Small Cap Value Report (Fri 17 Sep 2021) - STCM, PPS, AXS, ELTA

Good morning, it’s Paul amp; Jack here with Friday’s SCVR. Today’s report is now finished.

Agenda -

Paul’s section:

Proton Motor Power Systems (LON:PPS) – a bizarre share, with a crazy balance sheet. Jam tomorrow – i.e. awful historic (and interim) results, but the big valuation seems to rest on hopes for credible-looking orders received more recently. A complete punt, so wouldn’t interest me at all. In a sector that’s been in a speculative mania of late (clean energy).

Accsys Technologies (LON:AXS) – a good trading update. This looks an interesting growth company, but I find it difficult to value, and don’t see enough upside on the current market cap to make it look compelling to buy. I could be wrong though, as am only using broad brush assumptions.

Electra Private Equity (LON:ELTA) (I hold) – I cover updates on both portfolio companies, Hostmore (which owns TGI Fridays), and Hotter Shoes (to be renamed Unbound). I’ve just come off a call with management, with things seemingly going OK, as confirmed in recent trading update. Do check out the link to Unbound’s recent CMD recording.

Jack’s section:

Steppe Cement (LON:STCM) – Good results with revenue up 17% and profit after tax up 52%. This company has had a high StockRank for a few years now but is thinly traded and, having doubled in recent months, is no longer in deep value territory.

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), and make your own investment decisions. Reader comments are welcomed – please be civil, rational, and include the company name/ticker, otherwise people won’t necessarily know what company you are referring to.

40.7p (up 3% at 08:06) – mkt cap £316m

I haven’t looked at this share for over 6 years, and it has got considerably more bizarre over that time. Continuous losses, and very low revenues, combined with a soaring share price.

Note that the largest shareholder, SFN Cleantech Investment Ltd holds 78.6% of the shares.

Half-year Report

It’s another set of awful figures, to add to a long list.

Revenues of only £0.9m, and an operating loss of £(3.9)m. Remember this company is valued at £316m!

A large credit to finance income offsets the usual heavy finance cost, which reduces the H1 loss from £(10.3)m last time, to £(1.2)m this H1.

Now we come on to the fun bit, the balance sheet. It looks much as I would expect for a small, loss-making company, until we get to long-term liabilities, which includes £80.0m of borrowings, and a £396m liability called “Embedded derivative on convertible interest”.

Overall net assets are negative at £(474)m! That makes it completely uninvestable to me. The numbers are just ludicrous.

Clearly then, if you are tempted to buy this share, then the key issues to research would be -

• Terms of the large £80m borrowings – when is this repayable, to whom, are there any covenants, etc? It seems to be a loan from shareholders, as it’s difficult to imagine anyone else would be prepared to extend so much debt to a tiny, loss-making company.
• Terms of the convertible loan, and how on earth has such a gigantic liability of £(474)m appeared on the balance sheet, seemingly due to a derivative of some kind?

With these size liabilities on the balance sheet, this share cannot be considered a regular investment, it’s more a special situation, needing careful research from sector experts.

Orders/pipeline - this is the interesting part, and is clearly what has driven a frenzy of excitement around this share. It had a period end order book of £7.3m, and follow-on orders since the period end are mentioned. The value of customer quotes is significant, at 45m Euros.

This suggests to me the company has an interesting product (hydrogen fuel cells), which the market seems to think could become commercially valuable.

My opinion - it’s a jam tomorrow share, which makes it impossible for me to value. The historic figures show that the equity is worth nothing, so the £316m market cap is entirely based on excitement about its future potential, with significant orders now coming in.

Hence I think this share is only for gamblers, or sector experts. You would really need to know your stuff about fuel cells, and the competitive landscape, to be sure that you’ve found a future winner. There must be so many companies around the world trying to produce commercially viable fuel cells, hence for me this would be like trying to find the proverbial needle in the haystack.

Also, the whole renewable energy, or clean energy sector has been in a big speculative boom lately. Valuations are often ridiculously high, based on little of substance. So it’s really an area for speculation rather than sensible investment, in my opinion.

The long-term chart is interesting, below. This share has been listed for a long time, and most of that time it was valued at very little (understandably). However, something happened in early 2019 to start a multi-bagging frenzy, maybe contract wins, or something similar? As you can see more recently, a fair bit of the froth has since blown away, although at £316m market cap, I’d say it could fall considerably more without continued positive news on customer orders. About as far from a value share as it’s possible to get!

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162.5p (up 5% at 10:40) – mkt cap £313m

Trading Update

Accsys, the fast-growing and eco-friendly company that combines chemistry and technology to create high performance, sustainable wood building products, today announces an unaudited trading update for the first five months of the 2022 financial year from 1 April 2021 to 31 August 2021…

There’s a fair bit of detail in today’s update, which comes across well.

However, rather than me rehashing it all, I think the CEO’s summary sums it up very well as follows -

Rob Harris, Accsys CEO, said:

“Accsys has made a strong start to the 2022 financial year. Our established Accoya® business has delivered double digit volume and revenue growth. This reflects continued strong customer demand, our price increases, product mix, and lapping the initial more severe effects of COVID-19 last year.

During the last five months we have continued to make good progress with the construction of a fourth reactor in Arnhem, advanced our US JV with Eastman and whilst we experienced some previously communicated challenges with the construction of our Hull Tricoya® facility, we are working through these and expect to have the plant commercially operational by July 2022.

Looking ahead, we remain confident in delivering on full year expectations and underpinned by the clear market opportunities for our high-performance wood products, we continue to progress towards our ambitious 2025 fivefold increase in production target.”

Valuation - this is particularly tricky because AXS is not exactly jam tomorrow, because it already has production underway amp; is selling product. However, the share is all about scaling up production 5-fold in future, and how that would pan out in terms of profits? It’s all about achieving scale, but that is taking a long time, and of course costs money, in capex and working capital increases.

Broker consensus for FY 03/2022 shown on the StockReport is 108 Euros revenues, and just above breakeven with a net profit of 2.3m Euros. That’s fine at this stage, because new factories won’t have kicked in.

The question is, what would the figures look like once new factories are operating?

If we assume say 500m Euros revenues in 2025 as planned (“ambitious”) and what, maybe a 5-10% profit margin (I’m just guessing there), then this business could be making say 25-50m Euros profit per annum by 2025. Take off 25% tax, convert into sterling at £1 = E1.17, and put it on a PER of say 20, and I get a valuation of £321m – £641m. The current market cap is £313m, so it looks like a lot of upside is already priced-in.

You might want to try out different numbers to my assumptions above, and you could reach a higher (or lower) valuation – e.g. if you think the valuation might go above a PER of 20 (entirely possible for growth shares), and/or that the profit margin could be higher than 5-10% once scale is reached. Plus I haven’t factored in anything for downside risk, if the company doesn’t achieve its ambitious 5-fold increase in revenues.

My opinion - I’ve always liked the concept here – AXS makes a genuinely good product, that is in demand. Hence scaling up production should enable more to be sold. A 5-fold increase in sales would likely transform the numbers for the better, if achieved.

Valuation is the tricky part, and do I really want to wait 4 years until 2025, for a share that might potentially double in price, by my calcs? Not really.

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580p – mkt cap £225m

I’ve covered this share a lot this year, and it’s one of my top conviction holds. It’s an investment company which is divesting its main asset, TGI Fridays (casual dining chain). That is due to list imminently, by end October 2021. It will be called Hostmore, and ELTA shareholders will receive free shares in Hostmore.

After that, ELTA will change its name to “Unbound”, and its sole investment will be Hotter Shoes.

Both businesses have been extensively restructured and rejuvenated under decent new management teams put in place by ELTA. The prospects for both businesses look very good, in my opinion.

I reckon ELTA shares look substantially lower than my sum of the parts valuation – which gives good upside, and low risk, to ELTA shares, if the market agrees, once these shares are standalone regular companies.

Hostmore (TGI Fridays) Trading Update

This was issued yesterday.

Electra Private Equity PLC (“Electra”) is pleased to issue a trading update for its hospitality brands, Fridays and 63rd+1st, for the 16 week period since 17 May 2021, and to announce the composition of the Board of Directors of Hostmore PLC (“Hostmore”), the parent company for those brands.

Since re-opening, trading has been good – the comparisons are with 2019 pre-pandemic levels -

Averaging +11.8% on 2019.

The rate of increase accelerated within that period, to +15.2% in the most recent 7 weeks.

However, as the company flags up, the reduced 5% rate of VAT on food amp; soft drinks, a temporary measure, have caused most of that increase. They’ve provided VAT adjusted numbers too, which are flat against 2019, and +2.6% in the most recent 7 weeks.

The company says these numbers are out-performing the market, based on data provided by Coffer CGA Business Tracker. I think Wagamama did even better in a recent update from Restaurant (LON:RTN) .

I’m happy with that. It’s helped by the fact that Hostmore doesn’t have many sites in London, which is where the biggest footfall drops (and the worst staff shortages) have been. Its Covent Garden site has a lease expiry, so won’t be re-opened. That has helped drive more traffic to its expensive Leicester Square flagship site.

63rd+1st – this is a new, more adult-themed cocktail bar, which was trialled in a site in Cobham. The roll-out is now starting -

we are opening our next two 63rd+1st sites – in Glasgow later in September and Harrogate in November – following a successful launch in Cobham earlier this year in May.

Therefore, in Hostmore shares, we are getting 2 hospitality brands to roll out. This is a very good time to be opening new restaurants, as 10-20% of competitors have gone bust, and landlords are offering very attractive terms on new sites. Hostmore is currently focusing entirely on taking over well fitted-out sites, with reduced capex, compared with the shells that it might have typically taken on pre-covid.

If Hostmore attracts a premium, roll-out valuation anything like say Fulham Shore (LON:FUL) then it could turn out to be lucrative for shareholders.

Unbound Group (Hotter Shoes)

This is what ELTA shareholders will be left with, once Hostmore demerges.

I attended the recent Capital Markets Day (CMD) on a webinar, and thought it very interesting. Hotter Shoes has been turned around, comprehensively restructured, with physical stores reduced from 82, to 17. It’s now a profitable, digitally-led business.

The plans are to expand product ranges into complementary areas, such as gardening (already have concessions in Dobbies), clothing, even holidays. This is all going to be done on a low risk, capital-free model, in partnerships.

Hotter has a close connection amp; strong brand, with the over 55s women, its main market. There’s an opportunity to expand its menswear (only 10% of sales at present).

I gave feedback that management used a little bit too much MBA-speak, and that they clammed up during Qamp;A, refusing to answer some questions as too commercially sensitive. It was explained to me that the IPO process has seen them having lawyers amp; advisers swarming over everything they say, hence why they thought it best not to say anything that might cause problems. They’ll loosen up in future, I’m sure.

The good news is that there’s a recording published today of the Hotter Shoes (Unbound) CMD, do check this out. At the moment, I think some ELTA investors have almost disregarded Hotter Shoes, thinking it’s of little value. Whereas actually, I think it could be a decent investment. There’s also a chance that big holders might dump their shares, creating an overhang, and an attractive entry point for us, once it becomes a separately listed micro cap.

I wouldn’t want to hazard a guess at the market cap of Unbound (Hotter). Oh that’s too boring, I’m going to guess! In my view, I think it could be worth say £50m standalone. But as price discovery occurs, that could fluctuate wildly, from say £30-70m market cap, is my complete guess.

Another recent float targeting the older demographic is Parsley Box (LON:MEAL) . This still valued at £43m, even after almost halving in price since IPO. MEAL is still heavily loss-making, spending money mainly to get its brand known. Whereas Hotter Shoes already has a very widespread brand recognition amongst the over 55s, and is already profitable. So to my mind, Unbound/Hotter should be valued at considerably more than MEAL’s £43m.

A new research note is due out from Edison fairly soon, which I’ll flag if I spot it.

My opinion - I really like this special situation. Not many investors seem to know, or understand the situation here. That’s why this share sits at what could turn out to be a significant under-valuation still.

Both Hostmore and Unbound look excellent companies, that I would be very happy to hold. Hence my plan is to sit on the shares long-term, and hopefully watch them re-rate by maybe 50-100% of the current valuation, is my best guess. Considerable volatility could occur as the market finds a value for both Hostmore and Unbound shares. So I think people need to work out in advance whether you’re trying to trade this for a short-term profit, or whether you’re looking to the longer term (which is my position).

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Share price: 53.04p (+0.08%)

Shares in issue: 219,000,000

Market cap: £116.2m

Steppe Cement is the leading cement manufacturer in Kazakhstan with annual capacity of 2m tonnes.

Its facilities consist of two dry kilns (which use less resources) and four mothballed wet kilns. The group says its competitive advantage comes from being a low-cost producer but in truth there is little coverage on this company – one thing to note though is that it has been consistently flagged by the StockRanks as having good value, momentum, and quality. Today the group has a StockRank of 99.

The screeners out there will no doubt have seen Steppe pop up on various screens over the years.

There is competition risk in the form of overseas producers able to operate at even lower costs, and a lot of supply. There’s probably country risk too, and an unfamiliar major shareholders list sheds little light on the quality of corporate governance. Some known institutions on the register would help, assuming they use their resources to conduct adequate due diligence into the board and management structure.

That said, Steppe’s facility remains well invested and cost some $250-300m to create, compared to today’s market cap at a little over £116m. In that time, Steppe has generated profits and more recently began paying out dividends.

Interim results

Financial highlights:

• Revenue +17% to $39.5m,
• Profit after tax +52% to $6.2m.
• Earnings per share +47% to 2.8 cents.

Doubling that EPS figure and translating into GBP would equate to around 4p of earnings and a PER of 13.1x. What comes across in these results though is the disproportionately large increase in profits on the back of 17% revenue growth, so perhaps a mere doubling is too cautious, assuming trading dynamics remain constant or cement prices rise further.

Steppe managed to increase cement prices in H1, with the average ex-factory price up from $36 per tonne to $39 per tonne (+11%), leading to a 6% increase in gross margin to 46%.

General and admin costs also increased (up 16% in USD terms), production costs rose 5%, and reported inflation was 7%.

Market update – The Kazakh cement market increased by 28% during the first half of the year and total cement consumption in the country is expected to grow to 11 million tonnes in 2021, an increase of more than 1 million tonnes from 2020. Steppe’s share of that market has fallen by 1.5% to 15% however.

Balance sheet – net cash of $7.4m, up from $6.4m a year ago. Cash of $9.6m set against $3.2m. Nearly $50m of property, plant, and equipment. Net tangible asset value of $63.23m. Cash conversion was strong too, with free cash flow of just under $7m being more that reported profit attributable to shareholders of $6.19m.

Conclusion

Steppe Cement continues to be something of an oddity on the UK stock market. A cement producer operating in Kazakhstan that began life in the 1950s under the Soviet Union and, more than half a century later, finds itself listed on AIM where, judging by the figures, it remains either forgotten or mistrusted.

It could be that this is a high quality asset. More communication with the market would be a plus. I’ve never seen an offer to watch the management present, nor have I seen any broker notes on the company. It makes you wonder why the company is listed at all.

The cement market is huge, but are there any barriers to entry? The company points to its low costs and location near the capital, which is rapidly growing. But then again, in a growing market, it has lost some share.

It looks like a well run cement producer and if commodities go on a run it could still prove to be undervalued. But with the shares having more than doubled recently it is not the clear bargain it once was on, say, an NTAV basis. And that’s realistically the point at which I’d be willing to spend more time on it.

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