Small Cap Value Report (Mon 1 Nov 2021) - SHOE, PIER, LOK

Good morning, it’s Paul and Jack here, with the SCVR for Monday. Today’s report is now finished.

Agenda –

Paul’s section:

Shoe Zone (LON:SHOE) – trading update raises profit guidance again for FY 9/2021. I missed the update from 13 Oct, so cover both today. It looks an excellent recovery, although there is a question mark over undisclosed benefit from business rates relief, which will be substantial given SHOE operates from 410 sites. With net cash, and divis returning sooner than expected, this looks a credible, and good value recovery share. I also like the growth in online, and a change in strategy to make online sales “core” in the future. Thumbs up from me!

Jack’s section:

Brighton Pier (LON:PIER) – eight university town bars, eight mini-golf sites in retail and leisure hubs, a pier in Brighton, and a theme park in North Yorkshire. This is an unusual combination of assets. Current trading looks understandably positive and the shares are up, but the company has disappointed before and this looks like a complex and costly enterprise to run. The shares are illiquid too, so it’s high risk.

Lokn Store (LON:LOK) – strong results and although the shares look expensive, there is a long term growth opportunity here which can be realised via a relatively low risk strategy. Margins are already high but the company suggests these could improve further. It might be worth looking beyond the high earnings multiples but there’s no doubt 33.5x forecast earnings feels pricey.

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.

90.5p (pre market open) – mkt cap £45m

Further Trading Update

It’s called a “further” update, because this cheap shoes retailer had already given a year end trading update here on 13 Oct 2021. Unfortunately, that one slipped through the net here at the SCVR and we didn’t cover it, which is a great pity, as looking at it now, the previous update was strikingly good compared with previous gloomy utterances from the company.

Note that the share price has been a stand out performer in the last year, something that would not have been at all obvious as likely to happen, a year ago. Being an importer of cheap, fairly bulky items (boxes of shoes) made in China, I would have thought that SHOE would be in the eye of the storm re supply chain costs/delays. That’s why I didn’t really give the company a second thought. What a mistake that was! There doesn’t seem to be any rhyme or reason with supply chain problems – some companies are getting slaughtered, other companies are taking it in their stride, with SHOE seemingly being in the latter camp. Hence why investing is particularly difficult at the moment, with companies splitting into winners amp; losers, on an unpredictable basis. That’s why I’m increasingly looking through supply chain issues, as something short term, that should be resolved at some stage, hopefully in 2022. That’s clearly what the USA markets are thinking, and we tend to follow their lead, usually after we’ve had a panic sell-off in the UK, over potential problems that US investors largely ignore!

I’m increasingly seeing some good buying opportunities in UK small caps – I pointed out the illogical sell-off in Sanderson Design (LON:SDG) (I hold) on Friday when it lurched down to about 155p. Coincidentally the excellent David Thornton of Growth Company Investor also flagged the same buying opportunity just a couple of hours later, in the latest edition of GCI which was emailed out late morning. That seems to have driven a strong rebound in SDG on Friday, which seems fully justified by the recent good newsflow amp; figures, which both David and I simultaneously flagged up.

SHOE looks a good opportunity too, this is what it says today -

Today’s update – profit guidance has been raised again for FY 09/2021 -

…reported profit before tax is now expected to be in the range of £9.0m to £10.0m for the 52 weeks to 2 October 2021

This compares favourably with the previous guidance (13 Oct 2021) of

Profit before tax expected to be not less than £6.5m

That’s an increase in guidance of £2.5m to £3.5m.

Of this increase -

• Pensions – £1.5m is non-trading, relating to pension scheme contributions, which don’t need to go through the Pamp;L, but seem to have been mistakenly budgeted for via the Pamp;L, which does raise the question as to why SHOE’s finance department made this apparent mistake?
• Favourable forex has boosted profit by another £0.4m.
• The balance of about £0.6m to £1.6m of increased guidance must be down to improved trading.

That’s all clearly good news. Although we are not told the extent of taxpayer support in arriving at this decent level of profits. Business rates relief in particular will have been a large number, given that SHOE is trading from 410 sites, and therefore should have been disclosed as a material item, in my opinion. Without being told that number, we really can’t determine what the underlying level of profitability would be in future. The hope would be that if there are no further lockdowns, then increased profits from trading would offset the withdrawal of business rates relief in due course.

Previous trading update from 13 Oct 2021 -

I wish I’d spotted this at the time, but never mind, It reads very well.

Stand out items include a high gross margin of 61.3%, which is near the top of what retailers achieve.

Strong online growth, which has now grown to 25.7% of total revenues. There’s been a pivot towards online, with management now describing online growth as “core” – quite a big change in strategy.

Supply chain cost/delays had been offset through reducing the number of product ranges, thus reducing cost per unit – very impressive this has been absorbed. Although SHOE expects further supply chain cost/delays for a further 6 months.

Net cash of £14.2m, meaning dividends are expected to re-start sooner than expected – very positive. Although cash flattered by £2.5m due to temporary delays stock intake.

My opinion – this looks very good to me, and the market cap of only £45m looks too cheap. So a thumbs up from me. As management says, the business has emerged from the pandemic “a leaner, stronger, amore resilient business”.

EDIT at 08:24 – a note has just come through from Zeus, many thanks for that. They’re penciling in £8.0m adj PBT for FY 09/2021, falling to £6.5m next year, despite revenues forecast to grow 31% to £155.9m next year FY 09/2022. Hence clearly I was right about the materiality of business rates relief withdrawal, that must be the main factor for forecast profits to fall, despite a big forecast increase in revenues.

Zeus’s 10.4p EPS forecast for FY 09/2022 looks conservative though, and it’s only just above half pre-pandemic peak earnings. With a rationalised cost base, and more online sales, I would hope SHOE should be able to achieve forecast-beating numbers in FY 09/2022 and beyond. Hence the forecast PER of about 9 is probably under-valuing the company’s potential for further profit recovery, the way I look at things (i.e. the actual PER might turn out to be lower than 9, if earnings exceed these undemanding forecasts).

End of edit.

Share price: 77p (+16.67%)

Shares in issue: 37,286,000

Market cap: £28.7m

Brighton Pier operates Brighton Palace Pier, eight bars, eight indoor mini-golf sites and, more recently, it has acquired the Lightwater Valley theme park in North Yorkshire. It’s an unusual assembly of leisure assets, making PIER somewhat unique in the listed space.

It’s an unusual portfolio of assets so I’m curious to know if lasting value can be built, particularly with its move into theme parks.

The group was previously Eclectic Bars, so it has been forced to move away from its historical business of nightclubs, has bought a pier in Brighton, opened some mini-golf sites, and has now acquired a theme park in Yorkshire. The bars are in university towns, while the mini-golf sites are in ‘high footfall retail and leisure centres’.

It doesn’t immediately sound like a highly efficient enterprise. It actually sounds like it must all be very hard to run well, although the vision is quite ambitious.

Merlin (since delisted) was attractive due to its high barriers to entry so there is logic to running these kinds of assets. But a theme park is a much different enterprise to a mini-golf bar; one large, more complicated site with rides that require a significant amount of upfront capex.

Group trade over lockdowns has been heavily impacted, of course, and at £29m market cap, this is a very small company with poor liquidity, so the risks are high.

The share price chart shows the company ran into trouble before Covid, and has since failed to recover to its IPO price.

To its credit though, shares in issue have stayed broadly the same, which is quite a feat.

The group wants to create ‘a growth company that operates across a diverse portfolio of leisure and entertainment assets in the UK’ targeting both organic and acquisitive growth. Longer term, it wants to act ‘as a consolidator within this sector.’

There could well be organic growth opportunities across the estate and you could potentially build something of enduring value with these more unusual, large assets. Brighton Pier, for example, was the fifth most popular free attraction in the UK prior to the pandemic, with over 4.9 million visitors in 2019, making it the UK’s most visited landmark outside of London.

Nevertheless, there is also probably quite a high demand for capex and, operationally speaking, this seems like a complicated micro cap to run. Best of luck to management.

Final results

To end the year with the acquisition of Lightwater Valley has been particularly satisfying and a sign of how we have remained focussed on our stated aim to expand the Group by further acquisitions.

Both FY20 and FY21 have been heavily affected in differing ways by Covid, so comps are difficult. Nevertheless, here are the highlights:

• Revenue -40.3% to £13.5m,
• Profit before tax up from a loss of £9.5m to a profit of £4.2m,
• Basic and diluted earnings per share up from a loss of 25.5p to positive 11.5p,
• Group adjusted EBITDA more than doubled from £2.5m to £5.1m,
• Adjusted EPS up from a loss of 5.3p to positive 5.7p.

I would be wary of adjusted EBITDA for such an enterprise given the high demand for maintenance capex. Depreciation this year is £1.2m and, while capex was just £258k, in the prior year it was £1.6m which is likely more usual. So wear and tear is an ongoing business characteristic.

Furthermore, EBITDA this year was helped by some £5m of business interruption insurance income, £0.7m of COVID-related local authority grant income and £2.2m of furlough income which has offset staff costs. So adjusted EBITDA is fairly meaningless on an ongoing basis. I’m not sure that such government contributions should be included in ‘adjusted’ metrics.

Whilst the late-night bars were almost entirely closed throughout the whole 52-week financial period, the Pier and Golf divisions were able to reopen for trade during the key summer months of July to September 2020. This summer trading period contributed approximately £2m of earnings to the group, helped by the Eat Out to Help Out scheme.

Cash burn was reduced in the year and additional funding provided with help from suppliers, landlords, banks, and government.

Current trading sounds encouraging and the group comments:

​​With the easing of restrictions during summer 2021, the Group’s diversified offering has been in prime position to capitalise on pent up demand for leisure experiences. With the Pier and Golf divisions both open, the addition of Lightwater Valley for the full 13 weeks and the Bars finally open for 10 weeks, total sales for the 13-week period to the end of September 2021 were £15.9 million. This is 145% over the same period in 2020, and 44% ahead of the same (pre-Covid) period in 2019 (or 30% ahead of 2019 if benefit from the temporary VAT concession is excluded). This strong summer 2021 trading performance, coupled with the benefits from VAT and rates relief, indicates that this year could be an exceptional opportunity for the Group to recover some of its lost earnings if it is able to continue trading without further restrictions.

Lightwater Valley – On 17 June 2021, PIER acquired the entire share capital of Lightwater Valley for £3.6m with a further £1.2m paid to clear Lightwater Valley’s outstanding bank debt on the date of acquisition. Total cash outflow is therefore £4.8m.

The acquisition was funded from a £2.0m extension to the group’s revolving credit facility and existing cash resources. The transaction was expected to be immediately earnings accretive post completion.

For its last full year of uninterrupted trading (year ended 28 February 2019), Lightwater Valley recorded sales of £5.1m, EBITDA of £1.1m and pre tax profits of £0.6m. The total fixed assets being acquired are stated in the balance sheet at £4.1m.

Conclusion

It’s hard to gauge what the group’s underlying prospects are from such a set of results. The group says current trading is exceeding expectations, with like-for-like sales up 81% on the same 13-week period of 2019. That’s very positive and probably explains today’s share price reaction.

FY profits have been helped hugely by government schemes and insurance income, so it’s hard to gauge how the enterprise trades on an ongoing basis (not really the company’s fault). The group’s broker, Cenkos, forecasts 11.9p of earnings per share for FY22 which, if achieved, makes the shares look cheap at present.

The balance sheet does not look particularly strong, with net tangible assets of £8.8m although cash has improved from £2.6m to £7.1m.

There’s a lot of risk here in terms of the lack of liquidity and forced move into other business lines which arguably require different skillsets to run. I’m concerned about how large the ongoing cost base might be as well, given the group’s acquisition ambitions.

The theme park is an interesting move but I suspect these are highly specialised assets, so I’m waiting for a longer period of undisrupted group trading and to see how Lightwater Valley performs before making any serious decision.

Shares have responded positively to the update, up around 16%, and current trading looks quite buoyant but I worry that the spread of businesses makes this a tricky and costly enterprise to manage. I also wonder, given the size of the group and its more unusual collection of assets, if there is a temptation to take it private at some point.

Share price: 879p (+5.27%)

Shares in issue: 29,686,787

Market cap: £260.9m

This is a supplier of low cost, secure storage space, which is actually an attractive structural growth area.

The Self-Storage Association UK (SSA UK) Annual Industry Survey 2021 notes that public awareness of and demand for self-storage is increasing. Lok n’ Store opened its first self-storage centre in 1995 and has grown consistently over the last 26 years. Revenue has increased fairly steadily over time.

Today it operates 37 self-storage centres trading mainly in Southern England which generate strong profit margins, and it has a pipeline of 13 secured stores with additional opportunities beyond that.

But the shares do look expensive. It’s likely there’s quite steady growth to be had here, but you are paying up for it now.

Preliminary results

Excellent trading, significant asset value growth, ambitious store opening programme and accelerated dividend policy

Highlights:

• Group revenue +21.3% to £21.9m,
• Adjusted EBITDA +23.2% to £11.89m,
• Operating profit +29% to £7.46m,

There’s been a strong year on year recovery, with total occupied space up from 5.9% to 35.3%, occupancy up from 69.6% to 85.8%, and pricing up by 8.7%.

As a result, cash available for distribution is up 33.3% to 28.4p and the annual dividend has been increased by 15.4% to 15p – the tenth annual dividend increase in a row. Cash inflow from operating activities before investing and financing activities was £12.2m, up 25.6%.

Adjusted net asset value per share has also increased by 31.6% to £7.31. The average cost of debt is just 1.54% and the loan to value ratio is a modest 21%.

Pipeline – the group says new ‘landmark’ stores will deliver further growth. £26.9m has been invested in new stores and the pipeline of 14 new units will take the group total to 51, adding 38% more trading space.

Management comments:

We have made significant progress on our new store pipeline, with two new stores opened in the period and one existing store acquired contributing to our net asset value per share growth of 31.6%. Three stores are currently under construction opening early 2022, and four more are soon to commence. This pipeline of new stores delivers 38% more space and will add further momentum to sales and earnings growth.

The group has cash balances of £9.1m (2020: £13.1m) and a £100m revolving credit facility, which should finance the current pipeline. Interest cover is more than 10 times against a covenant of 2.5 times. LTV based on net bank debt was 21.0% versus a bank covenant of 60%. Net debt is £56.3m (2020: £38.3m).

Conclusion

Very positive results, and the outlook is equally as encouraging. Occupancy increases point to further revenue growth and potential margin expansion if sustained, momentum is expected to continue, and the group has a sensible and relatively low risk growth strategy of prudently opening new landmark stores.

The UK self-storage market continues to grow but remains surprisingly under-developed relative to Australia and the US. When the industry first emerged over here, companies were predominantly single owner sites often located in industrial areas. Larger operators (managing ten or more sites), such as Lok’nStore, have recently been developing purpose-built stores in retail-facing locations offering customers a higher standard of product and service.

You would think that it would be relatively easy to go into this line of business, but the group says that barriers to entry include the difficulty in finding and securing suitable sites as well as gaining the appropriate planning consents. This, it says, is why larger operators now own or manage around a third of all facilities and hold a 45% of market share in terms of revenue and space.

Returns have been strong over the past few years for the likes of Lokn Store (LON:LOK) , Safestore Holdings (LON:SAFE) , and Big Yellow (LON:BYG) but given the market stats quoted by the company perhaps there is a longer term growth opportunity. No doubt the valuation looks quite demanding at these levels, but then again brokers have been upping their forecasts and the company sounds optimistic.

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