Small Cap Value Report (Mon 31 Oct 2022) - CRPR, ARB, ESP, SAG, TPG, LOK

Good morning from Paul amp; Graham!

Paul’s weekly recap podcast went up on Saturday evening, the audio is here (and on podcast platforms). Also, for Stockopedia subscribers only, I’ve typed up a written summary, which is here.

Mello Chiswick - I’m looking forward to seeing many friends old amp; new at the resumption of this in-person event. I hope people support it, as it would be such a pity to see everything go online, and lose the important social aspect of investing.

Edmund’s article on Market Musings - this is a very interesting series of articles, which you might not have seen, so do check them out.

Paul’s Section:

James Cropper (LON:CRPR) – a profit warning for H1 (breakeven), but better results expected in H2. Reasons given are sensible – a 20% hike in raw materials, plus the energy spike, and time lags in passing this on to customers. The trouble is, this is now looking to be the 3rd consecutive year of EPS around 15p. So a share price of 995p looks crackers to me. There’s also some net debt, and a pension deficit. Cropper looks very significantly overvalued, in my view. Edit: the price has been marked down c.20% this morning, but hardly any trades printed (so far), it’s very illiquid.

Science (LON:SAG) – has been circling TP (LON:TPG) for a while now, and a deal has been struck for SAG to acquire the 72% it doesn’t already own. SAG has impressed us here at the SCVR for a while, so let’s hope it makes a success of this acquistion.

Graham’s Section:

Argo Blockchain (LON:ARB) (£35m) – this looks like it may be reaching some sort of conclusion. The equity investment that the company hoped for has not come through, and it has resorted to selling newly-purchased bitcoin computers that it has not yet taken out of the box. Bitcoin mining is an inherently leveraged activity and Argo has combined it with financial leverage, making for a toxic combination. Energy costs are up, crypto prices are down, and there’s a very real chance that these shares are worthless.

Empiric Student Property (LON:ESP) (£504m) – this REIT has issued two statements today. The first one is a dividend declaration (0.625p per share), and the second is a business update. Empiric’s properties are “effectively full” despite rents rising by 5.2% on a like-for-like basis for the new academic year. Further rental price increases of 5% are targeted for next year. The balance sheet here appears to be conservatively managed, and the company is behaving cautiously given the economic and interest rate environment: its development and acquisition pipeline has been “largely paused”. I think it could still generate respectable and reasonable returns for investors from the current valuation, despite running a cautious strategy.

Lok’n Store (LON:LOK) (£270m) – terrific results from this AIM-listed self-storage company. All the metrics are up sharply, having been boosted by “sale and manage back transactions” that have taken a huge chunk out of the company’s outstanding debt. It is now almost debt free and has great flexibility with how it wishes to plan its future strategies. The founder of the company is still the largest shareholder and is running it as Executive Chairman. While the shares aren’t cheap by any means, I think the company has done more than enough to justify this valuation.

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.

783p (down 21% at 08:25, but on hardly any volume so far)

Market cap £75m

Half Year Trading Update

In advance of its interim results announcement due on 15 November 2022, James Cropper plc (‘CRPR’, the ‘Company’ or the ‘Group’), the leading advanced materials and paper products group, today issues an update on trading for the half year ended 24 September 2022.

‘Unprecedented inflationary headwinds impact the half year; the Group continues to prepare for growth’

Strong Q1 (revenues up 36% vs LY)

Growth rate slowed to +26% for H1, implying Q2 might have been somewhere around +16% (my rough calculation)

Wholesale gas prices +148%, mitigated by energy surcharges to customers.

Raw materials price inflation up 20%

Margins “temporarily squeezed” due to time lag in passing on price rises.

Overall result for H1 is breakeven.

H2 outlook sounds better -

The second half of the year shows a recovery through aggressive pricing actions and surcharges, supported by the recently announced Government support on energy prices. Each division is projecting volume growth over the second half. Order books are full and the Company is focused on a range of enabling actions to build a solid foundation for continued future growth.

Profit guidance for FY 3/2023 -

As a result of the current unprecedented macro-economic environment, management expectations for FY23 have been reduced with a year-end adjusted PBT of £2.0m against previous market expectations of adjusted PBT of £5.4m.

Clearly that’s a big drop in profit expectations, but the reasons given shouldn’t really be a surprise to the market, surely? Although the company doesn’t seem to have guided brokers down in recent months, which seems surprising, given known cost headwinds.

These forecasts are going to be slashed now, probably by about two-thirds for FY 3/2023 -

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Management commentary sounds more upbeat for the medium term -

“Overall, despite the short term setback in profitability, growth prospects for the Group as a whole remain significant in the coming years.”

My opinion - as management says, this is an energy-intensive business, so I’m struggling to understand why they didn’t manage market expectations down earlier? The big spike in energy costs was several months ago now.

It made £4.0m adj PBT in both FY 3/2022 and FY 3/2021. So a drop to £2.0m this year isn’t a disaster, and the reasons look perfectly fair – due to unplanned external factors, not internal mistakes.

With EPS now likely to be around 15p for the 3rd consecutive year, why on earth is the share price anywhere near 995p? (pre market open) That’s a PER of 66. We’ve questioned the high valuation here before. These may be temporary factors announced today, but I think far too much of the valuation rests on future hopes of improved performance, rather than historic numbers, which are now looking weak, if you take into account this year’s reduced profitability.

Note there’s also net debt, and a pension deficit.

I think this looks way overvalued.

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388p (up 2% at 09:01)

Market cap £175m

Recommended Cash Acquisition of TP Group

For anyone not aware, “recommended” means that both sides have agreed the terms of the deal, so it’s highly likely to go ahead.

The price is 2.25p cash for TP (LON:TPG) shares, a striking 190% premium. That is until you look at the chart for the last 3 years of TPG -

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Still, a nice trade for anyone who was lucky (or naughty!) enough to have bought TPG shares in the last 3 weeks.

The deal is valued at £17.5m in total (this is about 10% of SAG’s current market cap).

Although because SAG already owns 28% of TPG, it will only need to buy the 561m TPG shares it doesn’t currently own, so a cash cost of £12.6m.

SAG will take on £7m debt from TPG.

Onerous contracts within TPG’s Maritime division.

SAG made a takeover approach at 6.5p in 2021, so today’s 2.25p offer reflects a worsening position at TPG.

Only one institution, Hargreave Hale with 11.7% has backed the deal so far, so with SAG’s 28% that makes nearly 40% – so not necessarily a done deal yet, but probably heading that way.

My opinion – I do wonder why SAG has been so intent on acquiring TPG, when its performance over many years has been so poor? It talks about synergies, but even so.

On balance though, SAG should know TPG very well by now, due to having Directors on its board, and SAG itself has established a very good track record of being well managed, and doing good deals. I recall we’ve reported positively on SAG here many times.

Share price: 7.5p (-52%)

Market cap: £35m

The SCVR has only occasionally covered this bitcoin miner. In late August, with a market cap of nearly £200m, I suggested that it was worthy of giving the bargepole treatment, on the basis of its levered balance sheet and (in my view) overly aggressive growth strategy.

Here we are two months later. The pre-open market cap has fallen to just £73m, and that’s before this disastrous RNS:

The contents of today’s announcement:

• The equity investment of £24m that the company was hoping for, is apparently not happening.
• The company sold nearly 4,000 freshly delivered bitcoin mining computers that it hadn’t taken out of the box.

And then the hammer blow (emphasis added):

Should Argo be unsuccessful in completing any further financing, Argo would become cash flow negative in the near term and would need to curtail or cease operations. The Company is endeavoring to complete such financing transactions to provide the Company with working capital sufficient for its present requirements, that is for at least the next twelve months from the date of this announcement.

If it wasn’t so heavily indebted, the prospect of curtailing or ceasing operations would not be so unsettling. Because without its debts, it would be more feasible to have the crypto equivalent of “care and maintenance” – preserving its operational capabilities and simply waiting for prices to become favourable again.

However, its debts are significant. As of June 2022, they were:

Note that even if the company gets the working capital it needs for its “present requirements”, there’s every chance that it will need more from investors after that. The share count has only gone in one direction at this stock:

My view

This looks like it could be headed for a wipeout of existing equity. I avoid saying that sort of thing with certainty, because there is always the possibility of a white knight turning up and giving a struggling business the funds it needs, before it goes bust.

Betting on that sort of thing is of course extremely risky. And without a white knight, these shares look destined for an ignominious ending.

Share price: 83.5p

Market cap: £504m

It has been quite a while since we looked at this one.

Empiric Student Property plc (ticker: ESP), the owner and operator of premium student accommodation across the UK, is pleased to provide a business and trading update.

FY 2022 earnings will be “broadly in line with consensus at 3.2 pence share”. The Stockopedia EPS estimate is 3.23p.

Key points:

• Revenue occupancy 98% for the new academic year (it was only 86% last year).
• Like-for-like rents are up 5.2%, and minimum growth of 5% is targeted for 2023/2024.
• Disposal of a non-core property for £13m, above book value.

The CEO says that they are “effectively full” at this record-high occupancy level. Reaching 99% or 100% is in practical terms impossible, I imagine.

He continues:

“The wider economic outlook remains uncertain, however the higher education sector is known for its resilience and we expect UK universities to remain attractive to both domestic and international students. We are firmly focused on our premium accommodation offering and believe our approach to high quality customer service delivered through our Hello Student brand places us in a strong position.”

Developments – the economic environment is not conducive to expansion:

Given the current market volatility we have largely paused our development and acquisition pipeline.

Indeed, the Empiric share price reflects the uncertainty in the broader property market.

Note that net tangible assets per share, calculated in accordance with the rules for real estate companies, was reported at 117.8p for June 2022.

This compares with a share price of just 83.5p as of this morning:

Debt – the share price reflects its financial risk too, of course. Fortunately, Empiric’s financial situation appears to be sound: The LTV and the cost of debt are both low:

As at 30 September 2022, LTV was 29.7 per cent (based on 30 June 2022 valuations) with a weighted average cost of debt of 3.7 per cent, and a weighted average term to maturity of 4.8 years. Two thirds of our debt is fixed and one third floating. Cash and undrawn committed facilities totalled £100.6 million.

With an average term to maturity of 4.8 years, there will be a little bit of work to do with respect to refinancings in the years ahead. They say they are “in active and constructive discussion with lenders in respect of refinancing requirements.”

My view

I like the overall theme here. Premium student accommodation tends to find tenants easily, even if most of them come from abroad.

Empiric does say that after “targeted marketing during the pandemic”, it has raised the share of UK students to 50% of bookings. After a couple of years of normal international travel and normal marketing efforts, maybe this will head back to its historical average?

29% of bookings are from China and I suppose any strain in UK-China relations could impact this very large and important segment.

But overall, I like what this share is offering: a discount to NAV, a property niche that tends to find tenants quite easily, modest leverage ratios, and foreign customers whose spending power is somewhat immune to local considerations.

This share is unlikely to shoot the lights out but barring exceptional circumstances, it should generate a reasonable return for its investors, hopefully including both a dividend stream and a reduction in the share price discount to book.

Share price: 900p (+8%)

Market cap: £270m

Let’s check in on this self-storage company and see how it performed in FY July 2022:

• Revenue +22.9% to £26.9 million
• Adjusted operating profit +49.8% to £11.4m
• Operating profit +130% to £17.2m
• Adjusted NAV per share up 33% to £9.72.

It’s an amazing set of numbers.

Lok’nStore managed to sell four of its stores at a nice premium to their book value, in deals that it calls “sale and manage back transactions”. It is now generating revenues from managing these properties that it used to own.

As a result of this strategy, net debt has collapsed to just £20m, for an LTV of 6.6%. At this level, we can think of it as virtually debt-free.

The growth ambitions are still there, however: it currently has 40 stores (24 owned and 16 managed), and has 10 sites in its “secured store pipeline”.

The strategy is “unchanged” – “increase revenue from existing stores and open more new Landmark stores”.

The comment from Exec Chair Andrew Jacobs is brimming with confidence:

We aim to build more Landmark stores in the under-supplied UK market. We are growing the business from a strong financial platform that gives us great flexibility to respond to market circumstances. We have multiple levers to allocate our capital in ways which are most accretive to our shareholders through the economic cycle, and we are confident that we will continue to increase net assets, cash flows and dividends.”

Note that Mr Jacobs is the founder of the company and still owns 19%, making him the largest shareholder by some margin:

Aside from the very rare family business that we occasionally come across, this is the ideal situation. It doesn’t get much better than being able to co-invest with a successful founder who still owns and manages his or her business.

Valuation: properties are valued each year by Jones Lang La Salle.

There’s some alchemy here involving discount rates and exit yields, but the valuations shouldn’t be too far wrong. So I would give some weight to the adjusted NAV of £9.72 per share.

Outlook statement

Here’s an excerpt:

This year’s results are excellent with all metrics sharply higher, and trading since the period end is good. The continued strong demand and high occupancy levels across our stores give us pricing opportunities in the coming year.

Lok’nStore continues to experience strong year to year revenue growth on a same store basis and this will be enhanced by the three stores opened this year and the opening of four new stores opening over the coming year.

My view

Self-storage is an outperforming niche in the property market, and I think the positive underlying drivers are here to stay (increasing population density and lack of space!).

And within this niche the large, specialised self-storage companies provide a level of service that I presume the independent, smaller operators can’t guarantee.

These shares aren’t available cheaply but investors are getting a lot included in the price: excellent financial performance, a rising stream of dividends, great underlying growth prospects, and aligned management. These things are rarely priced at bargain levels.

Stockopedia