Small Cap Value Report (Mon 14 Sept 2020) - TUNE, COST, BOO, TPX, PIER, PCIP, XPD, SCE, SYM

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

This article will gradually take shape during the day, but is initially here for you to add your comments on the 7 am RNSs.

Estimated timings – I’m mostly done now (at 12:42), but might add a bit more later this afternoon.

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Second wave?

I’m sure we’re all very conscious of the news, showing considerably increased numbers of covid cases in the UK (and elsewhere). Whether it should be called a second wave, or just a continuation of the first, who knows? It doesn’t augur well for the colder autumn weather, once we’re all inside again, does it?

Should this affect our investing, that’s the trickier question? People who panic sold in March, have since missed out on one of the best bull markets ever, and certainly the quickest. Apparently there’s still money on the sidelines, of people waiting for another big pullback, which so far just hasn’t happened.

Personally, I’ve decided to focus new positions on companies which have demonstrated that they can ride out, or even trade well, through the last covid/lockdown crisis. Or companies that took a hit, but recovered very quickly, with very strong sales once lockdown was lifted. Also, companies which are strongly financed, and previously paid out big divis, are high up my agenda.

There are some super opportunities to lock in probable future divis of 5-10% p.a. (I like Somero Enterprises Inc (LON:SOM) (I hold) and Headlam (LON:HEAD) (I hold) as good examples of this). In a super-low-permanently interest rates environment, which is increasingly my view of the future. then big and safe yielding shares are likely to become more sought after – buying now locks in a lovely yield, and probably a future capital gain as other investors chase the price higher to get the yield once it becomes more obvious.

I’ve got enough of my post-covid recovery shares which are looking riskier right now , so am not adding to those positions (e.g. Revolution Bars (LON:RBG) and Ten Entertainment (LON:TEG) and Hollywood Bowl (LON:BOWL) ). Although we’re probably only months away from at least the early stages of vaccines, and better treatments. Vulnerable people are (rightly) isolating themselves, and it looks as if we might need to get some degree of herd immunity amongst younger people, maybe? That might happen whatever the rules are, as we’re seeing increasing reluctance to follow rules, which seem a contradictory muddle anyway. Helped along by media which seem to be actively trying to make them seem more complicated – e.g. by running through all the different rules in England, Wales, Scotland amp; N. Ireland, whereas actually they only need to tell people which rules pertain in their local area.

On balance, as long as the death rate remains very low, then I’m not planning on making any changes to my current portfolio.

I’m reading a book on the far worse 1918-19 Spanish Flu, which is certainly helping to put the current situation into perspective.

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Share price: 805p (up 9.5%, at 09:40)
No. shares: 58.1m
Market cap: £467.7m

Trading Update

The market cap has gone above my usual (flexible) £400m limit, but this is such an interesting company, I’ll carry on doing updates on it. Sadly, I didn’t buy any, because it always looked too expensively-rated. The trouble with over-paying for shares is that you might be buying the best companies, but some of them can’t maintain the growth and then drop heavily in price. Without a crystal ball, it’s very difficult to determine which are longer term winners, and which ones are just in a speculative bubble. I think that’s where sector knowledge comes into play.

Focusrite plc (AIM: TUNE), the global music and audio products group of companies, supplying hardware and software used by professional and amateur musicians and the entertainment industry, is pleased to update the market on a strong trading year in which revenue, profits and cash flow have all grown substantially.

It’s been making some acquisitions, so some of the growth comes from that. Organic growth also looks very strong at +23%;

The Group expects revenue for the financial year ending 31 August 2020 to be ahead of market expectations at approximately £129 million, up from £84.7 million last year. This growth comprises a full year of ADAM Audio revenue, acquired in July 2019; eight months of revenue from Martin Audio, acquired in December 2019 and growth of approximately 23% in the core Focusrite Audio
Engineering business.

It’s so much clearer amp; easier to when the figures are put in a table, rather than text like this. The £129m revenue figure above is £5m ahead of the broker consensus forecast shown on the StockReport – a decent revenue beat, especially as it’s all come at the end of the year, when most revenue is already in the bag. This probably suggests that a strong start to the new financial year is likely.

Gross margins are up, and EBITDA is ahead of expectations;

Gross margins have improved from the prior year and as a result EBITDA is also expected to be ahead of market expectations.

That’s a great combination – when products are in strong demand, then selling prices can be raised, giving a lovely geared boost to the bottom line.

Cash generation - this is particularly impressive. I was previously a bit concerned about the level of debt taken on to make this acquisition, but it’s been rapidly repaid;

Cash generation remains a high priority for management and, as at 31 August 2020, the Company had a net cash balance of approximately £3 million. This has improved substantially from a net debt position of £19.9 million as at 29 February 2020. For comparison the net cash balance as at 31 August 2019 was £14.9 million, prior to the acquisition of Martin Audio for £35.3 million, net of acquired cash but prior to acquisition costs.

Note that this has been partly achieved by reduced inventories, due to strong demand. It would have been helpful for the company to give us some figures on that. So net debt is likely to rise again somewhat, as inventories rebuild. But it’s so low, it doesn’t matter now.

The company is paying back £164k Govt support under the furlough scheme.

My opinion - this is a really good group of companies, in the right area – business must have been boosted considerably by lockdown, increasing blogging amp; vlogging, etc. There are a lot of musicians out there, kicking around with nothing to do (as live gigs are a thing of the past for now). Plus millions of amateurs also. Focusrite serves that niche with suitable equipment.

The consensus forecast shown on the StockReport is 27.5p EPS, so let’s assume something like 30p is more likely. That puts the PER at nearly 27 – quite high, but as you can see below, the track record justifies a high rating;

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Overall, I see this as a terrific company, probably priced about right, in my view. Expensive, but the facts amp; figures justify that premium.

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I’ve covered this infrastructure company a lot in the past, always concluding that its complicated, large contracts, on low margins, make it an unattractive sector.

Looking through today’s results, the size of the exceptional charges relating to 2 contracts that went wrong, is such that I’ve decided to drop coverage of Costain. It’s just not a good use of my time, to spend hours unpicking the results, to draw the same conclusion every time. I’d rather write about companies which are quicker amp; easier to analyse, and where I see a good opportunity for us to make some money. Talking of which…

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306p- mkt cap £3.73bn

This has become my largest personal long position in recent weeks. I know the business very well, and believe that a combination of misjudged short selling, and indiscriminate selling by so-called ethical investing firms (triggered by re-hashed allegations of supply chain problems in Leicester), may have created an artificially advantageous buying opportunity.

As it’s become my biggest holding, I spent some time over the weekend revisiting the facts amp; figures, to reassure myself that risk:reward is still favourable.

Downside risk - this comes mainly from an adverse market reaction to the findings of the supply chain investigation which is due to report directly to BOO tomorrow (15 Sept). The timetable is that BOO will then update the market on its findings, together with its Q2 trading update (June, July, August trading) on 30 Sept.

It’s not clear whether the report is going to be published in full, or whether BOO will filter it and summarise the findings? If the latter, then there is clearly scope for BOO to edit out any unhelpful details.

The bottom line with this supply chain issue, is that it won’t affect profitability, and the liability for any malpractice rests with the suppliers concerned. All manufacturing is subcontracted out, so there should not be any liability with BOO itself, I believe.

Commentators who say that BOO’s profits are built on low wages in Leicester, don’t know what they’re talking about. Leicester is used for convenience, not because it’s cheap. As mentioned here before, the product can be made far more cheaply in Bangladesh, and then air freighted into the UK. Which is what some of BOO’s competitors do. Therefore moving production abroad will raise gross margins, not lower them.

Overall then, I see the risk being purely of another short term, sentiment-driven spike down in price, which would present us with another buying opportunity.

Last trading update – I looked again at the RNS on 17 June 2020, updating on Q1 progress. It’s remarkably good. After initially weak lockdown sales, trading rebounded, and the group hit +45% sales growth vs LY Q1. Core UK growth was +30%, but overseas much better, e.g. USA +79%, Europe +66%. Total international sales are now half the group total, and growing faster than the UK, so by now are probably exceeding UK sales.

New brands were all trading well in Q1. Gross margin was up to 55.6%. Guidance for the full year was raised. Longer term guidance is for continued revenue growth of +25% p.a. 2 new brands (Oasis amp; Warehouse) bolted on for just £5.3m.

On the back of this, the share price rose to over 400p. It’s now just over 300p, so the supply chain issue is knocking 100p+ off the share price, for no reason.

I reckon EPS could rise to c.20p in 2-3 years. Put that on a PER of 40-50 (justified by the continuing growth), and we’ve got a share price target of 800-1000p, with patience. Hence why this is now my largest position.

New Look - in today’s news, rumours are that BOO is interested in buying major competitor New Look. It’s not clear whether that is an alternative to the CVA underway, or if it would involve BOO buying NEW post-CVA? So far, BOO has determinedly resisted the temptation to operate any physical shops, but that might change in future, if it can acquire shops on turnover rents? (which is what CVAs are increasingly seeking to do).

Overall, I reckon that once the supply chain issue has been forgotten about again, then maybe we could see the share price of BOO surge again to maybe 400-500p? Longer term, the sky’s the limit, as long as it keeps growing.

Obviously please DYOR, and we have to be prepared for a potentially bumpy ride, but I think the fundamentals look very strong here.

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Share price: 138p (up c.6%, at 12:21)
No. shares: 67.3m
Market cap: £92.9m

I remember listening to the podcast version of the last results presentation published by PIWorld, and thinking this company sounds interesting. Here is the video of it.

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Although when I got home and crunched the numbers, I didn’t like the way it was funding acquisitions, which from memory was something like having large deferred consideration dilution in the pipeline. This means the PER isn’t actually as low as it seems, once you take into account future dilution.

Today’s update- sounds reassuring;

“The Board are confident that results for the full year will be in line with their recently upgraded expectations and in their ability to achieve their three-year commercial vision to deliver £100m run rate revenue by 31 March 2023 with EBITDA of £12-14m.

Acquisitions – the last bit above is an aspiration only, remember. It’s fuelled by acquisitions mainly too, so the big question is whether management can execute well. A key question is therefore, what previous experience of acquisitions do management have, and did those work out well in the long term, or not?

The financial year end is 31 March, so Q2 trading referred to below means July, Aug, and Sept to date;

“Following the Group’s record performance in the first quarter, in which we delivered organic revenue growth of 10% on a like-for-like basis, I am pleased to report that trading remains strong.

The Group has signed approximately £10m of new contract wins in the first two months of the current quarter, including a £1.8m contract win with Cheshire West and Chester Council, and Cheshire East Council, as well as the previously announced Land Registry contract. In addition, we have enhanced our offering by welcoming Arthurly and Difrent to the Group, with the integration of both companies progressing well”.

That’s a bit vague, with no figure given for Q2. Good to see that it delivered organic growth in Q1, as well as acquisitions.

My opinion – the valuation looks stretched to me, given a very strong recent rise.

Anyone looking at this share needs to examine the detail of the acquisitions, in particular what dilution amp; deferred payments are to be made. That’s quite material to the valuation, I seem to recall. As I’m not interested in buying this share myself, I’ll leave you to do the work on that point!

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I’m taking a break for lunch now, but might add a bit more later this afternoon. We’re mostly done though.

A few brief comments, now that the temperature has reduced to a level where I can think again!

Brighton Pier (LON:PIER)

33.5p (up 10%) - mkt cap £12.5m

This micro cap owns the Palace Pier in Brighton, and has a small group of 12 sub-par late night bars, and 8 golf sites.

It says trading since re-opening has been better than expected, but of the bars, only 2 seem to have re-opened.

Group trading for the period from 4 July to the 6 September has been better than the Board expected, with total revenue from all the Group’s open operations at 77% of the same period last year.

On a divisional basis, during this same period, revenue for the Pier was 78% compared to last year, for the open Golf sites was 86% compared to last year, and for the open Bar sites was 59% compared to last year.

I’d have preferred an indication of profitability, more than revenues, or both actually.

It talks about trialling all-seated nights in 2 venues, and being encouraged by the results, but I don’t see how that can possibly work longer term – why go to a dark, smelly nightclub, if there’s no DJ, and you have to sit down, instead of dance? It doesn’t make sense to me. Whereas the larger venues operated by Revolution Bars (LON:RBG) are more versatile, and seem to have better converted into basically being large pubs.

My opinion – I’m struggling to find much appeal to this. Maybe if it jettisoned the bars division, with a pre-pack administration, that would clean up the balance sheet, and get rid of the heavy lease liabilities. I don’t mind lease liabilities, if a company is trading profitably from those sites, but doubt that is the case here.

As for Brighton Pier, it’s anybody’s guess what it’s worth? It certainly attracts huge footfall, and is a major landmark.

Group net debt was £11.0m when last reported, and NTAV about £13.2m – similar to the market cap. It’s impossible to value, without knowing what someone might pay for the pier. There must be quite a high de-listing risk here too, as I cannot see any point in it remaining a listed share. Maybe Luke Johnson might come up with a plan to inject some new assets into it?

Overall, I can’t form a strong view either way, so am neutral.

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40.5p (up c.1%) – mkt cap £24.0m

This is an interesting little software company, that provides niche product to help call centres take card payments securely. Something like that anyway. My friend, who’s an expert in call centres, reckons this share is one to back. So I picked up some stock a while ago, but recently got a margin call, and this position had to go, as I had less conviction in it than everything else.

I’ve not yet had a chance to talk to my pal, for his better-informed-than-mine view.

Skimming over the results for FY 06/2020, there are some interesting signs of progress. Here are my very brief notes;

• Strong growth, revenues up 56%, but only to £4.4m, so still very small
• Recurring revenues now at a run rate of £6.75m (up strongly, +66%)
• Heavy loss of £4.35m, but this is in line with expectations
• Cash for about another year of burn, at £4.3m, plus a £1.25 debt facility. Hopefully the cash burn would reduce as it grows further, with high gross margins
• Recent trading looks solid at +41% in July amp; August, although maybe it needs more growth than that?

My opinion – looks interesting. Maybe a £24m market cap is appropriate at this stage given that it still has a mountain to climb to reach profitability? I’ll probably buy back into this, on a small scale, if/when I have any spare cash burning a hole in my pocket.

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26.25p (unchanged) – mkt cap £37m

Xpediator Plc (AIM: XPD), a leading provider of freight management services across the UK and Central and Eastern Europe, is pleased to announce its unaudited condensed interim results for the six months ended 30 June 2020.

I can’t see myself ever investing in freight companies again, but on a quick skim of these interim numbers, XPD seems to have done fairly well in H1 2020. Adj PBT is up a little on H1 LY, at £2.1m – low margin work though, as you would expect, with revenues around £100m for H1.

Outlook comments sound solid, if unexciting, with business returning to normal, and profits expected to be similar to last year.

Note the large adjustments in both years – so how real are the adjusted profits?

Balance Sheet - write off intangibles, and NTAV is only £3.6m. Note also the very large receivables, and payables. So managing risk amp; financial control generally, is of the utmost importance, in a low margin business like this. You need credit controllers with nicknames like “The Rottweiler”, within this type of business.

My opinion – I wish them well, but XPD has not impressed since it listed. To be acquisitive, and create shareholder value, the trick is to get a high stock market rating, then make lots of cheap acquisitions funded by expensive equity and cheap debt. That doesn’t seem to have worked here, and I can’t really see any reason why it would begin to work in future. Probably best to spend our time researching things with more upside potential amp; better business models?

In the back of my mind, I had a hunch that this IPO was about shareholders wanting to make a killing from the stock market and then retire comfortably? It’s not really worked, if that was the agenda. Can’t blame anybody for wanting to make a few bob though. Caveat emptor amp; all that. Nobody forces anyone to buy any share.

Interesting to see that the StockRanks seem to like it – maybe I’ve missed something positive? Do let me know if so, as always opinions here are subject to change whenever the facts change.

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41p (up 67%) – mkt cap £63m

This share reminds me a bit of Torotrak – remember that one? Both companies seemed to have invented solutions to automotive problems that didn’t exist. Torotrak decided that tractors, or ride-on lawnmowers, or something like that, suffered from inefficient gearboxes. SCE thought that conventional brakes weren’t good enough. Investors randomly seemed to become emotionally attached to the shares, and support repeated fundraisings, defying all logic, and occasional clear-outs of management.

The reason I’m highlighting SCE today, is that it’s put out an announcement which actually looks quite interesting, hence is worth a closer look. Sports car makers seem to be convinced of the merits of its brakes, hence it seems possible that a viable business could eventually emerge here?

What sustainable advantage does it have? With vastly larger Ramp;D budgets, how can it stop competitors copying/beating it? Won’t costs just rise as fast as revenues? Will there be any sustainable divis?

Answers on a postcard please! Good luck with it. I’ll stick with my juicy divis from cheap sofas, and concrete screeding!

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29p (up 24%) – mkt cap £47m

Interim results show £4.8m revenues, and breakeven.

So why is it valued at £47m? Jumping on the covid bandwagon, in my view. Previously, the story was all about biodegradable plastic. Now its switched to covid-proof plastic.

I got smooched into this a while back, on some rampy story, and I lost £8k on it by the time I realised it was largely hot air! Not by the company, I hasten to add, but an over-excitable friend.

So please forgive me for being a bit more sceptical, second, or maybe third time around.

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I’ll leave it there for today. See you in the morning!

Regards, Paul.

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