Small Cap Value Report (Weds 9 Nov 2022) - PURP, VLX, GYM, NMRP, SNWS

Good morning from Paul amp; Graham!

Agenda

Paul’s Section:

MADE.com - As a post script, ThisIsMoney reports that, as expected, Next (LON:NXT) has bought the brand amp; intellectual property of this failed online furniture retailer – which went from a well-financed IPO in June 2021, to insolvency in Nov 2022 – astonishing. The price paid is a paltry £3.5m. The article says that inventories are likely to be disposed of via TK Maxx, the dicount branded retailer, so it might be worth a visit to see if there are any bargains on offer.

Volex (LON:VLX) – Interim results look good to me, given tough macro conditions. I have a good dig into the numbers, including balance sheet and cashflows, and overall it looks pretty good to me. Shares seem reasonably-priced, and overall I give this a thumbs up.

Smiths News (LON:SNWS) – encouraging results, ahead of expectations, for FY 8/2022. Legacy problems are now resolved, and what remains is now a reliable cash generative, largely de-geared business. The remarkable divi yield of c.11% looks sustainable in the medium term too, as finance charges should fall sharply. Long-term, who knows? As a high yielding value share, I can’t help but give this a thumbs up! Whilst being a bit wary about the longer term uncertainty. 

Graham’s Section:

Purplebricks (LON:PURP) (£35m) – shareholder anger over the long-term Chairman’s position has bubbled over and resulted in a requisition for a General Meeting. I agree with the shareholder that the Chairman has failed and needs to go, to take responsibility for many unwise ventures and the incineration of vast amounts of shareholder cash. Unfortunately, it looks like the shareholder might struggle to get the necessary votes needed to get this done. Purplebricks is an interesting special situation where net cash and speculatively some brand value might help to support the valuation. However, its efforts to stop losing cash are probably about to run into lower property prices and reluctant home buyers, which I expect will make the job much more difficult.

GYM (LON:GYM) (£196m) – a disappointing update from this gym operator as the WFH trend has prevented it from reaching pre-Covid levels of performance at some of its mature sites, as it originally hoped to do. Other sites, not dependent on workers, are at 93% of pre-Covid levels. Unfortunately, the recovery has been slower than I hoped to see play out. Additionally, rising energy costs are set to increase costs by up to £10m next year. I’m starting to wonder if the company’s existing expansion plans might be too aggressive, given the changed circumstances.

National Milk Records (OFEX:NMRP) (£25m) (unchanged) [no section below] – this “agri-tech information services provider” issues a Q1 update (for the three months to September). Note as always that this stock is listed on Aquis, not on AIM or the Main Market. Q1 revenues are up 4.4%, with Johne’s disease tests doing slightly better than the other primary revenue streams. Q2 will see “a major engagement with milk processors and vets to underpin the detrimental role that this wasting disease has on animal health, milk production and sustainability.” Elsewhere, genomics testing revenue is still in its infancy but could prove to be an important new source of profitability. I retain my positive view on this share.

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.

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273p (yesterday’s close)

Market cap £434m

Interim Results

Volex plc (“Volex”, the “Company”, or the “Group”), the global supplier of integrated manufacturing services and power products, today announces its half year results for the 26 weeks ended 2 October 2022 (“H1 FY2023″).

So this is H1, in FY 3/2023.

The headline numbers look good to me (it reports in US dollars) -

Revenue $357.5m (up 22.1% – of which 14.3% is organic, the balance from acquisitions)

Underlying profit before tax (PBT) $29.1m (up 14.1%) – that’s an 8.1% profit margin, which strikes me as fairly decent, in tough economic conditions (down from 8.7% H1 LY).

Statutory PBT $21.5m is 26% lower than underlying PBT. Given that gap, I’ll need to check out the adjustments, and make sure I’m happy with them (see below)

Underlying EPS is 14.4c (up 4.3%)

Acquisitions are progressing well – remember that VLX has a strategy to grow through acquisitions of complementary businesses in various geographies amp; niches, that enhance its overall offering.

Target is $1.2bn revenues by FY 3/2027 (currently running at almost $700m annualised).

Net bank debt has risen a lot, due to acquisitions, it’s now $98.8m (LY: $22.3m)

“Robust customer demand”

Interim dividend of 1.3p (H1 LY: 1.2p). Note that, in the last 3 years, the final divi has been exactly double the interim divi, which implies 3.9p this year for total divis, a low yield of 1.5%, so it’s a growth share, rather than an income share.

Demonstrated ability to pass on cost increases to customers – very important.

Gross margin is low, at 20.6%, so keeping overheads lean is of paramount importance, which Volex seems to manage, with an underlying operating profit margin of 9.0%.

Webinar – is today at 14:00, on InvestorMeetCompany, with Qamp;A. Well done to the company for doing these, all companies should do results webinars for private investors, no excuses!

Markets - as mentioned before here, Volex seems to operate in generally attractive, growing markets, which is reinforced today with these comments -

Outlook - trading in line -

As you can see below, broker consensus earnings expectations have been trimmed a bit over the summer, but have been edging up a little in recent months, which I like to see – it’s good to have this graph moving about a bit, as it suggests to me that the company is probably communicating with brokers, and steering them in the right direction, which reduces the likelihood of an obligatory 30% plunge on a profit warning -

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In unpredictable times, we need to pay much more attention to how market expectations are being managed, and that’s a good question to ask management on webinars – e.g. how closely does the FD work with brokers, to keep market expectations accurate? Do you leave a margin of safety in forecasts, to mop up anything unexpected?

Balance sheet – NAV is $200.9m, but of that $75.3m is goodwill from acquisitions, and $41.2m is “other intangible assets”. I always write these off, which brings NTAV down to $84.4m, which still looks reasonable for the size of business. There’s always a risk with acquisitive groups that they end up hollowing out the balance sheet, and taking on too much debt, but that doesn’t seem to be the case here. Note that the balance sheet has taken a forex hit (which by-passes the Pamp;L) of $19.4m – shown in the “unaudited consolidated statement of comprehensive income” – this is a statement that most investors amp; analysts ignore, but it’s there to enable us to reconcile the movements on the balance sheet, with net profit (which should be the same once these non Pamp;L items are taken into account).

Working capital looks healthy, with current assets (incl. $23m cash) of $307m – note that inventories amp; receivables are both rising, as I would expect in inflationary times. Plus these will also reflect acquisitions made. Current liabilities are much smaller, at $172.4m, giving a current ratio of 1.78 which looks good to me. For this type of business, I like to see a current ratio upwards of about 1.3, so 1.78 passes my test by a generous amount.

Non-current liabilities is where the bank debt sits, at $115.9m, which is getting towards the upper level of what I’m comfortable with.

Net bank debt is $94.4m (cash of $23m, less gross bank debt of $117.4m) – a little high, but well within the bank facility limit.

Acquisitions – 10 have been done in 4 years, totaling $200m, and the section on this in the commentary I think rightly claims to have a proven, methodical approach.

We have an interesting acquisition pipeline containing highly attractive targets that we are pursuing, all of which fit within the core competency of our senior operations team. We qualify every acquisition extensively using our deep industry knowledge to find the best opportunities. We firmly believe that our strength in this area will be a significant value driver.

There is a potential issue of dilution – given that bank debt is looking a bit high now, then I would prefer future acquisitions to be funded at least partly from fresh equity. Although with the share price low, this is not a good time to be issuing new shares. The boos, Nat Rothschild, will be more aware of this than anyone else, as he owns 25% of the company. So shareholders can rest assured that interests are aligned.

Cashflow Statement - cash generation was good, but a fair bit $22.2m was sucked into additional working capital – as I would expect in a time of higher inflation. Both inventories and receivables go up, but trade payables also rising only offset just under half. Nothing to worry about, that’s just what happens when businesses grow, and in times of higher inflation.

After capex, payments for acquisitions, and divis (small), there was a cash outflow, financed from increased bank borrowings.

Going concern statement - is short, and fine. Points out that there is $82.3m headroom available under the existing bank facility.

Broker updates - nothing has come through yet, but Singers usually update us.

Its last forecast will do, as we’re told today that expectations are in line for the full year.

That indicated $690m revenues, and adj EPS of 26.4c, or c.23p in sterling, for FY 3/2023.

The share price is currently 268p, so that’s a FY 3/2023 PER of 11.7 – that strikes me as an attractive price. Although net bank debt is about 19% of the current market cap, so if you adjust for that, then the PER on a cash/debt free basis would be something nearer to 14 (roughly), which is still a fairly reasonable valuation I believe. Not amazingly cheap, but fairly decent.

My opinion - I’ve admired the big turnaround at Volex executed by Nat Rothschild, and the thoughtful acquisition strategy seems to be working well. Today’s results look solid to me, given the challenging macro environment. In particular, the proven ability to pass on cost increases, is a key point in favour of these shares.

Why has the share price dipped 2% this morning? Who knows, it did rise strongly yesterday, and I don’t tend to read much, if anything, into short term share price movements when a company reports trading in line with expectations.

Is this a good long-term investment, is really the key focus we have here at the SCVR? Based on the good track record in recent years, the solid H1 figures today, and a robust outlook statement, and a reasonable valuation, my view is that yes, it looks good. So a thumbs up from me, for a decent company, on a reasonable valuation at 267p per share.

As you can see from the chart below, it’s been a wild ride in the last year, reaching an overvaluation (as with so many other shares) a year ago, but now having de-rated to something a lot more palatable.

38.3p (down 1% at 11:20)

Market cap £92m

Preliminary Results

Audited Financial Results for the 52 weeks ended 27 August 2022

Performance ahead of expectations with material debt reduction and increased dividend

We’ve covered this value share extensively here in the SCVRs in recent years, with a very convincing turnaround having been executed.

Figures today look good, with EPS flat vs LY at 10.8p, putting this share on a tiny PER of only 3.5

Bank net debt has been almost wiped out now, from some expected one-off cash receipts, and the reliable cashflows of the core business, down to only £14.2m (down 73% in a year). Hence bank net debt should now be seen as almost insignificant.

Pension schemes have now been sorted, with SNWS even receiving a cash surplus, as planned. So I think that issue is now permanently resolved.

As a result, finance costs on the Pamp;L should reduce in future years, meaning profit could go up.

Outlook comments reassure -

The new financial year has started well. Trading to date is in line with expectations, and in October 2022, contracts representing 35% of newspaper and magazine sales revenues, were renewed until 2029. Despite recent economic volatility, inflationary pressures continue to be consistent with planning assumptions and the combination of sustained margin mix and close cost control give us confidence in maintaining performance in FY2023.

Balance sheet - is still in a net liabilities position, so NAV is £(32.0)m, but I don’t think that matters, because the business is decently cash generative.

Dividends - this is the most interesting bit. Total divis for the year are 4.15p, giving a yield of 10.8%! That yield could conceivably rise further, because the problems have now been sorted (debt, and pension scheme).

My opinion - the turnaround here has panned out exactly as management guided, when I started focusing on this share a few years ago. It’s not often that happens!

Given that it’s trading well, has fixed the main problems, and is paying out huge divis, why are the shares still so cheap? It’s because the market sees this as a dying business, given that it’s distributing newspapers amp; magazines, through a rapid overnight system, with mainly outsourced logistics. However, cover price rises have offset a lot of the volume decline, and SNWS revenues are based on volume x price, thus making its revenue declines much slower than people might have imagined.

The wild card, is that some bright spark might dream up some additional use for this high speed delivery network, to transform it into a growth business, instead of a dying legacy business. Imagine what the re-rating could be like, were that to happen? Previous management tried this, with the Tuffnells acquisition, but it was a disaster. So new management are understandably reluctant to try out any new ideas. Maybe an acquirer might bid for it, if they come up with a new strategy?

Overall, and despite the sharp recovery in share price recently, I think this share remains a very attractive value share. Especially for income seekers, with that c.11% yield, which looks sustainable in the medium term anyway. Longer-term, who knows, that could be tricky.

The StockRank has been consistently very positive about this share (as have I!) over the last 3 years -

Share price: 11.55p (pre-market)

Market cap: £35m

It’s not every day that you get a requisition of general meeting: a disgruntled Purplebricks shareholder is looking for change at the top of the company.

The shareholder is Lecram Holdings, controlled by Adam C Smith:

The first RNS relating to Lecram Holdings and Purplebricks was published on 11 July 2022, notifying that Lecram had a 4.18% stake in the company. By October, this was revealed to have increased to 5.0%.

Over on Lecram’s website, there is a letter to the Purplebricks Chairman dated 4th July 2022, stating that they owned 2.98% at that time. I wonder when they bought their shares – hopefully not anywhere near the peak!

In their July letter, Lecram’s investment banker states the following to Purplebricks Chairman Paul Pindar:

Following the destruction of shareholder value evidenced by decline in the share price from 489p in 2017 to around 15p today, we believe that urgent action is now essential to stabilise the Company and restore its credibility within the investment community.

As Chairman you have presided over this highly unsatisfactory performance and you should now stand aside in favour of a replacement with necessary experience and skills to address urgently the Company’s continuing cash burn and operating performance within the residential estate agency sector.

In August, Lecram went public with their criticism.

Yesterday, they sent a new letter, this time to all Purplebricks shareholders. It’s less than three pages long and is a very quick read.

The argument in simple terms is that Purplebricks has wasted most of the cash it has raised on multiple bad decisions, has seen its share price fall by 89% since its 2015 IPO, and yet is still overseen by the same Chairman, despite having had four CEOs and five CFOs during this time.

Excerpt:

Paul Pindar has thus far chosen to dismiss these concerns by remaining in post and has, therefore, prompted me to call a general meeting… I regret the short-term disruption this may cause and, rest assured, have engaged extensively with Mr Pindar in order to avoid this course of action. We have also been encouraged by other frustrated shareholders over this period.

In the place of Paul Pindar, they would like to see the appointment of Harry Hill (former CEO of Countrywide and former Chairman of Rightmove, in which I have a long position).

Response by Purplebricks: Purplebricks are “reviewing the legal validity of the Requisition”, which is standard. If there has been any procedural mistake on behalf of Lecram, they will certainly deny the request.

As for the position of their Chairman, they say:

The Board reaffirms its support for Paul Pindar as a director of the Company and Chairman of the Board and believes that Paul has the continued support of a number of major shareholders. This includes Axel Springer SE, a 26.5% shareholder in the Company, which has confirmed it remains supportive of Paul and intends to vote against the proposed resolution for his removal as a director of the Company.

As regards to Purplebricks turning itself around, they say that their FY 2022 results included a clear plan “to improve business performance, return to positive cash flow and profitability, and build a scalable business model”, and they point to the recent addition of new NEDs and a CFO as having bolstered the Board’s capabilities.

My view

Firstly, I of course agree with Lecram that Paul Pindar’s position is untenable. If you have been running a listed business for seven years and the share price is down by 90% over that time, then you have failed. Simple as that.

Secondly, I agree with Lecram that there are likely to be more qualified candidates for the job, including their preferred candidate. Mr. Pindar has had an incredible career but it’s not a real estate or estate agency career. It looks like it’s time to bring in a specialist.

Unfortunately, being right does not mean that you get your way. Lecram’s ownership stake is big enough to call a general meeting, but it’s much smaller than Axel Springer’s stake and is not even as large as Mr. Pindar’s (who has recently been buying Purplebricks shares, perhaps because he doesn’t want to own fewer shares than Lecram?).

At the end of the day, Lecram/Adam C Smith can have all of the facts and the logic in the world on their side, but it won’t count for anything unless they convince fellow shareholders.

In normal circumstances, I would expect a Chairman who presided over failure for seven years to voluntarily step down. One of the major reasons to do this is precisely to avoid confrontations with angry shareholders. But Mr. Pindar must somehow have convinced major shareholders that the company’s disastrous expansion efforts were not his fault.

Axel Springer were joint venture partners with Purplebricks in Germany, so they clearly bought into the expansionary vision.

With Axel Springer’s support, my best guess is that Mr. Pindar will get to keep the role of Chairman. I could be wrong about that, but it’s difficult to beat a 26% shareholder in a vote!

As for the merits of Purplebricks shares at this level, the £43m cash pile (as of April 2022), plus some brand value, suggest that there is a level at which it is “cheap”.

However, the company did burn through £20m of cash in its operating and investing activities last year (before movements in working capital, which were an additional £15m outflow).

It said that it was looking to cut £13m of annual costs, and that would certainly help, but it also now faces the challenge of higher interest rates and a weaker housing market. It’s entering this difficult economic period from a position of severe weakness, not of strength. And this is a company that has never demonstrated consistent profitability.

Therefore, from my perspective, these shares should be trading at a very big discount to net cash. Anything more than that relies either on a turnaround or on another company finding value in the brand and taking it over. Recent reviews on Trustpilot are hit-and-miss and their competitor’s reviews are better. So I’m not sure if the brand is ultimately going to be worth much. As a consequence, while I accept that a turnaround is possible, my personal view is that Purplebricks shares are to be avoided.

110p (down 11% at 09:59)

Market cap £196m

Trading Update

This low-cost gym operator issues an update for the first four months of H2. Unfortunately, the company’s hopes to reach 2019 like-for-like performance has not yet materialised, and it may not be able to do so at some of its sites. Revenues at the “majority” of its sites are now at 93% of pre-Covid levels. However, there are 16 sites (out of a total of 224) where “changes in working practices”, i.e. more people working from home, have impacted performance. They still plan to open 25-30 new sites next year. Non-property net debt stands at £68.5m, up by over £10m since the end of June, although the company says that it had “tight cost control, leading to strong margins and cash flow in the period”.

Looking ahead, utility costs are expected to rise £8m-10m in 2023. New sites are performing in line with expectations and total membership numbers are up 16.7% year-to-date. This company was very badly hurt by Covid and I think we do have to make an allowance that a full recovery will take some more time. Unfortunately, the rising energy costs are an additional headwind although it could be argued that a low-cost gym operator should find it easier to keep winning market share in this environment. And the balance sheet could be stronger, even though Gym has already raised over £70m in fresh equity in the last two years. Would it make sense perhaps to put the brakes on the expansion, to enable some internally generated cash flow to pay the bills for the next year or two?

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