PHSC - A Micro-Cap Option

http://www.phscplc.co.uk/

 PHSC Logo

AIM is home to many micro-cap stocks, and most of them tend to be difficult to value. That is down to them usually being fairly speculative, but also because there is a real risk of the company running out of cash, or de-listing from the exchange. Annual costs of being listed on AIM differ dependent upon the company but usually exceeds £200,000, meaning that sometimes the cost cannot be justified, especially if the company is not profitable. For those reasons, investors tend to limit their exposure or not deal within the micro-cap arena at all. PHSC (LSE:PHSC) is an interesting case because it is profitable, and its financial performance seems to be improving. That said, when investing in such companies, your research needs to be meticulous and you need to accept that any investment would be very high risk, but potentially high reward. PHSC's share price stands at 31.50p and there are 12.69m shares in issue. The company is valued at £4m.


As is typical of micro-cap companies, PHSC does not have a large investor base. The result is that the shares are relatively illiquid and struggle to gain traction easily and multiple tests of resistance levels are often required before there can be a sustained breakout. The reason is that (having been a lot higher in the past, pre-2008), there are a number of 'stale bulls'. These are investors who were once bullish on the company's prospects but who have since seen the share price fall considerably. Combined with the years of false dawns since 2010, these stale bulls will have sought to sell into any strength. That happened during late 2012 and early 2013. On that occasion, the bull case broke through and the shares have been moving in an upward channel ever since - the share price currently at 31.5p having made a recent minor high just short of 35p. The point to derive is that the market seems happy to take the shares higher, and there is no real resistance until 40p, and even that resistance is fairly weak. However, as I always stress, there needs to be a fundamental backing for such a move.

The company is headed by Stephen King (CEO and Chairman) and Nicola Coote (Deputy CEO and Deputy Chairman). They hold a significant number of shares (50% between them), which is a bit of a double-edged sword. On one hand, their interests are very much aligned with that of shareholders (their salaries are not excessive), but on the other hand, should they ever choose to sell the shares then the market can develop an overhang, and that can depress the share price. Two venture capital trusts hold a disclosable amount of shares in PHSC, so that is encouraging. Overall, the technical picture is bright although certainly don't expect quick movements from PHSC. It's a slow burner.

RSA Environmental
The business itself is highly uninteresting, and somewhat confused (in my opinion). That is due to the sheer number of operating subsidiaries (6 in total. There were 7 before two were effectively merged together). There are some synergies between the businesses that operate in the same sub-sector, but aside from those there aren't many and the industries operated in differ.

- PHSC (Personal Health & Safety Consultants)
- RSA Environmental Health = Provider of consultancy and training services to a range of markets
- AdamSons Laboratory Services = Another provider of consultancy and training services to a range of markets
- Inspection Services UK = Engineering inspection company
- Quality Leisure Management (QLM) = Service provider to the sport and leisure management sectors
- QCS International = Consultancy and training service provider to multiple industries
- B to B Links (B2B) = Security solutions provider (e.g.CCTV installations and product tagging)

QCS and B2B were the most recent additions to the PHSC portfolio, and those are showing the best growth and financial performance. However, all of these businesses operate in sectors which have low barriers to entry, and are thus very competitive. That means that gross margins tend to fall over time, and there is a strong emphasis on trying to build up recurring revenues through brand strength and good customer support.

(figures are in £'000)
The more mature businesses of the bunch include PHSC, RSA, AdamSons, Inspection and QLM, although they each account for a different proportion of revenues and profits. As can be seen from the interim results on the right, there are several businesses that contribute very little to the overall performance of the group. The profits are made on quite large revenues as well (the smallest is £98k by Inspection) and to pick one out, AdamSons made £35,000 on revenues of £1.33m for the half-year. Of course, all these figures should be at least doubled to get the annualised figures (note that PHSC's performance is slightly weighted towards H2), but it highlights the low margin nature of the business. Any revenue swings therefore can have a disproportionate impact upon the profit/loss readings, which is not a good position to be in. It will be interesting to see whether PHSC decide to dispose of any of the companies - they have said that Inspection will have a reducing impact going forward, so given that it doesn't fit into the portfolio, it could be disposed of.

The most promising business is undoubtedly B2B. For the half-year it produced revenues of £1.475m which was a healthy increase on the prior 6 months. The increase was down to an ongoing contract to install CCTV for a national retailer - that has led to monthly revenues of £140,000 being booked. The obvious question that remains to be seen is whether they can secure more contracts to ensure this is not a one-off increase in profits once the installation ends. However, management has stated that B2B has required more work than initially anticipated, and that gross margins have fallen due to the focus on the CCTV deal. QCS has performed well since it's acquisition, and "ahead of management's expectations".

Total interim results were pretty impressive and as follows:


As can be seen, those metrics are a vast improvement on those of recent years once factoring in a 10% H2 weighting. That may be slightly generous, but it still highlights the progress the company is making, albeit that performance is being almost entirely driven by the two new businesses. Indeed the management commented that the other subsidiaries that dealt with health and safety, saw 'mixed fortunes' with the performance broadly flat. That is an issue, particularly if the revenues start declining. As mentioned earlier, a decline in the revenues could easily translate through to worse profits or losses. Looking beyond that, the revenue figure itself is a substantial 79% rise year-on-year and EBITDA was also very healthy at £359k. These figures are more impressive because they actually beat management's expectations that had been set out in August. The expectations included forecast 2013/14 revenues of £6.5m -> £6.8m, and an EBITDA profit of £700k -> £750k. At this rate they look certain to beat the management's revenue expectation, although whether they do on the EBITDA figure will be tight. Thus if momentum continues, the full-year results could look very good.

The H1 post-tax performance amounted to £244k vs £72k the year before. There were also significant net receivables on the balance sheet, although looking at past trends there has been a large amount of net receivables for a while now. The net asset value figures given by the company are not particularly useful as the majority of it comes in the non-cash form of goodwill.

Taking the figures, annualising them symmetrically and adding in the +10% weighting (again, that may turn out to be slightly generous) retrieves a possible EPS figure of 4.83p. In any case, circa 4.20p should be the base case for the current FY, assuming that current momentum levels are sustained. At that level, the shares would be trading on a 2014 forward PE of just 7.5. However, the cost of the acquisitions has been a deterioration in the strength of the balance sheet and a placing was undertaken in September 2013 to correct that. The placing was completed at 25p/share and was oversubscribed, which is no surprise given that it was organised at a steep ~25% discount. Positively though, the shares did not fall near to 25p, which perhaps suggests that the placed shares were not immediately offloaded. At the end of October PHSC had £523k in cash with £200k in bank facilities with HSBC.

CEO Stephen King, commenting on the Placing, said: "After factoring in the stage payments related to our two most recent acquisitions, the board felt that it was appropriate to seek additional working capital. The purpose of the funding is to enable the continued growth of the Group, and to reduce our
reliance on financing assistance available through our bank. As can be seen from the trading update above, the Group continues to trade profitably and ahead of the position last year. The consequences of the increased activity include higher stock levels, additional work in progress, and a larger debtor
register. With this new funding in place we are confident that we can overcome the cash flow constraints that have been impacting the business."


Security solutions subsidiary, B to B Links
Whilst the cash balance is good at the moment, the future cash balance is what is plugging the shares from rising. As part of the acquisition of B2B and QCS, deferred payments were involved, the level of which were performance based. The final parts of these payments are set to fall due between July and September this year. The QCS payment will be between £40k -> £80k (probably near £80k given that the performance has beaten management's expectations), whereas the B2B payment will range between £120k and £800k. That is the key here. Anywhere up from £300k and cash will start being an issue again and in those circumstances it would be prudent for the company to not issue a dividend (which amounted to 1.5p last year). The answer would be to complete another placing (if necessary). That could cause a short-term blip again, although based on the last attempt, that damage certain wasn't lasting. Arguably the cash concerns are therefore being overstated and that the shares are good value.

I would concur with the view that the shares are good value based on historic financials, even when factoring in the very small chance that the company will de-list (PHSC is profitable and growing). However, the corporate structure and lack of intellectual property, combined with the insecurity over how recurring the revenues at B2B will be, are enough to detract from the overall investment case. That may well be a shallow view, but I wouldn't be completely comfortable with having PHSC down as a Buy at the current point of time and you need to be when investing in such small businesses. That said, I can fully understand why investors would take a bullish stance on the company and there is every chance that they will be rewarded. A micro-cap company that is making solid progress. No Rating

2 comments:

  1. Good article el1te! HNY

    CraigJ

    ReplyDelete
  2. I concur. The business model looks like anyone can come in and replicate what they do. in the long run you have margin pressure which makes the business not worth operating

    ReplyDelete