Small Cap Value Report (Thu 7 Oct 2021) - POLX, RWA, RBG, SUR, SOS, PDG

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

Market comment (from Paul)

We’ve had a brutal correction in small caps especially in the last few weeks. Looking at the futures (FTSE 100 predicted to rise 81 points [as at 07:01]) then this could be a good day for putting some fresh cash to work, grabbing some bargains. The early bird catches the worm. Unfortunately, my longs have taken such a battering in the last week especially, that I don’t have any spare cash to deploy, having recycled all my French Connection (LON:FCCN) (I no longer hold) gains promptly into Scs (LON:SCS) (I hold), where I see excellent risk:reward (long term – I’ve no idea about short-term price).

I feel there have been some unreasonable price drops in good quality small caps, and can certainly see bargains around, for the first time in ages. Although plenty of other over-priced shares have rightly come down in price (and many still look overvalued to me).

I can understand why companies with supply chain risk would fall back a bit, but not to the extent that some have fallen (30%, even 40% can be seen in some cases). After all, supply chain disruption is a temporary factor, and probably isn’t going to affect earnings much, if at all, from 2023 onwards.

Although this does have the look of a panic sell-off, because I’ve noticed plenty of companies with little, or no supply chain exposure (e.g. services companies) also sell-off. Some people, especially relatively new investors, tend to panic sell when things fall, then try to buy back, thinking they can catch the bottom. I’ve found that doesn’t work well for me in the long run.

I’m not going to provide a list of bargain shares – this site is all about doing your own research (DYOR) remember, we’re not tipsters, and you already know which shares we rate highly (from a value/GARP standpoint), from our daily commentary.

EDIT: it also occurs to me that companies which put out positive trading updates now, which have seen indiscriminate share price declines, could be a good place to start, in terms of deploying cash, because there’s no uncertainty about current performance – which improves risk:reward (the most important investing concept). Whereas buying other companies, which have not yet provided a recent trading update, involves more guesswork about current trading. End of edit.

By all means post comments explaining what you’re buying amp; why, if you want to discuss particular shares. Or if you’re not buying yet, also we’d be interested in hearing why.

Agenda -

Paul’s Section:

Polarean Imaging (LON:POLX) (I hold) – a shattering disappointment last night for holders, with FDA approval denied. Price dropped c.60%. The company says it has enough cash to tide it over, and is addressing the issues amp; hoping to resubmit. Long delay likely. Terrible news, bad luck to fellow holders.

Revolution Bars (LON:RBG) – a superb trading update – LFL sales +17% since restrictions lifted on 19 July. With the high operational gearing, this has fed through to stunning free cash generation of £8.7m in just 3 months! The market seems to be asleep as to how good this is, and I think we have a lovely buying opportunity right now. Covid remains a risk though maybe. Now holding net cash, and with all problem sites disposed of, this business is now comprehensively fixed, but the market cap has yet to reflect that, in my opinion.

Sosandar (LON:SOS) – very strong revenue growth in H1, and on track to meet market expectations for the full year. I think a beat looks more likely. Still (modestly) loss-making, but profits now clearly on the cards for future years, assuming nothing serious goes wrong. Lots to like here, but how to value it? Under £100m strikes me as reasonable, given sector comparisons.

Pendragon (LON:PDG) – another car dealer reporting very strong profits, and an upgrade. Doesn’t seem quite as positive as yesterday’s updates from LOOK and MMH though. They’re all cheap, but riding an unsustainable profits boom. PDG confirms what we heard yesterday, that golden market conditions for profits (driven by supply shortages) are set to continue for the rest of 2021.

Jack’s section:

Robert Walters (LON:RWA) – continued strong trading from this recruiter, with Asia Pacific in particular doing well. The shares are approaching all time highs and recruiters are cyclical, but it’s hard to argue with the current momentum and it seems as though further EPS upgrades must follow.

Sureserve (LON:SUR) – positive update, with the order book up 30% year-on-year and a recent £140m contract extension suggesting buoyant conditions. The momentum on display suggests the share price could go higher, but the inherent business model risks must also be considered.

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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 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.

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Polarean Imaging (LON:POLX) (I hold)

43p (down 59% yesterday) – mkt cap £89m

Complete Response Letter received from FDA

Polarean Imaging plc (AIM: POLX), the medical‑imaging technology company, with an investigational drug‑device combination product using hyperpolarised xenon-129 gas to enhance magnetic resonance imaging (MRI) in pulmonary medicine…

Bad luck to fellow holders of this speculative share. The nightmare scenario unfolded yesterday afternoon – the widely expected approval by the USA’s Food amp; Drug Administration actually resulted in a rejection. The story with Polarean was that it was supposedly quite straightforward, using existing chemicals (something like that!), so FDA approval would be straightforward. that’s turned out to be wrong.

The FDA has -

… provided a list of issues to be addressed by the Company. These issues are mostly technical or manufacturing-related in nature and centre around the Xenon hyperpolariser system.

Polarean will work to address the issues identified by the FDA with a view to resubmitting the NDA and securing FDA approval as quickly as possible. Following resubmission of the NDA, it is expected that the FDA review period will take 2-6 months…

…the Company believes that the issues to address in the CRL are attainable…The Company will seek additional discussions with the FDA as a matter of urgency and further update the market when material information is received.

Liquidity - crucially, the company says it has enough cash to get through -

Polarean’s net cash balance of $38.2m as of 30 June 2021 allows the Company to fund operations comfortably through the anticipated Company response and FDA review periods.

My opinion – this type of share is completely out of my comfort zone and expertise, so I hardly ever invest in speculative, jam tomorrow situations.

In this case, I followed several friends in, so it was just a smallish punt (under 1% of my portfolio), which so far hasn’t worked. I take full responsibility for my research amp; buying decision, so it’s my fault that I made a loss, not my friends’.

Given that the company has cash to continue, and that it’s now a tiny position (under 0.5%!) I’ll just run with it, and see what happens. In terms of timescales, it sounds like we could be looking at a wait of maybe a year, at a guess? I’m not interested in averaging down on a losing position where the fundamentals have gone badly wrong.

All in all then, a big disappointment, which often happens with speculative shares. I’ll stick to my knitting in future I think, with profitable value/GARP shares instead! Lesson learned.

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Revolution Bars (LON:RBG) (I hold)

22.5p (pre market open) – mkt cap £52m

Trading Update

Revolution Bars Group plc (“the Group” or “the Company”), a leading operator of 67 premium bars, trading mainly under the Revolution and Revolucion de Cuba brands, is pleased to announce a Q1 update.

RBG has a FY 06/2022 year end.

We last heard from the company in a year-end trading update, which I reported on here (1 July 2021). Here’s my summary from 1 July 2021, to save time -

Revolution Bars (LON:RBG) (I hold) – a strong trading update. Since re-opening indoors, 86% of 2019 revenues achieved, on only 28% capacity. Guidance raised, and net debt largely eliminated by recent 20p placing. Good upside here in my view, providing covid restrictions don’t return. [SCVR, 1 July 2021]

Today’s update is the first since covid restrictions were removed, and the company previously told us that they expected to see strong pent-up demand, which is very much the case.

Here’s my summary of today’s update -

Restrictions removed in England from 19 July, 2 weeks into new financial year

Like-for-like (LFL) revenues up a barn-storming +17% against pre-covid 2019 comparatives (this figure is from 19 July, not including the first 2 weeks of still-restricted trading, until last week 2 Oct) – this proves that there is indeed strong pent-up demand – probably helped by a reduction in overseas holidays, and staycations?

Unrestricted English sites (56 out of 67 total) did even better, +21% LFL vs 2019

Refurbishment programme has recommenced – this is key because, with hindsight, it was the gradual deterioration in condition of sites which caused the previous problems (they had a 7-year refurb cycle, when it should have been 5-year. Previous management focused on opening new sites, instead of properly maintaining the existing ones)

Profitability -

This strong trading performance was well ahead of the Company’s expectations for this period, and costs have continued to be well controlled resulting in good profit generation from these sales.

Outlook – just a standard statement here – fair enough, if we’ve learned anything from the pandemic, it is surely that nobody knows what the future holds -

Whilst confident in the outlook for the business in the current trading environment, the Board remains cautious of the potential impact of an escalation of Covid-19 and any associated restrictions on the business in the upcoming key trading months, including Corporate Christmas parties…

… We are therefore confident in the Group’s outlook assuming that there are no further restrictions on our ability to trade.

Liquidity - this is very impressive -

The Group’s balance sheet remains strong, with net cash of £3.7m and £36.5m facility headroom as at 6 October 2021.

It doesn’t specifically say so, but the net debt figure quoted does not include lease liabilities (rightly so). Sorry, net cash. Yes, net cash! Last time the company reported, as of 30 June 2021, RBG had net debt of c.£5m.

Therefore, today’s number of net cash of £3.7m means that it has generated £8.7m of free cashflow in just 3 months! That’s an astonishing figure. It probably won’t include much working capital benefit either, because the bars were already trading (hence stocked up) at the start of the period. There could be other one-offs in that number, but I can’t think of any unusual receipts that were due. If anything, there would probably have been outflows, to catch up with any stretched creditors. Although the company had previously said that there were no rent arrears.

It’s fair to say that LFLs are likely to gradually settle at a reduced rate, +17% is probably not sustainable, but the prior year comps remain soft for about another year, so I’m anticipating very strong peak season trading at Xmas/NYE (assuming no lockdowns).

Diary date – 16 Nov 2021, for (now largely irrelevant) results for FY 06/2021.

My opinion – I think the market is asleep, and doesn’t seem to have realised what a fabulous update this is. I haven’t looked at all competitors, but off the top of my head cannot remember other bars groups achieving such strong LFL growth. I did look at J D Wetherspoon (LON:JDW) results over the weekend, a fascinating read actually, as Tim Martin gives a superb critique of corporate governance rules, and how they damage good businesses. He also writes convincingly about other issues, such as supermarkets undercutting on price, and the social damage this causes. JDW’s recent trading was not at all impressive, with LFL sales down -8.7% on 2019. RBG is up 17%, a huge outperformance against arguably market leading pubs group JDW. There again, RBG is not a pubs group, it focuses on late night bars, a hybrid of a bar/nightclub really, targeting mainly younger people.

Moving into net cash at this stage, shows the business is now generating shedloads of cash. This removes any lingering worries about solvency, and means the company can press on with refurbs, new site acquisitions (there must be plenty of good sites available on reasonable rents), even divis/buybacks.

The situation is completely transformed, and the market often takes a while to digest that, so I think we have a very good opportunity here, to buy at an extremely attractive multiple of likely cashflows. That’s assuming of course that covd restrictions don’t once again cause chaos – your individual view on that is the key factor here.

VAT is not mentioned in today’s update, but the reduced rate of VAT will have helped boost profits amp; cashflow. Although food amp; soft drinks are a small part of RBG’s business, and alcoholic drinks did not attract lower VAT. Therefore, the benefit is probably not material.

Based on today’s information, I see potentially 50-100% upside on this share price, based on a reasonable multiple of cashflows. That’s taking into account the awful dilution we’ve seen, with 2 emergency fundraises, both at a lamentable 20p. However, that doesn’t matter, if you filled your boots at 20p or less, as we make back the previous losses by holding many more shares now.

Hospitality generally is attracting a lot of interest at the moment, with Various Eateries (LON:VARE) managing to float at (to me) an inflated valuation in Sept 2020. Also, Nightcap (LON:NGHT) managed to float (again at an inflated price, in my view) in Jan 2021. Both have drifted down since, as the newness premium begins to wear off.

I much prefer the old/staleness discount for RBG, because I’m getting a radically improved business that is now generating massive cashflows, and has ditched all the problem sites with a CVA or consensual negotiations with landlords, raised 2 lots of cash so it’s now eliminated that bank debt completely, and is now in expansion mode again just at the right time.

This is a really good opportunity in my view, if you can focus on the future, not the past. I’m staggered that we can still buy at 23.5p at the time of writing. That seems the wrong price to me. 30-40p looks justified on the greatly improved fundamentals, in my opinion. I could be wrong of course, and have been before.

I’m completely ignoring broker forecasts, which seem way too pessimistic, given the stunning cash generation announced today.

NB. When viewing the 3 year chart below, remember that the share count has risen from 50m to 230m in two placings at 20p. Therefore previous highs are unattainable now. so it’s meaningless to draw lines on the chart, unless you do it from when the share count was most recently enlarged (June 2021).

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Sosandar (LON:SOS)

30.25p (up 20%, at 10:58) – mkt cap £67m

(For accuracy, I always recalculate the market cap manually, so the £67m above includes today’s 20% rise).

Several friends messaged me early, to say it’s a good update, confirmed by a 20% share price rise.

Readers have already covered the main points in the comments section below.

Looking back through our archive, Sosandar last reported on 20 July, which I reported on here, concluding that stellar Q1 (Apr-Jun) revenue growth of +256% looked like a game-changer, with Sosandar probably heading for breakeven or a small profit in FY 03/2022.

Half Year Trading Update

Sosandar, the online women’s fashion brand, is delighted to provide the following trading update covering the six-month period ended 30 September 2021.

A very strong first half with revenue up 184% year on year, continued improvement in EBITDA and a record start to autumn trading

Very strong revenue growth – bear in mind that growth had almost stalled a while back, so this is a dramatic turnaround -

Revenue of £12.2 million, a 184% increase against the same period in the prior year, and more than was generated in the entirety of FY21

Still loss-making though (no figures given, but it’s only 7 days after the H1 period end) -

Continued improvement in EBITDA loss

Gross margin – is up decently to 56.5% (H1 LY: 52.3%). That’s a very good margin for the modest size of the business. In my view this shows that SOS has pricing power from designing its own products amp; targeting an under-served market. The improvement is also because H1 LY saw margin pressure due to discounting when covid began, reducing the gross margin at the time.

Net cash - looks ample at £7.3m, benefiting from the fundraise in May 2021. Operational cash burn should now be a thing of the past.

Inventories are rising, as planned, which sucks in cash, to achieve higher sales particularly at third party websites, the key ones being Mamp;S, J.Lewis, and Next – “very strong” trading with them.

Current trading -

… in line with market expectations…

… Early autumn sales have been very strong as demand for ‘going out’ and work wear has increased.

(no footnote provided)

Customer returns rate – this is the bane of online fashion retail, with returns rates of 40-50% being the norm. During the pandemic, returns rates dropped across the sector, helping profitability – partly due to more loose-fitting casualwear sales replacing complex fit party/work dresses, and partly due to possible reluctance/difficulty of customers getting to post offices, etc.

Today Sosandar says this, which I think is positive -

Now that returns rates have normalised in line with buying behaviour, the diversified category mix has also proved to have a positive effect on returns rates which are at a lower level than pre-pandemic.

Supply chain - a smart move to bring in autumn/winter (A/W) stock early -

The Company took the decision to bring in stock early for autumn, anticipating early demand for partywear, coats, boots and knitwear. Sequins, Christmas jumpers and fur coats are already best sellers…

With all the widely publicised supply chain problems, I’m perplexed as to how Sosandar has sailed through without any disruption. I’ll have to ask them!

Sosandar has not experienced any material impact from supply chain disruption, maintaining a constant flow of stock to meet customer demand.The Company is well stocked for the autumn season across both its own site and third parties and has good visibility of incoming goods.

As the Company scales and increases its order quantities it has seen margin growth, which has offset the small degree of upwards pressure experienced on supply chain costs.

Sosandar remains mindful of the wider market disruption, is constantly reviewing the situation and will take mitigating actions as appropriate.

Diary date – early December, for H1 figures to 30 Sept.

Broker update – many thanks to Singers for an update note today, which leaves forecasts unchanged, which is: Revenues £24.4m (double H1, which seems unduly pessimistic given H2 is seasonally stronger), Adj loss before tax of £(1.5)m.

More modest growth is then forecast for the next 2 years, with a move into profit.

I think it’s too early to think about next year’s growth, as growth companies are so difficult to predict. I prefer to focus on what’s driving the growth, and is that likely to continue?

The biggest third party websites are key, and that area is clearly expanding rapidly, with more lines amp; deeper quantities of each, in the pipeline. Hence continuing growth looks a reasonable assumption, not wishful thinking.

My opinion – as mentioned here a few months ago, it’s now clear that Sosandar has passed the inflection point from being a cash-burning, jam tomorrow share, to becoming a viable business.

The major acceleration in growth rate this year is superb, and in contrast with the sector, which tended to have a very good 2020 (helped by lockdown), but suffering this year from much slower growth, and supply chain problems (cost amp; delays).

Sosandar seems to be doing the opposite – accelerated growth, and no material issues from supply chain. That is really impressive, in such a tough market.

The big problem – how to value it? I honestly don’t know. Comparing Sosandar (LON:SOS) (I hold) with In Style (LON:ITS) which has a similar market cap, I think SOS is a much better, more differentiated brand. ITS has also just warned on profits, and cited supply chain problems. Whereas SOS has just announced stellar growth, in line with expectations (small) loss, and no supply chain problems.

Another issue is the competitive threat from aggressive Chinese app Shein, and many other smaller me-too fashion eCommerce businesses. This is a direct threat to Boohoo (LON:BOO) (I hold) and all the other young, fast fashion chains (including ITS), but I really don’t see it being an issue for SOS, due to the older, more affluent demographic it serves, with differentiated product styles amp; fit.

SOS also does not have the heavy expense of paying (often huge sums) to “influencers” (think Love Island, reflective white teeth, plastered in makeup, botoxed lips, pouting a lot amp; flicking their hair around constantly) , which the fast fashion companies compete over. Whereas SOS’s influencers get the product free, but are not paid any fees at all (Lorraine Kelly is much more down to earth!). They wear SOS because they like the product. That’s a big bull point for the shares, in my view – free marketing.

Consequently, I remain an enthusiastic long-term holder of SOS shares, but don’t ask me to value it, as I haven’t got a clue. Oh go on then! Anything under £100m is reasonable in my view, so at £67m I see it as sensibly priced. If growth continues (which looks likely) then it’s the type of share I’d probably run to an over-valuation (i.e. continue holding, even if it looks expensive). It would be such a pity to sell up now that the business model has just been proven, and then watch from the sidelines as it goes parabolic (Sod’s Law!).

Something Julie Lavington (joint CEO) said in a Qamp;A on recent webinar stuck in my mind. She said that when they created Sosandar, the plan was to create something big. They’re not in this to build a small, niche business. Their ambition is to build something that could be as big as Asos (I hold) or Boohoo (I hold) long-term. That’s quite interesting I think. You also couldn’t wish to have more determined, and hard-working, passionate management. When I asked Julie about the risk of burn-out, she laughed and said, “We don’t see it as work, we love what we do”. That’s more than a slogan, it comes across very much in the webinars. So a big tick in the box for entrepreneurial, passionate management who have proven all the doubters wrong so far!

When I first got involved in SOS shares, it was a total punt. Now it’s a proper business at/around breakeven, growing very strongly. Hence risk:reward is dramatically better than it was a while ago. It’s interesting to note that not all jam tomorrow shares go disastrously wrong – SOS shares are double the IPO price now, despite them having to double the number of shares in issue. So 4 times the market cap at IPO.

Note how even the grumpy StockRank system (which hates jam tomorrow shares, rightly so!) has reflected SOS’s better prospects, with a now middle-ranking rating.

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Pendragon (LON:PDG)

18.5p (up 6%, at 12:44) – mkt cap £259m

I’m almost out of time, and have two company meetings online scheduled for this afternoon to prepare for amp; attend, so need to keep this brief.

Also, we already know from yesterday’s updates from Marshall Motor Holdings (LON:MMH) and Lookers (LON:LOOK) that car dealers are continuing to have a bonanza of profits at the moment, due to unprecedented increases in gross margins, more than offsetting lower volumes due to vehicle shortages. So I’m sure Pendragon will say something similar.

Trading Update

Pendragon PLC (the “Group”) today provides a trading update and increases underlying profit before tax guidance for the full year to 31 December 2021 from approximately £55.0m – £60.0m to approximately £70.0m.

Crystal clear guidance there, very helpful.

Same story as we heard yesterday from the competition -

Performance has remained strong during the third quarter, with the shortfalls in new vehicle supply mitigated by strong gross profit per units in both new and used cars, as well as cost and efficiency savings delivered under the Group’s strategy implementation.

Q3 order intake up on last year, but deliveries down

Key point of difference – some volume brands which PDG represents saw volumes down more than the 34.4% sector drop (SMMT figures also mentioned yesterday)

New car margins have mitigated (note – not offset, or more than offset) the volume shortfall.

Used car gross profit ahead of expectations “during September” (what about the rest of Q3?)

Used car prices (which have gone through the roof as we know) – it says this -

Whilst we also continue to expect a realignment of used vehicle margins over time, we expect these to remain strong for the remainder of this financial year, providing us with some mitigation to lower new vehicle volumes in particular.

Outlook/guidance -

Our strong year to date financial performance, together with these factors, means that we now expect Group underlying profit before tax for FY21 to be approximately £70.0m. The Board continues to believe the Group’s strategy positions it well to respond to the ongoing market uncertainty and to capitalise on any resultant opportunities.

My opinion – this is obviously a good update, but it doesn’t seem as strong as the updates yesterday from MMH and LOOK, both of which pointed to out-performance against SMMT new car sales, whereas PDG says it’s behind.

I’ve heard that the car manufacturers are prioritising higher value cars, given shortages of chips. Therefore seems to be a better time to be supplying premium brands, not mainstream ones maybe?

All the car dealers seem to be trading their socks off, so I think the shares look much of a muchness.

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Jack’s section Robert Walters (LON:RWA)

Share price: 758.92p (+3.68%)

Shares in issue: 76,556,670

Market cap: £581m

The Robert Walters Group is a specialist professional recruitment group with over 3,300 staff spanning 31 countries. It was established in 1985 and now recruits across a broad range of fields including finance, banking, IT, legal, and engineering fields.

The client base ranges from the world’s leading blue-chip corporates and financial services organisations through to SMEs and start-ups.

Business is good in recruitment right now due to widely reported labour shortages and a busier jobs market in general. Now the RWA share price is comfortably ahead of pre-Covid levels, a situation that may well be justified.

The forecast rolling PE ratio is 18.1x but the PEG is just 0.6x, suggesting further growth. We can see the broker upgrades began in April of this year, increasing steadily from 22p to 33p.

Q3 trading update

Highlights:

• Group net fee income +32% to £91.8m
• Asia Pacific +54% to £44.4m,
• Europe +22% to £22.7m,
• UK +17% to £18.7m,
• Other International -6% to £6m

Trading was strong across all major regions and profit for the full year is now expected to be comfortably ahead of guidance. I can’t actually find any concrete guidance in the half year report, but RWA has already increased guidance a couple of times. According to Stockopedia, it’s somewhere around £26m of profit before tax. That figure should now be comfortably beaten.

The Asia Pacific region performance was strong considering ongoing lockdown disruption, with Japan, Australia, and mainland China getting namechecked as particularly strong markets.

RWA continues to invest in headcount across all markets and disciplines (up 5% in the period to 3,376) and purchased 46,308 shares at an average price of £7.27 for £0.3m through the Group’s Employee Benefit Trust.

Balance sheet – this is just a Q3 update so no balance sheet is reported but RWA says it had net cash of £126.0m as at 30 September 2021 (30 September 2020: £138.9m), along with a £60.0m committed loan facility until 2024. Looking back at the most recent figures suggests there’s nothing to get too concerned about here.

Robert Walters, the CEO and founder, commented:

With candidate and client confidence accelerating across all recruitment disciplines and candidate shortages becoming ever more acute, the competition for talent is fierce. Significant wage inflation has emerged particularly for the most sought after skill-sets. In short, the jobs market is hot. I am pleased to report that the Group has once again benefited from operational gearing and that profit for the full year is expected to be comfortably ahead of current market expectations.

The group will publish a trading update for the fourth quarter ending 31 December 2021 on 11 January 2022.

Conclusion

The near term outlook continues to look promising for good recruiters, with labour shortages and increasing demand for workers potentially paving the way for higher wages, which should mean higher fees for the likes of RWA.

As with a few dynamics right now though, it’s important to consider for how long strong conditions might persist, and what might happen to the share price on a 2-3Y view if the same companies benefiting from strong tailwinds right now see a bit of a cooldown.

That’s something I continue to wonder about, given my exposure to Marshall Motor Holdings (LON:MMH) and Scs (LON:SCS) , both of which report strong demand and low earnings multiples, but which feel hard to value at present due to the complex macro situation. You can add the brokers and investment banks to that list as well, which have been reporting stellar results due to an increase in corporate activity. Which trends will prove transient, and which will persist?

But back to RWA, the StockRanks are very favourable here so that points to a number of positive financial data.

And the group’s exposure to Asia Pacific markets is clearly working in its favour at present as this is both the largest and fastest growing reported segment.

If you take a long term view, the shares are as high as they’ve ever been. These are cyclical companies, so it is worth bearing in mind that risk.

Ultimately though it’s hard to argue with the current momentum. Half year basic EPS was 20.9p compared to the FY consensus of 33p, so that looks very beatable and you’d have to think there are further upgrades in the pipeline. The current share price level is justified in my opinion.

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Sureserve (LON:SUR)

Share price: 79.7p (+13.97%)

Shares in issue: 161,213,788

Market cap: £128.5m

A new company to me. In these instances. I often open up the StockReport and head over to the Discuss tab to see everything the community has said about it.

On this occasion, it’s led to a bit of a detour into this excellent Market correction watchlist post from gringo made on the 5th of October, a great idea and I imagine the comments are well worth reading later on in the day.

Sureserve originally floated in 2015 as Lakehouse but it quickly ran into trouble and has more recently been in turnaround mode. The share price chart certainly suggests progress has been made. That recovery did occur in a generally rising market, however.

This is a compliance and energy services group that performs critical functions in homes, public and commercial buildings, with a focus on clients in the UK public sector and regulated markets. Services are delivered through two divisions: Compliance and Energy Services.

This type of contracting company is accident prone, and margins tend to be low, so it’s a risky part of the market. It is possible to grow though, and there are some good institutional investors on the shareholder register including Slater and Chelverton, so they’ve found something to like.

Coincidentally, the group is one of only three qualifying for the Jim Slater ZULU Principle Screen.

Trading update

Strong performance with full year expectations in line with management’s expectations

Sureserve reports ‘strong growth in revenue, earnings and cash flow’ in the year to 30 September 2021 and expects results to be in line with expectations. Net cash stands at £16m and the order book is up more than 30% year-on-year (2020: £356m)

The group’s services are non-discretionary, driven by mandatory inspections and accreditation requirements, so that gives some security of business, while other services here ‘form a critical part of the Government’s growing Green Agenda.’ This sounds similar to Kinovo (LON:KINO) .

Sureserve will publish its full year results on Tuesday 25 January 2022.

Chairman Nick Winks comments:

The Board is focussed on our medium- term strategic options and is progressing with its search for a Chief Executive Officer as a matter of priority. Our growth strategy remains, as previously announced, focused on expansion through a mix of organic growth and prudent, earnings enhancing acquisitions.

Conclusion

It’s a short update, but a positive one given the increasing order book. Sureserve also recently won a £140m contract extension for The Guinness Partnership. The long term nature of such agreements is attractive, and the fact that this is an extension with a known and reputable client could perhaps help Sureserve’s reputation in winning new business.

Its forecast PEG is just 0.6x so more growth is forecast to come. But it’s also a competitive sector where margins tend to be low and cash flows can be lumpy. These aren’t perfect businesses, but they can grow and money can be made. It just pays to be cognisant of the risks, too.

The balance sheet looks ok but not strong. There’s about £44m of goodwill and intangibles in its £113m of assets, with £43m of receivables and £9.7m of cash. Set against that is £44.3m of payables, which looks high. I think the current ratio could be stronger, to protect against shocks. Even with a market cap of £128.5m, it looks like it’s difficult to trade in size with a 286bps spread and an EMS of 3k suggesting less than £3k can be reliably bought or sold at quoted prices. So if there is a rush for the exit at some point, it could get nasty.

The valuation does appear compelling though, with the forecast PER of 9.1x. It looks like Sureserve is doing a good job in what can be a tricky sector, and the share price could do very well if it continues to win new business and extend contracts in a recovering market, but it’s not without risk.

Stockopedia

Source: https://www.stockopedia.com/content/small-cap-value-report-thu-7-oct-2021-polx-rwa-rbg-sur-sos-pdg-881434/