Small Cap Value Report (Tue 20 July 2021) - SDG, GTLY

Good morning, it’s Paul amp; Jack here with the SCVR for Tuesday, a very busy day for updates.

Timing – TBC

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover trading updates amp; results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it’s anybody’s guess what direction market sentiment will take amp; nobody can predict the future with certainty.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research) – don’t blame us if you buy something that doesn’t work out. Reader comments are welcomed – please be civil, rational, and include the company name/ticker.

Preamble for Tuesday – market conditions

Lots of people have emailed me (Paul), and asked for some market comment.

As a value/GARP investor, I’m not really interested in market fluctuations. I tend to just research things in as much depth as I can, then buy amp; hold for several years. Some of them work, some don’t. If the results amp; trading updates disappoint, then I chuck them out. There shouldn’t be any emotion involved at all, and buy prices are best ignored amp; forgotten, because the market doesn’t know or care what we paid for our shares. It’s the occasional multi-year, multi-bagger, that makes the money amp; mops up all the mistakes.

Where are we now? This is what I see -

• Takeover bids – loads of them, especially from overseas, suggesting that the UK market is cheap – which is bullish.
• Low broker forecasts – results are mostly ahead of expectations, and there are many forecasts being raised a lot – this is bullish
• V-shaped economic recovery, based on the economic data – this is bullish
• Companies are generally reporting that they have adapted to covid, stripped out costs, profits are rising – this is bullish.

Set against that -

• Momentum arguably carried many share prices too high in the anything amp; everything rally since Nov 2020
• Balance sheet weakness was ignored by some punters – with inevitable consequences when reality comes home to roost amp; fundraisings are needed (I got caught on Revolution Bars (LON:RBG) in this regard, and there are plenty more banana skins out there – watch out!)
• Stretched valuation multiples
• Naive punters, new to the market, don’t know how to value anything, so prices are highly volatile
• Thin summer markets, with little volume = extreme volatility
• Mixed messages from central banks over interest rates
• China threatening to nuke Japan
• Profit-taking snowballing
• Blah blah blah
• Take your pick, it’s all nonsense to a certain extent!

Lots of people have emailed me, asking what I’m buying. The truth is, when you’re 100% invested, there’s not much cash on hand to buy anything. Although I have eked out a little cash to buy what I think are terrific bargains: SAGA at 303p. JOUL at 235p. BOO at 275p. As usual, just my personal opinions, and DYOR. We’ve discussed them all at enormous length here, so just search the archive for the bull amp; bear cases, if you’re interested.

As I always say to people who email me with great concerns about price movements – just try to work out your own strategy. Are you a trader? Or an investor? Most people think they are investors, but are actually traders – flitting in amp; out of things, trying to time the market, losing confidence when prices fall. Not many people can do that well, consistently, in my experience, and it’s a horrible way to live, being permanently on tenterhooks – who wants to live like that?

I think that, if we seek out great companies, with entrepreneurial management, they usually do well over the long-term. Nearly all the self-made multimillionaires I know, have made their money from a handful of major multibaggers – typically about 4 big investments over their career that have made them the really big money – which usually means holding, for a long time, often when the share was unfashionable. Everything else was a sideshow.

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(I hold)

147p (at close, last night) – mkt cap £116m

AGM Trading Update

Sanderson Design Group PLC (AIM: SDG), the luxury interior design and furnishings group, will hold its Annual General Meeting (“AGM”) at 9.00am today. Ahead of the AGM, which will take place as a closed meeting as detailed in the Notice of AGM, the Company provides the following trading update in respect of the first 23 weeks of the current financial year ending 31 January 2022.

Recovery continues with forward momentum

It’s more good news from this convincing turnaround situation -

The positive trading in February, March and April 2021, outlined in our full year results announcement on 18 May 2021, has continued throughout the 23-week period with the result that profits for the six months ending 31 July 2021 are expected to be ahead of Board expectations.

Total group sales for the 23 weeks are up 39.8% vs LY, and up 1.4% vs the previous year (a more meaningful comparison, pre-pandemic).

Pandemic has still had an impact this year, so recovery is good in that context.

There’s lots of detail in today’s update, here are some points covered -

North America is the best performing region, and makes up 20% of total brand product sales. The UK is the largest market, at 52% of brand product total sales

Figures for the manufacturing division are shown in a separate table, and look very good, up 52% on LY, and up 21% on the pre-pandemic year

Licensing income is also up strongly

Collaboration with Next (LON:NXT) (Morris amp; Co designs for clothing) has performed “very strongly” in the first few weeks – note that deals such as this tend to be short-lived, so it’s a bonus rather than anything to get too excited about, in my view

Liquidity - net cash of £13.9m on 16 July 2021, down from £15.1m on 31 Jan 2021, due to seasonal factors amp; payment of corporation tax

Dividends – objective is to resume divis, more details with the next results

Diary date – mid-October 2021, for half year results

Employee engagement survey now 78% positive, up strongly from 58% two year ago – an important factor, often overlooked by investors, the staff are the business, so we should want them to be happy

Positive external factors are mentioned, which are quite interesting -

The Board believes the Group is benefiting from the convergence of three positive impacts:
(1) pent up demand for home interiors,
(2) the trend towards maximalism, and
(3) the post-Brexit increased demand for British design and manufacturing.

“Maximalism” – there’s a new word for me!

Outlook – caution is expressed, but I don’t think that’s anything in particular to worry about, it sounds more a generic thing – supply chain issues are affecting almost everyone at the moment it seems -

“Whilst the Covid-19 pandemic and potential cost inflation continue to create some uncertainties for the near-term outlook, our focus remains on mitigating the potential impact of those uncertainties and continuing to progress the Company’s strategic development.

My opinion – the newish CEO Lisa Montague has worked wonders here, modernising the company’s operations (e.g. product launches amp; sales are done online now), reducing costs, and halving the product lines to focus on best-sellers (thus reducing inventories amp; boosting cash).

A strong balance sheet means no need for equity to be raised during the pandemic. There’s plenty of scope to resume divis, due to the recovery in profitability amp; bulging coffers.

I can’t see any broker updates today, but on existing consensus forecast, this share is only on a multiple of 14.0 times. With a cash rich balance sheet, and an ahead of expectations update today, that’s great value. Mr Market has thrown an impromptu mid-season sale in recent days, which in my view is a good buying opportunity here.

High StockRank too.

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A little more detail on the X-axis below would be helpful, but each blob is a month, so it’s easy enough to see what period this covers. Note that forecast EPS was reducing last year, but this year forecasts have shot up, and what’s the betting they’ll be more positive earnings upgrades? Seems likely to me.

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Share price: 210p (-0.94%)

Shares in issue: 117,888,007

Market cap: £247.6m

Gately is a legal and professional services group. It listed in 2015 following changes to the law to adopt an Alternative Business Structure (ABS), allowing non-lawyers to own and invest in law firms. There are a couple of similar listed plays now, including Rbg Holdings (LON:RBGP) which we discussed at the Mello BASH last night. There’s a consolidation and disruption opportunity in this part of the market.

Since floating in 2015, the group has acquired:

• Capitus and Hamer Associates in 2016,
• GCL Solicitors, Kiddy amp; Partners, and International Investment Services in 2018,
• Persona Associates and T-Three in 2019, and
• Paul Tweed and The Vinden Partnership in 2020.

More specifically, the group has built a ‘platform’ of market-facing structures on which complementary legal and consultancy services are aggregated.

Unlike RBG Holdings however, 90% of group revenue still comes from legal (for RBG it’s something like 66% of FY20 profits from legal and an expected 50% of FY21) so it is more concentrated but this could change pending further acquisitions.

This was last covered in the SCVR earlier this month by Paul, noting the delay to accounts.

Preliminary results

High levels of activity, strong trading momentum, overall sense of optimism and confidence… have continued into the new financial year and the Board is confident in the outlook for FY22.

Highlights:

• Revenue +10.5% to £121.4m,
• Underlying profit before tax (PBT) +7.1% to £19.3m; PBT +10.5% to £16.3m,
• Adjusted diluted EPS +5.8% to 13.17p; basic EPS +8.1% to 11.18p,
• Net assets +32.2% to £59.3m; net cash +£20.5m to £19.6m.

Non-legal revenues increased by 27.3%, thanks in part to a £14m contribution from Gateley’s consultancy businesses. Cash generation looks very good, with Covid cost savings and working capital management allowing for the repayment of all bank debt.

Net cashflows from operating activities was £25.4m (FY20: £13.3m) representing some 193.2% of profit after tax. That’s arguably not sustainable, but cash conversion in the prior year was an encouraging 113.5%. Free cashflow was £20.8m.

Staff bonuses and dividend payments have been resumed. Total personnel costs increased by 21.9% to £77.5m (FY20: £63.5m) – that’s 64% of revenue. No surprise given the business model, which relies on retaining and recruiting human capital.

Other operating expenses reduced by £2.7m or 11.5% to £21.0m as the cost of travel, marketing and premises reduced following a full year of remote working.

The second half of FY21 was ‘extremely strong’ with high levels of activity, which more than compensated for the impact of the first National Lockdown. The turning point arose just before the half year-end, when activity levels returned and the group’s pipeline strengthened significantly.

Outlook – Strong trading in the first two months of the new financial year with good pipelines of new work and acquisition candidates. The latter is to be ‘widened and enhanced’ in FY22 and beyond.

The dividend policy remains to distribute up to 70% of profit after tax (PAT) to shareholders, typically one third following its half year results and two thirds after the full year results are known.

Conclusion

The above values GTLY shares at 16.3x adjusted diluted earnings, 19.2x basic earnings, and about 12x free cash flow. Not obviously cheap, but not expensive either if you believe in the growth prospects.

Gateley took a conscious decision not to make any acquisitions during FY21, and instead focused on integrating its FY20 acquisitions. It intends to resume acquisition activity now.

There’s a consolidation and expansion opportunity in this space that a couple of players have identified. Gateley’s own strategy of creating a market-facing ‘platform’ to which it can bolt on complementary professional services businesses looks to be sound. The key will be in identifying appropriate acquisitions, purchasing them at attractive prices, and successfully integrating them.

I’ve a favourable impression of a couple of these legal and professional services firms. The opportunity should reward entrepreneurial operators with a deep history in the space, Gateley being one of them.

Is there a ceiling to the strategy, I wonder? It’s a fragmented market but how big can these platform companies become before they begin to get unwieldy? Perhaps there’s more to aim for before that becomes a serious consideration.

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