Small Cap Value Report (Weds 1 Sept 2021) - VLX, ECK, CHH, MNZS, SFR

Good morning, it’s Paul amp; Roland here with the SCVR for Wednesday. It’s September already – that’s summer gone then.

Today’s report is now finished.

Agenda -

Paul’s section:

Volex (LON:VLX) (I hold) – Ops Director’s wife spends £238k buying shares at 390p in the market – a hefty vote of confidence in the company.

Eckoh (LON:ECK) – A very brief in line with expectations trading update. Looks expensive, and note that broker forecasts have been falling this year.

Churchill China (LON:CHH) – Interim results reflect the part-closure of the hospitality sector, but more recent trading is now ahead of pre-pandemic levels. That’s very encouraging, so I can see why the share price has been strong this year. Lovely balance sheet. Overall though, it’s too expensive to interest me, with recovery fully baked into the current price.

Roland’s section:

John Menzies (LON:MNZS) – this aviation services specialist has reported half-year profits ahead of 2019 even though air travel hasn’t yet made a full recovery.

Severfield (LON:SFR) – this steelwork group has reported a record order book and trading in line with full-year expectations. Is there still further to go?

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.

415p (yesterday’s close) – mkt cap £634m

Director Purchase

This caught my eye last night – a hefty Director buy, from the wife of Volex’s Chief Operating Officer, who has bought 61k shares at 390p (£238k) in the open market. Taking their total holding to 1,372,589 shares (worth £5.7m). That’s quite a vote of confidence, and suggests to me that maybe more good performance is on the cards?

It’s an unusually large purchase anyway, so thought I’d flag it here.

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59p (yesterday’s close) – market cap £150m

AGM Statement

Eckoh plc (AIM: ECK), the global provider of secure payment products and customer contact solutions, is holding its Annual General Meeting later today.

This is certainly a concise trading update! -

The Board is pleased to announce that trading in the period was in line with market expectations.

The Group’s financial position remains strong.

That’s it!

I hadn’t noticed that the share price for Eckoh had fallen back quite a lot from the peak back in late April 2021 – a lot of shares got a bit frothy and have seen profit-taking since around then.

Despite this, the StockReport shows a high forward PER of 37, which strikes me as too expensive.

Note that broker forecasts have been reduced this year, which is unusual (most brokers seem to be upping forecasts from overly cautious previous estimates).

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My opinion – it doesn’t interest me. Expensive, and with forecasts reducing, is not a good combination.

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1883p (yesterday’s close) – mkt cap £208m

Interim Results

It’s a little perplexing to see that the share price of this crockery maker has almost fully recovered to its pre-pandemic peak. Maybe these figures will shed some light on why the share is being priced for a full recovery in earnings, when broker forecasts have been falling?

Churchill China plc (AIM: CHH), the manufacturer of innovative performance ceramic products serving hospitality markets worldwide, is pleased to announce its Interim Results for the six months ended 30 June 2021.

Revenue of £23.9m is up on last year, but still well down of the pre-pandemic revenue of £31.9m in H1 2019.

However, the run rate looks much more encouraging -

Group: May / June 2021 recovered to 2019 levels…

Current trading is at levels ahead of the comparable period in 2019 and whilst market activity has not yet fully returned, we believe we have secured further gains in market share across our key markets in line with our long term growth objectives…

… the performance above 2019 levels seen in May and June has been maintained into the second half year. It is not yet clear to what extent Hospitality markets have fully recovered to previous levels, but it appears that we can now be more certain that we can maintain and improve our competitive position in our core markets…

The Company continues to trade in line with the Board’s expectations and we remain confident that we will make good progress against our business and financial targets in both the short and long term.

That all sounds very encouraging, so I can now see why the share price has recovered so strongly. It’s probably safe to value the business on a full return to pre-pandemic profitability, say for 2022.

It’s clear that CHH is a resilient business – it managed a pre-exceptional pre-tax profit of £848k last year FY 12/2020, no mean feat when its hospitality customers would have been decimated by lockdowns.

In H1 2021 it produced £977k PBT (with no exceptional charges this time).

Historically, there is a H2-weighting to profits, and I assume that is likely to be more marked this year, as the hospitality sector comes alive again. Some capacity has left the sector (e.g. CVAs for some chains), but anecdotally I seem to be seeing new restaurants amp; cafes popping up all over the place. After all, if a restaurant goes bust, what’s likely to happen? The landlord lets the fitted out unit to someone else, who operates a new restaurant, on a lower rent. Some chains seem to be expanding again as well, e.g. Fulham Shore (LON:FUL) .

Therefore the outlook for CHH is probably pretty good, providing we avoid the disaster scenario of a resumption of covid.

Balance sheet – remains very strong, with ample working capital (the current ratio is excellent at 3.57 – anything over 1.5 is strong, in my view, so this is very strong). Net cash is £12.4m, with no interest-bearing debt.

Note there is a pension deficit, of £9.8m.

My opinion - this looks very encouraging. The business is clearly recovering well, so I’m happy to largely disregard 2021 earnings due to pandemic disruption, and instead value the company on a multiple of 2022 forecast c.76p EPS.

What P/E multiple to use? It’s a quality business, so I’d be comfortable with 20 times (obviously readers can replace that figure with whatever you like, to flex the valuation to your own assessment).

That implies a share price of 1520p.

The actual share price at the time of writing is 1,882p.

Hence, by my workings, this share looks too expensive to interest me personally.

But there’s no doubt that it’s a decent business, and is recovering well. Hence I can see the appeal for long term investors, who don’t worry too much about valuation! There’s a good argument for buying the best companies, then waiting for them to grow into the valuation.

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324p (Tuesday close)

Market cap: £295m

Interim results

John Menzies provides ground services for airlines, including cargo handling and fuelling. The company operates in 200 locations globally and has more than 500 customers.

Today’s half-year results show profits higher than the comparable period in 2019, with a reduction in net debt. That’s a little better than I’d expect given the ongoing restrictions on air travel.

In my view, a recovery in air travel over the next couple of years is pretty much certain, so I wonder if this could be a buying opportunity?

Here are the highlights from today’s numbers, which cover the six months to 30 June 2021. I’ve included 2019 comparators in several places, where I think these are more meaningful than comparisons with the first half of 2020.

• Revenue: £415.8m (H1 2019: £649.9m)
• Underlying pre-tax profit: £10.9m (H1 2019: £8.2m)
• Underlying earnings per share: 9.2p (H1 2019: 6.8p)
• Underlying operating cash flow £86.6m (H1 2019: £58.9m)
• Net debt ex-IFRS 16: £183.1m (H1 2019: £215.1m)
• Government support measures received H1 2021: £64.7m
• £22m equity raise completed “to fund business development and Mamp;A pipeline”

It seems clear to me that Menzies’ profit during the first half of the year was largely driven by government support payments. These covered 16% of group operating costs of £402m.

Management admits that strong operating cash flow was driven by “good trade debtor collections and upfront support from government agencies”.

Accordingly, no interim dividend has been declared today.

Outlook: As far as I can tell, today’s results are broadly in line with expectations. The company says that cost-cutting and other actions taken at the start of the pandemic have left the business “in a good position to prosper now the aviation sector has begun to recover”.

Passenger volumes are said to be on an improving trend that’s expected to continue. However, the group does not expect a return to 2019 levels of ground services and fuelling activity before 2023.

Cargo services are said to be more resilient, with better margins. Profitability on passenger services is expected to normalise gradually.

John Menzies’ strategy is to expand through bolt-on acquisitions and organic growth. The group says it has a good pipeline of growth opportunities and expects to make further announcements later this year, as new ventures complete.

Balance sheet: Net debt of £183m has fallen since the first half of 2019, presumably helped by the £22m equity raise completed in May.

John Menzies doesn’t seem to include EBITDA in its results, but adding back reported depreciation and amortisation to operating profit gives an estimated H1 EBITDA of £54.6m. This is consistent with broker forecasts I can see for FY21 EBITDA of around £125m.

On that basis, Menzies’ covenant leverage (excluding leases) is around 1.5x EBITDA. That sounds quite comfortable, but in my view it may be a little flattering.

Depreciation costs are high in this business. The company reported depreciation of about £85m in both 2019 and 2020. This depreciation primarily reflects the replacement costs of the group’s airport equipment. I’d imagine this expenditure is essential to deliver safe and competitive services to its customers.

For this reason, I don’t see EBITDA as a very useful measure of Menzies’ ability to repay its debts. I prefer to take a more conservative approach and compare net debt to net profit.

Stockopedia forecasts show net profit of £13m in 2021, rising to £30m in 2022.

Even using the 2022 figure, that still leaves Menzies with net debt of six times forecast net profit. In general, I prefer to see this multiple under four times. In my view, John Menzies’ leverage is higher than I’d really want to see.

Valuation: Are the shares cheap? Stockopedia forecasts suggest they might be:

However, I think this depends on whether the sweeping cost cuts and other measures enacted last year can deliver an improvement in profitability. Margins had started to recover in 2018 and 2019, but we don’t yet know if this trend can be resumed from 2022 onwards:

My view: John Menzies seems to be a good operator, with attractive market share and decent geographic diversification.

The group’s business in the Americas appears to be its most valuable asset, generating around one third of revenue and significantly higher margins than operations elsewhere. Fortunately, flying activity in the Americas appears to be recovering more quickly than in Europe.

Broker forecasts are showing an improving trend, which is also encouraging:

I can see some potential value here. However, the business looks quite highly geared to me and only generates fairly average returns on capital employed.

The gradual withdrawal of government support measures could also be a concern, if flying activity remains restricted by local regulations. The UK furlough scheme ends on 30 September.

This isn’t a stock that would interest me today, but it might be worth further research for investors with an interest in this sector.

82p (+1%, 9am)

Market cap: £250m

AGM Trading Update

“Order book at record levels”

Structural steelwork group Severfield has performed well over the last year:

Today’s AGM update maintains the bullish tone of recent results. Trading so far this year has been in line with management expectations. Although input costs have increased short-term working capital needs, the outlook for the year ending 31 March 2022 is unchanged.

However, results for the full year are expected to have a heavy weighting to the second half, with around two-thirds of profit due in the latter part of the year. So we won’t get much idea of full-year profitability from the first-half results.

Order book: New orders won over the summer have lifted Severfield’s UK/Europe order book to a new record of £376m, from £301m on 1 June 2021. Recent wins include the new stadium for Everton FC, a number of new distribution centres and bridge work for the HS2 rail project.

The order book includes £291m for delivery over the next 12 months. This suggests to me that earnings visibility for FY22 (year ending 31 March 2022) should be strong.

Severfield’s Indian joint venture business (JSSL) has an order book of £135m (1 June 2021: £140m) but is only expected to break even in H1. This is blamed on disruption from Covid-19.

However, even in the FY20 financial year, which was unaffected by Covid-19, Severfield’s share of profit from its Indian JV was just £2.2m. When compared to the group profit of £25.8m for the same year, I wonder if the India venture is worth the capital commitment and risk.

My view: Stockopdia’s algorithms rate Severfield as a Super Stock, with a StockRank of 94. I agree that the company’s recent performance has been good. The outlook also remain positive:

Arguably, Severfield still looks cheap, if you have a positive view on the outlook for the construction sector.

My personal view is a little more cautious than these figures suggest. I recognise that I am probably making this call too soon, but my feeling is that the construction sector is probably closer to the top of the market than the bottom

Severfield appears to have a strong pipeline of work for the next 12 months. But the question I’d ask is whether the company is now a bigger, better business than it was a decade ago, or whether it’s just benefiting from cyclical effects.

Using revenue as a simple way to measure this, I see that Severfield’s revenue is forecast to reach £373m in FY23.

Revenue previously peaked at £394m in 2008. It subsequently fell as low as £202m in 2015.

The long-term share price chart tells the story:

The chart also reminds us of the big rights issue that took place in 2013, increasing the share count by c.70%.

I admit that this is a very simplistic view. I may not be recognising the changes and improvements made to the business by current management. One example of this is the recent acquisition of DAM Structures, which is expected to broaden the group’s exposure to markets including rail – not obviously cyclical.

However, the construction as a whole has always been cyclical. I don’t see any reason why this should have changed. Before buying these shares, I’d want to take a view on this question. Personally, I wouldn’t be confident enough to buy the shares today.

Stockopedia