Small Cap Value Report (Wed 26 Aug 2020) - VNET, PEB, VLX

Good morning, it’s Paul here with the SCVR for Wednesday.

It’s a quiet day for news, so I should be able to wrap up today’s report by late morning.

Today's report is now finished.

Technical gremlins struck this morning, so I was weighing up whether to go back to bed, or type up the SCVR in Word, then copy/paste it into Stockopedia once it was back up again. So I did both! Anyway, we're back in business now!

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Vianet (LON:VNET)

Share price: 95.5p (up 2% today, at 13:00)
No. shares: 28.95m
Market cap: 27.6m

Trading & COVID-19 Update

Vianet Group plc (AIM: VNET), the international provider of actionable data and business insight through devices connected to its Internet of Things ("IOT") platform, today provides an update on trading and the Group's current status regarding COVID-19 ("C-19").

VNET has a 31 March 2021 year end, hence today’s update covers April – July 2020.

We are pleased to report that trading for the first four months of the financial year has been ahead of our own C-19 revised revenue and profit forecasts with a corresponding positive impact on free cash flow.

Ahead is good, but with no figures given, we don’t know how far ahead. Could be a little, could be a lot, so not a terribly useful update.

Working from home (WFH) - Interesting comments on staff working from home, which might have read-across for other companies too, possibly?

• Very successful, but
• Difficult for many
• Often less productive & inspiring than working in an office

Maybe the gloss might come off working from home, as more companies recognise its limitations? Fine as a short-term emergency measure, but probably not a long-term replacement for the office, is my current feeling about WFH.

Re-opening - most customers have re-opened their pubs (now 80% trading), and beer sales are favourable versus last year. Vianet owns the Brulines beer flow monitoring business of course, which is the group cash cow.

Bars could be susceptible to possible future closures? And/or vaccines/treatment could eliminate this issue in time. Nobody knows for certain, and timings are key.

Pricing – discounts were given to all customers during lockdown, now being reduced. Re-opened pubs are being given a 30% discount until end October, when full price will resume. The 20% of closed pubs are getting a 70% discount.

Smart Machines business (vending machines) – more positive level of trading, but no meaningful figures given either. Benefiting from move away from “dirty” cash, to contactless. 1,900 new orders for its vending machine telemetry & contactless payment units. Beefed up sales team is winning new business.

Outlook comments – too vague to be worth quoting here.

My opinion – this is such a waffley update, with no useful figures, that it tells us virtually nothing of any use in valuing the shares. Trading updates need to tell us what market expectations are for profitability, and then tell us how the company is performing versus those expectations. Vianet says it’s doing better than expected, but doesn’t say by how much, nor what those expectations were. Hence I can’t take this any further.

It’s the type of business where I would expect a gradual recovery, as its clients re-open. Hence it’s reasonable to assume figures for FY 03/2021 are likely to be poor, but next year should recover to more typical previous years performance.

Historical growth has been anaemic, and painfully slow, so I don’t imagine this share is ever likely to attract a premium rating, unless growth moves up a gear - I've been waiting years for that to happen.

The core business has been a decent cash cow though, and likely to remain so, with the usual continued attrition of long-term pub closures.

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Pebble Beach Systems (LON:PEB)

Share price: 11.1p (down 16% at 13:17)
No. shares: 124.6m
Market cap: 13.8m

Interim results for the 6 months to 30 June 2020. Strike me as lacklustre. Although on reflection, given the covid crisis, remaining profitable is creditable.

• H1 revenue down 20% to £4.5m
• Adjusted EBITDA is down 23% to £1.5m, but £620k of development spend was capitalised,
• Profit before tax of £739k for H1
• Diluted EPS of 0.6p
• Cash generation of £710k

Balance sheet – this is the deal-breaker – it’s very weak, and laden with far too much debt.

NAV: negative, at (£4.14m). Deduct intangible assets, and the more conservative measure of NTAV is worse, at (£8.87m) – make no mistake, this is a financially distressed company. With interest rates at historic lows, banks can bide their time, and it makes sense to allow the company time to possibly trade its way out of the over-indebted position. An equity raise is going to be needed at some stage, and the risk is that the bank’s patience might run out, and force a fundraise when the share price is low.

Therefore, this share has to be seen as very high risk.

Note that the company has fully drawn down its bank facility, so financial headroom looks tight. It doesn’t have the financial strength to survive a downturn in trading, in my view, were that to happen. For now though, H1 was profitable & cash generative, and the H2 outlook sounds OK, therefore probably no immediate solvency risk. It is totally dependent on continued bank support.

Receivables look high, at £3.3m, which implies that most of the £4.5m revenues in H1 hasn’t been paid for yet by customers. That would need to be queried, as a potential problem.

My opinion – I wouldn’t touch this share until the weak balance sheet is fixed, because it’s too high risk for me in the current position.

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Volex (LON:VLX)

(I hold)

Director Buys – an interesting cluster of decent-sized Director buying has reinforced my bullishness on this share. I was late to the party with this share, but started buying recently, and am pondering whether to buy more when funds permit.

It’s a very convincing turnaround, which I’ve covered extensively in the archive here.

There’s a terrific results presentation here on InvestorMeetCompany, which clinched it for me, and made me want to buy the shares, after having done my own research. In a nutshell, the new strategy is to focus on high margin, more complex electrical assemblies. This has raised the operating margin to about 8%, with a target of 10%. Bolt on acquisitions (often from owners who want to retire) is expanding the group, hence it is targeting $650m revenues in 5-years’ time. Put that on a 10% margin, and we get $65m p.a. profit. Take off tax, that’s now say $52m, convert into sterling, is almost £40m p.a. earnings. Put that on a PER of 15-20, and I get to a valuation of £600-800m. The current valuation is £260m. (at 176p per share). Hence good potential upside over 5 years, and growing divis whilst I wait.

The balance sheet is stuffed full of cash, so I don’t think it will need to dilute through placings, and management own a ton of shares, so won't want dilution. What’s not to like?! Plus it’s got good organic growth potential from electric vehicles, which are likely to boom in the next decade, and data centres. Management really impressed me on the IMC video presentation.

The more I think about this share, the more I like it, as a 5-year buy & hold. As always, this is just my personal opinion, which is sometimes wrong, so you must do your own research, and take ownership of your own trades/portfolio.

I’d be particularly interested in any informed negative views on VLX, as it’s arguably more important to hear the bear case, than seeking confirmation bias from people who agree with me!

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Volex Director transactions announced recently have been;

26 Aug 2020 – 500,000 shares bought at 165p by company connected to Exec Chairman, Nat Rothschild. His total holding now 37.97m shares, 24.9% of the company.

19 Aug 2020 – 47,302 shares bought at 160p by CFO, Daren Morris. His total holding is now 1,070,000 shares, 0.7% of the company – quite a chunky holding for a CFO. Meaningful sized purchases in the market by a CFO are generally perceived as being a positive indicator.

7 Aug 2020 – 50,000 shares bought at 145p by wife of COO, Sharon/John Molloy. Their total holding is now 1,311,589 shares, 0.86% of the company – again, a meaningful sized stake.

5 Aug 2020 – 98,561 shares bought at 137p per share by wife of COO, Sharon/John Molloy.

6 July 2020 – 139,210 shares SOLD at 148.2p by CFO Daren Morris. This is curious! I wonder why he sold these shares, then bought some of them back at a higher price just weeks later (see above)?

26 June 2020 – issue of 432,040 new shares, re deferred management bonuses. Not stated, but I assume these have been issued for nil consideration as they’re bonuses, to: Nat Rochschild 155,201 shares, Daren Morris (CFO) 155,201 shares, and John Molloy (COO) 121,638 shares.

23 June 2020 – 67,171 shares bought at 151.4p per share by Nat Rothschild (Exec Chmn)

22 June 2020 – NED buys 10,000 shares at 156p per share

The only oddity in the above list (which I stopped at an arbitrary point working backwards), is the CFO selling his bonus shares on 6 July, but then buying some back shortly afterwards. I wonder what the reasons behind that were?

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