total drinks market (excluding bottled water) has grown by 20% in value, Nichols's sales have more than doubled. Nichols does not give sales figures by brands, but it is reasonable to assume that this is the result of acquisitions and license agreements:
  •     2005 - Panda (including Panda Cola, the 3rd cola drink after Coca-Cola and Pepsi in the UK),   was purchased for 5.5 million pounds.
·         2010 licensed Levi Roots (Caribbean flavoured carbonates) worldwide rights.

·         2011 licensed Weight Watchers cordials and fruit juices for the UK and Ireland.

·         2012 licensed Extreme Sport and Energy for the UK.

Vimto is the brand Nichols launched in 1908. And Cabana is the third largest supplier of dispensed soft drinks, to pubs etc., in the UK, after Britvic and Coca-Cola Enterprises.

Vimto exports account for 21% of Nichols's sales, mainly to the Middle East and Africa.

Shares in Nichols (in blue) have outperformed the FTSE All Share (in green) by a wide margin.

Courtesy Yahoo, click to enlarge

Nichols runs a very lean organization. It bills 660,000 pounds per employee. The company relies on contracting out production, which keeps capital expenditure and inventory low while avoiding any temptation, as its CEO remarks, "to feed the factory." 

Financial results are excellent:

1. Earnings per share have increased by a compound 16% per annum since 2004, and equity per share has increased by a compound 12% per annum in the same period. 

2. Net margins are a comfortable 15% of sales. 

3.  Return on equity, both historically and on retained earnings, averages 35%, and this is without any financial leverage. The company holds 31 million pounds in net cash. 

4. 5-year net operating cash flow, after small amounts of capital expenditure, covers the dividend 2.2 times, leaving 19 million pounds to build up its cash holding. 

5. The only concern is its 6.6 million pound liability for its defined benefit pension scheme. Though the scheme is closed to new entrants, this liability will only rise. 

2013 has begun well. In the interim report at June, Nichols reports an 11% increase in earnings and a 13% increase in the dividend. 

At 1,145p, Nichols trades on an historical PE ratio of 28 and yields 1.5%. The outlook in the interim report is positive: 

"UK consumer spending remains cautious and for the remainder of 2013 we expect the soft drinks market to be characterised by low volume growth and significant promotional activity. Against this backdrop, we are pleased with the Group’s performance in the first half of 2013, in particular the success of our strategy to improve margin and increase profitability. 
   In the second half of 2013, we will be finalising our revenue growth plans for 2014 and beyond including the introduction of further new products, entering new international markets and importantly continuing to invest in our existing core brands. 
   We expect Group performance for the remainder of 2013 will be similar to the first half of the year and therefore anticipate the full year results will be in line with current expectations."

My valuation model values Nichols' shares at about 1,000p.* This is not far from its present price of 1,145p, which is just 7% off its all-time high.
 *Assumptions: earnings per share growth 10% p.a.; equity per share growth 10% p.a.; return on equity 30%; dividend payout 43% of earnings; average PE ratio of 21.5, all discounted at 10.8% (3.8% SLXX + 2% operating risk + 5% margin of safety) for the years 2013-18.

The cautious investor will note that: 

1. Nichols has a new CEO. She is the former managing director of the Vimto brand. 

2. The company has moved its promotion from carbonate to still drinks. While margins are better at the still drinks business, it does imply that its 2005 purchase of Panda has not worked out as expected. 

3. The soft drinks business is fiercely competitive. Nichols is dwarfed by Coca-Cola, Pepsi, Snapple, Suntory, Britvic and A G Barr (see This makes it very difficult for Nichols to get shelf space in the supermarket chains.  

4. The underlying soft drinks business is not growing in volume terms. Nichols management has proven to be wily. It has improved margins and licensed new products. But, can it match its past performance?



Advanced Medical Solutions PLC

Sticking plaster, courtesy Wikipedia

Every once in a while an undeserving company, from an investor's viewpoint, slips through my filters. I read its annual and interim reports and run some numbers to confirm that it is a financially solid business with decent growth prospects at a reasonable price in the stock market. Then, after spending hours on researching its history, its market, its management and its accounts, I detect a decidedly fishy scent.  Normally, I would spend no more time or thought on the company.

However, Advanced Medical Solutions (AMS) is an example of a company that looks good on the surface, but is the classic trap for the unwary investor. So that is why I am discussing it in this blog. The name suggests a company run by science PhDs with laboratories of white-coated scientists developing new advanced solutions to medicine. The world, one might imagine, is their oyster. And a quick look at their accounts shows sales have grown at a compounded 22% since 2004 and net debt, at only 3% of equity, is expected to be paid off by December this year. Trading on a PE ratio of just 19, and Cheshire-based AMS would seem to be a snip.

But consider:

1. Most companies that list on AIM require funds to grow their business. And they are often owned by their founders or directors. AMS came to AIM in 2002 from the main market, where it had been listed since 1996. AMS's shares tumbled in value as the company ran up years of losses and then raised funds via an emergency issue of new shares. Long-term investors have not recovered their money. AMS shares (in blue, FTSE All Share in green) are 20% below their 1996 issue price.

Graph courtesy of Yahoo, click to enlarge.

2. AMS's wound care products are pretty low tech - sticking plasters, super glue and collagen sutures that surgeons use for sealing and stitching wounds.

3.  The company has a tiny market share in wound care products, both in the US and globally. In the US 80% of wound care products are sold by Johnson and Johnson, compared to 1% by AMS.

4. Half AMS's business is providing 'white label products' and bulk materials for concerns such as Boots, which then add their own label. So about a half of its revenues is by nature a commodity business.

5. AMS has bought growth, rather than generated growth organically. In 2002, it acquired Medlogic, which had developed LiquiBand and Liquishield liquid sealants, for 2.5 million pounds. In 2009, it paid €4.8 million for Corpura, a Dutch company manufacturing foam dressings for wounds. And in 2012, the company increased its revenues by 50% with the purchase of Resorba for 55 million pounds. Roserba is a German company specialising in collagen sutures. On each occasion, AMS has issued shares to pay for part, or all, of the purchase cost.

6. Management, in its annual and interim reports, largely avoids references to market share, its main competitors or overall market dynamics. This is strange coming from a company that is essentially a marketing and acquisition-based concern.

AMS has succeeded in integrating its acquisitions and improving their profitability. Net margins are now (2013 interim report) at 22% and its most recent return on equity is a respectable 15%. With its end market, wound care, growing slowly (by 3% in the US and by nothing in the UK) AMS must acquire more companies to keep growing. So although 2012 sales were 55% ahead of 2011, all but 3% was due to its acquisition of Resorba. And the problem, for the shareholder, is that the company must issue new equity to finance its purchases. It does not generate sufficient cash from its business. This also explains the miserly dividend payout of just 11% of earnings, giving a yield of 0.5%.

The long-term investor will want to avoid companies that:

1. Must regularly issue new shares to finance their growth. The constant call on new capital is a drag on performance.

2. Carry an unfounded aura of technology at the forefront of their industry. Many companies survive on the fringes of a large market. But, from the investor's viewpoint, the main hope is that they will be bought out by a bigger competitor. This is not a good reason to buy their shares.

3. Employ management that obscures the trading conditions of the market where it operates.

4. Beware of public relations reports masquerading as analyst reports. For example, City Insights begins by describing AMS in the following terms:
"Founded in 1991, AMS is a leader in the development and manufacture of innovative and technologically advanced products for the US$15 billion global wound care market. These products are sold in countries across the globe either directly or through strategic partners and distributors."
With a turnover of $84 million, AMS's global market share is 0.6%. A leader it is not.