Small Cap Value Report (Thu 16 Dec 2021) - RWA, MCB, SMK, BMY

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

Agenda -

Paul's Section:

Boohoo (LON:BOO) - trading update - too large for the SCVR now, so I've posted my comments on the BOO thread, which is here. Please would you post your comments using that link there, rather than cluttering up this article, which some subscribers get uppity about! Many thanks.

Mcbride (LON:MCB) - oh dear, another profit warning - with continued input price inflation being the problem. It's trying to raise selling prices again, but that takes time, impacting profitability. Now trading at a significant loss, and in talks with the bank over covenants, makes this too risky for me to want to consider investing.

Jack's Section:

Earlier in the week I had the pleasure of talking through some small (and large) caps with Paul Hill and David Thornton. Great guys, both full of enthusiasm for the markets and their own investment ideas. Here's a link to the YouTube upload - have a watch and let me know if you have any thoughts on the stocks covered.

Robert Walters (LON:RWA) - another upgrade for this recruiter. The stock has rerated and is close to all-time highs but, with wage inflation across a number of countries, the near-term outlook continues to look positive. The StockRank of 96 and Quality Rank of 98 are positives, so it looks like a good candidate for those looking for exposure to labour shortage and wage inflation themes. Broker estimates are behind the curve.

Samarkand (OFEX:SMK) - I hold - H1 business disrupted by supply chain challenges for its customers, although an improving trend has been reported from October onwards. The stock itself has a lot of growth priced in and there’s not much trading activity, so there’s downside risk. Of more interest is the read across comments on supply chain.

Bloomsbury Publishing (LON:BMY) - acquisition of US-based academic publisher. Bloomsbury says it should be able to use its Digital Resources division to scale ABC’s digital offering. There have been a few acquisitions here recently, and BMY still has cash, so it’s worth taking a closer look at the growth strategy IMO.

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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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Paul's Section:

Mcbride (LON:MCB)

53p (down 10% at 09:22) - mkt cap £93m

Financial Year 2022 trading update

McBride plc (the "Group"), the leading European manufacturer and supplier of private label and contract manufactured products for the domestic household and professional cleaning and hygiene markets, today provides the following trading update ahead of the close of the first half of the financial year on 31 December 2021.

The current financial year is FY 06/2022.

Supply chain & inflation -

… raw material and packaging costs have continued to experience very significant inflationary pressures with availability continuing to impact our supply chain efficiency. In addition, the shortage of haulage capacity and even higher fuel costs has not abated and have continued to substantially inflate distribution costs.

As we know, inflation is all around at the moment, and companies have to be able to raise their selling prices, to protect profit margins.

Price rises -

McBride has been actively engaged with all its customers to secure substantial price increases to mitigate the impact of these exceptional cost rises affecting the whole industry. Our early increases in late summer have now been outpaced by further rises in input costs and hence further pricing action has been underway more recently.

It is pleasing to see the support of most customers to these price increase requests with the effect of these further increases starting to benefit December trading and delivering more fully from January onwards.

Revised guidance (profit warning) -

The Group now expects to report an adjusted loss before interest, tax and amortisation (EBITA) of between £14m and £17m for the six months ended 31 December 2021. The increase in this loss compared to our previous update in October is a consequence of the ongoing rapidly rising input costs and the timing of pricing agreements. At this stage, our wide range of outcomes is a result of pricing delays with a small number of customers and the resultant implications, which could impact short term volumes.

Checking back my review of its last profit warning here on 19 Oct 2021, previous guidance was a £(10)m loss on the same basis (EBITA).

The £(14)-(17)m revised loss for H1 is a big number, considering it’s for only half the year, for a company with a market cap of £93m. This is starting to look worrying to me.

Liquidity & bank covenants - also worrying is the mention of bank covenants, so it sounds as if the company could be heading for a breach of them. It’s rare for banks to pull the plug in this low interest rate environment. However negotiating revised covenants could mean possibly higher fees & lending margin from the bank, and the risk that the bank might insist on an equity raise to reduce its risk. So be aware that the risk of dilution has just increased a lot. What I don’t like in these situations, is that we have no way of knowing how supportive the bank will be. Some banks seem to be remarkably relaxed when problems emerge, whilst others lean heavily on management to raise equity at the first sign of trouble. It’s the uncertainty I don’t like.

McBride continues to enjoy a strong liquidity position with c.£80 million in available cash at hand, and we are currently in supportive and constructive discussions with our bankers regarding our December covenants.

My opinion - as mentioned before, in inflationary times the last things I want to be invested in, are very low margin suppliers of anything. A low net margin tells us that the company’s products are not sufficiently differentiated, and that there’s lots of competition.

Being in that position when costs start rising considerably, is a bad place to be, because -

• There’s no buffer to absorb cost increases, given that profit margins were already so low, and
• It takes time to persuade customers to accept price rises, hurting profits at least in the short term
• There’s a risk that some customers might have fixed price contracts, which of course the customer could refuse any price rises for the contractual term

Overall - this looks a very unappealing investment right now, and wasn’t particularly appealing to start with. Why get (or remain) involved, when the risks are increasing? Upside could eventually come from a turnaround, but when is that likely, and is the company going to return to profitability, if so how much? Will the bank remain supportive? How much dilution might occur if it's forced to raise fresh equity? There’s too much uncertainty here for me. With a battered portfolio, I want to pick my spots carefully, where the situation is an absolute no-brainer. I don’t see that here.

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Jack’s section

Robert Walters (LON:RWA)

Share price: 766.47p (+1.12%)

Shares in issue: 76,612,035

Market cap: £587.2m

We saw Sthree (LON:STEM) down earlier in the week on what looked like decent results. After such a rerating, I suppose the market was looking for a little more in terms of fireworks. The shares there are still comfortably up on the year (from c300p in January to 459p at yesterday’s close).

Still, it’s a reminder that staffing company shares go down as well as up and are historically quite volatile, even though they are currently benefiting from positive conditions with wage inflation increasingly taking hold.

Robert Walters stock has underperformed the market by c7% over the past month but has outperformed by 50% on a one-year view. The long term chart shows how close it remains to all-time highs.

The StockRanks remain strong here at 96, with a notable 98 for Quality, although operating margins are quite low.

Trading update

Another short update:

The Board of Robert Walters plc announces that as a result of strong trading across all regions in the first two months of the fourth quarter and improved visibility in respect of December trading, profit before tax for the full year ending 31 December 2021 is expected to be comfortably ahead of current market expectations.

The group will publish a trading update for the fourth quarter ending 31 December 2021 on 11 January 2022.

Conclusion

Current expectations are for 37.3p of earnings per share for 2021. How much will ‘comfortably ahead’ equate to? This is not the first time RWA has announced that it is trading ahead of expectations this year. Last time I looked, the group had just reported c21p of EPS at the halfway stage of the year while FY forecasts were for just 33p. I think the estimates are stale here, and brokers are suffering from incrementalism.

So I’m assuming the forecasts are just anchored at too low a number.

EPS in the 42-45p range would give an FY21 PER of 17.0x - 18.2x. Not overly expensive, but not obviously cheap for a company whose outlook is tied to economic conditions. At some point, perhaps market participants will seek to look through current trading towards some sort of downturn or moderation.

That said, Robert Walters is a fundamentally well run business and conditions are presently favourable. This shows no sign of slowing down. Recruiters are often some of the first stocks to recover from a downturn, so the question is whether the share prices here have further to run. That depends not just on trading performance but also market sentiment.

For now it’s hard to argue against that backdrop of labour shortages and wage inflation. It’s a global business, too, which separates it from some of its listed peers. My impression is that the current recruiter cycle has further to go, with salary inflation evident in many developed countries.

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Samarkand (OFEX:SMK)

Share price: 160p (unchanged)

Shares in issue: 51,618,966

Market cap: £82.6m

(I hold)

I’ve just had a call with management here.

Samarkand is listed on the Aquis Exchange and does a few things. At its core, the group’s Nomad tech is designed to integrate with China’s consumer market. This is trickier than it sounds and is a barrier to entry for many overseas businesses looking to win share in the world’s largest ecommerce market.

Samarkand also has three of its own brands selling consumer healthcare and fertility products. Sales here are more focused on domestic markets, but the plan is to leverage the core Nomad tech platform to sell them in China.

There’s a lack of liquidity here though and the stock is listed on the Aquis Exchange. While the potential is huge, Samarkand is still early on in its journey in terms of revenue and profits, so there’s a lot of future growth priced into the £83m market cap.

Reading the room, it’s the kind of growth story that the market doesn’t really have time for at the moment, but the company’s comments about supply chains are of interest.

Interim results

• Revenue of £7.2m, flat year-on-year against strong comparable period,
• Nomad technology revenue is up 15% and brand ownership revenue is up 13%,
• Wholesale distribution part of the business has been deprioritised as planned and revenue has decreased 31% from these activities,
• October and November trading was 15% and 25% ahead YoY respectively ‘with this trend continuing to accelerate significantly into the first two weeks of December’.
• Adjusted EBITDA loss was £2.6m (H1 2021 profit: £0.3m) which reflects the ongoing investments,
• Continues to enjoy a strong balance sheet with cash and cash equivalents at 30 September of £10.4m.

FY22 (March end) forecast is for revenue of £22.6m, which implies there’s a bit of catching up to do. Supply chains are currently the biggest challenge facing the group and that’s the area I was hoping to get a bit of insight and wider read across on.

For Samarkand itself, getting product from customers into China is not the problem. It’s getting product from the customers, who are facing supply chain issues and component shortages that’s the issue. Samarkand’s customers are consumer businesses looking to increase their cross-border trade.

To summarise the key points from the conversation:

• October, November, and December performance at SMK has improved due to adapting to global supply chain issues.
• The group has invested in more stock (inventory of £3.5m compared to the £1.9m at the same point in the prior year).
• Disruption has been from existing brands being out of stock or struggling to give guidance on stock, which SMK needs in order to plan a couple of months ahead for key trading periods.
• ‘People have realised that just-in-time (JIT) is not going to cut it for the foreseeable future so there is more stock-building’.
• There was a lag period while people tried to make JIT work.
• The situation is ‘starting to stabilise a bit’ but there was definitely a period when nobody seemed to know when they would get products or components.
• Managing supply chains continues to be the key challenge in the short term.

Conclusion

A challenging time for an ecommerce tech company to IPO and find its feet.

Re. Samarkand itself - there’s some catching up to do to hit forecasts but longer term it’s a question of whether or not you think the company’s strategy of building out a tech platform that facilitates cross-border ecommerce is likely to be a source of enduring value.

There has been promising operational progress, including good traction from customers and SF Express coming on board as a very big partner. The group says it is in talks with some other large enterprises that could accelerate growth in ecommerce tech, payments, and logistics.

But there is a lot of growth already priced into the shares and the conditions right now are difficult, so there’s a derating risk here. I wouldn’t be surprised if shares fell in the short term. It’s really a lack of trading activity keeping them up at the moment.

I’m not flagging it as an immediately enticing investment prospect - of wider interest are the comments on supply chains. It seems like JIT just isn’t cutting it at the moment, which means many operators are having to build up inventories. Low margins and stretched balance sheets are at risk over the next few months at least.

Samarkand says the situation is showing signs of stabilising, but I still view this dynamic as a key risk to the global economy. Working capital management is important now. In the coming years, I wouldn’t be surprised to see companies shorten and ‘reshore’ their supply chains.

Prices are rising, pushing up inflation. The CBI reported in October that stocks in relation to expected sales were at a record low for the seventh consecutive month. The Bank of England’s view is that the worst of the disruption will have eased by early next year, but for now, it’s a dynamic that continues to drive market sentiment.

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Bloomsbury Publishing (LON:BMY)

Share price: 351p (+5.72%)

Shares in issue: 81,608,672

Market cap: £286.4m

Bloomsbury has spent much of the past five years with an SR of above 90. Its shares have more than doubled in that time, with dividend payments to boot.

At this point, a growth catalyst is needed in order to keep the shares interesting as there has been an expansion in multiples here. Earnings per share forecasts have been increasing and the group has been making a couple of acquisitions, although I’m not familiar enough with the situation to say more than that.

It does seem to have led to a slight shift in perception re. how to value this share though.

Acquisition

Bloomsbury has acquired ABC-CLIO for $22.9m (£17.3m). This is an ‘established academic publisher of reference, nonfiction, online curriculum and professional development materials in both print and digital formats for schools, academic libraries and public libraries, primarily in the USA’.

Strange that Bloomsbury does not give a net assets figure here, just gross.

The company was founded in 1955 and is based in Santa Barbara, California, providing ‘curriculum-aligned content and lesson plans, professional development support and student activities to US schools and academic institutions’.

In the remaining two months of Bloomsbury's financial year ending 28 February 2022, ABC-CLIO is expected to contribute approximately £2.1 million of revenue and £0.3 million of profit before tax, prior to integration and acquisition costs. It should be earnings enhancing in the current year.

Conclusion

It’s this move into digital and academic publishing that is of interest, so good to see an acquisition here. More of a focus on academic publishing presumably means income is more dependable.

ABC-CLIO strengthens Bloomsbury Digital Resources and accelerates Bloomsbury's academic publishing in North America. The business will operate within Bloomsbury's Academic and Professional division and ABC-CLIO's 32 databases will be included within Bloomsbury Digital Resources, enabling Bloomsbury to scale ABC-CLIO's digital offering globally.

The deal itself doesn’t look particularly cheap, but some of that depends on just how well the business fits in strategically with Bloomsbury. The group’s ability to scale ABC’s digital offering could explain the price.

ABC looks like it has a strong reputation as a ‘long-standing and respected American publisher of academic reference, nonfiction, online curriculum, and professional development materials in print and digital formats for academic institutions and schools, faculty and students, and public libraries.’

I remember thinking a few months ago that full year forecasts for Bloomsbury were leaving room for an ‘ahead of expectations’ announcement at some point. The group has a net cash position and is putting that to work with a few acquisitions, so it’s worth tracking back to properly go over the group’s growth strategy.