Small Cap Value Report (Tue 28 Mar 2023) - ALT, UBG, XAR, MRL

Good morning, it’s Paul amp; Graham here!

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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.

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SCVR Agenda – Tuesday 28 March 2023 Main Sections

(summaries here, main sections further down)

Altitude (LON:ALT)

Trading Update (ahead)  - 47.5p (up 17% at 08:34) - market cap £34m – Graham – GREEN

FY 2023 adj. EBITDA is ahead and broker estimates for 2024/2025 increase. A speculative but promising share. Based on last night’s close, FY March 2024 price/sales ratio is only 1.1x.

Xaar (LON:XAR)  

Finals – up 5% to 189.8p (market cap £149m) – Graham – AMBER

Weak 2023 estimates and nobody wants to forecast 2024. Chinese demand, margins too unpredictable. A shame that the company can’t generate better performance with its proprietary technology.

Marlowe (LON:MRL)

Trading Update – down 4% to 480p (market cap £460m) – Paul – AMBER

In line with expectations for FY 3/2023, and the tone of today’s update sounds positive. Although on closer inspection, I dislike the very weak, overly indebted balance sheet, and poor cash generation. Looks like they’ve been in too much of a rush to do too many acquisitions, so it’s not for me.

Quick Comments -

Unbound (LON:UBG) – Possible offer – 7.75p (up 87% at 09:00) - market cap £ 5m – Paul – RED

This footwear company was a disastrous demerger from Electra Private Equity. It today discloses an approach for a possible takeover bid at 10.5p cash, plus rights to any recovery from an insurance claim. The possible bidder is called WoolOvers, which seems strangely appropriate! Certainly I feel the wool was pulled over my eyes with this share. Let’s hope the deal goes ahead, and we don’t hear from this lot again. The market’s not convinced it will go ahead, judging by the 7.75p share price now. It would be tempting to grab the money and run, rather than waiting to see if the bid actually happens

Companies Reporting -

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Paul’s Section:Marlowe (LON:MRL)

480p (down 4% at 09:14)

Market cap £460m

Trading Update (and Capital Markets Day)

Marlowe plc (“Marlowe” or the “Group“), the leader in business-critical services and software which assure regulatory compliance

I can’t remember anything about Marlowe, as it’s not something I’ve written much about before, apart from when it was trying to buy Restore (LON:RST) – a deal which seems to have fallen through.

Marlowe is doing a capital markets day to explain the company and its strategy. These can sometimes be a precursor to an equity fundraise.

Trading update -

FY 3/2023 in line with market expectations.

Revenue expected to be £475m (up 50%)

“High single digit” organic revenue growth.

Accelerating momentum, expected to continue into FY 3/2024.

On track to achieve £500m revenue, and £100m adj EBITDA in FY 3/2024.

Net bank debt c.£170m at 3/2023 year end.

Expects increasing free cashflow in future.

That all sounds quite positive, so I’m not sure why the share price has fallen right back almost to where it floated in 2016, after peaking in Jan 2022 -

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Valuation on a forward PER of 10.3 looks attractive.

It doesn’t seem to pay divis, and the historic track record seems poor, reviewing its StockReport. Also the StockRank is low at 30.

Looking at the last published accounts (interims to Sept 2022) almost all the profit seems to come from adjustments, with statutory profit being negligible.

85% of revenues are said to be recurring.

Balance sheet - this is problematic. NAV is £448m, but that includes a gigantic £645m intangible assets. Whip that off, and NTAV is negative, at £(197)m. We can be generous I think and also remove deferred tax (which is often related to goodwill), which reduces the deficit on NTAV to £(145)m. Still very weak, although software companies don’t need a lot of net assets. I’d prefer to see it repay the heavy debt burden though, if that is possible.

Companies with a lot of debt are not attractive to me, given that interest costs are rising, and banks are probably getting more nervous about extending amp; renewing large facilities.

It’s clear from Marlowe’s balance sheet that it is heavily dependent on its bank facilities, so that would need careful scrutiny for anyone thinking about buying or holding this share. It could all be fine, but it needs checking.

This is reflected in a Z-score (a historically proven warning system re risk of company solvency) that sounds a caution alert -

Cashflow statement – where’s the cash generation? I don’t see any meaningful cash generated in H1 this year, nor the whole of last year.

The stand out line is acquisitions of other companies – £37.1m cash outflow in H1 of this year, and a staggering £316m last year – nearly all of which was fuelled by increasing bank borrowings.

Acquisitions – you only have to skim the RNS to see that Marlowe has been highly acquisitive, some of them quite big.

My opinion – I can’t reconcile talk of £100m EBITDA next year, with an almost complete lack of cash generation in H1 FY 3/2023, and the whole of the prior year.

It looks to me as if Marlowe has rushed into too many acquisitions, overloading itself with debt and goodwill on the balance sheet.

Although it does look cheap on a PER basis. So if future performance improves, and starts generating cash to pay down debt, then it could be interesting.

Overall then I’ve got to be AMBER. Although I’m leaning towards RED, given the balance sheet risk, high debt, and poor cash generation.

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Graham’s Section: Altitude (LON:ALT)

Share price: 41p (pre-market)

Market cap: £29m

As we’ve discussed before, US-based Altitude has two major sources of revenue:

• “Services” – connecting suppliers and distributors in the promotional products industry.

• “Merchanting” – the sale of promotional products by Altitude itself.

Today’s update informs us of “multiple new significant contracts” relating to the second activity:

These multi-year New Major Contracts will generate an expected total combined gross revenue value of c.$30m, including $8m signed and subject to State clearance, throughout their 5-year terms. All New Major Contracts are expected to begin generating revenue for the Group in the first half of the next financial year ending March 2024 (“FY24″).

Additionally:

A number of other major contracts of material value to the Group are in late-stage legal negotiations.

The new contracts sit within what Altitude calls its “adjacent market programme”. There is an explanation of what this is on Youtube at this link, in which CEO Nichole Stella refers to opportunities in the education sector – this may explain why some of the new contracts are subject to State clearance.

Year-end trading update: this section is short but sweet.

The Group has had a strong close to the year and the Board are pleased to announce that FY23 Adj EBITDA will be ahead of market expectations. Furthermore, as a result of the New Major Contracts, trading in FY24 is expected to start strongly and the Board are very confident in improving on Altitude’s record profitability.

Estimates

Zeus upgrade their revenue forecasts by 6.6% (FY March 2024) and 14.8% (FY March 2025), to £26.1m and £35.6m respectively.

The adjusted PBT forecast for FY March 2024 moves from £1.1m to £1.3m.

The adjusted PBT forecast for FY March 2025 moves from £1.7m to £2.2m.

My view

I tentatively gave this stock the thumbs up last time, and the market cap hasn’t increased since (although I’m sure it will when the market opens this morning). Therefore, I’m going to retain my positive view on it.

Personally, I would prefer to see more growth from the Services side of the business, as that strikes me as a higher-quality source of revenue (it’s platform revenue, not direct sales revenue). However, I won’t say no to Merchanting revenue.

Altitude has not yet generated material profits so for now it is inevitably on the speculative end of the spectrum and has to be valued based on its growth prospects over the next few years, its price to sales ratio and the quality of its revenues.

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Xaar (LON:XAR)

Share price: 189.8p (+5%)

Market cap: £149m

We last covered Xaar, the inkjet technology company, at the time of its trading update in January. A profit warning that day caused the shares to fall by 13%. They have held steady since then:

Today’s full-year results for 2022 are as follows:

• Revenues +23% to £73m (+8% organically), slightly below expectations.

• Gross margin 39% (up from 34%)

• Adjusted PBT £3m is ahead of expectations

• PBT £1m

The once-mighty cash balance reduces to £8.5m.

FY 2023 estimates are unchanged, although Gareth Evans at Progressive has taken a “cautious” approach and reduced his cash flow estimates.

CEO comment:

We have transformed and re-energised Xaar as demonstrated by our good performance and further strategic progress with positive contributions from across the Group. We have delivered strong profitable revenue growth and the important milestone of achieving full year profitability which represents great progress against our plan.

The company has launched a new printhead, Aquinox, and it says that this product “opens new markets to Xaar with its water-based capability”.

Let’s see what the company has to say about China, which is such a volatile source of demand:

Reduced revenue in China has impacted our Ceramics sector printhead sales, however, we are confident in returning to previous levels of trade with our customers in the region as COVID-19 restrictions continue to be lifted. Our commercial and technology proposition remains compelling, and we have retained market share in the region.

That sounds positive, but later on in today’s statement they strike a more cautious tone, saying “it remains unclear when normal levels of business will return”.

Acquisitions – the two acquired companies are trading “ahead of our initial expectations”.

My view

I remain intrigued by this share but I have two major question marks:

1. The demand from China seems beyond anyone’s ability to forecast.

2. The company has used up the majority of its cash balance and now needs to see the financial returns from its investments, to prove that the money has been put to good use.

2023 estimates have already been slashed to just £2m of PBT (£2.5m adj. PBT), and nobody is brave enough to make estimates for 2024 yet.

I’m on the fence between Amber and Red – I’ll go for Amber even though I don’t have any faith that 2024 will be the year that sees a proper financial turnaround.

Stockopedia

Source: https://www.stockopedia.com/content/small-cap-value-report-tue-28-mar-2023-alt-ubg-xar-mrl-965452/