Small Cap Value Report (Thurs 4 Nov 2021) - SNWS, TPFG

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

Agenda:

Jack's section -

Smiths News (LON:SNWS) - business in structural decline but predictable cash flows, large revenues, a low PER, and reassuring turnaround progress mark this out as a value opportunity worth paying attention to.

Property Franchise (LON:TPFG) - solid quarterly results from the UK's largest property business. Along with Belvoir (LON:BLV) and M Winkworth (LON:WINK) , these are robust, cash generative companies that could grow steadily over the long term, although some concerns over property market prospects likely persist.

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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 are analysing the company fundamentals, not trying to predict market sentiment.

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Jack’s section

Smiths News (LON:SNWS)

Share price: 38.9p (+1.04%)

Shares in issue: 247,700,000

Market cap: £96.4m

This is the UK’s largest distributor of newspapers and magazines. It’s a structurally declining business, but still a large one with over £1bn revenues, long-term contracts, and predictable cash flows.

The group’s in turnaround mode, with Tuffnells and its pension scheme now offloaded. Bank debt is reducing and dividends are resuming. So it looks like what needs to happen is happening. Still, the shares trade now on an historic PER of less than 4x.

It’s perhaps not the sort of company you’d want to hold forever, but it’s very possible at these levels that the recovery progress is not priced in.

Preliminary results

Performance ahead of expectations, with dividends restored

Highlights:

• Revenue -4.7% to £1,109.6m,
• Adjusted EBITDA (ex leases) +9% to £42.6m,
• Profit before tax +10.8% to £30.9m,
• Earnings per share +11.3% to 10.8p,
• Free cash flow +120.2% to £24m,
• 1.5p dividend declared,
• Bank net debt -33.2% to £53.2m.

Revenue from combined newspaper and magazine sales declined by 4.7% in line with our long term expectations of market trends. Magazines, which attract a higher margin, performed more strongly than newspapers, with a particularly good performance from one-shot titles, including stickers and albums. Performance varied across the year with sales being 11.5% down in H1 2021 but up 3.1% in H2 2021.

The performance is ahead of full year market expectations, with sales in line with pre-COVID trends and above target cost savings of £6m across operations and central support functions. Cash generation has been used to reduce bank net debt and recommence dividend payments.

The group does note, however, that ‘recent inflationary pressures on distribution costs [is] tempering expectations for FY2022’.

Financial health -

Our capital management goals were aided by the successful renewal of our banking facilities in November 2020. Good progress has been made in improving the key metrics of Bank Net Debt, free cashflow and capital expenditure, and we are on track to reduce Bank Net Debt to 1x EBITDA, ahead of our initial target of the end of FY2023. As a consequence, in July 2021 we reinstated the payment of regular dividends which we regard as an essential element of our ongoing capital management objectives.

Usefully, the group explicitly details its average net debt for the year, which few companies actually do. The difference is notable.

It should be noted that, as a consequence of the timing of payments and receipts, intra-month debt typically fluctuates by up to £40m across the payment cycle, with average net debt of £82.6m (FY2020: £98.8m). Looking ahead, we are on track to reduce Bank Net Debt to 1x EBITDA, ahead of our initial target of the end of FY2023.

Pension scheme -

Smiths operated a defined benefit scheme, the news section of the WH Smith Pension Scheme which, as at 28 August 2021 had an IAS-19 pre-tax surplus of £14.8m (FY2020: £15.2m). It’s closed to new entrants and future accrual.

The Trustee of the news section of the WHSmith Pension Trust has confirmed that the Company will receive the benefit of the cash surplus which will arise on the wind up of the scheme following the buyout of the scheme by Legal & General in March 2021. The surplus (net of professional fees and tax) of £8.0m is expected to be paid to the Company during November 2021. The proceeds will be used to reduce net debt in line with the terms of our banking agreements.

Outlook and current trading - Smiths expects to continue generating profits and cash to pay down net debt and pay out dividends.

Although some uncertainty remains, the immediate outlook for our markets suggests a continued stabilisation of sales and a gradual improvement to the prospects of those retailers most affected by the pandemic.

Inflationary pressures in distribution labour markets began to impact the business in August 2021 and have increased since the period end, however. Currently, the group estimates the impact on EBITDA in FY2022 to be in the region of £2m after mitigation.

Trading in the year to date is in line with the board's expectations.

​​Sales and margin this year have been boosted by the European Football Championship and England's successful run to the final, together with an increase in Pokémon sticker collectables as children went back to schools. The benefit of these two opportunities in the year amounted to circa £1m of EBITDA. Although they will not be repeated in FY2022, the FIFA World Cup finals should once again boost sales in the first quarter of FY2023.

Jonathan Bunting, CEO, comments:

By focusing on our core competencies, we have returned a strong performance, ahead of market expectations. In doing so, we have met our key strategic targets for the year and strengthened our capability to deliver for all our stakeholders. Looking ahead, we face increasing inflationary pressures and must continue to focus on managing costs, but we have clear plans to do so, underpinned by a flexible business model that is a robust foundation for the delivery of shareholder value.

Conclusion

After generating 10.8p of earnings per share, Smiths now trades on a lowly PER of 3.6x, which looks too low given the cash generation, net debt reduction, and dividend payments. Free cash flow per share works out at about 11.3p, big numbers for a 38p share price (as of yesterday’s close).

More work must be done on the balance sheet, although progress so far is encouraging. The pension scheme has been offloaded and net debt is reducing, but the current ratio is just 0.83x. Net tangible asset value is a negative £60m, so risks remain here. Dividend payments are a sign of progress, but perhaps using this cash to build more of a financial buffer would be a prudent move.

A key point here is that Smiths has fairly predictable cash flows, though. ​​The core business benefits from exclusive absolute territorial protection (ATP), long-term contracts with suppliers (publishers) and strong relationships with customers (retailers). This means that revenues are quite predictable, allowing management to focus on the turnaround.

Smiths has delivered a robust performance over a difficult period, and has managed to reduce costs as it continues to restructure its operations. At present, the FY21 dividend yield of 3.9% exceeds the PER of 3.6x, which is rare these days. These things are always cheap for a reason and there are of course risks with inflationary risks growing but nevertheless, Smiths looks like an intriguing value opportunity at these levels.

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Property Franchise (LON:TPFG)

Share price: 296p (-1.33%)

Shares in issue: 32,041,966

Market cap: £96.2m

(I hold)

Last time I looked here, I was surprised to find the shares looked no more expensive than they looked before nearly doubling over the past year. This is in part due to a fortuitously timed acquisition that increased TPFG’s property sales business just in time for a surging market.

Aside from valuation, these property franchise groups tend to come with great profitability metrics, resilient lettings cash flow, and operate in a large market with plenty of runway for growth. Their fortunes are tied to the wider property cycles, but TPFG has a good track record of profit growth.

Trading update

The Directors are pleased to confirm the Group continues to trade in line with market expectations for the full year.

Highlights:

• Group revenue increased 126% to £17.9m (2020: £7.9m), with like-for-likes up 34% to £10.6m,
• Management Service Fees (royalties or MSF) up 72% to £11.3m, +29% LfL to £8.5m,
• Strong cash generation with net debt of £2.8m after borrowing £12.5m to fund the acquisition of Hunters in March 2021 (30 June 2021: £5.4m net debt, 30 September 2020: £nil).

Post-acquisition, network income has increased 84% to £119.7m, with LfLs up 30% to £84.3m. The sales agreed pipeline is strong despite the ending of the stamp duty holiday, standing at £28.2m on 30 September 2021 (£29.5m on 30 June 2021, £31.0m on 31 March 2021).

TPFG is currently managing 73,000 rental properties (up from 58,000 last year) and EweMove - a slightly controversial acquisition - now kicking on, with 46 new territories sold (2020: 6) and 161 territories under contract as of 30 September 2021 (2020: 116).

Gareth Samples, CEO, says:

I am delighted to report that after announcing record results at the half year, we have continued to trade strongly. Whilst the market would benefit from increased stock of properties to let or sell, we have continued to achieve significant transactional activity. Most notably our sales agreed pipelines continue to be replenished, even after the three peak months for residential property completions this year. Beyond the buoyant market we are pleased to see our strategic initiatives delivering and are confident they will continue to drive growth going forward.

Mello Investor presentation - TPFG management will appear on Mello on Monday 8 November 2021 to update investors on trading since the half year.

Conclusion

The shares look reasonably priced to me - a forecast PER of 12.5x and a forecast yield of nearly 4% for a company with good quality metrics and growth prospects.

There is the potential for softer markets in the medium term but so far things like the ending of the stamp duty holiday are not yet having too much of an impact. Still, the pipeline has come down slightly and a concern remains that, after emerging from lockdowns in remarkably good shape, these companies are now reporting peak good news.

Nothing’s certain but I think the long term prospects are solid here, though. It’s entirely possible that shares will fall at some point in the coming years depending on how the property market plays out, but the business model is strong and the company should be able to survive such downturns and even use them as consolidation opportunities.

Macro considerations aside, the group is profitable, cash generative, growing, and well placed to take market share in a large and fragmented market. Financial services is a useful new growth driver and EweMove is on track to double its operating territories within two years by the end of FY22, so TPFG looks well positioned to grow acquisitively and organically from a profitable and cash generative base.