Capital Appreciation: cost jolt masks gains
Capital Appreciation hasn’t had much of either from the market since listing, but there’s a compelling growth story to tell
In a market where sentiment for small-cap shares is at best fickle, fast-growing fintech business Capital Appreciation (Caprec) did the worst thing possible in reporting a drop in bottom-line profits for the year to end-March.
Caprec has yet to reward investors since listing at 100c a share in October 2015, and last week’s post-results fall, to 72c a share, didn’t exactly dispel the doubts.
But a deeper look at the latest results might well convince serious small-cap acolytes that the drop in earnings is not such a dreadful development … and, in fact, might point to enhanced longer-term growth prospects.
In terms of fast-moving shifts in consumer payment systems, there is a good fintech story unfolding at Caprec. The company specialises in the distribution and maintenance of handheld payment devices as well as related software and services through subsidiary companies African Resonance and Synthesis.
The company, which acts as an enabler rather than a consumer brand, showed sprightly top-line growth, with revenue up 20% to R607m. The bigger payments & payments infrastructure division reported turnover up 13% to R470m, with the number of terminals growing 52% during the year to 140,000.
What would have spooked the casual observer was the nearly 60% jump in operating expenses to an unpleasantly chunky R128m. This reduced after-tax profits by 13% to R125m or 8.33c a share.
The operating expenses figure was bloated mainly by the costs associated with bringing new products to market and building operating capacity. It also had to renegotiate terms with a key client "in the interests of gaining increased volume and further market share".
Caprec joint CEO Bradley Sacks notes: "If a market opportunity requires it, we will spend on that opportunity. But it won’t be of the same step change experienced in the past financial year."
While it’s heartening that Caprec’s operating expense line will not reflect such large additional costs in the financial year ahead, it is even more reassuring that management took these costs upfront rather than capitalising expenses. In a time when investors are increasingly suspicious about accounting practices that massage bottom-line numbers (see separate story on Trustco on page 43), Caprec should earn credit for not opting to cushion the blow to earnings by writing costs off over a number of years.
Sacks says: "We could have decided not to pursue these new opportunities and ended up losing future revenue growth. We think we took the prudent option." Of course, shareholders will want to see that the spend pays off in the next few financial years.
In that regard, Sacks says the company is winning market share from its largest competitor, Verifone. There is also plenty of scope for further market share gains. He believes the total market for handheld payment devices is 800,000 to 850,000.
Perhaps more exciting is the steady move towards securing more annuity income flows. New applications are also being piloted — like the Independent Vets Association, where payment points are now offering credit lines, pet insurance and special deals on pet nutrition.
There were questions at Caprec’s investment presentation around increased competition from other fintech players and from the banks opting to develop their own products.
The sense is that Caprec’s dominant market share stands it in good stead against existing and new competitors. Banks are also unlikely to prioritise such niche technology spend on an in-house basis when there are much bigger challenges in a fast-changing marketplace.
Investor and Caprec shareholder James Gubb believes it’s unlikely competitors will swamp Caprec. "I think competitors would be idiots not to buy them."
Gubb believes Caprec presents an intriguing investment proposition in having the attributes of a value stock but also holding enormous growth potential.
Not only does the share trade at a modest earnings multiple of less than nine times and offer a yield of about 6%, but investors buying at the ruling price of 78c have some security in a 39c a share or R611m cash underpin.
While Sacks is adamant the cash pile is still ready to be used for organic growth and acquisitions, there will be a sizeable portion earmarked for a significant specific share buyback in the months ahead.
Caprec will spend R155m on 245-million shares from African Resonance founder Hanoch Neishlos (who will be remembered as a prime mover at Datakor and Aplitec/Net1) at 80c a share. These repurchased shares will be cancelled. That cost will be offset by a related deal in which Caprec plans to sell its 17% stake in Resonance Australia back to Neishlos for R40m.
The prospect of a marked reduction in shares in issue might encourage investors to look more closely at the key figures in the latest financial statements.
The operating margin was 28% — but should return to around the mid-to upper-30s in ensuing years when expenses normalise.
If turnover continues to run at sprightly levels, the FM reckons Caprec should comfortably post bottom-line earnings of 12c a share in the new financial year.
The quality of the earnings is also top-notch on the back of a strong stream of operating cash flows. Cash flow from operations was R213m, representing an enviable cash conversion ratio of 112%.
Gubb says cash flows are compelling
"To me, Caprec is a value stock at the moment. Will it perform? We’ll wait and see. But while waiting I collect a 6% dividend yield. If I had 20 other positions in my portfolio like Caprec, I would be very happy."
The FM reckons Caprec is a well-priced option on future payment technologies. The share price looks cheap compared with iconic financial services brands like Mastercard and Visa on multiples of 26 and 23, as well as smaller players like Wirecard (24), Paypal (27.5), WorldPay (21.6) and Evo (19.5).
A possible X-factor at Caprec could well take the form of an advance by a larger competitor (keen to access its emerging market platform) or a local entity wanting to take an influential stake in new payment systems (Transaction Capital, Long4Life, Sabvest and even existing shareholder African Rainbow Capital Investments spring to mind).
No doubt the prevailing dour mood for small caps will continue to mute enthusiasm for Caprec. But investors should not wait too long to start accumulating scrip as the interim results might already show clear evidence that the spending on new technology is more than justified.