Small Cap Value Report (Fri 5 Nov 2021) - ELTA, MORE, SNWS, PURP, NICL, GATC

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

Agenda –

Paul’s Section:

Electra Private Equity (LON:ELTA) (I hold) – update on valuation. Recently demerged Hostmore (LON:MORE) looks excellent value to me at 118p. Price dislocation in the first few days of the demerger could be providing a buying opportunity?

Smiths News (LON:SNWS) (I hold) – additional comments on the FY 08/2021 results, which Jack covered yesterday. This looks a strikingly cheap value share, with big dividend income in the pipeline, now that historic issues have been largely resolved.

Purplebricks (LON:PURP) – profit warning from yesterday. I’m tempted to buy back in, but am worried about potential legal case, and cash burn. New strategy doesn’t seem to be working.

Gattaca (LON:GATC) – in line results for FY 7/2021 were published yesterday. Recent share price sell-off looks to have brought it down from an inflated valuation, to something much more reasonable. I would consider a purchase at 177p.

Jack’s Section:

Nichols (LON:NICL) – owner of Vimto, with some attractive quality metrics. The company has been in business for over a century and it remains financially healthy, so a potential buy and hold candidate. Today it announces an ‘ahead of expectations’ update and the shares have derated recently, so it’s a better time to look now than it has been at other times in the past.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review 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.

Following my recent criticism here of the demerger of Hostmore (LON:MORE), I’m hoping to speak to the company, and its advisers next week (both have kindly offered to speak with me). My main concerns are the outrageous level of fees, of £11m, and the apparent failure to line up buyers for the new Hostmore shares. Also of course that Numis produces excellent research, but then hides it away from the reach of key market participants – private investors. Hopefully I can persuade them to re-think this approach, I’ll try anyway!

It’s important to give a right to reply, where I’ve been critical, so it will be interesting to see what they say. There are always two sides to any story.

Timing has been unlucky too, with restaurant stocks selling off a fair bit recently.

Looking at the valuation of Hostmore (LON:MORE) (hopefully new ticker now working on Stocko), either I’ve got my analysis wrong, or it’s an excellent bargain at 118p. I think it’s worth closer to 200p, and a similar figure is targeted by Numis, at 211p. I’ve seen the Hostmore note from Numis, and it confirms everything I’ve previously written about Hostmore. Although I think the Numis forecasts look modest, and set up to be beaten.

The current prices of ELTA and Hostmore equate to a price of 488p for old ELTA. That doesn’t make sense, because it had been around 550-600p (and was too cheap at that level, on fundamentals). The demerger hasn’t changed the value of the underlying businesses whatsoever, hence we clearly have some irrational market dislocation currently in the prices of the individual shares. That should correct itself over time.

New ELTA (which is just Hotter Shoes, and will be renamed Unbound) looks an interesting business, and the current market cap of £41m (at 105p) looks about right to me at this stage, so I’m not rushing to buy more, but am happy to hold long term.

The strikingly cheap valuation to me, is Hostmore at 118p. That’s a market cap of £149m, or an EV of about £180m, for a business that should be generating £30-40m p.a. EBITDA. It’s very cash generative, and is self-funding a roll-out of 2 brands, with lots of good sites available on attractive deals. I think this could prove an excellent entry point, but am happy to listen to other views too.

The usual negative comment is that TGIs is a tired brand. There’s some truth in that, but it ignores the work new management has been doing to revitalise it. Bottom line, it doesn’t matter what we think about the brand, the sites are busy, and generating substantial cash inflows, which is what matters more.

39p – market cap £96m

Jack’s excellent review in yesterday’s report covers the main points.

I looked through the numbers for FY 08/2021 last night, and am delighted with the way this turnaround is progressing. It’s unusual in that it’s playing out exactly as planned, whereas usually there are at least some bumps in the road with turnarounds.

Adj EPS of 10.8p is excellent, so the PER is a ludicrous 3.6 – that’s clearly the wrong price for such a reliably cash generative business that has now fixed all its legacy issues (Tuffnells, pension scheme, excessive debt).

As Jack correctly points out, net debt is still too high at £82.6m daily average throughout the year, but it’s rapidly falling from cashflows. Also, post period end cash receipts of £6.5m from Tuffnells and £8m from the pension scheme surplus were confirmed yesterday. There’s another £9m due from Tuffnells I think. Put that together, and it means net debt is rapidly reducing, and getting close to the targeted level of 1x EBITDA. When it reaches that level, the brakes come off for dividends, which could easily soar into a double digit yield. Hence this share looks very attractive for future incomes.

Yes it’s true that newspaper/magazine distribution is structurally declining, but the costs are variable, or semi-variable, and are managed down on a 3-yearly cycle, to match declining revenues. Cover price rises offset some of the circulation volume decline.

There’s also the wild card that some other activity could be bolted on to SNWS’s rapid overnight delivery network.

It’s not a share I want to hold forever, but purely on vauation/yield terms, it looks highly attractive at a price I consider irrationally low. Edison put out an excellent recent note, saying SNWS shares are probably worth about double the current price. I think that’s correct. Very much one for value investors, who are prepared to be patient.

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34p – mkt cap £104m

I don’t currently hold this one, as a recent MailOnSunday article about potentially large legal action spooked me into selling. Then it issued a profit warning yesterday.

New instructions – have “slowed significantly” in recent months down 38% – that’s a big problem, because PURP earns fees up-front, on signing new instructions.

Cash pile has reduced sharply, to £58m (from £75.8m a year ago), implying substantial cash losses. Expected to “stabilise” in H2.

Adj EBITDA to be “below previous guidance”

Medium term guidance unchanged.

Legal action not mentioned.

My opinion – the market cap is looking really low at £104m, for the best-known online estate agent. Half of the market cap is supported by net cash too. Although how much of that cash might be absorbed by legal costs? The issue seems to be over the status (employed, or self-employed) of its staff. It has switched over to employed status now, but there could be legacy costs if courts decide to overturn the previous self-employed status. It’s a material uncertainty at least.

Also, I swallowed the strategy update from the company in a webinar a while ago, but it has clearly not worked. The money back guarantee (with lots of conditions attached) was supposed to stimulate new instructions growth, but the opposite has happened.

Hence I think there are big question marks over strategy (and management). Also the company should have said something about the legal case, which is a risk.

That said, I’m finding the £104m market cap very tempting. Will give it some more thought. I’m tempted to buy back in, but need to think it over some more.

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Gattaca (LON:GATC)

173p – mkt cap £56m

Preliminary Results – issued yesterday

Gattaca plc (“Gattaca” or the “Group”), the specialist Engineering and Technology recruitment solutions business, today announces its unaudited Preliminary Results for the year ended 31 July 2021.

Improvement plan complete; well positioned for growth

The numbers don’t look very good, e.g. underlying (continuing ops) EPS is down from 11.7p last year (FY 7/2020) to 8.4p for FY 7/2021. However that’s ahead of Equity Development’s 6.7p forecast. Liberum also says in a new note that the figures were in line with expectations, with no surprises. Therefore I’m puzzled as to why the share price has sold off? Maybe there’s something negative in the outlook comments? No, doesn’t seem to be anything untoward here -

Outlook -

Given the current market conditions, our clients are finding it more challenging to identify and secure specialist talent, which plays well to Gattaca’s expertise in delivering critical skills and talent for their businesses. With strong demand for STEM skills, and our investment in our people and technology, we are well positioned for growth.

Notwithstanding evolving pandemic and macro supply chain factors, the business continues to trade in line with market expectations. We continue to invest to ensure sustainable growth over the long-term in our chosen markets.

Valuation – forecasts are for a substantial rise in earnings, as follows -

FY 7/2021 actual: 8.4p

FY 7/2022 forecast: 13.6p

FY 7/2023 forecast: 20.7p

Those are aggressive uplifts in forecast earnings, which might be a challenge to achieve. I’d need to know why brokers think it can drive EPS up that fast?

With the share price at 173p, the current year PER is 12.7 – which looks quite good value, if earnings do rise as forecast.

Legal case in USA – is ongoing. Could be a risk? Costs have been high in the past.

Balance sheet – looks fine to me, with a strong net cash position.

My opinion – if you like the company, then the sell-off in recent months looks to have brought it back down to a reasonable valuation. I would consider a purchase, if I could build up conviction that forecast earnings are likely to be achieved.

Share price: 1,220p (+8.44%)

Share in issue: 36,924,219

Market cap: £450.5m

There’s a lot to like about some of these Beverages companies in the Consumer Defensives sector – profitability, financial health, free cash flow generation, margins, returns on equity are all good and contribute to strong Quality Ranks.

For all this quality though, the share price of Nichols has done little over the past decade. There’s a real opportunity cost to this type of holding if you’re not careful.

This lack of progress is backed up by limited revenue growth. There were some signs of this changing more recently, but FY20 was a step back. More growth is required to drive the share price in future, given the 20.6x forecast PER.

Still, these are good companies, often with strong brands (Nichols has Vimto) with international potential and scope to expand margins, so I would never outright discount them.

Trading update

Group revenue for the period was ahead of the Board’s expectations, increasing by 17% year on year to £107m.

Vimto has continued to deliver a strong performance across all of its markets. In the UK, Vimto brand value has increased by 4.5% YTD, according to Nielsen. In Africa, the Middle East, Europe and the US the brand continued to see progress year on year, with International revenues increasing 36% versus the prior year.

The group’s Out of Home (OoH) route to market continues to recover from the impact of the pandemic and has seen growth of 29% year on year.

Cash generation has continued to be very positive through 2021. Cash and cash equivalents at the end of the period were £55.6m (30 September 2020: £45.4m).

Outlook – Uncertainty remains but in light of the strong trading in the year to date the board now believes that adjusted full year PBT will be ahead of the current market consensus, most likely in the range of £21m – £22m. Applying a 20% tax rate to that suggests an adjusted EPS range of 45.5p – 47.7p or a PER of 25.6x – 26.8x, which still seems pricey.

Revenue momentum is expected to continue into 2022 but the outlook for the next financial year ‘is adversely impacted by inflationary pressures including logistics, labour and materials’, therefore profit expectations for 20224 remain unchanged.

The next trading update will be on 12 January 2022.

Conclusion

Nichols is classified as a Falling Star but it’s hard to say anything too negative about this company. The clear thing that makes me hesitate is the lack of historical revenue growth, the PE ratio, and relatively static share price.

This could all change with the right strategy and top line growth. The group has remained profitable, cash generative, and financially sound throughout that time, so it has a stable platform from which to grow. And, while revenue expansion has been lacking, Nichols has been able to make more progress in terms of earnings per share for its shareholders.

I’m assuming here that the group can fully recover from the 2020 dip but I don’t know it well, so that assumption needs checking.

Brokers are forecasting a recovery in EPS, from 24.7p in FY20 to 42.3p in FY21 (now potentially more like 46p) and 56.8p in FY22. Over the past few years the group has averaged between 60p-70p in EPS, which would return the group to a PER of 17x-20x if reached.

These forecasts have been revised down recently but will likely be nudged up once more after this update.

Nichols was founded in 1908 and is now available in countries around the world. It has done particularly well in the Middle East and Africa. So it probably warrants more research but it needs to realise the global growth potential.

It’s got the characteristics of a buy-and-hold candidate but, despite the quality metrics on offer, I’d need more signs of long term growth potential before paying up. That said, this is an ‘ahead of expectations update’ (balanced against inflationary pressures in the coming year) and the shares have derated recently.

If it can navigate the developing challenges well, then there could be scope for further upgrades, so I can see the logic in spending a little more time on this one.

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