Small Cap Value Report (Thurs 20 May 2021) - BEG, NEXS, MMH, BWNG

Good morning, it’s Paul and Roland here, with the SCVR for Thursday.

Timing - I’ve got 2 company zooms coming up from 12-1, and 1-2, so am going to be quite busy today. Am struggling to get my head around the complexity of BWNG too, so think I’m going to need to spend the whole day on this – hence estimated finish time 5pm. Update at 18:58 – what a nightmare! I’ve finally got through BWNG now, so declare today’s report is finished.

Agenda –

Paul’s section:

Begbies Traynor (LON:BEG) (I hold) – year end trading update for FY 04/2021 – comfortably ahead of expectations. Also strong cashflow, ending the year with net cash of £3.0m. 4 acquisitions in the last year have gone well. There’s lots to like here – I see BEG as cheap, and executing well on acquisitive growth.

N Brown (LON:BWNG) (I hold) – very complicated accounts for FY 02/2021. Massive EBITDA of £86.3m turns into only £9.9m statutory profit. Strong balance sheet. Not a very good business, but it has interesting turnaround potential, I think.

Roland’s section:

Nexus Infrastructure (LON:NEXS) – half-year results from this infrastructure group, which has its roots in civil engineering and utility services, but has a growing focus on electric car charging. Can this former AIM growth story get back on track?

Marshall Motor Holdings (LON:MMH) – A solid trading update from this car dealership group. Management expects to match 2019’s pre-pandemic profits in 2021, despite the spring lockdown. Is there still value here?

(I hold)

121p (pre market open) – mkt cap £182m

Year end trading update

Begbies Traynor Group plc (the ‘company’ or the ‘group’), the business recovery, financial advisory and property services consultancy, announces an update on trading for its financial year ended 30 April 2021.

Begbies has been putting out decent trading updates for a while now, plus making a flurry of acquisitions. It now seems that it finished the year with a strong Q4 -

Results expected to be comfortably ahead of market expectations

As you can see below, forecasts (in particular for FY 04/2022) have been rising a lot, due to some quite decent sized acquisitions -

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Key points in today’s update -

• Comfortably ahead of expectations
• There’s a footnote (many thanks, very helpful) – analysts range of forecasts is £10.5 to £11.1m adj PBT
• Strong Q4 (Feb, Mar, Apr 2021)
• 4 acquisitions in the last year – significant increase in scale amp; scope of the group – I don’t think this has been properly grasped by the market yet
• All parts of the business are doing well, including acquisitions
• Strong cashflow
• Net cash of £3.0m at end April 2021 year end – better than expected
• Outlook – well positioned for material earnings growth

Valuation – broker consensus for FY 04/2022 is 9.0p (the lighter coloured, higher line on the graph above). The company is tending to out-perform forecasts, so I reckon 10p might be a better bet. That puts the shares on a PER of around 12, which strikes me as cracking good value for an acquisitive group that doesn’t seem to have put a foot wrong.

Insolvency work is highly specialised, and very high margin (about 30% I think). Begbies (and Frp Advisory (LON:FRP) which I also hold) are both out-performing the sector (which is quiet due to Govt support measures for so many companies averting insolvencies for now).

I can’t see any reason why BEG shares are under 150p, so I’ll be sitting tight on my shares, and am very pleased with progress. Also as mentioned before, I see scope for BEG to be re-rated as a successful acquisitive group, rather than a vanilla insolvency firm.

Plus in any case, earnings are on a strongly rising trajectory, from well executed acquisitions, which usually contain a big earn-out element, hence are partially self-funding. This is the advantage of having an owner-manager in charge (Ric Traynor) – equity is only issued for very good reasons.

Note that the Stockopedia algorithms don’t like acquisitive groups, because I have a feeling the figures don’t strip out goodwill amortisation, which pushes down the quality metrics. Whereas generally accepted practice is to adjust out goodwill amortisation.

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(I hold)

64.75p (down 8%, at 11:44) – mkt cap £298m

N Brown is a top 10 UK clothing and footwear digital retailer, with a Home proposition, serving customers across five strategic brands. Our strategic brands are JD Williams, Simply Be, Jacamo, Ambrose Wilson and Home Essentials and our financial services proposition allows customers to spread the cost of shopping with us. We are headquartered in Manchester where we design, source and create our product offer and we employ over 1,800 people across the UK.

I would describe it as a hybrid of an eCommerce business (selling mainly outsize clothing, and homewares), and a high cost/high default credit provider. I think it’s difficult to avoid the conclusion that it’s not very good at either of these activities.

Full year results

(for the 52 weeks to 27 Feb 2021)

These are really complicated accounts, and it’s taken me hours to get my head around things. The key question I’ve tried to investigate is whether this business actually makes any money?! See the my opinion section at the end for my conclusion.

Adjusted EBITDA – huge numbers are given for this (artificial) measure of profitability. £86.5m is reported for FY 02/2021, and company guidance for FY 02/2022 is £93-100m.

The problem with EBITDA, is that it ignores many real world costs. £86.5m adj EBITDA turned into just £9.9m statutory profit before tax in FY 02/2021.

The main culprits are these costs, which are real cash outflows, so cannot just be ignored -

Depreciation amp; amortisation £39.8m – checking the notes to the accounts, it turns out this is nearly all amortisation of software. BWNG seems to have bloated, extremely expensive legacy IT systems, including a mainframe which was mentioned in the commentary today -

Providing credit to make shopping affordable is at the heart of N Brown’s business model and remains at the core of the strategy moving forwards. N Brown’s current credit platform is built on a mainframe system which is robust but lacks flexibility to make changes to enhance the customer proposition. Customer behaviours have evolved and are generally shifting towards a range of more flexible payment products, which the Group’s current system cannot currently service. To deliver more modern products, the Group needs to develop a new Financial Services platform that has the flexibility to offer these products and the equity raising completed in December 2020 will enable investment in this.

Interest cost – net finance cost of £16.6m is important, because BWNG is a finance company, extending expensive credit to its customers, many of whom defaut – e.g. the impairment charge in FY 02/2021 for customers who don’t pay, is a staggering £144.1m. How on earth does that stack up? It does, because BWNG charges interest to its customers of £239.5m in the same year.

The way I look at this, is that BWNG is ripping off its customers with exorbitant consumer credit. The customers then in turn rip off BWNG by not paying! It reminds me of those old Lily Savage monologues, where she used to boast about getting free stuff from the catalogues, by moving house before the weekly payments started!

Despite being a shareholder in BWNG, I’m not at all comfortable with the business model, and it’s fraught with regulatory risk. If you read the notes to the accounts, there are all sorts of legacy issues that have required provisions – e.g. PPI mis-selling, VAT disputes, a £29m claim amp; counter-claim over PPI liability with insurer Allianz (see note 18).

Hence adj EBITDA of £86.5m becomes only £29.9m profit, once we deduct just the software costs (capitalised amp; then depreciated), and the net interest cost. Plus there are all sorts of other costs, some classified as exceptionals, fair value adjustments, impairments, etc.

Overall then, I’ve established that the quoted adj EBITDA figures are complete fantasy, and best ignored.

Revenues – fell 13% to £729m, so it’s a substantial business.

This is split £469m product revenues, and £260m financial services revenues, so you can see how important FS is to the overall business model. Some might say that selling stuff is just a mechanism to generate high cost lending here.

H1 was worse, at minus 17.6%, and the company shows a table which demonstrates a sequential quarter-by-quarter improvement in revenues.

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Whilst it’s good to see an improving trend, I can’t help compare how badly BWNG has performed, compared with recent results from Boohoo (LON:BOO) (I hold) which produced barn-storming growth in revenues amp; profitability. BWNG went backwards over the same timeframe.

Variable costs – a massive advantage for eCommerce businesses, because in a downturn they can quickly amp; easily cut back on costs, given that many costs are variable. BWNG massively reduced its marketing spend from £136m last year, to £60.3m in the year being reported. It strikes me that a lot of that marketing spend is probably wasted, as they seem huge numbers, even the reduced spend.

The management commentary in this morning’s webinar seemed to imply that previous marketing spend had been wasteful. They seem to have discovered digital marketing fairly recently, and are moving into that area. So there could be good upside here from more effective digital marketing spend in future, perhaps?

Equity raise of £100m, and a move to AIM. This has greatly strengthened the financial position. Also, bad debts were expected to be much worse due to covid, which hasn’t happened. They showed a slide on the webinar which seemed to demonstrate that customer defaults had briefly spiked in lockdown 1 but since returned to normal.

Overall, BWNG looked financially distressed last year, but now it looks fine to me. Hence I think we should view this as a stable, well-financed business.

Balance sheet - NAV is £416.3m, less £133.0m intangibles, gives NTAV of £283.3m, which is close to the market cap of £298m. Therefore this share is strongly asset-backed, and there should not be any further dilution.

Are the assets being used productively though? Clearly the market thinks not, as a low multiple of price to tangible book value means that investors see poor returns from capital. Note that Stockopedia shows a P/TBV of 1.72, which is out-of-date now due to the equity fundraise. That should drop to just 1.05 once the database updates in the next few days, from the new numbers published today.

I like tangible asset backing. It means that the downside should be limited, insolvency/dilution risk is little to none, and buys time for management to improve the business.

Although the covid crisis did demonstrate that a business like this, which borrows from banks, and then extends consumer credit, is vulnerable to the banks getting twitchy in times of crisis. Hence why a £100m equity fundraise was necessary at the time. So if the banking system were to shake itself to pieces again, then I suppose we couldn’t rule out the possibility of another placing being demanded by the banks.

Land amp; buildings of £40.4m – looks like that could be freehold property, I’m not sure, but would be a nice asset to have if so.

Pension scheme – there’s a £25.5m surplus on the balance sheet, but I haven’t checked if there are cash outflows relating to that – because accounting surpluses are often deficits in the real world actuarial calculations, under the absurd rules we have for pension scheme accounting, which can give a highly misleading picture sometimes.

Shareholding structure - Lord Alliance amp; family have dominant ownership. I wouldn’t be surprised to see a bid from them, to take it private.

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Other points -

Bank debt – £500m securitsation facility (lending secured on the customer receivables book), plus £100m RCF and £12.5m overdraft. Plenty of headroom on facilities. Dec 2023 renewal.

Dividends – none at present, look likely to resume at end FY 02/2022

Gross margin for product fell a lot, but due to pivoting to home amp; garden products during pandemic, when less clothing was sold. Lower margin, but much lower customer returns rate, so this is fine

Guidance is for a return to modest revenue growth in FY 02/2022, 1-4% total revenue growth, but 3-7% growth for product. Shouldn’t an eCommerce business be growing faster than this?

My opinion – overall, it’s not really making much real world profit. I think these figures show a bloated, inefficient, old-fashioned business, which needs a massive sort out.

Why do I hold shares in it then? Because I can see the turnaround potential here. Imagine if the product ranges were improved, and sold at higher margins – then gross profit would soar.

Imagine if they could improve their credit scoring, so that they sell things to people who will actually pay up?! Although high cost credit is only really going to appeal to people who can’t afford it.

If BWNG could get some product amp; digital marketing experts in, to transform the business into something more like BooHoo, then the shares could really take off.

So I see this share as an unimpressive existing business, with terrific turnaround potential.

The balance sheet strength amp; asset backing mean that I feel it’s a safe share to tuck away for a couple of years, and see what happens. Any sign of a convincing turnaround, and the upside could be quite exciting from a £298m existing market cap. Look at what BOO amp; Asos have achieved, they’re valued in the billions now.

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173p (pre-open) – market cap £78m

Half-year results

Nexus Infrastructure (LON:NEXS) has published its half-year results today. This infrastructure group operates in three main areas:

• TriConnex (38% of H1 revenue): this business builds utility infrastructure for new housing developments
• Tamdown (57% of H1 revenue): Civil engineering for housebuilding and commercial sectors. Services include groundworks, roadbuilding, etc
• eSmart Networks (4% of H1 revenue): Launched in 2017. This business covers electric car charging infrastructure, renewable energy connections and on-site high voltage electrical infrastructure

Nexus has a September year end, so today’s interim results cover the six months to 31 March 2021 and appear to be in line with expectations:

• Revenue of £63.7m (H1 2020: 84.2m)
• Operating profit: £1.5m (H1 2020: £3.5m)
• Order book: £301.6m (H1 2020: £299.5m, FY 2020: £282m)
• Net assets up 22.4% to £30.1m
• Net cash £10.7m (H1 2020: £4.6m)
• Dividend restarted with interim payout of 0.6p

To understand the performance, I think it’s worth splitting out these numbers across the group’s three operating businesses:

TriConnex: Revenue rose by 5% to £24.4m during the half year, while operating profit was down 4% to £2.4m. TriConnex’s order book grew by 4.7% to £190.9m – that’s 63% of the group’s total order book.

This business builds the multi-utility infrastructure needed on new housing developments. Trading appears to be stable – indeed, I’d say that TriConnex is supporting the wider group at the moment.

eSmart Networks: Still early stage, but growing fast as electric car charging infrastructure becomes a high priority across the UK. Revenue rose by 156% to £2.8m, while eSmart’s operating loss was cut from £0.7m to £0.4m.

Importantly, the order book is growing fast – up 455% to £12.2m versus H1 2020. As Jack has commented previously, this business could potentially standalone in the future and certainly seems likely to become a bigger part of the group.

Tamdown: the oldest part of Nexus and currently the most problematic. Tamdown is essentially a construction contractor performing work for housebuilders and commercial property developers.

Nexus says that Tamdown’s client list includes “the majority of the top ten largest UK housebuilders”. According to management, uncertainty relating to Brexit and Covid-19 put new contract awards on hold during the first half of 2020.

Order momentum is now said to be improving, but the numbers aren’t great. Half-year revenue at Tamdown fell by 40% to £36.8m (vs H1 2020) and the unit generated an operating profit of just £0.3m.

Tamdown’s order book of £98.5m is still lower than at the end of H1 2020 (£114.9m) but has increased since the end of September 2020 (£92.8m).

I think it’s fair to say there are early signs of improvement at Tamdown, but this business still has a way to go to return to its previous run rate of revenue and profit.

Balance sheet: This is a sector where solvency and liquidity can become a problem, thanks to sizable working capital requirements and slim margins. Given this, I’m pleased to see the group’s net cash position improved last year. Gross borrowings and lease liabilities look manageable to me, too.

I don’t have any serious concerns about the balance sheet here. I’m also reassured to see that CEO Mike Morris remains Nexus’ largest shareholder, with a 22% holding.

If I was going to invest in this sector, I’d prefer to go with owner management, to (hopefully) reduce the risk of dilution or worse.

Cash generation: Nexus reported an operating cash outflow the half year, due to large working capital movements:

Given the group’s net cash position and lack of significant dilution since its flotation, I don’t see anything to be alarmed about here. But before investing I’d want to look at the longer-term pattern of cash generation and understand more about these inflows and outflows.

Outlook: The company says that eSmart and TriConnex are expected to continue trading well, supported by government programmes to encourage new housing and electric transport. Tamdown is expected to show improved profitability “over the medium term”.

The outlook is said to be confident, hence the decision to reintroduce the dividend.

My view

Nexus floated on AIM in 2017, but after a strong start progress has been somewhat mixed since then:

Oddly enough, profits appeared to peak in 2016 (the year before IPO) and have not yet returned to those levels. Another example of private owners knowing the right time to sell?

The Stockopedia stats show revenue was flat from 2015 through 2019, while profitability varied:

In fairness, this isn’t a terrible performance for this sector. But today’s half-year results show a further decline in operating margin, to 2.4% (H1 only). The direction of travel needs to reverse soon, in my view.

Looking ahead, consensus forecasts suggest that after the setbacks of last year, earnings are expected to improve over the next 18 months.

However, a fair amount of growth does seem to be priced into the stock already:

I reckon that this valuation could be supported over the medium term by the growth of the eSmart Networks business. But for now, my view is that Nexus is probably close to fair value.

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175p (+1.5% at 0845) – £137m market cap

AGM Trading Statement

Car dealership groups such as Marshall Motor Holdings (LON:MMH) have been a good recovery play over the last year. In Marshall’s case, the stock is now trading ahead of pre-Covid levels.

Profits have recovered strongly, too. In today’s AGM trading statement, the company says that underlying pre-tax profit for 2021 is expected to be “not less than 2019’s result of £22.1m”. This will be achieved “after repayment of CJRS and non-essential retail sector grants” totalling £4m.

I’m pleased to see Marshall’s repaying these government monies. Although the business was entitled to them, my personal view is that companies should not retain these payouts unless they’re needed to support employment or the operation of the business. That’s clearly not the case here.

Moving on, what can we learn from today’s update?

Trading summary: Trading during the first four months of 2021 was hit by the lockdown closure of showrooms. However, like many of its peers, Marshall was able to continue operating on a click and collect basis.

According to the company, both new retail and used car sales outperformed the wider market during this period:

Used car sales have also been strong:

One comment I’d make on these numbers is that the comparison period (the first 3/4 months of 2020) is not necessarily very meaningful, given the situation in the early stages of the pandemic. Even so, I think Marshall’s performance looks very respectable.

Indeed, I’ve been impressed by how quickly car dealers have made the shift to online retail during the pandemic. In my view, this is a trend that aligns well with the reduction in outright car ownership (versus contract plans). I think online car buying will stay with us.

Financial position: No detail is provided, but the group says its financial position “remains strong”, with good cash generation so far this year.

Although I’d like to see some numbers, I’m inclined to accept this claim based on the group’s historical performance and its 2020 year-end net cash position (ex-leases).

Growth opportunities: Marshall’s describes itself as a consolidator in this sector and says it is reviewing a pipeline of potential acquisition opportunities. However, management promises to focus on deals which add shareholder value and complement brand partners’ objectives.

Again, based on past performance I don’t have too many concerns about this.

Outlook: Management are pleased with performance so far, but flag up significant uncertainty for the remainder of the year. In addition to Covid-19 risks, the company warns that the market could see supply shortages of new and used vehicles, as a result of global semiconductor shortages.

This is an issue for a number of sectors at the moment. But one account I read recently suggested that car manufacturers have ended up at the back of the queue for chips, after cancelling orders early last year and then being forced to reinstate them more recently.

However, despite “a range of possible outcomes” for 2021, the board remains confident of matching 2019’s pre-pandemic profit.

My view

I’ve admired this business for a while. My perception (as an investor and a customer) is that the company is well run and disciplined. I don’t see anything to change that view in today’s statement.

Are the shares attractively valued after such a strong run? Rather like housebuilders, a lot depends on your view on the outlook for the economy. I try not to take a strong stance on this as I view it as beyond my paygrade and competence.

What I can see is that Marshall’s underlying trading seems likely to remain at the upper end of the group’s recent historic range:

This business also seems to be emerging from the pandemic in good financial shape, with its historic competitive advantages intact.

However, we need to remember that this is a famously low-margin sector which depends heavily on aftersales for profitability. Gross margins on new and used car sales were just 0.66% last year – the equivalent figure for aftersales was 45%.

There’s also some cyclical risk to this business, which is hard to quantify right now..

On balance, I think Marshall’s stock’s forecast P/E of 9 and prospective yield of 3.7% could be attractive, if not obviously cheap

Stockopedia