Small Cap Value Report (Thu 23 Sept 2021) - BEG, FNX, XLM, DFS, FCCN, VLG, EVE

Good morning, it’s Paul amp; Roland here today. Today’s report is now finished.

Agenda -

Paul’s Section:

Begbies Traynor (LON:BEG) (I hold) – AGM trading update says the company is confident about delivering market expectations for FY 04/2022. Acquisitions are going well. This share looks good value to me, and should benefit from the withdrawal of Govt support measures. Hence I’ll be buying any dips in the coming months, to add to my position.

Dfs Furniture (LON:DFS) – sparkling results for FY 06/2021. The balance sheet is still weak, but has improved a lot. Clear guidance given for the current year. Obviously supply chain problems are an issue for everyone, so a range of profit guidance is provided. Given the significant improvements, I’m happy to turn positive on this share.

French Connection (LON:FCCN) (I hold) – announces (without their consent) that a consortium of investors is mooting a cash bid at 30p/share. Let’s hope this smokes out a more generous bid.

Venture Life (LON:VLG) – a poor market reaction to interim results, with the shares down 14%. As mentioned in my last review of this company, it’s difficult to value now, because 2 material acquisitions are not yet bedded in. Let’s see what the numbers look like in future. For now, I’ll continue to steer clear.

Eve Sleep (LON:EVE) (I hold) – a quick look at its interim results. Outlook comments give me some hope. This is a special situation, value share, not a regular type of investment, so won’t interest most readers.

Roland’s Section:

Fonix Mobile (LON:FNX) – a strong set of figures from this mobile payments specialist, but I have some concerns about long-term growth and the risk that its technology could become redundant.

Xlmedia (LON:XLM) – the renewed management team is doing all the right things to turnaround this digital marketing business, in my view. But I remain concerned about the underlying durability and quality of its earnings.

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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.

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Begbies Traynor (LON:BEG)

132.6p (last night’s close) – mkt cap £202m

AGM Statement

Begbies Traynor Group plc (“the group”), the business recovery, financial advisory and property services consultancy, is today holding its Annual General Meeting…

The current financial year is FY 04/2022.

This is the most important bit, on current trading amp; outlook -

In the first quarter of the new financial year, commencing 1 May 2021, we have achieved double digit growth in revenue and profit reflecting the benefit of our recent acquisitions and the bounce back in activity from last year’s lockdowns. At this early stage of the financial year, we remain confident of delivering market expectations* for the full year.

* current range of analyst forecasts for adjusted PBT of £17.0m-£18.5m (as compiled by the group)

Note the shareholder-friendly footnote, many thanks for this.

Other points -

• Acquisitions doing well.
• Since May 2021, insolvencies have been rising, expected to continue as Govt support measures are phased out.
• Diary date – interim results due out in Dec 2021

Track record - an impressive track record is being built up, which I think has not yet been properly reflected in the rating given to BEG by the market. This is an impressive growth business, which has made a series of canny acquisitions. But it’s still being rated as a value share -

Over the last four financial years, we have delivered compound annual growth in adjusted earnings per share of 20%, including 10% organic growth. Over the same period, we have moved from net debt of £10.3m to net cash of £3.0m at the year end, whilst making value-enhancing acquisitions and delivering 8% compound growth in dividend per share.

Valuation – many thanks to Shore Capital for issuing an update note this morning. It’s pencilled in 8.5p EPS for FY 04/2022, which is consistent with the 8.86p EPS consensus forecast shown on the StockReport. I’ll push the boat out a bit, and say I reckon a more realistic figure is probably 9-10p EPS for this year, so that’s what I’m going to use for valuation.

With a share price of 132.6p before the market open today, that gives us a PER range of 13.3 to 14.7.

I think there’s scope for this share to re-rate to a PER of 15-20, which implies a share price target of 135-200p. Hence decent upside. Also that’s only based on this year’s earnings, and doesn’t factor in any future growth or more acquisitions, which would add further to this price target range, longer term.

EDIT: an update note has just come through from Equity Development, which forecasts 9.2p EPS, higher than Shore Capital’s 8.5p, and more in tune with my 9-10p range. End of edit.

My opinion - this share looks attractively valued to me. It’s a growth company, priced as a value share, which seems anomalous. Hence I see scope for a decent re-rating, if we’re patient.

The core insolvency practice business is very specialised, and high margin work (c.30% profit margin). So it’s strange to see a high quality business on a low rating. Maybe the market has not yet cottoned on to the fact that the business is growing well now? It did go through a bit of a flat patch a few years ago, and investor perceptions persist. Here are the SCVR, we’re eager to change our minds, once the figures/outlook change, that’s why we turned positive on this share in early 2021, when it became clear that stronger growth was coming through.

There are likely to be many companies requiring restructuring services, as furlough amp; business rates support are phased out.

Personally, I picked up some shares in early 2021. Based on revisiting the figures today, I’ll be buying some more when funds permit.

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Charity pledges

Just before I get on to looking at Dfs Furniture (LON:DFS) next, I wanted to share some wonderful news with you.

Renowned investor David Stredder (who also founded Mello Events) came up with a great charity fundraising idea a while ago, where investors set a price target for a share we like, and then pledge a charity donation (free to choose the charity, and the amount), if the share price target is hit. This makes charitable donations fun, and self-funding! More details are here.

The list of investor pledges to charities is here.

One pledge astonished me for its generosity, a £25k pledge to my favourite African humanitarian aid charity, ZANE, from an investor who wishes to remain anonymous, using the psedonym Investore1. I did wonder if it was pie in the sky, but the wonderful news is that Investore1′s chosen share, Polarean Imaging (LON:POLX) (I hold) smashed through its price target yesterday, and the £25k has been received by ZANE, with thanks.

Even better, investore1 has pledged another £25k to ZANE, if Electra Private Equity (LON:ELTA) (I hold) gets to 700p by the end of 2021.

It’s a fun thing, and I’ll give some thought to putting in some more pledges myself soon. I can’t get anywhere near to investore1′s level of generosity, but every pound counts, so size doesn’t matter. Thanks again to investore1 – that donation will literally save amp; greatly improve many lives out in Zimbabwe.

Right, back to shares…

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Dfs Furniture (LON:DFS)

266p (down lt;1% at 08:45) – mkt cap £689m

Preliminary Results

DFS Furniture plc (the “Group”), the market leading retailer of living room and upholstered furniture in the United Kingdom, today announces its preliminary results for the 52 weeks ended 27 June 2021 (prior year comparative period is the 52 weeks ended 28 June 2020, non Covid-19 disrupted comparative period is the unaudited pro-forma 52 weeks to 30 June 2019(2)).

MARKET OUTPERFORMANCE DRIVEN BY OUR SCALE AND INTEGRATED RETAIL MODEL,

CREATING A SUSTAINABLE BASE FOR FURTHER GROWTH

The highlights table is very good – giving 3 years, so we can see the changes both from last year, and from pre-pandemic trading. Very clear, and informative – all companies should be reporting like this.

The numbers look fantastic, and profit/EPS seems to be way ahead of the consensus forecasts shown on the StockReport -

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Also note how the % of sales done through the internet has almost doubled to 35.3% – which calls into question the uniqueness of Made.com (LON:MADE) and its premium price. If DFS is achieving similar sales online, and rapid growth, then maybe we should be piling into DFS, instead of paying a premium for MADE (which doesn’t make much profit yet)?

Adjustments to profit are small this year, so I’m happy to rely on the adjusted numbers.

High order bank – that will be recognised in H1 of the new year, FY 06/2022.

Strong consumer demand continues to be experienced over the first 12 weeks of FY22 with the current order bank at a record high, providing further resilience.

Supply constraints – the well-publicised problem area for all companies that move physical goods around -

Current trading

As detailed in our year end trading statement, strong customer demand in the final quarter of FY21 was already expected to underpin revenues and profits in the first half of FY22. Order intake has also remained strong in the current financial year to date, well ahead of our previous scenario of +7% growth on FY19, resulting in an order bank that continues to grow and which in absolute terms is very significantly ahead of normal levels.

This order intake provides significant resilience, and confidence in our outlook. However the constraining factor on our reported short-term financial performance will be our pace of conversion of the order bank, which depends on both our supplier partner manufacturing capacity and also the capacity of our proprietary logistics operations.

We believe the Group is well placed to achieve the medium scenario of our range of FY22 profit outcomes identified back in June.

We already have increased output capacity significantly in FY21. We continue to strengthen our operations, increasing warehouse capacity and resourcing levels, to meet customer demand. Notwithstanding this, it should be recognised that the short-term operational environment continues to be exceptionally uncertain and difficult, given well-reported logistics disruption, cost inflation pressures and unplanned Covid absences.

We believe that we have the right plans in place to mitigate these impacts, underpinned by our scale, operating experience and long-standing relationships, and we are focused on delivering good customer service, protecting our colleagues and creating long-term value.

Balance sheet – is still weak, but getting less bad.

NAV: £284.5m. Intangible assets are £535.4, which gives us a very weak NTAV of negative £(250.9)m.

However, I would improve that by stripping out the IFRS 16 lease numbers, which are not of any importance at such a profitable company. That removes £345.1m right of use assets, and liabilities of £88.1m, and £366.0m. That means we can add back £109m onto the balance sheet (since IFRS 16 liabilities exceed assets by that amount), which reduces the deficit of NTAV to £(141.9)m. For the first time, I now see this improved situation as being tolerable. It’s far from good, but the big profits of FY 06/2021 have gone some way to repairing the balance sheet.

Also, we have to take into account that furniture retail has a lovely reverse working capital structure – customers pay up-front, so DFS benefits from sitting on the customer cash before the product has even been made. Then after a time lag (as most things are made to order), DFS is paid in full, and pays the supplier some time later.

As we’ve seen, even during lockdowns, there are enough orders in the pipeline to continue deliveries to customers. Then when lockdowns end, pent-up demand causes a surge of new orders. Along the way, more sales have been moving online too.

What’s even more remarkable, is that a combination of factors have combined to almost eliminate the previously heavy interest-bearing bank borrowings.

This is a very much improved position.

Guidance – wonderful clarity is provided, as usual – this low, medium, high range of guidance is absolutely spot-on, and really should be standard practice for all companies. It helps investors, but it also tells us that the company is in control of its business, and finances, thus giving me confidence.

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My opinion – this is very encouraging. For the first time, I would consider investing in DFS, because the risks have now reduced to a level that is acceptable to my (admittedly quite strict) criteria.

Supply chain issues are only temporary, so long-term investors shouldn’t really be worrying too much about such short-term, fixable issues.

Remember also that furniture retailers actually benefit from supply chain delays – more delays and a longer order book, means more cash in the bank. When supply chains ease, and order backlogs reduce to normal, then the cash pile would reduce, or rather net debt would increase.

My sector favourite remains Scs (LON:SCS) and these strong figures from a larger competitor augur well.

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French Connection (LON:FCCN)

26.5p (up c.15%, at 11:24) – mkt cap £25m

Statement re Share Price Movement

A possible bid approach has been received at 30p cash -

… it has received an approach from a consortium of bidders including the Company’s second largest shareholder Apinder Singh Ghura, Amarjit Singh Grewal and KJR Brothers Limited (the “Consortium”) as a potential offeror for French Connection Group Plc, which may or may not result in an offer for the Company. The indicated offer price is 30 pence per share in cash.

Discussions with the Consortium remain ongoing…

This announcement has been made without the consent of the Consortium.

My opinion – I’d be surprised if the founder is willing to sell up for only 30p.

However, the fact that the company has put out this announcement, without the consent of the consortium, and is continuing to discuss it with them, does suggest we might be nearing the end game maybe?

FCCN probably wants to smoke out other potential buyers.

I remain of the view that the brand is well-known internationally, generates significant profits from wholesale amp; licensing, hence is clearly a valuable brand. That’s been obscured by the retailing division losses, as we’ve discussed here many, many times over the years!

I’ve still got just over 1% of the company, so will sit tight and see what happens. Personally I’d be happy to accept any offer of 50p+. Stephen Marks, the founder, will be making the decision, as he has a near-controlling stake.

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Shorter sections now, to rattle through a few more companies.

Venture Life (LON:VLG)

Down 14% to 56p – mkt cap £71m

I’ve just re-read my notes here on VLG’s profit warning on 13 August 2021.

Skimming through its interim results out today (which the market clearly doesn’t like, with the shares down 14% today), and there’s not a lot more to add.

H1 adjusted profits halved to £1.3m. Last year benefited from one-off sales of hand sanitiser. H1 statutory profit is about breakeven.

The cash pile has mostly been spent on 2 acquisitions, as planned.

Balance sheet looks OK overall, although I think the £50m bank facility for acquisitions looks excessive amp; risky.

Personally I would attribute little value to the existing businesses, with the main value probably coming from recent acquisitions, which will materially increase the size of the group’s revenues amp; profits.

My opinion - I don’t want to guess what profits the recently acquired businesses might achieve, that just seems a risky approach to investing. For me, the less guesswork, the better. Hence why I’m happy to sit on the sidelines, and watch. I’ll be happy to review the numbers next year, once the acquired companies are bedded in.

For now though, I’ll neutral/avoid this share, because I don’t know how to accurately value it.

It’s interesting to see from the chart below that, like many other companies which had a speculative boost from the pandemic, a lot of that froth has since blown away.

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Eve Sleep (LON:EVE) (I hold)

3.8p (up about 5% at 12:58) – mkt cap c.£10m

eve Sleep, the direct-to-consumer sleep wellness brand operating in the UK, Ireland (together the “UKamp;I”) and France, today issues its results for the six months ended 30 June 2021 (the “Period”).

I’d describe this as a special situation – where the original high growth business model hasn’t worked, but there’s plenty of cash left, and still a potentially viable business.

Somebody might buy it, given the low valuation, even if it’s just to take out a competitor.

So I’d be happy with a potential exit at say double the current price, but don’t have any expectations beyond that.

H1 numbers look poor at first sight -

Revenues up 13% to £13.9m – not too shabby this bit

Loss before tax of £2.3m

Cash pile sharply down from £8.4m to £5.2m in the last 6 months – this is a worry, as the cash pile was my main comfort (weighted!) blanket. It’s still about half the market cap, but will it be burned through in continuing marketing spend?

The commentary reassures me on the main issue, cash burn -

The company remains on-course to deliver the Board’s previous full year expectations, with the strength of the UKamp;I trading expected to offset any variability in the French market. Marketing investment which was up £1.4m year-on-year in the first half, was front loaded, and is expected to be broadly flat in H2. The cash outflow in the first half of the year exceeded the operating performance by some £1.2m reflecting £0.9m for the timing of payments to HMRC and higher stock levels, as well as £0.3m for additional working capital movements.

Net cash at the end of August increased to £5.9m, from £5.2m at 30 June, with the cash outflow over the remaining four months of the year expected to be minimal.

Supply chain has “held up well”

There are some positive elements in the current trading section -

Trading in the UKamp;I in July and August has been above the Board’s expectations, driven by ongoing strength in eve’s ecommerce channel. While the comparatives in the prior year were very strong, eve’s UKamp;I sales in July and August increased 46% on 2019 pre-Covid equivalents. The new sleep away range has been a standout performer, and has surpassed all expectations with its early sales, though demand has also been strong for the rejuvenated bedding range and the premium ‘spindle’ bedframe.

My opinion - it’s obviously a fairly low quality business, so not something I would normally touch. However, for me this is a potentially interesting value special situation, with half the market cap in cash, and some signs of life with current trading, and new products.

At £10m market cap, I think there might possibly be a value situation here? It’s not a high conviction one though so I’ve only sized my position quite small (under 1% of my portfolio).

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Roland’s Section Fonix Mobile (LON:FNX)

Share price: 150p (pre-open)

Shares in issue: 100m

Market cap: £150m

Final results

This mobile payments and messaging stock floated in October 2020. The company’s core business is allowing consumers to make payments that are charged to their mobile bill through carrier billing or SMS billing. The main client sectors are media, charity and gaming.

Despite my general caution about recent IPOs, Fonix appears to be highly profitable and growing fast. Checking back through the archives, Fonix’s half-year results were covered here by Jack in February. They showed a fairly solid picture – let’s see how things have changed in the six months since then.

“Strong earnings growth and momentum”

Today’s full-year results cover the 12 months to 30 June. They show continued growth in client numbers, revenue and profits.

• Total Payment Volume (TPV) +10.3% to £233.4m
• Revenue +19% to £47.7m
• Adjusted pre-tax profit +14.6% to £8.3m
• Adjusted EPS +14.7% to 7.0p
• Final dividend: 3.53p
• Unrestricted cash balance +158% to £5.0m

The company says that all three of its business segments have performed in line with expectations since Fonix’s IPO in October 2020. Today’s results are indeed very close to the consensus figures shown by Stockopedia.

Profitability remains strong. My sums indicate:

• Operating margin: 16%
• Return on capital employed: 134%

These are slightly below last year’s figures, but I suspect that reflects costs and changes connected with Fonix’s IPO. In my view, Fonix still boasts very attractive levels of profitability.

The company’s operational metrics also show progress.

• 34 new customer contracts signed, increasing customer count by 13% to 111
• 18m unique mobile users made 628m interactions with Fonix’s services
• Record £32m payment volume processed in a single month
• 50% increase in number of charity clients
• 100% client retention, with over 99% of income of a repeating nature

Customer numbers: Growth in new customers and 100% client retention sounds impressive. But the numbers don’t quite add up for me.

Today’s results show that 34 new contracted customers were added last year, lifting the number of active customers by 13% to 111 last year. The comparable number of active customers at the end of FY20 is given as 98.

Fonix defines an active customer as one that has generated at least £500 of gross profit over the last 12 months. So today’s active customer numbers appear to imply that 21 customers have become inactive (given that the company reports 100% client retention).

In fairness, I’d guess that some inactive customers may be new customers who have signed up, but not yet activated their services. But I suspect that there may also be some previously active customers who have become inactive.

If a customer has not generated £500 of gross profit in 12 months, I think we might question how valuable their business is to Fonix.

Outlook: Fonix reports a

“positive start to FY22, with trading in line with the Board’s expectations”.

The company says it is building the foundations for international growth and has won its first international payments contract. Management says that a number of existing multinational clients are looking to expand Fonix’s services overseas. International markets are expected to provide “a meaningful contribution to growth” in the years ahead.

By leveraging existing customer relationships and technology, Fonix expects to incur minimal costs and benefit from a high degree of operating leverage as it expands.

House broker FinnCap has left its FY22 forecasts unchanged today, so for now I think we can rely on the consensus figures in Stockopedia. These show earnings growth of 10% this year, putting Fonix on around 20 times forecast earnings, with a 3.5% dividend yield. That doesn’t seem unreasonable to me for a growing, profitable business.

My view: Fonix has an impressive roster of clients, including ITV (I hold), Bauer Media and Children in Need. My feeling is that the key attraction for clients is that Fonix’s services facilitate impulse/emotional transactions by making them seamless and removing the upfront payment process. This isn’t true with other payment methodologies.

The key question for me is whether this service is a stopgap that will eventually be made redundant by (future) payment functionality in Apple Pay and Google Pay. I’m not an expert in this area, and it may be that Fonix offers additional functionality that’s not available elsewhere.

Another potential attraction is that Fonix’s solution is guaranteed and universal – it does not depend on whether users have configured card payments through their phone.

On balance, I’m impressed with Fonix’s continued growth and profitability. I think the shares could be attractively valued at current levels. But I do have some reservations about the longevity of its technology. I’d also like to know more about customer activity levels.

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Xlmedia (LON:XLM)

Share price: 49.9p (-6% at 09:00)

Shares in issue: 262.6m

Market cap: £128m

Half-year results amp; Acquisition of BlueClaw Media

This Israeli digital marketing company has made and lost fortunes for shareholders since it joined the AIM market in 2014. This business makes money by publishing informational websites which generate new customer sign ups for casino, sports betting and personal finance businesses.

When I last looked at XLMedia in May, I took a cautious stance and explained my reservations about this business model.

Today’s half-year results have again received a cautious reception from the market, sending the stock down 5%.

Financial highlights

The headline figures for the six months to 30 June look strong, but profitability is suppressed due to “transformational activities”. In other words, this is a turnaround situation.

• Revenue +16% to $32.2m
• Adjusted EBITDA +29% to $6.6m
• Transformation costs of $1.0m (H1 2020: $1.5m)
• Reported pre-tax loss of $0.4m
• Cash and short-term investments of $36.9m (31/12/20: $13.9m)

Divisional results show progress with diversification, but the vast majority of revenue still comes from gambling of one kind or another:

• Sports: $11.7m revenue, split roughly equally between EU and US markets
• Casino: $12.5m revenue
• Personal finance: $6.6m revenue- this US-focused business is being built around the Money Under 30 site, which XLMedia acquired in 2017. MU30 Founder David Weliver is leading the business and editorial activities.

Transformation programme

XLMedia’s transformation programme is focused on building portfolios of fewer, higher quality websites. The company aims to cut its portfolio from more than 3,000 websites to “fewer than 100”.

More emphasis is being placed on quality content and site structure. In my view, XLMedia is now focused on building genuine editorial-led websites, rather than thinly-disguised advertorial. I would say this is an essential – and overdue – change.

However, costs seem to be high. Today’s report shows just $1m of transformational expenses, but the cash flow statement shows $11.9m of spending on websites, domains and software. This follows on from $12.8m of such spending last year.

Acquisition: XLMedia has acquired Leeds-based SEO agency BlueClaw Media for up to £1.8m. BlueClaw has been working for XLMedia over the last eight months, so presumably this deal is designed to bring a valued service provider in house.

Outlook

The outlook for the full year is unchanged, with revenue guidance of $65-$70m. However, costs are expected to be higher this year than previously guided, as the company accelerates its pace of change.

House broker Cenkos is forecasting adjusted earnings of 3.3 cents per share in 2021, rising to 6.6 cents per share in 2022. These are slightly ahead of the consensus figures shown in Stockopedia.

My view

I think XLMedia CEO Stuart Simms is doing all the right things to improve this business. He may succeed in creating good quality editorial brands, which generate reliable web traffic and thus sustainable revenues.

This, for example, is the model that’s being successfully pursued by £FUTR.

However, I’m not enthusiastic about a business that relies so heavily on gambling, through its sports and casino operations. To me, these are sectors that will always attract aggressive competition and be at risk of harsh regulation.

XLMedia’s turnaround may deliver, but there are too many risks and moving parts here for my liking. This isn’t a stock I’d be interested in buying.

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Stockopedia

Source: https://www.stockopedia.com/content/small-cap-value-report-thu-23-sept-2021-beg-fnx-xlm-dfs-fccn-vlg-eve-872265/