Small Cap Value Report (Wed 31 Jan 2024) - SOM, IHC, AGFX, SNWS, ATG, PEB

Good morning from Paul amp; Graham!

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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 (usually) between £10m and £1bn. We usually 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. OR it’s such deep value that we see a good chance of a turnaround, and think that the share price might have overshot on the downside.

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. Sometimes risky shares can produce high returns, if they survive/recover. So again, we’re not saying the share price will necessarily under-perform, we’re just flagging the high risk.

Links:

Paul amp; Graham’s 2024 share ideas - live price-tracking spreadsheet (2 separate tabs at bottom),

Frozen SCVR summary spreadsheet for calendar 2023.

New SCVR summary spreadsheet from July 2023 onwards.

Paul’s podcasts (weekly summary of SCVRs amp; macro views) – or search on any podcast provider for “Paul Scott small caps” – eg Apple, Spotify.

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Agenda – Weds 31 January 2024

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Summaries

Somero Enterprises (LON:SOM) – up 6% to 370p (at 08:18) £206m – Trading Update [in line] – Paul – GREEN

A reassuring year-end trading update confirms FY 12/2023 performance was in line with guidance. Cautious forecasts for 2024 look likely to be beaten in my view, if the US economy continues its recovery. Lovely balance sheet, cash generation, and divis. Valuation is still modest I think, and with macro uncertainty for SOM probably receding somewhat, I see a lot to like in this share, so we’re back up to GREEN. 

Inspiration Healthcare (LON:IHC) – down 24% to 41p (£27m) – Trading Update [profit warning amp; covenant breach] – Paul – BLACK (PW flag) – on fundamentals – AMBER/RED

A rather concerning update, saying that a large order is delayed, which has triggered a covenant breach today. So it will be talking to the bank requesting a waiver. That should be forthcoming I imagine, as overall it’s a proper business with an OK balance sheet. I raise questions over strategy amp; financial controls below. Doesn’t look very exciting overall. If bank agrees covenant waiver later today, then I’ll move it up to amber, but I have to flag the risk as it stands right now.

Argentex (LON:AGFX) - down 19% to 56.4p (£64m) – Trading Update [profit warning] – Graham – BLACK (profit warning) / AMBER

This currency broker has had a turbulent few months and released another profit warning yesterday. Currently led by an interim CEO and an interim CFO, it is in the middle of a strategic review (results due in April). It may offer some value at current levels so I’m happy to keep a neutral stance.

Smiths News (LON:SNWS) – uo 4% to 49p (£116m) – Trading Update [in line] – Paul – GREEN

A very appealing valuation, for reasons we all know well – slow, structural decline of the newspaper distribution core business. Could it re-rate if management find some game-changing new activity to take on, without almost destroying the business as old management did with their disastrous diversification strategy? Super yield, that is well covered, so likely to rise as bank debt is paid down. Lots to like, for value investors, but the background worry of long-term decline means it will probably always be really cheap.

Auction Technology (LON:ATG) – up 18% yest to 542p (£659m) – Trading Update – Graham – GREEN

I’m going to take a positive stance on this share for the first time, as I like the online marketplace niche and ATG’s trading statement is encouraging with value-added services helping to produce positive organic growth. The company is carrying some debt and is a 2021 IPO so this is certainly not without risk.

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Paul’s Section: Somero Enterprises (LON:SOM)

Up 6% to 370p (at 08:18) £206m – Trading Update [in line] – Paul – GREEN

Somero® provides the following update on trading for the financial year ended 31 December 2023.

This is the laser-guided concrete screeding machines maker, which seems to dominate this niche, especially in its core US market.

Going through our previous notes, it had a slightly uncertain 2023 but remains in good shape overall – with our previous coverage here being -

8/3/2023 – I wondered if there was a risk of a profit warning.

20/6/2023 – mild profit warning, but we stayed amber/green.

24/7/2023 – In line TU. H2 recovery possibly? Graham had niggling doubts re competition, so went amber.

31/8/2023 – H1 profit down 30%. In line outlook. Great bal sht. Paul ups it to amber/green.

Given tough macro conditions in 2023, it stands to reason that a maker of capital equipment for flooring companies might see a dip in performance, so nothing to worry about in my view. Historically the damage was bad in severe recessions (2008 almost killed off Somero), but not in minor downturns.

What’s the latest today? There’s a fair bit of detail, but this is the key bit -

Commensurate with the level of expected revenue, the Board expects the Company to report annual adjusted EBITDA in line with previous guidance and market expectations of US$ 36.0m.

The yearend cash position is expected to be $33.0m, slightly better than anticipated reflecting lower net working capital. These estimates remain subject to any audit adjustments…

The Board is pleased to report that with good trading and excellent operational performance in fulfilling customer orders globally during H2 2023, it expects the Company to report 2023 revenue of US$ 120.7m, in line with previous guidance and market expectations.

This is down on c.$134m revenues in both 2021 and 2022, but these were exceptionally good years, so some decline was expected.

Outlook - I think this is guiding a small fall in profit for 2024, given the higher planned costs to develop the business -

In 2024, the Board expects the US market to remain strong, supported by customers reporting high levels of activity and healthy backlogs, continued growth in Europe and Australia, and multiple new product launches. With consideration to these factors, the Board expects 2024 will be another highly profitable year with healthy cash generation, revenues that are comparable to 2023, and EBITDA that reflects modest incremental investment including the new Belgium service and training center and the annualized impact of strategic resources added in 2023. This incremental investment is expected to be within our traditionally targeted US$ 2.0m.

Broker update with our thanks, from Cavendish. It’s saying FY 12/2023 should be 46.7c (remember SOM reports in US dollars, don’t forget to divide by 1.27 for sterling equivalent!) = 36.8p (PER of 10.1x based on 373p share price). That’s cheap, given macro is probably turning positive now, esp in the US main market.

Divis of 30c are expected, so 23.6p = 6.3% yield – excellent, and there have often been specials on top in the past.

Cavendish assumes a small drop to 43.3c for FY 12/2024, which is consistent with the company’s guidance, but describes its own forecasts as prudent. I agree, and personally I would be guessing at 2024 EPS rising somewhat on 2023, maybe 50-60c outturn if there’s no major macro shocks to the US economy? This would take the PER below 10. There’s possible upside from new products and international growth (which has never impressed in the past).

Paul’s opinion - I’m very happy with this, so it’s back up to where SOM probably should have been all along – GREEN!

Well done to people who held their nerve during a wobbly macro year in 2023, I think that was the right decision, with hindsight. Plus you’ve enjoyed a generous stream of divis too.

Chartists might like to tell us if this is a new up-trend starting, or a bear market rally? Looks positive to me! High StockRank too, please note.

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Inspiration Healthcare (LON:IHC)

Down 24% to 41p (£27m) – Trading Update [profit warning amp; covenant breach] – Paul – BLACK (PW flag) – on fundamentals – AMBER/RED

Inspiration Healthcare Group plc (AIM: IHC), the global medical technology company pioneering best-in-class, specialist neonatal intensive care medical devices, announces a trading update for the year ended 31 January 2024 (“FY24″).

Delayed order -

The Company expects to report revenues for FY24 of £37.0 million, which is below current market expectations. This mainly relates to a delay to one material export order that was due to be shipped during the current financial year and is now expected to be shipped early in FY25.

Problem with bank covenants – this is a worry, as 31 January is today! If the bank doesn’t agree a covenant waiver, then the debt could be technically repayable on demand. In practice though, banks don’t usually want to push companies into insolvency, so the likelihood is a deal gets struck today, but on what terms I wonder? All a bit nerve-wracking for investors (and management I’m sure) -

As a result of the timing difference, net debt is approximately £6.4 million (excluding IFRS16 lease liabilities) and the Company has sought a covenant waiver from its lender in respect of the 31 January 2024 covenant test date. A further announcement will be made in due course.

Paul’s opinion – it’s not a company we follow closely. Roland looked at IHC nearly a year ago, and thought it looked worthy of further research at 51p, but was only amber overall.

Giving a quick look at the StockReport, I can see the share count has more than doubled in the last 6 years, so growth has obviously come from acquisitions. It’s profitable most years, with a couple of decent years during the pandemic. I see a small acquisition ($1.5m up-front paid) was done early this month. So to be breaching bank covenants so soon afterwards, suggests management weakness in financial controls. Large lumpy contract risk is an obvious point from today’s warning.

Net debt was only £2.1m at July 2023, so it’s gone up a lot since then, to reach £6.4m now.

H1 results were weak, only just above breakeven in the statutory results.

Small divis are paid, but maybe that policy needs to be reviewed?

The last balance sheet July 2023 had about £18m in NTAV, so it looks soundly financed, if they can reduced the rather large inventories and receivables – again raising questions over financial controls.

Overall I’d say this looks an OK company, and hopefully it can ship the large order soon, and agree a covenant waiver with the bank. Hopefully not a cause for alarm, but question marks remain over financial management – maybe they should stop doing acquisitions, and focus on tightening up the main business?

I think it would need some game-changing positive news to make me want to get involved here.

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Smiths News (LON:SNWS)

Up 4% to 49p (£116m) – Trading Update [in line] – Paul – GREEN

This is the third most viewed share on Stockopedia today, so despite only being in line, I’ll check it out.

Smiths News (LSE: SNWS), the leading distributor of newspapers, magazines and ancillary services to retailers across the UK, today provides shareholders with an update on trading ahead of its Annual General Meeting taking place this morning.

The current year is FY 8/2024, so we’re nearing the end of H1.

It’s a very predictable business anyway, so there shouldn’t be any surprises.

The Board is pleased to confirm trading for the year ended 31 August 2024 (“FY24″) remains in line with market expectations*.

The asterisk links to a page on SNWS investor website, where it provides broker consensus figures – excellent stuff, and investor-friendly – why can’t all companies help investors with this disclosure? – it saves us time, and avoids confusion -

Good contract visibility is reiterated, but no new disclosures.

H1 2024 – it points out that the prior year numbers benefited from some one-offs which won’t repeat, so I think that is preparing the ground for H1 figures which might show a decline in Y-on-Y profit? Shouldn’t be a concern though, but it might panic a few people on H1 results day early on, if they haven’t been paying attention maybe?! (buying opp on a spike down possibly?)

This is the crux for me -

In line with the Group’s strategy, management continues to explore and progress growth initiatives that are complementary to existing operations and leverage Smiths News’ existing capabilities and expertise…

“I am pleased to confirm that 2024 has started positively, and the Group remains on track to deliver financial results in line with market expectations for the year. Whilst we are cognisant of the ongoing financial pressure on consumers and the broader macro-economic outlook, our focus remains on securing and maximising revenue opportunities in our core newspaper and magazine distribution business, whilst exploring growth initiatives in adjacent areas that leverage on our existing capabilities and market presence.”

The problem is that SNWS shares will probably always be super-cheap, because the market perceives it (probably correctly) as a slowly dying business, like the newspapers themselves. That’s not entirely fair, because SNWS has actually done a great job in mitigating that long-term decline, and matching its costs to slowly reducing revenues, but that process can’t carry on forever because it will need a minimum number of sites to operate from (and I’ve been told it’s already at, or close to that minimum). Although lots of costs are variable (eg delivery drivers being self-employed contractors).

Legacy issues (like pension schemes, disposals) have all been dealt with, so SNWS is very clean now.

The holy grail for this share, is if management can figure out what new things it could do that leverages its existing overnight delivery network (ie more revenue with negligible extra costs), and turn it from slowly declining, into a growth company. That could be transformational for the valuation.

Old management tried various things, and the Tuffnells acquisition in particular was an absolute disaster, so you can see why newer management are reluctant to take the plunge again in that direction.

For investors though, I think it’s worth keeping an eye on strategy at SNWS, and this could be a very nice risk:reward share in future, if they find some new game-changing activity to bolt onto the existing network. So watch this space! In the meantime the legacy business delivers reliable cashflows and divis.

Or, another business might come along and bid for SNWS, to adapt it some way into their own business? 3 big institutional holders together have 40%, so a deal could probably be agreed with 3 phone calls. Would investors turn down 75p? I think they’d grab it, if someone offered around that level!

Valuation – 10.4p EPS gives a PER of only 4.7x

4.2p divis are more than twice covered, so scope to rise in future as we’ve discussed before, I can’t remember the detail but think the bank caps divis until debt is paid down to a certain level. It’s a very healthy 8.6% yield now, with scope for that to rise further – but for how long, that’s the big question? Earnings/cashflow may be holding up now, but will that still be the case in say 5 years or more? We don’t really know, that’s why the valuation is so cheap. It could be a cigar butt, but people have been saying that for many years and it’s defied the gloom.

Paul’s opinion – obviously I like SNWS, as I’m conceptually drawn like a moth to the bright lights of low PERs and big yields. Although personally I don’t have the right temperament to buy amp; hold for years shares like this with my own money, as I prefer buying things that are reasonably priced and have long-term growth potential to ideally 10-bag or more! How good are moths at finding needles in haystacks?!

It’s got to be GREEN from me at this valuation.

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Pebble Beach Systems (LON:PEB)

Up 25% to 10.35p (£13m) – Trading Update – Paul – AMBER

Small and illiquid, but readers are looking at it (no.5 on the most viewed widget today).

Pebble Beach Systems Group plc (AIM: “PEB”, “Pebble” or the “Group”), a leading global software business specialising in playout automation, content management and IP Control solutions for the broadcast and streaming service markets, is pleased to provide the following trading update for the year ended 31 December 2023 (“FY23″).

I last looked at PEB on 25/1/2023 here, concluding amber – trading OK, in line. Profitable (£1.7m adj PBT for FY 12/2022). Not bad, but weak bal sht increases risk, net debt still too high.

The share price was 8.25p then, a year ago, and it’s moved mostly sideways throughout 2023, but leaping up 25% today to 10.35p.

Latest news – this is all self-explanatory, and sounds positive -

The Board was encouraged by the resilient performance of the business during 2023. Following a strong second half performance, we expect to report FY23 trading ahead of current market forecasts, with revenue of approximately £12.4m (FY22: £11.2m) and Adjusted EBITDA* of approximately £3.8m (FY22: £3.3m). The revenue generated by the business includes Recurring Revenue** of approximately £5.2m (FY22: £4.6m), growth of 13% in the period.

In line with the previous year, project orders improved significantly in H2 and were 84% higher in H2 than H1. This included significant wins in APAC, Europe and North America in H2 which the Group was also able to deliver in the period giving Pebble a strong end to the year for revenue.

The strong cash generation of the Group enabled it to not only make further investment into its product development but also to continue to reduce its indebtedness. In the year, the Group reduced gross bank debt by £1.0m, and we expect to report net debt at 31 December 2023 of £4.8m (FY22: £5.8m).

Where debt is a problem, then I think companies should switch to reporting average daily net debt, not just balance sheet one-day snapshots. £4.8m of net debt is starting to look more reasonable now for the size of the company.

The next question is how much of adj EBITDA turns into actual profits?! Cavendish’s helpful update today shows it’s less than half. So £3.8m adj EBITDA becomes £1.6m of adj PBT.

Also note that Cavendish’s latest forecast today is actually a small reduction in FY 12/2023 PBT compared with the last forecast, dropping 4% from £1.7m to £1.6m adj PBT. This is not looking so impressive after all, and it’s barely up on LY, with FY 12/2022 adj PBT actual of £1.5m.

Outlook for FY 12/2024 – sounds promising -

As a result of the growth in Recurring Revenues and the benefits the Board are expecting to be delivered from the Group’s new product launches, the Board now expects FY24 trading to be ahead of current market forecasts and that this will be a platform for further growth in FY25 and beyond.

Cavendish has slightly raised revenue amp; EBITDA forecasts for 2024, but again higher interest costs mean adj PBT forecast is actually slightly lower than before, £1.9m vs previous estimate of £2.0m. So it’s not really ahead of expectations in terms of overall profit, and we can’t ignore finance costs, as they’re real, cash costs.

Paul’s opinion – I’d say risk is reducing, but the balance sheet is still weak, with negative NTAV of about £(7)m a year ago at end 2022, which will have improved a little in 2023, but it’s still not great.

The business itself looks OK – modest growth, it makes a profit each year, but it’s difficult to see any signs of an exciting business here. It’s survived, is about the best I can see from these numbers.

How much is the business worth? Niche software businesses can be highly valued, and it’s good that PEB is making nice profits despite being small. The excitement would reach fever pitch here if some big contracts began to roll in, as in multi-million recurring revenue deals. Then the shares could be a multibagger. So that would be my main line of enquiry if researching this in more detail – how likely is it that an upward step change in growth might happen?

In the absence of stronger growth, and with the upbeat numbers amp; talk in today’s TU not really standing up to closer scrutiny, it’s not something I can personally get excited about, and it’s possible stale bulls might dribble out shares into today’s spike up in price? Sorry to sound a bit flat on this, but I’m just reporting what I see. 

Overall, I’m happy to stick with AMBER – it’s a nice enough little business, and financial risk has reduced somewhat from another year’s profitable trading. Should it be listed? Doesn’t make a lot of sense to me, with all the extra costs amp; hassle. A buyer might see they could strip out say £0.5m to £1.0m in costs by taking it private, which could make it more attractive as a private company?

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Graham’s Section: Argentex (LON:AGFX)

Share price: 56.4p (-19% yesterday)

Market cap: £64m

There has been no shortage of news from this provider of currency management solutions. Co-founder and CEO Harry Adams left in October. The CFO followed in November. The next day we had the world’s least surprising profit warning.

Yesterday we had a trading update which revealed::

• 2023 revenues £49.8m (2022: £50.4m)

• 2023 operating profit: £8m (2022: £11.3m)

The November update said that revenues and operating profits in 2023 would approximately match 2022.

So we have a c. £3m shortfall in operating profit, compared to the November guidance.

Reasons given?

The Group invested, as communicated at the time, for growth in 2023, with significant investment in people, technology and overseas expansion. However, market conditions have remained challenging and there have been a number of costs which had not been anticipated previously.

The interim CEO comments:

The results for 2023 are clearly below market expectations but we remain confident that there is a significant market opportunity for us to exploit. We will share our plans for the business with investors following the publication of our full year results in April and after we have completed our strategic review.

The Group continues to be profitable and highly cash generative, with a new senior management team fully focused on transforming the business to capitalise on the growth opportunities ahead. We will be looking for operational efficiencies in addition to sustainable growth and Guy’s [new interim CFO] rigour will strengthen our forecasting capability and help drive cost discipline and accountability across the management team.

Graham’s view

Is it worth bottom-fishing this one?

Investors may be tempted by a low-ish P/E multiple (market cap is 8 times 2023 operating profit) with the possibility of an earnings recovery over the next few years.

The company is still profitable – as pointed out by the interim CEO – and it had net cash of £19m as of June 2023. If that has continued to move in the right direction, then the enterprise value here could be less than £45m.

Against that, I’d be cautious when considering:

• Recent loss of senior management

• The possibility or likelihood of share sales by departing managers

• An unknown future strategy

• Competition in the currency space – did senior management/the Board disagree over strategy as growth momentum was running out of steam in a crowded market?

It’s remarkable how much has changed in a year. In Dec 2022, the company was flying high and even I was persuaded that prospects for shareholders looked reasonable.

At today’s much lower share price, that could still be the case, with the company now in the category of a value investment rather than an exciting growth story. But there are much higher-quality sectors than this. I agree with Paul’s neutral stance here.

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Auction Technology (LON:ATG)

Share price: 542p (+18% yesterday)

Market cap: £659m

Roland covered this company’s full-year results in detail in December.

The company struck a cautious note then, citing uncertainty around “underlying market growth”. The company owns a range of online marketplaces that sell everything from art and antiques to industrial machinery.

Fast forward to Jan 30th 2024 and the company seems to be less nervous in its disposition.

Q1 is from October to December, and has been in line with expectations:

• Revenue up 3% organically and up 11% in total to $43.9m, “driven by the continued strong growth in value added services offsetting the wider market dynamics”.

• EstateSales.Net has continued to perform well.

FY24 Outlook

Trading in the first quarter is consistent with the FY24 outlook provided at our FY23 Results on 1 December 2023, reflecting an expected improvement in performance over the year due to the year-on-year stabilisation of Iamp;C [industrial and commercial] asset prices and activity levels and an increasing contribution from value-added services revenue. We therefore maintain our guidance of FY24 full year organic revenue growth of 5% to 8% and adjusted EBITDA margins to be maintained.

Graham’s view

I am drawn to “marketplace” stocks and so this one does strike me as interesting.

Some reasons for concern might include

1) it floated in 2021, one of the worst vintage years for stocks;

2) it hasn’t got a consistent track record yet, only just turning a profit for the first time in 2023;

3) it’s running on over £100m of debt;

4) organic growth has been struggling to beat inflation.

However, maybe all of this is priced in at a moderate P/E multiple combined with decent growth prospects?

I’m starting to lean towards taking a positive view on this one.

For example, I know I’m always banging on about the poor quality of the 2021 IPOs, but with nearly three years having passed since the date of ATG’s IPO, maybe enough time has passed to drop any additional scepticism we might bring to it.

Its IPO price was 600p, so there is still a discount available against that price.

Inflation has cooled down in every geography, so that the planned 5-8% organic revenue growth does imply we will see some “real” growth this year.

The leverage multiple (net debt/EBITDA) was less than 2x as of the full-year results, with a nice reduction in net debt from £131m to £116m.

I’m going to stick my neck out and take a positive stance on these shares, really just highlighting that I think they are worthy of additional research. I’d like to know more about the competitors facing each of ATG’s brands.

Stockopedia

Source: https://www.stockopedia.com/content/small-cap-value-report-wed-31-jan-2024-som-ihc-agfx-snws-atg-peb-987640/