Small Cap Value Report - ELTA, W7L, UPGS

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

A quick reminder, can people please remember to put the company name or ticker in your comments. We're still getting orphan comments, where e.g. people say how much they like the company. The trouble is, many readers won't know which company you're referring to, so the comment is completely wasted. Maybe there's only one company in the article when you leave the comment, but please remember more sections are added during the morning, Thanks.

Agenda -

Paul's Section:

Electra Private Equity (LON:ELTA) - it's demerger day! ELTA shares now become just Hotter Shoes, and ELTA shareholders will receive newly listed Hostmore (ticker: MORE) shares, 3 for every 1 ELTA share. Now the market will decide how much each company is worth separately. Expect considerable short term volatility.

Jack's section:

Warpaint London (LON:W7L) - continuation of improving trends and FY results expected to be ahead of expectations. Strong momentum here after a couple of setbacks, and the founders and major shareholders remain in charge, so worth assessing the longer term prospects.

Up Global Sourcing Holdings (LON:UPGS) - supply chain issues are being mitigated and the growth prospects continue to look attractive. The recent moderation in sentiment means you can buy a growing company with a forecast dividend yield approaching 4%.

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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.

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:

Electra Private Equity (LON:ELTA)

Demerger complete, and update

This is it. It’s what I’m calling price discovery day. I hope nobody has got a stop loss order on ELTA shares, as it’s likely to plunge to c.100-150p today due to the demerger of Hostmore.

ELTA is a breakup situation, with its main investment, casual dining chain TGIs, becoming a separately listed company called Hostmore (new ticker: MORE) from 8am today. ELTA shareholders will be credited with an entitlement of MORE shares - apparently it’s 3 Hostmore shares for each ELTA share held, which will get credited to our accounts in the coming days I would imagine. So don’t panic!

Electra Private Equity PLC ('Electra', the 'Company') is pleased to announce the successful completion of the demerger of Hostmore plc ('Hostmore') and provides an update on strategy, Board composition, Hotter Shoes trading and the appointment of a new corporate broker.

I’m expecting the share prices of ELTA and MORE to be highly volatile, as the market goes through the process of price discovery to determine what it thinks each share is now worth.

Summarising the new situation from 8am today -

ELTA shares now contain just the Hotter Shoes business, and will be renamed “Unbound”, and will move to AIM, ceasing to be an investment trust, after a (formality) shareholder vote. This is all exactly as expected, there’s nothing new here.

MORE (Hostmore) shares are new, and we will get 3 for every 1 ELTA share held. This is the TGIs restaurants, and 63rd+1st new brand of cocktail bars beginning its roll out. This is the most valuable part of ELTA, so it will be interesting to see how the market values it. There should be about 117m MORE shares in issue. I’ve no idea what the starting price will be, nor where it will go, we’ll just have to wait and see. Hence I’m going to ignore the price gyrations that are likely, seeing both Unbound and Hostmore as longer term investments - they’re both excellent businesses in my opinion, that I want to hold. It could take some time for them to settle at a rational valuation, and that depends on how the market sees their prospects as independent companies, but in the short term, anything could happen because individual trades are not necessarily driven by rational calculations of the companies’ value, as we know from the markets generally - people buy & sell for all sorts of reasons, not valuation.

Hotter Shoes (to be renamed Unbound) - looks like a mini Saga (LON:SAGA) (I hold), for shoes! This could be quite a nice little share to hold, you know. Time will tell.

Unbound will initially be based on Hotter Shoes ('Hotter'), the main remaining investment owned by Electra. The transformation of Hotter over the past few years has led to a digital first proposition that has returned to growth, is profitable and cash generative. Hotter now sells to almost 30% of the female population of the UK over the age of 55 underpinned by a strong British heritage brand.

The strategy is that Hotter Shoes will broaden out into other product/service areas, targeting the over-55s, on a low-risk, partnership basis.

Board changes - not important, see RNS for details.

Hotter Shoes trading update -

This sounds good - I think it’s in line with expectations, judging from the last sentence -

Current Hotter trading has been strong and extremely pleasing in light of the market wide supply chain issues and other headwinds facing ecommerce businesses.

In H1 FY22 (ending July '21) Hotter generated EBITDA of £2.5m from revenue of £25m. As at the end of October 2021, over the prior 12 months Hotter generated revenue of £50.4m with gross margins and costs consistent with those envisaged in giving medium term guidance at the Unbound Group Capital Markets Day on 15 September 2021.

Supply chain - I can’t recall other companies saying it’s improving, so interesting to read that Hotter is seeing problems reduce now -

Hotter is seeing a reduction in the supply chain disruption evident at the start of the Autumn / Winter season in August and September. Hotter's UK manufacturing facility has provided some resilience and the reopening of supplier factories following Covid lockdowns in India and Vietnam has allowed product availability to recover in October, with further progress expected before the key November trading period.
Product demand has remained high during this period of disruption and Hotter's direct-to-consumer focused model allows some level of back-orders to be accumulated that are being satisfied as components and finished goods become available.

Recent results include higher air freight costs, which should reduce as normal sea shipping costs reduce in future. Hence higher margins in future, once costs reduce.

Note that Hotter Shoes has an interesting business model, where it imports the shoes components, and then does the final assembly in the UK. Hence product is shipped flat, i.e. compact. Whereas competitors shipping finished products are paying mostly to ship boxes with plenty of air in them!

My opinion - I’m not doing anything, will just watch with interest as price discovery for MORE & ELTA begins!

EDIT at 08:29 - I've done a very simple spreadsheet to give me a ready reckoner for how the prices of Hostmore & Unbound will compare with the old ELTA share price. I thought this might be useful to readers.

Many thanks (and my apologies) to readers Boilermaker & SurreySteve, for pointing out that I'd picked up the wrong figure for number of Hostmore shares in issue. I've now corrected the spreadsheet screenshots below, and included the Googlefinance live price look up formulae, now they're both working. Much obliged!

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And here's what it looks like in normal view -

This is now automatic, so it updates itself with the prices of MORE & ELTA (which will be renamed Unbound shortly, so the ticker will need to be changed).

Day 1 was certainly a flop. So clearly the broker (Numis) has not done a proper job in lining up buyers, and matching them with sellers. Pathetic, considering £11m was extracted in fees, in total. Also Numis are notorious for completely ignoring private investors. What are they thinking? Well, they're not thinking, obviously. Since these are consumer stocks, then promoting them to private investors was a key element of floating them, I would have thought. They've not done anything on that. I did explain to ELTA management that they would need to promote the shares to private investors, but that's been ignored. As a result the price flopped on Day 1. Never mind, over time it's the performance & prospects of the two businesses which will determine their share prices, and I'm not in a rush.

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Jack’s section

Warpaint London (LON:W7L)

Share price: 176.85p

Shares in issue: 76,752,355

Market cap: £135.7m

Warpaint has been a volatile share since listing, with a period of disappointing trading and a tricky US expansion responsible for its initial falls back in 2019. It’s come roaring back in 2021 as it’s been one of those companies that has used Covid to improve its cost base and accelerate positive change.

The share price has moderated slightly after sailing past 200p a few months back, but the underlying momentum is favourable here.

The valuation is fairly pricey: a forecast PE ratio of 33.1x falling to 27.6x (after this morning’s share price rise), so the company needs to grow but its collection of affordable cosmetics brands stand a good chance of doing so in my opinion. Earnings per share forecasts for the next two years will likely soon be upgraded, bringing those prospective PERs down.

Trading update

The improving trends seen in the first half of the year have continued and the group now expects its results for the year ending 31 December 2021 to be ahead of market expectations.

Sales for the year ending 31 December 2021 are expected to be similar to those achieved in 2019 (2020: £40.3m, 2019: £49.3m), meaning an almost immediate recovery in trade. This has been driven by growth both from new and existing customers, and is despite continuing disruption earlier on in the year.

Gross margins are being maintained ahead of those achieved in 2020 and 2019 (2020: 31.1%, 2019: 33.5%), despite some increased costs in the supply chain, particularly with freight. Adjusted EBITDA (2020: £4.2m, 2019: £7.0m) and adjusted profit before tax (2020: £2.3m, 2019: £5.2m) will be ahead of 2019 and current market expectations.

‘Adjusted’ PBT accounts for exceptional costs, amortisation of intangible assets, and share based payments. The group says it is closer to the underlying cash flow performance of the business.

An interim dividend of 2.5p per share will be paid on 26 November 2021 and the shares will go ex-dividend on 11 November 2021.

Group CEO Sam Bazini says that growth in the UK is ‘particularly strong’, with ‘significant growth elsewhere internationally and further increases in online sales’.

In line with our stated strategy, we have significant opportunities for further growth, both with our existing retailers, those such as Boots where we are expecting to launch soon, and with others that we are in discussions with. I look forward to the remainder of the year and into 2022 with a high degree of confidence.

Conclusion

The group’s own measure of adjusted earnings per share in FY19 was 6.3p. This was significantly different to the reported level of 1.8p as a result of exceptional items, amortisation costs, impairment charges, and share based payment costs. Free cash flow was healthily in excess of net profit for that year due to nearly £2.5m of amortisation, so the adjusted measure looks understandable on the face of it.

FY21 adjusted earnings per share of 7p would put the company on 25x earnings per share after this morning’s 15% rise, so still on the pricier side but not exorbitant for a small, growing cosmetics company.

The group has had its share of setbacks over the years but shareholders can be rewarded for patience as management find their feet as listed operators. That might prove to be the case here, as revenues are now growing and net profit is forecast to bounce back strongly (in fact, the forecasts will be upgraded after today’s announcement).

The StockRanks have also markedly improved. All in all, it’s worth assessing the future prospects of the group as it has shown it can adapt in the face of adversity. Current trading and the outlook appear positive, the group’s founders remain major shareholders and continue to operate the company, and it is turning out to be a strong cash generator and dividend payer.

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Up Global Sourcing Holdings (LON:UPGS)

Share price: 185.5p (+7.23%)

Shares in issue: 89,312,457

Market cap: £165.7m

UPGS has been on an exceptional run since its initial Covid fall as more investors cotton on to the group’s growth track record and competent management. Multiples have expanded but not as much as you might think. Earnings continue to rise, so the shares do not look too expensive.

Investors are much more focused on growing supply chain issues now, and UPGS’s business model relies on sourcing product from China, which means that sentiment has taken a bit of a hit more recently.

Nobody knows for sure how this will all play out and how well various management teams will be able to handle such issues, but it’s worth noting that brokers continue to expect earnings growth this year. There’s every chance the market has overreacted, although that’s far from certain and will likely only be clear in hindsight.

Final results

Highlights:

• Group revenue +17.9% to £136.4m,
• International revenue +4.4% to £43.5m; online revenue +23.2% to £20.6m,
• Underlying EBITDA +28.3% to £13.3m,
• Underlying PBT +36.6% to £11.2m; PBT +13.7% to £9.5m,
• Underlying EPS +34.2% to 10.6p per share,
• Net Debt amounted to £18.9m (FY 20: £3.8m), with a Net Debt/Underlying EBITDA Ratio of 1.4x (FY 20: 0.4x); financial headroom of £16.2m (FY 20: £21.3m),
• Full year dividend up 26.9 % to 5.020 p per share.

10.6p of EPS is marginally above the consensus forecast and puts the group on 17.4x falling to 13.2x.

The Salter purchase from FKA Brands Limited was completed on 15 July 2021, is now fully integrated, and is ‘expected to be significantly earnings enhancing in FY 22’. PETRA, the German kitchen electrical brand, has also been acquired and will be relaunched and refreshed, before initially entering the German market, followed by launches into other territories.

Current trading remains in line with expectations, with growth expected in FY22, despite the ongoing challenges of shipping availability and cost.

UPGS’s CFO Graham Screawn is to retire after eleven years with the group.

Commenting on the results, Simon Showman, Chief Executive of Ultimate Products, said:

As restrictions ease, it is becoming clear that the pandemic has ushered in structural changes to consumer behaviours, which are to the benefit of Ultimate Products and that we believe are here to stay. More home working and home cooking, a greater emphasis on hygiene and cleanliness, and a more considered approach to spending all complement our long-standing strategy of developing and building our portfolio of brands that focus on mass-market and value-led consumer goods for the home. The Board therefore remains confident in the Group's long-term prospects.

Conclusion

There’s not much comment on the supply chain situation, which is why sentiment moderated here in the first place, but perhaps that should be taken as a positive given the expectation of continued growth.

The folks over at Equity Development have a new note out and a fair value target of 275p. They expect adjusted earnings per share to continue increasing, from 10.6p this year to 14.1p next year and 15.3 the year after that. It’s a comprehensive note and well worth the read, far more thorough than you might see elsewhere for other companies.

There have been two recent acquisitions, with Salter looking particularly sensible. It’s a sizable and significant purchase that means UPGS shares continue to look reasonably valued even after the recent increase. It’s worth remembering that despite clocking up double digit long term growth CAGRs, the group is forecast to pay a 3.7% dividend in FY22 at the current share price.

M&A might well become a more regular feature in future as UPGS continues to drive growth. Online is performing well and the group’s move into supermarkets could see its branded products take share. International will also likely become more significant in the years ahead.

I would view any freight-related disruption as a temporary headwind that UPGS, as a quality operator, is able to navigate. Reports suggest these issues could last into 2023, so the problem should not be taken lightly, but I suspect the negative reaction to supply chain fears might end up proving to be a reasonable entry point.