Small Cap Value Report (Weds 11 Nov 2020) - ZOO, MKS, WATR, RCDO

Good evening/morning, it’s Paul here with the SCVR for Wednesday.

I’m starting this report early, on Tuesday evening, with some catch up sections from my backlog.

Agenda –

Zoo Digital (LON:ZOO) – Interim results from yesterday (Paul, done)

Marks And Spencer (LON:MKS) – interesting interim results webinar (Paul holds a long position)

Water Intelligence (LON:WATR) – interesting news on a new product

Ricardo (LON:RCDO) – trading update and share placing (Jack)

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Timing – TBC

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Share price: 53.5p (down 3.6%, at market close)
No. shares: 74.6m
Market cap: £39.9m

Interim Results

ZOO Digital Group plc (LON: ZOO), a world-leading provider of cloud-based localisation and digital media services to the global entertainment industry, today announces its unaudited financial results for the six months ended 30 September 2020 (“H1 FY21“).

I’ve been following this company for several years now, and it never seems to manage to live up to the expectations created. As you can see from the graphs below, at times it’s been valued at a high PER, despite lumpy and overall rather unimpressive profits, and it doesn’t pay any divis;

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I covered the trading update from ZOO here on 23 Sept 2020 where it indicated H1 (to 30 Sept 2020) should deliver double digit revenue growth. Nothing was said about profitability.

Interim results today;

• H1 revenue growth of 15%, to $16.4m, consistent with the last trading update
• Lower gross profit though, due to increased costs
• Loss before tax of $(710)k vs. $374k profit in H1 LY – not very impressive
• Balance sheet – quite weak, with NTAV negative, at $(2.0)m. Receivables look rather high at $9.2m

Outlook comments seem quite positive, especially the bits I’ve applied the wonky highlighter to below;

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My opinion – I‘ve not seen anything in these interim results to make me want to buy this share.

To be fair to ZOO, the TV/film sector has been struggling this year, due to social distancing, which has led to a marked slowdown in production of new programmes. Therefore the figures for H1 from ZOO are not representative of what it might be able to achieve in future.

I’ll keep an open mind about the future, but there’s not enough in this announcement to get me interested at the moment.

The StockRank algorithms don’t rate it either;
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Share price: 120p
No. shares: 1,953.4m
Market cap: £2,344m

(I hold)

Just a quick mention, but I’ve just enjoyed watching a very interesting interim results webinar here. Highly recommended, it’s really thorough.

MKS has been trying to turn itself around for a long time, with repeated restructuring programmes. It feels to me, as if this time it could be the real deal – Chairman Archie Norman is well respected, and a few things jump out at me from this webinar, so here are the key points from my notes;

• High performing food business, with LFL sales up 6.6% in H1, once things likes cafes are stripped out (as they were forced to close)
• Full Mamp;S food range now available on Ocado, doing well apparently, profitable
• Plenty of liquidity: £1.4bn cash amp; undrawn facilities – “far better” than anticipated
• Costs cut amp; layers of management removed
• Supply chain being “radically reshaped” amp; costs removed
• Mamp;S is now the UK’s #2 clothing retailer online – surprising
• Relaunch of Sparks loyalty scheme, with 1.5m app downloads
• Targeting gt;40% of total sales online, within 3 years
• Digital transformation, lots of credible stuff to back this up

My opinion – I think Mamp;S could be beginning a genuine resurgence. As mentioned last week, I’ve dipped my toe in with a starter size position at something like 96p. Lucky timing, because then the positive Pfizer covid news came out. So it’s important not to delude oneself that lucky timing was anything more than just luck. It’s now about 118p, due to that indiscriminate vaccine bounce.

The mkt cap of MKS is about £2.3bn now, yet I reckon it’s by far the best brand on the High Street. How many other food retailers make you feel special, and warm/fuzzy, even privileged, as you walk in? Maybe just Waitrose, but none of the others do. I think the MKS brand is incredibly valuable, potentially multiples of the £2.3bn market cap.

Debt is fine, at £1.4bn (excluding leases), with loads of headroom.

The challenge is obviously how they turn around the clothing/home part of the business, which lost its way many years ago, and has never really recovered?

I’ll keep monitoring MKS, and for the time being am only dipping my toe in the water, with a small position (about 1% of my portfolio). I really do think it could be a recovery story, not a terminal decline story. Time will tell!

Pretty awful chart, so there’s a lot to do.

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Share price: 490p (up 2% yesterday)
No. shares: 17.6m
Market cap: £86.2m

Initiation of Sales of Sewer Diagnostic Product

Water Intelligence plc (AIM: WATR.L) (“Water Intelligence” or “Group”), a leading multinational provider of precision, minimally-invasive leak detection and remediation solutions for both potable and non-potable water is pleased to announce the initiation of sales from Orca^TM, its proprietary sewer diagnostic product. Such initiation of sales has been delivered on schedule, as guided by the 3Q Trading Update previously released…

This sounds rather interesting -

Orca has been in development at the Group’s UK-based, Water Intelligence International subsidiary (WII). The proprietary product uses acoustic technology to identify sewer blockages in municipal pipes more effectively than any competitive solution.

WII has paid engagements starting with 4 large municipal customers in the UK. The Group expects that such engagements will lead to a broader rollout in 2021 in the United States, Canada and Australia within a subset of the Group’s 140+ locations.

It would be good to get some third party confirmation of what this product is like, and what potential it might have. No financial details are provided today.

Directorspeak –

Commenting on the Group’s performance, Executive Chairman, Dr. Patrick DeSouza remarked: “We are pleased with the initiation of commercial sales of Orca. The product is timely and will add to the growth of our Water Intelligence International subsidiary. Such sales, combined with our recent insurance customer wins, will reinforce our growth trajectory for the remainder of 2020 and 2021.

My opinion - every time I report on this company, I moan about the high valuation. However, the company keeps throwing more red meat to shareholders, with a succession of positive-sounding announcements.

It’s looking quite interesting. If this Orca product takes off, then the addressable market must be very large, globally. What other competitive products are there, I wonder? If WATR has something genuinely ground-breaking, then things could be good. Its not for me to say, I’m just flagging up the share as something that readers might want to look into in more detail.

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Share price: 340p (-7.4%)

Shares in issue: 53,406,250

Market cap: £181.6m

(Jack writing)

A hat-trick of RNS statements from Ricardo (LON:RCDO) this morning: a trading update, a proposed share placing, and a linked PrimaryBid offer.

This environmental and engineering consultancy specialises in the transport, energy and scarce resources sectors. While those areas are hopefully poised to recover in the months and years ahead, 2020 has been a hard year so far. The same can be said for Ricardo’s share price.

Mind you, this has been another defining week and market sentiment has totally flipped – for now, at least – on the back of Pfizer’s vaccine announcement. So perhaps this type of beaten up share will be viewed more favourably by the market in the weeks ahead.

Trading update

This is for the first quarter’s trading to 30 September 2020. Half year results are expected in February 2021.

In the quarter to 30 September 2020, overall order intake was strong at £105.2m, up 19% year-on-year (note that comparable was before COVID disruption) and an improvement on the £70m of orders received in the quarter ended 30 June 2020.

All segments delivered an increase in order intake except for Performance Products. Running through those business units in a little more detail, we have:

• Energy amp; Environment orders up 29% to £11.7m.
• Rail orders up 40% at £26.9m.
• Defense orders up 141% to £14.2m.
• Performance Products down 42% with received orders of £13.2m.
• Aamp;I up 27% with an order intake to £39.2m.

The group continues to experience challenging conditions in Automotive amp; Industrial (Aamp;I) EMEA and expects the order intake to remain at a low level over the next few months.

Consequently it’s guiding towards more of an H2 weighting in full-year results – this can be (but isn’t always) an early warning sign. Per the group:

Historically operating profit phasing has typically been 40% H1 and 60% H2 and in FY21, as we emerge from the impact of COVID 19, we expect this to be approximately 25% H1 and 75% H2.

So at least the company is sticking its neck out and giving some guidance, rather than pinning hopes on poorly-defined H2 recovery.

Dave Shemmans, Chief Executive Officer, commented:

The economic outlook continues to be uncertain and we approach the year ahead with a degree of caution, with our non-Automotive businesses providing some resilience against continuing challenges in the Automotive segment. Nevertheless, we have established a firm and diversified platform for our business and looking forward I remain confident of the prospects for the Group.

Proposed placing

Mixed orders aside, Ricardo anticipates a small net cash outflow in addition to the payment of £5.2m of earnout costs in relation to previous acquisitions and approximately £3m of redundancy costs. It’s burning cash and net debt has increased. That’s why it is placing shares.

Up to 7,981,809 new ordinary shares at a price of 333p, with directors subscribing to 29,128 (c£97,000). There’s an additional offer of up to 801,093 shares to retail investors on Primary Bid. So gross proceeds of around £29m representing 16.5% of existing share capital.

This is driven by the Automotive EMEA business, which continues to receive a lower than required level of workable orders.

Per the group:

The Fundraise is intended to reset the capital structure of the Group, reducing leverage to achieve an appropriate level of balance sheet efficiency and resilience. The net proceeds will be used to pay down drawn debt facilities, resulting in increased headroom, lower net debt and lower adjusted leverage, and providing greater flexibility to invest in growth projects and meet working capital requirements.

Conclusion

This looks like an interesting company but I’m not tempted.

There’s a slight mismatch between the tone of the trading update, which sounds reasonably resilient, and the placing, which, reading between the lines, sounds much more distressed.

Given that, perhaps I am more sceptical about the H2 weighting. Obviously I hope the company prospers but I don’t see why I need to risk my capital to make that happen. You can see the net debt spiking up this past year.

Directors are participating but have been heavy sellers in the past. I’m quite happy to leave this one for now and potentially revisit once we are well and truly past this COVID disruption. The outlook for its problem division, Automotive and Performance Products, continues to look uncertain.

In fairness its other divisions appear to be performing strongly and there could be longer term potential here if trading recovers – but right now seems a particularly intriguing time elsewhere in the market.

Is there a changing of the guard taking place, with a rotation from lockdown beneficiaries to beaten down recovery stocks? Or have the past few days been a false dawn? There might be more immediate reratings out there.

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