Small Cap Value Report (Wed 27 Oct 2021) - preamble on markets, WIX, ACSO, BMY, OTB, RPS

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

Agenda:

Paul’s Section -

Preamble on the markets generally – just some random thoughts that I woke up thinking about, that I thought would make an interesting discussion starter.

Accesso Technology (LON:ACSO) – a positive-sounding update, albeit very confusingly worded in places. Bulls in the share will probably be encouraged by talk of strong trading (undefined), and improved margins. I look forward to reviewing the FY 12/2021 numbers in due course, when we’ll see the full picture. Personally, I’ve never been convinced by this share – it hasn’t grown much in the last 5-6 years, and has not produced reliable profits or cashflows. So it doesn’t seem to be a value or GARP share at the moment.

On The Beach (LON:OTB) – this beach holidays company has only just resumed trading. The valuation is about 20 times peak pre-covid earnings. So where’s the upside for me, if I pay up in full. now, for a recovery that has only just started? There could be a couple of years bonanza trading from pent-up demand though.

Rps (LON:RPS) – a solid Q3 update, in line with expectations. Looks a decent company, probably priced about right.

Jack’s section -

Wickes (LON:WIX) – recent listing that has been reporting positive updates on the back of increasing demand for home renovation. Today’s Q3 is slightly less good, but total revenue is still up by 16.3% over two years and the company reiterates it is on track to meet the upper end of analyst expectations. The valuation appears modest.

Bloomsbury Publishing (LON:BMY) – confirms it is on course to meet FY expectations but I wonder if another ‘trading ahead’ might be in store. That depends on how much business has been pulled forward from customers stockpiling ahead of Christmas. Trades on a fairly high PER, but its IP is top class and digital is growing strongly, so still worth considering.

Preamble from Paul

Whilst the UK small caps market seems bearish about temporary supply chain issues, and inflation, the US markets continue to romp ahead to record highs, seemingly ignoring any worries about the future. It’s a strange mismatch of investor sentiment. They can’t both be right.

I’m still digesting the ugly profit warning from Ig Design (LON:IGR) yesterday. How can we spot similar situations in advance? The key factor seemed to be;

IGR is a low margin business – the operating profit margin, even after a ton of adjustments, was only about 4%, or 2% before adjustments – that’s dangerously low when costs are rising suddenly.

Inability to pass on price rises to customers. How on earth do we predict this for other companies? It’s not a factor that is typically included in financial reports. I suppose retailers have an advantage, as they set their own selling prices. Whereas manufacturer/distributors have contracts with customers, who will obviously try to resist price rises. All we can do is to quiz management of every company about this issue, in webinars they do, during the Qamp;A.

With my own portfolio, I’ve already gone through every position, and tried to work out supply chain risk. Most have fallen a lot already, so I’m happy that downside is already in the price. If a profit warning comes out, so be it, I can live with a say 10-20% drop, if the price is likely to recover next year. Shares go up amp; down, and if you can’t cope with short term losses, then you’re in the wrong game.

I’ve also avoided low margin businesses with obvious cost pressures, so I sold all my supermarket shares a while ago, when the rise in NI was announced. On top of rising input prices across the board (e.g. product, wages, energy), a significant hike in both employers and employees NICs is yet another headwind for these low margin businesses which already face cut-throat competition from Aldi amp; Lidl. Hence it’s just not a sector that looks attractive to me at all.

A commentator on CNBC last night made a really good point about eCommerce. He reckons that supply shortages could be widespread, as peak Christmas season buying combines with a bit of early/panic buying, and supply holdups (e.g. Los Angeles port is apparently chock-a-block). Hence if the shops start running out of some products, which seems likely in the UK and other counties, then eCommerce businesses could well be the beneficiaries, seeing stronger demand and being able to raise prices. Who knows?

If things are in short supply, then sellers can raise prices in some cases. I’m still mesmerised by the huge profits being made by car dealers on secondhand cars at the moment. Why are customers bidding up prices so high? (reports are saying some prices are up 10-20%). That’s both a problem with supply shortages, but it’s also a clear sign of excessive demand, due to money printing amp; the Govt’s covid support measures arguably over-stimulating the economy – i.e. people can afford to, and are willing to pay much higher prices for used cars.

So this looks like a combination of demand pull (too much money sloshing around) and cost push (shortages, and rising cost inflation) happening at the same time. Nobody really knows of course, experts and interested amateurs (like me) usually get predictions wrong, because economics is not a precise science, and predictions from everyone are usually laughably wrong after the event, apart from a lucky few who happened to guess correctly.

So if you’re looking for some predictive pearls of wisdom from me, forget it! Overall, I suppose I’m currently (subject to change) seeing things like this (and it’s only one person’s opinion remember) -

• Inflation looks like it’s going to be a much bigger problem – anecdotally I’m hearing of big price rises in the pipeline for goods. The full impact hasn’t hit consumer prices very much at all yet, due to the delays caused by forward purchasing. So the next wave of goods hitting shops in early 2022 could cost a lot more.
• Skills shortages with labour are also clearly pushing up wages (a good thing in my view, but not good for corporate profits).
• Logistics problems widely reported, but nobody seems to know when they’ll get sorted out – but they will get sorted out, timing is the only question. So this could help inflation moderate, at some point next year maybe?
• Pricing power is everything at the moment, so I’m only happy holding shares in companies that make decent profit margins, and can pass on price rises to customers (the absolutely key question to ask in webinar Qamp;A sessions).
• Or avoiding companies which shift physical goods at all – maybe it’s better to focus investments into services companies?
• Share prices in UK small caps have fallen a lot already, and some that have reported stable supply chains, and are managing the problems well, are rebounding in price. Most of my companies have reported already and it’s generally been OK.
• It’s probably too late to sell in many cases. If it’s a fundamentally sound business at a reasonable price, then I’m happy to sit tight and wait for recovery in 2022 (or maybe earlier).

Everyone will be doing things differently of course, each of us has to make our own decisions. But there are lots of opportunities out there at the moment, as well as threats. Plenty of good companies have been punished with nasty moves down (often from unrealistically high starting points, as the everything rally got out of hand in the spring/summer I think). So, for the brave, there are opportunities for sure. I think the trick is to remove the uncertainty, by buying companies which have already reported on supply chain/inflation, and not seen particularly bad problems.

I think this is a time when good management shine, and take these problems in their stride. Poor management amp; business models are brutally exposed in circumstances like these, and certainly there have been some surprises (so far), with probably more to come.

915p (up 8%, at 08:41) – mkt cap £379m

Trading Update

accesso Technology Group plc (AIM: ACSO), the premier technology solutions provider to leisure, entertainment and cultural markets, today gives the following update on trading…

The current year is FY 12/2021, so at this stage the company should have a good idea what full year performance is likely to be.

Accesso mainly provides digital queuing amp; ticketing systems for theme parks, with other bells amp; whistles. It’s obviously a recovery share, with theme parks re-opening.

Whether it’s any good, even once its business is operating normally again, is the main question. I’ve never seen any convincing evidence to date of a decent, or cash generative business here, and nobody wanted to buy it when it was put up for sale a few years ago.

However, let’s look at it today with fresh eyes, as things may have improved.

Summarising its update today -

“continued strong performance through September and into the October trading period. “ – great, but what is strong performance? It’s not defined.

“High demand in end markets” - and “increasing use of its revenue-generating technology” by customers. Again a bit vague.

Revenue guidance for FY 12/2021 is gt;$124m – that’s a nice uplift on H1’s $50.7m, so $73.3m in H2, with theme parks re-opening more. I don’t know what the breakeven revenue level is, so it’s difficult to put this in context. Seasonality with this share does I believe have a heavy bias to H2 anyway, so maybe the uplift from H1 to H2 is not so great?

“profitability continues to improve as the growth in its higher-margin products outpaces those products with lower margins.” – sounds good, how about some figures?!

Costs - this is confusingly worded. To me, the word “impact” means something bad, i.e. lower profits. But Accesso seems to be using it the other way around here, i.e. a sort term benefit form reduced costs –

“… It also continues to see an impact from a lag in its return to normal cost levels while it deploys additional resources to calibrate for the increased demand. As previously signaled, these investments will have a limited impact on Cash EBITDA in 2021, while their full annualised effect will be felt in the 2022 financial year.

Actually, that’s so badly worded, it’s getting close to being gobbledygook. Can I suggest the RNS writers at ACSO and its advisers submit to some retraining in how to explain things in plain English?

The last bit above seems a convoluted way of telling us that costs are going to rise next year, which is what the company said previously (from memory).

Cash EBITDA – is not defined in today’s announcement, and we know from its history that Accesso has been extremely aggressive in capitalising development spend. Nothing necessarily wrong in that, development spend is a genuine investment. However it renders EBITDA meaningless, and often grotesquely inflated at software companies, since often a large part of the payroll is entirely ignored, and is in reality a normal running cost of the business, usually.

… Due to these dynamics the Group now expects its Cash EBITDA margin for the full year 2021 to exceed 20%.

My opinion - if you already like this share, then I would imagine you view today’s update positively.

Personally, I don’t like this share, because it’s not really a growth company (see graphs below), and has never established a decent level of sustainable profits or cashflows, like say some other software companies, e.g. Dotdigital (LON:DOTD)

The story feels quite stale now with jam tomorrow never really being delivered, well not of Bonne Mamon quality anyway!

That said, it’s a tech business, and we’re in a tech boom, so anything could happen to the share price. Punters bid up the market cap of this one to c.£1bn in the past, so who knows we could see a repeat of that? Market sentiment is anyone’s guess, and seems completely irrational in some areas at the moment.

From the perspective of a value/GARP investor though, this share has little to no appeal to me. Of course that doesn’t mean a thing, because we’re in a bull market, and different types of investors buy into this type of share, often impervious to real world economics amp; valuations it seems.

If we’re heading towards higher interest rates (driven possibly by tapering of QE, and higher inflation), then I wouldn’t want to be holding growth shares whose valuation relies on guesswork about future growth.

UPDATE at 09:39 – Broker forecasts – getting hold of broker research on this company is fiendishly difficult, but a friend has just contacted me to give me the latest broker forecasts, which are:

FY 12/2021 – Profit before tax $20.1m, EPS 26.1p = PER 35.1 (based on share price of 915p currently)

FY 12/2022 – Profit before tax falling to $16.7m, EPS 21.4p = PER 42.8

That reinforces the point that the shares are certainly not cheap. However if that $20.1m profit is genuine, and turns into cash, then I would view this share a lot more positively.

Let’s see what the full year numbers look like in due course. I tend to put more reliance on the cashflow statement, than the Pamp;L, with this type of software company.

.

124p (down lt;1%, at 11:35) – mkt cap £344m

Trading Update

RPS, a leading multi-sector global professional services firm, provides the following trading update for the quarter ended 1 October 2021 (‘Q3-2021′ or the ‘period’).

“Performance in line with the Board’s expectations”

Revenues amp; margins improving

Year to date fees up 4% (at constant currency) to £353.6m

Net debt of £34.4m looks fine for the size of business, at 1.2x EBITDA

Plenty of headroom on bank facilities

Market confidence is generally improving

Outlook - sounds fine -

“Group performance has, as anticipated, strengthened as we have progressed through the year, and we expect momentum and business performance improvement to continue in the final quarter.”

Forecasts – many thanks to Liberum, for an update note today.

They’re guiding for 5.48p in FY 12/2021, rising to 6.57p in 2022.

The PERs are 22.6, and 18.9 respectively, which looks about right.

My opinion – this looks a decent company, and trading is recovering.

Valuation? Looks about right to me, therefore it doesn’t interest me. I’m looking for things that are either cheap, or are beating expectations, primarily. RPS has had a smashing run, which looks justified, but I think we would need to see performance exceeding expectations to justify any further share price rises for the time being.

.

.

326p (down 3%, at 10:53) – mkt cap £541m

Full Year Trading Update

On the Beach Group plc (LSE: OTB.L), the UK’s leading online retailer of beach holidays, today provides an update on trading for the 12 months to 30 September 2021 (“FY21″) ahead of announcing its Preliminary Results on 9 December 2021.

The company only resumed selling holidays from early Sept 2021 – so numbers for FY 09/2021 are irrelevant – good job, as we’re not told what they are!

Is it going bust, is the main question? It looks in a solid position from this:

Liquidity – I would need to see the whole balance sheet to be sure, but on the face of it this sounds a comfortable liquidity position -

On 30 September 2021, the Group had cash in excess of £55m, excluding customer prepayments of c.£40m which are held in a ring-fenced trust account. The Group has access to a £75m credit facility which is undrawn. The Group continues to refund all customers in cash and in full where their holidays are cancelled.

There might be other stretched creditors, we’re not told either way.

Outlook –

… demand for international leisure travel currently remains below pre-pandemic levels, our specific initiatives, including the “Free Covid Tests” promotion, combined with a further softening of government restrictions, have stimulated bookings in the final weeks of the financial year. The increased awareness of brand and strengthening of trading over this period provides confidence that there is pent up demand for travel, and positions the business well as we enter 2022.

My opinion – this update is light on details. Would I really want to pay £541m for a business that has been effectively dormant, and burning through cash, for c.18 months?

Peak earnings – net (i.e. after corporation tax) profit peaked at £26.2m in FY 09/2018. Therefore the PER is currently 20.6 times peak earnings. That doesn’t make sense to me.

It’s possible that FY 09/2022 earnings could be a blockbuster year, with pent-up demand.

OTB makes strangely high profit margins, which suggests to me that it might find headwinds from impressive competitors such as Easyjet (LON:EZJ) and Jet2 (LON:JET2) who I imagine would also be likely to launch massive advertising campaigns, and both offer package holidays too, not just flights.

Put that together, and I can’t see any attraction in OTB shares at the current price – it factors in all the upside, in my opinion, whilst the company has only just resumed trading. Why would I want to pay in full, and up-front for future recovery that hasn’t actually happened yet?

I remain of the view that by far the most strikingly mis-priced leisure sector (hybrid) share is Saga (LON:SAGA) (I hold) – where the market seems to be studiously ignoring the upside from its resumption of travel operations, and also seems to be ignoring the fact that its successful insurance business fully funded the cash losses of the travel divisions. Plus belt amp; braces refinancings, mean it’s sitting on an over-sized cash pile, with long maturities on the debt. Nothing else I’ve looked at comes even vaguely close, in terms of positive risk:reward. Obviously other people don’t see it that way at the moment, but such is life.

.

.

Share price: 221.2p (-2.12%)

Shares in issue: 259,637,998

Market cap: £574.3m

Wickes is a recent listing, a well known brand spun out of Travis Perkins. Such situations can be interesting as it’s often a case of a successful division being freed of a larger companies time and investment constraints. I believe Peter Lynch said as much in One Up on Wall Street, which was one of the first investment books I read and is well worth a look for anyone that hasn’t picked it up.

It’s a home improvement business that has invested heavily in its digital proposition, offering products to local trade and DIY and DIFM (‘Do It For Me’) services to customers. Revenue is split fairly evenly between these three lines and Wickes says that few others offer such a spread of activities.

New listings can be risky though. So far, the share price has not really moved.

But the company is receiving some interest from the community, perhaps due to its brand name and the idea that more people are now spending time and money at home.

While the enterprise value is significantly higher than the market cap, this difference is almost exclusively capital lease obligations (presumably on its shops), so on a pre-IFRS 16 basis the company should be net cash.

Q3 trading update

Wickes continued to perform well in the third quarter, with a resilient sales performance. As expected, Core sales moderated as we annualised tough 2020 comparatives, and remained strongly ahead on a two-year basis, underpinned by our digital leadership and operational strengths.

Core sales were down 2.3% like-for-like on the prior year but up 27.4% on a two-year basis. DIFM was up 0.7% but down 12.4% over two years. Total revenue was therefore -1.6% yoy and +16.3% over two years.

Comps over the past year or so have been quite variable owing to lockdowns with a surge in DIY products in the same period last year, but there is a declining trend over the past two years (although still positive), with 2Y LfLs of +25.6% in Q1, +19.7% in Q2, and +16.3% in Q3. That Q3 is decent of course, but the trend itself could be something to monitor.

This graph is from the group’s interim presentation, so is slightly out of date now, but provides a good impression of rapidly changing conditions.

Core sales were supported by strong performance in local trade, where home renovations continue to drive robust order books for our trade customers. Supply shortages had no material impact on sales in the period, although the group does note an acceleration in price inflation. Wickes is focusing on cash margin recovery while maintaining its price position.

DIFM reported sales were ahead year-on-year, with an improving trend on a two year basis. Q3 DIFM ordered sales (which are not yet recognised in the accounts) were ‘broadly’ in line with 2019. The total DIFM order book remains considerably higher year-on-year, impacted by extended project completion lead times, and this will result in a higher carry over of orders into 2022.

The full year outlook for adjusted PBT (excluding demerger and IT separation costs) remains in line with expectations and guidance given with the interim results. This is from the interims:

Given the strong outlook for Core and DIFM trends, together with half year results which delivered adjusted Profit Before Tax £1.5m ahead of guidance, we now expect adjusted Profit Before Tax for the full year to come in towards the upper end of analyst expectations (range £67-£75m).

Conclusion

Declining 2Y trends or not, this is still a double digit 2Y improvement and it means Wickes is on course for PBT at the upper end of £67m-£75m. That values the company at just 7.8-8.8x profit before tax.

The group has strong brand recognition and appears to have built up a fairly unique market position, with its DIFM line particularly hard to replicate. It is cash generative with a healthy and well-invested business and a strong digital presence that has served it well over a difficult period. So if there is to be a UK renovation boom, then at the current valuation, Wickes looks well placed to benefit and perhaps even take market share.

There are cost inflation pressures, as with a lot of operators, but there is also healthy demand from a large and growing home improvement market. I think the shares look good value given the outlook, although the usual caveats concerning recent listings remain. The good news with that though is that there will be a wealth of material in the recent prospectus to dig into.

It’s a particularly difficult time to gauge companies’ prospects at the moment. Wickes management refers to it as a ‘dynamic’ environment, which means there are all sorts of competing factors at play. Cost inflation, logistical logjams, spiking demand, and varying abilities to meet that demand.

The company is flagging a moderating trend in 2Y growth rates, so that must be considered. Again though, I come back to the valuation. This alone makes Wickes worth looking at in order to more deeply assess its outlook, as a net positive environment and continued earnings increases could lead to good upside over time.

Share price: 368p (+4.55%)

Shares in issue: 81,608,672

Market cap: £300.3m

We last covered Bloomsbury after it published its third profit upgrade of the year and declared a special dividend. The share price has appreciated by about 20% since then, understandably. Trading can be choppy for publishers depending on the quality of what they have coming out, but Bloomsbury has been able to generate dependably profitable results.

This is reflected in a Quality Rank of 91. In fact, the StockRank has been exceptionally strong for a long time now.

The current valuation requires ongoing growth, so it’s good to see that brokers have been raising both FY22 and FY23 forecasts.

Interim results

Highlights:

• Revenue +29% to £100.7m,
• Adjusted PBT +220% to £12.9m; PBT +265% to £11.1m,
• Adjusted diluted EPS +210% to 12.82p; diluted EPS +263% to 10.41p,
• Net cash down a percent to £43.7m,
• Interim dividend +5% to 1.34p.

Cash conversion was some 173%, with £43.7m of cash generated.

Consumer division – revenue was up 29% to £62.9m and adjusted PBT increased by £5.6m to £8.4m. The Head of Zeus acquisition, completed in June, contributed £2.7m of revenue and £0.4m of profit before tax.

Within Consumer, Adult Trade performed well with revenue up 27% to £23.9m and adjusted PBT up 23% to £1.3m. It was the ‘excellent’ performance in Children’s Trade that did the heavy lifting though, with revenue up 31% to £39m and adjusted PBT up by £5.4m to £7.1m.

Harry Potter sales were steady, sales of the front and backlist titles of Sarah J. Maas grew by 130%, and other Children’s titles increased by 10%.

Non-consumer division – again, an ‘excellent’ performance with revenue up 27% to £37.7m and adjusted PBT up some 220% to £4.6m. Another acquisition completed in June, RGP, contributed £1.7m of revenue and £0.4m of adjusted PBT.

Bloomsbury Digital Resources (BDR) revenue increased 44% to £8m with profit up from £1.2m to £2.8m and the group has some ambitious targets for this division. It is on track to achieve its five year target of £15m in revenue and £5m in profit for 2021/22, with a new target from next year of achieving a further 50% organic growth and 30% margin.

CEO Nigel Newton comments:

Retailers and online booksellers have significantly increased stock levels over previous years to ensure they have sufficient stock for Christmas given the supply chain problems. Our first half revenues have therefore been boosted by customers ordering earlier than in previous years.

Whilst the Board remains mindful of the external environment, including impediments in the supply chain and the possibility of higher returns of the increased stock ordered early, the strength of the first half performance means that we are confident in achieving market expectations for the year ending 28 February 2022.

Expectations are for revenue of £193.4m and profit before taxation and highlighted items of £19.3m. Given that results tend to be heavily H2 weighted and the group has already reported H1 adjusted PBT of £12.9m, I would think there’s a fair chance of exceeding these expectations, although that depends on how significant this first half increase in stock from customers is.

The group sheds some light on this in its outlook. Print supply chain challenges are ongoing and Bloomsbury is working with suppliers to print earlier, working with customers to deliver earlier, and ‘being agile’ about where it prints.

The result of this is that Bloomsbury has achieved earlier print sales to customers, ‘well in advance of our historical peaks in the run up to Christmas and at the beginning of the academic year in the Autumn’, meaning first half revenues have been boosted by customers ordering earlier than in previous years.

Conclusion

Bloomsbury is a top tier publisher, there’s no doubt about that. Its backlog, reputation, and market position are solid competitive advantages. It’s amazing to see that the first Harry Potter book was the fourth bestselling children’s book of the year, some 24 years after it was first published. But there is more here than the boy wizard.

The business has had a particularly successful past four years or so, growing diluted normalised earnings per share well over that period.

Looking to the future, the group has several long term growth objectives. In Non-Consumer, characterised by higher, more predictable margins and greater digital and global opportunities, it wants to grow the portfolio. In Consumer, it wants to nurture and retain high quality authors and illustrators, while looking at new ways to leverage existing title rights.

And the group also has international ambitions. Last year, 64% of group revenue was overseas and 76% of Academic BDR sales are international.

There’s a long-term strategy for growth, including growing digital formats. Supply chain issues have no impact on digital sales, which continue to materially increase and are a growing proportion of both revenue and profits.

Digital and non-print sales accounted for 26% of revenue in the first half and the group is on target to achieve its five year ambition for BDR revenue of £15m and profit of £5m for 2021/22. The new BDR target from 2022/23 is to achieve a further 50% organic growth and 30% margin over the next five years.

This is probably a company I should have paid more serious attention to earlier, but it’s never too late for the right company. It’s possible that we’ll get another ‘trading ahead’ update at some point, depending on just how much H2 demand has been pulled forward.

The PER multiple is on the high side for a book publisher and I do wonder about that, but I can also see the argument for why it might be deserved in Bloomsbury’s case.

Stockopedia