Small Cap Value Report (Tue 17 March 2020) - BOTB, ALY, JDW, IND, CINE

Good morning, it's Paul here. I'm feeling a bit under the weather, so am not sure how much I'll be able to cover today.

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Hi all,

It's Jack here - as you've heard, Paul is feeling unwell so I'll fill in for now.

I've been thinking about the Leisure and Travel industry and have some general thoughts on these areas. I haven't had a proper look for companies today so throw suggestions my way. The only one that's caught my eye so far is Best Of The Best (LON:BOTB) but I'll have a proper look in a second as I'm sure there's a lot more.

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I’m not about to mince words: it’s been a brutal stock market drawdown so far and most investors are feeling a lot of pain. We’re all in the same boat.

In good times, we say as stock market investors that we can handle volatility and capital losses. In the bad times, we find out if this is true.

There is likely more bad news to come, but I also think we can weather this storm and when the dust settles (to mix some metaphors), we will likely be looking at some once in a lifetime buying opportunities. I can see enough tweets and comments to know that people are hurting. Investing is a lonely pursuit and during these kinds of market conditions we must talk to each other and keep morale up for those who need a boost.

Getting back to stock picking though, I feel that now more than ever it is important to be identifying opportunities and drawing up watchlists.

We will work through these events, although operators in certain industries face an existential threat. This has been well documented. The bets are off for virtually all airlines. While the industry will survive, it is hard to know who the winners will be now, if any. Operating costs are brutally high and grounded fleets are not generating revenues. These companies will not be able to hold their breath for very long at all - without substantial government help we will see a lot of them fall in weeks. The implications for shareholders are unclear.

Question: how fast do you need to be to outrun a bear?

Answer: faster than the person next to you…

Ordinarily in a market shakeout, the best in class survive and thrive during the recovery. What we are seeing is unprecedented, however. Balance sheet strength is king, but even that may not be enough. For these reasons, I am staying away from Travel and Leisure until some semblance of normality is resumed. There is the real possibility that, in this instance, the bear gets everyone. However, paying attention to what is happening in these sectors might give us some insight into how people are feeling. Millions of people are employed here, after all.

Restaurants and bars

I would hazard a guess that operators in these industries could survive maybe two months without aid, paused rents and interest payments, and steep temporary job cuts. For a good “boots on the ground” commentary of the situation here, I would recommend signing up to the Langton Capital newsletter.

The writers there are well connected with senior figures in the Leisure and Hospitality industries, which is in the eye of the storm at the minute. One reader and industry participant there has warned that “20 years of work could be undone in 20 days unless someone gets a grip on this problem.”

Langton solicited anonymous feedback from senior Hospitality industry figures over the weekend.

The findings might not be surprising. Here are some highlights from the feedback:

• Sales are doing poorly and are getting worse
• London and travel hub sites are faring the worst; community pubs are holding up better
• Forward bookings are down c30%
• Events have “collapsed”
• The trade needs to lay off staff
• Some landlords are helping, others are not
• Most capex projects have been halted
• This will ‘finish off a lot of restaurant groups who were hanging on by their fingernails and narrowly avoided CVAs previously.’
• Gyms are “very bad”

Clearly, we are at the point where the government has asked the nation to change its habits. I would expect therefore some pretty sweeping temporary measures to support the businesses that suffer as a result. We are talking about small businesses that make up a lot of the economy - local pubs, bed and breakfasts, etc.

In my view, we need banks to allow landlords to suspend rents - otherwise the next rent quarter date could be terminal for many businesses and employees.

According to a letter sent to UK chancellor Rishi Sunak seen by the BBC, UK Hospitality boss Kate Nicholls said that the impact from coronavirus was an "existential threat" to the sector and that news laws need to be made to allow for temporary staff redundancies. She says:

This is business-critical - these are cash businesses, put simply, if you don't have people coming through the door, you will run out of cash very quickly. So we are talking about intervention that is needed next week to make sure that in six to eight weeks these businesses continue to trade, and if we don't get that support, by May, we will be facing business failures and a significant number of jobs at risk.

Airlines

The situation is going to be quite dynamic in the next few weeks. For this reason, watching from the sidelines is the order of the day. Extensive and extraordinary measures are required.

The Centre for Aviation has warned that by the end of May most airlines would be bankrupt due to the unprecedented travel restrictions that are being rolled out by governments around the world. It says:

Many airlines have probably already been driven into technical bankruptcy, or are at least substantially in breach of debt covenants… By the end of May 2020, most airlines in the world will be bankrupt. Co-ordinated government and industry action is needed — now — if catastrophe is to be avoided.

This is a brutal industry with complex balance sheets, cut throat competition, and very high operating costs. When it comes to playing “how long can you hold your breath”, airlines are not very good. The news flow here is quite staggering when you add it all up. I’m sure to have missed things from the list.

Macro:

• Italy is in lockdown
• The US has banned travel from Europe and has said it will “immediately” begin working on ways to help the aviation and cruise industries as the scramble to stem losses and protect jobs
• Poland has shut its borders
• A number of South American countries have brought in flight restrictions
• Australia and New Zealand are requiring inbound travellers to self-isolate for 14 days

Micro:

• Dart Group has suspended flights to Spain
• TUI is not paying prepayments to hoteliers
• EasyJet said it may have to ground most of its planes as a result of travel bans and falling demand, saying: “"These actions will continue on a rolling basis for the foreseeable future and could result in the grounding of the majority of the EasyJet fleet,"
• IAG (net cash £9bn): BA is to ground flights 'like never before' and is laying off staff. It is cutting capacity by at least 75% over April and May. The airline sent an email entitled ‘The Survival of British Airways’ to staff calling this a ‘crisis of global proportions’.
• Norwegian Air (net debt of c£7bn) has laid off half its staff and says it has “weeks not months” to avert collapse
• SAS is to ground ‘most’ flights & lay off 90% of its staff. It says demand has ‘more or less disappeared’.
• Air France Klm (net debt c£6bn) has said it will cut jobs and is seeking government support
• Virgin Atlantic is asking for money
• American Airlines (the second biggest in the world) said on Saturday it would start implementing a phased suspension of nearly all long-haul international flights from Monday

Airlines bleed quickly and I bet all routes are seeing bookings dry up. It really could get quite bad here and I’m certainly not looking to get involved at this time. As far as I’m concerned, all bets are off and previous analysis does not really count for much right now given that the conditions are so radically changed.

Calendar Q1 is usually the least profitable quarter for airline stocks, with weak Easter demand also likely to hurt Q2 profitability significantly; this will inevitably stretch weaker airlines beyond their limits.

What I am looking for

There are signs that China is past the worst of it, although it will take time before output returns to normal levels. The larger trend is of increasing global supply chain and general economic disruption. This will continue to weigh on business sentiment in the short term.

And, right now, everybody is laser-focused on the short term.

The situation is severe but I do think that if we keep our heads, we will be rewarded with some fantastic investment opportunities.

I will keep looking for high quality companies that are available at good prices and can be held for the long term. Given the wild, indiscriminate selling I am being more selective, however. Now I am looking for quality that has been unfairly marked down. These companies should have:

• Strong underlying trading, prospects and growth track records
• Big addressable markets
• Strong balance sheets; little to no debt, cash cushions
• Strong free cash flows
• Relatively insulated from Coronavirus disruption, but hammered share price anyway
• High returns on capital over long periods of time

In these exceptional markets, I am also broadening my remit. There will be some extraordinary value plays as a result of this volatility. The big opportunities might well be otherwise strong companies that find themselves in deep value territory as a result of these conditions.

For that reason, I will keep checking the Bargain Screens to see if good stocks fall far enough.

I’d like to know what other investors are looking for, too.

Anyway, those are some of my thoughts for now. On to company news.

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Best of the Best (LON:BOTB)

• Share price: 390p (+4%)
• No. of shares: 9.3 million
• Market cap: £35 million

Trading Update

I actually think Best Of The Best (LON:BOTB) could fit the quality checklist above, although its share price has understandably stood up well so far.

It is an illiquid micro cap, which people should be aware of. That said, holders are very aligned with the founder owner, William Hindmarch, who retains a large holding in the company.

I don't see why BOTB's operations should be disrupted by current events too much. It is an online organiser of weekly competitions to win cars and other lifestyle prizes. On this note, though there may also be a degree of regulatory risk.

The group's competitions are deemed to be "skill-based" rather than gambling, although this might be a slightly subjective judgement. I don't know enough about the competition myself but comments left in this recent article on the company are worth a read, just to hear a different take. I believe the rather colourful(!) comment was left by bryans1311.

That aside, trading is good. The strong start to the second half of the financial year has continued and, as the company generates more sales, it reinvests more into marketing and customer acquisition. This strikes me as a good mix and a "virtuous circle" type of situation.

BOTB concludes:

As such, the Company is pleased to advise that it is currently trading ahead of market guidance, as updated on 30 January 2020, in respect of both full year revenue and profit. The Board looks forward to updating shareholders in further detail on publication of its final results for the year ending 30 April 2020

My view:

I covered BOTB for the first time last week and liked what I saw, although I have yet to take my research further. This brief update strengthens the case for a closer look. To summarise my thoughts so far, pros:

• Cash generative; high levels of free cash flow
  
• Safe balance sheet
• Good trading and earnings momentum
• A strategic shift to online competition that can be a catalyst for the share price and considerably widens its total addressable market
• Increasing marketing spend
• Broader product offering can attract more customers
• Founder owner is CEO and has large shareholding

Cons:

• Illiquid micro cap
• Possible regulatory risk (must investigate BOTB's competitions in more detail)

All in all I like what I see.

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Laura Ashley Holdings (LON:ALY)

• Share price: 0.31p (-68.86%)
• No. of shares: 727 million
• Market cap: £7 million

Shares suspended

Unfortunately, this could be the first of many. This puts 2,700 jobs at risk across 150 shops.

The group says:

The COVID-19 outbreak has had an immediate and significant impact on trading, and ongoing developments indicate that this will be a sustained national situation... based on the Company’s revised cashflow forecasts and the increased uncertainty facing the Group, the Company expects that it will not be in a position to draw down additional funds from third party lenders in a timely manner sufficient to support working capital requirements

My view:

As above - Laura Ashley Holdings (LON:ALY) will not be the only casualty. The priority for investors should be to look at their portfolios and see which, if any, stocks they hold that could go bust or see equity wiped out as part of a prolonged nationwide shutdown. I would be extremely sceptical regarding Cineworld (LON:CINE) 's recent "going concern" assumption. If last week's preliminary results statement came out today instead, surely it would have to drastically revise its Going Concern statement. If you recall, the group said just last Thursday:

The Group's forecasts and projections, taking account of reasonably possible changes in trading performance, show that the enlarged Group will be able to operate within the level of its facilities for at least 12 months from the approval date of these Consolidated Financial Statements. Accordingly, the Group continues to adopt the going concern basis in preparing its Consolidated Financial Statements.... The uncertainty as to the future impact on the Group of the recent COVID-19 outbreak has been considered as part of the Group's adoption of the going concern basis. Thus far, we have not observed any material impact on our movie theatre admissions due to COVID-19.

Clearly, that is no longer the case. And if this Going Concern point is true for Cineworld, it is true for many other companies across the Leisure, Retail and Travel sectors.

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J D Wetherspoon (LON:JDW)

• Share price: 614p (-13.52%)
• No. of shares: 105 million
• Market cap: £743 million

Holding Announcement

Thanks to GoStevie for flagging this.

Funny how a -13% is small fry these days!

Tim Martin, quite rightly, raises the economic impact of a nationwide shutdown. The benefit of immediately reducing the spread of COVID-19 must be balanced against the longer-term economic repercussions and the potential impacts of such disruption. Martin believes we should continue with the "group immunity" strategy that is still being pursued by the Dutch government.

In classic TM style, he says:

The Prime Minister should show Dutch courage and follow the example of their PM Mark Rutte - and avoid taking French leave of his senses by following the lockdown example of perfidious Emmanuel Macron.

He is nothing if not colourful. Going back to the previous point re. market shakeouts: I will be watching J D Wetherspoon (LON:JDW) as it is the UK's best pub operator by some distance. Mind you, if we are shut down for a year or so that doesn't really matter for the moment.

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Indigovision (LON:IND)

• Share price: 370p (+109%)
• No. of shares: 7.3 million
• Market cap: £27 million

Recommended cash acquisition by Motorola Solutions

Some good news!

Congratulations to shareholders of micro cap Indigovision. The group, which designs, develops, manufactures and sells networked video security systems has been bid for at a substantial premium.

The Acquisition values the entire issued and to be issued share capital of IndigoVision at approximately £30.4 million (approximately $37.2 million) and represents a premium of 129% to the closing price of 177p. Hopefully this goes to show that there is value in these markets, even if the current conditions remain harsh. It's not a company I know well, but worth flagging some good news given the circumstances.

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City Pub Group (LON:CPC)

• Share price: 57.5p (-30%%)
• No. of shares: 59.7 million
• Market cap: £34 million

COVID-19 update

These trading figures look relatively good: for the first 11 weeks to 15 March 2020, total turnover is up 11% year-on-year and LFL sales for the same period are down 4.5%. The situation has no doubt deteriorated rapidly since then though.

Indeed, the group says that "recent trading has been impacted by COVID-19 and its wider effects, particularly on sport, and certain sites have witnessed noticeable reductions in trade as a result" and is expecting to update further with a "material reduction to our expectations for 2020."

In keeping with the Langton feedback, the group says trade at its local community pubs has been more resilient. Again though, this all feels slightly historic given the evolving government advice.

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There is more commentary from various companies regarding COVID-19 but I am running out of time. I will summarise here.

Tasty (LON:TAST), -28%, says it has had a positive Christmas trading period and good start to 2020. It adds:

We continue to monitor closely the rapidly evolving COVID-19 outbreak with its attendant risks to the business and will make further announcements as and when appropriate. Despite the challenging and uncertain trading environment we hope 2020 will be a year in which trading will continue to improve.

I would suggest this statement has already been overtaken by events. Brighton Pier (-1%) and Compass (-11%) have also updated, but the talk is much the same. They are closely monitoring developments. What more can they say for now?

I'm breaking for lunch now - if I see any other updates, I will include them later.