Small Cap Value Report (Fri 24 July 2020) - FCCN, RNO, CALL, BEG, CHRT, HOTC

Good morning, it’s Paul here with Friday’s SCVR.

I nodded off after lunch yesterday, so there’s still a section missing on Cohort (LON:CHRT) . I’ve been through all the accounts, and taken notes, just need to write them up. So I’ll catch up with that later, and indicate here when it’s done.

UK retail sales for June have come in reasonably robust in the circumstances, down -1.6% year-on-year (better than -6.4% forecast).

UK PMI survey data (confidence) have just come out, and look surprisingly strong. Composite PMI (flash, for July) is 57.1, versus 47.7 in June. That’s very reassuring indeed. Similarly strong PMI data has also come out today in France amp; Germany. Therefore, it looks like economic recovery in the UK and Europe’s biggest economies, is well underway. That gives me more confidence to sit tight on my long positions, and that the time for shorting may have now passed? Possibly? Nobody knows, because markets anticipate these things, and hence often do the opposite of what we might expect.

Face masks in shops, etc, become supposedly compulsory today, but police say it’s unenforceable. I’m finding it bearable, wearing a light, cloth face covering, that’s reasonably comfortable. So it’s really not a big deal, and can only help (ie. it can’t make things worse).

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French Connection (LON:FCCN)

Share price: tbc
No. shares: 96.6m
Market cap: tbc

(I’m long)

Refinancing

The RNS is actually called “Trading Statement”, but I’ve renamed it to be more accurate!

This is a bit of a game changer. I was worried that FCCN might run out of cash, and go bust. However, that risk has now disappeared for the next 2 years, because it announces today a new £15m working capital facility with Hilco (restructuring experts). FCCN says this is sufficient for its needs. Hopefully Hilco might give FCCN a push to do a pre-pack administration on the moribund stores portfolio? FCCN did not qualify for Govt financing schemes, but hints that it has deferred tax and other payments, which will need to be paid sooner or later.

Collection of wholesale receivables (a substantial part of the balance sheet) better than expected during the lockdown period – good news.

Own website sales up 24% over last 15 weeks – not great, it should be a lot more than that in my view.

Stores – initial sales since re-opening have been low, but good conversion of people in the shop into buyers.

Outlook – no guidance given.

My opinion – this is a huge sigh of relief, and we could see a bounce in the share price today. The risk of a 100% loss should have disappeared for 2 years now, giving the business time to continue the recovery that was underway prior to covid. Once those onerous leases are ditched, there should be a profitable wholesale amp; brand licensing business remaining. I’ve been saying this for years, because it’s true – look at the divisional performance figures.

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Share price: tbc
No. shares: 225.4m
Market cap: tbc

(I’m long)

AGM Statement

Renold, a leading international supplier of industrial chains and related power transmission products, issues the following statement ahead of its Annual General Meeting to be held at 11:00am today. The statement provides an update on the Group’s first quarter of the financial year ending 31 March 2021 (‘the Quarter’).

Q1 is April to June 2020, in other words.

Today’s update is light on detail!

Group performance during the first Quarter has remained in line with the Company’s Results Statement issued for the year ended 31 March 2020. Renold has been profitable and cash generative in each month of the first Quarter of the new financial year.

Whilst Group order intake has reflected the challenging market conditions, gradual improvements have been seen since April 2020.

It is still too early to give specific guidance for the year ahead.

However, with the strategic actions and cost saving measures taken to date, the Board is confident that the Company can manage through the current period of disruption. Renold is well positioned to benefit as markets stabilise and demand recovers.

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My opinion - there’s not enough information in this update for me to go any further with this.

What it seems to be saying, is that things are bad, but not disastrous. If it can get through the crisis without having to raise fresh equity (which was suggested could be achievable, in its last update), then there could be nice upside here on a recovery. That’s why I took a small long position in it after the last update. I’ll neither buy more, nor sell, on today’s news.

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(I’m long)

The recording of the investor presentation earlier this week is now live – here is the link.

It’s a stock we’ve followed here for years, always seemingly on the cusp of good things. So I can understand that many investors are sceptical. But it does sound as if the company is on the right track now.

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Quarterly Red Flag Report

Thank to Edward John Canham and others, for flagging up this interesting, regular quarterly report – useful background reading for investors, although it rarely contains any surprises.

Obviously financial distress for companies is up again. Here’s an interesting point I hadn’t considered before;

The rise could have been much higher, were it not for reduced court activity due to the coronavirus pandemic which has substantially reduced the number of CCJs and winding up petitions being taken against indebted companies.

CCJs lodged are down 40%, and winding up petitions are down 73%. That backlog is likely to unwind at some point.

This sounds ominous;

… it is likely that the true impact of the coronavirus pandemic will only become apparent during the third and fourth quarters of 2020 as government support initiatives are unwound and courts fully reopen so that enforcement action can be taken.

There must be lots of bad debts building up, particularly with smaller businesses in sectors such as retail, hospitality, travel, etc. Who takes the hit, and will bad debts pull larger companies down as well, maybe?

The effervescent Julie Palmer of Begbies concludes cheerfully;

“The latest figures from our Red Flag Alert research show that there is a dam of company financial distress waiting to break upon the UK economy. Despite more than 30,000 businesses having fallen into distress since the start of the year, the real level of corporate underperformance is being concealed by inaction on distressed businesses in the courts.

More sector detail is given.

Here’s an additional point from me;

Credit insurance – many companies insure themselves against bad debts by using insurers like Euler Trade Indemnity. I remember dealing with them years ago, when I realised they were actually more important than out bank, as they insured a lot of our supplier base. So I used to go to their offices and give them a presentation on our annual results. They were a bit of a nightmare, since they switched cover on and off, on a whim, causing a lot of disquiet amongst our suppliers, and hassle for me to get cover reinstated repeatedly.

Anyway, trade credit insurers must be pulling cover left, right, and centre, at the moment. That can often tip companies into insolvency, because suppliers may refuse to deliver goods, if they can’t insure the invoice. Or demand cash up-front, if there’s no insurance.

These issues must be hurting a lot of companies. At least listed companies have better access to funding, so may not be so badly affected.

We need to keep this issue at the forefront of our minds. How solid are receivables, within current assets? What level of provision might be needed for bad debts? Is there concentration risk from big customer(s) that could go bust, within receivables. There’s often something buried in annual reports about this kind of risk, so it’s worth checking.

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Share price: 591p (up 4% yesterday)
No. shares: 40.96m
Market cap: £242.1m

Preliminary Results

This is a group of 5 companies, mainly focused on the defence sector, with the MoD being a big customer. It has diversified into other areas too.

The main share price rise happened from 2010-2015. Then it traded sideways for several years, and has had a more recent spurt upwards;

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There’s been a steady stream of growing divis too, although the rise in share price has kept the yield quite low;

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Note that the final divi stream is continuing, despite covid, with a final divi declared of 6.9p (up 10%), giving a total of 10.1p – a yield of about 1.7% – worth having, but not madly exciting. It sends a strong message of confidence in the business, by continuing with increasing divis.

Results for FY 04/2020

EPS 37.1p (up 10% on LY) – looks a beat against consensus by TR data of 34.9p, but the company says results in line with its RNS of 21 May 2020.

Net debt £4.7m, down 27%. Note that this masks £25.2m of long term bank debt, offset largely by a £20.6m cash pile. This suggests to me the year end cash balance is probably at a seasonal, or window-dressed high. Hence underlying debt is higher than it might at first appear. Not a problem, I’m just pointing it out so you’re aware.

Order intake down 34%. Looks nasty, but company says this is as expected, due to a large multi-year contract win last year. Order book covers 75% of forecast revenue for the current year, FY 04/2021 – that looks solid.

Covid – estimated to have hit profit by c.£1m

Profit growth has all come from the Chess acquisition – so some question mark over growth from other businesses.

Guidance – company says FY 04/2021 expected to be in line with FY 04/2020. Great to have some proper guidance, and demonstrates that company has decent visibility on earnings.

Balance sheet – looks OK to me. NAV: £81.8m , less intangibles of £55.3m, gives NTAV of £26.5m – adequate.

Cashflow statement – only unusual items are £3.7m purchase of own shares, and £1.5m sale of own shares. Everything else looks as I expected.

My opinion – this looks a decent collection of 5 quite high margin, niche businesses. I like it.

PER of 15.9 is probably about right.

I wouldn’t know how to assess the group’s future prospects, so overall I’m neutral on this one.

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Share price: 304p (up 9% today, at 12:08)
No. shares: 125.5m
Market cap: £381.5m

Trading Update

Hotel Chocolat Group plc, a premium British chocolatier and omni-channel retailer, today announces a post-close trading update for the 52 weeks ended 28 June 2020 (“FY20″), and an update on recent trading, the Group’s financial position and outlook.

Obviously the physical stores were closed during lockdown. What interests me most at the moment, is how adaptable companies are, in moving sales online. There looks to be a big tick in this box for HOTC;

In total, digital sales accelerated to over 200% year-on year in the fourth quarter. In addition to increased gifting sales, digital sales growth throughout the period was supported by a 47% year-on year increase in the sales of subscriptions and recurring purchases, including Hot Chocolat refills for the Velvetiser in-home system.

That’s impressive.

The revenue shock in H2 from closing the stores (and temporary closure of its factory) is much lower than I would have expected, due to successfully moving sales online;

That’s astonishingly good actually, considering that all the shops were closed 12 weeks from 22 March to 15 June.

Underlying profitability -

The Group anticipates underlying pre-tax profit to be in line with expectations. In the light of current and anticipated trading performance the carrying value of existing fixed assets is being reviewed. This review may give rise to a higher than historic impairment charge, but any such adjustment will be a non-cash charge and will be confirmed at the release of preliminary results, scheduled for 29 September 2020.

I’m not bothered about fixed assets being written down, that doesn’t matter. I’d be more worried about what the leasehold liabilities are for any loss-making shops. That could be a cash drain for years to come, if town centres don’t recover enough to make them viable.

Store re-openings – no figures provided unfortunately;

119 of 125 UK locations are currently open for business. Sales in “High Street” locations are performing more strongly than in city-centre “commuter” locations. Whilst total sales from physical locations are lower year-on-year, digital growth remains very strong and Group-wide sales since the end of the period remain in line with management expectations. A similar pattern has been seen in both the USA, and in Japan, which is operated by a joint-venture partner.

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Forecasts – only 1.2p for FY 06/2020, and 2.2p for FY 04/2021. Hence the share price of 302p looks insanely high on a conventional PER multiple valuation basis. However, I think that is missing the point. What this share really is all about, is the potential to roll out the Hotel Chocolat brand internationally. Not just stores, but also online. It’s the strong growth amp; resilience of its internet offering over the covid crisis that really makes me sit up amp; take notice.

My previous scepticism may have been misplaced. I don’t think I can bring myself to pay up such a high valuation for a business that’s likely to be trading little above breakeven for a while, and may have years’ worth of problem sites to wriggle out of, possibly? But the brand clearly has strong appeal, otherwise online sales wouldn’t have rocketed during lockdown.

Overall then, my conclusion is: very expensive, but could be exciting long-term, maybe.

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