Small Cap Value Report (Weds 13 Jan 2021) - QTX, CHH, CARR, MNZS, ASC, SOS, WEY

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

Timings - I have to be finished by c.1pm today.

Agenda -

I wrote the first 3 sections last night, to clear up some of the backlog.

Quartix Holdings (LON:QTX) – Trading statement for 2020

Churchill China (LON:CHH) – Full year (2020) trading update

Carr’s (LON:CARR) – Trading update (19 weeks to 9 Jan 2021)

John Menzies (LON:MNZS) – Trading update for 2020

Asos (LON:ASC) – Trading update – I’ve reviewed this because of read-across for BOO (I hold) update due out tomorrow.

Sosandar (LON:SOS) – Q3 (Oct-Dec 2020) trading update

Wey Education (LON:WEY) – Trading update for first 4 months (Sept-Dec 2020) of FY 08/2021

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403p – mkt cap £193m

Trading Statement

Quartix Holdings plc, a leading supplier of subscription-based vehicle tracking systems, software and services, is pleased to provide an update on trading for the year ended 31 December 2020 (the “Period”).

The Board is pleased to report that it expects revenue, profit and free cash flow to be in line with current market forecasts1

[1] The Board believes that consensus market expectations for 2020, prior to this announcement, were as follows: revenue: £25.9m; adjusted EBITDA £7.9m; free cash flow: £5.3m.

Actual results (pre audit) are very similar, at £0.1m below expectations for revenue amp; adj EBITDA, close enough to be a rounding error, so that’s fine.

Many thanks for the footnote, providing us with market expectations figures, but it would have been useful to also provide the EPS result in this RNS.

I’ve got a consensus forecast of 12.3p EPS for 2020, whereas Finncap’s latest note says 13.1p adj EPS for 2020. Using the latter, that gives a PER of 30.8 times FY 12/2020 earnings – quite pricey, given the lack of profit growth in recent years – this share is on a growth company rating, but isn’t really growing overall (decline in insurance business offsetting growth in fleet business) as you can see from the graphs below.

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Quartix repaid the furlough monies to the Govt, and is up-to-date with VAT. Good stuff, that’s the right thing to do.

Customer churn (“attrition rate”) seems modest at 12.2%

Growth improved in H2

Insurance segment declining quite rapidly: 15% of total 2020 revenues, expected to reduce further to 10% of 2021 – not important, as this is low margin business

Intends to increase spending on sales amp; marketing in 2021, to accelerate growth – estimated at £1m extra costs, mainly in H2

US 3G network is being retired, which will involve Quartix spending £1.7m to replace equipment at its US customers – quite a nasty hit – I wonder if this issue could impact other territories too?

UK lockdown expected to have an impact on short term new subscriptions

Outlook – significant opportunity to accelerate growth, confident in 2021 and beyond.

My opinion – this is a good quality, high margin, recurring revenue business. It’s proven its resilience with decent 2020 results, actually slightly higher EPS achieved than the original, pre-covid forecasts.

Finncap has forecast a much bigger 2020 dividend, up from 5.4p previously forecast, to 20.5p.

The problem with Quartix, is that the decline of its insurance telematics business, combined with increased spending on sales amp; marketing in expanding overseas markets, completely masks the underlying growth. So the overall figures make it look like an ex-growth company, when you can dig below the surface and see it is actually growing the core business.

I feel that the valuation looks quite full at the moment. Lovely business, excellent management, but fully priced, is my opinion.

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1275p – mkt cap £141m

Full Year Trading Update

Churchill China plc (AIM: CHH), the manufacturer of innovative performance ceramic products serving hospitality markets worldwide, is pleased to announce the following trading update for the year ended 31 December 2020.

• Traded around breakeven in H1, depending on which figure you use.
• Q4 impacted by covid restrictions
• Still profitable overall in H2 (no figures given).
• Comfortable liquidity (no figures given here either)
• Expecting 2021 to improve, but not in Q1 (due to lockdown)
• No dividends for now – will reassess in April 2021

My opinion – there’s inadequate information in this update to crunch any numbers.

Looking at the last balance sheet, as at 30 June 2020, Churchill is very well financed, e.g. a current ratio of 4.45 is very healthy indeed. This included £14.8m cash, with no interest-bearing debt. Note there is a small pension deficit.

Therefore there are no solvency worries at all – this company is very solid, and probably trading around breakeven currently, so it could survive current conditions indefinitely.

So it all boils down to what the future holds for the hospitality sector? It seems inevitable that many restaurants are likely to go bust. Also, I’ve seen many doing CVAs, which involve closing under-performing, over-rented sites. That’s bound to reduce the demand for new crockery.

Therefore, my best guess is that CHH could take several years to recover, and might not attain previous levels of profitability when the hospitality sector was booming. Sector over-capacity could take years to unwind.

If CHH shares were dirt cheap, then I would consider it, for a 2-3 year recovery in earnings. The trouble is, as you can see below from the 3-year chart, the share price now is actually higher than it was 3 years ago, when revenues amp; profits were growing consistently. Profit has collapsed this year, so why is the market cap so high still?

Valuation here doesn’t make any sense to me, it’s far too expensive given the sector woes amp; outlook, in my opinion. Why pay up-front for an uncertain recovery?

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126p – mkt cap £115m

Trading Update

Carr’s (CARR.L), the Agriculture and Engineering Group, provides a trading update to coincide with its Annual General Meeting being held as a closed meeting in Carlisle today at 11:30am. This update relates to the 19-week period ended 9 January 2021.

Carrs has an unusual end August year end.

It’s trading in line;

The Group has made a positive start to the year with trading overall in line with the Board’s expectations.

Agriculture is trading ahead, and Engineering trading below, netting off by the sounds of it.

Net debt has reduced by £6.3m to £20.4m, compared with a year earlier. It doesn’t say if any creditors have been stretched or not.

Brexit deal on 24 Dec 2020 provides clarity, and that customers (farmers) remain competitive across the EU. New system of agricultural support is pending.

Confident in the long-term prospects of both divisions (implies maybe not so confident in short amp; medium term possibly?!)

Points out resilience of business, due to essential nature of its supplies.

Outgoing CEO is thanked.

Diary date - Interim results to 27 Feb 2021 are scheduled for 21 April 2021

My opinion – forward PER of 10, and divi yield of 4.0% put this in the value share category. Here is my review of the last FY results. It’s a good solid company, with a strong balance sheet. The trouble is that the market isn’t really interested in value shares, so this one has just gone sideways for years on end. That might change of course, so there is the possibility of a one-off revaluation at some stage, once the tech shares bubble has burst, maybe?

Given the in line with expectations update, we can rely on the forward looking valuation metrics. This is noteworthy for being a sea of green:

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252p (up 7% yesterday) – mkt cap £212m

Given that it provides airport services, it’s having a grim time. Interim results to 30 June 2020 were ugly, with an underlying loss before tax of £(48.7)m. Plus an additional £(31.4)m of exceptional costs.

The balance sheet was bad before the covid crisis. Now it looks terrible. Altman warns on this too;

NAV is negative at £(8.3)m, then deducting £181.6m of intangible assets, takes NTAV to negative £(189.9)m. The whole thing is propped up with mammoth long term borrowings of £470m. Although it is also sitting on net cash of £137m within working capital (cash of £224.2m, less £87.2m in short term borrowings). Those figures do include lease liabilities though, of £177.6m, so it’s not quite so bad when you reverse those out.

However, bear in mind these figures are as at 30 June 2020. By June 2021 it could look worse still.

This balance sheet will need to be fixed in due course, hence I reckon a big placing is probably inevitable at some stage.

Revised bank covenants were agreed in Sept 2020. It makes sense for the banks to support it, until business is back to normal.

Trading update (issued 12 Jan 2021) –

John Menzies plc, the global aviation services business, today announces a trading update for the year ended 31 December 2020.

the Board is pleased to report that the Group has continued to trade in line with the expectations set out in the Group’s interim results on 29 September 2020. Revenues for the second half were similar to those reported in the first half and for the full year were 37% below the prior year…

As anticipated, in the second half, the Group generated an underlying operating profit which was in line with the Board’s expectations. As previously guided, this second half performance was driven by increased volume, a significant contribution from various government support programmes, the positive impact of continued effective cost management and a proactive flexible approach to operations.

Liquidity is good, but bear in mind this is due to very large bank facilities.

Outlook - continued difficulties in the early part of 2021 expected.

While there has recently been some renewed Covid-19 related disruption, the positive developments with regard to the roll out of vaccination programmes are encouraging and support assumptions of a gradual recovery in volumes from the second quarter of 2021.

Assuming a more stable, if still subdued, backdrop in 2021, the actions taken to structurally reduce costs, should show an increasing benefit in the current year, with government support schemes also continuing to provide a material benefit in the first quarter.

Over the medium to long term, the Board expects that the benefits of the reduced cost base, together with the ongoing good commercial momentum will contribute to structurally improved operating margins and consistent cash generation. This will enable the Group to both reduce its leverage and take advantage of selective strategic opportunities that may arise.

My opinion – I’m amazed the banks are being so supportive. Holders of the shares need to be aware that they’re totally reliant on the bank continuing to be supportive, which makes this share high risk.

Also I would expect to see equity diluted considerably (maybe as much as 1:1) in a placing in due course. The recent bounce looks considerably overdone to me, so personally I’d be taking advantage of that, and selling.

It’s interesting to note that the company has stripped out costs. That should logically lead to higher profits once things are back to normal, than pre-crisis. So maybe I’m being too harsh, concentrating on the weak financial position?

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5350 (up 3% at 08:05) – mkt cap £5.3bn

Trading Statement

I was wondering why Boohoo (LON:BOO) (I hold) opened up this morning. It’s probably due to read-across from competitor Asos putting out a good update today. Asos has a 31 August year end, so updates us today on Sept-Dec 2020, 4 months. This covers the peak seasonal trading period.

Key points;

Revenue growth “surpassed our expectations”

Lower customer returns rate – a benefit from covid/lockdown (I suppose customers less likely to want to return packages to the post office, etc)

Net covid benefit of at least £40m extra profit in H1 (6m to end Feb 2021)

FY 08/2021 outlook unchanged, but expect to be at top end of mkt expectations – wonderful, there’s a footnote, very helpful, thanks;

2Company compiled PBT market expectations for FY21 as at 5th January 2021: Consensus: £141m, min: £115m, max: £170m

That’s quite a broad range of forecasts, so pretty significant to be at the top end.

Growth table is provided (see below) – what strikes me is that Asos is doing very well in the UK, but international growth is much lower. That’s a bit disappointing, given that overseas markets are huge in total.

Whereas the last update for BOO, showed stellar growth in USA (+83% in H1 to 31 Aug 2020), different period I know, but Asos is only reporting +13% in USA today. Therefore, I think BOO could be a stronger international growth proposition than Asos, we’ll have to see when it reports tomorrow.

Here’s Asos’s growth table from today’s update (remember this is only 4 months);

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Brexit – this cost seems to have been absorbed by out-performance. It would annualise to a larger figure, if the company is not able to get round it somehow;

Brexit tariff costs of c.£15m in FY21 associated with country of origin rules

Capex – continued very heavy spending on warehouse automation;

FY21 capex guidance increased by £20m to around £190m reflecting investment into US automation

Strong net cash amp; balance sheet, but no figures provided.

Outlook – I would imagine BOO is likely to say something similar tomorrow. This is what Asos said today;

Looking forward, given the uncertainty associated with the virus and the impact on customers’ lives, our cautious outlook for the second half of the year remains unchanged. However, the strength of our performance gives us confidence in our continued progress towards capturing the global opportunity ahead.”

My opinion – it’s pretty obvious that online fashion is a strong structural, and lockdown-boosted growth area.

I much prefer BOO shares to ASOS, because BOO makes a much higher profit margin, generates stronger growth, and is delivering more impressive international growth. ASOS has never really generated any free cashflow to speak of – the cashflow seems to be sucked into building more amp; more warehouses.

As you can see below, Asos badly disappointed in late 2018, and was a remarkable bargain in the covid panic in March 2020, but has since strongly recovered. 2017-18 is a warning that these highly-rated growth stocks can be a disaster in the short term, if high expectations are not met.
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(I hold)

15.5p (down 16% at 10:10) – mkt cap £30m

Trading Update

The market has reacted negatively to this update today.

Sosandar, the online women’s fashion brand, is pleased to provide the following trading update covering the three-month period ended 31 December 2020.

We’re now just over ¾ of the way through FY 03/2021.

Key points -

Revenue growth in Q3 only 6%, to £3.98m

However, this has been achieved despite a 66% or £1.61m reduction in marketing spend – NB the cost base is extremely flexible, with marketing spending being discretionary – a massive advantage over physical retailers.

Covid/lockdown means that the main focus on partywear didn’t happen (as expected)

Hence two very considerable headwinds there, which means reporting positive sales is actually not bad.

Profitability – EBITDA loss is down 60% on LY – but no figures given – this is more important to me that revenue growth. I want the company to conserve cash, and not do another placing. Although a top-up placing of £3m would only be 10% dilution, so not a disaster if it happens.

Returns rate has gone up from 42% in the interims, to 46% – so I don’t like the way this has been presented in the RNS as if it is a reduction! It is a reduction Y-on-Y (49% to 46%), but it’s a sequential increase from when last reported in the interims (46% vs 42%). Another example of Sosandar’s technically correct, but slightly misleading style of reporting, which investors here can see through, and don’t like (see the reader comments below). Cherry-picking or omission of important numbers is another example. Sosandar needs to ditch the previous era style of reporting (a bit rampy at times), and look to the transparency of Next (LON:NXT) as the model for its future reporting, in my view.

It’s a growth company, so it doesn’t cut the mustard telling us that sales are at a new record. They need to be, that’s the whole point.

John Lewis amp; Next new ventures are doing well. That’s encouraging, although bear in mind it started small, but should be good for future growth.

Net cash is £3.9m as at 31 Dec 2020 – this is the most important number to me, and I’m pleasantly surprised. I didn’t think SOS would get through 2020 without another placing, but it has done, and indeed still has a decent pot of cash. Well done to management. It hadn’t stretched creditors last time I enquired. So this is good news. I prefer the leaner, lower cash burn strategy at the moment.

Current trading - January 2021 has “already started well”

Brexit – no significant impact expected.

My opinion – I place more emphasis on keeping cash burn low, rather than chasing sales at a time when people were not buying partywear. This shows a flexible, and sensible approach in my view.

As things stand, the share price looks about right to me, for now.

Broker forecasts are still withdrawn, but who cares, because Shore Capital don’t let non-institutions see them anyway, so are irrelevant to the active part of the market, private investors.

Revenue for FY 03/2021 is going to be nowhere near the original forecasts of c.£20m. I calculate that we’re heading for about £10-11m revenues instead.

Far more importantly, the EBITDA loss is going to be drastically reduced on last year. It lost £1.0m in H1, and I reckon H2 should be less than that. Cash burn seems negligible at the moment, which is a huge improvement on where they were. Slower growth, with cash in the bank, is better than shooting for the stars, and running out of cash. Look at the mess that was Koovs, which eventually blew up, as I warned people it would, for years, because it targeted growth at any price. Sosandar has neatly avoided the same pitfall.

I’m happy to hold, given the sound cash position, and that cash burn seems to have been almost eliminated. To me that’s more important than chasing stellar revenue growth at a high cost.

It’s still (slightly) above the IPO price, which isn’t bad at all for what was originally almost a blue sky startup at the time. I rate the management team here very highly. What they’re trying to do is incredibly difficult. So to have got this far, is highly impressive.

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36.5p (unchanged, at 11:41) – mkt cap £50.6m

This is a very interesting online education business. There’s a good trading update today -

Wey Education announces that trading in the first four months of its financial year has been significantly ahead of budget and market expectations. The Company expects to exceed market forecasts in both turnover and profitability for the year ending 31 August 2021.

That’s a strong statement to be making 4 months into the new financial year.

The share price initially surged this morning, but has come back down to flat now. I think that might be due to this statement about VAT -

Following a group structure and tax review, the Company also reports that InterHigh will henceforth charge VAT to its UK clients. This change will also allow the Company to recover VAT on UK expenditure and ensure that future InterHigh profits are distributable.

Part of the benefits from current trading will be used to smooth the transition in these charges for existing clients and notwithstanding this and a further targeted increase in marketing expenditure the Company expects profit before tax for 2021 to be ahead of market expectations.

I find that all a bit confusing, and the company clearly needs to give a more detailed explanation.

My questions;

1. Why has the company decided to charge VAT now for UK customers? It seems likely to be adverse in its impact on profitability (20% extra cost of fees is likely to reduce net revenues as some customers are deterred). Also given that the big costs would be teachers salaries (non VATable), then I can’t see how reclaiming input VAT would be a greater benefit than lost sales due to the price of the service going up 20% to the end customer.
2. If the company is being forced by HMRC to start charging VAT, then surely that implies it should have been doing so in the past, in which case, is there a risk of a back-dated VAT claim? Revenues since 2015 have totalled about £23m, so back-dated VAT on that would be c.£4.6m, which couldn’t be reclaimed from customers.
3. Why would a change in VAT have any impact on distributable reserves to fund dividends?

My opinion – I’m not going to jump to conclusions about the above, but the company needs to issue a more detailed explanation of the VAT issue to the market.

The share price has risen very strongly recently, on the back of considerable interest from investors. It got wide coverage in end of year investor reviews, for quite a few opinion leaders, successful investors. I’m a little worried that it might now be a rather crowded trade, so I’m not interested in buying back in at the current level, although I do like the company and think it has a good business model, and strong growth prospects.

Overall then, I’m positive about the company, feel the current valuation looks a bit rich for my taste, and need clarity on the questions asked above.

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(work-in-progress)

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