River and Mercantile UK Micro-Cap (RMMC) has published its annual report for the 12 months ended 30 September 2021, during which the portfolio NAV increased by 59.5%, significantly outperforming its benchmark, the Numis Smaller Companies plus AIM ex Investment Companies Index, which increased by 45.7%. Over the five years to 30 September 2021, the portfolio NAV has achieved an annualised net performance of +21.1% outperforming the Benchmark at +10.4%.
Compulsory redemption mechanism
As at the end of RMMC’s financial year, its NAV stood at £111.3 million. RMMC has a compulsory redemption mechanism that is designed to return the NAV to around £100m. This redemption mechanism is usually subject to a minimum value to be returned to shareholders [at NAV] of approximately £10m.
RMMC’s Board says that it is very conscious of the size of the Company and remains committed to the operation of the redemption mechanism, with the aim of ensuring that RMMC continues to deliver high and sustainable returns to shareholders. Two redemptions (worth £35 million) during the last financial year, bringing the number of redemptions that have been carried out to five in all. For the most recent redemption that took place in May of this year, 16.3% of the shares in issue were redeemed and cancelled. This means that the Company has now returned more in capital, £77.0 million, than the £70.1 million it originally raised.
Manager’s comments on portfolio activity
“I am going to focus on the portfolio changes that have been made in the second half of the year ended 30 September 2021. Details of the changes made in the first six months can be found in the Half-Yearly Financial Report for the six months ended 31 March 2021 and include (in order of portfolio weight at the end of the period): ActiveOps (2.6%), Supreme (2.6%), Distribution Finance Capital (2%) and Virgin Wine (1.2%). We continued to build our positions in Supreme and DF Capital in the period and added to Virgin Wine post period end.
“CMO Group (1.9%): approximately 10% of the very large building merchant market is transacted online and only 4% of this by businesses that are exclusively online operators. CMO is the largest of these, representing approximately a quarter of the pure play online value. This is a market that is vulnerable, like so many that have gone before it, to disruption by online players. Category expertise and vast range enables users to be acquired cheaply online and the drop-ship model leaves fulfilment with the ultimate supplier. The stock was purchased at IPO and is held as a Growth thesis, supported by the 30% compound annual revenue growth that the company has delivered over the last four years.
“LendInvest (1.52%): is a fintech business that is looking to take share in both the UK buy-to-let and specialist homeowner mortgage markets. As opposed to owning the mortgages like a conventional lender, LendInvest places the mortgages with institutional owners in exchange for an origination. I’ve somewhat simplified the business model here as there are several different funding structures, but you can see how this approach would be less capital intensive than a traditional lender. The company has set itself some ambitious targets, doubling platform revenue and growing EBITDA by 3-5x, and will deliver great shareholder value creation if it delivers to them. We also purchased this position through the IPO and the stock is also owned under a Growth thesis.
“eEnergy (1.1%): an energy consultancy business which helps small and medium sized enterprises reduce their energy requirements by identifying wastage and implementing more energy efficient solutions and procuring green energy. The core business provides a solution to schools to convert to more efficient LED lighting and in-doing so reduce their energy costs. The company has since acquired additional services to broaden the offering and client base. We invested at the most recent placing which was undertaken to acquire UtilityTeam.
“Given the timing of the two capital returns (January 2021 and May 2021), most disposals were made in the first six months which, again, are detailed in the interim report. In summary, DX Group was exited as we felt that the recovery thesis had largely played out and did not see it transitioning to either a Quality or Growth thesis. Adept Technology, Harvest Minerals, STM Group, Tekmar and Hummingbird Resources were all exited to fund the fourth return of capital. Sylvania Platinum was exited given concerns over the gearing to the rhodium price with the proceeds being used in the second capital return.
“M&A also played a role with AFH Financial, Cambria Automobiles and Sigma Capital being taken private.”
Manager’s comments on portfolio attribution – holdings with a contribution to relative return of +/- 1.5 percentage points
Positive Contributors:
“MaxCyte: +5 ppts: MaxCyte was, for the second year running, the most material contributor to performance. We ran the position with high conviction and the share price performance in the period was exceptional (+174%). This was in part due to continued operational delivery by the company which is positioning itself as the gold standard partner for cell therapy companies. The share price performance was clearly also aided by the introduction to the Nasdaq exchange in the US. We saw this as a key catalyst for the shares and have since taken profits to move to a lower conviction position (2% position at the end of the period).
“Joules: +2 ppts: We originally invested in Joules in April 2020 as the company needed to raise capital given the impact to the business from the pandemic. The business has since delivered exceptional growth in its eCommerce business and, more recently, has successfully re-opened its bricks and mortar estate. We purchased the business on a cheap valuation and have benefitted from both the recovery in earnings and the valuation re-rating which delivered a share price gain in the period of 120%.
“Allergy Therapeutics: +1.9 ppts: Whilst there are obvious differences – one has a focus in cell therapy and the other in allergy vaccines – both Allergy and MaxCyte were business that have, for many years, delivered strong operational improvement supported by innovative R&D. However, the market dismissed each as loss making biotech stocks and left them trading on depressed valuations (and us holding positions with large unrealised losses). Like it did for MaxCyte, sentiment towards Allergy has flipped in the last 18 months. The last stock we purchased was at 7.6p in March 2020 – the share price was 37.5p at the end of September, up 144% from September 2020.
“Science in Sport: +1.8 ppts: a leading sports nutrition brand, Science in Sport has delivered strong results and appears undervalued versus transactions for similar businesses. The shares gained 109% in the year and was our highest conviction position at the end of the period. Whilst net profit is depressed given the investment into driving the top line, the company is now profitable with a track record of strong top line growth and an improving gross margin.
“City Pub Group: +1.7 ppts: as the owner and operator of 50 pubs, City Pub Group has seen a period of extremely depressed profitability. Trading has recovered since the removal of trading restrictions and, having been through a period of consolidation via the disposal of poorly performing sites, the company is once again investing in new sites and acquisitions. Significant costs savings have also been delivered meaning that run rate profitability should exceed pre-pandemic levels. The shares gained 101% over the twelve-month period.
“Sylvania Platinum: +1.7 ppts: the producer of platinum group metals (PGMs) from chrome tailings delivered a gain of 100% in the period to the point of sale, which was completed in April, on the back of strong PGM prices. We saw strong gains in the metal prices with the rhodium price particularly strong, gaining 75% (according to the Johnson Matthey Rhodium Price index) from the start of the year to the high in March. Ultimately, Sylvania Platinum’s profitability became very geared to that one price which was a key factor in our decision to exit.
“Boku: +1.7 ppts: a position held since the company’s IPO in November 2017 and a great long-term performer for us. Boku delivered several upgrades given the strength of the performance in the core direct carrier billing business where they partner with some of the largest eCommerce businesses in the world to enable seamless payments. The shares have been re-rated, gaining 114%, and we reacted to the higher valuation by taking profits.
“Ince Group: +1.6 ppts: an unfortunately timed original purchase in early 2020, Ince was, as a recovery thesis with high financial leverage, a significant underperformer in the period from purchase to September 2020. We have since seen a recovery in the share price as the business has delivered positive cash generation and paid down debt. This is reflected in the share price gain, from an extremely depressed level, of 148% in the period with the shares remaining firmly in the value camp at the end of the period.”
Detractors:
“Venture Life: -2.9 ppts: one of the standout performers of the prior year with the shares gaining 159%, Venture Life shares fell 44% in the twelve months to September 2021. The company is executing a buy and build strategy of selfcare brands and has executed on two additional acquisitions in the period. The key issue has been disappointing trading in two areas which resulted in expectations for this year and next year being reduced. Hand sanitiser gel sales, under their brand DisinPlus, have deteriorated faster than expected and sales of their two mouthwash products into China have disappointed. Whilst the latter is more material than the former, neither are critical to the success of the business.
“Shanta Gold: -2 ppts: another top performer from the prior year when the shares delivered a gain of 109%, Shanta has executed well on many of the key growth drivers, namely the expansion of the business from a single site, single country operator to a mid-tier, multi-site operator across two countries (Kenya and Tanzania). However, Shanta’s long track record of meeting guidance came to an end as underground grades at their existing asset were lower than expected and production guidance for the year was reduced. The shares lost 26% in the period.
“Argentex: -1.8 ppts: Argentex has compounded high organic revenue growth, margins and return on capital since (and before) they listed in 2019 which are attributes we look for in both our Quality and Growth categories. However, the revenue growth has failed to deliver to expectations and the margin, whilst high, has been falling given the investment in costs, mainly people and premises, through the pandemic. Revenue expectations were reduced in July which contributed to, alongside the sale of the ex-Co-CEO’s equity stake, a decline of 29% in the period.
“SDX Energy: -1.5 ppts: SDX is, in my opinion, one of the most undervalued companies in the portfolio. The shares trade at a substantial discount to the core net asset value (allowing for just the production assets and excluding any development or exploration assets). In my opinion, the attractive attributes of low costs of exploration, development and production and fixed price contracts covering much of the production are in no way reflected in the current valuation. Disappointing news on their latest high impact exploration well was the catalyst for the most recent drop in the share price with the shares losing 31% in the period.”