Small Cap Value Report - (Tue 25 June 2019) - CER, G4M, LWB, CPR, OPM, FA., D4T4, LOOK

Good morning, it’s Paul here.

Graham was meant to be writing today’s SCVR, but he’s been overtaken by unforeseen  international travel delays, so at this late stage, has asked me to cover for him.

I had been gently winding down for a lazy day, and lunch with Mum, but that’s all gone out of the window now! Instead I’ll have to try to think of something sensible to say about small caps, at short notice. Will do my best!

To get you started today, I wrote big expanded sections late yesterday, in the evening, on both Porvair (LON:PRV) and Cake Box Holdings (LON:CBOX) , both of which I think look potentially interesting (with some reservations). The completed version went live at almost 1am, after a lot of work.

(7-8 am section – I can only do these with prior notice amp; an early night, so not applicable today, I’m afraid)

Cerillion (LON:CER)

Share price: 170.5p (up 4.3% today, at 10:26)
No. shares: 29.5m
Market cap: £50.3m

Major contract win

Cerillion, the billing, charging and customer relationship management software solutions provider…

Not to be confused with Carillion, of course!

I don’t normally mention contract win type announcements here, as they’re often spurious. However, Cerillion has been on my radar (thanks originally to Graham flagging it here) as a reasonably-priced growth company. It supplies what looks like mission-critical billing software to telecoms companies. That suggests to me sticky revenues, always a good thing.

I reviewed its most recent interim results here on 20 May 2019, and flagged that it might be a buying opportunity, if the company is able to hit full year targets (which at the time looked a tall order, but it looks like the company should now achieve targets). Although interim results were not good, management flagged that 2 high value contracts were imminent.

Sure enough, they’ve announced winning two major contracts, one here on 14 June 2019, and the second today. That’s impressive – as it means we can rely on management commentary amp; outlook statements. Previous commentary was not just baseless optimism, they told it how it is – a big thumbs up for that.

It would be a great idea if someone were to start a website which collated outlook comments from every company on the market, and then reported what actually happened afterwards, and gave a score to show us which companies repeatedly fail to deliver, and which ones are more reliable.

Contract win today -

… is pleased to announce a major new contract win worth an initial £4.8m with LINK Mobility, Europe’s leading provider of SMS and message delivery solutions.

This win supports existing market forecasts and continues the Company’s trend towards securing larger deals, following the £5.1m contract win announced on 14 June.

These deals look very significant, given that forecast revenues for this year (ending 09/2019) are £18.7m. Although I imagine the contracts will be spread over several years, it’s not stated how much is recognised initially.

Large lumpy contracts are risky, as if anticipated contracts are not won, then it can cause a big profit warning. In this case though, the contracts have been won, so that de-risks this year’s forecasts. Although as mentioned above, these contract wins were already baked into existing forecasts, so are reassuring rather than significantly share price-sensitive.

Valuation – this is based on last night’s share price;

That strikes me as a good value PER, and the divi yield isn’t bad either.

Cashflow – the price to free cashflow figure above looks weak, so I’ve checked out the last 2 years’ cashflow statements, which actually look OK to me. There was a jump in capex from £198k to £730k from 2017 to 2018, and £933k of development spend was capitalised in 2018 – which isn’t a particular problem, as it’s around one quarter of operating cashflow, which i can live with.

As you can see from this excerpt below, operating cashflow was spent on capex, development spend, paying divis, and reducing debt. A very nice mix, being able to fund all those things from internal cashflow;

My opinion – this company is looking increasingly interesting, so it goes on my list of things to research in more depth.

The big problem is that the shares are so illiquid, so it can be very difficult to buy or sell, other than in small amounts – so it’s really only suitable for small investors. Management owns about 41% of the company (good to have skin in the game, but maybe that’s a bit too much?), so outside shareholders are completely in their hands. I imagine that eventually they’re likely to sell the company – as it must have strategic value, being embedded in various telecoms companies.

In the meantime shareholders are receiving reasonably good, and growing, divis. Plus the company seems to be on a roll, re contract wins.

Overall then, it looks rather good.

Share price: 212.5p (down 7.6% today, at 11:32)
No. shares: 20.9m
Market cap: £44.4m

(at the time of writing, I hold a long position in this share)

Final results

Gear4music (Holdings) plc, (“Gear4music” or “the Group”) (LSE: G4M), the largest UK based online retailer of musical instruments and music equipment, today announces its financial results for the 13 months ended 31 March 2019. Comparative information is on a 12 months basis unless stated, and as such may not be directly comparable.

Important to note that this is a one-off 13-month period, which makes it harder to analyse.

Positives

• Very strong revenue growth, both in UK and RoW – up 37% on a comparable 12 month basis, year on year
• Taking market share from physical retailers, and probably also from online competitors (can smaller competitors survive in the long run, with price competition so intense?)

Negatives

• Margin pressure – this is the main problem – gross margin of 22.8% is down 260bps. That’s a very low margin now, making it extremely difficult to turn a profit – although note that the average order value of £117 means that there’s a decent cash profit on each sale, even though it’s low on a percentage basis
• EBITDA down 34% to £2.3m
• Moved from £1.4m profit last year, to £163k loss this period – going the wrong way, although during the rapid growth phase some investors don’t care about profitability – arguably it’s more important to grab market share at this stage

Outlook – this is the most important part for me. We already knew about the above issues, from previous trading updates, so there’s nothing new in today’s update.

All that matters is what are management doing to fix things? I find the following comments encouraging, as in my experience (from having met them several times), management tell it like it is.

We have taken quick and decisive action to address the operational and commercial issues that impacted profitability in FY19. Whilst early in the current year, we are beginning to see positive trends establishing themselves which give us confidence in our refocused growth strategy.

Alongside this, we will continue to develop our excellent e-commerce platform, expand our customer base in the UK and internationally, extend and refine our product ranges, and deliver the market leading service and value that has made us a leading European retailer of musical instruments and equipment in such a short space of time.

Whilst the on-going Brexit uncertainty and its impact on consumer confidence is unhelpful, we remain well positioned to benefit from further consolidation within our market.

We believe we are well placed to deliver on our strategic objectives with a solid financial base and a better organised and refocused operational structure, giving us confidence in our trading outlook for the new financial year.

Another outlook section says;  

The Board has taken decisive action to address the underlying causes of the profitability challenges in FY19.

Pleasingly, many of the issues faced are within our grasp to resolve and we are already starting to see the benefits of a more rigorous focus on margin.

In parallel with these initiatives, we continue to see a significant opportunity to continue to win market share in the UK and across Europe.

With over £5m cash on hand at 31 March 2019, the Directors remain confident that the Group has the financial resources required to achieve its business objectives during the next financial period.

I believe the Group will emerge from this period as a stronger and leaner business, well prepared and better placed for the next phase of our exciting growth journey.

I would have prepared fewer words, and more specifics!

Still, it shows that clearly management is focused on improving margin. 

Margin improvement – Revenue is forecast at £138m for the new year FY 03/2020, so if the company is able to recoup just half of the gross margin loss this year, then that would add £1.8m to profitability. Hence there looks to be a good chance of profitability recovering this year, and that should improve the share price too.

Remember also that marketing spend is a very high element of costs, and can be dialled up or down at will – a key advantage for online businesses if times get hard. Physical retailers cannot do that, as their costs are mostly fixed.

Balance sheet – includes £7.2m in freehold property. There are mortgage loans of £4.6m outstanding against these properties.

Above that, there is £7.8m of bank debt, largely offset by £5.3m in cash. So net debt is only £2.5m, excluding the mortgages (which are well covered by freeholds).

I imagine net debt will flex around quite a lot, especially when stocking-up for Christmas.

I’ve been told by another company that banks like lending to online businesses, as they know that in an emergency, marketing spend can be switched off, to generate enough cash to repay the bank quite quickly. That would obviously leave a husk of a business with declining sales, but banks don’t care about that – all they want to know is that their loans will be repaid.

NTAV is OK, at £10.9m

Cashflow statement – even though profit was down, operating cashflow rose from £155k last year, to £2.6m this year.

Note that capitalised development spend rose from £1.7m last year, to £2.7m this year.

At this stage, capex amp; development spend (combined £4.5m) exceed operating cashflow of £2.6. So clearly the business needs to improve its cash generation, which should flow through from the improved gross margin that is anticipated in FT 03/2020.

Nobody is buying this share for its cashflow or divis (there aren’t any), because the investment case is all about the rapid organic growth, and international sales. We’ll find out in a few years’ time if the business does become more cash generative once it’s matured, or not.

My opinion – I’ll properly go through the whole RNS later today, so might add more points below.

Overall though, I think this share is attractively priced now, for a strong organic growth company.

Previously the company was focused on a dash for growth, and that seems to have let the focus on margin slip. Management is aware of the problem, and are fixing it. So I’m cautiously optimistic about this share on a 12 month view.

It should be a much bigger business in say 5 years’ time, which will mean increased buying power, greater efficiency in marketing spend, and a higher net margin. Therefore, I feel with patience, this share could multi-bag again. Or it might not, time will tell!

Share price: 6.1p (unchanged today, at market close)
No. shares: 689.8m
Market cap: £42.1m

Trading update

Low amp; Bonar PLC (the “Group”), the international performance materials group, confirms that it will announce results for the six months ended 31 May 2019 (the “period”) on 30 July 2019.

This update confirms the update on 20 May 2019, saying that interim results will be in line with the Board’s expectations.

Some more detail is given today;

• H1 2019 sales down 8% on LY H1
• Small underlying profit before tax (no figures given, so I’m assuming it will be just above breakeven)
• Net debt at 31 May 2019: £99m  (the group is over-leveraged, that’s why the share price has collapsed)
• Average net debt in H1 was £135m – this is a much more meaningful measure, and I think companies should be required to declare average net debt, as well as year/half year end snapshot on balance sheet dates
• Selling off 3 businesses – work-in-progress
• Bank covenants – within, but not much headroom, so this is a potential problem, if trading deteriorates further (figures are given – see RNS for more)

My opinion – this is a lot of business for the money, however I’m steering clear because of the high risk caused by too much debt.

Share price: 18.4p (up c.4% today, at market close)
No. shares: 303.8m
Market cap: £55.9m

Results for 52 weeks to 27 Apr 2019

This is an interesting RNS, from the UK’s largest carpet retailer. It has undergone a CVA, to reduce its rents amp; dispose of loss-making stores. The total number of stores fell from 410 to 334. It also has operations in Europe. The text gives some interesting perspectives on how that process has gone.

Carpetright has done well to survive this upheaval, and that was only possible from generous shareholder support in fresh equity amp; loans. Without that, it would have gone bust.

LFL sales – were clobbered by the CVA process, but have gradually been improving. LFL sales have now turned positive in the last 8 weeks (+8.5% in the UK), but that’s against very weak comparatives of -14.6% prior year. I think it’s best to not get too excited about the recent sales growth, as it’s only partially recouping previous declines.

Underlying EBITDA for FY 04/2019 was £2.9m (prior year £7.1m). Since that performance was adversely affected by the CVA process (disruption to sales, supplies, adverse publicity, withdrawal of trade credit insurance, etc), it’s difficult to know how much performance is likely to improve this year. I can’t find any recent broker research, so that takes me to a dead end on being able to analyse it.

Balance sheet – this is problematic. Net debt is too high, at £27.4m, and note that bank facilities expire at end Dec 2019. Plus a large £25.7m shareholder loan is due for repayment in July 2020. Whilst the company says it should be able to refinance these facilities, it’s still a lot of debt.

On the upside, it owns a substantial property portfolio, of £52.3m in freeholds amp; long leases. I was very surprised that landlords agreed to the CVA, and did not require the sale of its freeholds.

So if you match up the freeholds with the borrowings, it doesn’t look too bad.

My opinion – I seem to recall there was an aggressive competitor, set up by Carpetright’s founder’s son? Investors would need to carefully consider the competitive landscape before buying into Carpetright’s survival/recovery story.

With its CVA successfully completed, Carpetright is in a much better position to compete, having ditched its loss-making stores. Although we’ve seen in the past, that the companies which needed to do CVAs, are the weakest, and often go on to fail again a few years later.

There might be some upside here, if Carpetright reports stronger trading later in 2019, against very soft comparatives. It doesn’t really interest me though – recent experience has been that investing in struggling retailers is usually a mistake.

Quick comments to finish off with;

Fireangel Safety Technology (LON:FA.)

Trading update for its AGM today.

Encouraged by growth in H1 sales.

First half trading to be slightly ahead of budget.

Thanks shareholders for supporting recent fundraising.

My opinion – terrible track record in recent years, of burning through tons of cash, and multiple operational mistakes. That rules it out for me.

1pm (LON:OPM)

A sub-prime lender. I’m only commenting because a reader has asked me about it.

Clearly the update today has upset shareholders, as the share price is down 23% to 32p.

I’ve never been sure how to value this company. A PER basis is not meaningful, since profits depend so much on what defaults are on the loan book. I cannot see how its bad debt provisions of 1.9% (increased from 1.5% last year) can be anywhere near enough over the full economic cycle. Although OPM seems to broker some loans, as well as taking others onto its own balance sheet.

Today’s RNS talks about additional costs, together with macro uncertainty, making FY 05/2020 a year of investment amp; consolidation (i.e. not very good!)

Experience shows that sub-prime lenders suffer huge bad debts when recessions strike, which is what puts me off investing here.

£D4T4

Flagged up by readers, I’ve taken a quick look at its results today, for FY 03/2019.

Very impressive is the short version!

• Beat forecast, with adj diluted EPS of 13.89p, up an impressive 57% on LY
• Share price of 260p gives a PER of 18.7 – not cheap, but with profit growth this strong, and a positive outlook, that’s probably a reasonable price
• Adj PBT up 48% to £6.0m
• Revenue up 37% to £25.2m
• Very strong cashflow – net cash has risen from £3.85m LY, to £11m this year – giving scope for potential acquisitions, they say
• Positive outlook comments
• Significant contracts won
• Strong balance sheet
• Has done share buybacks

My opinion – this is a company I like, and have previously owned (but not currently).

In more normal markets, I would consider buying back, but given the political uncertainty, am playing it safe right now, in not opening new positions unless they’re stunningly cheap.

Lookers (LON:LOOK)

I’ve only just spotted that this car dealership’s shares plunged 24% to 53.5p late in the day today. Why? An RNS at 3:14pm today, saying that the FCA is to investigate its regulated sales practices;

The Company has now been informed by the FCA that it intends to carry out an investigation into the Company’s sales processes between the period of 1 January 2016 to 13 June 2019.

The FCA investigation is newly commenced and no findings have been made.  The FCA will reach its conclusions in due course and, at this stage, the Company cannot estimate what effect, if any, the outcome of this investigation may have. The Company is co-operating fully with the FCA in relation to this and will update the market further when appropriate. 

The drop in market cap today is c.£66m, which seems a rather extreme reaction. Will costs amp; fines really amount to that much? I don’t know, as I’m not familiar with how FCA investigations work.

I’m wondering if this might have read across to other car dealers?

Following some recent poor trading updates, this sector no longer interests me.

Thanks for reading, and for posting some superb comments today – star of the show today is Zipmanpeter, with several excellent comments!

Regards, Paul.

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