Small Cap Value Report (Wed 19 July 2023) - WJG, RTN, FIF, CHRT, SPR, PGH

Good morning from Paul amp; Graham!

News today from the ONS that UK inflation has dropped a little more than expected, but is still way too high of course. Here are the main points (with thanks to the ONS) - 

• The Consumer Prices Index including owner occupiers’ housing costs (CPIH) rose by 7.3% in the 12 months to June 2023, down from 7.9% in May.
• On a monthly basis, CPIH rose by 0.2% in June 2023, compared with a rise of 0.7% in June 2022.
• The Consumer Prices Index (CPI) rose by 7.9% in the 12 months to June 2023, down from 8.7% in May.
• On a monthly basis, CPI rose by 0.1% in June 2023, compared with a rise of 0.8% in June 2022.
• Falling prices for motor fuel led to the largest downward contribution to the monthly change in CPIH and CPI annual rates, while food prices rose in June 2023 but by less than in June 2022, also leading to an easing in the rates.
• There were no large offsetting upward contributions to the change in the rate.
• Core CPIH (excluding energy, food, alcohol and tobacco) rose by 6.4% in the 12 months to June 2023, down from 6.5% in May, which was the highest rate for over 30 years; the CPIH goods annual rate slowed from 9.7% to 8.5%, while the CPIH services annual rate was 6.3%, unchanged from May.
• Core CPI (excluding energy, food, alcohol and tobacco) rose by 6.9% in the 12 months to June 2023, down from 7.1% in May, which was the highest rate since March 1992; the CPI goods annual rate slowed from 9.7% to 8.5%, while the CPI services annual rate eased from 7.4% to 7.2%.

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This was the brilliant presentation/Qamp;A by veteran, renowned fund manager Christopher Mills at Mello Monday that I was on about – it starts at 2:36:35

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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 £1bn. 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 (thumbs up) – 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 (thumbs down) – means we see significant, or serious problems, so anyone looking at the share needs to be aware of the high risk.

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Summaries of main sections below 

Watkin Jones (LON:WJG) – down 36% to 49p (£127m) – Trading update (profit warning) – Paul – RED

A very disappointing update, saying conditions have worsened again for this build to let, and student accommodation company. Profit warnings for both FY 9/2023 and FY 9/2024. Possible contract slippage. Another hefty increase of £30-35m in cladding remediation. Looks a mess short-term, but I still hope for medium-term recovery. Let’s wait until the dust has settled, so RED for now unfortunately.

Restaurant (LON:RTN) - up 9% to 42p (£325m) – Trading update – Graham – RED

The market likes this update: they are “confident” on expectations for the current year. Post-Covid trends are boosting dine-ins and airport bars. I remain negative due to risks around possible disposals. Without disposals, I think they could use some additional equity.

Finsbury Food (LON:FIF) – up 1% to 96.6p (£126m) – Trading update – Graham – AMBER

Sales are in line with expectations at this bakery manufacturer. Management has succeeded in passing on very high cost inflation to customers so the company can keep performing well for shareholders. I’m tempted to go green but in the current market the price may be right.

Cohort (LON:CHRT) - Up 10% to 490p (£203m) – FY 4/2023 Results (unaudited) – Paul – GREEN

Good results, a bulging amp; growing order book, sound balance sheet, and a reasonable valuation – these are exactly the things I look for, so this defence group gets a thumbs up.

Springfield Properties (LON:SPR) - up 1% to 65p (£77m) – Trading update – Graham – GREEN

This Scottish housebuilder maintains a defensive posture and a cautious short-term outlook, as buyers remain subdued by the cost-of-living crisis and higher rates. This is a riskier housebuilder than most but the risks may be fully priced in here. An adventurous choice.

Personal group (LON:PGH) - Up 4% to 192p (£60m) – H1 Trading Update – Paul – AMBER/GREEN

An unusual company, which I don’t fully understand! In line with expectations update today. Change of CEO. If it can return to pre-covid performance, then this share could re-rate, and continue paying out all its earnings as divis, as it has historically done.

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Paul’s Section: Watkin Jones (LON:WJG)

77p (pre-market) £198m – Trading Update (profit warning) – Paul – RED

Oh dear, this looks grim. We’ve had a couple of previous profit warnings from this build-to-rent and student accommodation specialist. However, it now looks as if the company’s previous reassurances that demand was returning to the sector was much too optimistic, and premature.

The CEO stands down today, to be replaced on an interim basis by the Chief Investment Officer, a long-standing internal candidate, whilst they seek a permanent replacement.

What’s gone wrong now?

They’re now saying it’s a “very challenging backdrop” for the sector, hit by macro amp; interest rates, with no talk about the recovery they previously indicated was supposedly happening.

5 projects were scheduled for completion by 30 Sept 2023 year end. One has completed, but a “greater degree of risk” on the others – so safe to assume some slippage (hopefully no cancellations?) here.

Exploring sale of a “limited number of non-core assets”

Impairment of assets c.£10m.

H2 could be another breakeven result (similar to H1) if projects don’t complete by year end.

FY 9/2024 also likely to be hit due to challenging conditions, with PBIT (operating profit) guided at £15-20m.

Provision for cladding remedial works has gone up again, by another £30-35m, which hits the balance sheet, but the cash cost to be spread over 5 years.

Cash positive, at £68m gross, and £36m net, at 30 June 2023. Although taking into account all the above, the balance sheet support to the share price seems to be melting away somewhat.

Paul’s opinion – this is a disaster, so I’m expecting a 30-50% share price fall today (writing this before 8am). No wonder the CEO has stepped down, as clearly his previous reassurances were wrong, and the risks were far greater than we were told.

Hence I can’t possibly keep a GREEN stance on this (which was always for a medium term recovery, as mentioned in SCVRs of 23 May, and 13 April, rather than any hopes for a short term re-rating). When the facts, figures amp; forecasts change, we change our minds. So I’ve got no other option than to go RED on Watkin Jones until the dust has settled.

Very disappointing, but a good reminder that when management keep reassuring us, despite being in a tough cyclical sector, they might not be giving a realistic version of the outlook. I need to be more sceptical about reassuring updates from cyclical companies. This makes me wonder about the brick companies – can they continue to perform well? Maybe not.

I think this one is a warning for us to keep away from obviously cyclical sectors like commercial property building, and anything that’s likely to be hit by interest rate rises. It’s too early to be bottom-fishing it seems.

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Cohort (LON:CHRT)

Up 10% to 490p (£203m) – FY 4/2023 Results (unaudited) – Paul – GREEN

Cohort plc (www.cohortplc.com) is the parent company of six innovative, agile and responsive businesses based in the UK, Germany and Portugal, providing a wide range of services and products for domestic and export customers in defence and related markets.

Cohort plc today announces its unaudited results for the year ended 30 April 2023.

Record operating profit, revenue and order book. Further progress expected.

Checking our previous comments on my quick reference summary spreadsheet, these were our previous views on Cohort, for background -

14 Dec 2022: 430p. GREEN. Good H1. Mgt upbeat about demand.

25 May 2023: 503p. AMBER. Slightly ahead exps for FY 4/2023. Large order book, so good visibility. Quite interesting at 14x PER.

On reflection, maybe I was too stingy only concluding with an AMBER view on 25 May, it should have been AMBER/GREEN I think! (I must have been having a bad day!)

FY 4/2023 Results -

Look very good, some key numbers being -

Revenue up 33% to £183m

Adj operating profit up 23% to £19.1m – a healthy 10.4% margin (of revenue)

Statutory operating profit of £15.3m is 20% lower, so are the adjustments reasonable? Yes I think so, the main one being amortisation of intangibles. It’s not capitalising anything new into intangibles (per the cashflow statement), and the £3.67m Pamp;L amortisation charge ties in perfectly with the reduction in intangible assets on the balance sheet, so all good I think – it’s fine to adjust this out, in order to show underlying profitability.

The forex adjustments above are also OK I think, as it evens out over the two years.

The problem with operating profit these days, post IFRS 16, is that it misses some lease costs, which are too far down, in the finance costs line. Hence why I prefer adj PBT as the best profit measure to use, but it isn’t provided.

So overall, for valuation purposes I think adj EPS is the most appropriate number, which is 36.5p, up 17%. Giving a PER of 13.4x - that looks very reasonable to me, for a nice quality, growing business. Assuming of course that profits continue growing – which you can’t just assume will be the case, with a business like this that tends to have large, lumpy contracts with customers.

Order book – this reassures me that most, and it’s up 13% to a whopping £329m, or 1.8x FY 4/2023 revenues. A big, and growing order book is one of the key things I look for in businesses like this, as it makes the risk of a profit warning much lower.

Dividends – a table is provided showing impressive long-term growth in divis. Total divis are up 10% to 13.4p, yielding 2.7%, not terribly exciting, but that is covered 2.7x by earnings, so the dividend paying capacity is much higher. The strong balance sheet also means Cohort is not in any way struggling to pay these divis, it’s easily affordable.

Balance sheet - net assets are £100m. I’ll take off the £56m intangible assets, arriving at £44m NTAV, which looks fine to me. That includes a £5.3m pension deficit, which would need checking out to see that it’s not an iceberg deficit. I can’t see any other info about the pension scheme in today’s numbers, that will probably be in the later Annual Report once it’s audited.

One query, to ask management if you get the chance, why does its balance sheet show cash of £41.5m, and bank borrowings of £25.8m? Surely it would make more sense to pay off the bank borrowings with the cash, to save on interest costs? Then just dip in amp; out of an overdraft when required for short term cashflow gyrations. Also, what is the average daily net cash, which is more meaningful than a 1-day snapshot on the year-end date?

Cashflow statement – provides a nice clear explanation of how this business works.

My summary (re-jigged so it makes more sense!):

£16.5m positive operating cashflow

(£2.0m) lease payments

£14.5m subtotal: real cashflow

This is spent on:

Capex £(5.2)m

Acquisition £(1.0)m

Divis paid £(5.1)m

Share buybacks £(0.6)m

New shares issued £1.1m

Bank debt repaid £(4.0)m

Exchange gains £1.2m

Total all the above, and cash is up by about £0.9m + £0.1m rounding.

That’s a nice roughly equal split, with positive cashflow paying divis, funding capex, and reducing debt.

They don’t really need to reduce debt, as there’s enough cash to pay it all off, so to my mind the cashflow would be capable of paying a dividend about double the current level. Hence dividend paying capacity (more important than the actual yield, in my view) is that Cohort could pay divis yielding 5%+ without straining itself. Although maybe just not yet, as the outlook says it needs to increase capex in this new year.

Outlook – here it is in full, this sounds very encouraging to me -

Encouraging outlook for Cohort
Our order intake for the year was strong and as a result of this success, the Group has entered the new financial year with a record order book of £329.1m. As we have indicated in the last few years, our order book is not only growing in value, but its longevity continues to increase. We now have orders across the Group stretching out to 2032. We have good prospects in the coming year to secure further long-term orders for our naval systems and support work, including from the UK MOD, Portugal and in export markets, as recently exemplified by the £26m order announced 9 May 2023 and a first order for our KDS anti-submarine system of over £7m announced on 30 May 2023.

The order book underpins over £140m (80%) of current financial year revenue expectations (2022: £128m). Following order wins since the start of the financial year of over £60m, that cover now stands at just over 90%.

Overall, we continue to expect that our trading performance for 2023/24 will be ahead of that achieved for the year ended 30 April 2023. We have had an encouraging start to the new financial year and our expectations for the full year are unchanged.

As a result of planned capital expenditure and expansion in working capital we expect that our net cash balance will decrease, but that we will maintain positive net funds at the year end.
We are optimistic that the Group will make further progress in 2024/25, based on current orders for long-term delivery and on our pipeline of opportunities.

Paul’s opinion – I’ve spent a fair bit of time on this, as it looks really good to me.

So an unequivocal thumbs up, GREEN, for what is clearly a GARP (growth at reasonable price) share.

Cohort seems to have made good progress in the last 5 years, not reflected in the share price, so I think this could be a good long-term buying opportunity.

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Personal group (LON:PGH)

Up 4% to 192p (£60m) – H1 Trading Update – Paul – AMBER/GREEN

Personal Group (AIM: PGH), the workforce benefits and services provider, is pleased to provide the following update on trading for the six-month period ending 30 June 2023 (HY23).

A rather long-winded update, and not a business I’m up-to-speed on, but overall it sounds in line with expectations, but with no footnote saying what these market exps are -

Board to remain confident that trading for the full financial year remains in line with market expectations.

• H1 revenues £46.4m (up 34%) – nice growth.

• H1 adj EBITDA up 75% to £2.7m

• Claims to have a strong balance sheet, with £22.6m cash and no debt (I’ve checked, and the bal sht is pretty good)

• Good visibility from recurring revenues.

That all sounds quite interesting actually, which has motivated me to have a quick look at the FY 12/2022 accounts, which are -

Revenue £87m (up 16%)

Adj EBITDA £6.0m (H1: £1.5m, H2: £4.5m), so the H1 2023 EBITDA figure above is actually a step backwards sequentially on H2 2022.

Historically PGH has paid out almost all earnings as divis, and it did this in 2022, earning adj EPS of 10.6p, and paying out the whole lot in divis, so a nice yield of 5.5% – and that could grow considerably, if it returns to the pre-pandemic days of divis around 23p pa – an upside scenario case which could get it up to a 12% yield in future, possibly?

A goodwill write-off suggests that the company isn’t very good at acquisitions, which could be why the CEO is being replaced?

I’m not very keen on the list of costs on the Pamp;L, it seems to be taking insurance policy risks.

Balance sheet at Dec 2022 looked OK, at about £25m NTAV.

Paul’s opinion – neutral, as I don’t know the company well at all.

However, even on just a quick desktop review, I can see that there might be potential here. If it can return to pre-covid profitability and divis, then that would justify a decent uplift in share price, I reckon. I can see why employers (customers) might now be wanting to buy enhanced benefits for employees, due to the importance of retaining staff in a tight labour market.

So this share could be one for readers to investigate further yourselves. Getting to properly understand the insurance products, and the risks, looks key.

Delisting risk is worth considering with the top 2 owning c.50%.

I’ll go AMBER/GREEN I think.

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Graham’s Section: Restaurant (LON:RTN)

Share price: 42p (+9%)

Market cap: £325m

Covering this stock back in March, I was flummoxed by six different measurements of adjusted profits.

I also see that Paul, in May, described what they published as “a really badly-written, unclear trading update”.

So my expectations were low as I opened up RTN’s H1 trading update this morning. Thankfully, the final line of the update does state in simple English that the company is “confident in delivering management’s expectations” this year.

Before that, we had a couple of tables to review.

Here’s the main one:

The numbers I’ve shaded in yellow are the new Q2 like-for-like figures (the Q1 figures were published in May). To me, it looks like a net deterioration compared to the illustrative figures seen in Q1.

RTN paid the best part of £600m for Wagamama in 2018, and its own market cap is now little more than half that figure. Even if RTN overpaid (by a lot), I think Wagamama remains one of the better parts of the RTN empire. But 5% like-for-like sales growth isn’t quite good enough in this inflationary environment, sadly. Hopefully Q3 will be better.

The company also provides a split of year-to-date delivery/takeaway vs. dine-in sales. I won’t subject you to another table, but the main point is that dine-in sales are much stronger than delivery/takeaway (comparing 2023 vs. 2022); this must be a lingering effect of Covid-related trends. Delivery/takeaway are down c. 10%.

Wagamama – has “outperformed the market”, and “recent openings are trading ahead of expectations”. Similarly, Pubs are outperforming the market with dine-in covers having increased year-on-year.

Leisure is the problem child. RTN puts a brave face on it, saying “good progress has been made on further improving cash generation”. More could have been said.

Concessions (airport bars) are showing the best year-on-year growth, “benefitting from the rapid recovery of passenger volumes and strong operational delivery”. Since this is a Covid-related recovery, I wouldn’t read too much into it.

Property – 35 sites are being closed, including some freehold sites to be sold. Wagamama continues to steadily expand.

Strategy – they are trying to get net debt/EBITDA below 1.5x by the end of FY 2025.

We also get this:

Whilst we are pleased with the progress being made in delivering these medium-term plans, the Board has continued to review its wider strategic options with the assistance of independent advisors in order to examine the potential to accelerate TRG’s deleveraging profile and further enhance EBITDA margin accretion. In evaluating strategic options including potential disposals, the Board remains mindful that any transaction must be at attractive levels for shareholders and must reflect both the strength of current trading and the long-term prospects of our businesses.

Graham’s view

I said last time that RTN might want to think about raising more equity.

Today’s update gives more information about the “long-term strategic options” they are considering. We now know that they are talking to advisors, that they want to accelerate their deleveraging, and that disposals are on the table.

I agree that they should deleverage faster. Even a net debt/EBITDA profile of 1.5x would not be very good, since EBITDA is a very poor (in my view, almost useless) measure of profitability for a capex-heavy sector such as this. And RTN is only aspiring to achieve that leverage profile by the end of FY 2025!

Whether they raise equity or make a disposal is up to them – the economic effects are similar. If they can get good bids for the troubled Leisure business, they should do that.

In the meanwhile, I am going to maintain my RED position on these shares because in my view they should be trying to get a deal done, to get onto a comfortable financial footing (net debt last seen at £186m, excluding leases). But there is no guarantee that any deal is going to be on favourable terms for shareholders, and they could be left holding a much smaller (but hopefully more profitable) business afterwards. Or else they might raise equity.

The current market cap of £300m might seem low in comparison to sales of over £900m, but the quality of this business is questionable and its financials are uncomfortable. I could switch to a neutral stance if the shares were being priced as options on the debt, but I don’t think we are there yet.

The statutory numbers don’t lie:

(Paul: note heavy dilution over this period, avg shares up from 277m in 2018  to 765m now)

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Finsbury Food (LON:FIF)

Share price: 96.6p (+1%)

Market cap: £126m

Finsbury Food Group Plc (AIM: FIF), a leading UK speciality bakery manufacturer of cake, bread and morning goods for both the retail and foodservice channels, is today providing an update on trading for the financial year, ended 1 July 2023, prior to entering its close period.

This is a low-margin food manufacturer that usually trades at a cheap-ish level:

The P/E ratio is currently 9x, which is about average for it.

Based on our notes in the archive, we tend to have a mildly positive view on it.

In recent times, high raw material Inflation has been passed onto customers, keeping it in the black.

Key points from today’s full-year trading update:

• Sales up 12.5% organically, up 16% including an acquisition. Sales are in line with expectations.

• Growth in sales is driven “primarily by price”. As we’ve noted before, volumes aren’t changing much.

It has been “an incredibly challenging environment” but Finsbury has weathered it thanks to “commercial terms, operational improvements and other supply chain and overhead initiatives.”

The company also sounds very pleased with its small (£6m) acquisition of Lees of Scotland. According to the Lees website, it was previously listed on the stock exchange, from 2005 to 2012! It had the ticker LEE.

Performance at Lees has been in line with expectations:

Lees has a well-established number one position in the UK meringue category and strong relationships across a high quality and diverse customer base. This provides Finsbury with the opportunity to build upon both businesses’ existing retail relationships and unlock further commercial opportunities, including out of home eating.

Graham’s view

I’m tempted to go green on this one, as it has previously traded at a PER of 12-13x. However, that may have been during periods when the market generally traded at richer valuations. In the current market, we aren’t short of possible bargains. In other words, Finsbury may be cheap but it’s not alone!

I will say that as food manufacturers go, this may be one of the better ones. It has almost always made a profit and earned a good if unspectacular return on capital. I would sleep somewhat soundly at night owning this one.

I’ll stick with AMBER but it’s a close call. Stockopedia computers think I should be more enthusiastic:

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Springfield Properties (LON:SPR)

Share price: 65p (+1%)

Market cap: £77m

Springfield Properties (AIM: SPR), a leading housebuilder in Scotland focused on delivering private and affordable housing, provides the following update on trading for the year ended 31 May 2023.

I stayed neutral on this in February (share price: 80p) due to what I perceived as limited liquidity headroom for the company. It had temporarily increased its overdraft as I suspected it had probably come close to maxing out its RCF.

Let’s catch up with this full-year trading update:

• Revenue approx. £330m (the prior consensus was c. £340m)

• PBT will be in line with expectations (Equity Development have “adjusted” PBT at £16.1m in their initiation note published today).

• Landbank is 16,300 plots. This is a slight reduction on last year’s figure (16,650 plots).

• Gross development value unchanged year-on-year at “c. £3.5 billion”. (although last year, they left out the “c.”!)

• Net debt is £68m at year-end. This is massively up year-on-year due to an acquisition, but it is down from £74m as of November 2022.

Profits will be lower for FY May 2023 compared to FY May 2022,reflecting “the impact of significant build cost inflation, particularly on fixed-price contracts in affordable housing, affecting margins across the Group.” It was already known that Springfield was taking a break from this sort of work, due to the problem that rising costs can make it unprofitable.

We do have some good news on this front:

in June 2023, the Scottish Government increased the affordable housing investment benchmarks by 16.9%. This is expected to enable housing associations to increase the price of affordable housing contracts to progress the building programmes required to meet the Government’s affordable housing targets.

Private housing has also had its fair share of challenges, although at least prices have been able to rise freely to offset rising costs. The average selling price achieved is now £290k (last year: £245k). With the ongoing cost of living crisis affecting confidence, Springfield reports that its forward order book ended the year lower than it ended the prior year.

Strategy: the company has taken a defensive posture. They have reduced land-buying activity, paused recruitment/reduced staffing, cut costs, and even sold some land.

CEO comment excerpt:

We remain cautious about the near-term outlook, particularly given the softening in demand following the increase in rates by the Bank of England to 5%. We are closely monitoring the economy and buyer behaviour in both the housing and land market and carefully managing our activities to limit our exposure in the slower sales environment. This will also ensure that we can respond quickly when normalised demand returns. With over half of our large, high-quality land bank having planning permission, we are well-positioned for when market conditions improve.

Graham’s view

I’m inclined to give this one the thumbs up, because my main concern last time was the use of a temporary overdraft – that worried me!

Since then, the company has made some progress in reducing debt and I would like to see it continue down this path. A housebuilder with net cash can feel like a very solid investment, while a housebuilder with net debt is a much more adventurous play.

The main attraction here is cheapness. Tangible book value per share should be in the region of 120p. It’s fair to question whether this value is “real” in the current environment, with rising rates, and to worry about stumbling blocks the company might run into. There is no guarantee that affordable housing will be profitable again in the short-term, although the signs are positive. So this is not without risk.

Ultimately though, I’m going to give this one the thumbs up, since I find it difficult to resist a value housebuilder. Bellway is at a price to tangible book of 0.7x, Redrow is at 0.8x, and Crest Nicholson is at 0.6x. Vistry is at a premium to tangible book (all using Stocko numbers). The discount in the Springfield share price can be justified by its elevated financial risk, but that’s what diversification is for!

Five Stockopedia screens also flag this stock as being worthy of further research. Mostly these are “Bargain” and “Value” screens. When full-year results are published, with the higher debt load, I’ll be interested to see if Springfield remains on these lists!

Stockopedia

Source: https://www.stockopedia.com/content/small-cap-value-report-wed-19-july-2023-wjg-rtn-fif-chrt-spr-pgh-971976/