Small Cap Value Report (Tue 23 May 2023) - EMR, PMP, AVON, ETP, CLX, WJG

Good morning from Paul, and I’m joined by Roland today, to free up Graham for presentations at Mello Chiswick, which starts today. I’ll be wandering over this afternoon, to catch up with everyone!

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.

Lots of news today – we’ll do our best with this lot, focusing particularly on the news that’s moving prices the most, and less on things that are only in line with expectations and not moving prices - 

Avon Protection (LON:AVON)  down 8% to 889p (£267m) – H1 results, downgrade – Roland – AMBER

A revenue warning from this personal protection equipment group, which is still suffering the consequences of a poor acquisition in 2020. I think there could be some medium-term potential here, but the shares still look fully priced to me at current levels.

Eneraqua Technologies (LON:ETP) – down 36% to 168p – FY 1/2023 results , with a disguised profit warning – Paul – RED

Strong results for FY 1/2023, but it turns out that FY 1/2024 are set to plunge. This is almost completely obscured by upbeat-sounding, and I think highly misleading commentary. So a big thumbs down from me, and this now becomes a company I don’t trust, so uninvestable.

Calnex Solutions (LON:CLX)  up 10% to 109p (£95m) – FY results, in line – Roland – GREEN

Today’s results from this electronics firm show excellent profitability and cash generation, backed by a very strong balance sheet. Forecasts suggest a sharp drop in profits this year, but I think the long-term potential of this business remains very attractive.

Watkin Jones (LON:WJG) (Paul holds) - down 17% to 80p (£204m) – In line H1, but H2 forecast slashed (PW) – Paul – GREEN

I bought this forward-sold contract builder as a medium -term recovery share, half-expecting more bad news in 2023, as mentioned in previous SCVRs. H1 is breakeven (as expected), but contract delays are pushing some big projects into next year, so it’s another profit warning. Increasingly solid asset backing from a lovely balance sheet. I see this as a setback, but doesn’t change the medium term investment case for me, with my small initial position. You may not agree of course!

61.5p pre-open (£30.5m) – AGM trading update, profit warning – Roland – AMBER

This recruitment group says that the “softening of demand and slowing of hiring decisions” seen late last year have continued into 2023. Net fee income for the four months to 30 April 2023 is 5% below than the same period last year. Half-year profits are expected to be “down significantly”. Current expectations are for a full-year pre-tax profit of c.£7m, versus previous forecasts of £9m. Broker Cenkos has cut full-year earnings forecasts by 28% to 6.4p per share (available on Research Tree).

Roland’s opinion: Empresaria reported a slowdown in healthcare last year and booming demand in offshore services. I wonder if offshore demand may now be easing to more normal growth rates. Unusually in this sector, the group ended last year with a modest net debt position. While I don’t see it as a big concern, the timing seems poor. The shares don’t look expensive, but I think there are safer options elsewhere in this sector right now. I’d stay on the sidelines until we have more clarity on trading.

Portmeirion (LON:PMP) (Paul holds)

Down 8% to 465p [08:07] £65m – AGM Trading Update – Paul – GREEN

H1 is seasonally quiet as usual, expects to match last year’s H1 sales in 2023, which it calls “robust”. “Some increased caution” from US customers in recent weeks. “Well positioned” for seasonally stronger H2, with “strong Christmas order book”, ahead of last year. New products well received. Reiterates strategy to improve margins. Overall, “we remain positive” in both short, and long-term prospects, whilst mindful of challenging consumer headwinds.

Paul’s opinion – tricky this. Is it a profit warning? I’d say no, as it says well positioned for the busy H2, and Xmas orders ahead of last year. That sounds fine to me. But early warning signs from the US could spell trouble ahead maybe? Singers analyst Sahill Shan has not made any forecast changes this morning, sticking with FY 12/2023 forecast of 51.7p EPS (up c.10% on FY 12/2022 actual). So on a PER of only 9.0x, this share remains cheap for medium-term holders like me who don’t care about any short-term softness in demand. For more twitchy types, then today’s update might make them more nervous perhaps?

Down 19% to 210p

Market cap £70m

Preliminary Results

Eneraqua Technologies plc, a provider of specialist energy and water efficiency solutions, is pleased to announce its preliminary results for the year ended 31 January 2023.

ETP floated in late 2021, and looks quite an interesting company. I reviewed it briefly here in June 2022, noting the impressive results for FY 1/2022, and the big order book.

More recently it issued a mild profit warning which we commented on here in March 2023.

The share price has dropped almost a third since then. Today I was expecting it to rise, as the early snapshot was that trading was ahead of expectations, but it’s currently down 19%, so there must be something wrong, let’s have a look.

Moving on to the FY 1/2023 results, out this morning.

Here’s the financial highlights table

Several things stand out from the table above -

• Superb revenue amp; profit growth.

• But hardly any growth in adj EPS – why not?

• Negative cashflow – why?

• Tiny dividend compared with EPS.

Answers -

Cashflow – it blames having to bulk purchase scarce components in advance, due to supply chain issues. Also a Q4 weighting of sales, meant year end receivables were higher. It says this is now unwinding into cash, post year end. That sounds credible to me.

EPS – why no increase, despite profit being up 79%? There are 2 reasons. Note 5 shows that the weighted average no. shares in issue rose from 22.2m last year, to 33.4m this year. I can’t reconcile this with the AIM Admission Document, which shows 4.3m new shares being issued, resulting in 33.2m in total after listing, in Nov 2021. Since the last year EPS number mainly relates to pre-IPO, I think I’ll just ignore it.

Also there seem to be some adjustments to EPS in the highlights table, because lower down it shows 25.3p dil EPS vs 18.2p dil EPS last year. This is different to the 25.6p vs 24.9p adj EPS figures in the highlight table. Let’s move on, as I’m going down a dead end here, of little use to anyone.

Order book – sounds very strong, in the context of £55m actual revenues for FY 1/2022 -

Record order book3 of £130.4m of which 62% [Paul: £81m] is currently anticipated to be delivered in FY24.

This bit seems to be saying that FY 1/2024 margins will be lower, and is crucial negative information, that you could be forgiven for not having spotted at first  -

Unexpected inflation spike in other building works areas during calendar 2022 affected client programmes. This saw some urgent smaller value, higher margin projects move into FY23 with larger, lower margin projects moved to FY24. As a result, we expect to see FY24 revenues significantly ahead of previous management expectations with high-single digit PBT margins, before reverting to a more balanced mix of projects and margins in FY25.

This sounds serious, because the adj PBT margin was 18.3% in FY 1/2023. So high single digit PBT margin for FY 1/2024 seems to be roughly a halving of the PBT margin! That’s a big deal, but not in a good way.

Balance sheet - NAV is £25.0m. Deleting the £8.7m intangible assets, gives NTAV of £16.3m, which looks OK for the size of business.

Noteworthy numbers are that there’s little in inventories. Also a huge receivables figure of £29.2m stands out a mile. This is mainly work they’ve done, but not yet invoiced, and the commentary says it’s mostly turned into cash post year-end, so we have to take their word for that.

Net bank debt is £3.0m, which looks OK to me.

There is risk here. Lots of sales were booked in Q4 of LY, and were not paid for by year end, so we’re having to rely on the auditors having properly checked the receipt of those funds post year-end. Let’s hope they’re doing a particularly careful job on the huge receivables number – remember today’s numbers are unaudited, preliminary figures only.

Forecasts – huge thanks to Singers for crunching the numbers for us. What reads like a cheerful RNS is actually a big profit warning! Singers cuts its  aPBT forecast by 42% to £7.0m, which is 15.8p.

My opinion – I’m disgusted with the way this RNS tries to gloss over a big profit warning for FY 1/2024. The commentary sounds upbeat, and that might have misled people into buying shares earlier this morning. The bad news is almost buried, with only the words “with high-single digit PBT margins in FY24” giving any indication that something is wrong, and that profit is set to plunge in this new financial year.

For this reason, I don’t trust the company, and am not interested in buying any shares in it.

It’s probably best to see the FY 1/2023 results as a one-off bumper year, not to be repeated.

What had been a rare, successful 2021 float, has now joined many of its peer group in the discount clearance section. From 277p float, to about 170p no [10:32], down 35% on the day. I opened at 08:00 barely changed, which confirms that the bad news was nastily buried, only dawning on people a little while later. What a poor show.

Down 17% to 80p (£205m) – H1 results, FY PW – Paul – GREEN

An interesting property developer, which has a good history of building projects (e.g. student accommodation) to order, pre-sold to institutional clients.

To set the scene, there was a big profit warning in Oct 2022, smashing the price down from c.150p to 80p. I bought a few as a toe-hold for a longer-term recovery, but also (bizarrely maybe!) anticipated another profit warning here on 27 Jan 2023 concluding that 2023 could be a bumpy ride, with another profit warning being a distinct possibility.

On 13 April 2023 I covered its update, when a contractor went bust, disrupting amp; costing more for a project in Exeter. Again, my conclusion was cautious, that publication of H1 results could trigger another dip in share price.

With hindsight, it would have been better to sit on the sidelines completely, but never mind.

Today’s interims are poor, as previously indicated, they’re actually in line with expectations, around breakeven.

H2 is expected to be materially stronger than H1, which is good.

However, it now looks as if they were previously far too optimistic for H2, and Progressive has roughly halved forecast for FY 9/2023 to £25m aPBT, which is 7.6p EPS.

Historically WJG has tended to produce about 15-16p EPS, so I remain of the view it should eventually recover to that level.

What’s gone wrong this time? It’s just delays to project completions – remember that WJG develops a small number of large building projects, so the numbers can vary a lot if completion of projects slips into the next year, which is now looking likely. It could warn on profits again, if the 5 deals it needs to close don’t happen by year end. So this is not a share for the faint-hearted.

On project pricing, it says this is broadly as expected, but with clients wanting more back-loaded funding, to suit their needs (in a higher interest rate environment I suppose).

WJG sees early signs of a recovery in its market conditions.

Project delays mean £15m profit shifts from FY 9/2023 to FY 9/2024.

Pipeline is down from £2.0bn to £1.7bn.

It calls the land purchasing pipeline “exciting”.

Build cost inflation – early signs of a reduction.

Paul’s opinion – obviously a setback, but one I was half-expecting, as you can see from the 2 SCVRs referenced above. As the shares get cheaper, the balance sheet support gets stronger, NTAV is now £153m, and the market cap down to £205m, so the previously big premium to NAV is now quite small. I don’t see any balance sheet risk, as it doesn’t have a large landbank, as it’s a more build-to-order type of business.

I’m currently about 20% down on a small position size, so it’s no great shakes, and the asset backing is now more solid than before. Hence I’ll wait to see where the share price bottoms out, then probably buy some more. As a medium-term recovery share, it should do well I think, which was my original investing case. This year is going to be worse than originally expected, but there’s no reason to suppose the medium term outlook has changed at all. Hence why I’ll obstinately remain positive in my view of this medium term recovery share.

If you trade in amp; out of shares on short term movements, then you might see things very differently, which is fine, it’s what makes a market!

There’s also the interesting upside from Govt ideas to stimulate infrastructure spending, especially housing, by e.g. pension funds, insurance companies, etc. My thought is this could play right into WJG’s strengths, and trigger a nice recovery in this share at some point in the future. So it’s not a broken business, and with some patience, I think this could be a good recovery share, but maybe not until 2024 and beyond.

Roland’s view: AMBER

Share price: 889p (-8% at 08.40)

Market cap: £267m

Interim results

Full year Group revenue excluding armour now expected to be c9% lower than the prior year

In January, Paul noted that personal protection equipment group Avon was guiding for an H2 weighting to revenue and noted that the shares looked expensive. This stock has collapsed since the pandemic.

Today’s half-year results – the first under new chief executive Jos Sclater – reveal that full-year revenue is now expected to be 9% lower than the prior year. This compares to previous consensus forecasts for 11% revenue growth in 2023.

Avon says that a helmet programme with the US Department of Defense is going “slower than expected”. The group has also seen a decline in revenue from respiratory equipment following a strong prior year.

Increased revenue from body armour helped to offset this fall in revenue. But the armour business is currently being wound down, so will be excluded from future years’ results. Let’s take a look at some of the numbers.

Financial highlights: these figures cover the six months to 1 April 2023.

• Group revenue down by 3.9% to $116.2m

• Adjusted pre-tax profit of $0.9m (H1 22: $(2.8m))

• Adjusted earnings per share of 2.4 cents (H1 22 (7.2c))

• Net financial debt up 26.9% to $71.8m (2.6x EBITDA)

• “Record-high” order book up 20.1% to $160.7m

• Order intake up 11.9% to $125.6m

Improved order intake seems positive and could point to a stronger performance once the drag from the loss-making armour business is removed:

• Armour revenue: $14.6m

• Armour operating loss: $(4.7)m

At a statutory level, Avon remained loss-making due to a combination of amortisation charges, restructuring costs and transaction fees. However, these losses were reduced from last year:

• Pre-tax loss from continuing operations: $(5.3m) (H122: $(13.6m))

Outlook: the company points to its record order book and says that “good year-on-year revenue growth” in Head Protection sales is expected in FY23 and beyond.

However, sales of respiratory masks are expected to be slower in H2 and lower than previously expected for the full year. There is also some “ongoing risk to shipment timings in H2” – presumably this means that some revenue could slip back into next year.

As a result, full-year revenue excluding armour is now expected to be 9% lower than the prior year. Cost-cutting means that EBITDA margins excluding armour are expected to be “broadly consistent” with the 14.7% reported last year.

I can’t find any broker notes for Avon on Research Tree, so I’ve checked back to last year’s results to calculate comparative figures. I estimate:

• Revenue exc. armour of $240m

• Adjusted EBITDA exc. armour of $35m

The net debt position is expected to improve during the second half as inventories unwind – I estimate year-end net debt/EBITDA is likely to be c.2x. Still slightly high, but not a pressing concern, in my view.

Roland’s opinion: this business used to be a reliable performer, but the group still seems to be struggling with the consequences of the 2020 acquisition of 3M’s body armour business (and the sale of its milkrite dairy division).

New chief executive Jos Sclater may be keen to get the bad news out up front so that future results will show a stronger comparative performance. Certainly next year’s results should be cleaner and simpler, once the armour business is excluded.

But even so, the underlying profitability of the continuing head protection and respiratory business doesn’t seem that impressive to me, with an segmental operating margin of 8.8%. Perhaps there’s scope for this to improve back to historic levels, over time:

Avon’s debt levels are also worth monitoring, although the company’s explanations and guidance for reduction seem reasonable to me.

I estimate an operating profit of perhaps £17m (GBP) on a continuing, adjusted basis this year. The group’s shares still look expensive to me on that basis, with a market cap of c.£265m.

I think this business could return to growth from next year and may offer some medium-term value. But I’d need to do more detailed research into Avon’s products and markets to take a strong view on this. For now, I think it makes sense to remain cautious.

Roland’s view: GREEN

Share price: 109p (+10% at 09.40)

Market cap: £95m

Final results

Trading in the first few months of FY24 has continued as anticipated, and the Board remains confident in delivering results for the year in line with the revised market expectations.

This owner-managed network testing and measurement specialist floated in late 2020. The stock remains a double bagger, despite having come back to earth recently after the company lowered its FY24 guidance in March.

I’ve always had a positive impression of this AIM-listed business, so I’m interested to see what today’s results hold.

Today’s results cover the year ended 31 March 2023. Growth remained strong, but we need to remember the company’s most recent guidance is that “financial performance in FY24 will be below that achieved in FY23, with the Company’s revenues more heavily weighted to H2 of FY24”.

In other words, growth is expected to pause this year, or perhaps even reverse.

Financial highlights: here are the main figures from the year just ended. These are nice clean accounts, so I’m quite comfortable presenting you with the company’s own numbers:

Profitability and cash conversion are very strong at this business. I’ve calculated the following numbers from today’s results:

• Operating margin 26.4% (FY22: 27.2%)

• Return on Capital Employed: 25.4%

• Free cash flow (exc. acquisitions): £6.3m

• Free cash flow/net profit conversion: 107%

• Free cash flow margin: 23.0%

I don’t see anything to dislike in Calnex’s FY23 accounts. The shares don’t seem expensive to me on these historic numbers, either, trading on 15 times free cash flow (c.7% FCF yield).

The risks – such as they are – must clearly reside elsewhere. Let’s take a look.

Operating highlights: Calnex’s core customer base is the telecoms market. The company sells to both mobile and fixed-line operators. Unsurprisingly, 5G is cited as a major driver of growth.

Telecoms customers accounted for 75% of business last year, down from 77% the previous year.

The remainder of revenue came from data centre and hyperscalers (cloud operators) customers. Calnex sees these as offering good growth potential, given the scale, complexity and geographic dispersion of their networks.

The number of customers who ordered from Calnex last year rose by 72 to 305, but 47% of revenue came from the top 10 customers. So I think there’s still some risk linked to customer concentration.

However, customer relationships appear strong – those top 10 have been buying from Calnex for an average of 10 years.

Outlook: chief executive and 20% shareholder Tommy Cook says that “we have been encouraged to see the early signs of a more stable macro environment”.

The company has left its FY24 guidance unchanged in today’s results.So too has broker Cenkos, which is forecasting a 47% fall in earnings to 3.6p per share this year. That prices Calnex stock on a forecast P/E of 30.

This rating appears to price in a return to more normal ordering patterns over the next 12-18 months. That assumption obviously carries some risk. But given the structural growth characteristics of the telecoms and data centre sectors, I don’t think it’s an unreasonable assumption.

Roland’s opinion: today’s numbers contained few surprises, demonstrating the strong profitability and cash generation that this business has displayed since its IPO.

Founder and CEO Tommy Cook remains the largest shareholder, providing good alignment with shareholders.

Although the shares look expensive on a short-term view, I think this could be a case where it pays to stay invested.

The balance sheet looks bulletproof to me – net cash of c.£19m accounts for 20% of the current market cap.

While the growth outlook is a concern, I see Calnex as a good quality business with the potential to deliver long-term compound gains.

I’m going to give the stock the green light. Based on today’s results, I would be happy to start buying gradually into a position here, potentially averaging up or down later this year, depending on trading.

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