Small Cap Value Report (Mon 19 April 2021) - D4T4, CER, CHH

​Good morning, it's Paul here with the SCVR for Monday.

I hope you enjoyed the weekend, at long last it's starting to feel a bit more spring-like, with the sun putting in some appearances.

Charity Update

Before we get onto shares, I have to say a huge thank you to the 66 supporters who have contributed to my fundraising page for ZANE​, the humanitarian aid charity in Zimbabwe. Every donation means a lot to me (after visiting this wrecked country in 2019). Some amazingly generous donations have been made, and every one counts, large or small. Also I've enjoyed reading the lovely messages from donors.

Incredibly, the justgiving total is about £9,000, which has smashed my target of £4,000. I asked my family if they thought I should raise the target, but they agreed with my instincts, which is to leave it unchanged, as we can all get pleasure from seeing the target beaten by an every growing country mile! People have been so generous, it's really heart-warming. Also, I completely understand that many readers have your own favourite charities, so prefer to keep doing your own thing.

Right, it's nearly 7am, so am bracing myself for the RNS to start bleeping furiously. Jack and I are caffeined up & raring to go! (Sunday nights are early nights for me now, so I can start the week with a spring in my step, and then fizzle out more gradually as the week progresses!)

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Timing - Update at 12:43 - I have to pop out now for lunch, and a routine appointment, but will be back after lunch, aiming to look at Studio Retail (LON:STU) and Eqtec (LON:EQT) later this afternoon. If that changes for any reason, then I'll update this section. Update at 16:47 - sorry, I got side-tracked, so will revisit STU & EQT in tomorrow's report. Apologies for any inconvenience. Today's report is now finished.

Agenda -

D4t4 Solutions (LON:D4T4) (I hold) - change of CEO planned, and upbeat trading update. Not cheap, but the potential looks good to me.

Cerillion (LON:CER) - another strong update. Shares look expensive, but that looks justified to me, as with D4T4 above, due to strong growth & big contract wins.

Churchill China (LON:CHH) - 2020 results look resilient, and it has a terrifically strong balance sheet. All set for recovery. The trouble is, the share price has already factored in a full recovery to peak previous earnings. So where's the upside for investors from here?

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D4t4 Solutions (LON:D4T4)

(I hold)

320p (pre market open) - mkt cap £129m

CEO Retiring - Peter Kear, the current CEO, is to retire by 30 June 2022. A remarkable 36 years service with D4T4. His successor will be an internal candidate, Bill Bruno, currently VP of D4t4’s US business. Generally I quite like internal promotions, as they can hit the ground running, already understanding the business. As an aside though, I find CFO to CEO promotions often don’t work. CFOs like to imagine they could run the whole business, but don’t usually have the right skill set to drive sales & margins. Anyone with accounting knowledge can keep the score, but not necessarily win the game!

Background information is provided on the new CEO -

Bill's role at D4t4 has been heavily client facing and he has been at the forefront of many of the Group's most significant client wins in North America, D4t4's single most important market. Bill is well-known in the industry, and highly respected by senior managers and staff alike; his excellent track record in the digital data market and in growing an international digital media, analytics and intelligence business will be of great benefit to D4t4 as it moves into the next phase of its development.

Sounds ideal. Note also that the Chairman at D4t4 is Peter Simmonds, a safe pair of hands (formerly at Dotdigital (LON:DOTD) )

All in all, this looks fine, and contains nothing which is worrying to me. It’s unscheduled, immediate resignations that can be a sign of trouble. This isn’t like that at all, so it’s OK.

Trading Update -

D4t4 Solutions Plc (AIM: D4T4, "the Group", "D4t4"), the AIM-listed data solutions provider, announces the following trading update for the year ended 31 March 2021.

To summarise -

• Strong H2
• Revenues £22.8m, adj profit before tax (PBT) £4.2m - ahead of expectations
• Annualised recurring revenues (ARR) at a run rate of £10.6m (up 11% year-on-year) - this shows the transition from perpetual licences, to SaaS (software as a service - i.e. monthly or annual subscriptions) - which many software companies are adopting, to smooth out revenues long-term
• Year end cash pile increased again to £14.2m, with no interest-bearing debt. Quite significant vs the mkt cap of £129m, although average daily cash balance is the key number, which few companies provide (because it shows a less favourable, but truer picture of course!)
• No taxpayer support was taken re covid, and no creditor stretch either - well played, I like this, as it’s a sign of an ethical company
• New product launch in June 2021
• Positive outlook comments
• Diary date 29 June 2021, for results publication
• “Highly confident” - important, because D4t4 has a good track record of telling it how it is, and delivering on their previous outlook comments.

Broker update - many thanks to Finncap, for publishing an update note this morning. It had forecast £3.5m in adj PBT for FY 03/2021. So the actual figure of £4.2m is a healthy 20% beat - great, considering it’s come right at the year end, when you wouldn’t necessarily expect much movement against forecasts.

In EPS terms, that’s 8.4p, so a PER of 38 times on last week’s closing price. Clearly then this share is expensive, but the reason is that the market is anticipating further strong profit growth in future years.

There’s a 2.8p divi, so we’re paid a little whilst we wait. That’s a 0.9% yield.

Finncap’s forecast of a drop to 8.0p EPS in FY 03/2022 doesn’t make much sense now, so expect that to be raised as the new year progresses - upgrades are usually warmly received by the market, so more likely to be good news in the pipeline, than bad. There is a heavy H2 seasonal bias though, so perhaps Finncap want to wait until it becomes clearer how the year is progressing?

With major economies doing a V-shaped recovery, personally I wish analysts would be a bit more gung-ho. They seem to be exercising extreme caution which is no longer justified by the improving macro picture. This always happens in economic recoveries, and gives us rich pickings - i.e. plenty of companies with forecasts set too low, with upgrades then driving share prices higher.

My opinion - as mentioned before, this share is not cheap on conventional metrics. However it has what I personally look for - a great client list, of big organisations, and hence strong reference sites. It’s all about scaling up, which would then justify the valuation (and more).

D4t4 seems to operate in an up & coming segment (data analytics), so the global sales opportunity here could be exciting.

It’s difficult to value at the moment. Results have been erratic in the past, although the gradual move to SaaS should help smooth out future results.

I like that the new CEO is client, and sales focused, that’s what is needed in a CEO, in my opinion.

I’m happy to continue holding, and am (unusually for me) looking through the valuation, to what could potentially be a much bigger business in a few years’ time. It just feels like there’s something special here, and relevant to the modern world of big data - so likely to command a premium valuation on an ongoing basis. It’s already profitable of course, and has plenty of cash in the bank, so only a small risk of dilution.

As an aside, I know this share is liked by Small Company Share Watch (SCSW), a long-running tipsheet with a strong track record of finding good growth companies. Continued bullish updates can be expected from there, I imagine. In a bull market like this, share tips tend to attract buyers, although I wonder if many of them have staying power? Relatively new investors tend to flit from one thing to another, chasing the latest story or fad.

Looking at the Stockopedia metrics below, note the high quality scores for D4t4. Also, although the forward PER looks high, expect that to fall, as the low forecasts are upgraded in future.

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Cerillion (LON:CER)

537p (up 4%, at 09:30) - mkt cap £157m

Half Year Trading Update

Cerillion, the billing, charging and customer relationship management software solutions provider, is pleased to announce an update on trading for the first six months of its current financial year ending 30 September 2021.

This starts with a bang (in a good way!) -

Cerillion has experienced its strongest ever six-month trading period, exceeding management expectations.

Some numbers -

• H1 revenue £12.8m (up 25% on LY) all organic I think?
• Adj EBITDA (yuk!) c.£4.8m (up 77% on LY)
• Net cash c.£7.7m (up 60% vs LY)

Nice clear explanation provided -

This excellent performance reflects three major factors;

- on-going work on new customer implementation projects,
- strong demand from existing customers,
- and two major contract wins totalling £18.4m, which were secured in March 2021.

Outlook - sounds great -

Cerillion's sales pipeline remains strong, and prospects for the remainder of the financial year are very positive.

Diary date - 17 May 2021, for H1 results to 31 March 2021, a brisk reporting schedule, which I like.

My opinion - this business looks a quality outfit. The stand-out feature has been a series of big contract wins (although spread over several years), which validates that the software must be good, winning large international clients.

Am kicking myself for not holding these in my personal portfolio, as I’ve always liked the company, and did hold ages ago, but sold them for reasons I can’t now recall.

Is it worth throwing caution to the wind, and just paying up at the current (much higher) price? It is tempting. Winning a series of large contracts, does tell us something - that the software is good, and highly credible to big organisations. It’s very much mission-critical software too, being billing software. Hence contracts likely to be sticky.

Many thanks to Liberum for updating us (via Research Tree) with revised numbers this morning, that's so helpful. Forecasts look modest, at 15.5p for FY 09/2021, and 16.0p for FY 09/2022, with a comment that these should be “comfortably met” - i.e. likely to be an upside surprise.

Valuation - at 537p, the PER is 34.6 times, so it's expensive. But as with D4t4 above, there’s a reason why the PER is high - because the company is on a roll, and likely to grow future earnings considerably above the current year forecast. We saw a similar thing recently with Treatt (LON:TET) - high PERs aren’t necessarily a problem when companies are growing earnings strongly. A high PER does become a big problem though, if the company disappoints in any way, so it does bring higher risk with the high rating.

Overall, I think the signs are sufficiently strong that the future looks bright, that I could tolerate the high rating on Cerillion shares, in a similar way to D4T4 reviewed above.

A fabulous chart over 3 years below, and note the StockRank has been high for nearly all that time. I'm a little wary though, as to whether such rapid growth can be sustained? At some point people tend to bank profits, which does make me wary of buying at what could end up being a short-term high? Not of concern to long-term holders of course.

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The StockRank system is consistent with my thoughts - a high quality business, with strong momentum in earnings and share price, but not good value -

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Churchill China (LON:CHH)

1492p (roughly flat on the day, at 11:01) - mkt cap £164m

Preliminary Results

Churchill China plc (AIM: CHH), the manufacturer of innovative performance ceramic products serving hospitality markets worldwide, is pleased to announce its Preliminary Results for the year ended 31 December 2020.

Resilient performance in 2020, strong platform for recovery established

As a business providing products to the hospitality sector, then it comes as no surprise that 2020 was a one-off (we hope) bad year. So I don’t think it’s a good use of time to analyse the numbers in detail. All I care about now is (this is my generic list for any share in the the most heavily covid-impacted sectors) -

• Was 2020 a disaster, or a survivable downturn?
• Balance sheet strength
• Impact of dilution - whether it had to raise fresh equity last year? Or is likely to need to raise fresh equity in future?
• Likely trajectory of future recovery, and
• Valuation - is there still decent upside to be had on the shares, or is recovery already priced-in?

Working through my list in turn -

Trading - revenues for FY 12/2020 dropped 46% to £36.4m, but despite that, CHH remained (just about) profitable. That’s quite impressive, considering its customers would have been hunkered down, and unable to trade other than pre-covid (Q1), and for a period over the summer (eat out to help out period). Buying more crockery would not, I imagine, have been at the top of their list of priorities, when survival was the main issue.

Balance Sheet - remains beautifully strong. The most notable items are a large fall in accounts receivable, which reflects the slowdown in revenues. There’s a corresponding fall in trade creditors (amounts owed to suppliers). As business rebuilds, then I would expect both of these items to rise considerably, but in tandem, hence the effect on cashflow should be modest, if anything at all. Inventories are quite high, so it looks like CHH has product available to meet demand as it returns.

Working capital overall is very strong, with a current ratio of 5.47, which is almost off the scale good! There’s £10.7m of net cash, plus £3.26m of “other financial assets”, not sure what that is. Any ideas?

There are no bank borrowings, so this is a very soundly financed business, that has not come anywhere near to needing new equity injected, so the share count remains the same as pre-covid. That matters a lot, as it means EPS should be able to recover to pre-covid levels in due course, without the drag of dilution from new shares issued that we see at so many other companies which went into the crisis with weak balance sheets (false economy, as has been demonstrated in many cases).

Pension deficit, on an accounting basis (which can often understate the real liabilities, unfortunately) shows a potential problem, with the deficit up to £10.4m (LY: £5.3m). I’m flagging this, as it should be part of readers own research.

Future recovery? This is the big unknown.

As hospitality re-opens, then it’s inevitable demand for CHH’s products is likely to rise. How much, and how fast, nobody knows at this stage.

How many restaurants will disappear, due to smaller operators going out of business, and larger operators widely doing CVAs to jettison surplus sites?

We know there’s considerable over-capacity in the restaurant sector.

However, once a site closes, it doesn’t simply vanish. What’s the most likely outcome for a leased, fully fitted out restaurant site whose operator goes bust? The landlord probably re-lets it to a new tenant, on a much reduced rent, probably with a long rent-free period, giving the new operator a fighting chance of making a success of it. Then it re-opens as another restaurant.

Therefore all these closures could be sowing the seeds for a resurgence in the sector, possibly?

Also, having been denied the ability to meet our friends & family for dining out, I think many of us will be itching to return to this enjoyable activity, and have been forced savers during the lockdowns - the Bank of England saying that households have amassed over £100bn in surplus cash.

On the other hand, maybe some people may be nervous about dining out?

It will be interesting to see how these factors balance up.

Judging from what happened last summer, and that millions of people have now been vaccinated, I think the outlook is probably more positive than negative, but nobody knows for sure, we’ll have to see.

Outlook -

Market activity is starting to grow steadily and we believe that our established position will allow us to benefit as markets recover during 2021… there is now growing evidence from enquiries, order levels and sales that activity levels are recovering across our markets.

With hospitality in the UK not having properly re-opened yet, I don’t suppose there is much more CHH can say at this stage.

Valuation - this is the tricky bit, as I often say.

As there’s been no dilution, I am going to base my valuation on peak earnings, which was 80.8p in 2019, according to the StockReport (the data provider sometimes makes adjustments to make numbers consistent & comparable with other companies, that’s why they don’t always match the published numbers).

With the current share price of 1492p, that’s peak earnings multiple of 18.5 times! So where’s the upside for investors? If the share price has already factored in a recovery in earnings to the previous peak, which might take maybe 2 years to happen (assuming it happens at all), then this seems to me an unfavourable balance of risk:reward.

My opinion - I can’t see the logic in paying such a full price, when recovery is only just about to start. What the share price seems to imply, is that investors think CHH is likely to not only meet, but beat previous peak earnings. That’s a robust assumption, so you need to be very sure of your facts to hold that opinion, and wait say 2 years for it to be proven right.

Overall then, I like the company, it’s financially strong, but the valuation puts me off - too much recovery is priced in, so I can’t see where the upside would come from, buying in at this stage. Not in a reasonable timescale anyway.

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That's it for today. See you in the morning!

Regards, Paul.