Small Cap Value Report (Thu 12 Nov 2020) - SNWS, VLX, NXR, IDEA, TTG, CLG

Good morning! It’s Paul amp; Jack here with the SCVR for Thursday.

Agenda - this is what has caught our eyes today;

Smiths News (LON:SNWS) – Jack covering its preliminary results (Jack holds)

Volex (LON:VLX) – Half year report (Paul holds) – webinar today at 11am on IMC platform

Norcros (LON:NXR) – Interims

Ideagen (LON:IDEA) – Trading update

Tt Electronics (LON:TTG) – Trading update

Clipper Logistics (LON:CLG) – Trading update

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Timing - looks like it will be an all day job, as lots of interesting stuff to cover.

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A changing of the guard or too soon to call?

This has been another defining week in the markets, with Monday’s vaccine announcement flipping 2020’s winners and losers more or less on its head. Is this a changing of the guard in terms of stock market performers or just a premature celebration set to fade?

I’m thinking about this carefully and am curious to hear what others make of recent developments from an investing perspective.

For a month or so now I’ve been looking for a bit more Value-Momentum – the idea being that we will at some point return to normal life (say on a two year view), and so those companies with bombed out share prices, promising strategies, strong management, and good upside potential might offer attractive risk:reward.

But cheap companies are never perfect and do tend to come with higher risk such as large pension funds, so DYOR. The below are not recommendations but might spark a bit of conversation.

I’ve held one Leisure stock through thick and thin: Fulham Shore (LON:FUL) . I did hold Marston’s (LON:MARS) but sold on the spike up to 65p or so after the Carlsberg JV announcement. Now, with tangible (albeit preliminary) news of a vaccine I would buy back in if we saw some selling pressure there in the weeks ahead. I’ve also repositioned into Reach (LON:RCH) , Redde Northgate (LON:REDD) , and Smiths News (LON:SNWS) (but a small amount in the latter) over the past few weeks.

I bought some Novacyt Sa (LON:NCYT) on the steep drop on Monday but it’s a volatile stock so you do need to be able to handle that volatility.

Below is from an equal-weighted Folio watchlist of turnaround situations. This Folio dramatically underperformed in March and for a long period thereafter but the past three months show an interesting trend.

The watchlist is the blue line and the FTSE All Share is the grey line:

I do think the real deal lockdown winners will continue to be longer term winners. But I’m also keeping a closer eye on what have been losers, because the stock market is forward looking.

If there are continued signs of ongoing investment into COVID recovery stocks, I’ll devote more time to opportunistically playing this theme. Buy and hold quality investing is a great strategy – but the fact is being a nimble and responsive investor has served me well so far in what is clearly an exceptional year.

Risks remain and we’re not out of the woods yet of course, so there’s plenty to ponder – but I’m as curious as ever to hear how others are positioned.

(to avoid any confusion, this section was written by Jack)

Paul replies – very interesting, thanks very much Jack. I’ve been on what can almost be described as a buying frenzy this week, so I’m planning on writing a similar piece, giving my current market thoughts, and what I’ve been buying. Looks like that will probably have to wait until tomorrow though, as there are lots of other things for me to look at today.

Share price: 254p (down 3.4%)
No. shares: 152.3m
Market cap: £368.8m

(I hold – Paul)

Board changes - abrupt departure of the CFO today, which sounds like there must have been some kind of disagreement. Hopefully nothing more to it than that – many investors get spooked by sudden departures of CFOs, as it can indicate something might be wrong.

Daren Morris, who initially joined the business in June 2014 as a Non-Executive Director before becoming Chief Financial Officer in September 2014, has today left the Board with immediate effect and will be leaving the business.

Jon Boaden, who joined the business in April 2019, as Deputy Chief Financial Officer, has been promoted to the role of CFO with immediate effect.

There’s a presentation on IMC at 11am this morning, so hopefully we’ll get to see the new CFO. At least he already works within the business so knows the ropes.

Half year report

Robust H1 performance – resilient business model responding well to Covid-19

Volex plc (“Volex”), a global provider of integrated manufacturing services and power products, today announces its half year results for the 26 weeks ended 4 October 2020 (“H1 FY2021″).

These financial highlights look outstanding, considering the backdrop of covid/lockdowns;

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I’ve highlighted the most important numbers to me;

Revenues up 3.5%

I tend to ignore operating profit now, because IFRS 16 has rendered it unreliable. Hence underlying PBT and EPS are the figures I tend to work from, for valuation purposes, providing the adjustments are reasonable.

There’s a healthy cash pile too

Note the figures are all in US dollars, so EPS translates into about 10p for H1. Simplistically, if we double that to 20p for the full year, then the PER is only 12.7 – too cheap in my view.

Bank facilities - a big increase is announced, even though the group has a strong net cash position;

We have also signed a new, three-year $100 million multi-currency revolving credit facility to replace our current $30 million credit facility, increasing our capacity for investment in future growth. The facility consists of a $70 million committed facility with a $30m accordion feature and is effective from 12 November 2020

Acquisition - this is substantial, at Euros 61.8m, but only E37m initially, which Volex can easily afford from its cash pile, and borrowing facilities.

This looks an excellent acquisition, a strongly profitable, decent-sized, low cost producer based in Turkey. This should substantially increase EPS, and is a great use of the cash pile, which was otherwise sitting there doing nothing!

Outlook - sounds fine;

Having delivered a robust performance in the first half of the year, coupled with a strong forward order-book, the Board remains confident in delivering on full-year expectations, absent any material disruptions to our business that may be caused by Covid-19…

Balance sheet - is strong. NAV: $150.7m, less $40.6m intangibles = NTAV $110.1m. My only queries are what “Other receivables” of $4.59m and $9.158m pertain to? Also I wonder what $42.2m in “Other payables” are?

There’s a modest pension deficit.

Note that Volex does not capitalise development spend, which is good.

Share based payments – seem rather high. This was $4.0m in H1, or about 20% of adjusted profits. It was $8.7m last full year, so I’m not sure these should be adjusted out as one-offs?

There again, if we value the business on diluted EPS, then we’re taking into account all future planned dilution.

My opinion – on an initial, quick skim of the figures (I’ve not gone through all the commentary yet), I’m really impressed. The turnaround at Volex has been remarkable, with the operating profit margin now just above 10%.

I like the look of the acquisition announced today, which is going to considerably boost profitability and EPS, which the market doesn’t seem to have recognised yet.

Maybe the abrupt departure of the CFO today might have caused the share price to fall. On fundamentals, I think the share price should have risen considerably today, so for that reason I’m going to buy some more.

I’m becoming increasingly convinced that Volex is too cheap. The analyst at Small Company Share Watch, a long-standing tip sheet, which is often very good, came to a similar conclusion, with a very bullish write-up last weekend, suggesting c.400p is a sensible target. I completely agree. Once you add on the profits for the new acquisition, and that existing forecasts seem too low, then it could continue to rise to that sort of level, with a bit of patience, I reckon. Providing nothing goes wrong of course, as with everything.

I particularly like the impending boom in electric vehicles, as this plays right into Volex’s strengths. They need complex, critically important wiring looms, hence likely to be very much in demand, and at good margins, because manufacturers simply cannot risk using a cheap supplier that could render electric vehicles as write-offs if the wiring goes wrong.

Remember how Jaguar designed a beautiful vehicle, decades ahead of its time, the Jaguar XJS (disclosure: I hold), but they used cheap electrical connectors, which rendered the vehicles unusable after just 2-3 years. That and the rust of course. Such a pity.

I could see Volex becoming one of my largest positions at this rate, if progress continues to be this impressive.

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Smiths News (LON:SNWS)

Share price: 26.68p (-8%)

Shares in issue: 247,700,000

Market cap: £66m

(Jack writing – I hold)

Smiths News (LON:SNWS) has recently refinanced but the share price is still cheap – that’s probably because, even post-financing, it operates in a shrinking market as the UK’s largest news wholesaler.

It’s very cash generative but you can see the direction of travel in recent times is all wrong:

So there’s plenty to do and the jury is still out. That said, you would think this year is about as bad as it gets for a lot of companies, and Smith News has remained profitable and cash generative through it all.

Shares are down quite a lot on the full year results – perhaps some relieved long term shareholders are gratefully offloading their stock, having previously been contemplating permanent loss of capital?

There has been a rerating over the past month or two.

Audited Preliminary Results

This is a long and involved update so keeping it short will be a challenge.

Headlines:

• Performance ahead of revised full year expectations
• Trading resilience throughout lockdown and good recovery in Q4
• All major publisher contracts now secured to at least 2024
• Robust cost control delivering sustainable operating efficiencies of £6.7m
• Disposal of Tuffnells removes a loss-making operation
• New £120m three year bank facility agreed in November 2020
• Bank net debt of £79.5m equivalent to leverage of 2 X EBITDA at the year end

There are some heavily adjusted results here – perhaps to be expected from a company with a distressed valuation but also a further confirmation that this is a risky turnaround.

• Revenue -10.7% to £1.16bn
• Adjusted PBT -25.8% to £27.9m; statutory PBT -51.2% to £14.8m
• Adjusted earnings per share -15.7% to 9.7p; statutory EPS -45.6% to 4.9p
• Free cash flow -67.2% to £10.9m
• Adjusted bank net debt +7.6% to £79.5m; statutory net debt +52.8% to £112.9m

So the adjusted EPS figure puts Smiths shares at 2.75x FY20 earnings.

Statutory PBT of £14.8m is impacted by a non-cash impairment charge relating to goodwill and assets in DMD of £5.7m and the impact of COVID-19 on trading of c£7.5m.

Continuing Free cash flow of £10.9m is after the temporary closure and return of unsold supplies from a significant number of retail outlets during the lockdown. It’s good, given what the company has had to cope with this year.

Refinancing

The Company’s new banking arrangements provide facilities of £120m in three parts.

• Term loan A of £45m- amortising at £15m p.a. over three years

• Term loan B of £35m – non amortising but subject to agreed repayments from the deferred consideration due from the sale of Tuffnells and ‘any cash surplus arising from the proposed move to buy-out of the Company’s defined benefit pension scheme’.
• A revolving credit facility of £40m

Bank Net Debt at year end was £79.5m (FY2019:£73.9m), up £5.6m but ahead of Smith’s revised expectations.

As of FY19, there were also two pension funds to account for: WH Smith (surplus of £24m) and Tuffnell’s (deficit of £2.9m).

Conclusion

These results should be judged in the context of a very cheap valuation and good forward revenue and cash flow visibility:

The company is still profitable in 2020 which I view as quite a feat but the results aren’t pretty and I view this as a high risk turnaround.

There’s no doubt that Smith News is in a structurally challenged industry characterised by declining revenue and market size.

This is a long and complex update, but some of the key points include:

• The group has high visibility of revenue and cash flows through to at least 2024.
• The sale of Tuffnells in May 2020 gets rid of a loss-making division and simplifies operations.
• Network restructuring and efficiencies in the supply chain should deliver ongoing savings
• A key focus on debt reduction
• The board expects to resume dividend payments in FY21

In terms of outlook, management thinks it can ‘continue to trade profitably with positive cash generation in all reasonably foreseeable scenarios.’

It will be a bumpy road though. The company is cheap for a reason and it anticipates core revenue decline in the range of 3% and 5% per annum. Not just that – it expects ‘year-on-year sales declines to be greater over the next 12 months’, as a consequence of the ongoing impacts of COVID-19.

It’s a mixed update for sure, but I don’t see anything here that is a surprise or makes me want to sell just now. On balance, I’m happy to keep the small position as a deep value stock given the good revenue visibility.

There’s been net director buying over the past year or so.

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