Small Cap Value Report (22 June 2021) - CGS, G4M, SAGA, CRPR, MCL, TRI

Good morning, it’s Paul amp; Jack here with the SCVR for Tuesday.

Timing – TBC

Agenda –

Paul’s section:

Castings (LON:CGS) – brief comments from yesterday’s results webinar.

Gear4music Holdings (LON:G4M) (I hold) – so far so good! Sparkling results, boosted by lockdown, as expected. Current trading better than expected, and brokers upgrade forecasts by c.50% for the current year. A coffee can, hold forever stock, in my opinion. Still reasonably priced too.

Saga (LON:SAGA) (I hold) – financing changes proposed. I see this positively in principle, moving riskier bank debt onto safer, longer-term (and covenant-free) bonds. This would also provide another £80m of cash headroom, which is already ample, per trading update last week. I remain firmly bullish on this share, with a personal price target of 1000p in due course, I explain my workings amp; rationale below.

James Cropper (LON:CRPR) – I quickly review the FY 03/2021 results amp; commentary. Not madly exciting.

Jack’s section:

Morses Club (LON:MCL) – Q1 performance is ahead of budget and impairments are within the expected range. Covid investment in tech could drive further growth down the line.

Trifast (LON:TRI) – full year results impacted by Covid but conditions are improving and the group is investing for future growth.

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Paul’s Section Castings (LON:CGS)

Results webinar yesterday

Many thanks to Alex at Yellowstone Advisory, who organised a results webinar (and provided a link for us to join here, in yesterday’s reader comments)from this interesting iron foundry/machining group based in the UK Midlands. It certainly increased my understanding of the business, and it’s always good to get a feel for what management of any company are like. Castings management struck me as down-to-earth, hands-on managers, which is what I like.

A few key points I jotted down -

Potential for Mamp;A (acquisitions) – looking especially at the electric vehicles sector suppliers.

Customers disagree on which technology will become prevalent for trucks – electric batteries, or hydrogen.

Considered a special dividend for surplus cash, but decided against it due to macro uncertainty (have done special divis in the past, something I hadn’t spotted)

Pension scheme should be de-leveraged (?) this year – I didn’t quite follow this point, but it sounds like they’re gradually eliminating the pension deficit. Can anyone clarify this point?

Competitive advantage – Castings makes small batches of products to order for its customers, using efficient high tech equipment. This gives it a competitive edge. Would struggle to compete on large scale projects. Produces up to 2,500 product lines.

Research notes are available from Arden’s website. You need to register, but can then view all their research.

My opinion – Castings shares look very good value to me, especially when you adjust out the net cash. However, heavy reliance on customers within the EU (mainly truck manufacturers), puts me off, because if Brexit turns sour, then there could be trade barriers for exporting to the EU – too much of a risk for me.

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Gear4music Holdings (LON:G4M)

(I hold)

960p (up 3.5% at 08:54) – mkt cap £201m

Final Results

Gear4music (Holdings) plc, (“Gear4music” or “the Group”) (LSE: G4M), the largest UK based online retailer of musical instruments and music equipment, today announces its financial results for the year ended 31 March 2021.

As we already knew, from repeated upgrades last year, G4M has traded exceptionally well, helped by lockdowns, which drove increased demand for musical instruments, particularly lockdown 1. Key numbers – which look in line with the last update (April 2021) from broker N+1 Singer -

However, whilst lockdown(s) helped, G4M is also a structurally growing business. The challenge has been to estimate how much growth is one-off, and how much is likely to be sustained? As commented before here, my view is that existing broker forecasts for the current year FY 03/2022 seemed way too pessimistic, e.g. N+1 Singer was forecasting adj EPS to fall to just 20p (from actual FY 03/21 adjusted EPS of 60.4p, per N+1 Singers note published today). That seemed an excessively pessimistic forecast.

The good news is that current trading is ahead of expectations, and FY 03/2022 guidance has been raised today -

However, trading in Q1 FY22 has been stronger than the Board previously expected and, having retained a good proportion of the gross margin gain achieved during FY21, financial results for FY22 are likely to be ahead of the Board’s previous expectations.

Although we are reminded not to expect a repeat of FY 03/2021 sparkling results -

Given that the FY21 exceptional financial performance was driven by the initial COVID-19 lockdowns during H1, the Board does not expect to meet the same level of trading during H1 FY22, and as previously guided, does not currently expect to achieve the same level of full year profitability during FY22 that the Group achieved during FY21.

Forecast upgrades -

Both Progressive, and N+1 Singer have substantially upgraded their forecasts for FY 03/2022, so we were correct in believing the previous forecasts to be excessively pessimistic.

New forecasts for this year (FY 03/2022) are:

N+1 Singer old: 20.0p, new: 30.3p adj EPS

Progressive old: not sure, new: 29.0p adj EPS

N+1 notes that the raised forecasts are prudent, with forecast risk to the upside.

Personally, I’ve pencilled in about 40p EPS for the current year, which would put the PER at about 24, which looks good value for a structurally growing eCommerce business, that is executing well in Europe, as well as the UK.

The massive USA and possibly Asian markets could eventually follow perhaps?

Further European expansion – new distribution hubs are to be opened in Spain and Ireland

Acquisitions – in the past G4M has concentrated on organic growth, but is now talking about bolt on acquisitions. That makes sense, in a fragmented market, this could be a good way to pick up customer lists, and brands, on the cheap.

2 actual brands have been recently acquired – “Premier” (premium drums amp; percussion), and “Eden” (premium bass amplifiers). This is an interesting development. Margins are tight in this sector, so increasing own brand sales, raises margins considerably – own brand gross margin is 47.0%, and other brands (the bulk of sales) are 28.4%. I reckon the key to success is to shift more own brand product, at higher margins, hence acquiring brands seems a great strategy, if they can be acquired at modest cost.

Balance sheet - is strong. A new £35m credit facility from the bank opens up opportunities for more acquisitions, and more rapid expansion.

There’s a freehold head office in York of £7.35m in fixed assets, which I like.

NAV is £34.3m. To view it more prudently, deduct £10.4m intangibles, leaving a healthy £23.9m NTAV – a healthy position.

G4M has to keep a very large number of items in stock (SKUs are now up to c.60k), so it’s important that the balance sheet is strong, to support the large inventories.

Net cash was £2.7m, with most debt having been cleared from the bumper profits in the year (Gross cash is £6.2m, less £3.5m gross debt). Hence there is bags of headroom on the £35m revolving credit facility, giving scope to make more small bolt on acquisitions.

Cashflow - this bridge graphic neatly explains the numbers -

Dividends - none so far, but will be reviewed annually. Personally, I don’t want divis, I’d much rather G4M keeps investing in expansion amp; buys more brands. That’s a far better use of capital than divis.

My opinion – I’m delighted that the current trading is strong, against the toughest prior year comparators (in lockdown 1). In my view, there’s clear scope for further upgrades as this year progresses – the bar has been set too low, and getting an upgrade just 2 months into the new year is clearly a good indicator.

My feeling, reading through today’s commentary amp; broker notes, is that G4M seems a company which is only just getting into its stride. It’s becoming a much more significant business, making its first brand acquisitions, and holding out the possibility of hoovering up smaller ecommerce competitors (in a fragmented market).

Margins are improving, with increased buying power, and scale allows marketing spend to remain static at around £9m p.a. In the last 3 years, but that falls significantly as a percentage of revenue, hence raising the operating margin a lot.

To my mind, this share seems an absolute no-brainer. It’s likely to be a very much larger business long term, making much bigger profits. Yet we can still buy it today on a perfectly reasonable valuation (PER of about 24, based on my estimate of 40p EPS this year, down from c.60p last year).

What’s not to like?! It remains firmly in my coffee can (hold forever shares).

Of course something could go wrong, as it can with any share. So far, I think management has proven great ability at managing the growth. Remember it’s a founder owner-managed business, with Andy Wass still holding c.30%. That really does make a difference. Owner-managers just take greater care with businesses, are more committed, and hate dilution.

An interesting chart! Note also how the StockRank is now very high.
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Saga (LON:SAGA)

(I hold)

435p (up 3%, at 10:55) – mkt cap £609m

Financing transactions

Saga plc (“Saga” or “the Group”), the UK’s specialist in products and services for people over 50, today announces a number of financing transactions intended to improve its financial flexibility by -

increasing available liquidity,

extending debt maturities and

providing greater headroom against covenants.

That all sounds good to me, and helps reduce risk for shareholders, particularly the risk of further dilution.

The recent trading update showed that SAGA has plenty of liquidity, so I’m viewing today’s refinancing as shoring up the position further, rather than emergency funding.

Key points -

Roadshow being launched to investors for a new £250m fixed rate bond (it already has a bond of the same amount in existence, which has worked well, costing 3.375% p.a. Interest, and repayable in May 2024). Bond funding is secure, long-term funding, without the problem of covenants. It amazes me that more companies don’t use bonds to finance their activities, instead of much higher risk bank borrowings. I like the idea of moving borrowings onto a fixed rate, at a time when there is talk of interest rates rising at some point.

Tender offer to partially repay £100m of the £250m existing bond. To my mind this implies the new bond is likely to be issued at a lower interest rate than the existing bond’s 3.375%, otherwise there would be no point in doing it (other than to extend maturity perhaps?)

Repayment of £70m bank term loan.

Easing covenants further on revolving credit bank facility (£100m available, which is not currently being used)

My opinion – we don’t know the terms of the new bonds (interest rate) yet, nor the terms of the tender offer.

In principle though, I very much like moving borrowing facilities away from the bank, and putting it onto much safer, secure bonds, which don’t have day-to-day covenants, unlike the bank debt, which can be so problematic when unforeseen problems emerge.

This new package seems to involve: raising £250m of fresh bond funding. Repaying £170m of existing debt (£100m of old bonds, and £70m term loan), which would give SAGA an additional £80m in gross cash.

As at 31 May 2021, SAGA had £78m available cash, plus £100m undrawn RCF, so £178m headroom.

If the package above goes ahead, it would have £158m cash, plus £100m undrawn RCF, which strikes me as putting it in an unassailable liquidity position for the foreseeable future, providing the cruise loan lenders continue to be supportive. They’ve been highly supportive so far, so I cannot see any worries with the cruise loans.

Remember the insurance division generates enough profit amp; cash to support the mothballed travel division’s monthly cash burn of c.£7m.

The 2 cruise ships are about to resume business very shortly, and customer demand is high.

Cruise load factors strong at 77% and 48% for 2021/22 and 2022/23; per diems ahead of expectations.

Having forgotten all of my O-Level Latin, I had to google “per diem”, it means per day. So in this context, SAGA mean the daily revenue generated per passenger. It would be better in plain English I think.

Overall then, let’s see what the full terms are of this refinancing, but assuming the interest rates are reasonable, then this package looks very sensible – pushing out debt repayment dates, clearing higher risk bank debt, and giving tons of cash headroom to cope with any eventuality re pandemic restrictions.

The market seems to like it too, with the share price now up 4% on the day, and what looks like a chart breakout at 440p.

A recent Numis note shows that, once trading has normalised, this share should generate c.62p EPS (EBITDA of £168m, and adj PBT of £101m, in FY 01/2023). Personally I’m hoping for more. But going on the Numis forecast, the forward PER Is only 7.1. Most of the debt is like HP on the cruise ships, so it’s asset-backed.

I would value the company on a PER of about 15, so that implies a share price of 930p, and I think there’s upside on that EPS forecast too. Hence 1000p price target is roughly where I’m at.

When viewing the chart below, remember that more shares were issued at the bottom, so there has been a fair bit of dilution. For that reason, don’t expect the share price to get back to previous highs.

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James Cropper (LON:CRPR)

1210p (down 1%, at 11:51) – mkt cap £116m

Final Results

The advanced materials and paper products Group is pleased to announce its Preliminary results for the 52 weeks ended 27 March 2021

The pandemic caused a big drop in revenues, down 25% to £78.8m.

Despite that, profit remained surprisingly resilient, at £4.0m (LY: £6.7m) although that’s at the adjusted PBT level, and excludes £0.8m IAS19 costs [pensions] and £1.5m exceptional items, leaving statutory profit before tax down 70% at £1.7m.

Net debt (ignoring leases) is modest, at £3.7m

Balance sheet – looks OK, although the pension deficit has almost doubled to £18.4m, which would need careful scrutiny before buying any of these shares.

Outlook – I’m glossing over the now historic numbers, because as we move on from the pandemic, it’s the outlook which matters more. Costs of £2m have been removed during the pandemic. Capex projects put on hold last year are being resumed. The rest of the chatty (even a bit gushing in places) commentary is too vague, and doesn’t really give me anything to work on, in terms of how the future might pan out.

My opinion - I can’t take this any further, as there’s no guidance to speak of. Sorry about that. It doesn’t leap out at me as something I need to invest in. Although looking at the longer term chart, it did have a spectacular multibagger run from 2013 to 2017, but has been zig-zagging down since then.

Note it seems to be owner-managed, with the Chairman owning 19.4%, which is a positive in my eyes.

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Jack’s section Morses Club (LON:MCL)

Share price: 85.2p (pre-open)

Shares in issue: 132,530,539

Market cap: £112.9m

Morses Club (LON:MCL) is a provider of non-standard financial services with two separate divisions: Morses Club, the UK’s second largest home collected credit lender, and Shelby Finance, which is its digital division established after the acquisitions of CURO Transatlantic and U Holdings in 2019. The latter has two distinct brands: Dot Dot Loans, and U Account.

There’s arguably a need for this type of service that can be used by an underserved and excluded customer base, but there are also important and unavoidable ethical concerns as well. Regulators are aware of this and have been increasing their requirements recently.

The group itself says it ‘seek[s] to reward good customers with longer-term and lower cost products to improve their financial wellbeing.’

Home collected credit (HCC) is a specialised segment of the broader UK non-standard credit market. Loans are typically small, unsecured cash loans delivered directly to customers’ homes. Repayments are collected in person during weekly follow-up visits to customers’ homes.

The non-standard finance market is large and growing. An estimated 10-12m consumers (some 20-25% of UK adults) have difficulty accessing credit from mainstream financial institutions due to an impaired or non-existent credit history. While unemployment remains low, underemployment is an issue, with many adults working less hours than they would like or need.

It looks like Morses has been quick to adapt with an accelerated digitalisation strategy, where it hopes to see ‘ambitious volume growth’ in the years beyond 2020.

Q1 Trading update

Highlights:

• Customer numbers as at 31 May 2021 were 144,000,
• Collections performance 104% of target and 118% ahead of the same period last year,
• Total new credit issued within HCC is 16% ahead of budget,
• HCC impairment charges are expected to remain within the guidance range,
• Customer satisfaction for the HCC division is at 98%.

Morses has seen a steady increase in customer demand across all lending products in both its HCC and digital divisions.

The group has invested in its technology infrastructure and further platform development is underway. This should help drive volume growth in the second half of the year. As a result of Covid conditions, 66% of all HCC lending is now cashless and over 70% of customers are registered for the online customer portal.

Customer numbers in the digital division for short-term and long-term lending products have increased by 40%, with total loan book balances increasing by 99% relative to the FY21 year-end position. New credit issued is 33% above management’s budgeted plan, with collections performance also ahead of budget, so this increase in business is not affecting the quality of the loan book.

Morses anticipates that impairments should reduce as volumes stabilise. This is something to monitor.

Paul Smith, Chief Executive Officer of Morses Club, said:

Despite the continued impact of the pandemic, trading performance across all of our lending products has been very strong in the first quarter of FY22… The importance of a technology-led offering has never been clearer. Our investment and focus on ensuring our service model adapts to changing customer needs, whilst maintaining our core ethos of putting the customer at the heart of what we do, is central to our success as a Group.

Conclusion

This part of the market probably requires a more than average amount of due diligence. A cursory glance at Trustpilot shows a score of 4.6 from 2,129 reviews. That’s encouraging, although a smattering of one-star reviews brings home the potentially vulnerable position of some of Morses’ customers. These are important and delicate services to provide.

There’s regulatory risk here too – Morses et al need to comply with increasingly stringent regulatory requirements. This is a barrier to entry in terms of competition, but is also a risk to the business model. Others have left the sector due to these trends.

Recent regulatory changes following the FCA’s review of the high-cost credit market include the need to provide customers with details of the comparative costs of refinancing an existing loan versus taking out a new loan, and new rules were also introduced in relation to when and how an agent is able to discuss a new loan with customers.

Whatever your views on the above, Morses continues to offer decent value with a 4.6% forecast yield and a forecast PER of 12.3x despite a strong run up in the share price (shares have more than doubled since their November 2020 lows).

It looks like the group has a good market position, it is investing in its digital and IT capabilities, and it stacks up well across a range of factors. So, all in all, the situation here looks encouraging.

Directors appear to think so, with some sizable recent buys at the 65p mark.

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Trifast (LON:TRI)

Share price: 141.65p (-1.97%)

Shares in issue: 136,042,435

Market cap: £192.7m

Trifast (LON:TRI) is a leading international specialist in the design, engineering, manufacture, and distribution of high quality industrial and Category ‘C’ components, principally to major global assembly industries.

The group offers end-to-end solutions around industrial fastenings, including designing, problem-solving, engineering, manufacturing, and sourcing. It looks, on the face of it, like a promising company with an established global logistics network, technical and design expertise, a track record of investment, and high-quality manufacturing capabilities.

The market cap may be just under £200m, but this is clearly an enterprise of some scale. It employs c.1300 people across 32 business locations within the UK, Asia, Europe, and the USA, and supplies to c.5,000 customers in c.75 countries worldwide.

Paul last looked at it here, noting signs of recovery in keeping with wider trends across businesses.

While forecasts suggest a slight moderation in revenue growth, the longer term trend has been very encouraging.

Nearly £8m of unusual expenses put a dent in profits last year, but apart from that Trifast looks to be proving itself as a growing, profitable, cash generative UK industrials company.

Annual results

Highlights:

• ‘Resilient’ performance with revenues -6% to £188.1m,
• Gross profit -9.4% to £50.1m,
• Underlying operating profit margin down 150bps from 7.9% to 6.4%,
• Underlying diluted earnings per share -28% to 6.24p,
• Cash conversion at 147.9% of underlying EBITDA,
• £16m equity raise in June 2020 provides scope for investments and working capital,
• Strong pipeline and high activity levels,
• Freight, raw materials, and lead time pressures impacting margins in the short term.

While these results bear the marks of lockdown disruptions, the group believes it is in a much better position now than it thought it might have been at the start of April last year. It returned to growth across all regions and key markets in H2 following a rough H1.

Further, with demand ramping up in Q3 and accelerating into Q4, Trifast finished the year stronger than expected, delivering an underlying PBT of £11.0m. It now sees both the number and quality of organic and non-organic opportunities increasing.

Investment for organic growth – Trifast has continued to invest to support ongoing, organic growth opportunities in locations as diverse as Spain, Thailand, and the USA. Facilities in Hungary and within the UK will also be expanded.

The group will be using its base in Germany to hold stock in order to mitigate Brexit disruption.

Project Atlas is cited as a key initiative. This is ‘a transformational investment to build an integrated global business’ and is a significant multi-year investment into the integration and development of Trifast’s IT business platform and underlying processes. An annualised ROI of gt;25% is expected at the point of full realisation.

The group’s global talent management system is now operating in 16 locations, providing greater support of personal development goals of colleagues.

Acquisitions - Trifast says industry consolidation is ‘constant’, but the market remains fragmented with no one player owning more than an estimated 5%. Acquisitions therefore remain a key growth lever for the group and the current economic environment is creating greater momentum and opportunities.

Jonathon Shearman, group chair, comments:

The foundations are largely in place and Trifast stands on the cusp of an extended period of strong growth – both through continued organic growth and with an increasing focus on value-enhancing acquisitions. We aspire to be a much bigger company and are approaching matters with that in mind. In this pivotal year we will have to navigate a number of headwinds, even so, I can say that this is the most dynamic time for Trifast in more than a decade.

There are some risks flagged as well, however:

• Ongoing logistical challenges and pricing pressures continue to impact the global industrial supply chain environment.
• These include the semi-conductor shortages affecting automotive customers, container freight issues, as well as a global shortage of steel, causing pricing and significant lead time pressures.
• Trifast expects to see some impact on buy/sell margins and a potential build back of inventory levels at least in the shorter term.

Conclusion

As a slightly more qualitative aside, I quite like the way the management here communicates and the detail it provides in its reports to the market.

This does count for something, although it is impossible to screen for and its value is hard to quantify. If a team ever seems to be trying to make its business sound complicated, or is reluctant to provide obviously useful information to its shareholders, it’s sometimes best to walk away.

Trifast has a focused, experienced and highly skilled workforce. Given its expertise and track record (pre-Covid) of revenue growth, I’d back it to continue growing over the long term. But it is worth noting that its share price began to unwind in 2018, before the pandemic, so it could be that there is more to this story.

A lot of importance is attached to this major Project Atlas investment. Let’s hope it brings the anticipated benefits. Large, one-off projects are riskier to implement than smaller projects as they can be more complex and are more prone to slippage and increasing costs.

But Trifast does come across as a potentially higher quality industrial company worth investigating a little more closely. The business has exceeded pre-COVID-19 revenue levels of trading in HY2. Demand is continuing to grow, and customer orders are being brought forward.

The group says its pipeline of new business ‘has never been so exciting, including several new high-growth markets.’

At these levels, Trifast is probably more intriguing than it has been in the past – it’s just over half the price it was at its 5Y high of 273p back in April 2018 – but that’s not to say it’s cheap.

Its current level of 19.5x forecast earnings looks up with events for what appears to be a well run company with solid growth prospects.

Stockopedia

Source: https://www.stockopedia.com/content/small-cap-value-report-22-june-2021-cgs-g4m-saga-crpr-mcl-tri-826729/