Small Cap Value Report (Fri 03 Dec 2021) - BRCK, LGRS, MIND, DUKE, WIX

Good morning! It's Jack here with the SCVR for Friday.

Agenda -

Brickability (LON:BRCK) - good results seem to have been missed by the market. After a raft of acquisitions, the company is now materially larger at a time of heightened demand. It’s uncertain for how long these conditions will endure, but the company seems well placed to take share with its diversified offering.

Loungers (LON:LGRS) - perhaps the best listed operator in the bar / cafe space. Trading well, and the pace of roll out is set to be stepped up a notch. The group is targeting c500 sites in total and is well placed to improve its position in the market, although the shares are not cheap.

Mind Gym (LON:MIND) - investment in digital continues. The group’s behavioural psychology classes are used by some big S&P and FTSE companies, and the company was generating some attractive profitability metrics pre-pandemic, but I’m not convinced by the current valuation.

Duke Royalty (LON:DUKE) - positive results from a royalty financing company that has successfully navigated the pandemic and is now moving back into growth mode. Not an area I know well, but the company appears to be executing, so there could be an opportunity here.

Wickes (LON:WIX) - unscheduled update announcing an upgrade in adjusted FY PBT to not less than £83m. It could have floated at just the right time in the cycle, but the valuation does look modest and the company appears to occupy a good market position. One of the more interesting recent IPOs.

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Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review 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.

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).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed - please be civil, rational, and include the company name/ticker, otherwise people won't necessarily know what company you are referring to.

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Brickability (LON:BRCK)

Share price: 109p (pre-open)

Shares in issue: 298,534,802

Market cap: £325.4m

The interims came out on Wednesday. Brickability is a construction materials distributor, serving housebuilders and contractors across the UK and Europe for over 36 years through its national and local networks.

The group supplies over 500m bricks annually and has 41 locations across the country with over 500 employees but has been expanding the range of materials provided.

Across its 3 divisions the group now supplies bricks, roofing, timber, cladding, heating, flooring, doors and windows to meet demand from both housebuilders and contractors.

Interim results

Highlights:

• Revenue +197% to £223.5m; like-for-like revenue +53.6% versus H1 2020 (and up 30.4% versus H1 2019),
• Gross profit +146.8% to £39.0m, gross margin down from 21% to 17.4%
• Profit before tax +120.4% to £11.9m,
• Change from net debt of £2.7m to net cash of £2.8m,
• Interim dividend proposed of 0.96 pence per share (H1 2020: 0.8678 pence).

Acquisitions of Taylor Maxwell, in June 2021 following an oversubscribed share placing raising equity finance of £55 million, and Leadcraft, as announced in August 2021. The acquisition pipeline is healthy and the group reports continued organic development.

Post period end, Brickability has made two additional acquisitions: HBS New Energies and UPOWA in November 2021, the group's first acquisition in the renewable energy products sector.

This is quite a pace the company has established. Generally that makes me wary as it heightens integration risk and means management has a lot on its plate. Some teams are up to the task, it’s quite possible that this is the case here. The history and calibre of the management team is something I would want to look into more before buying.

New product ranges have been added - timber (just in time for the surge in prices, now unwinding) and non-combustible cladding, copper and zinc metal roofing, and heritage leadwork.

Conclusion

The timber acquisition has been exceptionally well timed - the effect here will fade, but it’s still worth mentioning. Apart from that, the stock looks reasonably valued of a PE basis and is certainly growing.

My main concern is the sheer pace of acquisitive activity and the rate of change in the group. On the other hand, you could say that the company is diversifying and de-risking the business by broadening its product ranges and customer depth. It’s both an opportunity and a risk. The size of the acquisition is important, too.

Construction materials is a good space to be in right now. How long will favourable conditions last, and what does ‘normal’ look like in the years ahead? The timber market, for example, is already showing signs of normalising.

There are reasons to be optimistic here. The group has expanded and diversified its construction materials platform in time to meet strong demand. As such, there’s scope to surprise to the upside in the short term. But there are enough uncertainties to warrant caution, too.

If it can integrate the existing acquisitions while growing organically, the company could outperform its less busy peers. I like it enough to look further, but not enough to buy at the moment. Certainly worth flagging in any case.

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Loungers (LON:LGRS)

Share price: 278p (pre-open)

Shares in issue: 102,738,664

Market cap: £285.6m

Loungers is one of the best bar / cafe operators out there. Its all day offering appeals to a broad range of age groups and is inspiring a new generation of copycats.

This means competition will increase in time but, for now, the company is trading extremely well and has an ambitious opening pipeline.

Interim results

Highlights (using 2019 comps):

• Revenue +28.2% to £102.4m,
• Adjusted EBITDA +87.1% to £27.1m,
• Operating profit up from £2m to £16m,
• Profit before tax up from a loss of £2.5m to £12.8m,
• Diluted earnings per share up from a loss of 2.3p to 10.4p,
• Cash from operations up from £12.6m to £35.9m.

Fantastic figures, the company is taking market share with headline like-for-like sales growth of 26.6% on 2019.

Resumption of new site roll-out - 12 new sites opened in the period, comprising 11 Lounges and one Cosy Club. A further four sites have been opened post the 3 October half year end in Ringwood, Reigate, Colchester and St Neots. The group has invested in its build and property teams to accelerate the roll-out.

Loungers may increase its number of build teams from four to five. This would allow the group to move from c25 units a year to c30-35. The group has been ‘delighted’ with the strength of recent openings

Inflation - Introduction of differential pricing in July 2021 allows additional pricing flexibility. Labour and supply costs are rising, but Loungers is increasingly benefitting from scale. Utility costs hedged in May 2020 through to September 2024. Continued reduction in non-property net debt to £11.9m. The net result is that margins have actually risen.

Impressively, older sites are still growing at the same pace as newer sites. The rent to sales percentage is below 5%.

Current & near term trading:

Loungers will ‘take a bit of price’ in response to the inflation it is facing. Food costs are under more pressure than drink. Utilities are hedged until Sept 2024. There is little upward pressure on rents.

Current Trading and Outlook

• Since the end of the period the business has continued to consistently out-perform the sector and achieve strong like for like sales growth post 3 October, headline LFL sales across the 28 weeks to 28 November of +23.4%
• Whilst mindful of the news of the Omicron variant, we are optimistic looking ahead to trading over the Christmas period and beyond. The Lounge business is very balanced seasonally, whilst Christmas trading is more important for Cosy Club and we are encouraged by the level of bookings.
• We anticipate 25 new site openings during the financial year ending 17 April 2022 and have the infrastructure in place to accelerate that pace as circumstances permit

Conclusion

Loungers is an excellent operator that is benefitting from its own initiatives and a favourable trading environment. Its sites, located in suburbs and market towns, are well placed to benefit from post-lockdown trends (work from home etc.).

I can’t see anything that will upset trading for a while yet, save for further Covid disruption. On that, the group says the impact of Omicron ‘remains to be seen’ and there has been ‘no change in sales yet.

For now, the pace of roll out is increasing, rents are more favourable, and the group is managing cost pressures, so it looks nailed on to be one of the winners in this sector. The shares are expensive though and this is what puts me off.

There’s not much downside priced, although this remains a quality operator performing impressively. The sector in general is a tough one though, with cost pressures and competition likely to increase in the medium term.

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Mind Gym (LON:MIND)

Share price: 165p (-4.35%)

Shares in issue: 100,105,660

Market cap: £165.2m

Mind Gym is a company that delivers business improvement solutions using scalable, proprietary products which are based on behavioural science. The group operates in three global markets: business transformation, human capital management and learning & development.

It typically provides in-person classes to companies looking to improve their workplace cultures and productivity. Obviously, lockdowns were a big hit, although the group did pivot towards digital classes, which could prove to be an innovation whose value outlasts Covid.

Prior to the past year or so, the group was generating some notable return on capital metrics.

Mind Gym is majority-owned by its married co-founders, with a free float of around 32%, so not the most liquid, although clearly the people running the business would like the share price to increase.

Half year results

Highlights:

• Revenue +67% to £24.1m (up 1% over two years),
• ‘Digitally enabled revenue’ +89% to £19.5m,
• Small adjusted PBT of £17k, up from an adjusted loss of £1.3m but down on the £300k adjusted PBT reported two years ago,
• Adjusted diluted EPS of -0.01p,
• Cash at bank of £12m, with a £1.2m outflow in cash from operations and £2.8m of capex.

The company is holding onto digital revenue. This is currently 81% of total, ‘reflecting growth in both digital products and live virtual deliveries’. Mind Gym’s new digital 1:1 coaching platform ‘Performa’, will launch in the New Year, with a first client already signed up and with strong prospective interest. Another new digital product, DXP (Digital Content Experience) will launch in FY23.

So it looks like the company is committed to building up its digital arm beyond Covid. In fact, it says its strategy is ‘to focus on investing in digital for future growth’. This could be important going forward as digital is higher revenue - group gross margin increased by 7.1 percentage points from H1 FY20 to 85.9% due to higher digital and virtual revenues.

Meanwhile, repeat revenue represented 92% of group revenue, returning to pre-COVID levels (H1 FY21: 87%, H1 FY20: 92%).

There’s a new CFO - Dominic Neary joining the board today and becoming CFO on 1 January 2022.

Current Trading & Outlook

The second half of the year has continued to see growth on FY20. We expect revenues to continue to increase on pre-COVID levels as we maintain our investment strategy to deliver long-term, sustainable growth with our first new digital product, Performa launching in Q4 FY22 and our new digital platform, DXP, which is in the middle of Beta trials, to be launched in FY23.

Conclusion

The shift to a more digital strategy is interesting and it’s worth keeping an eye on progress here with the release of Performa and the upcoming DXP. Could this be a case where lockdowns ultimately change a company for the better? It remains to be seen.

Mind Gym is currently loss-making, although this has been flagged as the company invests in these new projects. From the company:

The gross profit generated from the revenues was reinvested back into the business as intended to support future growth. Overheads of £20.6m in the six months to 30 September 2021 increased 38% (H1 FY20: £15.0m). The majority of the additional operational investment is in people costs as we expand and upgrade our commercial team, innovation, marketing and operations teams. Our marketing investment also saw the completion of our rebranding during the period including the website relaunch.

Still, the valuation at £173m is not cheap. It’s more than I would pay for the existing business, though I have no insight into the quality and utility of the group’s services. Perhaps they are revolutionary? The group says it has ‘helped over half the FTSE 100 and the S&P 100’.

That may be, but at present I just can’t get my head around the valuation. The company is forecast to remain loss-making in FY22 with a small adjusted profit in FY23. Some of the figures below are Covid-impacted, but even using FY20 figures (31 March year end), the group trades on a PER of 32.5x and a price to free cash flow of 16.3x.

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Duke Royalty (LON:DUKE)

Share price: 45.98p (+4.49%)

Shares in issue: 358,803,360

Market cap: £165m

Here’s a stock I feel as though I should have looked at more closely in the past - a royalty investment company paying out a 6% forecast yield. It’s an unusual proposition, hence why I’ve never got around to it.

It claims to be the first non-resource royalty company to be publicly-listed in the UK, born from a Canadian approach to royalties. The idea is that Duke buys the right to a percentage of future revenues from a business, allowing the existing team to retain control. This makes it a potentially attractive option to companies looking for finance.

Duke reassures that it’s buying businesses with a good chance of succeeding for the long-term:

The case studies on Duke's website are encouraging and suggest that the management team is disciplined not just in its investment selection but also in how much it's willing to pay.

Interim results

Current trading for the three months ended 31 December 2021 is strong and I am pleased to share the Board's confidence of exceeding the market's expectations for 12 months ended 31 March 2022.

Highlights:

• Cash revenue +78% to £7.8m,
• Net cash inflow +46% to £5.2m,
• Net profit +50% to £6.2m,
• Free cash flow +58% to £4.6m,
• Adjusted earnings per share +60% to 1.39p,
• Cash dividends of 1.1p paid to shareholders.

That’s 2.4% of the company’s market value paid to shareholders in cash in the period.

The group raised £35m of new equity capital in April, £23m of which has since been deployed into three new royalty partners. ‘Several large, new institutions were added to the Duke share register as part of the fundraising’.

New investments

• €10m investment into Fairmed Healthcare AG. Formed in 2012 and based in Zug, Switzerland, Fairmed provides high quality generic prescription medicines, over-the-counter pharmaceuticals, dermocosmetics and dietary supplements in various EU countries.
• £7.7m investment into InTec Business Solutions Limited. InTec is a UK company specialising in the design, implementation, and support of a wide range of cloud services and business applications and is undertaking a buy and build strategy of synergistic companies within the I.T. Managed Services sector in the UK and Ireland. The investment here was later increased by £2.2m, in order to facilitate InTec’s eighth acquisition.
• CA$20m (c£11.6m) investment into Creō-Tech Industrial Group Inc. A Canadian holding company that has been set up to acquire businesses that provide engineering, procurement and construction ("EPC") services in commercial and industrial settings.

Duke has exited two investments and has over £55m available for future deployment with the current deal pipeline ‘at historic levels in deal value and number’.

Divestments

• Almondclose Limited, trading as Berkley Recruitment Limited, a Cork-based resourcing and recruitment business. Duke received net cash of €1.3m at closing, delivering an IRR on the Berkley investment of 16.0%. This was regarded as a subscale investment for Duke, inherited via its acquisition of Capital Step back in February 2019.
• The second exit came from royalty partner BHPC Limited, an Irish insurance brokerage specialising in the not-for-profit insurance space, and at closing Duke received back net cash of £6.9m, delivering an IRR of 29.4%, Duke's highest realised IRR to date.

Dividends

In April 2021, the company increased its dividend from 0.50 pence per share to 0.55 pence per share, the first increase since the resumption of the cash dividend in Q3 of financial year 2021.

This was followed with a further dividend of 0.55 pence per share paid in July 2021. Post-period end, a dividend of 0.55 pence per share was paid to shareholders in October 2021. So since April, the group has returned 1.65p per share to shareholders, or 3.6% of the share price.

Neil Johnson, CEO of Duke Royalty, said:

This has been a very successful half year, characterised by substantial cashflow growth and accelerating investment deployment. Cash revenue is up 78% from the prior period to £7.8 million, and we have delivered a 58% increase in free cashflow to £4.6 million. This positive performance has been driven mainly by our team's rapid execution of new royalty agreements which has seen us invest over £23 million into three new royalty partners during the period.

This strong trading performance makes me confident that Duke will exceed the market's expectations for the 12 months ended 31 March 2022. Since the resumption of its cash dividend, Duke has increased its dividend payment from 0.50 pence per share to 0.55 pence per share, with the prospect of higher dividend payments for shareholders in the future. This growth will be supported by entering into new royalty agreements and I am pleased to report that our pipeline is the strongest in our history. We expect to announce a range of new deployments in the coming weeks and months.

Conclusion

This remains outside my circle of competence, but if enough investors think this way then good companies can end up being neglected by the market.

Duke appears to be showing that its finance model works, with five exits to date, but this is still a relatively new area for UK investors to get to grips with. The more Duke enhances its reputation, the more investments it can make and the more diversification it attains. And it does seem as though the performance through Covid has improved its reputation:

Furthermore, after such a period of global financial stress, the Company's unique, long dated and aligned product offering has meant that Duke is increasingly being seen as a preferred capital partner for many profitable, well managed private businesses who do not wish to become encumbered by the high refinancing risk associated with short-dated debt. To highlight this point, I am pleased to be able to report that Duke's current deal pipeline is as robust as it has ever been in the Company's history and I am confident that the Company will be able to announce a number of new deployments in due course.

The company is moving on from a period of internal monitoring of investments and getting back into growth mode. Having successfully navigated the pandemic so far, its current deal pipeline is the strongest it’s ever seen.

All in all, it’s worth looking a little more closely at the investment case here. There’s an investormeetcompany presentation on the 13th of December, which I plan to tune in for.

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Wickes (LON:WIX)

Share price: 240.8p (+12%)

Shares in issue: 259,637,998

Market cap: £625.2m

I looked at Wickes at the time of its interim results and came away with a generally favourable impression, so the slide in share price recently has come as a surprise. Sadly I didn’t get the chance to finish my research ahead of today’s unscheduled update.

Christopher Rogers, the chairman, joined the Wickes team ahead of its demerger, stepping down from the board of Travis Perkins where he was senior independent director and NED since 2013. He says the demerger was thoughtfully executed and well planned. David has assembled a strong team here, one focused on creating medium term value for all stakeholders via a continuous focus on improving relevance and DIFM (‘Do It For Me’).

This is not straightforward for other retailers to replicate and the group’s strong digital presence (two thirds of business was digital in 2021) means it is a uniquely balanced business with a clear and distinctive place in the market. As a standalone business, it is better positioned than ever before to capitalise on growth opportunities.

Trading update

Resilient trading and strong margin performance, FY2021 profit guidance raised… raises FY2021 adjusted PBT guidance to no less than £83m.

Wickes has continued to perform well in the fourth quarter to date, benefitting from its balanced business model, with sales in line with expectations.

Delivered sales in Do It For Me (DIFM) are strengthening as it works through an elevated order pipeline. It also expects a higher carry over order book in DIFM, supported by continued strong sales which will benefit the first half of FY2022.

Core sales are lower year-on-year against tough comparatives but remain ‘materially ahead on a two-year basis’ driven by a further strong performance from local trade.

The group credits a better than expected margin performance to its agile business model and strong supplier relationships, with rising inflation and freight costs mitigated.

David Wood, CEO of Wickes comments:

This has been a period of further progress for Wickes, where our focus on value, stock availability and exceptional service have underpinned our customer offer. Our forward planning and early strategic decisions have resulted in an improved profit performance, and we continue to navigate inflationary pressures and raw material constraints well. Clearly, this remains a time of uncertainty, however our differentiated business model leaves us well-placed to continue to outperform within a large and growing home improvement market.

Conclusion

Cyclicality is a concern. It’s possible Wickes has floated at the top of a cycle, it wouldn’t be the first time - in fact, cynically, you might say that’s often the aim. But there have at least been a couple of director buys here recently.

The market environment aside, I have a positive impression of the quality of management here. Wickes is a strong brand name, and it occupies an intriguing market position that appears difficult to replicate or compete against. As such, I can see it gaining market share as a newly independent and re-focused entity.

The valuation is modest, with a single digit forecast PER and, while the company appears to have a lot of debt, this is just lease liabilities. Ex-leases, the group has a net cash position of around £200m.

It’s investing in its stores, digital platform, and product range, is performing well with a good management team, and trades on a low PE ratio with a forecast 3.4% yield. Wickes continues to look like an intriguing new IPO, in my opinion.