Small Cap Value Report (Fri 10 Sep 2021) - FUL, MTC

Good morning, it’s just Paul here with the SCVR for Friday, thankfully a quieter day for news, in a very busy week.

Today’s report is now finished, because it’s quiet, and I want to spend the afternoon visiting the Malta At War Museum!

Agenda -

Paul’s Section:

Fulham Shore (LON:FUL) – a positive trading update, with recent sales showing a strong trend. Ambitious expansion plans are underway. Shares look pricey, but that reflects the growth in the pipeline, with many new sites being offered by landlords on attractive terms, hence an excellent time to be expanding.

Mothercare (LON:MTC) (I hold) – a strangely worded trading update, but seems to be saying that trading is improving. Remember it’s a franchise businss now, so much simpler. However, the pension scheme deficit recovery schedule looks set to absorb all the profit amp; cashflow. Hence it’s questionable whether the equity has an value at all?

Explanatory notes -

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18.15p (last night’s close) – mkt cap £113m

Jack published an excellent, and thorough review of the FY 03/2021 results from this casual dining chain(s), here in August. I’ve just read that, to get up to speed.

Trading Update

Accelerating momentum and continued expansion

Revenue growth is accelerating, which is clearly good news -

Since the Group’s Final Results announced on 17th August 2021 Group revenues have continued to grow. In the three completed weeks since (up to 5 September 2021), Group revenues for all restaurants have increased 27% compared to the equivalent period in the 2019 calendar year.

This represents a marked acceleration from the 8% average increase for the eight weeks ended 15 August 2021 announced in the Final Results.

However, the above is ambiguous. It’s not clear whether +27% (vs 2019) is for total revenues, or like-for-like (LFL) sites only (the more meaningful performance measure)? The way it’s worded, it seems to be total revenues, not LFL revenues. It’s generally accepted that LFL revenues gives a clearer picture of underlying performance. I’ve lodged a query with the company’s advisers, and will update this if/when I get a response.

Checking back, FUL had 67 sites at this time in 2019. It now has 75 restaurants, so a 12% increase in site numbers. Hence, crudely, that could mean the 27% increase on 2019 sales might reduce to about +15% on a LFL basis – still good, especially because the 17 sites in the West End of London amp; some other city centres, are still struggling, with sales negative vs 2019, albeit improving on a week by week basis, as people gradually return to offices.

UPDATE at 08:45 – my query has been answered, I’m pleased to report. My interpretation of the RNS was correct, so the 27% revenue increase on 2019 is not LFL, so it does include the benefit of new sites opened over the last 2 years. That’s fine, I just wanted to clarify it. Apparently capacity has increased 15%, hence LFL is reckoned to be +12% – a bit below my estimate of +15%, but I was in the right ballpark pleasingly! This is very positive, because it includes the drag of some London sites amp; other city centres, which are reckoned to now be trading about -20% LFL (improved from -41%)

Analyst forecasts – FY 03/2022 is currently pencilled in for only just above breakeven at the profit before tax level. Although the share seems to be valued on an EBITDA multiple. Forecast EBITDA for FY 03/2022 is £8.3m (this number strips out the ludicrous IFRS 16 distortions). This is a reminder that the capex has been very considerable, hence the large depreciation charges. I’m a bit uneasy that the market ignores capex by valuing the business on an EBITDA multiple.

Forecasts have not been changed today, but expect upgrades in September.

End of update.

There has been other data reported in the press confirming that cities are coming alive again, e.g. rail and public transport volumes recovering (albeit still well below pre-pandemic levels).

It’s clear that the trend is improving anyway. Let’s hope it stays that way.

New site openings – this is a key aspect of this share. It’s a roll-out, with a major expansion planned in coming years, with conditions now very favourable (many sites, on reasonable rents, being available). Also there’s less competition, with Italian-style restaurants seeing the greatest loss of capacity, according to some data provided by TGI (I hold via Electra Private Equity (LON:ELTA) ) recently. There was an obvious glut of me-too Italian casual dining chains, so it’s a good thing for FUL that the market has thinned out somewhat.

Also, I think most people would probably agree that FUL has a clearly differentiated, even quirky, product offering, which makes it stand out, and builds customer loyalty. I also like its every day low pricing model. Plus it seems to have bolted on successful takeaway amp; delivery options during the pandemic, making it a better business now. As we’ve seen with many other companies, a crisis often leads to efficiency amp; innovation, making businesses better.

2 more sites are currently fitting out, with 15 more in solicitors hands, so it looks like the pace of expansion is cranking up. It’s going to be a much bigger business in a few years’ time which is one of the reasons why the share price is so buoyant.

We continue to see a number of exciting growth opportunities and are on course to open 10 locations during the current financial year, with more than 150 additional sites in our medium-term plans.”

Diary date – 29 Sept for yet another trading update (which will be the third in 7 weeks) – which makes me wonder if the company might be planning to raise some fresh equity, since it seems so keen to update the market on improving sales repeatedly? That’s complete speculation on my part. The NOMAD amp; broker was changed on 5 August 2021, which can also sometimes be precursor to a placing.

I don’t think it would be a problem – FUL could probably raise funds from a position of strength, and without needing to offer a discount. But I would factor in possible 10-20% dilution into my valuation calculations.

My opinion – it’s a good business I think. Valuation looks a bit toppy, but the rapid expansion plans mean that the business should grow into the valuation, with new sites being acquired on favourable terms, due to the glut of empty units out there. Mind you, new restaurants, cafes amp; bars seem to be springing up all over the place, so I wonder how long the glut of supply is likely to last?

Headwinds are considerable – business rates kicking back in, well-publicised staff shortages amp; rapidly rising wages, food/drink cost inflation amp; shortages from supply disruption. So it won’t be easy, and shareholders in lots of companies need to brace for problems over the autumn/winter.

Overall, I’m not sure about valuation, but I do see FUL as a long-term winner.

The hidden gem in this sector, in my opinion, is TGIs – owned by Electra Private Equity (LON:ELTA) (I hold) and about to be spun out in a separate listing. The valuation there looks extremely attractive in my view, especially as you get strongly performing Hotter Shoes thrown in for free (which I think could be worth £50-100m in due course, when it is also separately listed). Hence I have a big (for me) holding in ELTA, and would only buy FUL on a significant dip in price from the current level – possibly also because I’m being emotional amp; still kicking myself for not buying FUL when it was 6p! We’re all human, and I really missed a trick there, never mind.

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17p – mkt cap £126m

I should emphasise that I only have a tiny scrap of this share, which I should probably sell to clear the decks, but haven’t got round to it. So it’s not a conviction hold at all.

AGM Statement amp; Trading Update

This update came out during market hours earlier this week – it’s infuriating when companies do that, and it should generally be outlawed I think. It’s just not right to put out price sensitive information when the market is open, because it gives an unfair advantage to professionals, and disadvantages non-professional investors who will be busy doing something else during the day.

All 14 AGM resolutions were passed with 99%+ votes.

More of interest to us here, is this trading update -

Trading Update

Whilst we still anticipate that the steady state operation of our existing retail franchise operations, in more normal circumstances, should exceed annual operating profits of £15 million, the Group has continued to be impacted by Covid-19 during this financial year.

For the first 21 weeks of our current financial year to March 2022 our total retail sales were £136 million, generating an adjusted EBITDA of approximately £4.0 million representing a significant improvement over the adjusted EBITDA of £2.2 million reported for the year ended 27 March 2021.

What a strangely worded announcement!

As it says, this is a franchise business now, which doesn’t handle any stock – it’s supplied direct, and paid for by the franchisees, with MTC just taking a profit cut – a really nice business model actually.

As I read that, it seems to be saying operating profit should recover to £15m p.a. over time, as the pandemic recedes. The problem with that – it’s not enough. Look at the currently agreed pension scheme deficit recovery payments due -

A reminder of the cash over-payments as currently scheduled -

FY 03/2021: £3.2m

FY 03/2022: £4.1m

FY 03/2023: £9.0m

FY 03/2024: £10.5m

FY 03/2025: £12.0m

FY 03/2026: £15.0m

FY 03/2027: £15.0m

FY 03/2028: £15.0m

FY 03/2029: £15.0m

FY 03/2030: £5.7m

Total: £104.5m

Therefore, unless Mothercare can significantly increase profits from its normal run rate (it’s behind that at the moment remember), or the pension scheme can somehow be changed so that reduced deficit recovery payments can be arranged in future, then the business really only exists to service the pension fund. There’s likely to be little, if anything, available for shareholders.

My opinion - unless something changes for the better, then it’s difficult to see any value at all in the equity. That said, investors seem to be ignoring, or are unaware of the pension deficit, or maybe have some insight which makes them think the problem will get resolved somehow. The shares seem to be finding a bid at the moment, so I’m going to let my small position run, and see what happens.

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