Small Cap Value Report (Tue 16 May 2023) - CNIC, ZYT, ACRL, EQLS

Good morning from Paul amp; Graham. Thank you to Roland for standing in yesterday – great output as always!

** Sorry we had a technical problem earlier that duplicated today’s SCVR.  THIS is now the live version which I’ll be updating. I’ll try to get the duplicate removed. Profuse apologies! **

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.

What does our colour-coding mean? Will it guarantee instant, easy riches? Sadly not! Share prices move up or down for many reasons, and can often detach from the company fundamentals. So we’re not making any predictions about what share prices will do.

Green – means in our opinion, a company is well-financed (so low risk of dilution/insolvency), is trading well, and has a reasonably good outlook, with the shares reasonably priced.

Amber – means we don’t have a strong view either way, and can see some positives, and some negatives. Often companies like this are good, but expensive.

Red – means we see significant, or serious problems, so anyone looking at the share needs to be aware of the high risk.

We’re a bit overwhelmed with the workload today, so will do our best with this lot, but won’t be able to cover everything -

CentralNic (LON:CNIC) – down 2% to 112p y’day (£321m) – Q1 Results – Paul – AMBER

I have a good rummage through the Q1 numbers below, and it’s better than I expected overall, although some concerns remain.

Zytronic (LON:ZYT) – 100p pre-market (£10m) – Interims – Graham – AMBER

A recent profit warning was just the latest blow here. Cash is c. half the market cap. A possible recovery play with the sales pipeline due to start maturing over the next year.

Accrol group (LON:ACRL) – 36.5p (+4%) (£116m) – Interims – Graham – RED

I stubbornly maintain my stance despite share price momentum and an earnings upgrade for FY April 2024. I’m not convinced that its real profitability is particularly high or sustainable.

101.3p (+4%) (£183m) – AGM TU – Graham – AMBER

Equals, the banking and international payments group, confirms that it is “confident in achieving expectations” for FY December 2023. The heavily adjusted forecasts (as of March) suggested an adjusted PBT of £11.5m this year, rising to £15.5m in 2024.

The company is experiencing fast revenue growth and reports that in the 90 working days to 15th May 2023, revenues were up 47% year-on-year to £32.7m. The full-year revenue forecast (again, as of March) was £89m so that looks very achievable based on performance so far. The gross margin has risen to over 50%, which is another significant improvement over performance in 2022.

I’m leaning towards a favourable view on this one. Perhaps I’ll be late to the party, but I’d like to see proof of strong unadjusted performance before I get too excited. But the signs so far are encouraging and I do recommend this for further research. I’d like to understand the USP of Equals’ products, compared to all of the many competitors in the forex/payments sector.

Down 2% to 111.9p

Market cap £321m

Share Buyback

Another $4m share buyback has been announced. This follows a $4m buyback which was implemented in Q1 (Jan-Mar 2023) – as shown in the cashflow statement for Q1.

The rest of this announcement sounds standard. Buybacks make sense when the share price is bombed out, although debt reduction might be a good idea too. I like the change in focus (previously announced) from an acquisitions spree which has greatly enlarged, but complicated the group, to organic growth and instead using cashflows to pay down debt and pay some (modest so far) shareholder returns too.

What does CNIC do? Two divisions -

1. Digital advertising – this is the larger division by revenue, but I can’t find a profit split between the 2 divisions. This seems to be centred on “advertorial” and review websites. Does anyone know if CNIC has disclosed which websites it owns, so we can check them out? (I know they have mentioned some acquired websites, but what others are there?) This doesn’t sound a high quality activity to me. Similarities with XLMedia (LON:XLM) or Tremor International (LON:TRMR) maybe? (which are also on low PERs).

2. Domain name management solutions – with recurring revenues amp; revenue sharing agreements.

Q1 Results (Jan-Mar 2023)

The obvious first question – why is a UK-listed company issuing quarterly results, when the requirement here is six-monthly accounts? I queried this with an adviser, who replied that it’s for transparency, so investors and analysts can better get our heads around the numbers, seeing a clean set of quarterly figures without acquisitions muddying the water. OK, that’s fine, I’m happy with additional voluntary disclosures. I wonder if it might also be a precursor to the company trying to list its shares in the USA, where quarterly reporting is required?

Strong revenue growth in Q1, up 24% to $195m (note US dollar reporting).

Zeus has just raised its FY 12/2023 revenue forecast by 7% to $826m – a substantial business? Well, yes and no. It’s low gross margin of only 23.5% in Q1, down a bit from 24.4% gross margin in FY 12/2022. Therefore I am seeing revenue as a vanity number, with most of it being pass-through revenue, so not a share to value on a price to sales ratio (never a good idea in my view!). Indeed, the company calls gross profit “net revenue”. On this basis, the more realistic number is net revenue/gross profit, forecast at $190m for FY 12/2023 (Zeus).

Profitability – Q1 generated adj EBITDA of $21.3m, but only $7.7m operating profit, and just $2.9m of profit after tax (PAT) – here’s the reconciliation -

As you can see above, the largest reconciling item is $9.0m (just in Q1, so annualised c.$36m) of amortisation/impairment of intangible assets. The argument is that this is a non-cash charge, so can be reversed out. Is that reasonable? This might surprise you, but having delved into the numbers, I actually think this adjustment can be justified.

The thing I always check, is what type of amortisation is it? Amortisation of goodwill (and similar) can safely be ignored when valuing a company – that’s what most investors and analysts do, and I agree.

Whereas amortisation of other internal costs that have been capitalised onto the balance sheet is very different. The place to look is on the cashflow statement, to see how much of its (usually) payroll costs are being capitalised into intangible assets on the balance sheet, and compare that with the amortisation charge. In this case, not much is being freshly capitalised, as you can see here -

Hence the freshly capitalised costs of $1.8m in Q1 is only one-fifth of the amortisation charge. Therefore, it seems to me that CNIC is indeed cash generative, and its adj EBITDA figure does at least hold some water.

We can’t completely ignore finance charges, and tax though, which is partly why EBITDA is a fairly unreliable concept to me, and doesn’t translate into real world cashflows, precisely because interest costs and tax still have to be paid, so why would you ignore them? Maybe an acquirer might remove these costs, if planning a private equity type deal, with debt loaded up, and taxes avoided? Hence possibly why EBITDA is widely used in acquisition deals.

So I would use a fairly low multiple of EBITDA to value CNIC, maybe 5x its forecast $91.8m FY 12/2023 adj EBITDA? That would be $459m. Add on net debt of $49.3m at end Mar 2023, we get EV of $508m, divided by 1.25 to convert into sterling, and I get £407m. Stockopedia is showing an EV of £377m, so pretty similar, suggesting this share might be priced about right, or slightly too low? But it depends what EV multiple you’re happy to use.

EPS measures for Q1 again show the gulf between statutory amp; adjusted numbers -

Basic EPS Q1: 1.06 US cents.

Adj EPS Q1: 5.54 US cents

Zeus forecasts 20.8 US cents for the full year, so 16.6p, giving a FY 12/2023 PER of 6.7x – which looks cheap.

What adjustments should we make for the debt? This is a problem area. Net debt reported at 31 March 2023 sounds modest, at $49.3m. However, I’m not at all comfortable with this net figure. Why? Because that net figure breaks down into two large gross numbers -

Gross cash $102.9m, and

Gross bank debt of $147.3m L/T, plus $4.1m S/T = $151.4m

That makes net debt of $48.5m, and there’s a difference of $0.8m relating to derivatives, as explained in note 9, hence we get to net debt of $49.3m.

Simplifying the numbers, CNIC is saying that at 31 March 2023, it was sitting on cash of 2, whilst having outstanding bank borrowings of 3. That doesn’t make any sense! It would cost millions in extra finance charges to borrow a large amount, then sit on the cash, earning a lower level of interest income on it. I think it fixed some of the debt costs, using SWAPs? But I’ve not done too much digging on the terms of the debt, so you would need to do more work on that yourself if considering a purchase.

What it suggests to me, is that the period end dates are probably spikes up in cash, maybe customers pay at the end of the month? Then a lot of that cash probably goes back out again, days later, thus giving a favourable (but untypical) period end cash balance. That’s my hunch, I should emphasise, and could be wrong.

If that wasn’t the case, i.e. if the company sits on c.$100m of cash all the time, then it would just pay off ⅔ of it’s bank debt, surely?

We can get to the bottom of this by the company disclosing its average daily net debt position. All companies should do this routinely, as it’s the only meaningful measure for reported cash/debt. Whereas a snapshot on one day (a balance sheet date) means little to nothing, as it can easily be managed so that it shows a favourable position that is not typical of the day-to-day average cash/debt position.

This is why I find the whole concept of Enterprise Value (EV) to be so dangerous, as you can easily end up over-valuing shares due to basing your valuation on an unrealistically favourable snapshot of net debt/cash position on one day. Average daily net cash/debt (audited) is the number we need, for all companies.

Dividends – a 1.0p maiden divi is being paid on 16 June 2023. That’s a start. With 286.1m shares in issue, it’s a £2.86m cash cost, not much in the overall scheme of things. The buybacks are larger, with $4.0m done in Q1, and $4.0m being done in Q2.

Although note that a 12.4m Euro cash outflow occurred on 8 May 2023, for deferred consideration, which seems to be buried in trade creditors. So I would like to see a full breakdown of what is in trade creditors.

Share based expenses (i.e. free money for the Directors, on top of generous 2022 salary/bonuses of £1m each for the 2 Execs, plus £2.3m for the outgoing CEO) are too high in my opinion, at $5.7m last year. I can understand why outside investors feeling the squeeze of a poor share price performance probably won’t be impressed with nil-cost share options being issued.

The Director dealings page is mixed, with Max Royde (of Kestrel Partners, the biggest shareholder) making repeated purchases, whilst Dayani and Siffrin have been £ multi-million sellers.

Shareholder register is concentrated, with Kestrel owning 23.1%, Siffrin owns 12.5%, Slater 10.0%, Canaccord 5%, Chelverton 5.0%.

Kestrel and Slater seem to be buyers, with the other large holders all having been sellers -

It’s probably time to wrap this up!

Paul’s opinion - here are my conclusions.

Bull points -

I do think CNIC looks genuinely cash generative, and a large part of the gulf between adjusted, and statutory profit is due to amortisation charges related to previous acquisitions, so I think we can safely ignore that amortisation.

With the acquisition spree now having stopped, it should be possible for CNIC to reduce net debt.

The PER is low, at 6.7x

Over time, assuming it does generate cash in future, the market might re-rate this share.

Bear points and queries -

Awful balance sheet, with negative NTAV of $(175)m. I would be inclined to use this number for valuation purposes, not the (I think probably window-dressed) period end net debt figure of $49m.

Are profits sustainable? We’ve seen many times in the past that digital advertising companies can be big cash generators one minute, and dead ducks the next, when Google or Facebook change their algorithms. The current lowly valuation suggests to me that the market doesn’t think CNIC can necessarily keep churning out good numbers.

How will it be affected by AI and cookies? CNIC says that it doesn’t use cookies, so will benefit from them being banned. I don’t know anything about this sector, so don’t trust my judgement on what the future holds, so am not making any predictions.

Overly rapid expansion – although to be fair, management has addressed this concern, with a revised focus on cash generation amp; debt reduction.

Gross cash of $103m, and gross bank debt of $151m – this doesn’t make sense. So we need average daily net debt to be disclosed, to better understand reality.

No divisional split of profitability that I can see, so where does the profit actually come from? Advertising, or domain services? What’s the split?

Overall, for me, I wouldn’t want to invest in a digital advertising group. I’ve seen too many of them turn out to be bad investments, despite often looking superficially cheap, because things can suddenly change in this sector, and blow up business models overnight. That’s often why insiders are keen sellers.

That said, the numbers here are superficially quite attractive, so if you think that profit/cash generation will be sustainable, then it could be worth a look.

Hence overall, I’ll just be neutral, as I can see both sides of the story here. AMBER.

The share price has roughly doubled in the last 4 years – not too shabby -

Share price: 100p (pre-market)

Market cap: £10m

I’ll try to keep this brief given the very low market cap. We last covered this two weeks ago when it issued a nasty profit warning, as it emerged that a customer had overstocked Zytronic’s products, and another important end-customer was in Chapter 11 US bankruptcy.

Revenue forecasts for FY September 2024 were slashed from £13.5m to £8.0 – 8.8m, with (I presumed) another loss-making year. At least the company maintained its traditionally strong cash pile.

Today we have interim results (to March 2023), with the following headlines:

• Revenue £4.7m (H1 last year: £5.9m)

• Pre-tax loss £0.9m (H1 last year: profit £0.4m)

• Net cash £5.4m

The interim chair describes the results as “disappointing”, and says the Board is “working on a number of initiatives to address the headwinds the Group is currently facing so that the Group may return to revenue growth and profitability as soon as practicably possible”.

Let’s skip ahead to the latest outlook statement:

The headwinds caused by the noted effects of the overstocking and Chapter 11 event are expected to remain to the end of the financial year. The positive resumption of business development activities and the Group’s Board restructuring with the future Chair appointment, together with other initiatives being pursued, are expected to help position the Group more favourably for a future return to growth.

I note the reference to the “resumption of business development activities” – the company talks about business development taking two years for bespoke projects to mature, with Covid having caused a period of inactivity from 2020-2022.

In other words, they argue that they are still getting back on their feet post-Covid, but can point to a large number of open opportunities that they are working on in their sales pipeline. Supply chain issues also appear to have been resolved now.

Graham’s view

I won’t change my view here: this could be worth researching in more detail, as a potential recovery play, as the market cap is now covered half by net cash. Pre-Covid, they were able to generate a few million pounds of profit every year and their commentary suggests that they are looking to get back to pre-Covid performance levels as soon as their sales pipeline starts to mature (which will take more time).

Against that, you have to weigh the very poor current trading and the risk that the problems could be more fundamental than is apparent from the company’s releases.

I don’t feel confident in either direction and so I’m neutral.

Share price: 36.5p (+4%)

Market cap: £116m

This is “the UK’s leading tissue converter”. We looked at its interim results in January. While acknowledging that it had some bull points, I nonetheless decided to give this stock the thumbs down. I was wary of its focus on adjusted EBITDA rather than real profitability, and its ongoing debt load.

The shares are up another 20% since then as the stock makes a gradual recovery towards the levels seen in 2021:

Today’s trading update is again positive with FY April 2023 full-year results to be “at least in line with market expectations”.

Here’s the key news:

…the Group has continued to perform strongly, gaining further market share through its great value product range, broad retailer base, and new routes to market. The Group has successfully navigated and mitigated the well-reported and substantial inflationary pressures on a broad range of input costs through further process efficiencies and by engaging constructively with its customers to pass-on these additional costs.

Accrol makes paper for the likes of Aldi and Lidl, and the cost-of-living crisis is quite beneficial for discounters, so they are sitting pretty right now!

Some highlights:

• FY April 2023 revenues £242m (vs. £230m forecast), up 52%

• Adj. EBITDA to be “at least in line with expectations” of £15.5m

• Adj. net debt to be higher than forecast (though the RNS does not say this) at £26.8m. The company failed to hit the leverage multiple of 1.5x that it was targeting by year-end.

• Volumes up 7.7%, versus a flat tissue market.

Note that inflation is primarily driving the revenue gains, not volumes!

Outlook

Margins to “improve back towards pre-pandemic levels at a faster rate than previously reported”.

However, “prices are expected to soften in the year ahead, while volumes are expected to grow ahead of the overall private label sector”.

Net debt should go back to 1.0x EBITDA (latest was 1.7x).

20% of production capacity remains available to support further volume growth, and the company plans to build its paper mill by the second half of 2025.

Estimates for FY 2024

I’ve dug out a broker note to see the latest estimates.

With tissue prices expected to soften in the current year (FY April 2024), this has knock-on effects. Revenues for the current year are now expected to fall by nearly 5%, back to £230m.

However, with the help of a faster recovery in gross margin than previously anticipated, the adj. EBITDA forecast is raised to £19.3m (from £18.8m).

Graham’s view

They say that you should cut your losses and for that reason I’m tempted to withdraw my “Red” opinion on this stock, given that it has strong positive momentum behind it currently:

I will give the company credit for reducing its net debt. Even though it failed to hit its year-end target, it is moving in the right direction. That’s important especially as it plans to build a new paper mill, where costs could overrun.

However, I don’t want to change my negative view here as there are still several elements of the stock that make me uneasy, mostly to do with how it presents its results. Many, many different types of cost are excluded from the headline “adj. EBITDA” figure.

If you can find a broker who estimates the actual, reported profits of the business (Liberum is doing this), you’ll find that these estimates are a far cry from the adjusted numbers.

It sort of reminds me of this meme:

The current positive momentum in the share price may continue for some time, but this stock is not for me. It’s producing a commodity product and even if current conditions are favourable, I’m not convinced that it would be comfortable to hold this one for the long-term.

Stockopedia