Small Cap Value Report (Thu 24 June 2021) - TND, LTHM, IBPO, VTC

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

We had another StockSlam last night, they continue to be great fun so well done to all the Slammers, Tamzin and the team at PIWorld, Damian for hosting, and Sam amp; Lawrence for helping out with the promotion.

If you haven’t gone to one yet make sure to sign up for the next slam when it comes round in September. It’s a short format (around ten different stock ideas presented in an hour) so it’s a handy way to brush up on a range of investment ideas that you might not otherwise encounter. There should be a video out on Youtube by Friday, I believe.

Quick note – a friendly reminder that we don’t recommend any stocks. We aim to cover notable trading updates amp; results of the day and offer our opinions on them as possible candidates for further research if they pique your interest. We tend to stick to companies that have news out on the day, and market caps up to about £700m. We avoid the smallest, blue sky type companies, and a few specialist sectors (e.g. resources, pharma/biotech).

A central assumption is that readers then DYOR (do your own research) and discuss in the comments below. The comments, incidentally, sometimes add just as much value as the articles. We welcome all rational views, whether bull or bear!

Timing – today’s report is now finished.

Agenda -

Jack’s section

Tandem (LON:TND) – slower revenue growth and possible margin impact from well-flagged supply chain and input cost issues, but demand and order book at record levels; investment in longer term growth continues.

James Latham (LON:LTHM) – family-owned timber distributor reports FY earnings growth and encouraging outlook, but also flags supply chain congestion. Prudent balance sheet and long track record of trading. All in all, looks good.

Ienergizer (LON:IBPO) – resilient performance over Covid from this business process outsourcer. It has grown strongly in the past and could do so again in future, but the shares are tightly held and liquidity is an issue.

Vitec (LON:VTC) – unscheduled update to communicate better-than-expected trading and record order book. Shares up by than 10%, having already doubled from lows recently.

Share price: 565p (-6.61%)

Shares in issue: 5,231,516

Market cap: £29.6m

(I hold)

Speaking of the StockSlam, Andrew Robinson (Castleford Tiger on Twitter) pitched Tandem (LON:TND) which has its AGM statement out today. This is a small, previously neglected stock that designs, develops and distributes sports, leisure, and mobility products.

It has been strikingly cheap in the past and, even today, after multibagging in just months, the shares still look good value compared to other stocks out there.

It has a specific focus on wheeled goods and garden leisure ranges like Gazebos. It’s also got a bike division with some historic brands including Dawes, which are delivered to independent bike dealers and national retailers, and more recently management has set up ExpressCo, which is Tandem’s growing ecommerce operation.

This latter division could be the group’s source of longer term growth. Building out this division may be one of the reasons behind the group’s recent acquisition of freehold land – a positive signal of long term thinking on management’s behalf.

Tandem plans to build a much more modern and efficient warehouse and distribution facility here, which bodes well for future revenue growth.

Certain of Tandem’s ranges have done exceptionally well over lockdowns. Bikes, obviously, but also Ben Sayers (the group’s entry-level golf range), gazebos and other leisure products people might buy ahead of a staycation.

Revenue has been pretty unexciting for a while, but that masks a lot of underlying progress. While certain departments and product lines rose or fell in popularity, the management team has been duly building the business. The result so far has been steady revenue but a notably improved net profit figure.

This has been achieved with an exceptionally strong balance sheet and a tight rein on the number of shares in issue.

The obvious risk with any lockdown beneficiary is a post-lockdown reversion in trade. So far in FY21 though, Tandem has actually reported robust revenue growth so its products remain in demand. The growth in revenue is now moderating as the group laps tougher comps.

What many people took from the most recent statement was a degree of caution around being able to source product to satisfy this demand. Freight costs and supply chain disruption were also flagged, but these are universal factors facing many businesses right now.

The statement caused some fuss at the time, but I interpreted it as management’s habitually cautious tone. Business conditions are rarely 100% positive. There’s always some headwind out there ensuring the team earns their pay.

We have another update and the shares have opened down so let’s see if that’s the case.

AGM statement

Highlights for the 25 weeks to 22 June 2021:

• Continued positive trading year, with revenue c14% up year-on-year,
• Revenue from sports, leisure and toy business c11% ahead of last year ‘against a very strong comparative’
• Over $3 million of products manufactured and ready to ship pending improvements in shipping conditions
• Licensed property ranges: Paw Patrol, Nerf and Disney Princess were significantly ahead of the prior period.
• Other licences including Peppa Pig, Batman and Barbie were also ahead of the prior period.
• Own brands: sales of Wired and Li-e brand escooters ‘made an excellent contribution’, Kickmaster football training and Hedstrom outdoor play products along with uMoVe and Stunted scooters were all ahead of the previous year to date period.
• Revenue from our Ben Sayers golf business was approximately 95% ahead of the same period last year which in itself was also a strong period. The forward order book remains well ahead of last year.
• Bicycle revenue was approximately 12% ahead of the prior period. Tandems lightweight children’s bicycle range Squish was c29% ahead.
• Expressco B2C revenues were c14% ahead

Revenue growth is slowing from an exceptional start early in the year.

The ExpressCo performance comes despite relatively poor weather prior to June 2021, with May 2021 being the fourth wettest on record and coldest since 1996.

There were also supply chain issues in June and a strong comparative period to consider. Regardless, ExpressCo performed well in gazebos, party tents, golf, heating and various other home categories.

The group continues to invest in its key websites:

• Garden Comforts by Garden amp; Camping (www.garden-camping.com),
• At Home Comforts by Jack Stonehouse (www.jackstonehouse.com),
• Pro Rider Mobility (www.proridermobility.com), and
• Pro Rider Leisure (www.proriderleisure.com)

Tandem has also recruited additional digital marketing and product development/buying resources for H2 ‘which we expect to have a positive impact in 2022 and beyond’. This is welcome news.

Tandem tends to be conservative, which is good in terms of limiting the downside risk – but the group must also invest for growth and this investment along with the big warehouse project does begin to outline the possibility of a larger enterprise in time.

The outlook for the remainder of 2021 remains positive, according to the group.

The forward order books are at record levels and currently total £34.7m compared to £10.7m at the same point last year.

Bicycle customers have ordered much further forward than usual, well into 2022, to ensure that they have ongoing supply in order to meet future predicted demand which may or may not materialise. Currently, there are no signs of a slowing in demand.

Challenges do remain though.

• Global demand is high and containers are in short supply. Far East container ports are overloaded and in some cases have closed for a period or are operating at reduced capacity.
• Shipping lines persist with blank sailings of container ships.
• During June, the Malaysian Shimano factory was closed due to COVID which has reduced the supply of cycle components.
• Input costs such as steel, oil, plastic and cardboard have risen significantly during the year.

The group notes:

These issues have led to stock shortages, unparalleled freight rates, reduced freight capacity and large supplier cost increases which, in turn, put pressure on margins.

Nevertheless, we are managing these challenges well. Operating expenses continue to be closely controlled and, taking account of the impact of furlough at the beginning of the lockdown last year, are broadly in line with the prior year.

Although there are still uncertainties regarding what will happen as the economy returns to a degree of normality, the Board remains confident that the Group will deliver another strong year.

It’s the middle paragraph that I’m drawn to. Yes, there are serious pressures at the moment which face many businesses and these must not be dismissed. They could even get worse. But Tandem management is navigating the present conditions well – which is what it has actually done for a great many months now. They deserve credit for that. Sellers will no doubt be focusing on the slowing rate of revenue growth and the potential hit to margins of the factors flagged above.

A final dividend of 5.50p per share will be paid on or around 1 July 2021 subject to approval at today’s AGM. Dividend payments are to a degree curtailed by an agreement with Tandem’s pension fund. The scheme is in good shape though and is less of a risk than it is for some other companies – although it’s certainly something to bear in mind, as any scheme is.

Conclusion

What probably ruffled some feathers in Tandem’s previous update was a lack of detail in the statement. This update provides more colour.

Investors get such little communication with the company that we often attach a great deal of importance to quite brief market updates.

I’m not talking about Tandem specifically here but, as we are effectively part-owners in companies, isn’t it strange that we spend so much time in the dark? There must be more that can be done to bridge the gap between companies and their owners.

I’ve spoken with Jim Shears (Tandem CEO) before and he’s a very level-headed, plain-speaking CEO who appears to be quietly focused on growing a business that probably continues to fly under the radar. So is the lack of broker coverage and investor relations engagement an opportunity for smaller investors here, regardless of shorter term pressures?

That’s the position I’ve taken, but you can never be sure in investing. Paul has certainly taken a slightly different view of this company in the past. DYOR.

In my view the team has done a competent job over the past year, the shares are good value, the finances are conservative, and there are clear growth initiatives. The acquisition and development of freehold property suggests long term vision from management.

But there are well flagged risks as well. Freight issues, supply chain disruption, input cost inflation, margin pressure, apparently slowing top line growth, and the risk that sales will revert post-lockdowns by more than anticipated. So there’s enough for both the bulls and the bears to be happy with here.

If anybody’s curious to know more, I recommend Castleford Tiger’s Slam on the company – it’s amazing what he managed to fit into just three minutes and, as an active business owner himself, his comments are rooted in commercial common sense. The recording should be out in a couple of days.

Share price: 1,138.5p (+4.45%)

Shares in issue: 19,900,800

Market cap: £226.6m

James Latham (LON:LTHM) is one of the UK’s largest independent trade distributors of timber, panels and decorative surfaces. It’s family-owned, which often signals long-term thinking and an alignment with smaller shareholders. Indeed, Latham traces its roots back some 260 years.

The company supplies products to a broad range of trade customers, from contractors and merchants, through to designers and makers. It does not supply to the general public.

It operates from twelve branches throughout the UK and Ireland, working with merchants amp; distributors, construction professionals, designers, and architects to meet construction and design needs.

It has recently mentioned that conditions in the timber market are positive. But there may be a degree of cyclicality to consider here. You can see some volatility in the (very) long term share price chart below. But you can also see steady progress upwards through that time.

And revenue growth has actually been remarkably consistent.

So all in all there are a few indicators that this could be a good longer term investment, assuming you can stomach a bit of a short term drawdown. After April 2020 most of us are probably quite battle-hardened in that regard.

No surprise that the enterprise value is less than the market cap here, indicating a net cash position. If you scroll to the bottom of the Financial Summary, you’ll see that LTHM maintains this net cash position over time.

Final results

Highlights:

• FY revenue +1.3% to £250.2m; like-for-like volumes +6.6%,
• The cost price of Latham’s products rose significantly in H2 and are on average 7.3% higher than at the start of the financial year,
• Gross margin was 18% compared to 17.6% the previous year – up from 16.9% at the half-year stage,
• Profit before tax +18.5% to £18.6m,
• Profit after tax +20% to £15m,
• Net assets +16.8% to £121,8m due in part to 9% increase in inventory levels to £48.3m,
• Cash and cash equivalents of £28.6m (2020: £17.0m); good cash flows from operating activities,
• Diluted EPS +19.4% to 75.2p,
• Final dividend of 15.5p per share (2020: 10.0p) payable on 27 August 2021. Total dividend of 21.2p is up 37% and covered 3.6x by earnings.

The above values Latham at 15x FY21 earnings and puts its shares on a yield of 1.9%. That does not appear overly expensive, but there’s no doubt lumber prices are strong right now.

The defined benefit scheme under IAS19 (revised) has reduced to £2.6m from £11.8m due to improvements in asset valuations and revision of mortality assumptions following the actuarial triennial valuation. This scheme has been closed now for many years.

Current trading and outlook

The strong demand seen towards the end of the financial year has continued and margins are improving.

Global demand for timber products is very strong, being driven primarily by North America, but also from the construction sector worldwide.

This part is becoming increasingly familiar:

We have seen significant price rises on many commodity products… This is an area where our volumes have grown as we have been able to use our supplier relationships to secure supply of product for our customers in these exceptional market conditions. There have also been worldwide issues on shortages of shipping containers, with increased container rates which has further increased the costs of many of our imported products, as well as creating severe delays to shipments.

What’s notable in the above is Latham’s reference to use of supplier relationships to secure supplies in exceptional markets. Presumably one of the perks of having been a trusted operator for more than two centuries.

The group adds:

The outlook is difficult to predict, but the current challenging supply situation looks set to continue through 2021, but visibility beyond that is much more uncertain, but we know that the market will change at some point.

Whilst the supply side remains challenging we would expect our margins to be better than normal for the next few months, but returning to normal after that, and as we know from experience in our industry, the balance between supply and demand will change.

Latham sees several development opportunities:

• Looking for suitable acquisitions that support target market sectors and geographical areas,
• Invest in warehouses to further improve service to customers, ‘which is critical for our future success’.

This last part from Nick Latham is a nice touch:

These results are a real testament to the teamwork and commitment of everybody for which I am very grateful. In recognition of this, the board has decided to award all staff an additional day’s holiday this year, and to extend the Christmas shut down by one day. I am looking forward to visiting the depots to thank everyone in person.

I’d be happy with that! Although a qualitative consideration, I pay close attention to signs that a company genuinely looks after its employees.

Conclusion

What’s your time horizon? If you are looking to buy and hold something for many years, timing the market is less of an issue. If you are measuring success on a 1-3 year basis then you might have to more carefully consider the near term outlook for the lumber market. That’s not something I’ve done yet.

But assuming your horizon is longer, Latham appears to bear some of the hallmarks of a company worth holding through thick and thin. The group is profitable and dividend-paying, is family-owned, has been operating for centuries, and typically maintains a net cash position.

There is a pension scheme to take into account but apart from that the finances are robust. This scheme has been closed for many years.

And the trading result is good given the conditions, with minimal bad debts and growth in earnings per share.

The share price can be volatile over time but, then again, Stockopedia has this classified as a ‘Balanced’ stock so even that might be a red herring. All in all, there’s plenty here to warrant a closer look.

Share price: 311.55p (+2.82%)

Shares in issue: 190,130,008

Market cap: £592.4m

Founded in 2000, Ienergizer (LON:IBPO) provides business process outsourcing (BPO) solutions – think accounts receivable management, human resource outsourcing, back office support, sales and fulfilment, and many other services. It also provides content delivery services (CDS).

These outsourced services are provided to companies in banking, healthcare, publishing, legal, financial services, gaming, and utilities.

It’s got a very small free float – just 17.3% of shares in issue, and the spread is 462bps. The vast majority of stock appears to be owned by CEO Anil Aggarwal (see Major Shareholders). In fact that page suggests that some 97.66% of stock is held by Ienergizer’s top ten shareholders. So in a sense, this is barely a listed company.

Its About page contains the rather mystifying line: ‘Our BPO capabilities help companies increase operating website that writes essays for you efficiency through cost-effective, value-generating customer contact and back-office processing centers.’

That aside, this looks to be an outsourced back office enterprise of some scale: more than 12,000 employees in 11 delivery centres across six continents.

And the profitability figures are notable:

What’s more, the trend in returns on capital is improving. The group was net cash (it’s now net debt following a significant special dividend) and is strongly cash generative. It has also been growing at pace, with the 5Y compound earnings per share growth rate standing at some 45.4%.

This rate of earnings growth is forecast to moderate though, from +41.8% in FY20 to -2.85% in FY21 and +8.7% in FY22. We’ve seen before with G4M that brokers can be conservative with their forecasts at the moment, understandably given the conditions.

Annual results

Continued revenue and margin growth generating a substantial return and exceeding management expectations

Highlights:

• Total revenue +2.8% to $200.3m; service revenue +2.6% to $196m,

• Operating profit +2.6% to $57.6m,
• Profit before tax +1.8% to $53.5m,
• Earnings per share +8.3% to $0.26,
• Net debt of $115.9m compared to net cash of $1.96m at FY20 due to $127.3m special dividend,
• 8.4p final dividend payment to shareholders, representing a total dividend payment of 14.12p, a 4% increase compared to 2020.

So earnings per share looks to be ahead of the 23c forecast and the dividend makes for an attractive 4.5% yield.

The special dividend is huge – 49.4 per share, or nearly 16% of today’s share price. It’s rare to see such a large special dividend and I’m surprised to see the company fund this payment with debt. The fact that Aggarwal will be receiving the majority of this special dividend probably explains a lot.

The group is cash generative though, no doubt about that.

iEnergizer increased share of revenue from some of its key international clients operating in Media amp; Entertainment and Online Training amp; Education. It added several new customers in E-Learning and Healthcare amp; Pharmaceuticals industry segments

Refinancing – iEnergizer group entered into a 5-year senior secured term loan facility for an aggregate amount of $165m, including a $15m revolving credit facility. The senior secured term loan facility bears floating interest rate per annum equal to LIBOR plus 3.5% per annum (with a 0.75% LIBOR floor), which was used to refinance its existing term loan in full and utilize the balance amounts to return cash to the shareholders subsequently paid as a Special Dividend (49.4 p per share)

Group chairman Marc Vassanelli comments:

The first three months of fiscal 2022 have started well continuing the recent positive trend with extensions of existing contracts and new contract win especially in the Healthcare area and we look forward to another strong performance in 2022.

With iEnergizer’s solid foundation, proven strength in operational execution, new sales initiatives, differentiated offerings, healthy balance sheet, and with substantial opportunities for further growth identified, the Board is confident in the Company’s continued growth path as a unique, end-to-end digital solution enabler.

Outlook:

• Group sees a sizeable project pipeline across both BPO and CDS.
• Will continue to keep a close eye on costs.
• There’s operational leverage in the business model, so revenue growth should drive even more earnings per share growth for shareholders.

Conclusion

This is a company with quirks and so probably requires more dedicated due diligence.

No doubt it is growing strongly and if it can maintain growth CAGRs then today’s share price will prove to be cheap in future. Brokers forecast moderating growth in FY22 but Arden has just upgraded its forecast to 24c (from 23c) today, so it’s possible that these are conservative.

The concentrated shareholder base and lack of liquidity could be ruling this one out for some. I’m wary of the amount of control one person wields at this company. And are you investing in a robust business model, or the entrepreneurial spark of the group’s CEO, founder, and major shareholder?

What’s stopping competition? Perhaps the outsourcing market is sufficiently large for this not to be an issue for some time, but with profitability figures improving and current trading strong, this could attract competitors if there are profits to be harvested and few barriers to entry. Points to ponder.

That said, this looks at first glance like a growing, cash generative, well managed enterprise in the ascendancy. IBPO does talk of the recurring nature and longevity of contracts. Perhaps there are switching costs. And performance over the difficult past year has been robust.

The group comments:

Our focus is to continue to provide enterprises with an integrated suite of solutions… We have continuously worked hard to develop our differentiated offering and advantageous market positioning to keep ahead of our competitors. Healthcare, Online Education and E-Learning related Market opportunities created in recent times are being serviced with a higher degree of focus and these areas are all expected to contribute favourably towards the Company’s success.

Arden has a target price of 600p compared to today’s share price of 313.55p, so there’s the possibility that this company is simply mispriced right now but more research is needed. If you were to invest, you would need to take a view on Aggarwal himself given the influence he has on the company.

Share price: 1,387.58p (+12.81%)

Shares in issue: 46,151,798

Market cap: £640.4m

Vitec (LON:VTC) is a leading global provider of premium branded hardware products and software solutions to the growing content creation market.

Customers include broadcasters, film studios, production and rental companies, photographers, independent content creators, gamers and enterprises. The product portfolio includes camera supports, video transmission systems and monitors, live streaming solutions, smartphone accessories, robotic camera systems, prompters, LED lighting, mobile power, bags and motion control, audio capture and noise reduction equipment.

Scrolling around the investor relations website, this reads like a good business. But a look at the financials shows stagnant revenues (forecast to improve) and a drop in net profits.

Cash flows have been more resilient, however, so there’s a chance that this is a quality company that has hit a temporary snag. The shares have doubled since November last year and if it hits the FY21 normalised EPS forecast of 56.4, I make that a forecast PER of 24.6.

So whether or not there is value here depends on the group’s ability to continue growing, rather than just reverting to previous profitability levels.

Trading update

This is an unscheduled update bringing good news to the market and shares are up in excess of 10%.

Here the group describes itself as an ‘international provider of premium branded hardware products and software solutions to the growing content creation market’.

Since the last trading update, the group has achieved a stronger than anticipated recovery and ended May 2021 with a record order book (c.50% higher than at the start of the year). As a result, the group’s adjusted PBT for H1 2021 is expected to be not less than £19.0m.

Adjusted PBT for H1 2019 was £23.5m including £5.8m insurance income. Presumably we can strip this out and get an underlying figure of £17.7m, and so H121 PBT will be at least 7.3% higher.

Vitec does note electronic component and raw material shortages but expects adjusted PBT for FY 2021 to be materially above current market expectations. That’s currently £35.6m, per the company.

Conclusion

It looks like the easy money has been made here in the short term, with the shares having doubled in short order.

You’d need to be confident of future growth at the current valuation and that’s not immediately obvious from the income statement.

But current trading momentum is encouraging obviously, hence today’s unscheduled update. It’s not a stock I know well, so perhaps holders can make the argument for that in the comments.

Stockopedia