Small Cap Value Report (Mon 13 Sep 2021) - TST, GMR, STEM, SCE, XPD, BIRD, LUCE, WATR

Good morning, it’s Paul amp; Jack here with the SCVR for Monday.

Agenda -

Paul’s Section:

Touchstar (LON:TST) (I hold) interims. Brief comment, as it’s very small.

Gaming Realms (LON:GMR) – strong interim results, moving into profit. Potentially interesting, could be worth readers taking a closer look. 2021 outlook is in line with expectations If forecast growth in 2022 happens, then the shares could end up looking cheap. I don’t know enough about the business model to be sure either way, so am neutral.

Surface Transforms (LON:SCE) – another set of poor results, to add to a 20 year track record of poor results. However, big orders in the pipeline mean things look set to dramatically improve in 2021 and 2022.

Blackbird (LON:BIRD) – interim results don’t impress at all. It’s still loss-making, and needs to at least double revenues just to reach breakeven. There’s enough cash to keep going for several years. I’ve no idea why the market cap is so high.

Luceco (LON:LUCE) (I hold) – my notes from today’s interim results webinar on InvestorMeetCompany. I’ve taken a small opening stake, because the share price has fallen 30% on worries about supply chain problems. That might be a reasonable entry point maybe?

Water Intelligence (LON:WATR) – strong interim results, but the top dollar valuation amp; lack of divis rules it out for me.

Jack’s Section:

Sthree (LON:STEM) – strong trading continues and FY profit is expected to be significantly ahead of consensus. The shares have been strong recently so there’s a question around valuation and also around how long the market remains buoyant, but the group is investing in headcount and it’s not hard to envisage continued strong trading.

Xpediator (LON:XPD) – recently upgraded guidance for at least £8.5m of FY profit before tax is maintained. Big increase in receivables and swing to net debt due to restructuring and Brexit complications. It’s a buoyant market for logistics, but it’s also low margin and costs could rise to so overall I’m neutral.

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.

Paul’s Section Touchstar (LON:TST) (I hold)

Too small to report on here properly, as only £7m market cap. However, interim results today (c. breakeven) show some signs of life. In particular, I like the outlook comments -

– H2 2021 started well and expect strong result

— FY 2021 we now expect to be above market expectations despite continued uncertainty

— Current prospects give us confidence that 2022 will be an even better year

— Order book as of the 10 September 2021, stood at GBP836,000.

The balance sheet is just about OK (net cash of £1.3m, unchanged), and the order book has been growing, now at £836k.

My opinion – it’s a tiny business, not sure why it’s listed really. However, I’ve always thought there might be something potentially interesting here, so have held a small position for several years. The new “Podstar” product (software for transportation) is being rolled out in 2022, after trials this year. Very illiquid, so won’t interest many people.

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Gaming Realms (LON:GMR)

35p (Friday night close) – mkt cap £101m

Interim Results

Gaming Realms plc (AIM: GMR), the developer and licensor of mobile focused gaming content, is pleased to announce its interim results for the six months to 30 June 2021 (the “Period” or “H1’21″).

Headlines -

Revenue growth of 50% generates adjusted EBITDA[1] of £3.1m[2], up 144%

Continued U.S. expansion post period end with content launched in Pennsylvania

Strong revenue growth to £7.7m in H1

Adj EBITDA of £2.7m (after share option charge) is best ignored, because it’s not reality – the company capitalised £1.6m of development spend onto the balance sheet

Profit before tax is a more meaningful number, and has moved from a loss of £(693)k in H1 LY, to a profit of £804k H1 this year – an impressive turnaround

Balance sheet looks adequate

Cashflow has benefited from a one-off receipt of £973k deferred consideration, plus £362k sale of something – GMR did look like it was scraping the barrel for cash last year, but I’m impressed it has pushed through without needing to dilute shareholders with a placing.

Note there is a convertible loan of £3.5m due for payment at end 2022 – it would be worth checking the terms, to see if conversion might occur, and cause dilution or not.

Outlook - the commentary sounds generally positive, and concludes that it’s trading in line with expectations -

With a strong game development pipeline, a clear strategy to continue expanding its distribution internationally and with demand from the Group’s customers expected to continue, the Board expects trading for FY21 to be in line with market expectations and remains confident in the strategic outlook for the business.

My opinion – an interesting company, which has clearly made good progress this year, moving into profit.

I’ve never managed to get to the bottom of exactly how the business model works. In particular, how much of the revenues are recurring, and how much one-offs? Previous management webinars amp; results statements have been a bit vague on this, in my view, more clarity is needed.

Is GMR worth just over £100m? Not to me it isn’t, because I’m not sure how likely it is to deliver profit growth.

On the upside, current year forecast is for 0.9p EPS, rising to 1.8p in FY 12/2022. If the FY22 forecast is achieved, then the PER would only be about 19 times – which looks too low for a fast growing software business, with products that look popular with gaming companies, internationally.

Overall then, GMR looks potentially interesting, and this could be worth readers spending some more time doing the detailed research. If you can get to the bottom of how the revenues work, recurring/one-offs, then do please let me know!

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Surface Transforms (LON:SCE)

66.5p (up 2% at 08:27) – mkt cap £133m

Surface Transforms (AIM: SCE) manufacturers of carbon fibre reinforced ceramic brake discs, announces its half-year financial results for the six months ended 30 June 2021.

There’s very little for me to say here, because this share is all about future growth which seems to be in the pipeline. The interim numbers have not yet seen that growth coming through.

Tiny revenues of £1.2m in H1

Strong gross margin of 62% – I like that, because it shows that there’s good operational gearing once revenues really start to rise strongly. Bulls in this share say that it has special expertise in ceramic brakes which gives it a defensible moat. That’s the key issue to research.

Cash is strong at £17.2m, from a placing.

Outlook -

The Company now expects to enter a period of high growth, partially, but not solely based on a lifetime value OEM order book of circa £70m. Indeed, we repeat the statement made by the Chief Executive in the manufacturing strategy announcement of 1 September “at the time of the fundraising we said that we thought there could be sufficient demand to fill the Knowsley factory by 2025 (£75m sales), albeit these projections are still uncontracted…we have now concluded that we may want this capacity by 2024.”

It goes on to say that the timing of orders is uncertain for 2021, and some might be pushed into 2022. I don’t think that matters particularly, because the value in this share will be all about what revenues/profits it makes in several years’ time, hence the timing of short term production isn’t significant, but could possibly cause some volatility in the share price maybe? Although in my experience, when people buy into a share like this, they tend to be “believers” and hold tight through any short term disruption.

However, we reiterate our previous statements, that we expect to be profitable in 2022.

My opinion – neutral, because this type of share doesn’t generally interest me. I’ve had lots of bad experiences with loss-making companies on the cusp of great things, as something nearly always seems to go wrong.

That said, SCE seems to have a genuinely impressive order book, and looks on the cusp of strong growth, and imminent profitability.

How to value it though? That’s the tricky bit, because there are no existing profits, we have to forecast what it might make in future, or rely on inherently uncertain broker forecasts. There’s also the question of competition which might crop up, if SCE starts making big money.

Good luck to holders! It would be good to see SCE finally come good, after about 20 years as a listed company producing dismal numbers every year. It does look like that’s about to change for the better!

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Blackbird (LON:BIRD)

34p (down 12% at 10:53) – mkt cap £115m

I’m amazed the market cap is £115m, given the track record of negligible revenues, continuous losses, and fundraisings. Although as SCE has shown above, occasionally jam tomorrow stocks do actually look set to serve up some jam – nearly always years late, and after burning through a lot more cash than originally planned. I wonder what Blackbird shareholders will be spreading on their crumpets? Jam, or regurgitated worms?! Let’s have a look.

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Interim Results

Blackbird plc (AIM: BIRD; OTCQX: BBRDF), the developer and seller of the market-leading, patented cloud native video editing platform Blackbird®, announces its interim results for the six months ended 30 June 2021.

Revenues are still tiny, but up somewhat – is this growth enough?

record revenues for the six-month period of £867k, up 21% year on year

A similar amount of revenue is secured for H2.

It’s still loss-making, and cash-burning, and this is just a half year remember -

Net loss before tax £1,168k (6 months to 30 June 2020: £942k)

Cash of £5.7m, so looks financially secure for the time being.

Outlook -

By the end of August 2021, we had grown 2021 secured revenue to £1,763k (2020 comparative: £1,453k) and had £893k of contracted revenue for 2022 which is up 18% versus the 2020 comparative for 2021 (£756k).

More excitingly, our recently announced first technology licensing deal opens up both a quicker expansion opportunity in our existing market and further potential in new markets outside the Broadcast sector. This deal clearly demonstrates the adaptability of our technology and significantly increases the Company’s TAM. The next few years will be most interesting for the Company as our markets recognize and respond to the flexibility, resilience and sustainability of our core technology…

The future prospects for the Company continue to be very bright and I look forward to working with the team to deliver these.

US Listing – shares are to be listed in the US, on the OTCQX Best Market – doing a bit of googling reveals this to be a junior market, where shares are traded by dealers, rather than having orders matched as on the main US markets.

Will this lead to a re-rate of Blackbird shares? It might do, who knows? Maybe it will get ramped on Reddit?!!

Balance sheet- looks OK for now.

My opinion – sales need to double from here, just to reach breakeven. The growth rate isn’t anywhere near fast enough as yet.

The market cap of £115m looks incredibly generous, considering performance to date.

I’d want to see a large acceleration in growth, before even considering an investment here, because performance to date simply doesn’t justify a market cap anything like this high. So investors must be very confident about the company’s future, because they’re paying a lot up-front for commercial success that has not as yet been achieved.

It’s surprising to see the share chart below looking so positive, when it is not supported by positive financial results. If it was me, I’d be banking my profits with grateful thanks to the buyer. Although we are in a bull market for tech shares, and valuations don’t necessarily need to make sense to value investors.

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Luceco (LON:LUCE) (I hold)

384p (up 1% at 11:54) – mkt cap £617m

I last looked at this company on 7 Sept here, on publication of superb interim results. With the share price at 474p, I commented that top-slicing looked a good idea, after a great run. I didn’t expect the price to fall as far as it has, down around 100p since then, although it showed signs of finding a floor this morning, so I did pick up a little scrap for my small punting account. At under 400p, the valuation looks more reasonable to me, in the high teens PER.

There’s just been a results webinar on InvestorMeetCompany (recording now available here), so here are my notes – as usual, this is not comprehensive, I tend to just jot down key points. So apologies for anything I missed.

Management pronounced the company name as “Loo-see-co”

Very clear explanation of what the company does -

Wiring accessories (50% of revenues, and bulk of profits)

LED lighting (25% of revenues) – newest part of the group

Portable power – e.g. electrical extension leads amp; reels

Customers – two thirds sold to electricians, the rest to end users (mainly power leads)

Markets – mostly UK, 80%

Demand is driven by construction, repair amp; remodelling markets, which are growing faster than GDP, stable market growth

Ramp;D and manufacturing have been done in China for last 12 years, half of what we sell is made in our own factory in China, competitors don’t tend to have their own factories, so this is a competitive advantage.

LUCE products have long-established, respected brands. Priced in mid-market, but with above average design amp; quality.

Good relationships with distributors.

Very successful recent interim results – more than doubled profits.

Driven by new business wins, and high product availability – production has risen 50% during pandemic

Favourable market conditions, plus market share gains.

Gross margin is coming under temporary pressure from cost price increases, but these are being passed on to customers, albeit with a time lag. Expected to continue in H2, then be sorted out by 2022.

Longer lead times out of China, have compensated by increasing inventories – which does make me wonder if supply chain problems could be a vicious circle – i.e. shortages amp; delays, so everyone increases inventories, thus making the problems worse!

Brands amp; pricing power mean cost price rises can be passed on to customers, but it takes a while for all customers to accept price rises.

Automating its factory, with 2 year payback on investments.

H2 will be a little softer – e.g. construction materials shortages are causing delays to some projects, out of Luceco’s control.

Inflation amp; supply delays are the major challenges at the moment. Don’t know when they will be resolved.

Qamp;A

How much of market share gains are temporary due to competitor supply difficulties? Not much, mayabe 4%? Difficult to know. Growth is slowing at e.g. Screwfix, but not likely to go backwards. Shipping costs are the big unknown. It got to $12k per container, we thought it couldn’t go any higher, then it went up again to $15k. Can’t last forever. Taking twice as long to get product in from China. Ports congested (anecdotally – I noticed that in Malta where I am currently residing, the horizon is dominated by long lines of static freight ships, at least 20 of them, not moving at all seemingly. They’re pointing north, towards Italy/Europe).

CFO chipped in that LUCE sells half its products FOB – i.e. the customer takes the goods from its factory in China, so shipping issues are the customer’s problem.

High hopes for new electric vehicle products, launching later this year.

China factory is running at c.80% capacity, but with further automation capacity could be extended, so maybe 60-70% capacity after those improvements.

Acquisitions – we can spend £80-90m without dilution. Working on 3 deals currently, totalling £70-80m, expect 1 or 2 to succeed in the near future.

My opinion – a good, clear briefing, which I found very useful. This is a good business, and the recent correction has I think provided a reasonable buying opportunity. It depends if demand remains robust, and of course the supply chain difficulties won’t help short term sentiment. I’ve bought a small opening position at 380p, initially as a punt, but after the webinar, think I might transition my holding into my long-term account, possibly buying more on any further share price weakness – but I’ve not decided yet, am still pondering things.

Management seem switched-on (geddit?!). Checking the last annual report, the long-serving CEO has a huge personal shareholding, of 31.5m shares. This is one of several striking similarities with electrical cable group Volex (LON:VLX) (I hold).

Overall, I’m braced for a bumpy ride over the autumn/winter, as supply chain problems could worsen, who knows? But the recent c.30% fall in share price from an admittedly rather toppy peak of c.500p, looks a fair entry point in my view.

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Water Intelligence (LON:WATR)

1265p (up 1%, at 12:38) – mkt cap £207m

H1 results look good, with revenues up 44% to $24.7m, and adj profit before tax up 77% to $4.2m.

The trouble is that the market cap is so high, at £207m.

For me, a far more attractive US share is Somero Enterprises Inc (LON:SOM) (I hold) which is valued at £303m, yet looks set to make 3-4 times as much profit this year as WATR. True, WATR is growing fast, and being a small business still, can achieve a higher growth rate. SOM is also a cash generation machine, and pays out generous normal amp; special divis. That suits me better than a highly rated growth share such as WATR, so it’s just horses for courses, depending on your investment approach00.

Valuation rules out WATR for me, but good luck to holders. There’s no denying the company is performing consistently well, and has interesting growth potential.

5-bagging in the last year and a bit, it must be very tempting to bank some profits.

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Jack’s section Sthree (LON:STEM)

Share price: 595p (+8.38%)

Shares in issue: 133,510,532

Market cap: £794.4m

SThree is a recruiter with ten brands across the Science, Technology, Engineering, and Mathematics (STEM) industries. It was founded in 1986 as an IT-focused specialist staffing agency but since then, there’s been an organic push into new geographies and sectors.

Most of its business comes through Computer Futures, Progressive, Huxley and Real.

As with certain other sectors, recruiters have proven to be post-lockdown winners and the SThree share price chart shows as much, with a six-month relative strength figure of +49.6%.

The group now qualifies for the Value Momentum Screen and today’s short update confirms that trading remains robust.

Q3 update

Full year profit performance expected to be significantly ahead of consensus

Highlights:

• Net fees +29%, with strong growth in Germany (+35%), USA (+31%), and Netherlands (+24%),
• Contract and permanent fees up 27% and 36% year-on-year respectively,
• Contractor order book +41%,
• Net cash up y-o-y from £39m to £51m,
• PBT to be significantly above market consensus (of £51.4m) due strong trading and delays to investment spending – this follows the upwards revision provided in June 2021.

Credit to SThree for including the market consensus figures. These look like strong results.

Importantly, performance versus 2019 is also positive: Q3 net fees are up 11% on a two-year basis, with Germany up 22%, the US up 28%, and Netherlands up 8%, while the contractor order book has risen by 20%.

The top five countries represent 87% of revenue, with Germany at 33% of the total and the US at 26%. Contract net fees represents 76% of Group net fees, more or less stable year-on-year (Q3 2020: 77%).

The strong order book reflecting strong ongoing high demand and a positive outlook

Group average headcount was down 2% year-on-year by the end of the period but SThree is hiring and expects a further increase in Q4 and FY22.

The Group plans to issue a trading update for the year ended 30 November 2021 on 13 December 2021.

Conclusion

Obviously the share price performance shows that investors understand trading is strong here. Are the shares attractive even after this steep rise?

Significantly ahead of £51.4m, so let’s say £55m-£60m. Let’s assume a tax rate of 28% (roughly equivalent to FY18 and FY19 tax rates). That would be £39.6m-£43.2m of profit after tax and 29.7p-32.4p of earnings per share, way up on FY20’s 17p and the forecast FY21 figure of 25.3p, and would equate to a PE ratio of 16.9-18.5x. The group has net cash of £51m, so we can also adjust for that.

It’s not obviously cheap to me given that this is a sector whose profitability can vary across the business cycle.

But you could argue that it’s fairly valued on near-term growth prospects, with scope to surprise further on the upside. Particularly if there’s a degree of operational gearing at play.

We have the uncommonly buoyant conditions, the fact that SThree is attractively positioned in structural growth areas, and the fact that it already benefits from a unified global database of clients and customers (so there are presumably fewer IT headaches than one might find in a company cobbled together via disparate acquisitions).

SThree appears confident and expects to continue increasing headcount over the next year, which suggests it expects to remain busy for a while yet. Revenue has increased steadily over the years in spite of choppier profits.

The group’s exposure to contracting presumably means it is well-placed for a more flexible working environment as well. This looks like a good company – one of the better listed recruitment companies out there so I’d happily spend more time on it. My concern is purely valuation for now – perhaps the easy money has been made and holders will now be looking at less substantial share price gains and even then, assuming a lot of things go right.

On the other hand, I certainly wouldn’t bet against this kind of momentum. When conditions are this strong there’s always scope for ongoing earnings beats. The group’s largest markets are robust and a more inflationary environment should feed through into higher wages. So I wouldn’t be surprised to see further positive developments here.

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EDIT from Paul – this PIWorld recording has just come through, thanks to Tamzin amp; Tim -

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Xpediator (LON:XPD)

Share price: 69.4p (-4.69%)

Shares in issue: 141,688,425

Market cap: £98.3m

Xpediator is an international freight management company providing logistics and transport support solutions. The group works across the UK and Europe with a particular expertise in Central and Eastern Europe (CEE) countries. These markets are growing at faster rates than the rest of Europe, while logistics itself tends to grow in excess of GDP.

Established in 1988, the group has an international network of offices providing road, sea and air freight services, together with logistics and warehousing in the UK and Romania. The three main areas are freight forwarding, logistics amp; warehousing, and transport services.

This can be a tough part of the market to operate in, but supply chain logistics and fulfilment are essential services for most companies and in the current environment, with Covid lockdowns leaving all sorts of supply chain disruption, there is high demand for these services.

But there are other investment candidates in this industry: Clipper Logistics (LON:CLG) is doing an exceptional job in e-fulfilment, and Wincanton is now making similar moves. Xpediator (LON:XPD) differentiates itself with its CEE exposure, but is this the right way to play supply chain disruption?

Interim results

Whilst market conditions remain highly competitive, demand for the Company’s freight management services has remained strong.

Highlights:

• Revenue +27.1% to £126.6m,
• Adjusted profit before tax +71.4% to £3.6m,
• Adjusted earnings per share +53.4% to 1.58p; basic EPS up from loss of 0.25p to positive 0.66p,
• Interim dividend up 11% to 0.5p.

Adjusted profit before tax of £3.6m reflects growth within key CEE markets, incremental revenue generated from customs clearance, and a full recovery from a COVID-19 affected market.

That figure adjusts for restructuring costs of £398,000, amortisation of acquisition related intangibles of £742,000 , and an additional interest charge of £167,000 (H1 2020: £171,000) resulting from IFRS 16. So that’s a material level of adjustments, about £1.3m.

Freight Forwarding specialises in moving freight, primarily internationally by road, rail, air and sea. The division accounts for 79.6% of group revenue. Sales increased 28.5% to £100.8m (2020: £78.4m) generating operating profit of £4.1m (H1 2020: £2.6m), driven primarily by growth in CEE, enhanced sea freight rates and successful implementation of a UK customs clearance department.

Logistics and Warehousing includes businesses in the UK and Romania under the Delamode and Pallex brands. revenue increased by 22.0% to £22.9m (H1 2020: £18.7m) giving an operating profit of £0.4m (2020: £0.6m). The Romania Pallex business was strong but was offset by start-up costs linked to the UK new build 200,000 sqft facility in Southampton and the UK Braintree facility turnaround.

Transport Support Services, trading principally under the Affinity brand, provides bundled fuel and toll cards, financial and support services for hauliers in Southern Europe. Revenue increased by £0.5m to £3.0m (2020: £2.5.m) and operating profit to £1.3m (2020: £0.9m). Note this is higher margin than the other two.

Balance sheet – Net debt excluding right-of-use assets debt at 30 June 2021 was £1.6m (31 December 2020: net cash £6.8m). This primarily reflects considerable advance supplier payments required in line with market supplier availability, increased freight rates, delays in client payments linked to acceptance of Brexit related charges and some delays in collecting UK receivables following a restructuring in UK freight forwarding finance and shared service teams.

The group says that ‘this item is receiving significant focus, has already improved and is expected to be fully unwound by the year end,’ so we can presumably look forward to an improving net debt position and hopefully a return to net cash.

Post period – UK strategic partnership with e-fulfilment leader Synergy Retail Support, opening of 200,000 sqft new build warehouse extension in Southampton, and further recruitment of key senior personnel to enhance and strengthen leadership.

The group says it is well placed to achieve an improved performance in the second half of 2021 with adjusted profit before tax for the full year expected to be in excess of £8.5m and a healthy pipeline of potential acquisitions.

Conclusion

With net debt of £1.6m, it’s not a hugely concerning level but I’d perhaps want to see Xpediator embarking on a more concerted acquisition strategy from a position of greater financial strength. The group does say it is managing this so progress here would be good. Receivables is a huge line item in the cash flow statement at £16m that turns an otherwise cash generative six months into a cash reducing one. It’s something to keep an eye on.

The group has a useful mix of geographies and freight management services and it is looking to grow. Management says it continues to review a number of acquisition opportunities. The group is maintaining its recently upgraded target of at least £8.5m of profit before tax.

Using a notional 20% tax rate, I make that out to be at least around 4.8p of earnings per share and a forecast PE ratio of around 14.4x. I think that’s towards the upper end of what I might pay though for this type of business.

Current conditions across a range of sectors continue to be affected by unusual post-lockdown dynamics. It’s net positive for Xpediator, but it’s also causing some complications as well, such as the increase in receivables. And who knows how long it all lasts for. These businesses are generally not that high quality insofar as margins and barriers to entry tend to be low, so I wouldn’t want to pay too high a multiple of earnings. Costs could increase as well, with papers recently flagging the shortage of drivers around.

It’s not dissimilar to the car dealers in some ways: exceptional current conditions, but for how long, and what happens when/if the tailwinds unwind in a year or two? It seems like brokers are also struggling to get a handle on the near term outlook.

It’s quite possible that the group is in for a period of exceptional trading but longer term this is a tough industry. With the right strategy Xpediator can certainly grow, but on the whole I’m neutral here.

Stockopedia

Source: https://www.stockopedia.com/content/small-cap-value-report-mon-13-sep-2021-tst-gmr-stem-sce-xpd-bird-luce-watr-865685/