Small Cap Value Report (Wed 25 Mar 2020) - HFD, WGB, DTG, VCP

Good morning, it’s Paul here with the SCVR for Weds.

Estimated timings – probably a little shorter report than usual, I should be done by the 1pm official finish time.
Update at 12:52 – today’s report is now finished. Thanks for the kind reader comments, much appreciated.

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Coronavirus amp; me

Firstly though, apologies for my absence of late. I started to feel unwell 9 days ago. I’ve rented a bedroom in my best friend John’s house in Islington for about 20 years now. 4 of us (including his Mum) share the house, and it’s very convenient and pleasant for me to have a London base. One by one, we started to fall ill last week, with coronavirus-like symptoms. John’s Mum is the eldest, at 74, and she had to be hospitalised. The hospital confirmed that she tested positive for coronavirus, therefore it stands to reason we’ve probably all got it. As things stand, she’s in intensive care, on a respirator, with things looking dicey, we’re desperately hoping that she pulls through. It’s striking how much more serious the virus is for older people, and we’re regretting not having properly isolated her. If any of your relatives are questioning the need for isolation, please forward them this article.

As regards for me, I’ve had a range of expected symptoms, but won’t run through all of that. In a nutshell it’s just like being hit by a bus. You don’t have any energy or physical/mental capacity to do anything, except lie in bed almost 24/7. Today’s the first day that I’ve felt up to writing a report, so my plan is to write sections slowly, then take naps! We’ll see how we get on.

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Market conditions

Unprecedented, I’ve never known anything like it. There are echoes of what it was like after 9/11 (when all the travel shares crashed), and at the worst point in the 2008 financial crisis, but the speed amp; severity of this crash has been astonishing, and horrible to witness. I chronicled the early stages of coronavirus here in these reports. My strategy was to take it seriously, and hedge my longs with various short positions (on travel companies, and on the Dow Index). That back-fired initially, but over the last few weeks it has very much saved my bacon. Hence whilst my existing portfolio of long positions is basically smashed to pieces, I have at least had a flow of profits come from hedging positions (shorts) that has provided a fresh pot of money which I’ve been using to snap up bargains. Despite very difficult economic conditions, I think this is an amazing buying opportunity right now – very selectively of course. I say that because over the next few months we should see the virus peak, then recede, and economic activity return to more normal levels.

I think it might take a year or two for corporate earnings to recover, and all current forecasts have really gone out of the window. However, I’m looking at lots of fundamentally sound companies, and salivating over how cheap their shares have become. The various Govt schemes to pay wages, suspend business rates, guarantee loans, and allow time to pay for VAT/PAYE/NICs should enable most at risk companies to survive. So much stimulus is being thrown at economies by Govts worldwide, that it’s bound to have some positive effects.

Therefore, I think this is a time to be bold, and pick up once-in-a-lifetime bargains.

EDIT: I should emphasise that I’m expecting 2020 to be a complete wipe-out for profits. So I’m expecting literally everything to warn on profits, that’s a given. My point is that share prices have already adjusted for this, and once the market can see light at the end of the tunnel, then it begins pricing in a recovery. Also, we should expect dividends to be widely cut or pulled altogether. Hence lots more bad news, but I think we’re getting to the stage where the bad news is now priced-in. Many companies will need to repair their balance sheets in due course too, so there is danger from dilutive fundraises.

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Share price: 65p (up 8% today, at 08:14)
No. shares: 199.1m
Market cap: £129.4m

Trading amp; COVID-19 Update

As a retailer, then obviously Halfords will be feeling the impact of Govt mandated store closures from recently. No surprise here then:

Whilst we are confident that the post-pandemic future of the business remains strong, trading in the near term is likely to be severely impacted.…

This bit is noteworthy, as a positive;

We have been designated by the Government as a provider
of essential services and so we have the legal flexibility to remain open
across the entire business. [Paul: highly significant I would say]

As it currently stands, our Autocentres
garages and Mobile vans are open and, within Retail, we are working
through a plan to provide partial store coverage from later this week.

Current trading - this first bit is only of passing interest, because events have since moved on;

Recent trading has been in line with expectations, and, in fact, very
strong in the last couple of weeks, but delivery of the FY20 profit
outturn is dependent on sales performance in the final two weeks of the
financial year.

Given the latest Government
guidance we believe there is a high likelihood that sales will drop
sharply and, if so, that the shortfall will have an impact on
profitability, such that FY20 underlying profit before tax, on a 52-week
and pre-IFRS16 basis, could be at the lower end of, or slightly below, the
current guidance range of £50-55m.

Again, that doesn’t really matter, because we’re moving into different circumstances now.

Guidance –

At this early stage in the pandemic, it is not possible to provide
meaningful guidance on earnings in FY21. Our focus now is on taking every
step necessary to secure future value for colleagues and shareholders.

Despite an improvement in recent sales performance, we expect that volumes
could now see a material reduction. We have modelled a range of disruption
scenarios, with our median scenario assuming significant sales declines
for the three-month period from April to June, followed by weakness for
the remaining nine months. Over the course of the full year, this would
result in a sales decline of 25% (c. £300m) with the most material impact
being seen in the first quarter of the new financial year.

At least it mentions shareholders, and not stakeholders (which can often be code for meaning that shares might be worthless).

It’s clear from the above that a 25% drop in sales would have a devastating impact on the bottom line. I think we’re likely to see horrendous losses from retailers in 2020, and I’m really not tempted to punt in this sector. Other than Next, which I have bought recently at around 4000p per share, because it’s the best in class and sells half online.

Cash is king in current circumstances. Looks like Halfords is OK for the time being;

The Group has access to substantial liquidity through a £180m revolving
credit facility (RCF) and a £20m overdraft facility, provided by a
syndicate of major banks, expiring in September 2022. We have drawn down
on the RCF in full and now have approximately £118m of cash on deposit.
Total liquidity is therefore £138m, including the overdraft facility. The
Group continues to expect that it will satisfy its covenant requirements
at the FY20 year-end. We are in active dialogue with our existing lending
syndicate to provide additional flexibility to support Halfords through
this period of uncertainty.

Sounds like it wants to increase bank facilities. Given the Govt guarantee scheme, hopefully that should be do-able.

The following are all common sense actions to preserve cash;

• Suspension of the dividend, resulting in a cash saving of
approximately £24m in FY21.
• As announced by the UK Government, business rate relief for the whole
of FY21. This currently applies to the retail estate only, saving
approximately £26m per year.
• Negotiations with landlords regarding rent relief, including an
immediate switch to monthly payments from quarterly.
• Where stores and garages are closed, we will access Government support
on salary payments.
• Reduced purchases of goods not for resale (GNFR), including lower
marketing spend.
• Postponing capital commitments: Our capital spend for FY21 will be
well below current guidance of £40-60m. We are currently planning for
capital spend in FY21 to be in the range of £10-15m, but this will
remain under review as the situation evolves.
• Optimising working capital, including changes to the timing and amount
of stock purchases.
• Deferral of VAT payments to March 2021.

My opinion – I would have liked to have done some modelling of various scenarios for retailers amp; hospitality businesses, but haven’t been well enough to slave over any hot spreadsheets.

Generally speaking, when unforeseen events force store closures, the financial impact is absolutely crippling – because a fixed cost base has nothing to fund it. That said, I think the Govt actions are probably enough to enable companies like Halfords to tread water, at least in terms of cashflow. What state their finances will be in, once business returns to normal, is anybody’s guess.

I’m giving this one a wide berth for now.

Share price: 31p (down 11% today, at 09:01)
No. shares: 71.0m
Market cap: £22.0m

(at the time of writing, I hold a long position in this share)

Covid-19 update

Walker Greenbank PLC (AIM: WGB), the luxury interior furnishings group, announces the following update in light of the Covid-19 pandemic, including the measures the Company is taking to protect its employees and mitigate risks to its business.

Its 2 UK factories, and some showrooms, are now closed.

Trading in the current financial year [Paul: 31 Jan 2021] started well and was in line with the Board’s expectations but Covid-19, and government measures in our key markets to prevent the spread of the virus, is now impacting our trading outlook. It is difficult for us to quantify the likely impact of Covid-19 at this stage. The Company is, therefore, withdrawing financial guidance until visibility on the impact of Covid-19 improves.

I think it’s safe to assume that current year results are likely to be terrible. I’m just assuming that to be the case for all companies.

Cost-cutting amp; cash preservation measures are being taken.

It sounds as if the company has access to aequate liquidity for now;

The Group had net cash as at 31 January 2020 of approximately £1 million, although this has now moved to a seasonal net debt position. The Group has headroom in its £12.5 million banking facility, an uncommitted £5 million accordion facility and discussions with its bank have been supportive. To further preserve cash, the Board does not intend to propose payment of a final dividend for the year ended 31 January 2020.

My opinion – as with most shares right now, it’s not possible to value WGB on an earnings multiple basis.

The way I look at things, once the dust has settled and business has returned to normal, then this company should be worth several times the £22m market cap. It’s soundly financed, hence I see little risk of it going bust.

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We’re seeing some absolutely bizarre price movements at the moment, both up and down. The way I’m approaching things, is that my normal approach (which is generally buy amp; hold for 2+ years, for generally quite small amp; often fairly speculative shares) has really gone out of the window. I’m seeing this as an opportunity to buy higher quality shares, at bombed our prices. Hence I’m broadening out into some mid and even larger caps, as well as picking up irrationally cheap small caps.

For example, a share that’s been on my wish list for a while, is Dart (LON:DTG) – a strange time to be buying an airline, you might quip. You’d be right! But my view is that DTG’s balance sheet is so unusually strong, that it should survive without a Govt bailout. That could open up all sorts of positive opportunities, as competition flounders. I think people will be itching to go on holiday once coronavirus is in retreat, I know I am!

To me, DTG is the stand-out buy for recovery in that sector. As mentioned here in my disastrously early buying spree on 13 Mar 2020, I got it into my head that the market had bottomed out, closed all my shorts, and bought up lots of things that I thought looked cheap, including some DTG at about 880p per share. Anyway, that turned out to be the quickest quarter of a million quid that I’ve managed to blow recently – in just 2 days. Not just on Dart, that was the total damage to my Spreadex account in 2 days from my jumping the gun. Anyway, there we go.

Meanwhile Dart had absolutely plummeted, and was now down to something like 400p or less. Spreadex closed me out, as my account had moved onto margin call, and I wasn’t well enough to answer the phone at the time. The next morning, DTG warned on profit (hardly surprising) and it dropped as low as about 200p. So by closing me out beforehand, Spreadex had actually helped. I read through the RNS, and concluded there was nothing particularly untoward. The price was now 300p, so I bought back in.

Anyway, where we are now, is that the price has doubled to about 600p. So I’ve sold. My point being that, if things do rebound unusually strongly, then I don’t see any problem with banking the profits. Prices are so volatile, that we don’t know where they’re going. There’s a lot to be said for being nimble and flexible in chaotic market conditions. It’s quite normal for there to be extremely powerful rallies in bear markets. I don’t think this is a time to be standing on principle. If the market presents a profitable selling opportunity, then I’m minded to grab it. The long term can look after itself.

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Share price: 163p (up 9% today, at 12:32)
No. shares: 125.4m
Market cap: £204.4m

Trading update

Victoria PLC (LSE: VCP) the international designers, manufacturers and distributors of innovative flooring…

Trading sounds OK, but bear in mind that coronavirus would probably only have just caught the tail end of this period, so this may not be a realistic overall view;

… despite the ongoing Covid-19 pandemic, which has impacted recent trading conditions, the Group expects that performance for the financial year ending 28 March 2020 will be broadly in line with market expectations.

It goes on to say that it’s not possible to give guidance for FY 03/2021.

This part of the announcement reassures over the survival of the business. I think this is an excellent format, giving specific reasons. The point about bond financing, and operational gearing, are very important;

Not an Existential Threat

The Board, however, is clear that the situation does not present an existential threat to Victoria. Whilst short term trading will be affected, the long-term outlook for the Group remains positive.

There are a number of key reasons that underpin the Board’s assertion in making this statement:

1. Victoria enjoys comparatively low operational gearing across its business. Of our annual operating cost base, approximately;

· 54% of such costs are wholly variable with revenue. This includes raw materials, energy, and freight.

· 36% is semi-variable (which the Board defines as being capable of being significantly changed within 60 days) such as direct labour, logistics, and marketing expenditure.

· 10% is fixed.

2. The Group’s supply chain is highly diversified and invariably localised to the key manufacturing plants. Our access to raw materials is secure.

3. Victoria is fortunate to have a highly experienced and motivated operational management team who have a track record of successfully navigating through deep economic downturns. Many of our managers have been in the industry for 30 years or more and the value of this experience is enormous.

4. The wide geographic spread of both our manufacturing operations and, more importantly, our customers means that the virus’s impact on Group revenue (and its subsequent recovery) is likely to occur at varying times and not simultaneously. This is important.

5. Shareholders will recall that in July 2019 and again in January 2020 Victoria issued a total of €500 million of Senior Secured Notes (“bonds”). These bonds are not due before July 2024 and, in themselves, carry no maintenance financial covenants.

6. Victoria has a strong balance sheet with sufficient cash on hand to support the business in even the most severe scenarios we have modelled. That said, we are taking every precaution to protect the liquidity of the Group. In addition to direct internal actions, we are in the process of accessing various Government schemes in our different countries of operation to help increase our cost base flexibility and mitigate adverse cash flow impacts.

7. The output of our internal stress-testing of the business (discussed in more detail below).

As a result, the Group goes into the uncertainty of the next few months from a position of considerable strength. However, as Darwin stated, those who survive “are not the strongest or the most intelligent, but the most adaptable to change.” Therefore, our managers have been willing to think the unthinkable and act decisively and promptly to protect their business – particularly its cash position – as the impact will, in the short term, be significant.

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For these reasons, I would actually be interested in considering a possible punt on Victoria. Its secure funding means that it should be able to trade normally through this crisis, without having to worry about potential insolvency. But the trouble is, what would earnings end up looking like? Probably pretty grim. It’s likely to survive, but it wouldn’t surprise me if FY 03/2021 is a write-off year, maybe even loss-making? So thinking about it, why get involved at all? I think I’ve just talked myself out of buying any of these!

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That’s all I can manage for today. See you tomorrow!

Regards, Paul.

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