Small Cap Value Report (Thu 11 Jan 2018) - TSCO, MKS, John Lewis, BOO, GMD, CARD, AO., GMD, LRM

Good morning, it's Paul here.

I got up early today, to finish off yesterday's article (was too tired last night to do any more work). So I've added new sections on ShoeZone results, and Focusrite's trading update. So to get you started today, here is the link for yesterday's expanded report.

It's an absolute avalanche of trading updates today, here are some quick bullet points on mid to large cap retailers, which might be of interest, for read-across to smaller companies, and the economy generally (we need to keep our eye on the macro picture);

Tesco (LON:TSCO)

• Seems to be trading well.
• Positive Q3 LFL sales of +2.3% on a LFL basis.
• Positive Xmas trading, +3.4% LFL in food
• Problems at Palmer & Harvey, and "ongoing drag" from general merchandise - "took the shine off an otherwise outstanding performance"
• We are confident in the outlook for the full year and are firmly on track to deliver our medium-term ambitions."

Marks and Spencer (LON:MKS)

Q3 update, for 13 weeks to 30 Dec 2017

• Full year guidance remains unchanged
• Total UK LFL sales down -1.4%
• Food better (-0.4% LFL) than clothing & home (-2.8% LFL)
• eCommerce growth only +3.0%
•  "M&S had a mixed quarter with better Christmas trading in both businesses going some way to offset a weak clothing market in October and ongoing underperformance in our Food like-for-like sales...

John Lewis

Update for 6 weeks ending 30 Dec 2017

• Waitrose LFL sales up 2.2% (adjusted for New Year's Eve mismatch)
• John Lewis LFL sales up 3.1%
• Black Friday went well, so looks like a permanent fixture in the retail calendar now.
• "The pressure on margin seen in the first half of the year has intensified because of our choice to maintain competitive prices, despite higher costs mainly due to the weaker exchange rate. This will negatively affect full-year financial results as indicated previously."
• "Looking ahead to 2018/19 we expect trading to be volatile due to the economic environment and anticipate that competitive intensity will continue, driven by the structural changes taking place in the retail industry. "

So, sounds like many retailers will continue to struggle in 2018. Good news for consumers though.

Boohoo.Com (LON:BOO)

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

Trading statement for the 4 months ended 31 Dec 2017.

A sparkling update here, so I expect the share price to rise today (good news if I'm right, as this is currently my 2nd largest long position)

• Revenues up 100% in most recent 4 months, and 103% (97% at constant currency) in 10 months.
• Retail gross margin slightly down, at 54.2% (2017: 54.4%).
• Net cash of £127m, but I think this is mainly ear-marked for capex to automate warehouse.
• Stand-out performer is PrettyLittleThing.com subsidiary - 4 month revenue of £73.8m is up a stunning 191%! This is now just over half the level of revenues of the core BooHoo business. So at this rate, it might catch up & overtake the core business. Hence why the forward PER is high for the group as a whole - this is now 3 fashion businesses, not just 1, which some market participants may not have realised.
• Guidance on sales for the full year is raised from +80% to +90% growth on prior year. Highly impressive.
• EBITDA margin range is narrowed from 9-10% (advised in Sep 2017), to 9.25-9.75%. So no change to mid point.
• Overall - I think this should trigger a decent share price rise today. I might buy more in the opening auction.

EDIT: something of an odd reaction from the market today, with the share price actually falling. Perhaps some investors might have been expecting even greater out-performance against forecasts? Anyway, I see this as a good entry point, at just over 200p, so I've been buying more.

The growth is absolutely stellar, and the company is expanding its distribution facilities to handle £3bn of sales - over 3 times next year's forecast sales of £835m. The forward PER is about 52 times 4.0p forecast EPS for the new year, starting soon (ending 02/2019), dropping to 40 times for the following year. Given that BOO has a track record of beating forecasts, the actual PER could be a good bit lower than that. So on this basis, the shares are really not expensive.

Also, I doubt the company will stop at 3 brands. They almost have a cookie-cutter method now of creating new online fashion brands, and growing them rapidly. So I think we could see continued growth for years to come. The company is so aggressive on price, that it's mopping up market share, whilst still keeping margins comparable with High Street operators. I like it a lot at the current level.

Card Factory (LON:CARD)

Trading update - for the 11 months ended 31 Dec 2017.

At first glance this looks OK, but it has a sting in the tail, hence the share price currently being down nearly 19% to 230p.

• Year-to-date LFL sales growth of 2.7%
• "Continued margin pressure leading to expected underlying EBITDA for the year to be in the range £93.0-£95.0m" - this is down from £98.5m PY
• About 50 new stores are being opened each year (total of 913 UK stores at end Dec 2017) - how much scope is there for more, they must be near market saturation by now?
• Margin mix isn't good - sales growth is coming from lower margin, non-card products.

Outlook - this is what's caused the trouble;

"We anticipate that the combined impact of foreign exchange and wage inflation in FY19 will result in £7-8m of additional costs; whilst we have plans to mitigate this impact as far as possible, we recognise that against this backdrop, any EBITDA growth for the year is likely to be limited. Looking further ahead, cost headwinds should ease unless there is a further dramatic shift in sterling.

It looks as if the market has de-rated this share to now be ex-growth in terms of profit. The yield is attractive now. Worries about structural decline are likely to persist - will younger generations still send physical cards? Maybe not at Christmas, but I think they might continue to buy birthday cards - which are so much nicer to receive than an eCard, or a message on Facebook.

My opinion - on balance, think I'll steer clear of this one, as it could have further to fall, as investors digest if moving from a growth company to being ex-growth, or declining. Although the business is still staggeringly profitable - it makes an operating margin of 18%, which is way ahead of almost all other retailers, regardless of sub-sector. So this is likely to remain a very profitable, and cash generative business for years to come. I'd probably want to see a really bombed out price (PER of 6 or less) to attract me in here.

AO World (LON:AO.)

Q3 update - 3 months to 31 Dec 2017.

Q3 UK revenue up 11.4%, Europe up 58.4% in constant currency (62% as reported in sterling)

We expect the Group's performance for the full year to fall within the range of analysts' expectations but remain cautious given the uncertain UK economic outlook.

Outlook statement sounds completely meaningless to me!

Looking ahead, although we need to be mindful of the uncertain economic outlook (particularly in the UK), as long as we are relentless in our focus on making things easy for our customers, we can be confident that they will continue to choose the AO Way."

My opinion - selling other peoples' generic products, on wafer thin margins, against stiff competition, just isn't a good business model.

OK, on to some small caps now.

---

Footasylum (LON:FOOT)

Share price: 239p (down 5.4% today, at 12:09)
No. shares: 104.5m
Market cap: £249.8m

Trading update

Footasylum, a UK-based fashion retailer focusing on the branded footwear and apparel markets, announces a trading update for the 18 weeks ended 30 December 2017

This trendy footwear retailer was floated in Nov 2017 at 164p per share, by Liberum. So it's been a successful float so far, trading at a 46% premium. What a pity then that my application for some shares in the placing was scaled back to zero. Never mind. Both Graham and I quite liked it prior to IPO, and wrote sections about the company  here on 16 Oct 2017.

Today's update gives total sales growth, but that's not terribly helpful when new stores are being opened. We need to know what LFL sales growth is, which they decline to disclose today.

Current trading - is in line;

Trading continues to be in line with the Board's expectations.

So I think we have to assume this also applies to the financial year to date, although that is not explicitly stated.

Valuation - I've been unable to track down any broker forecasts so far. My broker tells me that it's much harder to get hold of them, since Mifid II has been implemented. Let's hope this is scrapped after Brexit. Regulators should be helping investors to get more information, not further limiting our access to things that can be a significant help to us.

So I am not able to value the share, unfortunately.

My opinion - neutral, due to lack of information.

---

GAME Digital (LON:GMD)

Share price: 55.5p (down 8.1% today, at 12:38)
No. shares: 170.9m
Market cap: £94.8m

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

Trading statement - this company operates the "GAME" video games retail chain, in UK & Spain. It should be seen as a special situation, with the key points being;

• Most of its shop leases are up for exit or renegotiation in 2018, so there is an opportunity to overhaul & lower the rental cost of its stores estate.
• Cash rich balance sheet - cash of £67m at end Dec 2017, which is 39p per share. Note there was £4.6m of bank debt at the last balance sheet date of 29 Jul 2017, so net cash now might be a little lower than £67m. There was a £19m boost to the cash pile from a recent disposal.
• Opportunity from new "BELONG" format - of charging customers to play live, in-store, against other gamers.

Trading over Christmas has been positive (GTV is the company's preferred measure of sales);

Margins - by which I assume they mean gross margins, down 100 basis points, due to strong sales growth in lower margin hardware sales.

Cost savings - further savings (not stated how much) have been implemented.

BELONG arenas - utilisation level has increased from 21.3% in Q4 last year, to 28.2% now. It's not clear whether this is good or not, but at least it's going up. The company sounds happy with progress;

BELONG continues to make pleasing progress, with plans to invest in the roll out of further arenas in the UK from February onwards, and we have exciting plans to open our first two arenas in Spain later this year."

Outlook - this sounds as if it's in line with expectations, but with wiggle room in case something goes wrong;

"Over the peak period, GAME focused on its core trading in all channels across both its geographies in highly competitive markets whilst delivering further cost savings in UK Retail and made good progress with its strategic initiatives. These additional cost savings mean our performance remains on track; as ever our full year result will also be subject to continued availability of consoles, such as Nintendo Switch, and the timing and success of new game releases.

My opinion - I continue to see potential upside here. The company is well-funded, so there's no risk of it going bust again any time soon.

On the downside, the existing business is only forecast to breakeven this year (ending 07/2018), and make a modest profit next year. So it's not really a conventional investment at this stage. The upside potential comes from what the business might look like after it's rationalised its store estate from 2019 onwards. I suspect this might result in fewer, but larger stores, with prominence given to the BELONG group gaming experience. The business might therefore end up looking very different in a few years' time.

Note how loss-making Gfinity (LON:GFIN) is on quite a racy rating.

---

Lombard Risk Management (LON:LRM)

Recommended takeover bid - at 13p cash.

This is a very lucky escape from a lousy investment, for shareholders. The 13p bid price is very attractive, being a premium of almost 100%. The buyer can't be very shrewd, as they probably could have bought LRM for a much lower price, as it was fast running out of options.

LRM looked to be heading for insolvency, due to repeated fundraisings, and repeated failure to get anywhere near profit targets. Indeed, it was burning cash at a prodigious rate, and with contract delays, that another fundraising was on the cards. So why anyone in their right minds would still be holding this share, is beyond me.

Anyway, the day has been saved by a company called Vermeg, which has agreed to buy LRM for 13p. That's a terrific exit for shareholders. Not such a good outcome for people like me, who had shorted the share! So I woke up to a rather unpleasant loss here, but never mind, these things happen.

Shorting small caps can be very risky indeed, and I hardly ever do it. So this was a reminder of the risks involved.

---

I'll leave it there for today, unless I get a second wind later. 

Regards, Paul.