Small Cap Value Report (Thu 12 August 2021) - PURP, STCK, VTC, EMR

Morning all, it's just Paul here, with the SCVR for Thursday.

Today's report is now finished.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover trading updates & results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it's anybody's guess what direction market sentiment will take & nobody can predict the future with certainty.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

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Agenda -

Paul's Section:

Purplebricks (LON:PURP) (I hold) - recent changes to business model look interesting - new pricing, money back guarantee (with conditions) and agents moving to employed rather than self-employed status. £74m cash pile (and no debt), for a £202m market cap, looks an interesting albeit speculative situation.

Stock Spirits (LON:STCK) - agreed cash takeover bid at 377p, a 41% premium. Congratulations to holders!

Vitec (LON:VTC) - interim results show a strong recovery, getting close to pre-pandemic trading. Not the best balance sheet I've ever seen, but that probably doesn't matter because the group is trading well. Valuation seems reasonable. Looks an interesting company, operating in growing markets, worth a closer look maybe?

Empresaria (LON:EMR) - very impressive interim results, driven by restructuring rather than revenue growth. I'm not keen on the balance sheet, but this share does look cheap, compared with the much larger re-rating enjoyed by Gattaca (LON:GATC) so I'm tempted to have a little punt on EMR.

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Purplebricks (LON:PURP)

(I hold)

65p - mkt cap £202m

Change to Operating Model

The business model of PURP is changing for the better I think, addressing significant concerns. Already announced recently was this -

New pricing structure, including money back guarantee - previously the (valid) criticism of PURP was that it had no incentive to actually sell houses, because it was paid up-front by customers, regardless of outcome. That clearly wasn’t right, and the danger is that the longer it went on, then the company risked tarnishing its reputation by leaving a trail of dissatisfied customers behind, having paid a fee, and not achieved a sale of their property.

The new money back guarantee was trialled in the North West, and resulted in an 18% uplift in new business. Hence it is now being rolled out nationally, and is expected to help drive targeted 20% p.a. growth in revenues, with the aim to double market share from 5% to 10% in the medium term (source: recent company webcast).

This is what got me interested, so I picked up some shares personally after watching the company’s results webinar in July. The market cap of £202m, with £74m net cash on the balance sheet, and an improved strategy, strikes me as potentially attractive risk:reward. Although, as with all shares, it’s educated guesswork, because nobody can predict the future with any certainty.

Another bull point is that PURP has historically spent so much on marketing, that its brand recognition is now 97% with the public. Maybe it’s out-spent some of the competition? Like many online businesses, there are few barriers to entry, but large barriers to achieving scale - which needs very deep pockets, for extensive marketing, and funding losses.

Latest news -

Purplebricks, the UK's leading tech-led estate agent, announces that it intends to move to a fully employed model for its Field sales agents, with the transition commencing today.

Until now, they have been self-employed. I have to say that I’m highly sceptical of the reasons PURP gives for this change! Advantages from employment are said to be greater security, benefits & motivation/incentivisation of agents. Whilst that may all be true, I suspect the main reason for taking staff onto the books is probably regulatory - the rules have been tightened up recently, because the Govt is losing a lot of National Insurance generally from millions of workers being classified as self-employed, when in reality they are indistinguishable from employees.

Exceptional costs - PURP says it will incur £3-4m exceptional costs in FY 04/2022 related to this change in employment status for its agents, without disclosing what those costs are. That’s a lot of money, and I wonder if it might be penalties from HMRC?

Ongoing additional costs - will be £1m p.a., which sounds fine, that doesn’t particularly alter the investment case.

Marketing splurge - an additional £3-4m in marketing spend (above previous guidance) is going to be spent later this financial year. That makes sense to me - the money back guarantee is a big move, and should drive higher sales, so it makes sense to tell the public about it through TV ads, digital marketing, etc. Also, there’s no point in sitting on £74m cash, when you have something new to shout about. Providing PURP achieves a good return on investment (ROI) from this spending, then all good.

Medium term guidance - unchanged, at >20% p.a. revenue growth. If that’s achieved, then I think this share could re-rate higher. Obviously there are no guarantees it will be achieved, it’s an aspiration.

Short term guidance - too early to quantify the benefit from new pricing model.

Broker forecasts - Zeus puts out a brief note summarising the RNS, and says revised forecasts will be published in September.

My opinion - speculative, but this looks quite interesting to me at a £202m market cap. I like the massive cash pile on the balance sheet, and that costs are flexible.

Who knows whether the changes to the business model will work, but they make sense to me. It should be emphasised that the money back guarantee has several conditions - including an agreed price for the property, and if an offer within 10% of that price is received within 6 months, then that negates the money back guarantee. Quite loose conditions, that may not please customers who don’t read the fine print?

How to value this share? Given its main strategy is to grow market share, which costs cash spending up-front, then I don't think a PER valuation makes sense until the business has matured. So I'm not sure how we value it. If PURP delivers strong growth from this revised strategy, then history has shown the market gets excited and the market cap rises (I think it got close to £1bn in the past?).

Another thing to consider is that the Stamp Duty holiday accelerated activity in the housing market, and we could now be due the hangover.

You can see from the long-term chart below that the early euphoria after it listed in Dec 2015 wore off, as international growth aspirations ran into trouble (since disposed of). Also note that the share count has roughly tripled, from 101m to 307m after several funding rounds along the way. Hence the current c.65p share price is equivalent in market cap terms to about 200p before the dilution.

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Stock Spirits (LON:STCK)

268p - mkt cap £536m

Agreed takeover bid

I cannot recall seeing so many takeover bids in rapid succession, in the c.25 years I've been in the markets. The obvious conclusion is that the UK market is seen as cheap by overseas bidders in particular. Otherwise we wouldn't be seeing so many bids. Private equity seems to be awash with cash, and is snapping up lots of UK companies, typically mid caps rather than small caps, unfortunately.

This deal is agreed by the Directors, is 377p in cash, a healthy 41% premium.

That's an excellent outcome for shareholders, well done!

Of course at this stage, it's customary for investors to complain that it undervalues the company (whilst secretly being delighted at the bumper payday!). No it doesn't undervalue the company! The share price has never been anywhere near as high as 377p in all the time the company has been listed, since Oct 2013. This is therefore a good deal for shareholders.

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Vitec (LON:VTC)

1528p (up 3% at 08:05) - mkt cap £703m

Half-year Report

The Vitec Group plc ("Vitec" or "the Group"), the international provider of premium branded hardware products and software solutions to the growing content creation market, announces its results for the half year ended 30 June 2021.

That’s not a very clear company description. I wish companies would just describe what they do in simple, readily understandable (by anyone) terms. Oh, and not use abbreviations that anyone outside their sector may not know.

At some point, I really should create a checklist/scoring system for writers of RNSs & PRs, to help them avoid these basic missteps. Having ploughed through thousands of RNSs as a reader/analyst over many years, very few give us all that we need. That’s a general moan, let’s get back to Vitec.

Top marks here though - the table below is an excellent way of presenting the H1 numbers, showing 3 years in total - i.e. 2021 (recovery, possibly some impact from the pandemic), 2020 (H1 heavily impacted by lockdown 1), and then 2019 (pre pandemic, so the last normal year).

I’ve seen a few other companies adopt this presentation approach, and it’s ideal, and saves us a lot of time, not having to go back and manually compare the 3 sets of interim results, to ascertain the underlying picture.

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The footnote says it has adjusted the numbers to constant currency, which seems OK, I would expect companies to put their best foot forward in the highlights section.

What the above table is clearly showing, is that the most recent half year has largely recovered back to pre-covid trading. There’s still a bit of a decline 32.7p H1 2021 is 18% below H1 2019’s 39.9p, but a dramatic improvement on losses in H1 2020.

Has there been any dilution over this period? Nothing significant that I can see, with the share count stable at c.46m, so good news there.

Acquisitions look to have helped boost the figures, although they’re quite small deals.

Dividends reinstated.

Still a fair bit of debt though.

Outlook/current trading - this looks really good -

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Balance sheet - I’ve done my usual checks, to ascertain financial strength.

NAV is £161.2m, less intangible assets of £142.8m, leaves quite modest NTAV of £18.4m - not much for a £703m market cap company.

Net debt of £102m is too high for my personal tastes, I just prefer strong balance sheets with little to no debt, but does it really matter when a company is trading well, and decently profitable? Maybe not. Also in the pandemic, Vitec didn’t need to raise fresh equity, so it’s been successfully stress-tested. It’s up to each investor to make up your own mind how much importance you attach to balance sheet strength/weakness, I'm just flagging the facts for your appraisal.

Cashflow statement - it’s a decently cash generative business. Note that capitalised development spend seems high, at £5.8m in H1 (was £10.6m in full year 2020, so this is an ongoing thing). Hence EBITDA is not a valid profit measure. High R&D spending is a good thing, and essential in the markets where Vitec operates, as products are constantly changing & improving.

Broker forecasts - unfortunately I can’t find anything, so will have to guess. Stockopedia shows consensus 60.5p EPS for FY 12/2021. Today’s update says ahead of expectations, so let’s guess it might be c.70p - reasonable given that H1 was 32.7p EPS & a strong outlook for H2.

At 1528p per share, that gives us a PER of 21.8 - sounds fair, considering strong performance & rapid recovery from covid.

My opinion - based on a fairly quick review of the numbers, I like the look of this company. Am just listening to its webinar now, and it sounds as if the group operates in good growth markets, e.g. blogging, gaming, and streaming - all very topical and growing areas. Here are the results presentation slides.

The valuation looks reasonable to me, given strong performance, and interesting products in a growth sector.

Webinar - I've been listening to this, and a couple of points jumped out at me -

• Raised selling prices 3-5% already this year, more than recouping higher costs. "Our pricing power has never been stronger"
• We've maintained supplies to customers better than our competitors. Fewer competitors now than 10-15 years ago.
• Onshoring production back to Italy, from China
• Exciting prospects on operating margin - "mid teens is a realistic goal, reasonably soon"
• High single digit future revenue growth, combined with higher operating margins, "You can do the maths!" - high operational gearing
• Overall - mgt come across as confident & optimistic.

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Empresaria (LON:EMR)

93p (up 15% at 13:10) - market cap £46m

Interim Results

Empresaria Group plc (AIM: EMR), the global specialist staffing group, announces its unaudited interim results for the six months ended 30 June 2021.

Company summary -

Adjusted profit before tax up 67% and investing in future growth

Just like Vitec above, Empresaria has also provided a useful table showing half year figures for the last 3 years, enabling us to quickly see how H1 2021 compares with pre-pandemic H1 2019 numbers. Excellent stuff!

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What is striking about the above numbers, is that EMR has not recovered pre-pandemic revenues, in fact they worsened further from 2020 to 2021.

However, more importantly, adj profit before tax (PBT) in H1 2021 was actually above pre-pandemic levels, at £4.0m (up 8% on H1 2019). That says to me that EMR must have stripped out a lot of costs in restructuring, to considerably lower its breakeven point. It mentions “the exit from loss-making operations”, and “challenges in the aviation industry”.

Webinar today at 16:30 on InvestorMeetCompany, which I’ll attend & comment on here if any pertinent points arise.

Guidance is raised -

We are encouraged by our strong start to 2021 and as a result, profits for the full year are now expected to be significantly ahead of the prior year and current market expectations…

Although it also expresses caution & uncertainty about market conditions in some markets where covid restrictions are still in place, and vaccinations lagging the UK.

Broker forecasts - many thanks to Singer, for updating its figures today. FY 12/2021 goes up, but only to 6.5p. That seems cautious, since 4.1p is already in the bag from H1. I’d imagine there’s scope to beat that, and personally I’ll probably value this share on 7-8p EPS for this year. Maybe more, who knows? The existing consensus shown on the StockReport is only 4.32p for FY 12/2021, so that should rise considerably, and thereby lower the forward PER.

In 2017 & 2018 Empresaria managed c. 12.3p (average). I’ve just checked, and there doesn’t seem to have been any dilution during the pandemic, still 50m shares in issue, which means that EPS could return to that level in future, unless there’s anything negative I’m not aware of. With costs stripped out, maybe it could achieve more than 12.3p in future?

At 93p, the upside scenario would leave the PER in single digits, which is reasonably attractive, although small staffing groups don’t tend to be highly rated. Over the years, Empresaria shares have often looked very cheap, and stayed cheap! It has had some problems pre-pandemic, and several changes of management too. It does look as if things are back on track now though.

Management equity - this caught my eye whilst skimming through the commentary, and is quite an important point, in that it seems some subsidiaries are not 100% owned by Empresaria, and the potential buyout cost could be material, given the market cap is only £46m -

Based on the Group's results for the year ended 31 December 2020, and using applicable valuation mechanisms in shareholders' agreements but ignoring holding period requirements, the potential payment to acquire all those shares not held by Empresaria would be approximately £9.0m were the maximum multiples to apply.

Of this, approximately 98% relates to first generation shares accounted for as non-controlling interests in the consolidated financial statements. There is no legal obligation on the Group to acquire the shares held by management at any time.

No interim divi.

Balance sheet - looks quite weak. NAV is £41.3m, but NTAV is only £0.6m.

Working capital is funded by debt, rather too much of it I would say.

My opinion - a really good H1 performance, no doubt about that. Upgrades to full year expectations too, another plus, and the forward PER looks cheap.

Overall though, the weak balance sheet, and minority interests put me off a bit.

There again, look at how much more Gattaca (LON:GATC) has re-rated in the last year (up 344%), compared with Empresaria (LON:EMR) (up 123%). I think GATC has possibly overshot on the upside, but this chart below does starkly show that EMR might have more fuel in the tank to rise further? It’s quite tempting to have a little punt on this actually, I’ll give it some more thought.

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