Small Cap Value Report (Thu 25 Nov 2021) - ALT, IQE, MUL, CBOX, LTHM, MACF, AOM

Good morning! It’s Paul amp; Jack here with the SCVR for Thursday.

Agenda -

Paul’s Section (I’ve gone a bit nocturnal, so apologies for the erratic timings, this was mainly prepared overnight) -

Altitude (LON:ALT) – in line update. Altitude has over-promised and under-delivered in the past. £20m market cap could be a speculative idea?

Iqe (LON:IQE) – profit warning – shares down 24%. It sounds tech impressive, but doesn’t make any cashflow. Not for me.

Mulberry (LON:MUL) – interims looks good, but more than half profit came from a Paris lease disposal. Weird ownership – 95% owned by 2 shareholders. But if this brand takes off again, could be a multibagger. Worth a look, for fashionistas, not bean counters who mistakenly think they know about fashion! like me!

Cake Box Holdings (LON:CBOX) – when is it right for founders to sell? We love CBOX here at the SCVR – exactly the type of hard-working founder entrepreneurs, with big shareholdings. But they’re selling a quarter. How do we feel about that?

Jack’s section:

James Latham (LON:LTHM) (I hold) – strong H1 results, as previously flagged. The group faces a number of cost pressures now, while volumes and margins are normalising. The current period has benefitted from stock bought at historically normal prices and then sold at a mark up amid unprecedented demand conditions. Receivables have increased and customers are ‘a bit quieter’ as they hold off in order to source parts. It’s a good company but I wouldn’t be surprised to see the share price ease back over the next year or so, depending on how the wider market plays out.

Macfarlane (LON:MACF) – a short update confirming that the group now expects to exceed full year expectations. There’s a good track record of long term revenue growth and operating margin expansion here that warrants further investigation.

Activeops (LON:AOM) – relatively new software float with recurring revenue, although it remains loss-making. The company has cash to invest and I’m interested to see how it might grow in time but, for now, the valuation looks quite full.

28.5p (up 6% yesterday) – mkt cap £20m

Trading Update

There’s a change of Chairman too, which doesn’t really matter in my opinion.

The new Chairman has a background in the insurance sector, so I’m not sure how relevant that is to promotional products?

In terms of trading, this is the latest -

The Group is pleased to report that it has made good progress in the six months to 30 September 2021 (“HY1 2021″) with US recovery across the promotional product industry having accelerated recovery for the Group. The Company is trading positively and in line with management’s expectations.

The Group will announce its HY1 21 interim results on 30 November 2021.

My opinion – neutral. Altitude has over-promised amp; under-delivered in the past, so it’s difficult to muster much enthusiasm for the outlook.

However, at £20m market cap, for a company that’s trying to build an online marketplace type business in the USA, the upside could be considerable if it takes off.

I see this as a complete punt. It’s tempting to have a dabble with fun money.

38p (down 24% yesterday) – mkt cap £306m

IQE plc (AIM: IQE, “IQE” or the “Group”), the leading supplier of compound semiconductor wafer products and advanced material solutions to the global semiconductor industry, announces a trading update for the year ending 31 December 2021.

Here are my notes reviewing the FY 12/2020 results, back in March 2021, where I was left unconvinced by the business model – heavy capex, and uncertain/volatile profits.

The other difficulty, is that it’s difficult for generalists like me, to appraise companies in sectors that we don’t understand. Hence why sometimes I think it’s best to stick to your knitting – i.e. a few sectors that are simple, and where you have an edge, in terms of understanding.

There again, the numbers don’t lie (usually!), and it’s been clear for a long time that IQE has to run to stand still, in terms of capex. Is it doing anything unique? The numbers suggest not.

Trading Update (profit warning)

There’s useful detail in this update, but the outcome is that FY 12/2021 guidance is reduced, due to reduced demand amp; forex headwinds (weak dollar).

The new guidance is £18m EBITDA, and £14-17m capex (reduced, as some has been deferred into 2022).

The simplistic way I look at things, that is telling me that IQE is running at around cashflow breakeven, after deferring some capex into next financial year.

Net debt - sounds modest -

Net debt is expected to be less than £10m.

My opinion – I’ve had a look at the last (interims) balance sheet, and it’s robust, so there’s no solvency or dilution risk here, in my opinion.

It’s a capital-intensive business that owns the assets with equity, so there are no worries about borrowings.

IQE is a business that I’ve followed for years, and the pattern seems to be that it needs to constantly update/replace its machinery, with very heavy capex, just to stand still.

Looking at the last 5-6 years, revenues have risen, but profitability has collapsed. What does that tell us? Probably that competition might have caught up, or even overtaken IQE? I don’t know, because this sector is a mystery to me, but the numbers tell me it’s probably best to avoid this share, unless there are good reasons to expect a dramatic improvement in profitability in future – a story I’ve heard before from IQE, which didn’t work out.

Overall then, it’s not for me, but sector experts can probably give a better analysis.

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370p (up 23% yesterday) – mkt cap £222m

There’s been a striking rise in share price for this vendor of fancy handbags. As we’ve discussed here before, the big problem is that 2 shareholders own about 94% of the company -

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Unfortunately, the explanatory note on this Stockopedia page takes up so much width, that it compresses the columns to the left so that I cannot see the most important one! (% shareholdings). Hopefully the IT team can do a quick fix on this simple problem, by making the columns wider, or just getting rid of the explanatory note which obliterates the actual data? I’ve been moaning about this for a long time, so it would be good to get it fixed.

The problem is that I don’t have great eyesight, being over 40, probably like most Stockopedia subscribers, so I have to increase the font size to see things. That changes the layout, and sometimes it doesn’t work as a result. Although, to be fair, it usually works fine, this particular page about shareholders is the problem for me when I enlarge the font, everything else is fine. Don’t’ shoot the messenger, it’s constructive feedback!

Half-year Results

Mulberry Group plc (the “Group” or “Mulberry”), the British sustainable luxury brand, announces unaudited results for the twenty-six weeks ended 25 September 2021 (the “period”).

Further strategic progress amid strong consumer demand

Haha, the PR headline about “strategic progress” probably means the figures are no good. But, the share price is up 24%, which suggests the figures might be good (in a very thin market), let’s see which is right.

Balance sheet looks OK, but watch out for loss-making sites – lease liabilities are about double the right of use assets figure. This could improve in future though.

Very important – a profit of £5.7m on the disposal of a property lease in Paris. That provides just over half of £10.2m H1 profits.

My opinion – this is a very quick skim of the figures, so more work is needed (as always) by subscribers to do your own research. We’ve got to look at loads of companies here at the SCVR, so can only ever publish a quick view.

Mulberry is a very well-known brand, and it’s shot back into impressive profits, even when you strip out the one-off £5.7m disposal of a Paris property.

Clearly the 2 big shareholders control the company, so that makes me wary.

This share could be quite interesting. Why? Because of the fashion side of things. Bean counters like me, who’ve worked in the fashion sector, like to think that we know about fashion, but we don’t. We’re clueless about fashion! However, we have observed that when the design amp; buying team get the fashions right, then profits explode upwards, and often do that for several years. We’ve seen this with Mulberry before. So it could happen again. The brand could be very valuable again, who knows?

Women pay staggering amounts for fashionable handbags – it’s a status symbol apparently. Maybe a bit sad, that self-esteem has to come from a bag, but that’s a discussion for another day.

I’ve got to say though, Mulberry shares look quite an interesting punt to me. There doesn’t seem to have been any dilution, with 60m shares in issue, if these handbags hit the fashion big time again, then there’s a potential multibagger. Look at the long-term chart below.

I think it’s time to consult our fashion guru figures, and see what they think about the brand?

Overall – I like it, there could be a speculative opportunity here. What do you think? When I have some spare cash, I’m tempted to just tuck away a small position here and forget about it for 10 years.

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Cake Box Holdings (LON:CBOX)

405p – market cap £164m

Secondary Placing

The founders of CakeBox are selling some of their shares.

My view is that deals like this need close scrutiny, because if the people who know the business best want to sell, then that’s telling me the price is favourable to them, not to me.

The main issue with secondary placings in the past, is that the City brokers overtly lie about this – by trotting out the misleading phrase that, founders are selling due to institutional demand. Everyone knows that is untrue, so it needs to be stamped out. Hence why I add my voice to the widespread criticism of brokers publishing such lies – it’s not acceptable, stop it right now.

The truth is that there are many reasons why founders want to reduce their shareholdings in secondary placings. The main reason is that they want cash, instead of an over-sized position in the company they founded. That is perfectly reasonable, but please tell the truth! You’re not selling due to institutional demand. You’re selling because you want to sell at a good price, and there are buyers happy to pay up.

If the buyers offered a lousy price, you wouldn’t sell. We all know that, so don’t let the broker lie about it, which doesn’t fool anyone.

Scrutinising CBOX announcement, it says -

The Sellers announce that in response to investor demand and a desire for financial diversification, and in line the ambition expressed at the time of the Company’s IPO to increase the Company’s freefloat over time, they intend to sell in aggregate 3 million ordinary shares in Cake Box (the “Placing Shares”).

Sukh Chamdal and Santosh Chamdal currently own together c.12.79 million ordinary shares and will, assuming 3 million Placing Shares are sold in the Placing (as defined below), retain a significant holding in the Company of c.9.79 million ordinary shares representing approximately c.24.47 per cent. of the Company’s current issued share capital.

My view – that sounds fine. The explanation given sounds reasonable – founders want to partially sell, to diversify so that all their eggs are not in one basket.

Founders are selling about a quarter of their holdings, and retain a major shareholding. That seems fine to me.

Does it cap the upside if the founders want to sell a quarter? Yes, to be blunt, at least in the short term.

Overall, I think CBOX is a smashing business, management come across extremely well in presentations, as just the type of entrepreneurs I would want to back. Sorry I missed this opportunity early on, but you need to see track record build.

Given the secondary placing, I’d say it’s probably fully priced for now, with limited upside, after a great run? Long term, it’s probably good, CBOX looks a smashing business, based on an excellent track record so far.

If founders are happy to sell a quarter, it shows how shrewd they are! Also big positions remaining, and performance of CBOX has been really excellent, it looks a very nice business. On the watchlist, so something I would buy on dips to maybe 300p-ish?

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Share price: 1,294p (+3.11%)

Shares in issue: 19,900,800

Market cap: £257.5m

(I hold)

James Latham is a supplier of wood-based panel products, natural acrylic stone, hardwoods, high grade softwoods, cladding, decking and plastics to manufacturers, shopfitters and other market sectors.

It’s a 9th generation family business, publicly listed since 1965, which has grown to service customers from 11 locations across the UK. In 2019 it acquired Abbey Wood in Ireland and this year it has expanded its presence here with a further acquisition.

Half year report

Highlights:

• Revenue +81.2% to £193.9m,
• Gross profit +183.2% to £51.1m; gross margin up from 16.9% to 26.4%,
• Operating profit +421.6% to £34m; operating margin up from 6.1% to 17.5%,
• Diluted earnings per share +419.5% to 133p.

Revenue for the six months ended 30 September 2021 was £193.9m, up 81.2% on £107.0m for the same period last year (with the previous period significantly impacted by the first lockdown).

Cost prices on both timber and panels have risen significantly, with average cost prices up over 25%. The strong volume growth evidenced in the first quarter is returning to more normal volumes, finishing the half 4.9% higher than in the six months to 31 March 2021.

Gross profit percentage, which includes warehouse costs, for the six month period ended 30 September 2021 was 26.4% compared with 16.9% in the comparative six months. This six month period has been very turbulent with significant increases in the market prices for our products and well documented problems in the global supply chain leading to difficulties in obtaining regular supplies of inventory. We anticipated this issue and made sure that sufficient contracts were placed to ensure that our customers were not left short of stock. These significant increases in market prices did lead to a short-term improvement in margins as we worked through inventory purchased at competitive prices.

Overheads have been well controlled during the six months, although they are starting to increase with pressure on transport costs in particular.

Increasing cost pressures explain a notable difference between reported net profits (£26.6m) and net cash generated from operations (£1.7m), with the company investing £20.9m in inventory, while a similar £20.6m increase in receivables is something to monitor. The group says:

As at 30 September 2021 net assets are £146.4m (2020: £109.1m). Inventory has increased significantly, up to £69.1m from £41.3m. Apart from the increases due to the higher cost of our products, the supply chain has become extended leading to increased stocks on water from £7m to nearly £20m, as vessels are delayed both at the port of origin and the destination port. Trade and other receivables have increased by £23.65m to £68.4m due directly to the increases in revenues, but continue to show good debtor day figures, with bad debts remaining at a low figure. Cash and cash equivalents of £24.5m (2020: £26.1m) have been important to allow us to increase our investment in working capital especially the inventory levels. We continue to take advantage of additional early settlement discount opportunities with our suppliers.

The pension deficit is calculated as decreasing from £2.5m to just £12,000, largely due to a recovery in the plan asset valuations although the discount rate has slightly reduced. I would have expected the discount rate to rise in the current conditions, which would have been an added positive here.

Current trading and outlook – The second half of 2021/22 has started with slightly weaker volumes compared with the ‘exceptional’ six months to 30 September 2021, and margins are returning to more normal levels. There has been a reduction in prices of some commodity products but most products are seeing prices remaining firm.

The challenges persist in our supply chain, with shipment delays, congestion at the ports and container prices at all time high levels. Latham says issues could persist throughout 2022. Inventory levels have remained high in order to meet customer expectations. There will be continued inflationary pressure on the group’s overheads for the foreseeable future.

Some customers ‘are a bit quieter’, which is in part due to projects being delayed due to supply issues with non-timber products ‘but overall we remain confident that we will have a good end to our financial year despite the challenges ahead of us’.

The balance sheet looks fine – £24.5m of cash set against £50.4m of current liabilities, a current ratio of 3.21x, nearly £70m of inventories in hand (up from £41.4m), and a net tangible asset value of £143.96m.

Conclusion

These are exceptional first half results, well flagged to the market, but you can’t accuse the management of that classic strain of C-suite over-optimism. A number of pressures and challenges are noted in the update, with more time spent on these than on the stellar results. That strikes me as a prudent move.

It’s a fairly unforgiving market at present. Anecdotally, almost every private investor I’ve spoken to has had a difficult 3-6 months. So I wouldn’t be surprised to see Latham’s shares marked down on the cautious outlook. It doesn’t really matter to me, as I’ve bought in here for a long term hold. Any weakness could be a topping up opportunity.

The group’s recent acquisition in Ireland is integrating well and should complement Latham’s existing Abbey Woods business.

LTHM continues to be a relatively low risk investment given the strong cash position, no debt and stable yield. Can it repeat this performance in H2? It’s sounding unlikely, but what’s also far from clear is just where performance will settle given the variables. Based on the comments above, forecasting in the short term would be a complete stab in the dark.

With 133p of diluted earnings per share already in the bag (nearly double that generated in the entirety of FY21, and more than double that of any other year for that matter), the shares trade on less than 10x FY22 earnings assuming the group does not incur substantial losses in the second half. We’ll just have to wait as the conditions evolve to see what level of earnings per share H2 brings, and what more normalised trading conditions will really look like in the medium term.

It’s entirely possible that the shares might derate at some point in the future as volumes and margins normalise while managing the cost environment. Whatever the conditions may bring over the next 12 months or so, I view this as a sensibly managed business that can generate steady long term underlying growth.

Share price: 136.44p (+3.75%)

Shares in issue: 157,812,000

Market cap: £215.3m

Macfarlane has been listed since 1973 and has over 70 years’ experience in the UK packaging industry. It supplies a broad range of business customers with protective packaging and labels, which help its customers to reduce supply chain costs.

You might think that sounds boring, but that’s sometimes not a bad thing. It has worked well so far here.

There are two divisions:

Packaging Distribution – the leading UK distributor of a comprehensive range of protective packaging products; and

Manufacturing Operations – high quality self-adhesive and resealable labels for FMCG companies, and protective packaging for high value and fragile products.

These products are distributed to a range of sectors including e-commerce, consumer goods, logistics, and mail order.

Trading update

• Robust performance since the first half and the group now expects to exceed its previous full year expectations,
• Revenue has grown by 25% in the year to date and PBT is well ahead year-on-year,
• Both acquisitions made in 2021 are performing well,
• Net bank debt has reduced from £8.7m to £2m.

The remainder of 2021 will remain challenging due to input price inflation, supply constraints on various raw materials, and increased labour costs. Demand for packaging is also beginning to be impacted by customers’ own supply chain issues.

The group says:

The Macfarlane Group performance has been robust in demanding market conditions and is testament to the strength of our business model and the diligence of our people. At the interim results we indicated that we expected headwinds in the second half of 2021, so it is particularly pleasing to be once again raising our expectations for the full year.

Conclusion

This is a very short update to communicate that the group is trading ahead. Pressures are flagged for the rest of the year, but these were also raised at the interim stage and the company has since gone on to exceed expectations.

I have a positive initial impression of this company and it’s high up on the watchlist to research further. Today’s update does nothing to change that, in fact it probably makes it more of a priority given the relatively muted reaction to positive news this morning. Admittedly, it’s not all good given the challenges this company, and many others, presently face.

Even after a period of fairly strong share price performance, the company qualifies for the Neglected Firms Screen, which suggests it’s far from too late to begin investigating.

Share price: 187p (-0.27%)

Shares in issue: 71,320,680

Market cap: £133.4m

This software company is a recent listing. It allows complex businesses to outsource their back office functions with its Management Process Automation (MPA) software. It could be quite a big market, and if the company’s software is good and its market position is strong, then it could grow to become quite large in time.

That might be reflected in the valuation already though, with a fair bit of growth priced in. The group remains loss-making, is forecast to continue to be so for at least the next two years, and currently generates annual revenue of just over £20m on a market cap of about £134m. On the other hand it is growing its recurring revenue and should benefit from operational gearing if the company continues to win new business.

The thing to figure out is where will the company be in five years’ time? There are some notable institutions on the share register, including Canaccord, BlackRock, and Schroders, all of whom presumably feel this company can do quite well.

Interim results

Highlights:

• Total revenue +22% to £11.5m, made up of a 12% increase in software and subscription revenue to £9.6m and a 137% increase in training amp; implementation revenue to £1.9m,
• Gross profit +21% to £9.2m; gross margin of 80% is up from 78.4%,
• Loss before tax of £1m compared to a H1 20 LBT of £0.6m,
• Earnings per share of -1.4p compared to H1 20 EPS of -1.19p.

Annual recurring revenue at the end of the period was up 16% to £19.8m and the group notes ‘significant expansion sales in all key regions and targeted industries’, with five new customer logos added in the period.

Renewals have been in line with historical standards and retention is good, with three long term Australian banking customers extending their renewal cycle from one to three years (two of these came after the period’s end).

There has been a 60% increase in software development capacity and a data science function has been set up ‘to more rapidly address the many opportunities to exploit Artificial Intelligence within the product set’.

Increased investment in sales, marketing, and technology result in the increased loss before tax of £1.0m (H1 FY21: Loss £0.7m).

Outlook -

• Continued positive trading in the second half of the year, with a further new customer win, customer expansions and investment in product development
• Strong recovery of Tamp;I revenue continues, supporting software sales
• Increased confidence in delivering a positive full year performance, slightly ahead of Board expectations

Trading in the second half of the financial year has seen a continuation of the momentum seen in the first half. We continue to focus on our established strategy, maintain our position as thought leaders and expand the scope of our Workware+ platform to support our customers in simplifying the running of their operations.

With strong market drivers, alongside a proven and expanding proposition, we remain confident that we are well placed to deliver on our growth ambitions and we are excited about our future prospects.

Conclusion

The group is investing in its product suite and capability but the valuation remains a little high in my view.

Activeops does have a few trends working in its favour. The shift towards WFH and more hybrid methods of working increases complexity, which should benefit the group, as should the constant competitive search for efficiency gains, while the Covid pandemic has accelerated a more general digital transformation.

The StockRank has steadily improved (from a very low level) and the company has cash to invest, so it could be worth keeping tabs on in case growth trends accelerate or the valuation becomes more favourable.

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