Small Cap Value Report (Mon 2 Nov 2020) - PURP, HMSO, SEE, PIER, KBT, ACRL, NWF

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

We could have a bit of volatility to deal with this week, with a new lockdown for England having been announced, and of course the US Presidential election taking place on Tuesday.

Timing – Jack’s kindly done most of the work this morning, but I’ll (Paul) be adding bits this afternoon until about 3pm.

Agenda – as follows;

Purplebricks (LON:PURP) – Half year trading update (Jack)

Hammerson (LON:HMSO) – Completion of disposal (Jack)

Seeing Machines (LON:SEE) – Year end results FY 06/2020 (Jack)

Brighton Pier (LON:PIER) – Final results FY 06/2020 (Paul)

K3 Business Technology (LON:KBT) – Trading update (Paul)

Accrol Group (LON:ACRL) – Covid-19 business update (Paul)

Nwf (LON:NWF) – Cyber incident, suspension of shares (Paul)

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Share price: 62.5p (+8.9%)

Shares in issue: 306,806,039

Market cap: £191.8m

(Jack)

I wonder if there’s a post-Woodford bounce coming for certain stocks? Take Purplebricks (LON:PURP) for example – that’s a heck of a fall in share price since 2018:

The group continues to burn through cash and makes some punchy, double-digit net losses though:

• FY18 -£30.1m
• FY19 -54.9m
• FY20 -19.2m

Looking at the falling net cash balance, another equity fundraising isn’t out of the question. But see below – today the group reports an improved cash figure, which is encouraging.

Stockopedia rates Purplebricks as a Momentum Trap but shares are up 8.9% on today’s Half year trading update so let’s see if the tide is turning. If it is, then let’s not forget the share price was approaching 500p in 2017…

It’s actually a very brief update, with much more detail to come on 15 December 2020. Some highlights for now:

• Strong levels of new instructions during the last five months,
• An 8% increase in instructions for the six month period to 35,387 (H1 FY20: 32,850), and a 20% increase for the 5 months since June,
• First half adjusted EBITDA to be comfortably ahead of company consensus of £3.5m,
• Improved cash position since 30 April, with cash at the end of October in excess of £75m compared to £66m on 15 July 2020.

Vic Darvey, CEO, commented:

We expect to deliver a pleasing profit performance in the first half, but it is too early to extrapolate this out to the second half of the year given the expected end to the stamp duty holiday and the potential impact of increased COVID-19 restrictions on the housing market. As a result, we are planning cautiously around the outlook for the full year.

Conclusion

There could be something here, but I’d need to take a much closer look before committing to a view. I’m open to a turnaround though and the tone here is better than feared.

In fact I already have Purplebricks in a ‘Turnaround’ watchlist, so this update probably shunts it further to the front of the queue.

The Property Franchise Group recently noted floundering competition in the hybrid space, but it seems as though Purplebricks is rebounding from lockdown in decent shape. Reported activity, on balance, is stronger than I would have expected and appears to have positively surprised the market.

No doubt there has been a lot of operational activity, right-sizing, and cost-cutting going on here in recent years after its overly ambitious expansion into overseas markets.

What is hard to get over is the colossal operating losses and cash burn Purplebricks has achieved to date. But this latest update shows an impressive increase in cash position and a company well placed to outperform existing market forecasts.

Last year Purplebricks reduced its marketing cost as a % of revenue from 29.6% to 25.6%. There must be quite strong brand recognition there, so perhaps costs could be cut a little further in the short term.

Certainly the next month and beyond could be bumpy for a host of companies, with lockdown making its return. How will the UK housing market fare on a two year view? That’s a big question. On the whole though, this update bumps Purplebricks much higher up the watchlist.

Share price: 15.8p (-3.13%)

Shares in issue: 3,831,468,050

Market cap: £605m

It’s a bit too big for the SCVR strictly speaking, but there is interesting readacross we can all take from this brief RNS from Hammerson (LON:HMSO) .

Fulham Shore’s chairman recently sounded an ominous warning sign for retail landlords:

Landlords prior to COVID-19 were facing falling retail and restaurant demand for their sites, due to the continued shift to online shopping, the contraction of some large restaurant chains, and the challenging economic backdrop over the past three years. The bottom has now truly fallen out of their world.

And looking at the Hammerson share price chart is truly sobering. It’s a stunning collapse in equity value. There are winners and losers in this market, and here we have a reminder of the risks we face if we get it wrong IMO.

The heavy selling continues even at these levels. The latest update (here) is the disposal of its 50% interest in VIA Outlets for £277m, representing an 18.3% discount to gross asset value as at 30 June 2020.

Perhaps there are some super contrarians out there that see value here. Institutions and directors have been buying. But I view this latest news as a timely reminder of where not to be investing right now.

Share price: 4.4p (-5.45%)

Shares in issue: 3,737,214,374

Market cap: £164.4m

Year end results FY2020

Seeing Machines (LON:SEE) designs AI-powered operator monitoring systems to improve transport safety. It has been heavily loss making for a long time and it’s more of the same for this year.

Highlights:

• Revenue up 25% to AUD40m,
• OEM revenue up 32% to AUD27m despite COVID disruption
• Annual recurring revenue up 17% to AUD14m
• Cash down from AUD54.8m in 2019 to AUD 38.1m, currently at AUD35m
• Loss after tax of AUD46m (note this is buried way down in the statement).

Current trading looks reasonably positive, with Q1 21 revenue ahead of budget and 20% up year-on-year to AUD9.5m

Paul McGlone, CEO of Seeing Machines, commented:

I am pleased that our solid progress in FY2020 has continued into the first quarter of FY2021, with both revenue and cash ahead of budget. I am confident that we are on track for a successful year ahead with a strong strategic focus, foundational partnerships and a well established team to deliver.

Conclusion

The tone sounds positive but the historic trading figures are awful and the FY20 loss is similarly huge at AUD46m.

It’s the type of Financial Summary that wants to make me run for the hills as an investor.

Those are some pretty substantial and consistent losses for a £174m company. There’s been some extreme shareholder dilution as a result:

Cash is falling – from $54.8m in 2019 to $38.1m at 30 June 2020 and to $35m at 30 September 2020. Seeing Machines generated $40m in revenue in 2020, but it also spent $36m in research amp; development in FY19 and a further $31m in FY20.

At some point SEE’s technology might reach that all-important inflection point and see mass market adoption. But how much cash does it have to burn through to get to that point? Without knowing this company in detail, the track record suggests a cash raise might come before reaching sustainable profitability.

The most recent broker note is forecasting profitability by FY23. Given the macro environment facing us, it’s more likely this forecast will be extended rather than brought forward in my opinion.

The company’s loss after tax is buried way down in the update: a loss after tax of AUD46m. This is up from the FY19 loss after tax of AUD42m.

I’ll leave it to others to fund this heavily loss-making venture for now, but good luck to holders.

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Share price: 30p (down 2% today, at 11:50)
No. shares: 37.3m
Market cap: £11.2m

Final Results

The Brighton Pier Group PLC (the Group) owns and trades Brighton Palace Pier, as well as eight indoor mini golf sites and twelve premium bars nationwide …

These trading results for the 52 weeks ended 28 June 2020 (2019: 52 weeks ended 30 June 2019), a period which, since Spring 2020, has been defined by the COVID-19 pandemic.

All sites were closed from 20 March 2020 until just after the 30 June year end. Unfortunately, with the new lockdown measures recently announced, then presumably all sites will be closing again later this week, for who knows, maybe 4-6 weeks seems likely. Then in the worst case scenario, maybe another lockdown in the spring, if the virus once again picks up steam when the new lockdown is lifted? We seem to be in a vicious circle at the moment, although 2021 should see better treatments, better testing, and vaccines.

Therefore the end is in sight, even if it doesn’t feel like that right now. The biggest question is whether companies can survive until then, hence balance sheets and cash burn levels are the key issues in vulnerable sectors like leisure, travel, hospitality, and retailing. Some shares in these sectors could be multibaggers if they recover, whilst others could wither away or end up going bust. For anyone brave enough to search through the wreckage of the above sectors looking for the future winners, this focus on cash amp; cash burn is vital.

Revenue is down 29% to £22.6m. I imagine revenues in FY 06/2021 are likely to be down considerably more again, as the covid/lockdown impact continues (the bars division are late night venues, so not able to trade normally, if at all). I think PIER’s bars division might be a write-off actually, because they weren’t good sites to begin with.

Revenues had been up 5% at the half year stage, before covid.

EBITDA was still positive, at £2.5m, but that’s meaningless because there’s so much maintenance capex required, especially for the pier. Although we are told that no new maintenance issues were found in the annual survey of the pier’s structure.

After large write-offs, the loss before tax is awful, at £(10.2)m

Liquidity – the group has borrowed £5.0m under the CBILS, and the bank has been co-operative by waiving covenants amp; relaxing repayments for 2020.

Total bank debt of £16.8m is high, but no repayments are due for 6-12 months, so immediate crisis.

Outlook – with only one bar trading currently, the new lockdown doesn’t impact that division much. The pier is in its quiet seasonal period, so again closure there for a month or so, probably won’t have a huge impact. Re-opening trade was better than expected;

Like-for-like sales (excluding closed sites) for the Group as a whole were at 81% compared to the same 13 weeks last year. The Pier division has traded at 83%, the Golf division at 87% and the Bars division at 65% compared to the same 13 weeks last year. This trading was ahead of the Group’s expectations at the time of the reopening….

The announcement from the Prime Minister on 31 October indicating a return to a four week lockdown was not unexpected. Whilst disappointing, with only ‘Lowlander’ now trading in the Bars division and the Pier in its traditionally quiet period as we head into the winter months, the impact in all three divisions will be mitigated to a large degree by the extension of the furlough scheme to the end of November. This limited closure period was part of our considerations at the time we performed our stress testing of the business and does not in any way change the conclusions we reached.

Balance sheet - looks a bit wobbly to me. NAV is £15.0m, less intangibles of £9.5m, leaves £5.5m in NTAV - not much, when compared with the bank debt. Therefore, once this crisis is over, I imagine an equity fundraising would be needed to repair the balance sheet, and remedy the creditor stretch.

The downside scenario would be if the company is forced to raise fresh equity during this crisis, at a deep discount.

My opinion – I cannot see any reason as to why this share would trade above NTAV, which is currently 15p. That’s half the current share price of 30p.

With the risk of dilution at some stage, and uncertainty over when the bars can re-open at any time, if at all, then it’s difficult to see why anyone would find this share attractive at the current price. The only upside case I can think of, is if you reckon Brighton Pier is worth substantially more than book value. Then maybe it could be sold, at a premium to book, and money returned to shareholders, or the company’s listing re-purposed. This venture doesn’t seem to have really got off the ground, therefore it’s difficult to see what could be achieved by making more acquisitions.

There has to be some de-listing risk too. Note that Luke Johnson is the chairman, and he’s experienced amp; well connected, so might come up with a better strategy for the future. Although obviously after the Patisserie Valerie debacle, his star is somewhat dimmer than it was.

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Share price: 97p (up 5% today, at 13:30)
No. shares: 42.9m
Market cap: £41.6m

Trading Update

K3, which provides mission‐critical business software, cloud solutions and managed services, is pleased to provide the following trading update.

This looks to be a reassuring update;

Trading in the second half of the financial year to 30 November 2020, seasonally the Company’s stronger half, has continued to be in line with the second quarter and management expectations, with the own IP and Global Accounts businesses showing particular resilience. October is an important month for annual software licence and maintenance contract renewals, and these have progressed well with renewal rates tracking at normal high levels.

Restructuring? – it’s a pity we’re not given more specifics on this, but it sounds interesting -

Management continues to focus strategically on the significant opportunity to expand own IP sales, particularly of the K3|imagine platform and has made a number of new appointments to strengthen the senior team. The Board is also actively exploring a range of options to simplify the Group structure.

Several commentators have made the excellent point that the covid/lockdown crisis has forced many companies to restructure in drastic ways which would have been unthinkable in the good times. This is because companies often tolerate under-performance from people, or subsidiaries, in the good times. Yet when future survival is under serious threat, then very tough decisions are forced on companies, to address these issues.

The other, unique, aspect of covid, is that many companies have been forced to change their business practices. For example, if staff can work from home, then why do we need an office at all? Although my feeling on WFH (work from home) is that it’s fine as a stop-gap, but over time, I think it loosens ties between people and companies, and levels of customer service can decline markedly (maybe without management being aware). I’ve witnessed friends amp; family battling with companies over the phone, with appallingly long waiting times, calls cut off, etc, probably because staff are working from home, and are hence less efficient.

Several companies have reported that they have moved to installing and maintaining systems remotely for their customers, whereas in the past a team of people would have flown out, stayed in hotels, suffered from jetlag for a week or two, which is costly and disruptive. Whereas now, it can all be done over Zoom/Teams, and through other internet-connected software.

The point I’m making is that there are opportunities to buy into companies today which are going to emerge from covid as much better, more profitable businesses. Hence maybe we shouldn’t be just looking at companies returning to 2019 peak earnings, but possibly better than that?

Therefore, I’ll be interested to find out subsequently, what KBT intends to do, in terms of restructuring.

Liquidity - sounds OK;

As previously announced, management expected net bank debt (drawdown plus cash balances net of overdrafts) to be £6.0m at the end of September, historically the point of peak borrowing for the Company. Actual net bank debt at 30 September 2020 was £6.2m, and cash balances since then have grown strongly with annual renewal receipts.

My opinion – the above all sounds quite good, but checking back through my previous notes, the picture looked quite wobbly when I reported here on 27 July covering its (late) results for FY 11/2019. There was an important going concern note which the auditors drew attention to in their audit report. Plus a weak balance sheet, with negative NTAV, and a subsidiary had been placed into administration. I’m flagging these issues again, as this share does look financially weak. Although software companies can often operate fine, with a weak balance sheet, because they get fees up-front from customers.

Overall, I don’t like its weak balance sheet, and erratic financial performance in recent years.

Another issue which has long bugged me, is that banks currently lend on EBITDA multiples to software companies. I think this is a big potential problem, because at some point, the penny is likely to drop with the banks, that EBITDA is absolutely not a good proxy for cash generation in this sector, due to capitalising a lot of payroll costs into intangible assets, as development spending. It’s fine to do that of course, but it renders EBITDA as a meaningless measure, which in some cases greatly overstates the level of cash generation. A good example was seen last week, with Proactis Holdings (LON:PHD) which has a lot of bank debt, and trumpets a large EBITDA profit, but in fact doesn’t generate any free cashflow at all! Sooner or later, I reckon banks are likely to realise this, and withdraw the overly generous facilities they give to software companies.

That said, with KBT, the bank debt sounds quite modest, so maybe not a problem here?

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Share price: 44.5p (unchanged, at 14:38)
No. shares: 195.2m
Market cap: £86.9m

COVID-19 Business Update

Accrol buys large rolls of tissue paper, and turns them into toilet rolls. It’s a capital-intensive, and low returns business model – i.e. the opposite of what I would want to invest in. Although looking at the chart below, the market seems to believe its turnaround story, and likes it.

There’s also the bizarre stockpiling mentality of the UK public, who seem to rush out and buy toilet paper when lockdowns are announced. Although one commentator did point out that as a bulky item, the supermarkets tend to only keep a smallish supply on the shelves, and operate on a daily delivery, just-in-time stockholding basis. Therefore, it doesn’t take much additional demand to apparently strip the shelves bare. Then of course people buy less in future, as they work their way through their stockpile at home (Acrol says today that Q1 of FY 04/2021 saw a slowdown for this reason). Averaged out over the long term, demand amp; supply should even out, in theory. Maybe people are more liberal in their usage of loo paper, if they know their utility room is groaning with plenty more?

Today Accrol says;

Following the Government’s announcement over the weekend that a second lockdown is being initiated from 5 November 2020, Accrol (AIM: ACRL) confirms that, as an essential service provider, it expects to operate normally throughout the lockdown period.

During the first nationwide lockdown in the Spring, Accrol operated at full capacity to supply the heightened consumer demand for its toilet roll and other tissue products and remained fully operational across its three sites, successfully protecting the health and safety of its employees throughout and subsequently through the period of regional restrictions.

The business prepared for a second national lockdown and heightened restrictions and is ready to satisfy additional demand, should it materialise.

My opinion - that sounds fine, and I think it’s very helpful for Accrol to inform the stock market in this way. I’m hoping to see lots more companies let us know how this new lockdown might impact them. Although with a bit of our own work, we can ascertain from RNSs over the last 8 months, how individual companies are likely to be affected. Probably like many of you, I did a quick mental checklist of how my larger holdings will probably be impacted, along the lines of:

Boohoo (LON:BOO) – should benefit from another lockdown, as physical competition is once again forced to close the doors, But, fewer seasonal parties might reduce demand somewhat.

Revolution Bars (LON:RBG) – negative impact, but it was probably trading at a loss anyway (revenue down 50% due to 10pm curfew), and furlough scheme should help retain staff. Bad news already in the price anyway?

Intercede (LON:IGP) – traded fine through first lockdown, strong recurring revenues amp; blue chip clients, so little impact (if any) likely.

Volex (LON:VLX) – probably little impact amp; trading strongly. Got a very bullish tip from a respected tip sheet over the weekend, hence strength today. I’m also very bullish on this one, see the archive for why.

Redde Northgate (LON:REDD) – probably little impact. Van hire division likely to benefit from increased online ordering/deliveries, offset somewhat by accident management division likely to see some downturn due to fewer journeys amp; hence fewer crashes.

Quiz (LON:QUIZ) amp; French Connection (LON:FCCN) – unhelpful, and likely to increase losses in retail divisions, and harm wholesale customers further. Also likely to cause inventories headaches amp; write-downs. Both should be funded adequately to survive.

Saga (LON:SAGA) – not much difference, if any, as holidays division wasn’t likely to be able to re-start until the spring of 2021 anyway. Insurance division should be unaffected, or even a net beneficiary due to fewer claims against motor amp; household policies (fewer road accidents, and burglaries)

Etc. etc. for all holdings.

Because we already know how covid lockdowns impact different sectors, then there was no reason at all for a broader market sell-off this morning, so I wasn’t worried about this morning’s market movements, and had a lie-in, to ride out any early volatility in blissful ignorance!

It’s very difficult to make money from shares, if you panic sell every time there’s some bad news, then buy back once confidence has returned (and hence prices have gone back up again). It’s better to do the opposite – selectively buying the dips where panic sellers are offering you a bargain in an excellent company, something we discussed the other day. Then top-slicing on strong moves up, to provide some cash to deploy on the irrational dips. Easier said than done of course. Hence why these days I tend to just ignore short term volatility, and hold my best positions throughout. I only need 1 or 2 big winners each year, to mop up all the losses from the things that go wrong (this year BOTB has been my star, and also done well on a few other things, partially offest by RBG being a disaster). But everyone has their own style, and many different approaches can work well.

To conclude on Accrol, I could be wrong, but just don’t see any appeal to its business model. For completeness, I’ve just had a quick look at last reported figures for FY 04/2020, and it does look like a decent turnaround is underway, with a move back into (adjusted) profitability. Gross margin has improved, but is still extremely low at just 21.9%. A huge amount of costs have been removed, hence the move back into profits. Product innovation could drive margins higher perhaps?

The balance sheet is not too bad, although there’s quite a lot of debt on there, which will need to be reduced before decent divis can be safely paid.

I can see the turnaround here does appear to be working, which has been reflected in a stronger share price. Overall, I think it’s probably priced about right, and the business model doesn’t appeal to me at all. As we saw in the past, volatility of input prices, versus inflexibility of selling prices, caused profits to spike up, then suddenly evaporate in a downturn. The challenge is to somehow link input and output prices over the long term, to make profit/losses less volatile.

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Share price: suspended (at 200p previously)
No. shares: 49.0m
Market cap: £98.0m

Temporary suspension of trading on AIM

At the request of the Company, trading on AIM for the under-mentioned securities has been temporarily suspended from 02/11/2020 7:30am, pending an announcement.

Cyber Incident

This is the text in full, which is self-explanatory;

NWF Group plc (‘NWF’ or the Group), the specialist distributor of fuel, food and feed across the UK, announces that it has experienced an unauthorised access to the IT systems in two of its divisions (Feeds and Fuels) and at Group level. There has been no unauthorised access at the Group’s Food division.

The Group has engaged external specialists and has taken precautionary measures with its IT infrastructure, including taking systems offline whilst it continues to investigate the nature and extent of the incident, the recoverability of any compromised data and any effects on the operability of its systems.

The Group’s businesses remain operational; the customer service teams in Feeds and Fuels are using alternative systems and procedures to fulfil and deliver orders.

In light of the complex and evolving nature of this situation, the Board has requested that trading in the Company’s ordinary shares be suspended until it is in a position to provide more definitive information.

My opinion – I think the company is absolutely right to have suspended its shares. That should happen more often actually, when unquantified problems emerge. It’s impossible to value the shares, until we know the extent of the problem, and how it might impact trading.

This is a reminder that unforeseen problems can occur at literally any company. From discussions with management of Intercede (LON:IGP) (I hold) they say that weak or compromised passwords are often the way that hackers find a back door into a company’s system, and they can then wreak havoc once in it, especially if user permissions are not properly set up, to restrict access to sensitive parts of the system. Whereas 2-factor authentication is much more secure. Intercede’s software manages 2-factor authentication.

Proper cyber security is something that companies of all sizes have to take really seriously, and spend proper money to protect themselves. So when we’re talking to management of all companies, good questions will be to ask how secure are their systems against outside hackers? Have they experienced any hacking, or attempted hacking? Do you use two-factor authentication to log in to your computer system?

I think the level of detail amp; confidence/knowledge of this issue from their replies, could be revealing. I’d want to hear management reply that it’s a constant threat, and sound paranoid about it, and rattle off numerous measures that they have taken to prevent hacking, etc. Whereas a super confident reply that their systems are safe, with nothing of substance to back up that view, is probably an amber flag.

I’ll cover this story as it unfolds. Keeping my fingers crossed for shareholders that hopefully it won’t be too bad. This type of thing should be something the company can recover from, without too much damage being done. But it depends on whether the IT controller took proper backups every day or not. Then there are likely to be exceptional costs to restore the system, fix security weaknesses, and have no doubt very expensive experts work out what’s happened, and how to fix it.

In the context of a £98m market cap company, what could the damage be? Possibly a couple of million quid in extra costs, at a guess? I’d be surprised if that did significant, or permanent damage to the share price, but we don’t know yet.

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