Small Cap Value Report (Mon 18 Oct 2021) - Supply chains/inflation, TSTL, CNIC, SUP, MIND, BVXP

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

Agenda -

Paul’s Section:

Preamble on supply chains amp; inflation.

Tristel (LON:TSTL) – a quick look at FY 6/2021 results amp; outlook. After a “disappointing year” the outlook sees business returning to normal, and growth resuming. It’s a nice little company, but I question the high valuation – it will need to seriously beat current forecasts, to justify the current share.

Supreme (LON:SUP) (I hold) – a reassuring trading update today, from this entrepreneurial company. It seems to hint at possible out-performance later this financial year? Valuation looks modest, and with good quality scores too. Looks good to me.

Jack’s Section:

Centralnic (LON:CNIC) – profit to be at the upper end of guidance, with an improving organic growth trajectory. The valuation is modest relative to peers and the apparent growth prospects, but integrating multiple acquisitions while steering organic growth is tricky. Management is so far proving up to the task.

Mind Gym (LON:MIND) – revenue has returned more or less to pre-pandemic levels but the share price has risen faster than profits have recovered. The high valuation combined with a lack of share price liquidity is enough to keep me on the sidelines.

Bioventix (LON:BVXP) – a quick look over results for FY 06/2021. This is a remarkable little company, making a staggering profit margin for its niche disgnostic products (antibodies). Specialist knowledge is needed to assess this company’s prospects/value, hence I’m neutral on it.

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 are analysing the company fundamentals, not trying to predict market sentiment.

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.

Supply chain costs amp; delays, and higher inflation, are the key issues of the moment, impacting many companies around the world.

Inflation seems a straightforward issue – it’s here, it’s likely to persist for some time (we don’t know how long), and the key issue we need to ask all companies in webinars is: have they managed to pass on higher costs to end customers? If they have some pricing power, and can raise selling prices, then inflation doesn’t really matter, because profits should be unaffected. In some cases, supply shortages combined with rampant demand, have led to big increases in profitability – e.g. car dealers, and possibly some building supplies companies (e.g. James Latham (LON:LTHM) ).

Some of us here will remember the inflation of the 1970s and early amp; late 1980s. Although I was only a child, I do remember it being a big issue, and seeing my Gran’s modest savings destroyed in purchasing power over a few years. Most of the population seemed to be in a battle against rising living costs, and unionised workforces were constantly going on strike for higher pay. Inflation can achieve a horrible inertia once it gets going, since it creates not just price rises, but general expectations of further higher prices, which people begin to anticipate, hence making it self-fuelling.

Globalisation has protected us from inflation in recent decades, as we suck in cheap consumer goods, made from cheap labour. Has that process run its course now though? I see China factory output prices recently are up 10%, and of course China isn’t a low wage country any more, so I’m not sure how they’ve managed to dominate global production still?

Anyway, my main point is that we associate the inflation of the 1970s with bombed out share prices. However, I question whether higher inflation now is likely to produce low share prices again? There were all sorts of other economic problems in the 1970s, and the outlook was utterly grim. That’s not the case now.

With inflation rising, and interest rates still jammed at near-zero, negative real yields on cash and bonds mean that surely equities are the only game in town? Therefore I would imagine higher inflation, and maybe slightly higher interest rates, would make equities more attractive relative to other places to park your money which guarantee losses in real terms. Property being the only other attractive asset class that I can see (other than nonsense such as blockchain, which is just a classic speculative bubble).

Although there has been some evidence that very highly rated growth shares are losing momentum, possibly because the ratings don’t stack up when you factor in higher interest rates, who knows?

Anyway, I reserve the right to change my mind, as the facts change amp; develop, but this is just some pondering of where we might be at the moment. As always, we like the article to stimulate a debate in the comments section, so do please share your views too!

There’s a fascinating book called “When Money Dies” by Adam Fergusson, which chronicles the hyper-inflation of Germany’s Weimar Republic, which was one of the factors that laid the ground for Hitler amp; the Nazis (by wiping out peoples’s savings). I think a reader here suggested it. What’s interesting, is that money printing in earnest began in Germany (and neighbours such as Austria-Hungary) as early as 1913, and took c.10 years to finally destroy the currency through hyper-inflation. During that period, there was rampant speculation, and a massive stock market boom. Many people made fortunes, before the whole system finally collapsed, with a wheelbarrow full of bank notes needed just to buy a loaf of bread, famously. Obviously we’re nowhere near hyper-inflation, but it does renew my worries about the wisdom of doing so much QE. Too much money creation leads to too much money chasing the same amount of goods/services, hence inflation. That’s what’s happening right now, I would argue, albeit on a modest scale.

Wage inflation is clearly feeding in also, as workers demand higher wages, to compensate for higher prices in the shops, energy bills rising, etc. Employers are having to pay up, due to skills shortages, and the low overall rate of unemployment.

Vertu Motors (LON:VTU) (I hold) said last week that its wages bill would rise by £12m annualised. Unfortunately, I can’t find the total figure for annual wages cost, which is usually in the Annual Report, but Vertu only seems to publish abbreviated accounts on its website.

Companies having to pay higher wages is an obvious threat to profits, if they cannot pass on higher costs. So I’m trying to avoid companies with wafer-thin profit margins, in competitive sectors. Also long-term fixed price contracts could prove ruinous, when costs are rising.

Supply chain – US markets seem to have already shrugged off this worry, whereas as usual UK small cap investors have panic sold, leading to plunging prices. Mind you, prices and volumes here are much more volatile, and it doesn’t take many small sells to smash a UK small cap price – opportunities for the bold to take advantage of a mid-season sale!

It’s too early to be sure, but based on the companies I’ve been speaking to recently, and webinars (where the question of supply chains always comes up), it seems as if most companies are coping alright, albeit with some additional costs. E.g.

Sosandar (LON:SOS) (I hold) – recently said they’re seeing additional freight costs, but have recouped them from margin improvements from larger order sizes. Placed autumn orders earlier, so are fully stocked for peak period.

Quiz (LON:QUIZ) (I hold) – has seen some delays from China (40% of production), and higher freight cost. So they’ve placed orders earlier. Autumn/partywear is in for peak season, happy with stocking situation. Can air freight product in, but occasionwear not as fashion sensitive as for other retailers.

Boohoo (LON:BOO) (I hold) a key point from its recent webinar, CEO said “we hire a jumbo, about once a fortnight” to air freight in product from China, if delays at ports. Main problem amp; costs is cost of carriage to customers. Of the £26m extra freight cost in H1, £20m relates to additional costs in getting product to customers abroad, especially USA. Solution in sight, from Nov 2021, when transatlantic passenger aircraft resume. This will greatly increase capacity, and lower costs, of transatlantic air freight, which passenger planes carry with them. Longer term solution is opening a £1bn distribution centre in USA, in 2023. Problems in Europe, but they’re prioritising USA, as bigger potential.

Scs (LON:SCS) (I hold) – delays with supply from Far East. But 50% is made in the UK, and 10% in Europe. Main issue is delays from such strong demand, factories working at capacity. But it sounded as if SCS can handle these issues. Orders are delayed, but not lost, so will catch up at some point. Cash pile grows when orders are delayed. Cash should normalise at about £57m once order backlogs have been cleared (still more than half market cap! Ludicrous).

Gear4music Holdings (LON:G4M) (I hold) – Jack reported last week here on its H1 trading update. This reassured on trading, and also confirmed that inventories are fine (despite it sourcing much product from China). The share price has quickly rebounded, and recouped a lot of the pullback from people selling (presumably over supply chain issues). I reduced my position size, over misplaced worries about supply chain, just in case, on the basis that I can always buy them back.

Smiths News (LON:SNWS) (I hold) – its distribution network uses self-employed van drivers, so shortage of HGV drivers shouldn’t be having any impact.

Obviously I look closest at companies where I hold positions, and the above comments show that, so far anyway, supply chain worries seem to be overblown. Even where companies have suffered, it’s only temporary. At some point, supply chains globally will undoubtedly settle down again – they always do. Does it really matter that a company misses its forecasts for one year, due to external factors outside its control? I don’t think so, but I tend to think long-term.

Maybe we’re seeing a period where money is being transferred from the impatient, to the patient? Who knows, let’s see what happens. It’s all about sentiment in the short-term, but fundamentals in the long-term.

So far, companies I’ve looked at seem to be coping alright with their supply chains, or reporting some additional costs amp; disruption, but nothing too drastic. However, I bet we’ll see more profit warnings in the coming weeks amp; months. So maybe a good idea to keep sitting on a bit of cash, but also opportunities are now presenting themselves, with good companies having fallen too much, I reckon.

518p (pre market open) – mkt cap £244m

Final Results

Tristel plc (AIM: TSTL), the manufacturer of infection prevention products announces its unaudited preliminary results for the year ended 30 June 2021.

Tristel says it had a “disappointing year”, due to the impact the pandemic had on hospitals not doing as many procedures. The NHS also previously stocked up on Tristel products to safeguard against potential Brexit disruption, but is now working through its stockpile. The commentary sounds upbeat about more normal activity resuming.

Briefly, here are the key FY 06/2021 numbers -

Revenues £31.0m (down 2% on LY)

High gross margin, flat at 80% – giving strong operational gearing, so profits should rise strongly if revenue growth resumes.

Underlying PBT £5.4m (down 24% on LY) – still decent profits, even in a bad year.

Net cash of £8.1m

Very strong balance sheet, as usual with this company, which is conservatively financed, reassuring for shareholders.

FDA decision “before June 2023”

Outlook – sounds encouraging, but no figures provided -

We are pleased to report that during the first quarter patient examinations in most of our markets have increased from earlier in the year. Furthermore, the UK NHS has been using up the stock of Tristel products that it purchased in late 2020 to safeguard against a disorderly Brexit, and this supply overhang has nearly disappeared. For the first time in eighteen months, we look forward confidently to a resumption of our normal predictable pattern of business and a return to our growth trajectory.

Forecasts - many thanks to Finncap for publishing an update note this morning.

It says adj fully diluted EPS is 9.6p (down 19% on LY), so the PER is 54 times. That’s high, but understandable, given performance was impacted by the pandemic.

Finncap pencils in 10.3p, and 10.7p for FY 06/2022 and FY 06/2023. That’s nowhere near enough to sustain a share price of 518p, so shareholders in Tristel are clearly betting that the company is likely to beat these forecasts.

There’s also potential upside in future years if/when the FDA approves Tristel products, which has been on the cards for a long time now.

My opinion – this share still looks too expensive to interest me. Why pay up-front for a doubling of profits, necessary to make the PER look vaguely reasonable? You’d have to be super-confident that performance is likely to greatly improve, and be prepared to wait, for the fundamentals to catch up with the current share price.

For me personally, the valuation still looks far too high, despite a recent correction. It’s quite a nice little business though, selling small amounts of niche product in lots of markets, for high margins. The only question mark, is what are the shares worth?

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193p (up 7%, at 08:05) – mkt cap £226m

Trading Update

Supreme (AIM:SUP), a leading manufacturer, supplier, and brand owner of fast-moving consumer products, provides a trading update for the six months ended 30 September 2021.

This looks satisfactory -

The Board is pleased with the strong performance of the Group in the first half of the financial year and remains confident in achieving expectations for the full year.

Supply chain – this reassures, and it sounds like the group has everything under control. Also, note that Supreme’s products are small items, so I don’t suppose transport costs would amount to much as a proportion of total cost -

As manufacturing in Supreme’s key vaping and sports nutrition categories is in-house, the Group has been relatively unaffected by global supply chain issues affecting other areas of the economy. In addition, active management in the Group’s Batteries and Lighting divisions has also largely insulated Supreme from these issues.
Management remain cognisant of supply chain and labour constraints but are confident of being able to manage these risks in-line with the growth the Group is delivering.

Outlook – combined with the upbeat tone of the rest of the announcement, I think the following is hinting to us that we could be heading for a future upgrade, possibly? -

Overall, group margins have been particularly strong with significant year-on-year growth in profitability. Whilst it is too early to draw conclusions about the full year, the Board is pleased with the performance of the Group and looks ahead with confidence.

Diary date – 7 Dec 2021, for interims results to 30 Sept 2021.

My opinion – management came across very well in a webinar – this is an entrepreneurial business, seeking out profitable niches to supply to UK retailers, e.g. batteries, lighting, vaping, vitamins, etc.

With a positive update under our belts today, the valuation looks undemanding to me, so this gets a thumbs up from me as a decent value share, or GARP (growth at reasonable price) possibly, if the new product lines do well.

Note the low forward PER, and the decent dividend yield too. Quality scores are also impressive.

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3825p (down 3% at 10:17) – mkt cap £198m

Bioventix plc (BVXP), a UK company specialising in the development and commercial supply of high-affinity monoclonal antibodies for applications in clinical diagnostics, announces its audited results for the year ended 30 June 2021.

I wouldn’t normally cover something so specialised here, but know the story reasonably well, as I’ve followed the company for many years. It’s pretty much unique – having only about a dozen staff, and some very specialist niche products, which take years to develop. That gives it a big moat, and pricing power – hence the staggeringly high net profit margin – it typically makes about £7m profit on c.£10m revenues!

FY 06/2021 results, key numbers -

Revenues £10.93m (up 6%)

Profit before tax £8.12m (down 1%)

Profits amp; cashflows now mostly being paid out in divis: £7.7m paid in the year

Diluted EPS 128p – a PER of 29.9 – not outrageous, for the very high quality, high margin earnings. Although growth has been lacklustre in the last couple of years.

NAV: £11.8m, mostly receivables + cash, as it’s an asset light business model, relying on expertise, rather than equipment.

Reading through the narrative it’s becoming very obvious that I do not have any skills to analyse the business model or its prospects, that’s best left to sector experts.

My opinion – the investment case relies on properly understanding 2 key issues -

1. How sustainable are current products/profits?
2. How lucrative is the development pipeline likely to be?

I don’t have any idea on the answers to those questions, hence have no opinion on this share either.

As you can see, the share price has been going sideways for the last c.3 years. Maybe it needs some clear catalyst on growth, and new products, to trigger another wave upwards?

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Share price: 125p (+9.65%)

Shares in issue: 251,160,084

Market cap: £314m

(I hold)

CentralNic has been acquiring in recent years, consolidating in a fragmented market that it claims is $30bn in size. These acquisitions are increasingly taking the group into the rapidly growing world of marketing services (similar to Tremor International (LON:TRMR) ).

The group develops and manages software platforms which allow businesses globally to buy subscriptions to domain names for websites and email, monetise their websites, and acquire customers online. It focuses on acquiring cash-generative businesses in its industry with annuity revenue streams and exposure to growth markets. These new businesses are then integrated onto CentralNic’s software and operating platforms.

These recurring revenue and cash generation characteristics provide a solid base for reinvestment, organic growth, and further acquisitions. The management team is experienced and the group has some promising customers, including Fortune 500 ‘technology giants’, global brands, governments and SMBs.

Acquisitions have led to good revenue growth:

Shares in issue have increased nearly fourfold over six years however to finance these acquisitions. But earnings per share are forecast to jump this year as the dust settles. The shares in issue and earnings per share charts are below.

The share price has been strong recently but, if forecasts are anything to go by, there is still an opportunity at the present level to buy into that growth if it does appear sustainable (particularly relative to peers, many of whom are listed in the US). It’s riskier though, as it relies on future forecasts rather than proven historical financial performance.

Q3 trading update

CentralNic reports that, following its significant investment programme, organic growth has further accelerated during the nine months to 30 September 2021, up 29% year-on-year.

The company therefore expects revenue of at least $280m and adjusted EBITDA of at least $32m for the nine months ending 30 September 2021. This is an increase of at least 66% and 45% respectively over the $168.5m and $22.1m reported for the same period last year.

Cash rose from $28.7m at 31 December 2020 to $54m and net debt has reduced slightly from $85m to $79m, despite c.$13m being spent on the acquisitions of Safebrands and Wando and the final deferred consideration payment for Team Internet.

Adjusted operating cash conversion continues to be in excess of 100%.

Ben Crawford, CEO of CentralNic, said:

CentralNic’s growth rally has further accelerated during the third quarter of the year with year-to-date organic growth now reaching a record 29%. The Company expects to trade comfortably at or above the upper end of market expectations for the year for both revenue and adjusted EBITDA. We are particularly pleased that the accelerated growth is now also starting to translate into higher profits.

Analyst expectations of revenue and adjusted EBITDA for the financial year ending 31 Dec 2021 range between $348.6m – $355.3m and $41.1m – $42.0m respectively.

The more detailed interim report for the nine months will be published on 22 November 2021, accompanied by management presentations to analysts and private investors.

https://www.investormeetcompany.com/centralnic-group-plc/register-investor

Conclusion

This is just a short Q3 announcement but it does flag the company up as worthy of further research. It takes some time to unpack its markets and just how the recent spate of acquisitions (accompanied by an increase in shares in issue) affect its earnings per share prospects.

The improvement in organic growth (the 29% organic growth for 9M FY21, up from 20% organic growth in H1 2021 and 9% in 2020, is some trajectory) and the confident guidance does suggest that acquisitions have been well thought out, although this area is famously the most variable capital allocation method of driving sustainable shareholder returns. Some companies and management teams do get it right though.

This profit upgrade follows several revenue upgrades throughout the financial year.

There have been three acquisitions since June 2020 but it’s worth noting that it’s not all been about acquisitions – CentralNic has been investing heavily in its existing operations too. FY20 investment included the streamlining of group operations and IT infrastructure, increasing headcount, and streamlining the internal supply chain.

The group has recently been loss-making and the historic quality metrics are subsequently poor, but the profit profile is improving. So that could mean the opportunity here is being missed.

There’s still risk of course as things get integrated, and online marketing services is a rapidly evolving area where the risk of obsolescence is also real, but the current direction of travel is positive.

Interestingly for a tech / software stock, it qualifies for the Charles Kirkpatrick Bargain Screen, which focuses on positive share price momentum and the price to sales valuation multiple. Some of CentralNic’s web services and online marketing peers are on much racier multiples.

Share price: 190.2p (+0.11%)

Shares in issue: 100,105,660

Market cap: £190.5m

Mind Gym is a provider of human capital and business improvement solutions.

These solutions aim to deliver business improvement using scalable, proprietary products which are based on behavioural science. The group operates in three global markets: business transformation, human capital management and learning amp; development, and it says the addressable opportunity is some $100bn.

H1 trading update

Mind Gym bounces back ahead of pre-COVID levels

Revenue +76% to £24.1m and +7% up on two years ago at constant currency, in line with the board’s expectations. A total of 82% of revenues in the period were ‘digitally enabled’, with upcoming planned launches of a new digital product set.

Cash at bank was £11.9m. The group has recently entered into a £10m debt facility (£6m RCF, £4m accordion), which was undrawn as at 30 September 2021.

Octavius Black, Chief Executive Officer of Mind Gym, commented:

We are delighted to see strong growth in revenues in the first six months of the year, ahead of pre-COVID levels for the comparable period, driven by our digitally enabled capabilities with virtual delivery of our services providing clients with attractive workplace flexibility. We remain focused on our investments and new digital products and will update further at the time of our interim results in December.

Mind Gym will provide a further update with its interim results on 3 December 2021.

Conclusion

Another short update, albeit one confirming a recovery to pre-pandemic levels in terms of constant currency revenue.

The shares here are very illiquid, with a spread of around 526bps and a free float of around 32%. In reality, it’s probably smaller once you rule out the top 10 shareholders, who hold more than 90% of the shares.

This makes share price volatility more likely – you can see how the share price moves in the chart below.

That’s likely because the founders own more than half of the company (see Major Shareholders).

The group notes a $100bn identifiable market for its corporate behavioural science programs, which aim to make the workplace more productive and satisfying. The pandemic hit business hard and the group had to transition its workshops towards digital classes. It is forecast to break even this year but a return to pre-Covid profits is not expected by FY23.

When you compare that to the share price performance, it suggests that a degree of future recovery and growth is already priced in. Combine that with the lack of liquidity and it’s not hard to see a derating in the short term if the company disappoints. That’s not a view on the longer term prospects, but it’s a possibility in the near term given the slow forecast profit recovery and low share price liquidity.

But then again, Stockopedia flags up a 94 Quality Rank and revenues have risen fairly consistently over the years. So there must be some demand for its products.

I’m still unsure about that demand though. Are these programs seen by corporate customers as essential services, or just nice to have additions? That has implications for Mind Gym’s pricing and bargaining power.

There are some positives: high margins and good cash generation, a large and fragmented market. But I imagine demand for its services is cyclical – these types of programmes must be near the front of the line in terms of cost cutting – and the share price has recovered more than its profits have, so I don’t see much of an opportunity at the present valuation.

Stockopedia