Small Cap Value Report (Fri 20 Nov 2020) - TFW, WINE, SRT, QUIZ, TCM

Good evening/morning, it's Paul here with Friday's SCVR.

Timing - I've got a Zoom meeting just after 3pm, so will need to be finished by then. Today's report is now finished.

Agenda - the first 3 items are backlog sections from yesterday;

Fw Thorpe (LON:TFW) - AGM statement (done)

Naked Wines (LON:WINE) - Half year report (done)

Srt Marine Systems (LON:SRT) - Interim report (done)

Quiz (LON:QUIZ) - (I hold) - stores update (done)

Telit Communications (LON:TCM) - another sub-optimal offer approach (done)

Let's start with some catch-up items, left over from yesterday, which I wrote up last night.

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Fw Thorpe (LON:TFW)

Share price: 322p (down 2% at 14:43)
No. shares: 116.5m
Market cap: £375.1m

AGM Statement

This is a group of companies selling lighting equipment.

It issued an AGM statement at 15:15, which is most inconvenient. Far better to issue the text at 7am, so everyone can see it before the market opens, than issuing it during the trading day, when many smaller shareholders will be busy in their day jobs.

This trading update relates to FY 06/2021. It says;

"I am pleased to report that during the first few months of the 2020/21 financial year, despite the significant issues generally in the global economy, orders and revenue remain broadly similar when compared to the same period last year.

That’s encouraging, but the period covered is from July onwards, which was when lockdown had been lifted, and plenty of companies are reporting improved trading.

Lightronics factory fire in Sept 2020 - only minimal operational impact.

Outlook - sounds OK, but caution expressed;

Whilst management is satisfied with the current order situation, with order books around the Group generally healthy, both the COVID-19 pandemic effect and Brexit transition concerns are foremost in our minds. We plan for the future carefully, but at this present time we remain cautious about the Group's second-half performance."

My opinion - Stockopedia shows it on a PER of 24.3 times forecast EPS of 13.5p for FY 06/2021. Given the lacklustre growth in recent years, I really cannot understand why the PER is that high? Although the balance sheet is excellent, with surplus cash.

It’s quite a nice company, but it looks 20-30% over-priced to me, based on the figures available. Maybe holders/buyers think it could grow faster than forecast?

The share price hasn’t gone anywhere for 4 years, and dividends are small, at less than 2%. So why the premium valuation?

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Naked Wines (LON:WINE)

Share price: 502p
No. shares: 73.1m
Market cap: £367.0m

Half-year Report

This is an internet-based wine subscription service, connecting wine producers with wine connoisseurs. I made up that description, because the rambling one given by the company in today’s announcement isn’t clear enough.

Half Year Results for the 26 weeks ending 28 September 2020

My notes of the key points;

Very strong revenue growth in H1 of +80%, to £157.1m

Revenue is split: £124.9m repeat customers, £32.2m new customers - that’s impressive, and suggests customers are sticky, although I cannot find any actual figures on churn - a key metric for this type of business

Full year revenue growth guidance is 55-65%

Spent £22.7m to acquire new customers - very expensive, but once they become repeat customers, they are strongly profitable (£36.2m profit contribution from repeat customers)

Payback period (which I assume means Lifetime Value (LTV)) was stated at a ridiculous 20 years, but has been reduced to a possibly still too high 5 years (many internet businesses I’ve seen use much shorter LTVs). At 5 years, the LTV/CAC is 3.9 years - not bad, but not brilliant either. This is the big question mark - how long in reality will the Lifetime Value of each customer be? Does that justify spending so much on recruiting new customers at a heavy loss?

Overall the company is loss-making: £(2.7)m adjusted loss before tax, and £(8.9)m loss after accounting for one-offs

Cash has risen to £76.3m, but this is mostly up-front subscriptions from customers (called “Angels”)

Gross margin up, due to focus on USA, it’s largest market now - obviously America is a huge potential market, which could be good for growth

Standstill EBIT - a very interesting concept, showing what profit the company says it would make, if marketing & incentives for new customers were scaled down to achieve a steady state, i.e. only enough new customer acquisition to replace churn. It says this is positive at £26.0m, just for H1. Double that to annualise it, and it’s £52.0m. If that figure is reliable, then this share could be cheap.

EDIT: In the comments below, Mojo has raised the point that this £26.0m standstill EBIT might already be an annualised number. Can anyone clarify on this point please? As it's unsure at the moment, I've struck through my double it sentence above, until it's been clarified. Thanks. End of edit.

Balance Sheet - is pretty good. NAV: £106.4m, less intangibles of £34.2m, gives NTAV of £72.2m, a healthy position.

Cash of £76.4m needs to be offset by £61.1m Angels creditor - ie. subscriptions received up-front from customers.

Inventories look a bit high, at £83.9m, although that’s probably because WINE is funding production from the vineyards it supports, so I can explain that away to myself.

My opinion - this is such a tricky one, so let’s look at both sides;

Bull case;

• The overall loss obscures a highly profitable repeat customer business
• Balance sheet strong, with liquidity not a problem
• Very strong revenue growth, which could build up a highly profitable future business

Bear (or neutral) case;

• What is the level of customer churn? Are customers really loyal enough to stick around for 5 years or more on average? Seems far-fetched
• Loss-making overall, so chasing revenues without profit at the moment
• No dividends (OK for a rapid growth business though)
• LTV/CAC of 3.9x is not that good, and it assumes 5 year lifetime, which seems aggressive (previous 20 year lifetime was absurd)
• What is the total market size? Given that supermarkets, and vintners have huge ranges of wine, why bother spending time & energy researching individual vineyards on the WINE platform?

Overall, I just can’t make up my mind. It looks good, if you believe all the KPIs, but for me, it’s still loss-making, and I can’t shake off some scepticism about the business model. I’ve got higher conviction with other shares, so given that I’m uncertain about this one, will sit on the sidelines and observe. Good luck to holders!

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Srt Marine Systems (LON:SRT)

39.4p (up 12%) - mkt cap £64.8m

Interim results are poor;

Revenues £3.8m in H1

Loss before tax of £(2.7)m

Cashflow - note that £1.5m of development spend is capitalised every half year, so EBITDA is meaningless

“Validated sales opportunity pipeline” - these figures seem to be getting more outlandish by the year, and have never translated into meaningful revenues on anything like the scale suggested by this £550m pipeline, as you can see;

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The problem seems to be that, dealing with Government departments in various parts of the world, results in painfully slow and erratic decisions, taking years, if they happen at all.

My opinion - I wish the company well, but for me the disappointments have been so extensive, over so many years, that it’s too much of a leap of faith to pay a £65m market cap for it now.

Even if the company does have a bumper year, history shows that it’s difficult to sustain at a profitable level.

I think this share should be seen as a punt, rather than a reliable investment. It could pay off, who knows!

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Quiz (LON:QUIZ)

8.0p - mkt cap £10.3m

(I hold)

Store update

This is a special situation, given that this online & stores/concessions clothing retailer did a pre pack administration in June this year. That enabled it to ditch all loss-making sites. The sites retained are now on newly negotiated turnover rents - a highly advantageous arrangement.

The company updates us today, to show the state of play re its stores & concessions (see table below).

Also, it confirms that where shops are forced to shut, the staff have been put on furlough. Remember that the furlough scheme was recently extended to end March 2021, which is tremendously helpful for retailers, and other under-pressure sectors.

Turnover rents - this got me thinking, I wonder how QUIZ negotiated its turnover rent arrangements re further lockdowns? Would they have included a clause to make the sites rent-free in a further lockdown. Or, will they have to still pay base rent during lockdown? Base rents are usually quite low, but even so, it would be a nasty cash outflow. I’ve lodged a query via the company’s advisers, and will report back if I get a response.

QUIZ has a further advantage, in that its online operations are well developed. Online sales were £37.5m last year, which judging by the cost structure at Sosandar (LON:SOS) should be decently profitable for QUIZ. Although this year, sales will be well down, because special occasion wear, which QUIZ focuses on, has obviously been the worst type of product due to lockdowns. Therefore they’ve had to pivot more towards casualwear this year. Its margins have previously been very high (into the low 60’s% gross margin). Therefore with high gross margin, and hugely reduced store costs, it should be a viable business even during this very difficult, chaotic year. It’s still got cash in the bank, and an unused bank facility.

Definitely not for widows and orphans though! As I keep emphasising this is very much a special situations investment, for people who understand how pre-pack administrations work. It's effectively a business re-start, with a lowered cost base. So it's pointless looking at LFL sales, and concluding that everything is terrible because they are down so much. That's missing the point completely. Its's a recovery situation, with lowered costs, and all the problem sites jettisoned.

Another key point is that the founding family still own about 50% of the company, and trousered (from memory) getting on for £100m in the IPO. So they’re loaded, and I imagine it would be a matter of pride to rebuild the business, and the share price. It should be anyway! Possibly family money might be helping in the background, e.g. giving guarantees to suppliers, the bank, etc. That's speculation on my part of course.

Here’s the current status of the various stores;

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This got me thinking, I wonder whether stores (for QUIZ and other retailers) are likely to re-open, once lockdown restrictions are lifted? Before Xmas, and in early January, it would make sense to do so - as that’s peak trading for clothing retailers. But after that? There’s little point in re-opening after mid-January through to Easter, because that’s the seasonal trough, and shops would probably be loss-making then, even in a normal year.

Given that there’s no business rates payable until end March, and little staffing costs if you put them on furlough, then why re-open in the spring, just to lose more money than if remaining closed?

I think we could see a lot of retailers go bust next year, if they don’t have a well-developed online offering. There again, the Government has shown that it’s flexible/clueless depending on your point of view, so I cannot see them allowing so many companies to hit a brick wall at end March 2021. Therefore I think we can expect some kind of continuation of business rates relief (maybe more targeted this time?), and probably more flexibility on further deferring VAT/PAYE arrears, if the need can be demonstrated. I’m guessing there obviously.

QUIZ has a small free float, and it's really tricky to trade the shares. So that might provide good leveraged upside, once the fog clears and a viable business emerges. That's what I'm hoping happens, hence my long position here. The downside risk is that the cash runs out (no sign of that yet though), and business grinds to a halt next year. Or, the family buy it out for tuppence ha'penny.

The chart does seem to show that it's forming a base, possibly? I would have thought that anyone likely to sell, would have done so by now.

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Telit Communications (LON:TCM)

198p (up 18%) - mkt cap £264m

Takeover approaches - I reported here on 3 Nov 2020 that Telit told us it had 2 possible takeover approaches, from DBAY Advisors Ltd, and a tiny NASDAQ company called Lantronix, proposing an all share reverse takeover, which didn’t look at all appealing.

It’s smoked out another potential bidder, called u-blox Holding AG, a company listed in Switzerland. Unfortunately it’s another unsatisfactory all-share proposed deal. Why would UK investors want to own shares in a small Swiss tech company?

received a preliminary proposal from u-blox Holding AG, ("u-blox") regarding a possible all-share merger (the "Proposal").

Under the terms of the Proposal, Telit shareholders would receive u-blox shares with a value of £2.50 per Telit share, which would result in Telit shareholders owning approximately 53% in the combined company (based on the assumptions in the Proposal).

Telit's share price is only up to 198p today, because 250p in some (probably illiquid) overseas share, is not appealing at all. If that deal goes ahead, it would probably lead to unending selling pressure, from UK investors wanting to exit.

My opinion - I’m not keen on Telit, and the takeover approaches to date seem lacklustre. Hence there could be some merit in thinking about top-slicing in the market, to bank some of the recent gains, as none of the 3 proposals sound as if they're very serious.

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That's it from me. Many thanks for tuning in, and for all your interesting, and constructive comments, which are a pleasure to read once again. Have a lovely weekend, and I'll see you on Monday.

Best wishes, Paul.