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Small Cap Value Report (Tue 12 Oct 2021) - CLX, OTMP, MNO, FCCN, DLAR

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

Today’s report is now finished.

Agenda -

Paul’s Section:

Onthemarket (LON:OTMP) (I hold) – solid interims, although the profit comes mainly from adjustments. Balance sheet, and cash position look fine. Good recovery from last year’s downturn, with H1 revenues up 46%, and profits ahead of expectations. I see speculative upside here. It’s a bit of a special situation, not a value share.

French Connection (LON:FCCN) – a final look at this company, now the recommended bid at 30p looks likely to happen. I’ve sold out at 29p, since in my view a higher competing bid is unlikely. Figures are academic now, but aren’t too bad – a small underlying loss, helped by taxpayer support measures. FRC investigation is unhelpful, but doesn’t seem to have put off the bidders. I wouldn’t want to hold for 1p more, with that risk hanging over me.

De La Rue (LON:DLAR) – in line with expectations trading update, for both profits and net debt. Looks cheap, but beware the enormous agreed cash outflows to address the pension scheme deficit.

Jack’s section:

Calnex Solutions (LON:CLX) – comes across as a classy operator with a sustainable growth opportunity supported by several underlying trends. The valuation looks high in the short term, but it is worth considering the longer term growth prospects here.

Maestrano (LON:MNO) – provides rail networks with an automated railway inspection solution. The company is winning new clients but has still yet to turn a profit. Management expects to reach cash flow breakeven in the next six months, so it could be worth monitoring, but it’s still early days for this risky micro cap.

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.


Paul’s Section: Onthemarket (LON:OTMP) (I hold)

92p (pre market open) – mkt cap £68m

Interim Results

OnTheMarket plc (AIM: OTMP), the majority agent-owned company which operates the OnTheMarket.com property portal, today announces its unaudited interim results for the six months ended 31 July 2021

STRONG GROWTH AND STRATEGIC PROGRESS DRIVING PERFORMANCE AHEAD OF EXPECTATIONS

This is the UK’s 3rd residential property portal, behind market leader Rightmove (LON:RMV) and privately owned Zoopla (bought out in a £2.2bn deal in 2018, by some crazy Yanks, Silver Lake – venture capitalists).

At this early stage, I’ve only quickly skimmed through the numbers, and the outlook comments, I’ll read all the detailed commentary later, on the train up to London (assuming the train’s wifi works, which it usually doesn’t, and nothing works [not even normal phone calls] between the New Forest and Winchester, apart from a brief burst of connectivity in Southampton. What sort of backwater is this country, as I keep demanding from my MP via the handy WriteToThem website?!).

Key points -

H1 revenue up 46% to £14.9m – helped by soft prior year comparative, but it’s a strong rebound.

Impressive adj operating profit of £2.1m, although this strips out £1.2m of share-based recruitment charges (free shares for estate agents that sign long-term contracts, with a lock-in on the shares)

Net cash of £9.9m, down a little from £10.7m a year earlier – no risk of insolvency in my view, especially as we saw during the pandemic how OTMP can slash its mostly variable costs in a downturn.

Statutory (i.e. not adjusted) profit before tax is breakeven, at £45k. There’s a tax credit though, so PAT (profit after tax) is £485k. That’s fine, it’s a growth company, so I don’t expect, or particularly want, profits at this stage.

Zeus note – useful, many thanks. Zeus tends to be supportive, and provides the upside case.

Balance sheet - is OK, with NTAV at £7.7m. Note there is £2.1m in deferred consideration, which could dent the £9.9m cash pile.

Dilution risk as things stand is low. However, there could be dilution if the company decides to accelerate marketing spending in future.

Outlook – this is encouraging, and I’m relieved the new CEO is not blowing the cash pile on more lousy TV ads, which is what happened in the past -

After a positive first 6 months, the Board now anticipates revenues to be slightly ahead of expectations and adjusted operating profit to be substantially ahead of expectations for the full year to 31 January 2022.

Although instructions are subdued, which sounds like it might have read-across to other property related businesses, like estate agents, possibly?

Demand for residential properties in the UK has remained at very high levels, however sales and lettings instructions remain subdued.

Marketing spend is being increased in H2, so breakeven for H2 -

Full-year advertising expenditure is expected to be H2 21/22 weighted, with the rollout of a refreshed brand and website…
This increased marketing investment is expected to result in H2 21/22 adjusted operating profit being approximately breakeven.

“Encouraging pipeline” of new commercial arrangements – vague, but sounds interesting.

Webinar - on InvestorMeetCompany at 18:00 on 19 October. I thought the unfeasibly young-looking CEO came across very well on the last webinar. He’s spent his whole career in estate agency, so knows his stuff. I think the strategy is sensible. It’s working so far too, in that the company is not generating losses, or significant cash burn, which is the main battle with challenger companies like this.

My opinion - I see OTMP as a special situation. It’s difficult to value on current performance, but the potential upside could be seriously large if it achieves a step change in growth, and becomes a serious challenger to Rightmove and Zoopla. It’s already got a lot of agents signed up, initially on free, but now mostly paying contracts. OTMP is very much cheaper than price-gouging Rightmove (LON:RMV)

The key challenge, not yet achieved, is for OTMP to work out how to drive enough customer traffic to its website.

Remember that overheads are flexible, so to some extent the company can dial up whatever profit/loss it wants, within a range, by flexing marketing spend. Therefore I’m happy as long as it’s at breakeven or better.

I like OTMP as an each-way bet. It’s profitable, and not burning cash to speak of. Therefore, the downside is quite well protected. Meanwhile, the potential upside could be very large, if the upside case plays out. Or it might be modest, if the company grows more slowly. Or it could fizzle out slowly over time. Time will tell, nobody knows what the future holds.

Hence risk:reward looks intriguing to me, at £68m market cap, because the upside case could be a serious multibagger, but I don’t know how likely that is.

In terms of investor sentiment, ignoring the pandemic blip below, it’s established a base around 100p, which has held for about 3 years now, with a backdrop of improving fundamentals. That might attract momentum buyers, if it breaks out to the upside, possibly?

.

.


French Connection (LON:FCCN) (I do not hold any more)

29p (unchanged today) – mkt cap £28m

Interim Results

French Connection Group PLC (“French Connection”, the “Company” or the “Group”) today announces results for the six-month period ending 31 July 2021.

I’ll keep this brief, because there’s a recommended 30p cash bid currently in progress.

I sold my shares recently, and was required to issue a form 8.3, because I’d accidentally gone just over 1% before bid talks were announced. The Takeover Panel, and the RNS service were incredibly helpful in holding my hand through the process of issuing the forms required. So if you end up in that situation, it’s nothing to worry about, just ring them up and ask for help, which is readily forthcoming I found. It’s rather amusing, seeing my name on the list of company announcements!

It seemed to me that, with the share price at 29p, there’s only 1p extra upside to be had. I was happy to give that to someone else, because I reckon the chances of a higher competing bid are probably between very unlikely, and zero. The company’s been up for sale for such a long time, then surely anyone interested would have got involved by now?

Also, recent news of an FRC investigation into its accounts could increase the risk of the takeover bid falling through, so risk:reward looks negative to me now at 29p.

The interim numbers don’t look too bad at all, although remember business rates relief is a really big benefit to multi-site companies at the moment. You have to add that back in, when doing estimates of future performance.

Wholesale amp; licensing look OK (that’s the value in the business).

Balance sheet – is still OK, despite many years of losses, plus the chaos of the pandemic. This is a really important point to reinforce. The reason FCCN survived, and is giving shareholders a solvent exit, is because it had such a strong balance sheet. This enabled the company to keep trading, slowly dispose of loss-making sites on lease expiry, and come out the other side of the pandemic. Many supposedly better competitors (e.g. Topshop, Debenhams, etc) went bust. Why? Ruinous lease liabilities, and weak balance sheets, plundered by greedy owners in the good times (Philip Green amp; private equity, respectively).

Also of course, the shift online has killed off a lot of the High Street, and often ignored is the stellar growth of Primark – under-cutting the higher margin competition.

The 30p take out price is not great, but it’s adequate in the circumstances. It would have been a lot higher, if it hadn’t been for the damage done by the pandemic, so I think that does partially vindicate the original bull argument on this share (at least in the last couple of years anyway). Anyway, bottom line, I made a nice profit on FCCN, which has helped mop up some of the paper losses on Boohoo (LON:BOO) and Asos (LON:ASC) (both of which I hold).

There’s not really a lot else to say. Would I kick myself if a higher competing bid does come along? No, because I’ve made a rational decision to sell at 29p, based on risk:reward carefully thought through. If a surprise happens that could not have been foreseen, then that doesn’t in any way undermine the decision. We have to just act logically at all times, based on our assessment of the situation, and then accept the consequences, whatever they are.

I can’t tell you what a relief it is, to draw a line under FCCN, with a fairly decent outcome too. I’m sure readers will also be relieved to not have to read effectively the same article about FCCN from me, every time it reports numbers! Good luck to the new owners, I hope they make a success of the business, now the founder is finally retiring, after a stint of almost 50 years. Hopefully he’ll write his memoirs, which I’m sure would be an interesting yarn.

.


De La Rue (LON:DLAR)

168p (up 1% at 12:26) – mkt cap £329m

Trading Statement

Here’s the whole thing, as it’s concise -

De La Rue plc (LSE: DLAR) (“De La Rue”, or “the Company”) today announces a trading update for the six months ended 25 September 2021.

Trading in both our Currency and Authentication divisions for the first half has been positive, with our Turnaround Plan and cost reduction activities continuing to strengthen the Company’s performance versus the similar period in financial years 2019/20 and 2020/21. The outlook for the financial year 2021/22 continues to be in line with the Board’s expectations.

Net debt at the half year was lower than expected, and less than at the end of the financial year 2020/21. This was as a result of both the phasing of capital expenditure and strong cash collections. The outlook for net debt for the full year is in line with the Board’s expectations.

De La Rue expects to announce its results for the six months ended 25 September 2021 on 24 November 2021.

There’s not really much to say about that. In line with expectations for both trading, and net debt.

Here are my notes on the accounts for FY 03/2021.

To recap, DLAR is an excellent turnaround situation, but the agreed pension scheme cash outflows are absolutely huge. Therefore, this is why the shares look good value, on a forward PER of just 9.2 – it’s because a lot of the cashflows will be sucked out into the pension scheme. That’s the biggest issue in terms of valuing the share. It also means divis are not likely to be as large as you would expect from a low PER company, because the pension scheme has priority for free cashflow.

I don’t have a strong view either way. Given that the turnaround is proceeding as planned, at some stage there could be more upside on the share price, who knows? The upside case would be if pension scheme recovery payments are able to be renegotiated downwards in some way.

A PER sub-10 does seem to factor in a lot of downside, so it could be worth a deeper dive, if you understand pension scheme accounting properly. On balance therefore, I’m tilting towards being more positive than negative on DLAR shares.

Note also that the share count rose a lot in the refinancing, increasing from 114m to 195m, which has to be taken into account when looking at the chart – i.e. it’s not likely to recover fully to the previous highs per share, as there are many more in issue now.

.


Jack’s section Calnex Solutions (LON:CLX)

Share price: 127p (+10.92%)

Shares in issue: 87,500,000

Market cap: £111.1m

Calnex makes hardware and software solutions that test the performance of critical telecoms and data network infrastructure. This is an essential task for telecoms operators and there is increasing demand for it, with major drivers including 5G, the Internet of Things, and cloud computing. Calnex is well placed with a good reputation and a strong market position.

The shares rerated strongly after IPO, more than doubling in short order. Performance since then has been more muted just above the 100p level, but it’s interesting to note that the StockRank has recently been improving at these elevated levels.

Trading update

The Board is pleased to report that the Group has experienced continued strong levels of trading in the first half of the year and expects this trend to continue through the second half of the year. As a result of the strong performance the Board anticipates that revenue and profits for the full year will be materially ahead of previous expectations.

A strong cash position has allowed Calnex to bring forward planned investment in the team to increase operational capability, in line with order growth.

The group has seen a return to pre-COVID customer spending patterns in all regions, except for China where demand has been in line with the previous year. There has been ‘a sustained positive response to the launch of the enhanced Paragon-Neo’, which is Calnex’s Lab Sync Platform. This is being adopted both by existing customers and new customers looking to deliver products addressing the new O-RAN standards.

The new version of Sentinel has also seen strong uptake from hyperscale enterprise customers who are investing in their datacentre operations.

Calnex has not experienced any negative impact from the ongoing global semiconductor shortage to date on the ability to manufacture and ship product, ‘although the Board continues to monitor the situation closely.’

Tommy Cook, Chief Executive Officer and founder of Calnex, said:

Whilst we remain cautious with regards to the ongoing global semiconductor shortages, the strength in customer orders in the first half of the year provides us with confidence that the full year revenue and profits will exceed that of the record prior year and mark another considerable step forward for Calnex, as we continue to capitalise on the industry’s transitions to 5G and the growth of cloud computing.

Conclusion

Calnex is successfully delivering on its growth strategy and it is supported by several long term market growth drivers in the telecoms market. It has a strong position in this market and an opportunity for sustainable, profitable growth with its founder at the helm.

There’s no doubt the shares look expensive at present but a premium is probably justified owing to the positives above and the current trading.

Gross margins are high and the company has the cash generation to invest in growth initiatives. Meanwhile, its relationships with customers mean it is well placed to anticipate future needs, which should further entrench its market position over time.

A key short term risk is potential future disruption resulting from the semiconductor shortage, but this has so far been avoided. And at these levels, there is always scope for the share price to drift downwards should some investors be tempted to take short term profits. If there are any pauses in year-on-year growth over the medium term, that could also lead to some selling due to the high earnings multiple.

The dynamics are favourable here though so it’s probably worth thinking more in terms of where the company might be in five years’ time than, rather than today’s P/E ratio.

More detail will be provided in the group’s results for the six months ended 30 September 2021 on 23 November 2021.


Maestrano (LON:MNO)

Share price: 13.8p (-3.16%)

Shares in issue: 170,177,186

Market cap: £23.5m

This is a serial loss maker that has burning cash for many years now, with losses forecast to continue.

These kinds of speculative companies that require ongoing funding can make it big, but I suspect this is statistically less likely than the alternative (losses for longer than expected and additional equity dilution, potentially at lower share prices), and so caution is required.

So far, Maestrano’s share count since listing has increased from 80m to 170m, with all of the dilution occurring from 2019 onwards. So that’s a compound annual growth rate (CAGR) of about 28.6% in share count over a three-year period. Over the same timeframe, revenue has increased from £0.95m to £1.7m so we are not yet seeing the levels of growth that shareholders must be hoping for (although the company says its forecast 4Y revenue CAGR is a potentially transformational 104%).

The company offers an ‘automated railway inspection solution’ that lowers costs and improves efficiency for rail networks. Its cloud-based platform allows for the capture and analysis of large datasets within the transport sector, with the use of artificial intelligence algorithms.

This is a $30bn global market, but the fact remains that Maestrano is an illiquid, volatile, loss-making micro cap, so clearly it’s high risk. The group is changing its name to Cordel Group and will use the ticker CRDL, so that’s how I’ll refer to it going forwards.

Final results

Highlights:

  • Revenue +94% to £1.69m,
  • Total expenses +50% to £2.93m,
  • Loss before tax has increased by 26% from £0.97m to £1.22m (up by 12% on a constant currency basis)
  • Cash at 30 June 2021 of £1.54m.

The group has won its first US Contract with Union Pacific Railroad, the second largest Class 1 Railroad in the US. This could be a big win after a period of investment and cash burn in the US, potentially making future wins easier as well. The US is an extremely careful and conservative market and customers conduct detailed evaluations on the type of product that Cordel offers. It now has a foot in the door with a Class 1 customer and management expects the US business to quickly become profitable.

In the UK, Network Rail awarded Cordel a 12-month gauging automation contract and the group will provide analytics on HS1, the UK’s fastest railway.

This has been a year of international expansion. The next year will see more resources dedicated to customer acquisition in its key markets, as well as increasing both miles scanned and the range of analytical products delivered to existing customers.

If this happens, it would translate into organic revenue growth and margin expansion. A higher number of scanners running continuously upon a greater number of trains would result in a greater proportion of future revenues being recurring.

Cordel is currently investing in increasing the scale of the business, hiring additional people to process more customer data and set the platform for future revenue growth, but it still expects to reach cash flow breakeven within the next six months.

Nick Smith, CEO of Maestrano, commented:

We are confident of continuing our current growth trend in FY22, acquiring new customers for Cordel and providing greater levels of service to our existing customer base. The market is becoming increasingly receptive to our Cordel solutions and their ability to help rail operators minimise accidents and delays while significantly reducing costs and emissions. In addition, we are developing our distribution network to drive increased Nextcore unit sales. We look forward to delivering further growth in value for our shareholders.

Conclusion

I can see why some might be tempted by the prospects, but it’s still early days and so I’m waiting for further developments. If everything plays out as management says, then the company should be a much less risky proposition in a year’s time.

There’s a big market here and Cordel is building up proprietary AI and machine learning solutions capturing and processing data. That means its solutions can become increasingly valuable to risk-averse rail operators. The company is winning contracts too, so it does suggest the situation is worth monitoring.

Its FY22 should be cash breakeven with a smaller loss than FY21. It’s possible that large contract wins could lead to larger overheads but right now the plan is to wind back the cash burn and be cash flow positive by the end of the year. If all goes to plan, FY22 could be a transformational year. I would want to see confirmation of that before seriously considering the shares. Why invest today if the company might be substantially de-risked in twelve months’ time?

Stockopedia


Source: https://www.stockopedia.com/content/small-cap-value-report-tue-12-oct-2021-clx-otmp-mno-fccn-dlar-883380/


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