Small Cap Value Report (Thur 19 Mar 2020) - KETL, DTG, ADBP, MARS, ESC, RTN

Good morning!

This is the placeholder, for your early comments.

Today we have:

• Escape Hunt (LON:ESC)
• Ab Dynamics (LON:ABDP)
• Portmeirion (LON:PMP)
• LoopUp (LON:LOOP)
• Everyman Media (LON:EMAN)
• Tclarke (LON:CTO)

Cheers

Jack

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We are currently experiencing a barrage of Leisure updates as operators scramble to process the implications of a sustained lockdown and consequent financial aid packages. These updates are worth a dedicated report in themselves.

I haven’t had the time to properly process some of these updates but there could be some high risk / high reward opportunities. I do stress the “risk” part, though - there is the very real possibility of equity getting wiped out in these uncertain times, and we are still in the early stages. There were some huge share price moves yesterday - in both directions.

The companies going up were:

• Cineworld (LON:CINE) +152% to 54p
• Marston's (LON:MARS) +43% to 32p
• Hollywood Bowl (LON:BOWL) +41% to 100p

Some companies going down included:

• Carnival (LON:CCL) -34% to 620p
• Revolution Bars (LON:RBG) -32% to 16.75p
• £SSP -29% to 151p
• Mitchells & Butlers (LON:MAB) -19% to 113p

There is still a lot of uncertainty hanging over pubs, bars and other leisure and retail outlets. Forecast earnings don’t count right now and the market doesn’t know how to value these shares.

At some point I would like to take a look at these companies, but there may not be time today as the RNS feed is already filling up. At present, I feel like there are two big plays in this market:

• Quality, growing companies trading at a discount, and
• Companies with bombed out shares that are priced to go bust but will ultimately survive.

What does everyone else think? The top option is much less risky. Most of Leisure now falls into the bottom. There are also a lot of “do nothing” investors out there who have picked companies they have conviction in and remain fully invested. If you can handle the volatility and are confident in the companies you own, that is a totally valid position to be taking.

I’d like to start off by taking a closer look at some of these updates. On a busy day for announcements, Strix (LON:KETL) didn’t make the cut yesterday so I have some thoughts there. Restaurant (LON:RTN) has shared its COVID-19 modelling assumptions, which is an important read-across for the rest of the hospitality sector (and the millions of people across the country it employs).

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Hospitality sector, Restaurant Group, working assumptions

These businesses are right in the eye of the storm at the minute. What happens here has implications for the jobs and general morale of more than three million people. I think how rich or poor these people feel will be very important to economic conditions in the months and years ahead. Even after the financial aid package announced earlier in the week, many bar operators do not think they will survive a prolonged lockdown.

The government is making moves. The only question is whether the right moves will happen in time. Restaurants etc. are having to completely redefine themselves - for example, the government has lifted change of use demands so that restaurants and pubs can immediately start operating as takeaway venues… The speed of these developments is pretty breathtaking, but it is heartening to see people pulling together.

On Tuesday I noted that a senior Leisure/Travel figure warned that “20 years of work could be undone in 20 days unless someone gets a grip on this problem.” Thankfully we are seeing some signs of a government getting to grips - but I’m sure there are more twists and turns yet.

Despite the strong share price moves, this is not a “with one bound, our hero was free” kind of situation. Everybody is reacting to unfolding events as best they can. It feels like the government advised everyone to stay away from pubs, bars and theatres, and then realised they would have to support said pubs, bars and theatres. What we have now is the best financial support package some smart people could come up with at c48 hours’ notice. It’s good for what it is, but is it enough? I wouldn’t be surprised if further action must be taken.

In fact, the British Beer & Pub Association has sent the following statement around:

The British Beer and Pub Association is calling on the Government for further urgent interventions to keep pubs from closing, amid fears that thousands could collapse this weekend. Despite initial government relief, pubs urgently need liquidity measures in order to pay wages and prevent thousands of pubs from closing, with the subsequent loss of hundreds of thousands of jobs.

… Without immediate and decisive action to create cash and liquidity, thousands of pubs will be unable to pay staff wages and could be forced to close this weekend, before the initial government relief ever reaches them. As a priority, the British Beer and Pub Association is asking that the Government underwrites at least 75% of wages for all pub and brewing staff, enabling employers to pay staff during this period of uncertainty. It is estimated this would cost the government £1billion.

In addition, the British Beer and Pub Association is asking for the Government to cancel Excise Duty and VAT payments that pubs are due to pay on 25th March and 31st March respectively. This will enable pub operating companies across the country to redirect much needed cash directly into their businesses, helping to prevent closures and save jobs.

The industry is also urging the government to begin immediate distribution of the £10,000 and £25,000 government grants announced on 17 March, or underwrite them, to positively impact pubs’ cash flow. The industry also requires the government to underwrite all insurance costs for business interruption for a period of at least 3 months for the pub sector. This money must be given to insurers now or directly to businesses, to prevent thousands of pubs from closing permanently.

So that’s the verdict from the pub trade body at least. The £330bn aid package has been announced but operators need details, and the right money going to the right places, in a matter of days and weeks. It's all to play for.

I'm going to go over some of the news flow from yesterday before moving on to today. Send any requests my way.

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Yesterday’s updates

Restaurant Group (LON:RTN)

• Share price: 22.68p (-1.39%)
• No. of shares: 491 million
• Market cap: £113 million

Current Trading & COVID-19 Update

Restaurant (LON:RTN) has thrown its hat in the ring, with an assumption of -25% like-for-likes for 2020.

COVID-19 has taken a sledgehammer to this particular share price as you might expect. The year-to-date is a fall of some 87%.

Restaurant Group has been busy crisis modelling - you’d better believe every other operator of substantial scale and resource has been busy doing the same thing, even if they haven’t come out and said it yet. I appreciate the attempt at publicly quantifying the damage.

It’s operating figures and working assumptions for the rest of the year (as of Wednesday 18 March):

Current:

• Group like-for-like sales for the first eight weeks of the financial year (pre-COVID) were +4.5%
• Sales have weakened to -12.5% year-on-year over the past two weeks.
• The Concessions business has been hit hard. Like-for-like sales -21.7% and getting worse by the day given International travel bans.
  • This has implications for £SSP and £SMWS

Outlook:

Restaurant Group’s model assumes:

• An overall decline in Group like-for-like sales of 25% in FY2020 (assumed down 45% in the first half and 5% in the second half), comprising:
  • -45% in H1 and -5% in H2 as things recover
• Breaking this down, it anticipates a significant decline in its Concessions business (-92% in Q2) with significant disruption persisting through the remainder of the year (-31% in H2).
• Leisure, Pubs and Wagamama like-for-likes -68% in Q2, including 10 weeks of shutdown, before normalising through H2.

Mitigating actions the group is taking include:

• The Group will reduce capital expenditure for 2020 by at least £45m from the previous guidance of £75m.
• The Group will be working with landlords across all business areas to ensure that no minimum guarantees are enforced within Concessions, where rents are largely turnover based; and to ensure that the rent roll for 2020 across our other businesses equitably reflects the unique and unforeseeable situation. The forecast assumes at least a 50% reduction in fixed rent across all our Wagamama, Concessions, Pubs and Leisure restaurants, and reflects the business rates holiday for three quarters of 2020 as announced yesterday in the Chancellor's statement.
• The Group will work with lending banks to seek covenant holidays throughout 2020 in order to preserve maximum flexibility to operate the business through this challenging period.

The group concludes:

Under this scenario, we would retain a minimum of £75m of cash liquidity throughout the remainder of the 2020 financial year. The Group estimates that in the event that the entire group is in shutdown for a period in excess of that assumed above, then the adverse impact on cash would be no more than £15m for each further month of shutdown.

Clearly the situation is evolving rapidly and there is no certainty around the severity and duration of the impact on the business. The Company is continuing to consider its funding options, both equity and debt, on an ongoing basis.

So Restaurant Group is currently assuming: ten weeks of shutdowns, an awful Q2 before conditions normalise in H2, and continued travel hub disruption throughout the year…

Data company Tenzo reports that sales across the hospitality companies that it services were down 69% yesterday with 8% of sites closed. This is down from a drop of 51% on Monday and 44% on Sunday.

It is still too early to tell, but I do feel that some operators will survive this. When they do, they will find the field is much less competitive and landlords a lot more accommodating. On a more sombre note, I feel that Restaurant Group's assumptions might be too optimistic.

Marstons (LON:MARS)

• Share price: 29.36p (-7.85%)
• No. of shares: 634 million
• Market cap: £202 million

COVID-19 Update

I think bigger operators have more to play with in terms of cost cutting and belt tightening.

Take Marstons for example - it can cut its dividend, turn off capex, and hunker down while picking up government aid. It’s not ideal, but it’s a damn sight better than things were looking a week ago.

This is still a risky area for stock market investors. Equity is bottom of the pile when things go wrong. So if things do go wrong, there is the possibility of equity getting wiped out and permanent loss of capital.

In terms of what we know about trading:

• Regional pubs are so far holding up better than London dining, but we must assume the regions will follow London’s trajectory re. COVID-19.
• Marstons pub like for likes are down 1%, having fallen by 5% over the last eight weeks, largely due to stormy weather
• It has completed £60m of disposals and expects £85-£90m of disposals this year
• It is suspending the interim dividend. Last year this was 2.7p per share or c£17m.
• It is cutting capex. Last year this was £134m
• There are other costs it is cutting
• The company is having “constructive discussions with banks” re. Potential covenant waivers in H2
• The above might be enough for MARS to handle a c30% reduction in sales

It is worth bearing in mind that MARS has nearly £500m of net assets. Its £2.3bn of PPE is stacked with freehold property and is set against £1.4bn of total debt. With a £200m market cap, this means it trades at c0.4 times tangible book.

There is value here, but as above, in these exceptional times there is the real risk of equity getting wiped out at some point. I don’t see the need to rush in but I do think there is the opportunity to research this stock as a special situation.

Dart Group (LON:DTG)

• Share price: 271.4p (-28.6%)
• No. of shares: 149 million
• Market cap: £566 million

Trading Update

This airline is hurtling back towards small cap territory. After updating on 11 March, Dart snuck out an additional update yesterday at around 5pm. Usually this is bad news. I won't spend long on this one as there is not much new to say.

The group says that ‘unprecedented and unforeseen levels of travel restrictions have been imposed by governments across Europe’ and ‘this has resulted in Jet2.com having to suspend its flying programme until at least 1 May 2020.’ It is concerned about bad debts at hoteliers for next season's accommodation and the group "has reduced visibility on the financial implications". Profit guidance has understandably been withdrawn for the period to March 2020 and it says it has no clarity over the period to March 2021.

It says it has introduced "a reduced flying programme beyond 1 May 2020, freezing recruitment and discretionary spending and deferring all non-regulatory capital expenditure.... in addition, we are in ongoing discussions with existing liquidity providers who recognise the strength of our business model." We will likely see plenty more updates like this from airlines. The question is will they get government aid? Given the radically changed conditions, until there is more clarity on this and we can see some models of base, best and bear case scenarios I'm not about to catch any falling knives here. There will be opportunities, but I would much rather miss out on the early upside and have greater certainty of a recovery.

Strix (LON:KETL)

• Share price: 136p (+3.8%)
• No. of shares: 190 million
• Market cap: £249 million

Final Results

Has there ever been a better time to put the kettle on? I would argue not.

It's great to see these results from Strix and if I am going to put money anywhere in this market, this is one of the first stocks I will be considering. Note how this company, with a substantial operating base in China, has ended up experiencing far less disruption than domestic UK stocks. Not sure what to make of that.

Mark Bartlett, CEO says:

"Following on from our successful results in 2018, we are pleased to report another year of solid trading performance in 2019. We continue to focus on our strategic priorities which has enabled us to retain our c.54% global market value share amidst a challenging geo-political climate.

... The Group's high ROCE and high proportion of cash in advance payment terms limit the risk of non-payment and working capital fluctuations. This along with a robust balance sheet provide the Board with continued confidence in the Group's future growth prospects.

We have been extremely proud of the response of our leaders to the unprecedented situation as a result of COVID-19, with minimal impact to date. The Group's manufacturing operations in China have recovered with a c.100% production capacity and operational supply chain which is sufficient to meet customer demand. The Group will continue to focus on a prudent allocation of capital and be vigilant about the broader implications of COVID-19 which will include daily monitoring of consumer and brand demand. As a result, the Group is working on several strategic initiatives, including new products and efficiency measures, to minimise the impact to full year forecasts.

Key highlights:

• Constant currency revenue +1.8% to £95.4m
• Gross profit +1.8% to £39.6m
• Operating profit (excluding HaloSource acquisition) +8.3% to £33.4m
• PAT +2.1% to £28.9m
• Net debt down from £27.5m to £26.3m
• Basic earnings per share +2.1% to 15.2p - historic PE ratio of 8.8 times
• Total dividend +10% to 7.7p - 5.74% dividend yield

Given the overall quality of the business, its apparent ability to ride out China disruption and solid operating results, these shares look good value to me.

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Today’s updates

Escape Hunt (LON:ESC)

• Share price: 3.25p (+18.2%)
• No. of shares: 27 million
• Market cap: £740,000

Trading Update and Impact of COVID-19

These shares were getting battered before COVID-19. At this point, they might be an example of one of those “companies priced to go bust but that survive”. Of course, some of the companies in this pile will also just be “companies priced to go bust that go bust”.

In fact, so far, this company has to be up there for the hotly-contested “Most Overpriced and Mishandled IPO of the Decade” award.

That’s a 98% fall, folks.

By now, we know roughly what Escape Hunt (LON:ESC) is going to say. Trading was strong until end-February 2020. It says “COVID-19 will prove to be a huge challenge for us all” and has seen a spike in cancellations.

At the site level, ESC has “implemented a more stringent cleaning regime and... sites remain open for business.” It anticipates sales reductions and notes that the UK Government might follow other European countries in forcing the closure of all leisure facilities. Obviously, having no business would be bad for business...

The group is cutting costs, as all operators undoubtedly are. It says:

The recent budget and Tuesday's announcement of direct aid to the sector by the Chancellor of the Exchequer provides some welcome relief, although the extent to which the Company will be able to benefit is not yet known, nor is the depth or duration of the impact of COVID-19 on trading.

As at close of business on 17 March 2020, the Company had approximately £1.8m cash in the bank. A level of expenditure will need to be maintained throughout any hibernation period to enable the business to re-open as conditions permit, but the measures being taken are expected to be sufficient to sustain the business for several months.”

My view:

Cheap, but too risky.

If you subtract this £1.8m of cash from a market cap of (3.25p * 27m shares =) £877,500, that gives a negative enterprise value of -£922,500. The group seems to think it has enough cash to survive “several months”, which I take to mean at least the base case of a severely disrupted (ie. non-existent) Q2 followed by a gradually normalising H2.

It is not for the faint-hearted, but a lot of bad news is priced in. “All” the company has to do is batten down the hatches, survive this period of severe disruption, and then prove the profitability of its business model.

And, call me crazy, but I do actually think there could be a profitable business model here. Whether or not ESC will get the chance to prove that model is another question entirely.

The IPO was hugely overpriced and the company has had some setbacks as it's built up its operations. It probably should have had a period as a private company before listing, rather than have its growing pains on show for the whole world (and, no doubt, frustrated shareholders) to see. In fact, non-cash amortization expenses as a result of said pricey IPO are a big part of why ESC is currently so loss-making.

Around 60% of FY18’s operating loss resulted from these non-cash charges:

At the end of the day, though, it’s a risky, loss-making start-up that has already had to issue more stock and dilute existing shareholders. It’s not an encouraging track record so far, and there’s every possibility that more cash might have to be raised given the conditions. Maybe it can avoid doing so but I wouldn’t bank on it right now.

In fact, on balance, I think it is a very real possibility that more cash is required. FY18 saw about £8m of cash burn. Fair enough, the company is reducing costs, but it will be a close run thing. With everything else going on, do you need to make that bet right now?

If the shares are truly a bargain and the directors are confident they can make it all work out, I wonder why the directors aren’t filling their boots with cheap stock. The last buys I can see were three years ago. Activity here would be an interesting signal and something I’ll be looking out for.

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AB Dynamics (LON:ABDP)

• Share price: 1,200p (+36%)
• No. of shares: 22.5 million
• Market cap: £199 million

Trading Update

OK, time for some good news (presumably). Interim results ahead of comparative period and in line with expectations.

AB Dynamics designs and manufactures testing systems for vehicle suspension, brakes and steering. I’m less clued up on this one so any holders do chip in. I know Ab Dynamics (LON:ABDP) is highly regarded by some.

There’s no figures here re. trading. ABDP is just seeking to reassure investors by the looks of it. A more detailed interim update is due on 22 April.

COVID-19:

We have sufficient inventory levels to support ongoing production and alternative sources of supply for the majority of items that might be affected if the current situation continues into the longer term, absent any additional trade or travel restrictions. Clearly the global impact of COVID-19 is evolving however, we will keep the situation under close review and update investors on any material changes.

About as good as you could hope for at present.

Financial position:

Our balance sheet remains strong with cash at 29 February 2020 of £35.2 million, underpinning our investment plans. Following a detailed review of inventory, a number of items previously included in the carrying value have been written off. This one-off charge will be excluded from adjusted operating profit.

It would be nice to have more detail here. Why are they being written off? Due to the prevailing market disruption or some other reason?

The company has no debt, so that’s net cash of £35.2m or 17.6% of current market cap.

Business performance:

ABDP says good progress has been made against strategic priorities, is capitalising on “substantial growth opportunities across its end markets” and it continues “to invest in new products and new business systems”. Finding companies that can continue with investment at this time is surely a good sign.

Promisingly, ABDP also says that acquired businesses and its new international sales offices have generated a “material increase” in the proportion of recurring revenue. Sales also grew across both its operating segments: Track Testing and Laboratory Testing and Simulation.

My view:

So we’ve seen some “bombed out value” candidates. This might be an example of “quality at a discount”. It is a reassuring update and shows that this company warrants more detailed research.

Forecast earnings are up in the air for a lot of companies, but ADBP’s “in line” assurances suggest we can tentatively stick to these figures for now. That means the group trades on 18.5 times forecast 2020 earnings of c65p per share. Based on 2019 EPS, you have an historic PE of 28.5.

Not overly cheap, but this group has established an impressive growth track record:

If growth can be maintained, then these shares look promising. I still don’t think of them as “cheap”, but if it can continue to grow at CAGR rates of c30% then it quickly does become cheap.

ABDP does say “Clearly the global impact of COVID-19 is evolving however, we will keep the situation under close review and update investors on any material changes” so it is not home and dry.

Given its strong balance sheet, continued investment in operations, impressive growth track record, increasing recurring revenue and talk of “substantial growth opportunities” it certainly stands out as a stock worth looking at in more detail.

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Everyman Media (LON:EMAN)

• Share price: 98p (+20%)
• No. of shares: 73.6 million
• Market cap: £60 million

COVID-19 Update and Final Results

In terms of estate size, this small cap cinema operator says it is the fifth largest cinema business in the UK by gross box office revenue. It has 33 sites, 110 screens, and 9,224 seats. Its sites tend to have superior food, drink and seating options to your average chain.

Performance for the period (which does not include COVID) looks very good:

• Revenue +25.1% to £65m
• Admissions +17% to 3.3 million
• Pre-IFRS 16 EBITDA +31.3% to £12m
• Seven new venues opened

Of course, it’s all about the outlook now… A sentence from the CEO resonates:

We find ourselves in an unparalleled environment, where what was business as usual last month, is now a distant past.

COVID-19

It is as you might expect: sites are being closed, new sites halted, and capex projects are being suspended.

The group says:

We expect to see a significant pause in business and are taking all appropriate measures to reduce the financial impact of this on the Group. Whilst the exact longer term impact of the situation is difficult to predict the Board believes that shareholders should take comfort from the following:

The Group has in excess of £14m headroom in its loan facility currently

Action has been taken to postpone all non-committed capital expenditure, which will affect our planned rollout but maintains the strong financial position of the group

Actions to reduce operating expenses have been taken and further actions are in place to reduce expenses to a minimum during this period of closure

... Whilst site closures will clearly have an impact on the Group's ability to operate whilst restrictions are in place, this does not change the Board's confidence in Everyman and its proposition over the long term.

Let’s have a quick check.

As of 4 July 2019, EMAN had £137m of total assets (including £119m of plant, property and equipment) set against £71.9m of total debt. Net tangible asset value was £42.9m.

• Net cash generated from operating activities for the period was £15.9m (2018: £7.6m),
• Net cash outflows for the year, before financing, were £8.2m (2018: £15.5m).
  • The bulk of cash was spent on growth and maintenance capex.
• Cash held at the end of the year was £4.3m (2018: £3.5m).

Importantly, the group agreed a new 5 year loan facility of £30m in January 2019, up from £20m. At the year end the Group had drawn down £14m (2018: £7.0m). Charges have been put in place over the net assets of the Group as collateral against the loan balance.

My view:

My initial impression is that EMAN might be one to watch. Before this recent disruption, it was proving its business model. It appears to provide a service people want and has some scope to absorb costs during this exceptional period. If Cineworld (LON:CINE) does go into administration, then it could be an ultimate beneficiary.

I would want to compare its financial situation to the four operators above it in the pecking order. I don’t suppose many investors have a burning desire to invest in cinema chains right now, but I think Everyman might be one to watch.

The group does say:

Whilst the Group has significant headroom in its loan facility there is a risk of breaching the Group's financial covenants. The Board is in discussions with its lenders and is in the process of re-negotiating its loan covenants to maintain liquidity through this period of uncertainty. The Board is hopeful of lenders continued support in this period of uncertainty which is underpinned by the Government announcement to provide guaranteed loans to business.

Everyman won’t be the only operator currently discussing covenants with lenders.

There is also an interesting section in the statement under “Going Concern” (a phrase that will be making a lot of people nervous these days).

I’ll summarise EMAN’s going concern forecasts:

• The business is closed for a period of three months with reduced admissions for the following two months at 50% and 65% of normal trade respectively.
• A delay in all non-committed capital expenditure, reduction in variable costs including staffing and moving to monthly rent payments.
• Factoring in the recently announced twelve month business rates holiday for the hospitality sector.
• Under this scenario there is a risk of breaching the Group's financial covenants as stated above.

The Board has also considered “the severe but plausible downside scenario of complete closure and delayed re-opening”. Even considering this eventuality, it says it has the ability to remain trading for a period of at least 12 months, subject to the renegotiation of its loan covenants.

The Group also claims to have a very supportive shareholder base who are committed to the long term success of the Group.

EMAN says, though, that current circumstances “represent a material uncertainty that may cast significant doubt on the Group and Company's ability to continue as a going concern and, therefore, to continue realising their assets and discharging their liabilities in the normal course of business. The financial statements do not include any adjustments that would result from the basis of preparation being inappropriate.”

I think Everyman is right to flag these risks. At the moment, management appears confident the company can survive an extended period of closed sites. Whether you want to back the company right now is another matter.

The group appears to be saying it must renegotiate covenants and claims “material uncertainty” over the going concern assumption. I need to look at these covenants in more detail. For this reason, I would personally hold off until I can be more certain of survival.