River UK Micro Cap (LSE:RMMC) — Quarterly Investor Update

0:00 Good morning, and welcome to the RIVER UK MICRO CAP LIMITED investor presentation. Throughout this recorded presentation, investors will be in listen only mode. Questions are encouraged and could be submitted at any time by the q and a tab situated on the right hand corner of your screen. Simply type in your questions and press send. The company may not be in a position to answer every question you receive during the meeting itself. However, the company can review your questions submitted today and publish responses where it's appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand you over to Lucy Draper. Good morning to you.

0:29 Good morning, and thank you for joining us. Today, I'm joined by George Enzo, a lead portfolio manager for RIVER UK MICRO CAP. Before we move on to the main presentation, you may be aware that LIMITED has recently announced the proposed acquisition of RIVER Global. The transaction is expected to complete over the summer, at which point the investment team for this trust will transition to LIMITED. I'd just like to emphasize that this will not impact the team, the investment process, or the structure of the trust. And we are pleased that the board of RIVER UK MICRO CAP is comfortable that the investment team will move it intact and will benefit from greater resources across the business. And for those less familiar with RIVER UK MICRO CAP, it's a London listed investment company.

1:14 George and team investing companies with a market cap below 100,000,000 focusing on the bottom 7% of The UK market. These companies are typically less accessible to large institutions and have limited research coverage. The trust also has a unique capital return mechanism, which is triggered when the fund exceeds its optimal size. Historically, this has been above about 110,000,000. And since the launch in 2014, the trust has returned 77,000,000 to shareholders. If you have any questions on on, the LIMITED acquisition acquisition or others, please submit them through the q and a facility, and we'll pick them up at the end. And on that note, I'll pass over to George who can talk you through recent headwinds, latest activity, and performance to the last quarter. Thanks, George.

1:59 Thank you, Lucy. Good morning, everyone. Thank you for the introduction. So as Lucy said, this is a closed end vehicle, and we're trying to exploit inefficiencies at the bottom end of the market. So there's a... There's about 400 companies with a free float market cap of less than 100,000,000. We think there are inefficiencies there. One, there's a there's a a market beta opportunity. That's not something we've seen for the last four or five years, but long term, micro caps outperform small caps, small caps outperform large caps, and that's supported by earnings growth. So so that's a very useful bit of support. We also think there are inefficiencies because very few people are looking at this part of the market.

2:45 There's a lot of companies, and sell side coverage tends to be much lower with with with typically one broker. So we're trying to build a high conviction portfolio of microcaps. We typically have about half of the portfolio in the top 10. We guide to 30 to 40 holdings, and we have this split across what we call different categories or different stages of the company life cycle. And that's just us acknowledging that style performance even right down at the bottom end of the market is important, and it's very difficult or impossible to accurately forecast. And so we spread our bets across growth, quality, and recovery investment cases. To be honest, at this... In... At the bottom end of the market, we are more skewed to growth. And so we've 50% in growth, but you you you will see actually that the quality and the recovery companies do also tend to have an underpin of growth. And the ambition here is for us to take reasonable stakes in micro cap companies, so perhaps a a 5% position in a in a 50,000,000 market cap company.

3:54 For that company to compound double digit earnings growth and attractive return on capital, as that business does that, if we own it for long enough, say, three to five years, the company will grow. As the company grows and the market cap gets larger, we expect those companies to rerate. And so that combination of earnings growth and rerating, we think over a over a three to five year period can can return, you know, upwards of a 100% return. And then we tend to exit as those companies become more attractive to the wider open ended smaller companies peer group. That actually hasn't been a huge opportunity for us recently because those open ended small cap funds have been an outflow. We haven't had to deal with outflows clearly because we're closed ended, but we haven't returned capital since 2021.

4:42 Nevertheless, in a in a market, and this is something I'll come back to in a market where smaller companies have underperformed large cap companies, we've actually delivered pretty good performance. And given we've got a very large small cap or or size factor bet, you know, we're pretty happy with the fact that we've outperformed a much larger benchmark in a in a tough period. You can see our top 10 over on the right hand side. They're very happy to take any questions on those. But just to run through some very high level kind of stats on them to give you a feel for what we're seeing in the portfolio over the over the last couple of months. DF Capital, which is our largest position, we own about 9% of that company, and it's nine percent of the fund. They put out a q one trading update showing 23% loan book growth. It's a specialist lender.

5:29 Their new asset finance kind of growth driver actually grew 40% sequentially. So the loan book from the end of twenty twenty five to the end of q one grew 40%. There is a law of small numbers, and that's only very recently been launched. And their guidance for full year loan book of 900,000,000, they delivered 895 by the end of q one. So we're we're relatively confident that those guys will deliver to the current year expectations. Venture Life put out interims recently. They're moving to a seventeen month period, so it's a it's a bit of a funny time for tracking that one. But q one... Calendar q one of this year, they delivered 18% top line like for like growth and and took gross margin. So gross profit's growing in the in the twenties likely.

6:19 So seeing good growth coming through there as well. Capital is the old capital drilling business, so they hire out drilling equipment to gold and copper miners through The Middle East, Africa, and The US. They've put out their q one. They've delivered 25% of their full year revenue guidance in the first quarter. The first quarter is typically their quietest quarter. Last year, they did 21% of their full year revenue in the first quarter. So they seem to be on track as well. Active Ox is a March year end. They delivered 31% organic top line growth, 180% EBITDA growth. The one negative there was post period end. They've they've lost one of the customers that they acquired through the Enlighten deal, which was announced last year. So there's a bit of a headwind to revenue growth for this year as that customer customer churns out, but but results beat on revenue profits and significantly on cash as well. Sylvania Platinum is a South African based platinum group metal play. They had their q three results this morning.

7:23 EBITDA was up 61% year on year supported by both production and pricing of PGMs. If you annualize their q three, and clearly price is a big driver of that, so perhaps that's a bit generous. But if you annualize the q three results, they're trading on a... On one and a half times EVEBITDA, 40% free cash flow yield. So that's a very cheap business. Investec is a pension administrations business. They did a large acquisition at the back end of last year, which seems to have gone successfully, delivered 28% organic growth through last year, which is in those kind of buy and builds a big, big driver of of value creation. Diaceutics is a lead generation business for large pharma.

8:09 They delivered ARR growth of 30%. They're guiding to 25 revenue growth for the current year. So lots of growth coming through there as well. Ten Lifestyle have just had their results. They've upgraded... They've they've just had their interim results. They've upgraded the out year profit expectations. So that's a business that's delivering some excellent growth at the moment. Netcall, we haven't heard from for for some time, but they delivered their f y twenty five results with 11% organic growth. So that's probably the the lowest growth in our in our top 10. Reported growth was higher because they've had some acquisitions in there. And Supreme... Actually, Supreme will be a bit low growth, but they just beat on their full year numbers.

8:57 So I think they were up kind of high single digits ahead of EBITDA expectations. No upgrades there out yet. Couple of other ones, Keystone Law had numbers this morning. That was an upgrade. Traxxas, we've in the portfolio, had numbers yesterday, 31% EBITDA growth, trades on five times eve EBITDA. Gear for Music is one of our consumer discretionary stocks, delivered 30% organic revenue growth to the year... To the end of March. And the Beauty Tech Group is a business we put in at the IPO last year, delivering 60% top line revenue growth, and they've just upgraded profit expectations for the current year on better margins. So I know there's a lot of kind of concern, particularly around consumers and around kind of, you know, availability and price of energy.

9:45 But what we're seeing from our companies at the moment is still is still very, very positive and and and clearly these... In the main are very cheap businesses. So what have we bought recently? Carrero was a... Is a cybersecurity business we put into the portfolio last year. We've continued to build that through the last quarter, so through calendar q one. Trades on two and a half times EV sales. I think they're delivering kind of mid twenties ARR growth. So one of the higher ARR growth businesses in The UK, quite as high as as as ActiveOps or or Diceutics, kind of all in the in the mid twenties. HSS Pro Service is the old HSS hire business. So this is an early stage growth business. They're going through a transition. They're moving away from the very capital intensive hire business, and they are creating a marketplace to match the needs of people that run building sites with providers of services to those building sites, the largest of which is gonna be equipment hire, and they're doing that in partnership with SpeedyHire who are now 10% shareholders.

10:54 That business trades on four times EV EBITDA. Flowtech is a business we've owned for a long time. We backed the placing and acquisition that they did in February. So that it... Flotek have bought a European business cheaply. Company trades on four or five times EBITDA. They paid about the same for the business they're acquiring. That's also reduced the leverage, which has been one of the challenges for that business over the last couple of years. And then Jersey Oil and Gas is is a play on the North Sea oil and gas opportunity. They have a 20% carried interest in the Buchan Horse Field, which is in the greater Buchan area. The partners there are Neon Energy, Neo Energy, and Serica.

11:40 So if we start to see permitting coming through for the North Sea, then we think that that that business is is significantly mispriced. So it's a bit of an option on, I guess, a more pragmatic view towards North Sea oil and gas development.

11:59 Coming to performance. So these are all of our financial periods going back to our IPO. So I think there are 12 financial periods. The first is our kind of ten month launch period where we had significant cash balances, and then we've shown you from September 30 until the end of last week. This is a quarterly update, so probably right to say that we did underperform through q one. We actually outperformed through January and February. Significant risk off through March. I think we underperformed by 2.4% through q one. We outperformed through our our financial q one, so the fourth quarter of last year, and we've we've reearned our outperformance in April to date. So just the the key points on this slide are that we've got a long track record of of NAV growth, growing in 10 of the 12 periods.

12:54 We've got a strong track record of outperforming our benchmarks. We've outperformed our benchmark in 10 of the 12 periods. And importantly, the small cap premium, which has been either neutral or negative. So the the the the negatives, the single and double negatives show if it was greater or or less than 10% small cap premium. In an environment, you know, typically... So we've always outperformed our peers when we've had a positive small cap premium with the exception of our launch year. We've always been first quartile if there's been a positive small cap premium. We haven't had that backdrop for the last four years. That's something I'll come back to in a minute. But despite that, we've actually delivered one good relative performance to the benchmark.

13:40 At two years to '23 and '24, we were we were third quartile, but but just ahead of our much larger benchmark. And then more recently, we've moved back into the first quartile with with with much stronger performance. Our long term IRR on the fund, so if you take into account the capital returns we've made, our long term IRR after all fees, so this is cash on on cash IRR, is 12.2%.

14:09 So where are we in the small cap premium? We got pretty confident through the back end of last year and post the budget, which was a kind of disinflationary budget that we were starting to see the beginning of a new small cap cycle. That would have... You know, we had a view that we've we've been through this very long painful cycle of of smaller companies under performance, and there there there was a big mean reversion opportunity. The data on here shows peak to trough and then back to the relative peak for all of the small cap cycles going back to 1990. The yellow line on here is the financial crisis. So you can see there, smaller companies underperformed for about a year, a year and a half ahead of the GFC by 20%.

14:55 Very short, sharp period of underperformance. They they they bounce quickly, that v shaped recovery. But that whole cycle took six and a half years for smaller companies to get back to their relative performance point versus UK large caps. The the blue cycle in here is the cyclins.com, and you can see we are now as long as and and underperformed more substantially than that cycle. So this sets us up if you believe in mean reversion, which I do. This sets us up for a big opportunity. Now it could be a positive opportunity. It could be that small caps go up. And given the valuation on offer, that would be, I guess, my best guess. But it could be that large caps underperform and small caps either go sideways or or go down less and... Or or a combination of both. But this... We are setting ourselves up for some point, in the next few years, for a for a huge relative performance opportunity versus large companies.

16:03 As I said there, we we believe that the valuation opportunity today supports the the argument that that smaller companies should go up. We haven't actually seen... So the reason why people own smaller companies is for for the higher earnings growth. We saw underperformance. So if you look at FTSE two fifty earnings relative to the FTSE one hundred, we saw earnings underperform through COVID, so through 2020 and 2021. Since the end of twenty twenty one, FTSE two fifty, so UK domestic earnings, have outperformed the FTSE one hundred. That's to the end of last year. Despite that, you've had this massive derating of smallers versus large large indices. So the green line on here is the FTSE one hundred. You can see it's it's it's not at its highs. It got to 12 times EV EBITDA just before COVID or through COVID perhaps, and it's it's off those levels, but it's kind of in line with its long term history, perhaps a little bit higher than average.

17:06 On the flip, AIM is as cheap as it's been. So the Footsie AIM 100 is the red line. That's as cheap as it's been in the last fifteen years. The Footsie small cap is pretty much as cheap as it's been in the last fifteen years, and the FTSE two fifty as well. And the spread between the 100 and each of those smaller indices is as wide as it's

17:25 been in the last fifteen years. So that would, again, with the with the slide before around mean reversion, would support our arguments that at some point, we get a drop off in interest rate expectations, a drop off in inflation expectations, and you get a rotation from large, to small cap leadership.

17:45 However, we have obviously seen the opposite of that, in the last six weeks. So with the, start of the conflict between Israel, The US, and Iran, we've seen what was an expectation for for two rate cuts in The UK flipped to 1.3 rate hikes, and we're currently pricing about two rate hikes. So that's the chart on the right hand side shows you that in the space of about two weeks, we move from pricing where we are today, three point seven five to twelve months out, pricing three and a quarter base rate to flipping to pricing four and a half percent. And so that's... That drove the significant market sell off, particularly in the more interest rate sensitive parts of the stock market like house builders and large ticket consumer discretionary companies.

18:37 The the chart that's here on the left is an example of some of the research we get. So this is Berenberg's numbers in terms of what they think is gonna happen to base rates. So you can see on there the light gray line is the market expectations before the conflict started. The dark gray line is the is the market expectations now, and their expectations are in orange. So the consensus we're seeing from, the sell side is that there's a delay to interest rate cuts in The UK, but we're unlikely to see, rate rises. I think when we compare where we are today versus 2021, 2022, there are quite a few things that are different. Employment's much much softer. So we had kind of record vacancies in 2022.

19:26 There was the kind of the great resignation, lots of people moving jobs. Vacancies are currently below where they were in 2019, and they're below their fifteen year average. So the labor market is not in the same situation it was in twenty twenty one, twenty two. Inflation's probably gonna top out three and a half, 4%, maybe maybe just over 4%. We also got up to 11% through through the last cycle. So, again, inflation is very different as well. We've also got very different starting rates. So we're starting to stay at 3.75 versus starting pretty close to to zero in in 2022. So I think the playbook of 2122 is is is not the right one.

20:12 However, we are gonna see pressure on consumer discretionary spending, and so large ticket and interest rate sensitive companies have have have priced to reflect that. We actually don't have a lot of exposure in MICRO CAP to consumer discretion. We've got about 10% in consumer discretionary. It's geared for music, the beauty tech group, which both have very good numbers, and and also cake box, which had numbers yesterday and reported to 12% like for like for the twelve months at the end of March. We've got a couple of other, I would call them kind of industrial cyclical interest rate sensitive companies. It's about another 5% of the portfolio where you could see a slowdown in economic activity impacting demands. That'll be businesses like Flotek, which I mentioned earlier.

21:00 So that we, you know, we think we're relatively well positioned with respect to to concerns around demand. And so I will just finish with a couple of points both about The UK and the the portfolio. So we have been through a very significant,

21:22 deleveraging in The UK. So we've moved from... We've actually deleveraged by the most of any g seven economy. We are now... The UK across corporates and households is the second least geared in the g seven. Germany's the best, but we've degeared by the most. And this is why we were starting to buy into the view of The UK UK credit cycle and savings ratios coming down to support The UK economy, and you actually started to see that coming through in the numbers. We do not have a UK debt issue either. We're not an... We're not a negative outlier in terms of debt to GDP at the public level. We do have a cost of debt issue, and part of that is around our inflation profile. Part of that is around political uncertainty as well with with what everyone's expecting as a as a leadership challenge to Kirsterma over the next few months.

22:15 But, actually, the fundamentals are pretty good, particularly outside of the of the outside of government debt. And then looking at the portfolio, we've benefited from m and a. We continue to benefit from m and a. So we've had some very substantial premiums come through the portfolio that's helped performance. We'll split broadly fifty fifty between domestic and international revenue, so that's a good hedge to have. We've demonstrated both through the top 10, but also through the stats here that we've got a portfolio that has grown despite very low growth in in The UK. So 19% per annum revenue growth over the last three years and 50% profit growth per annum over the last three years for the portfolio. That data is actually as at January. We haven't rerun the the analysis for March, but it would be it would be similar.

23:04 The portfolio is extremely cheap. We trade on a 9% free cash flow yield. If you take into account the discount, that moves to, in excess of 10%. The vast majority of our companies are free cash flow positive, profitable, and net cash. So I will stop there and, see if there are any questions. That's great. Thank you very much for your presentation. Ladies and gentlemen, please do continue to submit your questions just by using the q and a tab situated on the right hand corner of your screen. Just while the company take a few moments to review those questions submitted today, I'd like to remind you that recording of this presentation along with a copy of the slides and the published q and a can be accessed via investor dashboard. Lucy, could I please just hand back to you to read out the questions and give responses where appropriate to do so, and I'll pick up from you at the end. Perfect. Thank you. Thanks, George.

23:49 So we've got some questions coming in. Let's kick off with, are you seeing more opportunities due due to capital scarcity in small caps?

23:59 Yeah. I I mean, yes. If... I mean, capital scarcity, I would read as the valuation on the market. So we've run these these data in terms of what the free cash flow yield is on the portfolio a few times. We also look at what our our average upsides to our base case for for fair value for our portfolio is. And I don't think we've ever reported a 9% free cash flow yield before the average upside to our... To to fair values as as high as I've seen it. So there there has, you know, we've continued to see UK smaller companies underperform despite actually very good trading momentum. I went through the top 10. I've mentioned a few other companies. So there is an aversion to illiquidity at the moment. We can absolutely see that, and that does bring up opportunities.

24:52 You know, we are fully invested, and we're... We we normally keep back a unit of cash to participate in in ideas that come along, but we're we're fully invested today. And, you know, we we don't have a huge amount of demand, to be honest, to look for new ideas because our portfolio is so so cheap.

25:11 It's interesting. Thanks. And what sectors are currently miss... Mispriced in your opinion? I I think The UK interest rate sensitive stocks are very mispriced. There's going to be some... There's gonna be impact on demand for those businesses, so particularly travel businesses. So if you're a jet too or an easyJet or Ryanair or or on the beach, which we've got in our small cap fund, you know, people are gonna certainly change where they want to go on holiday, and the price of holidays have gone up a lot because the price of flights have gone up a lot. The prices of flights have reset to a level where the the available molecules for for jet fuel come to Europe rather than going to the Far East Africa or or Latin America. So as long as the Strait Of Hermosa is closed, then we'll need to have high fuel fuel prices and and high ticket prices to support them.

26:06 So there... There's there's going to be a period where we have demand destruction. I think there'll become a point. It's not yet, but they'll they'll come a point where the market's willing to to look through that. The house builders are a sector that have definitely had disappointing updates. We don't have any in in MICRO CAP. We've got one in our small cap fund, but they've clearly seen a pretty a pretty rapid impact on demand. And I I expect we'll see the same on on other discretionary large ticket items. I I think one of the other differences... I mentioned the differences between the setup today and and 2022. Yeah. I don't think the consumer is gonna get bailed out by by very high real wage increases.

26:54 And it's kind of important that they don't because if they do, then we do need to put interest rates up, and we do go into a more similar cycle. And so there's gonna be retrenchment of consumer spending, and that will hit discretionary more than it will hit staples. And so that that... That's... You know, on a five year view, I think that's a very mispriced opportunity. But if you add into it demand destruction short term, but also a potential leadership challenge and someone else coming in, the market's gonna take a view on whether or not that new person will stick to Rachel Reeves' kind of financial discipline, and you could see another leg down in UK domestic cyclicals. And so we're being quite patient with that opportunity at the moment.

27:41 Interesting. Thank you. And we've got some questions here about the the bigger picture. So what's the board's role in challenging portfolio decisions? Yeah. I would say the board are pretty good. We... So I I obviously have a quarterly update with them. They do challenge on on stocks and and make sure that we're... You know, we've we've got a very structured philosophy and process. So our process starts with the quant screen. We do a lot of work on these stocks. We obviously meet management teams. We build models. And so they they challenge companies, both ones that have been doing well and ones that have been underperforming. I mean, there's going to be, as always, a bit of asymmetry of information because we do this kind of twenty four seven.

28:32 So we should know 35 stocks pretty well, But they but they do challenge on, you know, how how we're positioning and and what our view is on companies. And moving forward, so I would guess this references Lion Trust. Moving forward, will the team retain full autonomy over stock selection and position sizing? Yes. Absolutely. So that is unchanged. The the the process, the philosophy, everything we do on a day to day will be totally unchanged. You know, the... There is an issue, but the only place it would become an issue is if collectively, the whole business own more than 30% of the company. So that isn't a risk, but they've got a MICRO CAP firm. We've got a MICRO CAP trust.

29:18 You'd have to have a very large position in both of them for that to be an issue, or it'd have to be a very small company. But but outside of that, there's absolutely no change to to how we run the fund. Perfect. Thanks. I think that's all the questions for today. That's great. Thank you for answering all those questions you care from investors. And, of course, the company can review all questions submitted today, and we'll publish those responses on the investor meet company platform. Just before redirecting investors to provide you with their feedback, which is particularly important to the company, George, could I please just ask you for a few closing comments? Yeah. So, you know, as as I've said, I think rate cuts move to the right a bit, and we've got some potential short term demand challenges. That's not something that we think is gonna massively impact the portfolio. I do think there's a total mismatch between what we're being told by companies and the and the valuation.

30:06 We went through the the top 10, but we're we're seeing kind of as good a readout on company financials as we've seen for a long time. Expectations remain very conservative. Valuations remain really low. So when we think about our our our philosophy of of buying companies with strong fundamentals, buying them cheaply, and buying them with strong operating and earnings momentum, we do have that in the portfolio at the moment. And, you know, we think it sets us up alongside the the recovery in the small cap cycle at some point for generating some really positive returns over the next three or five years.

30:43 That's great. Thank you for updating investors today. Now please ask investors not to close this session as you'll now be automatically redirected to provide your feedback in order that the management team can better understand your views and expectations. This will only take a few moments to complete, and I'm sure be greatly valued by the company. On behalf of the management team, we'd like to thank you for attending today's presentation, and good morning to you all.