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Small Cap Value Report (Tue 4 Oct 2022) - CCT, WJG, NMRP

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Good morning from Paul amp; Graham.

Agenda - 

Graham’s Section:

Character (LON:CCT) (£94m pre-market) – a profit warning from this designer and distributor of toys, games and giftware. FY August 2022 has been impacted by freight rates and the strong dollar, as the company makes purchases in dollars but does not earn in dollars. As a consequence, results will only be “broadly” in line with expectations. FY August 2023 is shaping up to be worse, again due to the strong dollar/weak Sterling but also due to the expected cost-of-living crisis. This perhaps should not come as a surprise but CCT shares are likely to dip further into bargain territory as investors wonder how long they’ll have to wait for trading to recover. I view this as a decent company with a strong balance sheet and I suspect that the shares will offer good value over the coming months, until economic conditions start to normalise.

Watkin Jones (LON:WJG) (£258m) – an awful sell-off for this developer, builder and third-party manager of new homes for rent (purpose-built student accommodation and built-to-rent). FY 2022 finished with disappointment as some forward sales were delayed and higher borrowing costs for buyers hurt the margins achievable by the company. Watkin Jones is sensibly expecting this softness to continue, as there is no reason to believe that borrowing costs are going to reduce in the year ahead. The business model of forward sales and high visibility has served the company well over the years but I’m taking a neutral stance due to the risk that interest rates continue to increase and given the fact that Watkin Jones shares still trade at a high premium to their balance sheet value.

National Milk Records (OFEX:NMRP) (£23m) (+4.7%) [no section below] – please note that this company is listed on the Aquis Stock Exchange, not on AIM, which can have some tax implications. It also indicates that this is a particularly small company with even less liquidity than you would normally expect from an AIM stock. NMRP provides data services for farmers, vets and milk purchasers and as far as I know has very little competition in this micro-niche (50% of the UK cattle herd is tested by NMRP). This would explain its historically very high ROCE and ROE: for such a small company, it has a great track record of profitability. Today’s results continue the theme with revenues up 5.7% to £23m, operating profit up 20% to £1.6m, and diluted EPS of 11.5p (last year: 9.6p).

Digging into the commentary a little bit, the key drivers of the performance have been stable milk supplies from UK agriculture, along with increased demand for Johne’s disease tests, farm software, etc. The company is also working on various initiatives for growth including a genomic testing service where NMRP owns the underlying technology. I can’t help but have a positive impression of this company (I love any business with a high market share) and better still, the valuation does not look overly stretched. So this one is worthy of additional research and may be worth buying, in my view.

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.

Character (LON:CCT)

Share price: 489p (pre-market)

Market cap: £94m

Unfortunately this looks like a profit warning from Character.

The company “is engaged in the design, development and international distribution of toys, games and giftware”.

I’ve had a positive impression of this company for many years, but I felt priced out of it after the share price increased in 2015. Here’s the long-term chart:


Firstly, let’s deal with FY August 2022:

the Group’s sales momentum continued…. Despite the influence of adverse factors, such as continuing high freight rates and the increasing strength of the US Dollar, the Board expects the Group’s underlying profit before tax and highlighted items for the year ended 31 August 2022 to be broadly in line with current market expectations.

As a reminder, Character imports manufactured goods from China. Manufacturing “is carried out on a strictly managed, collaborative, sub-contract basis with closely vetted, reputable suppliers” (2021 Annual Report).

Contracts with Chinese manufacturers tend to be priced in US dollars and so Character is in the currently unenviable position of paying out dollars while earning other currencies (mostly Sterling but also Danish and Swedish Krone).

The interims were published back in May (see coverage by Jack here). Considering the difficult macro circumstances from May to August, I personally wouldn’t be disappointed with the outcome for the year only being “broadly in line”. (Broadly in line is usually code for a slight miss.)

The rest of today’s update is not great, however, detailing the company’s prospects in the run-up to the Christmas period for FY August 2023:

The industry previews of our new product ranges and introductions for the 2023 season have been well received by our customers and prospective customers alike. However, given current macro-economic headwinds, including the weakness of Sterling and the expected curtailment of consumer spending in the lead up to Christmas due to concerns over cost-of-living increases, the Group’s trading conditions remain challenging. Against this economic environment and although only one complete month into the 2023 financial year, the Board considers that the trading performance for the current financial year is unlikely to match the expected outcome for the year ended 31 August 2022.

For context, the EPS forecast for FY August 2022 is about 44p.

With the company “broadly” hitting that, we could pencil in 43p-44p.

But then FY August 2023 is “unlikely” to be at the same level.

As Character itself says, we are only one month into the new year and so it’s too early to pin down forecasts with accuracy.

Could the current year be as difficult as Covid-impacted FY 2020? I would say that’s unlikely, but for the record this is what happened to Character’s EPS in 2020:


The good news is that these conditions won’t last forever and the company has net assets of £35m, nearly all of which are tangible and include net cash of £21m (figures from the interim report).

The company reassures us today that it is currently still profitable and so the net asset/net cash position should continue to increase or at least not decrease too much, after the company pays out the progressive dividend it is planning.

As such, I think Character should be categorised as a decent company that’s potentially worth buying for the long-term during this broad sell-off in small-caps. It’s likely to have a difficult year, for easily understandable reasons, but maybe it will be a good stock to hold for whenever things recover?

Here’s a reminder of its quality metrics in a “normal” year:


The company also has the (in my opinion) very nice habit of buying back its own shares, which has done a lot to boost EPS over the years.

Watkin Jones (LON:WJG)

Share price: 100.8p (-34%)

Market cap: £258m

Commiserations to anyone holding Watkin Jones this morning after a nasty share price fall.

Let’s get straight into this update and see what happened.

FY September 2022:

  • Strong operational performance
  • Six schemes forward-sold in H2
  • “Some pricing and margin softness on sales concluded in the second half, with purchasers facing increased funding costs”.
  • Two forward sales impacted by market volatility and postponed.

As a result: FY 2022 underlying profit to be c. 10% below expectations.

According to a note published by Progressive in May, the adjusted PBT estimate for FY 2022 was £55m. So let’s make that around £49m now.


The company points to positives such as: “very good visibility over its development pipeline” (£270m of revenue secured already), “low levels of asset exposure” and “strong liquidity”, giving it plenty of flexibility when it comes to purchasing more land.


…we also believe it is prudent to assume that margin pressure as a result of purchasers’ elevated borrowing costs will continue into FY-2023.

My view

When I’m looking at housebuilders, my first port of call is always the balance sheet. At the interims, Watkin Jones had tangible net assets of £145m.

It looks like the company has paid a 2.9p dividend since then, which would have a value of around £7.5m if my sums are correct.

So excluding any profits made over the past six months, we have a balance sheet value of £137.5m. Profits made in H2 should have been substantial, however.

I use these numbers to anchor my expectations, because my long-run view is that most housebuilders tend to be worth around book. In the good times, margins and profits take off, and they trade at a premium. In the bad times, they can sometimes trade at a discount.

Even after today’s sell-off, Watkin Jones continues to trade at a very high premium to book, suggesting continued high confidence in the business model, management, and/or the development pipeline.

If we valued it on earnings, then I’d look for a modest PE ratio (all the way back in 2017, I was arguing that Watkin Jones should be valued at around 9x earnings).

Watkin Jones, prior to today’s sell-off, was actually trading at only around 7x forecast earnings. Unfortunately, these earnings forecasts in hindsight might be viewed as temporarily increased by low interest rates, and not representative of sustainable earnings:


If higher interest rates are here for the foreseeable future, then the margins and sale prices currently achievable are likely here to stay (and could deteriorate further).

Alternatively, you might take the view that rising interest rates are temporary, and that we’ll have low interest rates again soon, enabling higher sale prices for Watkin Jones’ projects.

It bears repeating that cyclical companies often look expensive when they are cheap, and look cheap when they are expensive.

Still, Watkin Jones shares might be worth buying at the current level if you have a strong belief in management and the business model – focused on purpose-built student accommodation and build-to-rent developments. But I prefer these types of shares when they get to around book value, which is where I think their valuation risk has been almost completely eliminated.



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