Small Cap Value Report - Mon 16 May 2022 - MADE, OCN, GRG, SRAD, VTU, RWS

Good morning, we have Paul & Jack here for you today.

Agenda - 

Paul's Section:

Made.Com (LON:MADE) - a severe profit warning. Instead of recovering this year, losses are now set to increase considerably. Consumer discretionary, bigger ticket items, are clearly being slammed at present, due to the squeeze on consumers, but that's already been reflected in big share price falls. MADE has a strong balance sheet, so I'm not worried about insolvency risk. Big hitter new CFO joins. 

Greggs (LON:GRG) - Greggs is doing OK (for now), and leaves full year forecasts unchanged. I'm looking at this mid cap for read-across to smaller caps, and the retail/hospitality sectors as a whole. A rather rambling section, covering macro factors too.

Vertu Motors (LON:VTU) (I hold) - I've typed up my notes from this morning's webinar. Some really interesting additional points.

RWS Holdings (LON:RWS) - bidder pulls out. I have a quick look to see if there's any read-across, but no clear reasons are given. So I assume it must just be general market bearishness? Looks a very good business, long-term track record.

Jack's Section:

Ocean Wilsons Holdings (LON:OCN) - a fall in volumes is offset by better revenue mix and foreign exchange rates at the operating division. Headwinds remain, with inflation and supply chain bottlenecks. This business is run for the long term so it could appeal to certain investors with its 5.7% yield and perennially high StockRank, but the shares are thinly traded and the share price has not made progress over the past decade.

Stelrad (LON:SRAD) - lower volumes but better mix and improved margins mean the group is trading slightly ahead of expectations. It’s been a very poor period for IPOs but Stelrad is so far doing better than most. It’s a tough backdrop out there and there are headwinds, but this is worth flagging as a potentially better-than-average and neglected new listing to keep tabs on. More research required though, and there's a nasty spread.

---

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.

---

Paul’s Section:

Made.Com (LON:MADE)

64p (pre market open)

Market cap £249m

New CFO appointed - sounds amicable, and with a handover period, so probably not something for investors to panic about.

Patrick Lewis takes over, and sounds a big hitter, previously CFO of John Lewis, and a NED at Ocado. This looksSounds a good appointment, as he apparently has experience of sorting out supply chains, which is clearly needed at Made.

This is one of a number of board changes, including when the CEO stepped down, replaced by the COO Nicola Thomson, in Feb 2022.

Trading Update

Made.com, the leading digital lifestyle brand for the home, today announces a trading update and revised guidance...

That sounds ominous. Is it another profit warning? (EDIT: Yes, and it's a bad one).

The current financial year is FY 12/2022.

• The first paragraph sounds terrific, saying the company is out-performing the market by >20%.
• Lead times are good, and on target at 3-4 weeks.
• Customer feedback & repeat orders are also improving.

Sounds great, but then they hit us with a series of negatives -

• Volatile trading in recent months
• More challenging than anticipated
• Gross sales were down “only” 10% in Q1 (but up 64% on pre-pandemic year)
• Market (for online furniture & home) said to be down 30-40% this year - an alarming statistic

Outlook - revised guidance. I do like the format that MADE provides, giving upper & lower guidance, which makes a lot more sense to me than just a single number -

.

The table above seems a bit muddled, because the first 2 lines are % change on last year, but the adj EBITDA line is an actual number, not an annual change. I’ve confirmed this by checking revised forecasts published this morning by Liberum, many thanks to its analyst Wayne Brown for crunching the numbers - it’s a big help to us.

Liberum’s update now suggests £(35)m EBITDA loss (so it is working from the “Lower” guidance given above, sensible at this stage I’d say). That translates into a thumping FY 12/2022 forecast loss before tax of £(47.6)m, and negative EPS of (9.8)p.

Its previous estimate was a loss before tax of £(5.7)m, so this is a massive profit warning I’m afraid.

This is going to be a tough year, which shouldn’t really surprise anyone, and has already been reflected in the share price losing two thirds of its (inflated, I would say) IPO price. Even so, I’m shocked at how much the forecast loss has ballooned.

We now assume the market will remain highly challenging for the rest of 2022 despite the significantly easier comps for H2…

Freight costs - good news here, with read-across to many other companies - but this benefit seems to be overwhelmed by reduced demand, for now anyway -

Spot freight rates continue to normalise in line with previous expectations, but lower sales mean the benefit will be reflected in gross margin later in 2022 than previously anticipated.

2023 outlook - expecting a big bounce back in profitability, which sounds ambitious to me -

These actions will position the business to deliver positive adjusted EBITDA and free cash flow in 2023.

Is it likely to go bust? - in a word, no. That’s because the balance sheet is strong (as last reported at 31 Dec 2021, NTAV of £74.4m, including plenty of cash, at £107m and no bank debt. That’s fine, and gives the financial strength to ride out a period of dismal trading.

Remember that furniture retailers have highly favourable working capital characteristics, getting cash in from customers, before they have to pay suppliers. So there’s a lot of headroom here.

In terms of listed competitors, DFS Furniture (LON:DFS) is high risk, with a very weak balance sheet. SCS (LON:SCS) (I hold) has a bulletproof balance sheet. I would say MADE is nearer to SCS than DFS, in terms of balance sheet strength.

Also remember that online businesses have the flexibility to cut their substantial marketing budgets, as far fewer costs are fixed, an advantage over conventional retailers.

My opinion - this announcement is a wake up call, that discretionary, bigger ticket consumer spending is really taking a pounding right now, and probably for the rest of this year, due to the increasing squeeze on consumer incomes, and confidence.

That said, share prices have already anticipated this, with huge falls across the board.

At some point, the market is likely to anticipate recovery, but it feels too soon to do that here.

At least guidance from MADE is now more realistic, and there’s little risk of insolvency, so shareholders just have to decide whether to bail out, or to ride out the downturn if you have a longer term perspective.

I don’t know which of those is the best thing to do, because the economic outlook is so uncertain. At some point, Govts might turn on the QE taps again, and get the economy moving again. Fed Chairman Powell has previously indicated this would be his reaction to a recession. At the moment we seem to be sleep-walking into a recession, so it all really hinges on Govt policy here & in other countries.

Here at the SCVR we do like the potential at MADE, but it’s never made a profit, even in the good times. That said, the business model has been to grow aggressively, and it’s definitely carved out a niche, particularly amongst younger customers (several friends/family in their 20-30s tell me it’s excellent, with great designs, and generally reasonable prices, in a rather staid sector).

Would I buy it now? Unfortunately not. Although I see the price has opened down 18% this morning, at 52p (as at 08:11), which is quite a modest drop, considering the huge fall in forecast earnings for 2022. So maybe we’re getting closer to the point where the downside is priced-in, and investors begin looking at recovery potential? I noticed the same thing with Boohoo (LON:BOO) (I hold) - terrible figures, but the price still seems to be forming a base at 70-80p.

Who knows, it’s really all just guesswork in the short term. Longer term, I think MADE looks an interesting business, but it’s very tricky to value right now. It doesn't scream value to me, even after the huge fall.

Let’s hope the new CFO does a proper sort out, including cutting costs to better reflect a very tough trading environment probably for this year, and maybe into next year too?

.

.

---

Greggs (LON:GRG)

2172p (flat today)

Market cap £2.2bn

Why on earth is a mid-cap in a small caps report, I hear you cry? Partly because my sector specialism is retail, but also because I’m looking for guidance on how consumer demand is changing, and how this might affect small caps. So it’s the read-across that interests me, as we’re apparently entering a much worse macro phase, due to inflation, higher interest rates, etc.

We can either ride it out - tempting, as share prices have already plunged so much, that it might make more sense to concentrate on the recovery, and ignore any further short term pain). And/or to make a list of the most attractive bombed out shares to buy, which have been beaten down unreasonably.

I liked the look of JD Sports Fashion (LON:JD.) the other day, which is performing well still, and looks strikingly cheap on a forward PER basis, for a very impressive business. It’s bounced a bit, but the fwd PER is still just under 11.

The thing that strikes me, is the higher quality companies with better management somehow seem to manage their supply chains, and cope with disruption, whereas others (often the smaller caps) seem to be overwhelmed by supply chain, and other problems.

Now we’re also looking at some consumers (especially those reliant on state benefits - uplifted by a ludicrously low 3.1% apparently) facing a really big squeeze on disposable incomes. The thing is, that doesn't mean an across-the-board reduction in sales & profits for consumer-facing businesses. Tightening their belts, different groups of consumers adjust our spending in different ways. Some businesses still do well, even in recessions. It would be worth looking back, and seeing what happened to companies' profits in 2008, the last severe recession. 2020-21 doesn't help a great deal, as the figures were so distorted by unprecedented Govt support measures.

Even more affluent consumers seem to be, as you would expect, demanding value for money before parting with money right now.

Which brings me on to Greggs. Its products are certainly good value for money, for stodgy, calorie-laden food. That matters because plenty of customers paying more (at, say Pret) might trade down in price/quality. Also if your product is already cheap, then raising prices by maybe 5-10% would barely be noticed by customers, e.g. a £2 bacon roll going up to £2.10-£2.20 is probably not going to make much (if any) difference to demand. Hence why I reckon Greggs should be doing OK, so it’s interesting to see if that theory is correct.

Trading Update - I won’t repeat all the detail here, but the short version is that things are fine -

Trading in line with plan, expectations for the full year outcome unchanged

LFL store sales are strong, but the prior year comparatives distort things, due to the last lockdown in early 2021.

Cost pressures -

are “increasing”.

“Considerable uncertainties”.

“Continue to work to mitigate the impact of cost pressures whilst protecting Greggs’ reputation for exceptional value”.

My opinion - the share price has come down a lot, but with a forward PER of 18.1, Greggs still looks far too high, in my opinion, compared with other high quality retail businesses, some of which are now on PERs much lower - e.g. JD Sports Fashion (LON:JD.) (PER 11), B&M European Value Retail SA (LON:BME) (PER 12.1), Halfords (LON:HFD) (PER 6.9) , Marks and Spencer (LON:MKS) (PER 7.8), Dunelm (LON:DNLM) (PER 11.2). I’m not sure why you would pay such a premium for Greggs, although it probably does have good earnings resilience, due to its products being popular, and cheap. It could be that the apparently cheaper companies mentioned there might be more vulnerable to forecasts being reduced, who knows? Hence forward PERs are currently very unreliable, with such poor earnings visibility for many or most companies.

Remember that this squeeze on consumers is only temporary, so people who can see further out than 1 year (which is meant to be the whole point of owning equities, but instead the market has turned into a giant casino) we could be in a position to buy attractive businesses at attractive prices, maybe?

Retailers actually have built-in inflation protection, as they can raise prices at will. The key question is whether consumers still find the product attractive, at say a 10% higher price. I reckon with Greggs, they probably will. So maybe it's premium rating is justified?

The other point is that we’ve really only scratched the surface of inflation for food. I’m hearing some horror stories about very much higher ingredients costs coming down the pipeline, combined with numerous other cost pressures & withdrawal of Govt support, which is likely to combine to make it absolute carnage in the hospitality sector. Only the best are likely to survive, with many independents likely to disappear.

.

.

---

Vertu Motors (LON:VTU) (I hold)

52.4p (up 1% at 11:03)

Market cap £187m

Webinar today

I spent an hour watching the webinar laid on today by PIWorld, superb quality as usual. Anyone interested in this share, and the car dealers sector, really should watch the recording when it is published. Robert Forrester always gives a masterclass in his webinars, and this was no exception.

I felt a bit sorry for the CFO, who was barely able to chip in, apart from a few specific accounting queries in the Q&A. Maybe it would be better to let her switch off her camera, rather than sitting awkwardly, being watched, whilst doing nothing for an hour?

I reviewed the bonanza results for FY 2/2022 from Vertu here.

Here are my notes from today’s webinar - which contained some interesting additional points.

So NB below is not a comprehensive report (you need to watch the webinar yourself for that), it’s just some key additional points which I noted down, in particular if they were new facts to me.

Long-serving CEO Robert Forrester, since group founded in 2006. He comes across as very (maybe too?) charismatic, rational, and forward-looking, on top of the detail too. So a thumbs up from me for management quality.

Strong tailwinds, 7 upgrades in FY 2/2022 (but obviously profits not sustainable at that level)

Only 900 cars sold purely online. But many more sold via deposits placed online, then subsequently purchased. 75% of customers want to test drive before buying.

Net tangible asset value (mainly freehold property) is 66.8p. This includes the pension surplus. In Q&A, asked whether this is a realisable asset? CFO replied yes, otherwise she wouldn’t be able to put it on the balance sheet, and the pension scheme was “no cash call on the business”. I didn’t know that, so maybe we should include pension surpluses within NTAV in future? More digging needed on this point.

I can’t think of any other car dealer chain that is trading below NTAV, as VTU is.

I queried if freehold property is worth more or less than book value? CEO replied that freeholds are in the books at cost. He doesn’t know what their market value is, because he’s focused on generating returns from them. Although I felt he was hinting they’re definitely worth more than book value, but not clear how much. Freehold property disposals have nearly always been at above book.

Strategy is growth - more expansion in the pipeline.

Multi-franchise (e.g. 4 brands from one site) is more efficient than large, single franchises.

Relationships with manufacturers - have to plan 5-10 years ahead. Mentioned Toyota as a good prospect. Close liaison with manufacturers. Can build better shareholder value by creating new sites, than buying existing ones.

Vertu has never lost money, not even in 2008 financial crisis, nor covid.

Govt support reduced to £6.6m, nearly all business rates relief.

Click-to-drive is an online sub-brand, doing well. Showed us advertising on a racing car. Creating other supporting businesses, eg a van online retailing business, and a parts business.

How to make huge profits? Sell less (sic) cars! Previously the sector was over-supplied, causing margin destruction. Tight supply set to continue - could be up to 4-5 years for used cars. This is a good thing, as tight supply = more profit.

Ukraine - is a big parts manufacturer, especially wiring looms. Very surprising that manufacturers became so reliant on key components from Ukraine.

Manufacturers have responded by reducing production of mainstream models, prioritising higher margin top end vehicles. Hence why secondhand car prices rose so much, as limited supply of both new & used cars. Bizarre situation, which drove up used car prices 25-30%.

Last 3 months more normal - used car prices falling c.2% per month.

Used car volumes have dropped 10-15%

Order books (for new cars) still at record levels.

Stock turn - at Vertu is fast, at 35 days. This is a competitive advantage, because VTU is now selling cars it has bought recently at lower prices, whereas competitors with more stock are having to discount cars they paid more for.

Gross profit on used cars rose from £1204 to £1,740, main driver of bumper profits in FY 2/2022.

Cinch/Cazoo are spending hugely on advertising. But customers still like the franchised dealers - and 75% want a test drive.

IT - Vertu has 50 in-house IT developers, so a lot going on.

Online “concierge service” is doing well, sold 400 cars so far (where browsing customers that drop out are nurtured back in).

Aftersales (e.g. servicing) will decline, due to lack of new car sales.

Cost discipline - as lots of suppliers are raising prices (i.e. for non-cars), then danger is we just accept price rises, and don’t challenge them or shop around.

Energy costs - a lot of work being done here (not explained what!)

Good start to current year, as in the RNS results, with Mar & Apr 2022 about level with last year, around £19m profit.

Consumer confidence - way too early to say. Noticed that some prospective buyers are mentioning reduced monthly payments as important.

I asked whether staff costs could be reduced again, in a downturn? “We’re no longer in control of staff costs”, due to minimum wage rising. We do have flexibility on staff numbers. Have 400 vacancies currently (implying could freeze recruitment if necessary). Also I noted from the slides that sales staff are getting performance-related pay, so there must be some flexibility in there. Typically each salesperson sells 120-150 cars p.a. (so about £200-250k gross profit per person, pretty impressive).

Good case for share buybacks, but main focus is on deploying capital to achieve high returns.

Acquisition of new sites - tight supply, only 2% nationally are empty.

Closing remarks were the most interesting, e.g. -

Industry is seeing emergence of “mega groups”. We need to grow, or end up in a mega group, “otherwise we won’t have a future”. CEO has a tendency to hyperbole sometimes, but I think it’s becoming clear that VTU is likely to be taken over by a bigger group.

Q&A - what is his attitude towards any bid approach? Would weigh it up, and if at a decent premium, would have to consult shareholders.

Financial buyers tend not to be interested in the sector, since manufacturer consents are very important if transferring business ownership - good point, that I think a reader here once mentioned in a comment.

My opinion - the interesting thing is that demand is still above supply at the moment (long waiting lists). This suggests to me that even if consumers do rein in big ticket spending, it might not have as much impact as we imagine? Supply is expected to continue to be constrained, in both new, and (knock on effect) used cars. Hence I think car dealers could surprise on the upside, with profits obviously falling from insanely high levels in 2021, but maybe to still above normal in 2022, possibly, who knows?

A very interesting share, and I remain of the view that priced well below NTAV, the price looks wrong to me, even if you factor in earnings falling by half or more.

Takeover bid very likely, in my opinion.

.

.

---

RWS

Possible bid falls through

It’s above our usual (flexible) £700m market cap upper limit, but I thought it would be interesting to have a quick look, to see why the possible bid has fallen through.

The potential bidder, Baring PE Asia Fd.8 has only issued 2 RNSs -

21 April 2022 - “Response to press speculation” that it was in the “preliminary stages of considering a possible offer” for RWS. This caused a c.30% spike up in the share price.

Today, it announces that it won’t be proceeding with a takeover bid. It kindly states that - “BPEA's decision not to proceed at this stage is not a reflection of its views on the RWS business. “

RWS responds today with this -

The interest from BPEA was unsolicited and did not result in any proposal being made to RWS. The Board of RWS believes the Company has a strong future based on its clearly defined strategy, as outlined at its Capital Markets Event on 23 March 2022, which includes accelerating organic growth, capitalising on a simplified technology portfolio, driving operational leverage and enhancing growth and returns. The Company is focused on the actions and investments which support this strategy and its five year accelerated growth plan. The Board believes the delivery of this strategy will create significant value for the Company's shareholders.

My opinion - it’s not clear why the potential bidder pulled out, but I can only assume it’s down to current economic & stock market bearishness. Also. we're not told how involved the bidder got - did they do due diligence, etc? I wish disclosures would be more open about bid approaches.

RWS has a long track record of delivering excellent shareholder value.

It’s now dropped by almost half from the average share price in the last 3 years.

It could be worth a look for investors with a strong constitution. Often the best long-term buys are when everyone is scared witless, like they are now.

.

.

---

Jack's section

Ocean Wilsons Holdings (LON:OCN)

Share price: 1,010p (unchanged)

Shares in issue: 35,363,040

Market cap: £357.2m

Q1 trading update to 31 March 2022

This is a Bermuda-based investment company with a maritime services division operating out of Brazil. A slightly unusual mix for the SCVR, which comes across in Ocean’s small average daily traded volumes and 302bps spread. It’s off the radar for most despite a StockRank of 98, a single-digit forecast PE ratio, and a 5.65% forecast dividend yield.

Q1 revenue of $101.4m is up 9.6% and EBITDA of $45.9m, up 9.5% on the same quarter last year. Net profit for the period was $27.8m, up some $23.0m on the previous period thanks to improved operating profits and foreign exchange gains.

Total containers moved declined 14.7% at 161,500 TEUs (2021: 189,300 TEUs) ‘as the impact of global container availability and delays in off-loading cargo continue to prove challenging’. TEU means 20-foot equivalent unit. Import volumes in the period declined with the closure of some Chinese ports as Covid restrictions were reintroduced.

Regarding the investment portfolio:

At 31 March 2022, the investment portfolio including cash under management amounted to US$328.2 million (31 December 2021: $351.8million) a decrease of a 6.7% decrease. At 31 March 2022, the investment portfolio represents US$9.28 or £7.08 per Ocean Wilsons share value. At 30 April 2022, the investment portfolio including cash under management amounted to US$312.9 million, a decrease of US$38.9 million (11.0%).

Conclusion

The OWIL portfolio takes a long term, conservative approach to investment and appears to be well diversified, although changes in valuation do affect group profits. The dividend yield is attractive.

There are near term uncertainties around the 57% stake in WSON, with supply chain bottlenecks and high inflation.

This is a thinly traded share, probably one to either hold as part of a diversified portfolio or to have a lot of long term conviction in. It generally doesn’t track the market, so there are periods of inactivity and the stock earns a rare Conservative RiskRating.

Directors and established shareholders own a good chunk of the business, so I think it’s going to just carry on doing its thing and not get too interested in external perceptions of progress. That could be an attractive feature for patient shareholders focused on income, but it might frustrate others.

Ocean remains something of an oddity. The StockRanks appreciate the business and have been consistently in the green since 2014, although the share price performance has been pedestrian. What would the catalyst be to spark a rerating?

---

Stelrad (LON:SRAD)

Share price: 214p (unchanged)

Shares in issue: 127,352,555

Market cap: £272.5m

Trading update

A new company here, Stelrad supplies radiators to over 500 customers across approximately 40 countries. Today we have a brief ‘slightly ahead of expectations’ AGM update.

Overall volumes are lower year-on-year against very strong comparators but this softening has been more than offset by improved margins, cost management actions, and an improved mix of premium steel panel radiators.

Stelrad's market leading products and brands ensure that the Group remains very well positioned across all key geographies. The Group continues to manage inflationary cost increases and avoid any adverse impact from supply chain dynamics through its well established supplier relationships.

Trevor Harvey, Chief Executive of Stelrad, commented:

As energy prices continue to place pressure on household incomes, our products remain central to how consumers across Europe affordably heat homes and reduce energy consumption while governments continue to debate how best to decarbonise homes and meet long-term net zero carbon commitments. We are confident in our strategy and ability to continue growing our market share both organically and through M&A as we address this important trend.

Conclusion

The share price hasn’t done much since listing, and the valuation remains fairly modest on 10.3x forecast earnings with a 3.9% dividend yield.

Again, we have poor liquidity with a 566bps spread. Trading has really dried up in general. And it doesn’t look like any analysts are covering the company so Stelrad is flying under the radar.

The group notes a leading market position, favourable regulatory tailwinds, and wider macro trends in relation to reducing home heating costs and carbon emissions. Sounds good, but this needs to be investigated in more detail. How will the company fare with inflation? Steel is a large input cost and that’s rising. There’s presumably a lot of competition out there as well.

I’m just flicking through the IPO doc now, here are some of the stated risks:

• Customer concentration - in the year ended 31 December 2020, the top 10 customers of accounted for 49% of revenue, the top 5 customers 35% of its revenue, and the largest customer 14%.
• Turkey - Stelrad has three manufacturing facilities (in the UK, The Netherlands and Turkey). The Turkish facility at Çorlu produces c71% of the group’s products in the year ended 31 December 2020) could have a material adverse effect on its manufacturing capacity.
• The Group may be adversely affected by the fluctuation in availability and cost of steel required for its products.
• Disruptions to international freight can adversely affect the Group.

Most of these strike me as particularly pertinent right now.

There’s a small free float, just 35%, and the major shareholder owns nearly 50% of the company. Meanwhile, the group’s long time CEO Trevor Harvey keeps a 9% stake.

I’m waiting to see how management handles the current difficult environment. So far, it seems to be going well, but the UK market has been plagued by poor IPOs over the past couple of years. So I think, statistically speaking, it makes sense to watch and wait for a bit. Made.com has lost nearly three-quarters of its value in less than a year for example, although Stelrad’s operating performance is certainly more encouraging.