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

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.

Graham’s Section:

Hostelworld (LON:HSW) (£93m) – an encouraging update for Hostelworld as September revenues exceed the revenues of September 2019 (the last comparable year). Even better, this has been achieved with a lower marketing cost as customers engage with Hostelworld’s new social app. This app allows travellers to see each other’s profiles, chat and make plans in advance of their stay. I’m greatly encouraged by this update and can see the company recovering to its pre-Covid performance levels in the next few years. However, what holds me back from taking a more positive view on the stock is the expensive debt facility which I think is going to take away most of the upside in principal and interest payments for the next few years. In the absence of the loan, I would say that these shares have a great deal of speculative merit. But with the debt overhang, the prospect of any cash returns for shareholders looks quite far away.

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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Share price: 79.4p (+4.6%)

Market cap: £93m

Paul normally covers this one, but I thought I’d take a look at it this morning. Paul covered Hostelworld’s interim results in detail in August.

Today brings a trading update for the past couple of months.

Key points:

• Total transaction value on the platform was up 16% on 2019 levels for the month of September.
• Confusingly, net bookings in September were down 17% on 2019 levels. So I guess compared to 2019, there are a smaller number of higher-value bookings.
• The result is that September’s net revenue is up 4% on 2019 levels. For Hostelworld, it would probably have been better to have a high number of low-value bookings than a lower number of high-value bookings?

Marketing as a percentage of revenue: Paul highlighted that marketing spend was at an unsustainable level in his review of the interim results. The company announces today that it expects this metric to improve from 70% in H1 to 55% in H2. It’s crucial that this continues to improve.

“App-based social platform” – the company claims to have an “innovative and differentiated social network strategy”, and that this is driving increased bookings through its app.

I downloaded its app this morning, to see what it’s talking about.

The key feature is that you can see other people staying at your hostel, and talk to them after you’ve booked, in advance of your trip. For example:

Do any other travel booking apps offer this type of feature? It looks fairly unique to me.

And it makes sense that a hostel-oriented app would do this, rather than a mainstream hotel app. People going to hotels probably have a more fixed idea about who they intend to spend time with during their stay!

They report that since launching this new platform in April, almost 50% of customers have signed up for it:

This, along with strong net booking and average booking value (ABV) growth, has translated into increased revenues, lower marketing costs and improved margins.

So let’s see how it’s shaping up financially. Remember that the interim results were awful (a loss of nearly €15m on revenues of €28m). Big financial improvements are needed:

We are also pleased to report that through our continued strong cost discipline and with marketing costs now lower than anticipated, we expect our closing cash balance to be higher than originally expected…

Based on the current business performance and trajectory we now expect to be modestly EBITDA positive for the Financial Year 2022. Given our continued momentum, the outlook for 2023 is encouraging and we expect our growth strategy to continue to deliver further significant benefits in FY 2023 and beyond.

My view

Adjusted EBITDA was negative €5m in H1. So I am very surprised and impressed if the final EBITDA result for the year turns out to be positive. That’s an over €10m swing in H2.

According to Stockopedia, the full-year revenue forecast is €61.9. That implies H2 revenue is about €6m higher than H1 revenue.

If H2 EBITDA is higher than H1 EBITDA by €10m, then we have a lovely combination of higher revenues and lower costs, in line with what the company is saying about cost discipline and lower marketing costs.

There are still a few months to go until the end of the year, however, so it’s important to remember that none of this is set in stone.

It’s also worth noting that there’s a big difference between adjusted EBITDA and the bottom line. In H1 alone, that difference was €9m.

So we are likely to still see a big loss for the year when it comes to the final reported numbers.

The encouragement I take from today is that the company may be recovering to 2018 and 2019 performance levels faster than previously expected.

Back then, it was a profitable company with a decent operating margin.

At the end of H1, it had cash of €23.3m, which gives it some space to recover. The problem is that this is borrowed money: it has borrowed €30m in a five-year facility that charges 9% + Euribor.

I think that in the absence of this facility, i.e. if Hostelworld owned its cash balance free and clear of any liability, I’d be a lot more positive on the stock. It would still be quite speculative, but there would be nice chances of a recovery working out well for shareholders.

Unfortunately, with this loan facility in place, the company will be incurring millions of euros in interest every year (remember that the interest is the “I” in EBITDA).

When the loan is eventually repaid, it is likely to eat up several years’ worth of profits. And that is the best case scenario.

So for me, the risk levels here are excessively high, as repaying the loan is going to eat into the upside for the next few years. While it could work out well for shareholders, I believe that the most sensible move is to avoid this one for now.

Stockopedia