Small Cap Value Report (Weds 12 Oct 2022) - SDG

Good morning from Paul amp; Graham!

Thank you for all the interesting comments that you’re posting, we’re really enjoying reading and discussing things with subscribers here. Even though market conditions are just dire, so depressing, but there we go, it’s just like that sometimes.

Agenda -

Paul’s Section:

Sanderson Design (LON:SDG) – solid interim results from this upmarket wallpaper amp; fabrics group.  I’ve been really impressed with the turnaround under Lisa Montague, and am hoping to interview her next week. Performance is expected to be in line with full year expectations, although there’s some understandable caution because peak selling period has only just started. The balance sheet is superb, so there’s no solvency or dilution risk in my view. The modest PER already factors in a downturn arguably, but of course it doesn’t work like that.  So as with everything right now, there’s short term share price risk, but long-term I think buyers now should do fine.

108.5p (up 12% yesterday)

Market cap £77m

Interim Results

Sanderson Design Group PLC (AIM: SDG), the luxury interior design and furnishings group, announces its unaudited financial results for the six months ended 31 July 2022.

Profit growth driven by licensing income, US sales and the Morris amp; Co. brand

Full year trading remains in line with Board expectations

I’m impressed with these interim numbers, because SDG is now up against strong comps from last year. I was just re-reading my notes here from last year’s interims, and some of it is quite prophetic actually – my crystal ball must have been having a rare good day this time last year! (before conking out)

The share price is now almost half what it was a year ago, despite SDG having just beaten last year’s numbers –

*excluding share-based incentives, defined benefit pension charge and non-underlying items as summarised in note 5

*** Net cash is defined as cash and cash equivalents less borrowings. For the purpose of this definition, borrowings do not include lease liabilities

Noteworthy points -

There’s a video recording here of the interim results presentation (46 mins), published today.

Licensing did particularly well, with revenue (high margin – almost all profit) up 90% to £3.8m. Without that, overall profit would have fallen. Is this increase sustainable?

Divis – note the interim is always small, with a larger final divi. So 0.75p interim divi (flat vs LY) should be joined by a c.3.2p forecast final divi – giving a yield of about 4% – not bad.

Outlook – sounds generally quite confident (below), but cautious as well, hardly surprising given the negative macro outlook. I covered its in line trading update for H1 here in early Aug 2022, when the company said it was planning for a wide range of possible scenarios, which was unsettling at the time I thought.

“Our current year performance to date is testament to the diversity of our model, and we continue to anticipate meeting Board expectations for the full year. Given the uncertainties in the current macro-economic and consumer environment, we look forward with caution and continue to actively manage the headwinds.

We have a high-quality brand portfolio, growing US presence and strong cash balances to support ongoing investment. Alongside continued management action to reduce costs and increase efficiency, we remain confident in the strategy for the business.”

We have focused on building a diversified model backed by our world class brand portfolio and strong balance sheet to enable self-funded growth. To that end, our performance in the first half of the financial year was resilient, with a profit performance driven by licensing income and margin improvement, as a result of operational efficiencies, growing US sales and the Morris amp; Co. brand. August 2022 was a softer summer month than last year but September and the first week of October 2022 have shown growth. Our key Autumn selling weeks in October 2022 and November 2022 have just started and, whilst we are vigilant in respect of ongoing external factors, we continue to anticipate meeting Board expectations for the full year.

Broker forecasts – there’s an update note (commissioned research) from Progressive, which now predicts 14.3p EPS for FY 1/2023. That’s down slightly from its previous (Aug 2022) forecast of 14.7p, only a 3% reduction, which is neither here nor there, and probably sensible, given uncertain macro conditions.

At the current share price of 108.5p, the PER is 7.6 - which seems remarkably good value, considering there is also a strong balance sheet, which helps valuation.

Obviously there’s a risk that the economy could fall off a cliff, and smash profits. But economies recover of course, so profits would then probably go up again.

Balance sheet – this is really strong for a £77m market cap company.

NAV is £83.2m, less £26.3m intangible assets = NTAV £56.9m

There’s a £15.0m cash pile, which has reduced £4.0m in a year, due to working capital movements.

Pension deficit is shown as a surplus of £2.6m, which is absurd pension scheme accounting standards, given that it’s actually costing cash outflows of about £1.2m p.a.. So you might want to manually adjust the balance sheet for that.

Cashflow statement – shows clearly how working capital has absorbed £9m of cash. Not a concern in my opinion, and it’s explained in the commentary -

Inventory levels have increased as we have made strategic investments in products with long lead times to ensure we are never out of stock on our best-selling collections and can fully support new product launches. Inventory levels peaked at 31 July 2022 and the subsequent focus has been the turn of stock to more normalised levels.

My opinion - this is one of my favourite value shares, and I’m impressed with the turnaround implemented successfully by Lisa Montague. I’ve reached out to see if she’ll do an interview with me next week, so fingers crossed.

In more normal times, this share would be ridiculously cheap at the current price. However, the market is obviously in a deep depression right now, and is pricing in the uncertainty of economies crashing, and hence profits following suit. However, that shouldn’t really worry long-term shareholders, because SDG has such strong finances, there’s no insolvency or dilution risk, so they can just wait for profits to recover in due course. The trouble is of course, we all want to buy right at the bottom, and as with everything right now, we simply don’t know what price, or when, the bottom will be.

In terms of company fundamentals though, and valuation, this gets a thumbs up from me. What happens in future, I have no idea, but it’s a fundamentally sound company, priced attractively I reckon.

As you can see below, it went a lot lower in the pandemic, bottoming around 30p, amazingly. 

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