Small Cap Value Report (Tue 3 Nov 2020) - ACRL, VCP, TCM, UPGS, WHR, OMG

Good morning! It's Paul here with the SCVR for Tuesday. Jack's busy with other stuff, so it'll probably just be me today.

I added more sections to yesterday's SCVR, finishing in the early evening, so here is the link for the full report.

PIWorld interview with Richard Crow ("CockneyRebel"). I've long admired Richard Crow, who's a brilliant investor, and an engaging, down-to-earth chap. His life story is interesting, and this video is chock full of straightforward investment common sense. I enjoyed it very much over the weekend, so I hope you enjoy it too. Highly recommended. I only ever provide links here to the best content that I've particularly enjoyed.

Agenda - this is what has caught my eye this morning -

Accrol Group (LON:ACRL) - significant acquisition, and placing

Victoria (LON:VCP) - 2nd lockdown comments & trading update

Telit Communications (LON:TCM) - 2 possible bidders

Up Global Sourcing Holdings (LON:UPGS) - Full year results

Warehouse Reit (LON:WHR) - Half year results

Oxford Metrics (LON:OMG) - Trading statement
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Timings - TBC - I've started early, so there should be plenty up by 1pm official finish time. Then a few more hours to finish off everything else later this afternoon.
Update at 12:46 - I'm taking a break for lunch now, and a haircut, as I'm starting to look like a yeti, and with lockdown 2.0 starting on Thursday, this is becoming an emergency! So I'll be back about 2pm to finish off the last 4 sections above. Hence likely overall finish time about 5pm hopefully. I like to dig into the detail properly, which takes time, so thank you for your indulgences.
Update at 17:24 - today's report is now finished.

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Accrol Group (LON:ACRL)

Share price: 45.0p (up 1% at 08:33)
No. shares: 195.2m + 87.5m placing + ?19.3m option shares? + up to 9.3m open offer = max 311.3m
Market cap: £140.1m (subject to change, depending on outcome of open offer)

I reported in yesterday’s SCVR about this company’s trading update. However, there has been a flurry of subsequent announcements, concerning quite a large (relative to ACRL’s market cap) acquisition, and a placing/open offer to finance it.

Acquisition & launch of ABB (accelerated book build) - when an ABB is announced, it’s nearly always a done deal - i.e. meetings have been going on for a few weeks behind closed doors, hence it’s little more than a formality to announce it. That’s why the books close so quickly after the initial announcement, as it’s buttoned up already.

Confirmation of successful placing - announced at 7am this morning. Key points;

• Quantity - 87.5m new shares to be issued in the primary placing (i.e. this is new money that the company will receive)
• Price - negligible discount, priced at 44p (very impressive, and shows strong demand, so the presentations from management must have been convincing)
• Secondary placing of existing shares (so no new money to the company) of 6.45m shares, from selling shareholders, cashing in some of their chips. This seems to be part of a share options deal whereby management get 19.3m new shares, and are selling 6.45m of them to fund the tax liability. That’s a very generous share options scheme, at almost 10% dilution of the existing shareholders.
• Brokers - this was managed by Zeus & Liberum, who’ve clearly done a good job, a decent sized fundraising, at negligible discount - which protects existing shareholders nicely
• Open offer to existing holders, 1 new share per 21 existing shares. I don’t really see the point of this, as open offers are only really needed where the placing is done at a discount, which this hasn’t been. There probably won’t be a big take up of the open offer, unless the share price rises strongly in the next few days, when it would make sense to take up entitlements for the instant profit.

Acquisition of Leicester Tissue Company - the announcement makes a good case for acquiring this well invested (modern equipment), rapidly growing competitor.

I’m a bit confused though, because the figures filed at Companies House for LTC, make it look as if Accrol might be over-paying for LTC. Consider these figures for FY 09/2019 (its 2020 figures mentioned in the RNS have not yet been filed);

Revenue £19.1m
Gross profit £3.62m (margin of only 19.0%)
Profit before tax £1.22m

Note that LTC's 4 Directors are only paid salaries of £100k in total, therefore to arrive at underlying profits, I would rebase those salaries to a more realistic level, of say £400k in total, which would reduce profits from £1.22m to £0.92m. Although the RNS says the vendors are leaving the business, and signing a non-compete clause. So this could be part of the £1m in projected synergy cost savings.

Net assets on LTC's balance sheet were only 2.43m as at 30 Sept 2019, and total fixed assets only £4.0m. That doesn’t come close to Accrol’s claim that c.£25m has been invested in the business. Unless huge additional investment was made in 2020?

I appreciate that Accrol is quoting 2020 figures, which are not available yet at Companies House, and that it says revenues are growing fast, but even so, the acquisition price looks very high when based on the 2019 numbers. So I question whether this acquisition might be over-priced?

The RNS says;

In the unaudited financial year ended 30 September 2020, the LTC business delivered revenue of £28.0 million, up c.44 per cent. on the previous financial year and adjusted EBITDA* of £4.5 million, up c.181 per cent. LTC's revenue grew at a CAGR of c.70 per cent. between 2017 and 2019.

Fair enough, revenue is up strongly on the 2019 numbers I’ve looked at. Quoting EBITDA isn’t much use, for a capital-intensive company. That said, the depreciation charge in LTC’s books was only £162k in 2019. So where is all this new equipment? It must have been installed in 2020, because there’s no sign of it in the 2019 accounts published by LTC.

How is LTC worth £35.0m plus possible £6.8m deferred consideration (based on earnings targets)? It seems to be based on new contracts, but certainly isn’t supported by the historic, 2019 numbers. My worry would be that recently won contracts might be temporary, and not necessarily turn into sustainably higher earnings. We’ve seen before how the supermarket customers shop around for the best deals, and have no qualms in dropping suppliers to get lower prices elsewhere.

Earnings enhancing? Accrol says;

The Acquisition is expected to be immediately earnings enhancing. Initial Consideration of £35.0 million representing an enterprise value / FY20 adjusted EBITDA* multiple of 7.8x before synergies and 5.5x when combined with the maximum Deferred Consideration (which is subject to new contract incremental EBITDA contributions of £3.1m).

Since the deal is being funded with substantial issue of new shares, then I’d be surprised if it is actually earnings enhancing on a per share basis. Time will tell.

My opinion - I’m a bit sceptical about this deal. The price being paid looks very high, based on historic numbers for LTC. So it appears to be based on new contracts won, or in the pipeline, for LTC. But how sticky are those contracts? Supermarkets aren’t known for their loyalty to suppliers, they ruthlessly drive down cost prices. Hence I wouldn’t place much value on any existing supermarket contract, unless it had binding pricing and long-term duration.

Still, the fact is that this placing was very well supported by institutions, who will have been given more information than is in the RNS. So maybe it is a good deal? Time will tell.

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Victoria (LON:VCP)

Share price: 425p (down 2.5% at 10:13)
No. shares: 125.4m
Market cap: £533.0m

Comment on the Second UK Lockdown & Recent Trading

I like to keep an eye on this acquisitive floorcoverings manufacturing business, as it’s an interesting share. As you can see, the share price is volatile, with opportunities for traders to make money either way.

I think it’s good practice for companies to update shareholders on how they see the 2nd lockdown affecting business, and am surprised we’ve seen so few company updates so far.

Before that, I should also mention a partial refinancing type of announcement here on 22 Oct 2020. It has various elements, and is quite complicated. The main element is that an American investor is investing in Victoria (a continuing theme at the moment with UK companies attracting investment from there) Koch Industries (interesting Wikipedia page on it, is here), a large US conglomerate.

Koch’s investment is being structured as an initial £75m investment, and a subsequent possible £100m investment will be made via convertible preferred shares. These are a class of shares that rank ahead of ordinary shares, and receive a more-or-less guaranteed dividend of 9.35%. So conceptually it’s a bit of a hybrid of share & loans. Koch seems to be getting Warrants (to receive newly issued shares, at a price of 350p each) over 12.4m shares, or 9% of Victoria. It’s not clear whether these warrants are additional to any conversion rights over the preferred shares into ordinary shares, or not.

A deal has also been done for Koch & another investor to buy out existing shares held by Invesco, also at 350p per share. Victoria is also buying back 8.44m of its own shares, from Invesco, also at 350p per share.

My view - just on an initial quick review, this looks an interesting deal, raising rather expensive (9.35% annual cost) new funding, to make more acquisitions. It looks like stop-gap funding, which Victoria has the option to repay in future. Therefore I reckon Victoria is trying to get its credit rating improved, by making good acquisitions now, in order to then refinance the preferred shares using cheaper bond funding (which is the main form of existing borrowings, much more secure than bank debt, as it doesn’t have covenants) at some point in the future.

Today’s update -

The Board of Victoria PLC (LSE: VCP) the international designers, manufacturers and distributors of innovative flooring, notes the announcement regarding the imminent one-month lockdown in England. Based on the Company's experience of the UK-wide lockdown earlier this year, the Board believes that, in the long run, this second lockdown will make little material difference to Victoria.

Or to put that another way, it is likely to have some short term impact!

All the Group's factories will remain open and continue to accept and deliver orders. Victoria's experienced management team intends to continue production throughout the next month, which is expected to minimise the impact of the lockdown on Victoria's UK business.

The Board believes the Group's liquidity position is strong and we expect to continue to grow at the expense of weaker competitors - particularly those with UK-centric businesses, that do not have Victoria's advantage of generating a very significant majority of earnings and cash from outside the UK.

Therefore, whilst the Group may not be as cash generative had the second lockdown not happened (with net debt therefore reducing slightly less), the Board expects improved profitability as we capitalise on the decline of weaker competitors.

Recent trading has been strong, although some of this must be catching up with pent-up demand from the earlier lockdown;

Trading in recent months exceeded the Board's expectations, with sales for the 3 months to 3 October 2020 recovering above both management's pre-Covid budget (which included the anticipated benefit of productivity investments made over the previous 18 months), and last year's levels. The Board believes this favourable outcome is a result of people spending more time in their homes and working remotely. This trend is encouraging increased investment by consumers in home redecorating, as well as driving new home purchases across all the markets where the Group trades.

Liquidity sounds fine;

Additionally, the Group continues to maintain a strong liquidity position and finished the quarter with cash and undrawn credit lines in excess of £200 million - up from £180 million as at 30 June. Shareholders will also recall that, despite the lockdown in all of Victoria's geographies in the June quarter, negative cash flow was just £7 million for the three months.

Guidance - still withheld;

It remains premature to provide meaningful earnings guidance for FY2021, although the Board looks forward to updating shareholders on 30 November, with the publication of the Interim Results for the six months ending 3 October 2020.

My opinion - this update today sounds reassuring, but it cherry picks the more positive Q2 numbers (July-Sept), but doesn’t give us the YTD numbers (April - Sept), which rather glosses over the lockdown impact. To be fair, it has provided Q1 revenue numbers before, but it’s a pain to have to manually add them up with the Q2 numbers, to get the overall total, that should have been presented in today’s update I feel.

The price in various transactions recently announced, was 350p. That to me sets a valuation benchmark for now. Hence with the open market share price being 425p, I feel that 21% premium is unjustified. I’d probably have a nibble, and add a few to my portfolio if it slips back down to c.350p, but am not interested above that.

There’s not enough earnings visibility at this stage, and it does have a lot of debt.

On the upside, I think the Exec Chairman, Geoff Wilding, has demonstrated a series of apparently successful acquisitions, and his decision to move nearly all the debt onto secure bond financing, just before covid, was a combination of genius, and lucky timing! This makes Victoria a lot more secure than other highly indebted companies, as it's debt cannot be withdrawn, as long as interest payments are made, and is long-term.

Carpets have done well this year, because people are revamping their homes. I forget which company it was, but someone in the sector said the other day that there’s a shortage of skilled carpet fitters at the moment in the UK, because so many people are wanting new carpets.

Overall, I’m often tempted to buy shares in Victoria, but haven’t quite managed to build up enough conviction to press the button.

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Telit Communications (LON:TCM)

Share price: 150.4p (up 8%, at 11:15)
No. shares: 133.0m
Market cap: £200.0m

DBAY Advisors Ltd - Statement re Possible Offer

The company seems to be in play now, with 2 possible takeover approaches;

Telit Communications PLC ("Telit" or the "Company") notes the recent media speculation and confirms that it has received a preliminary approach from DBAY Advisors Limited, ("DBAY") regarding a possible offer for Telit to be made by funds under the management of DBAY.

Telit has also received a preliminary approach from Lantronix Inc, ("Lantronix") regarding a possible offer for the Company (the "Lantronix Proposal"). The Lantronix Proposal was considered by the Board of Telit, together with its financial adviser, Rothschild & Co, and rejected. However, the Company remains in discussions with Lantronix to explore a possible transaction which could be in shareholders' interests. The consideration for any offer, if made, is likely to be Lantronix shares….

For the purposes of Rule 2.5(a) of the Code, this announcement has not been made with the consent of DBAY or Lantronix.

Doing a bit of googling, DBAY is an asset management firm, with a very simple website with little information on it. It says they’re value investors, with the obligatory Warren Buffett & Benjamin Graham quotes on each page - rather unimaginative. I like it when asset management companies give biogs of their team, and case studies on their investments. There’s nothing like that on DBAY’s website.

Lantronix is listed on NASDAQ, but looks very small. There’s a StockReport for it here, showing market cap equivalent to only £92m, so it would be a reverse takeover, if a deal was done with Telit. Maybe this would be a way of Telit getting a NASDAQ listing? Lantronix doesn’t look credible as a proper bidder, so I imagine the DBAY potential bid looks more likely, as a financial buyer.

The above is probably why the share price has only gone up 8% today, as they don’t look particularly exciting bidders able or willing to pay a large premium maybe?

I’m not keen on Telit. I didn’t like the way it presented its accounts, aggressively capitalising costs onto the balance sheet, when I looked at it a few years ago. Things might have improved since then, but for me it I don’t like the accounts, then it just goes in the bin for me as a possible investment.

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Up Global Sourcing Holdings (LON:UPGS)

Share price: 93.5p (down 8% at 13:59)
No. shares: 82.2m
Market cap: £76.9m

Final Results

Ultimate Products, the owner, manager, designer and developer of an extensive range of value-focused consumer goods brands, announces its full year results for the year ended 31 July 2020.

The share price has closely tracked broker forecasts this year. In the early stage of the covid pandemic, investors sold off this share because of China supply chain issues. That got resolved quite quickly.

Worries about UK retailers buying less stuff from UPGS also turned out to be wrong, as the company continued selling well, and grew its online presence to help compensate for other lost sales. So it’s been an impressive performance, which we’ve kept abreast with via frequent trading updates. Therefore there should not be any surprises in today’s numbers.

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Key points from FY 07/2020 results;

Revenue down 6% to £115.7m - a very creditable performance in my view, given the massive disruption from covid/lockdown

Underlying profit before tax down only 2.7% to £8.2m - again, I’m impressed

Underlying EPS down 2.5% to 7.9p - a PER of 11.8 (93.5p divided by 7.9p) - seems reasonable value to me

Dividends - final divi of 2.795p, giving a total of 3.955p for the year, a healthy yield of 4.2%

Balance sheet - looks fine, with NTAV of £13.3m. I wouldn’t call it strong though, it’s perfectly adequate. Remember that fixed assets are modest, so it doesn’t need a huge balance sheet.

Net debt - drastically reduced to just £3.8m. This has been achieved from positive trading cashflow, and favourable working capital movements (inventories down, but trade creditors up). There might be an element of favourable timing differences there, in that working capital movements can sometimes reverse in the following period.

There’s plenty of headroom £21.3m, on the bank facilities

Repaid furlough monies, and also up-to-date with PAYE and VAT by year end, so there doesn’t seem to be any creditor stretch, good to see

Cashflow statement - all looks fine to me.

Overall - these seem clean numbers, with minimal adjustments, so I can’t see anything untoward in the numbers. The company is financially sound, and I don't see any insolvency risk here at all.

Outlook - sounds fine to me, in the circumstances;

The market conditions for general merchandise remain challenging in the UK and Ultimate Products, like many others, is faced with an uncertain environment for consumers, retailers and suppliers. Despite these challenges, the Group has delivered a good set of results for FY 20 through a relentless focus on our strategy and the talents of our colleagues.

While the conditions in the UK and Europe look set to remain challenging, with further lockdowns now announced, current trading is in line with expectations with the FY 21 order book ahead of this time last year. As such, the Board remains confident about the Group's future prospects.

My opinion - this is a simple business to understand - it imports smallish consumer goods, and sells them to retailers at a modest gross margin of 23%. By having a low cost base, that translates into healthy net profits.

The valuation seems quite cheap, a PER of 11.8, plus you get a healthy dividend yield of 4.2%. Those figures are based on a hugely disrupted H2. Therefore I think it’s reasonable to imagine that future years’ performance could improve.

I think UPGS has demonstrated excellent management of the very difficult situation this year. That gives confidence for the future. Things haven’t always been plain sailing in the past, so I wouldn’t want to chase this share price too high, but where we are now at 93.5p, I think it looks good value.

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Warehouse Reit (LON:WHR)

Share price: 110p (up 2.3%, at 15:40)
No. shares: 379.3m
Market cap: £417.2m

Half Year Results

Warehouse REIT, the AIM-listed specialist warehouse investor, today announces its results for the six months ended 30 September 2020.

Robust financial performance with strong valuation uplift

I’ve mentioned this warehouse property REIT before, as a very interesting niche to invest, both providing a decent flow of dividend income, and relative safety in the current storm.

Earlier this year I looked at retail property REITS, Hammerson (LON:HMSO) and Newriver Reit (LON:NRR), and more through luck than judgement, I managed to catch a big move up in HMSO on a short squeeze, thankfully banking the profits, because HMSO in particular has been a complete disaster since then, as Jack reported here earlier this week.

The reason being of course that conditions for retailers have worsened so much, that CVAs and Administrations on a mass scale now seem inevitable. Hence geared retail property REITs have seen the value of their assets plunge, voids increase, tenants often not being able to pay the rents, etc. It’s just a hideous sector, and things have got a lot worse than I realised they would earlier this year. Asset values look set to continue falling, but the debt doesn’t fall, which squeezes equity down to a point where, as we saw with INTU, in the worst case scenario, the equity ends up worth nothing.

Warehouses are very different though, a few key points;

• As consumer demand shifts online, the demand for warehouses is rising, not falling
• Availability of warehouses is falling
• Rental yields are improving (going down) as investors are cottoning on to this interesting niche, thus driving up capital values for owners like WHR
• Tenants are paying their rents, mostly
• Rents are rising on conventional leases, when 5-yearly rent reviews occur
• WHR is continuing to pay divis, paid quarterly - ideal for income seekers, such as pensions in drawdown
• Properties are actively managed, with development potential being exploited
• REITs are exempt from Corporation Tax, provided they pay out 90%+ of profits as divis - making them good to put into a SIPP
• Share price of 110.5p is below EPRA NAV of 118.4p, which strikes me as decent value
• In a low, zero, or even negative interest rate world, a yield of 6.2p target for this year, divided by share price of 110.5p is 5.6% - good, but remember that there could/should also be a kicker of modestly rising share price in the long term, as asset values appreciate.
• Recession-proof so far, because there’s a structural shift in demand for warehouses, and away from retail space
• Good, solvent tenants - e.g. Amazon is lead tenant, with 11.3% of the rent roll. Wincanton another one.
• Tenants are mostly eCommerce, and logistics businesses
• Raised £153m of fresh equity in the period
• Low gearing - Loan To Value (LTV) was only 20.2% at period end. Target is a maximum of 35% as more assets are acquired. This seems prudent, given that capital values are rising, not falling
• Properties are managed professionally by Tilstone. Management fees don’t strike me as excessive

NAV rose strongly in the 6 months to 30 Sept 2020;

EPRA NTA per share at 30 September 2020 was 118.4 pence, up from 109.5 pence per share at 31 March 2020. The primary driver of the 8.1% increase in the period was the strong valuation uplift, which reflected a like-for-like increase of 6.6%, in part reflecting the like-for-like growth in rents and ERV in addition to yield compression, driven by the strong investor demand for the sector. There was also a smaller benefit from the timing of the payment of the first interim dividend, which was paid shortly after the period end.

My opinion - I really like this share. It’s not one I currently hold, as I’m targeting more rapid capital appreciation, not income. But when I day-dream about how my strategy might change once I hit £10m+ with my personal portfolio (not likely any time soon, I hasten to add!), then this is the type of share that I would switch into, for decent income, and a good kicker from capital appreciation too. What do readers think of it?

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Oxford Metrics (LON:OMG)

Share price: 75.5p (up 2%, at market close)
No. shares: 125.7m
Market cap: £94.9m

Trading Statement

Oxford Metrics plc (LSE: OMG), the international software company servicing government, life sciences, entertainment and engineering markets, provides the following update on trading for the financial year ended 30 September 2020.

Very clear information here;

The Group expects to report revenues of £30.3m and an Adjusted PBT* of £2.5m for the financial year.

The Group finished the year with a strong cash position of £14.9m and no debt.

How does that compare with broker forecasts, and last year’s performance?

It looks a long way short of the forecasts shown by Thomson Reuters, but with only 2 brokers reporting, it could include an out of date number perhaps? So I’m going to ignore that.

Unfortunately, there’s nothing recent available on Research Tree either, so I’m largely in the dark here.

Looking at the split between H1 & H2, it shows a good improvement in profits, in H2;

H1 Revenue £15.3m, Adj PBT £0.3m

H2 Revenue £15.0m, Adj PBT £2.2m

FY Revenue £30.3m, Adj PBT £2.5m

(manually calculated by deducting interim results from FY results)

Outlook -

The Group's fundamentals remain strong, supported by an encouraging pipeline of opportunities across both divisions and a strong balance sheet which together underpin confidence that the Group will continue to successfully navigate current challenges arising from the pandemic.

My opinion - based on these numbers, I cannot see how a £94m market cap can be justified. Nowhere near that actually. Therefore, the share is clearly being priced on hopes that profits should recover.

To me, this share price looks vulnerable, if the company cannot demonstrate a significant improvement on the FY 09/2020 numbers reported today.

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That's all I can manage for today, sorry there wasn't time to look at Senior (LON:SNR) - maybe for another day, if people are interested in it.

See you in the morning!

Best wishes, Paul.