Small Cap Value Report (Fri 14 Oct 2022) - BKS, LGRS, REVB

Good morning from Paul! It’s catch-up Friday today. For those of a nervous disposition, and reading this on Thursday, no you haven’t accidentally fallen through a worm hole in the space-time continuum, I’m publishing this early, partly so that I can have a bit more time in bed on Friday morning, and not get so stressed at 7am, but also so that everyone gets to see my notes on yesterday afternoon’s interview with Beeks Financial Cloud (LON:BKS) (I hold), which might have otherwise been overlooked, if it had been added late to Thursday’s SCVR.

Forthcoming CEO interviews – I’m really enjoying doing these CEO interviews, although it is quite a lot of additional work amp; stress, but if we can’t flag up decent companies at attractive valuations, and quiz management, then there’s little point in us being here!

So I’ve lined up some more. NB I only approach companies where they’ve issued a recent trading update or results which look good, and where I think there might be a long-term opportunity because the shares seem cheap, either as value, GARP, special situation, etc. So it’s really my best ideas from these reports, and then I contact the company and ask for an interview (no fee, as I want to be independent). So far, every company I’ve approached has been delighted to engage, so that’s encouraging. The next companies lined up for my interviews over the following fortnight are -

Sanderson Design (LON:SDG) – good recent results, and looks cheap. Lovely balance sheet.

Zotefoams (LON:ZTF) – we flagged it looked good in August, but yesterday’s update sparkled.

As always, these are never recommendations or advice. DYOR please, and it’s up to you to decide if or when to invest.

So if you have any particularly insightful questions, pop them in the comments section below, and I’ll pick up the best ones, as I did with BKS yesterday. If you’re finding them useful, then leave a comment, as otherwise I don’t know if these interviews are useful or not. 

Paul’s Section only as it’s Friday:

Beeks Financial Cloud (LON:BKS) (I hold) – I’ve typed up a summary (below) of my interview with CEO amp; CFO yesterday, also available on podcast, or here in audio version. It’s worth viewing the InvestorMeetCompany recording from yesterday first, as I did my interview immediately afterwards, and tried not to have too much overlap.  I got to the bottom of the kerfuffle over share options, and it’s not executive greed at all. I’m bullish on this share overall, due to the rapid amp; high quality recurring revenue growth, plus an obviously exciting pipeline. Over £20m of the £25m forecast revenues for FY 6/2023 are already in the bag, so I suspect upgrades are likely to continue (there were 3 last year). Not for everyone, and not a value share, and I think it’s probably priced about right for the time being. Long-term, I think this could be a significant winner. Time will tell, as always!

Loungers (LON:LGRS) – a reassuring-sounding scheduled trading update, but it glosses over the fact that whilst sales are up strongly on a 3-year pre-pandemic view, there’s been a significant drop from last year. It’s a quality operator, and a self-funding roll-out, but the profit margins are slim, and valuation looks way too high, given macro uncertainty. Although it’s not seen any downturn so far, and benefits from having local bars, so work from home helps. Overall, this share looks far too expensive for me, in current conditions. 

Revolution Beauty (LON:REVB) – shares are suspended – the CEO amp; Chairman are both stepping down from day-to-day operations, in order to focus on the forensic accounting investigation. Well-known turnaround specialist, Bob Holt, is coming in to run the business on an interim basis. I’m keeping an eye on this situation, but have no opinion on the shares, because we don’t have the full facts amp; figures to work out if it’s worth anything, and how much. We’ll keep a watching brief.  More detail below.

140p

Market cap £92m

CEO amp; CFO Interview – audio recording is here 

Summary of key points only (lots more detail in the audio)

1. Disclaimers – no fee being charged, I do hold shares personally, not financial advice nor a recommendation. Please do your own research.
2. Please describe the business in layman’s terms! It’s cloud computing to connect banks, brokers to financial exchanges, for trading purposes. Public cloud is small part of Beeks now. Private cloud is dedicated services for client’s own use. Deals typically $0.5m-$2.0m deals, over contract life (4-5 years). Proximity cloud – latest product entirely dedicated to one end client, $2-5m total contract value. Driven by client requests for better security where they control access to the servers amp; manage it themselves through Beeks user interface. Unique in sector, quick to implement, clients pay monthly. Exchange cloud – big deals in pipeline, with potential $5-20m total contract size, but complex amp; take time to negotiate amp; get through security/compliance.
3. Exchange cloud – ICE Group – biggest financial exchange group in the world, owns New York Stock Exchange. Built this for them, they then white label sell it to clients. Major endorsement of Beeks, and took 2 years to set up this deal. Rigorous testing, great reference site, they sell it for BKS. We’ve got dialogue with some of the next 10 biggest exchanges, at various stages of discussion. Big opportunity. New income stream for the exchanges, so they sell it. Can be switched on in an hour for ICE’s clients, as opposed to months to build their own connections. Don’t expect frequent big deals, it’s new business, longer sales cycle, but higher ticket size.
4. FY 6/2023 revenues – over £20m recurring revenues already committed. Forecast is £25m revenues. Big pipeline, nicely spread across each product. Sales processes are involved, lots of resource needed from the clients, but it’s a real quality pipeline that takes time to convert.
5. How sticky are customers? They’re “incredibly sticky” – getting into a big organisation is difficult, so once you’re in, and it works, customers don’t make changes. So if you become incumbent supplier, then inertia works on our side. Some churn for smaller clients, 1% churn per month is acceptable, as cloud services are meant to be flexible. Anything over 1% per month churn is flagged at Board meetings. Very sticky business.
6. Capex – I identified that half the £10m capex was one-offs (freehold amp; leases), regular capex is c.£5m p.a.. Bought stock (of IT kit) due to supply chain delays. That should be reduced as supply chains ease. Capex this year should be c.£5m too. Inventories could be sold to customers.
7. Reader question – most IT companies bill up-front, whereas Beeks seems to spend (capex) up-front. Couldn’t you change contracts? Yes, we’re looking at getting more cash up-front with new contracts. Also looking at debt amp; lease facilities. Looking at doubling RCF (undrawn currently). Want to preserve the cash on the balance sheet. Don’t want any more dilution. Large organisations look at our balance sheet, to make sure we show healthy cash balance. So we’re “very protective” of the cash balance. If mega deals happen, then we’ll try to work with customer to protect our cash pile.
8. Dilution – Gordon: I hardly take any salary (am lowest paid member of staff!), and I’ve never taken any share options. I’m heavily personally invested.
9. Share options – used up 80% of underlying profit, how can you justify this? This is not for management. CEO has never taken any options, and “never will”. Everyone at Beeks could walk out and get double their BKS salary, at big name banks in Glasgow. Average salary at Beeks is incredibly low (incl. Directors) is only £65k. Bulk of the options pot goes to the staff. Usually we do 2% p.a. In new share options to staff. Did a one-off 4% this year, as a thank you to staff for an exceptional year (i.e. as dilution of existing total shares). LTIPs come with 2-3 year lock-in. This is not executive greed. It’s to attract amp; retain talent. They’re locked in for several years, before share options vest. Will normalise to 2% p.a. Going forwards. We’re glad you’ve raised this point, so we can explain.
10. Conclusion – exciting time for the group, opportunity in front of us. Most product development done, headcount doesn’t need to rise much more, it’s all about sales execution.

My opinion - I hold this share as a long-term investment, and I remain of the view that it’s a credible, exciting growth stock. Which, to be fair, is reflected in the valuation of £92m, which does factor in a fair bit of future growth I think. The 57% organic growth rate in revenues was super-impressive for FY 6/2022. It’s clear that growth for FY 6/2023 should continue at a fair clip, although forecasts are for a slower % growth rate. Given that over £20m revenues are already in the bag for the current year, due to contracted monthly revenues, then it’s clear management don’t see the c.£25m forecast as challenging for this year, it’s likely to beat that. As they pointed out, last year saw 3 forecast upgrades, and with such a big pipeline (some are “mega deals” at a fairly advanced stage of negotiation), my money is on the company being well set up to beat forecasts. Plus, at some stage, we could get a big announcement or two about larger deals. So surprises look set up to be on the upside, rather than a profit warning, but of course we can’t guarantee that.

The CEO said this year is all about sales execution, with most of the product development now done. Headcount will continue to rise, but at a slower rate. This should mean that profitability now begins to significantly rise, as the operational gearing from rapid sales growth kicks in, on a cost base that won’t be rising as rapidly as in recent years.

Turning to share options, I got to the bottom of this. It’s not executive greed at all, and I think some subscribers here jumped to an incorrect conclusion, so I was happy to help clear up that misunderstanding. The bulk of the options go to staff, who are on lowish salaries (circa £65k average, incl. Directors), and the share options top them up by about £25k each. Double the usual share options were awarded in FY 6/2022 as a thank you to staff for their dedication and delivering an exceptional year of growth. That’s all great, and a wonderful example of how companies should be using share options. Sadly, at most other companies, executive keep the share options for themselves. Gordon McArthur is refreshingly different, saying “I’m the lowest paid person in the company…. I’ve never taken any share options, and never will, I’ve got enough shares already!” Isn’t that terrific?! I wish there were more entrepreneurs like Gordon on the UK market.

However, what this does mean is that the share options charge  of £1.6m last year, should not be adjusted out. It’s core remuneration for staff. It’s set to drop from 4% dilution, back to the normal 2% dilution this year, so £0.8m p.a. ongoing. Therefore I think this number should be deducted from the £2.0m underlying profit, to give an adjusted figure of £1.2m profit. That’s the real number, in my view.

I watched the InvestorMeetCompany webinar for Beeks, also yesterday, and tweaked my questions, so that my interview immediately after the IMC webinar did not duplicate too much. Therefore, I recommend subscribers here interested in BKS watch the IMC webinar first (it’s about 45 mins, and very interesting, with slides), then listen to my interview afterwards, as they fit together quite well I hope.  

206p (up 1% at 08:27)

Market cap £213m

Trading Update

Preamble – We didn’t cover the results for FY 4/2022 here, so I’m looking at them now, and the figures are really good – helped by Govt support measures of course, and hindered somewhat by the later stages of the pandemic (e.g. omicron caution either side of new year 2021/2).

LGRS is a successful roll-out, self-funding, of cafe/bars. Management are highly regarded by sector experts I’ve spoken to, seen as best in class.

We’ve also reported generally positively on LGRS here in the SCVRs since it listed in 2019, although at times the valuation has seemed a bit warm – but that’s because it’s well managed, and a good format, with a self-funding roll-out of new sites.

LGRS also seemed to cope well during the pandemic, and there’s only been modest dilution since it listed in 2019, and the share price is now similar to when it floated. Not bad overall, considering that period covered the pandemic, which obviously did tremendous damage to many companies in the hospitality sector.

I’ve done a sector comparison chart below, easy to do on the “CHARTS” tab from any company’s StockReport. Then you put in the tickers of the companies you want to compare it to, and can play around with the timescale (which often shows remarkably different stories, when you zoom in amp; out).

I’ve chosen some small cap competitors in the bar/restaurant space below, and chosen a 1-year timeframe -

.

As you can see, the whole sector has sold off in the last year, like so many other cyclical shares in this bear market. You can pick the comparison shares from the “Sectors” tab under “BROWSE” on the left menu. I normally sort the sector list by market cap first, to chose relevant comparison shares.

The stand-out ones are that Loungers’ share price has done the least badly, down 31% in the last 12 months. Note that its relative out-performance has all happened since July 2022, when it traded strangely sideways, whilst the rest of the pack continued falling. Suggesting maybe there has been a buyer in the market, accumulating shares, and supporting the price?

The bottom two are Hostmore (LON:MORE) which has been a disaster unfortunately, down 89%, and Restaurant (LON:RTN) isn’t a lot better at -62%.

Everything else is bunched in a pack, between about -36% to -56% in the last year.

If I widen the timescale out to about 3 years, starting pre-pandemic, then they’re all down about 65-85%, apart from NGHT (not relevant as it floated midway through this period), and actually LGRS is the stand-out relative success, being only down 2.6% since it floated.

So there we are, this has been a lousy sector (hardly surprising, due to the pandemic), but the stand-out relative success has indeed been Loungers.

On to today’s trading update, which is a scheduled update coinciding with the AGM, and the same reporting as last year.

Trading Update -

Loungers, a leading operator of all-day café/bar/restaurants across the UK under the Lounge and Cosy Club brands, today announces a trading update for the 24 weeks ended 2 October 2022.

Continued industry-leading like for like sales growth with 11 new sites opened during the period

Strong sales growth against pre-pandemic comparatives, but this is now 3 years ago, so the numbers need to be strongly positive, in order to absorb substantially higher costs (especially wages, which have risen a lot in the last 3 years) -

The Group has continued to significantly outperform the market. Over the 24 weeks to 2 October 2022, the Group delivered like for like sales growth of 17.0%, using the period 22 April to 6 October 2019 as the comparator…

LGRS doesn’t provide any comparison with last year’s sales, which I think is necessary. Although last year was distorted by the reduced 5% VAT rate (on food amp; non-alcoholic drinks) until end Sept 2021, then it moved to 12.5% until end March 2022.

I’ve looked back to what was said this time last year, in an update on 15 Oct 2021. That said LFL sales were up 26.6% vs pre-pandemic. That has now fallen to +17.0% against the same 2019 comparator, quite a big drop.

Therefore, today’s update omits the important information that LFL sales this year are actually down significantly vs last year. I don’t like that they’ve tried to hide this. I would have preferred it to have been disclosed, and then an explanation given – quantifying the VAT benefit to last year, which is probably a fair chunk of the shortfall this year, as that boost last year has now ended this year.

Net bank debt is £9.5m as at 2 Oct 2022, which looks fine I think, it’s quite modest for the size of business.

Site roll-out – is continuing, with 30 new sites expected for this full year FY 4/2023. 11 have already been done. Current portfolio is 206 sites, so it’s a decent-sized business.

Diary date – 30 Nov 2022 for interim results.

CEO comments are useful -

Out-performing the market.

New openings performing well.

Inflation – a bit vague -

We are operating in a particularly inflationary environment and we are working hard to mitigate inbound cost pressures

This below looks an important competitive advantage, and note they’re not seeing any downturn in trade currently (encouraging) -

As our strong sales performance demonstrates, neither uncertainty in respect of the wider UK economy nor consumer attitudes towards discretionary spending have to date impacted our sales. We are continuing to benefit from more people staying local, working from home, and supporting their community and high street, which are trends that we believe are here to stay.

My opinion - this trading update looks like an edited copy/paste from last year, following the same format. The trouble is, in both years, it doesn’t actually tell us the most important thing trading updates are meant to say – namely is the company trading in line with, above, or below, market expectations? That’s the point of trading updates, so to miss it out, is ridiculous I think.

We’re meant to deduce that it’s probably trading fairly close to market expectations, otherwise they would have been forced to say that it’s ahead or below.

We have to check broker notes too, in case any bad news is being quietly slipped out, in reduced forecasts. Although as mentioned the other day, I actually want to see forecasts coming down, to reflect worsening macro conditions. Otherwise we end up with profit warnings, and the obligatory 30% plunge in share price, that can be avoided if forecasts are steered downwards gradually beforehand.

As we can see from the Stockopedia graph (vitally important to check this for every share), forecasts have so far been slightly trimmed, which makes sense. I wouldn’t be surprised to see further cuts to forecasts, this doesn’t look enough, given how bad the macro picture seems to be getting -

.

Many thanks to Liberum for an update today, which makes an important point that energy costs are hedged into 2025. Its forecasts are unchanged today.

Forecast EPS is 8.6p for FY 4/2023, down almost half on last year’s exceptional profits. This is forecast to grow to 10.6p, and 13.2p in the following 2 years, but of course we can’t rely on any forecasts more than a few months out, in current uncertain times.

This puts LGRS shares on a PER of 24 times this year’s earnings, which I think is way too high.

So, it’s quite a nice expanding business, but the profit margin is thin, £11.4m adj PBT on £276m forecast revenue this year, is only a 4.1% profit margin.

The whole sector looks pretty horrible at the moment, and I understand why some subscribers won’t invest in the hospitality sector at all.

I’ll buy shares if they’re dirt cheap amp; improving their performance (e.g. Revolution Bars (LON:RBG) – no current position, but want to buy back), or XP Factory (LON:XPF) (I hold) which is a very rapid roll-out of a distinctive format, that is trading well (but we have to take that on trust from management, as there’s little track record in the numbers).

Whereas LGRS shares look very expensive, and why would anyone want to buy at this stage in the cycle, as conditions are worsening, unless you’re getting a stunning bargain, which we’re not?

So it’s not for me. I’d be interested if the share price halved from the current level.

.

19p (suspended)

Market cap £59m

Update on Independent Investigation

I’m keeping an eye on this share, which is currently suspended as an investigation takes place of all its accounting issues. If we keep abreast of developments, then it could be an opportunity to move quickly if a future opportunity arises, or to steer well clear!

Tom Allsworth (Executive Chairman) and Adam Minto (CEO) have voluntarily agreed to step away from the day-to-day management of the business for the time being, in order to allow them to support the independent investigation being carried out by Forensic Risk Alliance and Macfarlanes.

This decision to step away is not a result of any matter arising from the independent investigation to date. The Board, including Tom and Adam, considers that at the current time, the Group requires an operational leader that can devote their full time and attention to managing the Group’s business and lead the ongoing discussions with the Group’s stakeholders, including customers, suppliers and banking partners. Tom and Adam will remain Directors of the Group but will not take part in any day-to-day decisions concerning the Group until completion of the independent investigation.

An interim COO has been appointed, the well-known Bob Holt – that name has cropped up a lot in my investing career, but I can’t recall whether he did good things or not at previous companies. If any subscribers here have any recollections about him, please do share them below in the comments.

My opinion - nothing earth-shattering there really. I can see why it would make sense to bring in new operational management to focus on the turnaround. It strikes me that it probably needs 2 new leaders – one to actually run the business, and the other one to refinance it with the banks, shareholders, etc, as necessary, or maybe sell the business to a third party.

We’re completely in the dark as to how this might pan out. It’s not at all clear if the shares are worth anything now, and if so, how much? So no opinion from me, due to lack of facts amp; figures, but I’ll keep monitoring it.

.

Stockopedia