Small Cap Value Report (Tues 24 March 2020) - QTX, WYN, LTG, YOU, ESL

Morning,

Well, I think we'll all be talking about that address to the nation for some time. Historic stuff. Various monitors say footfall to retail, bar and restaurant sites have fallen by about 70% now. This will, of course, become closer to 100% over the next couple of days. Forecasts made as recently as last week might now be out of date as we face a more complete and, perhaps, longer shutdown than some initially envisioned.

The FTSE is actually set to open up 225 points at 5,130 - relief at signs of more decisive action? Or just volatile markets? It's funny how you get used to volatility - I remember when a 200 point move meant something. In fact we all do, it was only a couple of months ago!

The FTSE 250 is down by about 25% in the past two weeks alone. If you are looking at a double digit negative performance, know that you're not alone. Small caps in particular have been underperforming. The market is marking everything down, though, meaning good companies are cheaper than they were.

For anybody that hasn't seen, we've had a couple of useful articles so far this week that are worth reading. Yesterday, Alex wrote this historical perspective on the 'Corona Crash', and Graham has just published this piece on high margin companies that are better placed to ride out the storm.

I'm looking around for the day's news. Any suggestions leave a comment.

Edit: many thanks to MrContrarian for his excellent daily comments. Some of the companies I intend to look at so far include:

• Quartix Holdings
• Wynnstay
• Learning Technologies
• YouGov

Thanks,

Jack

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Quartix Holdings (LON:QTX)

• Share price: 240p (-1.64%)
• No. of shares: 48 million
• Market cap: £117 million

AGM Trading Statement

Quartix Holdings (LON:QTX) is highly regarded by some canny investors, but I have never looked at it closely myself because I have been put off by historically high relative valuations. That has probably changed now: the company trades on a historic PE of 21.4 times.

That’s still expensive, but much more palatable.

Quartix is one of Europe's leading suppliers of subscription-based vehicle tracking systems, software and services.

Some of the positives:

• High margin and cash generative,
• Recurring revenues,
• Well regarded management team,
• Good dividend yield (although divi cover is low, and companies cutting dividends given conditions now must be expected)

Update

This update is for the two-month period to 29 February 2020. Trading in that period “was consistent with... market expectations”.

(Note: consensus market expectations for 2020, based upon forecasts from finnCap and Shore Capital were: Revenue: £26.0m; Adjusted EBITDA £6.7m; Free Cash Flow: £5.3m.)

New fleet tracking installations were 30% ahead of the same period last year (8,400 vs 6,300) and order intake has been robust through March.

Quartix says it is now beginning to see more of an effect from its customers and management estimates that growth in installations completed will reduce to 12% by the end of the first quarter (circa 12,000 versus 10,600). If I’m reading that correctly, that implies negative growth for March in order to reach 12% growth for Q1 when two-thirds of that period has been trending at +30%.

The group adds that up to 1,500 installations due for March will be carried over to subsequent months, with the majority of this backlog in the UK - this appears to be deferred, rather than cancelled revenue.

In other news, Quartix’s international expansion was showing promising signs: a total of 600 new installations in the first two months, with France being its fastest-growing region. Orders have dropped considerably in March, particularly in Italy and Spain.

Coronavirus

As said above, updates made as recently as a week ago might now be out of date. Quartix updated on the 19th regarding this situation but now it says:

Over the past few days, however, we have heard from a number of customers who are taking vehicles off the road because of falling demand. This has not been restricted to the catering, hospitality and leisure sectors. We are working hard to help these customers and it is a priority of ours to maintain our fleet customer base through this crisis.

This is concerning but expected. What are the implications of much of the world coming to a standstill, even if it is for a short span of time? There are two phrases I have seen so many times over the past two weeks they have lost much of their meaning: “unprecedented” and “uncharted waters”.

We need some more synonyms...

The group adds that further declines are expected in its insurance telematics division, with new installations here expected to be down 3% in Q1 to 8,100 units. Further declines are expected later in the year.

My view

The group says it will be providing a further update in May. I get a positive impression from Quartix as far as communication with shareholders and the market goes. Some companies really don’t care to communicate adequately and I attach a reasonable amount of importance to this point on financial reporting quality. It’s a hard thing to screen for, so you just need to develop your own sense for it.

Quartix is updating regularly, it communicates clearly, and it actually provides us with the “market” forecasts everyone likes to refer to.

It looks to be well placed to ride out a period of prolonged disruption - better placed, at least, than many of its customers - with a 25% operating margin , a cash generative model, a modest amount of debt, and a net cash position of c£6.5m. Stockopedia likes it, with a Quality Rank of 95.

It is still not “cheap”, but I have seen enough to want to look more closely. I do notice that its F-Score is just 4… Understanding why this is the case might be my next step in terms of due diligence.

I can also see that growth appeared to plateau last year - another area I would want to dig into is the group’s addressable market and growth prospects going forwards, given its 20+ PE ratio.

There is the possibility of a “double” correction in these unforgiving markets - earnings forecasts will fall, but if the market decides to give this company a more modest PE multiple given its potentially low rates of growth going forward, that could be quite painful for existing holders.

For example, assume Quartix FY20 earnings are actually down 20% when all is said and done, to around 9p, and its shares are then priced at 15 times, instead of 21 times earnings - that would make for a share price of 134.4p compared to today’s 240p. This exercise might not be relevant for long-term buy and hold investors. For others I think it’s worth considering.

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Wynnstay (LON:WYN)

• Share price: 205p (-3.3%)
• No. of shares: 20 million
• Market cap: £42 million

This is a completely different situation. Where Quartix is a high margin, high multiple tech play, Wynnstay (LON:WYN) is a co-op of Welsh farmers founded in 1918 that has over time morphed into a manufacturer and supplier of agricultural products to the UK farming industry.

The elephant in the room with Wynnstay is low operating margins:

Wynnstay was having a rough time before COVID-19. It wasted some time acquiring pet stores that it then had to quietly offload. Meanwhile industry and weather trends have gone against it. As with currency moves, you would expect weather-related effects to cancel out in the long term.

Nevertheless, the past few years have not been a good time for shareholders, with shares down c69% over three years, from 652p to 205p. Note, though, the positive relative strength this year:

Is this an indirect admission that this group’s shares have been too harshly penalised? Trading aside for a moment, Wynnstay looks like a potentially attractive value play now:

While free cash flow, sales and EBITDA might all get disrupted in the months ahead, in terms of value, Wynnstay has a strong, asset-packed balance sheet with modest debt, net cash of c£8m and more than £20m of freehold property. In fact, impressively, the group trades at a discount to net current assets, so you can ignore all freehold and still have a margin of safety:

All this for a market cap of just over £40m and a company that has been in existence, in one form or another, since World War One. Wynnstay is not a fashionable stock, but will it survive COVID? If so, it might be a cheap entry point into an unexciting but reliable stock. It pays a forecast dividend yield of c7% - if it could buck the trend and maintain payments to shareholders that would be quite an achievement.

Before saying that, I should probably look at the update though...

AGM Statement

The group says subdued trading conditions have continued into the first four months of the new financial year. Results are “broadly” in line - ie. slightly disappointing. Market softness reflected generally lower farmgate prices, severe wet weather that limited sowing activities, and continued farmer cautiousness.

Not good news, but, on an historic PE of 6.5 times, probably priced in.

There is a paragraph on the pandemic. Wynnstay is unsure whether the government’s lockdown announcement extends to rural agricultural stores that “provide an essential service within the rural community and food chain”. Wynnstay concludes:

The Board's overriding priority is the welfare of colleagues, customers and communities, and while there is an uncertain macro environment, the Group's strong balance sheet, substantial headroom in banking facilities, and broad spread of activities provide considerable resilience to address challenges. The Board retains its view that looking beyond the current coronavirus crisis, the business is well placed in the sector.

My view

I think this stock could be a value opportunity.

Its share price decline was uncorrelated with COVID, however, so I’m not sure if it would particularly participate in any rebound once we move past this lockdown. Meanwhile, trading has not exactly been thrilling.

This could have a place in a portfolio focusing on safe income, but I wouldn’t expect strong structural growth from this company. Possibly a rerating in time as conditions improve, and steady long term "inflation + x%" growth. It has a strong balance sheet and sensible management.

My impression is this is a company managed for the very long term and it stands more chance of being around in 20 years time than a lot of hotly-tipped, highly-rated story stocks. Just my view.

That said, I can understand if the lacklustre trading environment, negative growth and low operating margins deter investors. Also, there might be a degree of safety here thanks to current assets and freeholds but, given the exceptional market moves in recent weeks, there might well be more attractive risk/reward opportunities out there.

I’ll keep looking for them, but I am monitoring Wynnstay as well.

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Learning Technologies (LON:LTG)

• Share price: 111p (+1.28%)
• No. of shares: 669 million
• Market cap: £732 million

This one is above the "small cap" cut off point, but since it deals in e-learning services and has fallen by 36% from its all-time of high of 172p on 11 February it might be worth a closer look. That said, it is still not what you would call cheap:

Learning Technologies (LON:LTG) is a hotly-tipped, fast-growing provider of e-learning services that has been busy acquiring various assets in this area.

The group starts off by noting the FCA’s moratorium on preliminary financial statements. It says:

An update will be given as to the timing of the publication of our FY19 results, as soon as further advice from the FRC, the FCA and the London Stock Exchange becomes available.

In place of these preliminaries, which were scheduled for today, the group instead provides a briefer update on trading. It looks like the fledgling dividend has been suspended.

FY19 strategic highlights

• Organic growth from cross-selling initiatives and product development investment
• Acquisition of Open LMS (post-period end) is immediately earnings enhancing and “adds expertise in a market-leading Learning Management System” for higher education institutions

FY19 financial highlights

• FY19 profit and cash performance ahead of expectations
• Revenue +39% to £130.1m; organic revenue +4%
• Adjusted EBIT +58% to £41m; EBIT margin up 380 basis points to 31.5%
• Strong increase in recurring revenues (up from 68% to 74%) thanks to strong performance of Software & Platforms segment, which now makes up 68% of group revenue
• Net cash of £3.8m is ahead of expectations
• Statutory PBT +316% to £14.3m
• Adjusted diluted EPS +47% to 4.7p, making for an FY19 adjusted PE ratio of 23.6

This is a fast-paced roll up, meaning there are quite a few adjusted figures flying around. One thing that jumps out to me is organic revenue growth of just 4%. Handling multiple acquisitions is a tricky business. You have to keep multiple plates spinning and, quite often, buyers end up regretting what they have bought.

Before investing, I would want to do some more detailed tracking of acquisitions. What is the track record like in this area? I will come back to this but first I’ll run through the rest of the statement.

Current trading

• FY20 has started well and is in line with management expectations, whatever they may be
• LTG says it has gross cash of £54m, including drawdown of its $21m revolving credit facility (in preparation for the acquisition of Open LMS, which is due to complete on the 31st of March)
• No material impact from COVID-19 so far although content projects may be impacted and new business wins delayed as customers manage their own cash positions

COVID-19 response

• Management says it is being proactive in conserving liquidity and net cash; it confirms it is postponing the final dividend of 0.5p per share
• Director cash bonuses are also being postponed. This is good - so far, companies have been much more vocal about postponing shareholder dividends than executive bonuses
• Staff bonuses will be honoured “to reflect their significant and positive contribution” although salaries are being frozen until 2021 and it is pausing recruitment
• LTG is reducing marketing, travel, and capex spend. The majority of contractors have been terminated
• The group estimates the combined cash saving in 2020 from these measures will be more than £13m and is keen to stress that further actions can be taken if required

My view

This is an interesting update but more information is needed. Given the extent of lockdown measures, few companies are immune to the disruption. That said, LTG looks to be in a relatively stronger position than most as far as trading is concerned. The increasing proportion of recurring revenues is helpful.

The group will see an impact to trade soon, though, particularly in its Content division. This is about a third of group revenue and a fifth of operating profit. FY18’s operating margin was 21.3% - if you apply that to 32% of FY19 revenue of £130m (£41.6m), you get FY19 Content operating profit of £8.9m.

I feel it still too early to quantify how much disruption LTG could face here but it could at least remain profitable this year. I can see it emerging relatively unscathed, given its increasing focus on recurring revenue in its Platform segment.

Strip out the acquisitions, however, and organic growth is a little pedestrian at +4%. Adjusted figures look impressive, but I can’t see any notes in terms of what adjustments to statutory figures have actually been made.

Its current valuation suggests quite a lot of future growth is priced in but the five year share price performance has been impressive, up from 22p to 111p. Note that the average number of shares has nearly doubled over that time, though, from 258m to 651m.

On balance, roll ups can be tricky and LTG is hardly cheap even after the pullback in share price. I would need to see more detail on the performance of acquisitions and the nature of adjustments made to trading figures before I got involved. This will come in due course. Right now, I don’t have a strong view.

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YouGov (LON:YOU)

• Share price: 436p (9%)
• No. of shares: 108 million
• Market cap: £430 million

H1 Trading Update

We find ourselves in High Flyer territory once more, with Yougov (LON:YOU) . Admittedly most high flyers don’t feel like high flyers right now. Nevertheless, YouGov has racked up an impressive five-year growth track record:

I wonder if the YouGov brand of data and analytics might be a moat? I have been meaning to look into this one for some time. Returns on capital have been improving as the company scales up:

Financial highlights for the six months

• Revenue +16% to £76.9m
• Adjusted operating profit +35% to £11.4m
• Statutory operating profit +13% to £9.5m
• Adjusted profit before tax +27% to £12.1m
• Adjusted earnings per share +35% to 8.7p

The group says it is benefitting from its continued strategic focus on higher margin work, which has driven a 19% increase in operating profit to £8m. The US remains its biggest driver and further investments are being made in Australia, India, Italy, Mexico, Poland, Spain and Taiwan. Leveraging its analytics know-how internationally could be promising.

Indeed, a lot of activity is coming from international expansion - post-period end YOU signed a contract with an international financial services company based in Germany and has continued to expand in Austria, Brazil, Switzerland and Turkey.

Re. COVID-19, YouGov says:

No material impact to our business to-date from the COVID-19 global outbreak, however it is too early to estimate what impact it may have on client budgets over the coming months… We recognise it is inevitable that some of our clients will be impacted by COVID-19. In the event the disruption caused by COVID-19 prolongs, there is a risk some of our clients may default or request longer payment terms. However, with strong cash balances and no debt, we are confident of YouGov's resilience in the face of any weakening client demand.

Again, I feel that this is a company whose business might be relatively well insulated as things stand. Growth is broad-based across divisions and there appears to be international demand for its services.

YouGov’s shares have fallen some 43% in a month, from a high of 763p in late February to 436p today, giving the company a much more reasonable valuation. The Graphical History section of the group’s StockReport shows that shares are trading towards the bottom of their five-year range in terms of yield and PE ratio despite a record of strong growth:

With c£27m of cash and no debt, the company’s financial position is robust. Given the FCA’s moratorium on interim financial statements, the update is brief. I can see some promising signs here, though, and would like to take a closer look at YouGov with a focus on the strength of its brand, market position, and growth opportunities.

I see last year, at 560p, Paul called YouGov’s valuation “bonkers”. Shares are still expensive by most standards, on an historic PE of 36 times, but now they are slightly less bonkers.

If FY20 forecasts can be trusted, the PE ratio comes down to 26 times. Maintaining growth over the medium term is key here - its five-year track record is impressive but what is the scale of opportunity for YouGov going forwards? How big is its addressable market and what is its existing share of that market? How secure is that share from competition? These are questions I want to find answers to.

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Eddie Stobart Logistics (LON:ESL)

• Share price: 12.4p (+4.86%)
• No. of shares: 379 million
• Market cap: £45 million

COVID-19 Update

This one is brief, with no numbers.

It’s been one long ride downwards for Eddie Stobart Logistics (LON:ESL) shareholders over the past few years. ESL is a cash shell, the shareholders of which own 49% of the Eddie Stobart logistics group.

Logistics is a low margin business and ESL has a net debt position far in excess of market cap to boot. Given current market conditions and economic uncertainty, most investors might be better off looking for high operating margins and safe balance sheets.

That said, there will be deep value opportunities for risk-tolerant investors in the months ahead. ESL is a bit of a special situation - I'm not familiar with it. Others might feel they are closer to events and have an informational edge.

The group says it is experiencing “exceptional volumes that we would typically see around Christmas” as we temporarily (or permanently?) become a much more delivery-oriented society. ESL adds that “no conclusion can be drawn as to the potential impact of the exceptional volumes highlighted above on the profits or losses attributable to the Company for the year ended 30 November 2020.”

You would think the effects are more likely to be good than bad for trade. This is an interesting one, although I don’t know it in any detail and I’m sure others on the site are much more up to date with events. Trading at just 0.05 times sales, ESL shares are clearly cheap by some measures.

The balance sheet has c£150m of net debt, which makes me pause. That makes for a market cap of £45m and an enterprise value of £200m. There is £60m of plant, property and equipment, along with £195m of accounts receivable (as of May 2019) on the balance sheet. The company tends to operate with a high proportion of current assets as accounts receivable.

How safe are these receivables in the current environment? I have no idea and would need to take a more detailed look. Stockopedia classes ESL as a Value Trap, and that is exactly what makes me pause here. High sales, low margins, lots of debt… Debt might be ok if the company trades well, but if anything adverse happens, then it doesn’t take a huge leap of imagination to see a bad outcome for equity holders.

I do appreciate, though, that the company appears to be benefitting from developments as things stand. Given the risk and capital profile, I can’t comment further without being much more familiar with ESL. My initial view is that, regardless of current trading conditions, the downside risks are material here and must be respected.