Small Cap Value Report (Mon 7 June 2021) - RIO, RCDO, CLG, GUS, STCM

Good morning, it’s Paul amp; Jack here with the first of this week’s SCVRs.

Market cap – upper limit for SCVRs

We’ve been discussing raising the market cap limit here to £700m, because a lot of interesting companies have now gone above our existing £400m-ish upper limit. I was watching an interesting video from my friend Chris Boxall at IHT specialist fund management firm, Fundamental Asset Management, who is a walking encyclopedia on small caps. When asked how he defines small caps, he said up to £700m, because that’s roughly the level when companies join the FTSE 350. So anything below that, it makes sense to call a small cap. Or micro cap below £100m. That makes sense to me.

What do readers think? Would it be useful for us to increase our coverage up to £700m mkt cap?

Mello – tonight

Starting at 18:00 tonight. I see that Keith Ashworth-Lord is being interviewed. Our own Jack is featuring in the BASH (buy, avoid, sell, hold?) session. More details here.

Check out Jack’s recent article on Gear4music Holdings (LON:G4M) here if you haven’t seen it. Very interesting. This is a coffee can (i.e. hold forever) share for me.

Timing - it’s quiet for news today, so I think we should be finished by mid-morning.

Agenda -

Paul’s Section:

Clipper Logistics (LON:CLG) – bigger than usual, but as there’s very little else to cover today. Today’s update is in line with expectations, but there’s lots of positive commentary about future growth. Guidance is raised. Looks excellent, and I think the big rise in share price looks justified by strong fundamentals.

Jack’s Section:

Gusbourne (LON:GUS) – another Kent-based wine producer but, as with Chapel Down (OFEX:CDGP) , valuation looks to be ahead of events given the scale of revenue being generated. Caution is advised given historic levels of capex and the track record of equity dilution

Steppe Cement (LON:STCM) – shares down on final results. The Ranks and value metrics here are consistently excellent but there are more qualitative due diligence considerations to factor in as well

Stock screens – I ran some of my personal stock screens over the weekend, looking for potentially cheap shares, and didn’t come up with much. At the moment, a really good field to search on, is broker upgrades, as that helps flag companies which are out-performing forecasts that are often too low right now.

Two shares that caught my eye for further research were;

Rio Tinto (LON:RIO) – amazingly good dividend yield of about 9%, combined with a low PER – could this be a good way to play the commodities boom, I wonder?

Ricardo (LON:RCDO) – low forward PER, and although it took a battering in H1, with profits down, the outlook amp; order book seem healthy. I was looking at the interim (H1 to 12/2020) presentation on its website, and the business is not just automotive, but also has other divisions which have been robust in the pandemic. All of the downturn in profit was due to the automotive division stalling. Could be a potential turnaround maybe? A big military contract was won recently.

Any views?

I had my second covid jab (Astra-Zeneca – cheap amp; cheerful!) on Friday, at the BiC (Bournemouth International Centre). It was well-organised, and doing things on quite a big scale, lots of medical staff, and volunteers doing a great job. A volunteer went down the queue of people, asking who was there for the AZ second jab, so she led me amp; another chap to a different, much shorter queue (or VIP area, as it has morphed into, in my account of things on Facebook, to wind up my left wing friends, of which there are far too many, I must have a cull!).

Once in the cubicle to get jabbed, I noticed the nurse calling the jabber by his unusual name, Tobias. Reassuringly posh. I cheekily asked Tobias, “You’re not our local Tory MP, Tobias Elwood are you?”, to which he sheepishly replied, “Unfortunately, yes”. At that point I broke cover, and told him I was the chap who bombards him with emails about topical issues, several times a week, using the website WriteToThem, which makes it very easy. “Ah yes”, he warily replied. I then proceeded to tease him gently about Alan Duncan’s memoirs which are riddled with criticism of Tobias. He replied, “Yes, he doesn’t seem to like anyone very much, does he?!”

It made my day to meet, and be personally vaccinated by my MP! I don’t know why I’m writing about that here, probably just to pad things out a bit.

Anyway, hardly any side effects from jab number 2, and it has already appeared on my phone, in the NHS App, which looks set to effectively become a travel passport facility at some stage (France is already saying double jabbed Brits can visit, but I don’t want to go there at the moment, they’re being too difficult).

The other issue which might make some travel/hospitality shares wobble today, are doubts over whether the full re-opening in the UK might be delayed by possibly 2 weeks? Also serious staff shortages, and wage inflation seem to be a growing issue. It seems to me that a spike in inflation generally is on the cards. The question is, whether it’s likely to be short-lived, or become self-fuelling? Who knows? Answers on a postcard. The key question for every share we hold, and to ask management in webinars, is what pricing power do they have – i.e. can higher costs be promptly passed on to customers? Or are they locked into contracts with fixed prices?

Inflation isn’t necessarily bad for shares, in fact it can be beneficial for companies which can readily raise their selling prices. I read a book recently about Weimar Germany’s hyper-inflation. In the early stages of inflation (which started in about 1913, before the war, then took about 10 years to build up to hyper-inflationary collapse in the currency, there was a stock market boom. People with fixed incomes (bonds, etc) got wiped out, but equities soared, until the final collapse of the economy some time later.

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817p (up 5% at 08:19) – mkt cap £832m

(note the share price is erratic in early trading, with hardly any trades printed, and a 60p spread on the published bid/offer prices, which are not the real prices of course).

Most shares in cyclical companies have done very well in the last year, but Clipper has done particularly well, as you can see:

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Today’s update:

Trading Update, Acquisition, Contract extension

Clipper Logistics plc (“Clipper”, the “Group” or the “Company”), a leading provider of value-added logistics solutions, e-fulfilment and returns management services to the retail sector, today provides a post-close trading update for the year ended 30 April 2021 (“FY21″).

There’s a nice summary at the start -

Strong performance in FY21 and continuing momentum with upgrades to guidance for FY22 and FY23

Acquisition of Wippet B2B marketplace to extend reach into life sciences vertical

ASOS contract extension in Europe

My summary of the main points -

• Accelerating contract wins in UK amp; Europe
• Very well positioned to further accelerate growth
• Structural shift to online – helped by the pandemic, but expected to continue – online now makes up 70% of Clipper’s revenues
• Traditional retail also strong for Clipper, as outsourcing growing in popularity
• Profit for FY 04/2021 in line with expectations at £31.6m operating profit on the old IAS17 basis – up 53% on last year – very impressive growth
• The IFRS 16 operating profit of £40.2m is also given, but of course this is meaningless, because a load of property rental costs are moved down into finance charges under the nonsense that is IFRS 16
• Revenue for FY 04/2021 is up 39% to £698m
• New contract wins – e.g. JD Sports, River Island, Joules (I hold), Mountain Warehouse
• European expansion, including helping UK retailers deliver into EU efficiently, post Brexit
• Strong new business pipeline
• Acquisition of Wippet Ltd – launching a B2B marketplace in Sept 2021 – sounds like a startup? Supplying healthcare products
• Asos (I hold) European contract with Clipper – extended by 3 years, doubling staff in Poland from 250 to 700
• Exploring acquisitions in Europe amp; N.America
• Net debt greatly reduced, from £45.1m to £17.0m in the last year (IAS 17 basis, ie excluding lease liabilities) – plenty of headroom on key bank covenant

Outlook –

Given the continued strong trading momentum and pipeline of contracts wins, we expect EBIT (under both IAS 17 and IFRS 16) for FY22 and FY23 to be ahead of Company-compiled consensus (https://www.clippergroup.co.uk/analyst-consensus/) by mid-single digit percentages in both years.

Guidance - this is the guidance provided by Clipper, using the link immediately above -

How about this for clarity! Why can’t all companies give specific guidance like this?

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Valuation – I’d be inclined to value this share on 30p forecast EPS, and put it on a PER of say 20-25, to reflect the strong growth. That values the shares at 600-750p. The current share price is 817p, a bit above my target price. However, that can probably be justified, in that the company is performing so well, that it’s likely to beat forecasts.

My opinion – this looks terrific. I can see why the share price has gone through the roof, as earnings growth has dramatically accelerated. The outlook sounds really positive too, together with international expansion.

If I held (sadly I don’t), then there’s more than enough in today’s update to justify continuing to hold. This is going on my “buy any dips” watchlist.

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Share price: 82p (pre-open)

Shares in issue: 46,478,619

Market cap: £38.1m

Another UK Kent-based winemaker reports today: Gusbourne (LON:GUS) .

The original Gusbourne Estate in Appledore Kent dates back to 1410. Andrew Weeber took over the estate in 2004 with a new emphasis on sparkling wines. It appears as though a couple of the wines so far have got some good reviews.

But as with so many obvious reopening trades (particularly in Leisure), a lot of the post-Covid recovery is priced in here.

And then a more fundamental point: interesting companies that you might like to see do well do not necessarily make good investments. Even considering the strong momentum, Gusbourne only has a StockRank of 27 due to low Quality and Value Ranks of 17 and 14 respectively.

What’s more, this habitually loss-making company is now valued at some 20x sales, with £1.9m of trailing twelve month (TTM) revenue and a market cap of £38m.

And an additional point: the free float is a minuscule 8.6% of shares in issue. With a spread of 732bps, liquidity is a serious issue to consider here.

Final results

Highlights:

• Net revenue +28% to £2.11m; 5Y CAGR (compound annual growth rate) of 35%
• Shift to direct-to-consumer (DTC) – DTC now represents 30% of net wine revenue, up from 20%
• International sales up from 19% to 33% of sales
• UK trade sales down from 61% to 37% of net revenue

As with Chapel, Gusbourne looks to have unlocked the DTC route to market over lockdowns. This could provide longer term value going forwards but, with other specialised delivery models like Naked Wines and Virgin Wines already owning quite a lot of market share, it’s unclear at present how this market evolves and who captures the profits.

The group will continue to focus on DTC. It plans to invest further in online and digital in the coming years.

No surprise that on-trade has suffered. In response, Gusbourne has worked on its off-trade offer and won the placement of its first exclusive product with a premium supermarket chain, as well as growing international sales.

Mid-year the group entered into a £10.5m asset-based lending facility with PNC Financial Services. This provides additional liquidity and long-term working capital finance. Gusbourne aims to maintain its ‘robust investment strategy into vineyards, property, equipment and of course wine inventory’.

Gusbourne has also increased capacity at The Nest, which is its retail, tour and wine tasting operation in Appledore, Kent.

Conclusion

Gusbourne has managed to grow revenues at a fair clip in recent years, with more expected in the year ahead.

But this is a perennially loss-making company. While some early investors might buy into the grand vision, the facts of the matter so far are that Gusbourne is heavily loss-making and capex hungry (and it sounds like there is more capex to come), meaning it burns up cash.

It has so far significantly diluted its shareholder base after raising cash via stock issuance in seven of the past eight years.

At the same time, net debt has been growing – up from £3.6m in 2018 to £11.7m on a TTM basis (including £2.03m of capital lease obligations). Given these characteristics, it’s no surprise to see the Piotroski F-Score (which gauges trends in financial health) at a lowly 3/9.

The Major Shareholders list shows a raft of individual investors. I do wonder if companies like Gusbourne are better off being held privately anyway, where long term shareholders can ride out volatile periods (which will undoubtedly come).

On balance the risk:reward here is not attractive, particularly given the current valuation. The same could be said for Chapel – while growing DTC and online business sounds could have potential, it’s all very early on and the numbers are small given the valuations on display at present.

Steppe Cement (LON:STCM)

Share price: 46.01p (-11.52%)

Shares in issue: 219,000,000

Market cap: £100.8m

Steppe Cement (LON:STCM) is the Malaysian-incorporated holding company of the two operating companies, (Karcement and Central Asia Cement) that form the cement manufacturing complex at Karaganda in central Kazakhstan. It listed on AIM back in September 2005.

It’s on the agenda today primarily due to the fact that it has, for a long time, generated an exceptionally strong StockRank. Here’s the three year chart.

It seems like this attractive blend of quantitative factors has seen the share price nearly double recently but the SR is still a sky high 99 so is there more to come?

Revenue has been choppy in the past so there could be a good reason for the stock’s previous lowly valuation.

Net income has been similarly volatile and, in 2010, 2014, and 2015, the group racked up some notable net losses.

There are a few other reasons that might put investors off this share. The shareholder base is unfamiliar and populated with individual investors and coverage of the company is sparse and the shares are thinly traded, which can lead to volatility (as seen this morning).

Results are affected by currency fluctuations around the Kazakhstani Tenge.

But then, some of the numbers here are hard to argue with. Steppe is paying out a forecast 9.51% dividend and is priced at 12.3x forecast earnings with a forecast PEG ratio of 0.7. The quality metrics are also good, with a ROCE of 20.7%.

Final results

Highlights:

• Revenue -6% to $74.8m,
• Net profit +14% to $11.1m and EBITDA up slightly from $23.9m to $24.2m,
• The overall domestic cement market grew by 6% to 9.4m tonnes but Steppe’s local sales fell by 6% due to milling limitations during two months of the high season,
• Exports increased by 20% ‘in line with the market’,
• Shareholders’ funds decreased to $57.9m from $62.9m due to currency devaluation and after dividend distribution to shareholders,

The average KZT/USD exchange rate fell by 8% in the period. Steppe Cement’s average cement selling prices increased by 6% in KZT, but decreased by 3% in USD, to USD 45.4 per tonne delivered.

Interestingly, the group adds that ‘the replacement cost of the Company’s assets remains many times higher than their current book value’, so that could be something for value hunters to investigate.

The group says the Kazakh cement market increased by 6% in 2020 despite the impact of Covid, and it expects a modest increase in 2021.

Imports into Kazakstan decreased by 13% to 0.6 million tonnes (equivalent to 6% of the total market), mostly due to the ban on imports from Iran. Exports from local producers increased by 22% to 2 million tonnes mostly to Uzbekistan and Kyrgyzstan.

Volumes exported to Uzbekistan by Kazakh operators will be reduced once the new factories built in Uzbekistan become operational, most likely in late 2021, however.

Conclusion

Kazakhstani cement production is not a market I’ve investigated or claim to know much about.

This is an unusual listed stock to find on the UK markets. Some might view that as a risk. Others might view the dearth of research and market communication as an opportunity.

While the financial data is undoubtedly attractive, I’m mindful of previous losses and volatile trading patterns. As a cement producer, Steppe presumably does not have much pricing power and must be subject to the vagaries of supply and demand. Is there any kind of moat here? What’s to stop others from establishing cement production if prices rise?

There could be good answers to these questions, so any views on the above are welcome.

The exposure to the Tenge also complicates the investment.

A company that has grown out of former Soviet assets, with operations in Kazakhstan, that exports to the likes of Uzbekistan and Kyrgyzstan, and is currently navigating a ban on imports from Iran… That’s a world away from what I know and there’s a lot of work to be done before I would feel comfortable here.

It could do well for holders. That’s what the Ranks appear to be saying, from a more quantitative perspective.

But considering its unusual location, history, volatile trading track record, and shareholder base, I would also want to do an above average amount of due diligence into the management, major shareholders, and business model of this company before admitting it into my portfolio.

In all likelihood, other opportunities will present themselves before I get that far.

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