Small Cap Value Report (Fri 29 Jan 2021) - BOO, CARD, BMY, DLAR, XPD, NCYT, SLP

Good morning, it's Paul & Jack here with the SCVR for Friday.

It's catch-up day today, thankfully the RNS is fairly quiet, as it usually is on Fridays.

Timing - Today's report is now finished.

Agenda -

Boohoo (LON:BOO) (I hold) - in exclusive negotiations to buy remaining Arcadia brands.

Card Factory (LON:CARD) - Banks extend covenant waiver by only 1 month. Clearly needs a refinancing. High risk.

Bloomsbury Publishing (LON:BMY) - Well ahead trading update

De La Rue (LON:DLAR) - positive trading update from yesterday

Xpediator (LON:XPD) - positive trading update

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Jack's section:

Novacyt Sa (LON:NCYT) (I hold) - FY update

Sylvania Platinum (LON:SLP) (I hold) - Q2 update

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Boohoo (LON:BOO)

(I hold)

Thanks to reader Alex, who flagged to me last night press reports (initially from Sky, who are usually reliable) that Boohoo (LON:BOO) (I hold) looks set to pick up the other Arcadia brands not already sold - Burton, Dorothy Perkins, and Wallis. A price of c.£25m is mooted. If that goes ahead, in addition to Debenhams BOO would by then have a total of 13 brands. Remarkable stuff.

As I've been saying a lot recently, the ambition of BOO's management is awe-inspiring. They want to build the best eCommerce business on the planet, and I remain of the view that this share should be a core, long-term holding. It's very much GARP at the moment too, with a forward PER below 30 by my calculations.

I've no idea what the short term share price will do, as it's a very volatile share. I see market gyrations as nothing more than background noise. It's the long-term that matters, and I'm very confident that my analysis on BOO is correct.

BOO has just confirmed the press articles, saying -

boohoo group plc

COMMENT RE: MEDIA SPECULATION

boohoo group plc (the "Group"), a leading online fashion group, notes recent media commentary. The Group confirms that it is in exclusive discussions with the Administrators of Arcadia over the acquisition of the Dorothy Perkins, Wallis and Burton (excluding HIIT) brands. These discussions may or may not result in agreement of a transaction. A further announcement will be made when appropriate.

[Paul: my bolding, as usual]

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Card Factory (LON:CARD)

I previously liked this greetings card & sundries retailer, but it went into the covid crisis with too much debt, hence it went onto my avoid list a while ago, due to weak finances/balance sheet.

As reported here on 15 Jan 2021, the company indicated it would breach banking covenants, and I concluded that an equity fundraising is only a matter of time.

Earlier, I flagged the weak finances here in July 2020, concluding that I wouldn't buy until it's refinanced properly.

The need for an equity refinancing is very much reinforced with an update today -

Liquidity Update

Banking syndicate has waived covenants from 31 Jan 2021 to 28 Feb 2021.

"Subject to certain conditions" - we're not told what these are.

We remain in constructive discussions with our banks, and have agreed a process to continue to explore a range of potential solutions, with scope for further extensions to the waivers as this process continues.

A further update will be provided in due course.

My opinion - not a good situation. Extending the covenant waivers by only a month, tells me that the banks see this as a problem, and want a solution. What could that mean? A sale of the business possibly? Asset disposals, if there's anything saleable? More likely, a long overdue equity fundraising.

The company is in a weak position, so who knows if there would be much investor appetite for an equity fundraising? I'd be worried that it might have to be done at a big discount. Existing shareholders are in a potentially weak position, so I'll continue to give this share a wide berth.

Conclusion - uninvestable until a big placing has been done, to greatly reduce the bank debt. Why would anyone want to buy/hold before that is done? Historically it's been a good, cash generative business, making high margins, just overloaded with debt & paying imprudently high dividends. Has it missed the boat with online greetings cards?

I'd be happy to take a fresh look at the share, once it's refinanced properly, and if there's a more convincing strategy to grow its online business. As I mentioned here ages ago, there's an obvious, and large gap in the market for some kind of automatic greetings card service online, to send out scheduled cards to customers' loved ones, direct to the recipient, without having to faff about with buying cards & stamps.

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Bloomsbury Publishing (LON:BMY)

Trading Update

Bloomsbury Publishing Plc (LSE: BMY), the leading independent publisher, today gives a pre-year end trading update for the 12 months ending 28 February 2021.

Trading ahead of expectations

This looks really good, and great clarity providing a footnote to quantify market expectations, thank you for this -

Bloomsbury is pleased to announce that revenue is expected to be ahead and profit well ahead of market expectations* for the year ending 28 February 2021.

* The Board considers that the consensus market expectation for the year ending 28 February 2021 is currently revenue of £161.8 million and profit before taxation and highlighted items of £12.1 million.

Consumer division doing well - best sellers are listed.

Academic & professional "continues to make good progress..."

Digital is in demand from academic institutions in lockdown.

Diary date - June 2021 for preliminary results FY 02/2021

My opinion - well done to shareholders, this should be a good day for you.

The share price has already surged from flattish around 200p last year, to nearly 300p now, so the question is how much is the good performance already in the price? We're about to find out!

I can't find any broker research, but based on this update, and previous results, it looks as if FY 02/2021 might come in around 15p EPS, suggesting a PER in the high teens, which looks priced about right to me. Note the consistently very high StockRank (green line below). You get a c.3% dividend yield too.

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De La Rue (LON:DLAR)

166p - mkt cap £324m

Trading Statement (from yesterday)

To refresh memories, here are my notes from 30 Nov 2020, on publication of the interim results to 26 Sept 2020. The key issue is to adjust for the £15m p.a. cash outflow required to service the pension deficit recovery. That’s highly material to the valuation, and remember this cash outflow is not accounted for on the P&L. Hence a low PER is absolutely correct. If you ignore the pension deficit, then it means you’re materially over-valuing the shares.

De La Rue plc (LSE: DLAR) ("De La Rue" or the "Company") today announces a trading update for financial year 2020/21 starting 29 March 2020, and developments in its polymer banknote strategy.

Positive trading, ahead of expectations -

The Company has seen positive trading in this financial year, with good progress on the implementation of its Turnaround Plan. As a result, the Board's expectations for adjusted operating profit for the financial year 2020/21 are in the range of £36 million to £37 million, compared with current market expectations of approximately £34 million.(1)
(1). Market expectations are based on the average of published notes from Investec and Numis Securities.

Both Investec and Numis are unfriendly to private investors, excluding us from seeing their research. Thanks a bunch guys. Maybe DLAR should appoint a new joint broker, someone like Finncap, N+1, or Liberum, who do publish good quality research on Research Tree which we can look at.

It’s so ridiculous to stop PIs getting hold of research, since we create the liquidity & set the share price! There’s no regulatory reason for this, since other brokers do publish research, that’s just an excuse to keep the city club nice and cosy, so that PIs are disadvantaged. It’s not good enough. Fair enough if the research is genuinely private, but it’s not. Analysts generally are given privileged access and information from the companies, which is not given to PIs. Not a level playing field at all. As one AIM CEO once said to me, “The broker’s forecasts are really the company’s forecasts”.

Summarising the rest of the update -

• Covid impact has been effectively mitigated
• Outperformance has come mainly from the currency division
• Authentication division - pandemic has caused some delays to securing contracts
• Capacity for polymer production capacity to more than double, with expansion of Bolton facility, operational before end Dec 2021, and create 70 new jobs
• Increasing “investment” in polymer, not clear if opex or capex, or mixture, by £5m, due to customer demand
• Diary date - 26 May 2021, for FY 03/2021 results

My opinion - sounds good. I like the stuff about customer demand. I like investing in companies which are scaling up capacity due to strong demand, as their shares often do well later.

How to value DLAR shares? It’s probably heading for about 13p EPS this year and 15p next year (maybe more?) IF there were no pension deficit, then I would probably be happy with a PER of about 20 as a reasonable price. That implies a share price of 300p (vs current price of 166p). With 195m shares in issue, that’s a valuation of £585m.

What should we take off for the cash outflows into the pension? It’s a £15m p.a. cash drain, so maybe I would discount that to say £200-250m negative valuation? Take that off my £585m valuation of the business, and I get to £335-385m, or 172p-197p per share price target for me personally.

At 166p per share that’s not exciting enough upside to make me want to buy now.

The opportunity here would be;

1) If the business beats performance, since that would all flow through to equity, with the pension cash outflows remaining the same. Hence you could view the pension scheme as providing some fairly low risk leverage to the upside.

2) If the pension scheme assumptions turn out to be better, making it a smaller problem.

Risks are obviously just the reverse of the above 2 points.

Overall, quite interesting, and I’ll keep it high up on my watchlist.

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Xpediator (LON:XPD)

44p (up 20% at 10:36) - mkt cap £62m

Trading Statement

Xpediator (AIM: XPD), a leading provider of freight management services across the UK and Central and Eastern Europe…

This looks really good -

… is pleased to confirm the Group expects to deliver profits for the year ended 31 December 2020, significantly ahead of market expectations. Following higher than anticipated demand for its services in the UK and Europe during November and throughout December 2020, the Group now expects to report adjusted profit before tax of approximately £7.2 million for the year ended 31 December 2020, a 40% increase over the prior year (2019: £5.15 million).

• High demand for freight forwarding & warehouse/logistics, outweighed challenges from covid
• Strong trading in Nov & Dec 2020, helped by various factors, including Brexit stockpiling
• Fuel & toll card business, Affinity, improved as road traffic volumes recovered
• Romanian pallet distribution (“Pall-Ex”) also strong, and above pre-covid levels
• Disposal of ESWD, previously announced, will eliminate £0.35m annualised losses
• Diary date - April 2021 for FY 12/2020 results.

Brexit - sounds quite relaxed about this issue, which has interesting read-across. Confirms my view that this is probably a temporary, fixable problem -

In 2021, as widely reported, transport volumes into Europe have been lower from the outset of the year due to the administrative changes caused by Brexit. In essence, there has been an increase in administration and it is taking time for businesses and customs officials to adjust. For Xpediator, as anticipated this is an opportunity to increase administrative support to our clients to enable them to manage the new environment which in time will settle down.

Outlook - sounds positive -

2021 has begun well across the Group during which we expect to benefit from the permanent £0.5m of cost reductions made in 2020, the first full year of revenues from the Nidd Transport acquired in October and the ongoing uplift in demand for our services across the Group."

My opinion - this sector doesn’t interest me at all. That said, I’m really impressed with today’s update from XPD. So its shares might be worth a closer look, if you want to invest in a haulage group.

I’d probably be more interested in looking at Wincanton (LON:WIN) or Compass (LON:CPG) Clipper Logistics (LON:CLG) than something this small, as their shares are more liquid.

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Jack's section

Novacyt (LON:NCYT)

Share price: 992.5p (-7%)

Shares in issue: 70,626,248

Market cap: £701m

(I hold)

There has been a long silence from this Aim-listed diagnostics company, and that gap has been filled with daily speculation regarding the nature of these results. Their release was always going to cause some trading action, one way or the other.

One of the key challenges for Novacyt Sa (LON:NCYT) , which has grown so quickly, is managing expectations.

Shares are down today, but the fact remains that NCYT has worked its way into a great position in a market that has been totally transformed by Covid. Just how long Covid testing lasts, and what more normal diagnostics trading looks like on a 2-3 year view is an essential part of the value equation here.

That future is uncertain and it’s hard to have a strong view on it at this moment. I do suspect there’s a chance we are underestimating how long testing will be around, but I’m no expert. Who is? Hence the dilemma re. NCYT valuation.

What’s more concrete is that for now Novacyt is a testing cash cow, generating fantastic year-on-year sales, margin, and profit growth as its PCR (and soon other) tests are deployed in the frontline against Covid.

Beyond that, how management allocates the capital generated from its Covid testing windfall will be an important driver (or destroyer) of value.

This is a key risk going forwards and is far from a slam dunk. Management has hinted at a transformational M&A strategy and, while the company has done an excellent job over the past year, that is still a very different strategy to what has generated their success so far, and one fraught with execution risk.

Given the above uncertainties, I can understand why the market might apply a steep (and forever shifting) discount rate to Novacyt. Ultimately though share price performance will track earnings - and if you think the outlook is good here, then you should be able to hold through short term volatility.

Still, the shares are down this morning, so let’s take a look at the full year statement.

Full year trading update

The picture is of sequential progress, with H2 figures trumping the transformational first half across the board. Just how many more periods there are like this is important to the valuation.

Highlights:

• FY Revenue increased by over 20x to €311.6m (£277.0m) compared to €13.1m (£11.5m) for the full year of 2019,
• H2 Revenue of €239.2m (£213.7m) compared to €72.4m (£63.3m) in H1 2020
• Gross margin above 80%,
• EBITDA profitability for the full year above €210m (£187m), with H2 2020 EBITDA above €161m (£143m) compared to €49.4m (£43m) in H1 2020,
• The Company's cash position at 31 December 2020 was €101m (£91.8m), compared to €1.8m (£1.6m) at 31 December 2019 and €19.7m (£18.0m) at 30 June 2020. This follows significant investment working capital to meet product demand and the paydown of all outstanding debt,
• Investment in pipeline of next generation COVID-19 tests and acquisition of IT-IS International.

Business clearly continued to accelerate during the second half of the year, driven by the global commercialisation of NCYT's COVID-19 product portfolio ‘and has resulted in the rapid transformation of Novacyt into a leading European integrated molecular diagnostic player.’

NCYT has expanded its global presence, with the UK, Middle East, Germany and US being its four largest revenue generating markets. It has secured significant contracts with national governments, including two with the Department for Health and Social Care in the UK (DHSC), as well as with other national non-government organisations, for the supply of its COVID-19 products.

And for now at least this is high-demand, high-quality business with conversion of EBITDA to free cash flow before acquisitions to be close to 80%.

Holders are still waiting for DHSC contract announcements. In the meantime, Novacyt has diversified its revenue base with the introduction of ten new products and has hired 124 people, with significant increases across manufacturing, sales and R&D operations.

More senior hires have also been made: James McCarthy was appointed as CFO ‘to support the Company as it enters its next stage of growth,’ while Anthony Dyer has taken on a new role as Chief Corporate Development Officer to focus on organic growth and acquisitions. Guillermo Raimondo is now the Chief Commercial Officer and was most recently Executive Vice President Global Marketing & Sales at Siemens Healthineers, ‘responsible for $4bn of global revenues’.

Full year results are expected in April 2021.

Conclusion

Demand for NCYT’s COVID-19 product portfolio remains strong and the directors believe this will remain the case ‘throughout most of 2021, with continued conversion of new opportunities, including a number of planned product launches, and the expansion of the Company's VersaLab™ service to support private sector testing of infectious diseases, initially focused on COVID-19.’

So on that note, I would pencil in one or two more ‘gold rush’ periods before considering a gradual normalisation across 2022 as the base case. Discussions to extend NCYT’s DHSC contract are ongoing, and a development here would clearly be price sensitive. So I would expect further short term volatility going forward.

The question really is of intrinsic valuation, and what is priced in at NCYT.

My current view is that the market remains overly optimistic regarding the Covid timeline and is attaching too short a lifespan to testing demand. I’m simply basing that on Hofstadter’s Law. This notes the tendency to by overly optimistic in the face of complex tasks:

It always takes longer than you expect, even when you take into account Hofstadter's Law.

It’s something I’ve found applies quite often.

If Novacyt can win the already flagged DHSC contracts, and then evolve its testing away from large contracts to smaller and more frequent transactions across various geographies to a private client base, that could be a promising mix.

Organically, Novacyt will continue to invest in its commercial infrastructure to deliver new products, a revamped R&D pipeline, and establish a direct sales force in key markets in the US and across Europe. It is also open to acquisitions.

I sympathize with NCYT management - the group’s remarkable transformation has attracted a certain level of expectation.

But there is also no denying that material aspects of the investment case make it quite ‘binary’ - DHSC contract news flow, the commercial lifespan of Covid testing products, the types of companies NCYT looks to acquire, and the prices it offers for them. All of these things are material uncertainties weighing on the share price.

It’s a very hard stock to value for those reasons.

I continue to think what NCYT has so far achieved is impressive - £200m revenue in half a year, with more to come. But there’s no doubt this is firmly in the ’high risk’ category given the wide range of possible trading outcomes over the next 12-24 months.

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Sylvania Platinum (LON:SLP)

Share price: 103p (-1.9%)

Shares in issue: 272,533,615

Market cap: £280.7m

(I hold)

There’s a Liberum broker note out there (available on Research Tree) which proposes that the price of Rhodium - one of the platinum group metals (PGMs) Sylvania Platinum (LON:SLP) produces - might increase from $20,000/oz to $100,000/oz, while SLP’s current share price implies just $4,000/oz.

Now I didn’t get the chance to properly dig into that note, but that spread of potential rhodium prices is useful to bear in mind. It’s a key input into the valuation of SLP and suggests potentially material upside if EV demand and the rest really does make the rhodium price pop. That cuts both ways of course - if spot prices go down, then so will Sylvania’s profitability.

SLP isn’t really a miner, although it does have some exploration assets in South Africa’s Bushveld Igneous Complex, where its operations are located. Most of its production comes from extraction of PGMs from chrome dumps and arisings.

The group’s earnings are heavily dependent on PGM spot prices, therefore so are brokers’ forecasts.

Nevertheless, SLP’s forecast valuation metrics remain striking, even with the share more than doubling over the past year.

Q2 update

These are quarterly figures referencing quarter-on-quarter progress.

• Sylvania Dump Operations (SDO) declared 18,363 4E PGM ounces in Q2 (Q1: 17,972 ounces);
• SDO recorded $43.7m net revenue for the quarter (Q1: $41.5m);
• Group cash costs increased 3% in ZAR from ZAR11,818/ounce ($699/ounce) to ZAR12,153/ounce ($780/ounce)
• EBITDA of $29.1m (Q1: $28.8m);
• Net profit of $20.3m (Q1: $20.1m);
• Cash balance of $67.1m (Q1: $60.9m) after payment of dividends, royalties and income tax.

Perhaps holders are looking for a little more growth in these figures, but even if you assume no growth beyond these levels, you still get FY net profit of around $81m (£59.3m). Divide that by the shares in issue and you get an FY21 EPS estimate of 21.7p per share, which gives a forecast PE of 4.7x.

So that’s still quite cheap - and note brokers are forecasting comfortably higher EPS than this.

Opportunities include:

• Ongoing circuit optimisation at the new Lannex mill and spiral upgrade will improve processing efficiencies and profitability;
• Mooinooi chrome proprietary processing modifications and optimisation project remains on track to commission during Q3; and

Conclusion

The Group remains debt free and continues to maintain strong cash reserves to allow for maintenance and growth capex. This includes not just its dump operations, but also upgrading its exploration assets.

SLP remains on track to achieve its target production of approximately 70,000 ounces of PGMs for the year. Financially the company continues to benefit from the stronger PGM basket price in recent months. There is also the expected ‘windfall dividend’, which is set to be decided in February.

Meanwhile, SLP has multiple operational opportunities. The Mooinooi chrome proprietary processing modifications and optimisation project should improve chrome recovery efficiency and is expected to be commissioned towards the end of Q3 FY2021.

The proposed MF2 expansion project at the Lesedi Plant to construct a new secondary milling and flotation module to improve the upgrading and recovery of PGMs has commenced and is scheduled to commission towards the end of FY2021.

What’s more, the company's ‘specific fine chrome recovery research and test work initiative,’ started in late 2019, has identified a circuit configuration and technology that enables the recovery of previously uneconomical dumps.

This could enable the Company to re-treat low PGM grade tailings resources and extend the operational life of PGM operations at selected sites.

And SLP also has exploration assets:

• Volspruit Platinum Opportunity - Detail design for the Permitting Applications has been completed and specialist work for updating the EIA and Water Use License will commence during Q3. The final test work report is expected during H2 FY2021.
• Northern Limb Projects - Specialist consultants have completed initial studies and identified specific higher-grade portions that could be attractive for shallow, low risk open cast extraction and PGM processing. A concept level mining study for the project has been scoped and will start during Q3 and continue until late 2022.
• Grasvally - The sale of Grasvally to Forward Africa Mining for ZAR115m is still ongoing.

It’s steady as she goes operationally and the shares continue to look cheap across all forecast metrics. But, as ever, the big driver here are the PGM spot prices. If these continue to go up, SLP should do well but if the increases are unsustainable then there could always be a share price correction.

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I can't believe it's Friday, this week has absolutely flown by, in a blur of RNSs and US market craziness. Fascinating times, but there are so many signs of financial mania, let alone exuberance about, that it's becoming rather worrying. Let's hope when the bubbles burst, they don't take down the good stuff with them.

Have a relaxing weekend!

Best wishes, Paul & Jack.