Small Cap Value Report (Fri 15 Dec 2023) - WINE

Good morning just from Paul today as it's Friday.

Podcast update - boring companies today, so I thought it was a better use of time to record my overdue 4-8 Dec 2023 podcast instead, which is here.   The mystery share is Future (LON:FUTR) - disclosure - I hold a small entry level position. 

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Explanatory notes -

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Green (thumbs up) - means in our opinion, a company is well-financed (so low risk of dilution/insolvency), is trading well, and has a reasonably good outlook, with the shares reasonably priced. OR it's such deep value that we see a good chance of a turnaround, and think that the share price might have overshot on the downside.

Amber - means we don't have a strong view either way, and can see some positives, and some negatives. Often companies like this are good, but expensive.

Red (thumbs down) - means we see significant, or serious problems, so anyone looking at the share needs to be aware of the high risk. Sometimes risky shares can produce high returns, if they survive/recover. So again, we're not saying the share price will necessarily under-perform, we're just flagging the high risk.

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Agenda - very quiet for news today, so far -

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Summaries -

Naked Wines (LON:WINE) - up 6% to 45.5p (at 08:38) (£34m) - Half-year report - Paul - RED

I trawl through the H1 figures, which seem to show a business that's shrinking, but trading around breakeven on a realistic basis. Balance sheet is massively over-stocked with a wine lake. If this can be turned into cash, then survival could happen. In the meantime, there's a material uncertainty going concern statement over the bank covenants, and a facility that needs to be refinanced. So high risk. But as I mentioned last month, also a potentially interesting, high risk punt for the gamblers amongst us!

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Paul’s Section:

Naked Wines (LON:WINE) 

Up 6% to 45.5p (at 08:38) (£34m) - Half-year report - Paul - RED

This subscription wine service has gone badly wrong, with us reviewing it negatively every time this year. However, on the most recent profit warning I did wonder whether it might be getting into punting territory? -

SCVR 8/11/2023 - RED - Another profit warning, looks in trouble. But at 29p tempting for a high risk punt.

That’s worked out quite well in the last month, with a 48% share price rise.

Will today’s interim results be a cold shower for shareholders, or provide a further boost on recovery hopes? Let’s have a look.

As you can see from the headline below, WINE has a history of being very PR-focused (and not actually doing what it said it would do, with repeated profit warnings & a disastrous long-term track record) -

Half Year Results for the 26 weeks ended 2 October 2023 

Doing what we said we would

H1 revenues £132.3m (down 20% on H1 LY)

Adj operating profit £2.2m (down 52%)

Lots of adjustments again of £10.9m (H1 LY £4.8m)

Statutory loss before tax £(9.7)m - a big deterioration from £(0.2)m in H1 LY - but the culprit for the loss is costs which are one-offs in nature, and non-cash (goodwill write-off mostly).

Using adj PBT, I see this as just above breakeven, at about £1.2m, so not a disaster.

Adjustments to profit - are these reasonable? Surprisingly perhaps, I think yes. The £10.9m adjustments relate mainly to impairment of intangible assets, and some problem property leases. So in terms of the underlying trading of the business, I think adjusted profit measures actually are reasonable.

Inventory write-offs - this was a big concern of mine previously, as inventories are excessive, which can often hide unsaleable stock that needs to be written off. A £7.9m provision was made in H1 LY, but this time it actually reverses £0.8m of that provision, which is reassuring (assuming the figures are accurate - remember that interim figures are not audited).

Going concern statement contains a lot of information, but seems to conclude negatively, with a “material uncertainty”.

Balance sheet - is complicated! The main issue remains that there’s way too much in inventories, which has gone up again to £162m (from £138m 6 months earlier). There’s also £27m in “inventory stage payments to winemakers” - a prepayment within receivables. £34m of cash, takes the total current assets to an excessive £228m.

How is this financed? What worries me is that £80m is owed to “Angels” - customers. So where has their £80m gone? There’s only £34m in cash, which you could argue has come from the £30m of borrowings. So essentially the clients’ cash has been spent on wine, and prepayments to the winemakers. That could turn out to be OK, if the wines can be sold at a profit. Or it could turn out to be dead money, tied up in unsaleable wines. Or, what happens if customers want to take their money out?! It's been spent, so that could be a big problem, particularly if the borrowing facilities are withdrawn (which would use up the remaining cash pile to repay then). We just don’t know at this stage how this is going to turn out, but it looks potentially problematic to me.

Cashflow statement - cashflow is still negative, but nowhere near as bad as the LY H1 comparative. It looks as if the figures are stabilising, but what investors really need to see in future, is a big reduction in the inventories, which hasn’t happened yet, but management assures us that actions have been taken to reduce inventories in future. Let's hope they're given enough time to achieve this. 

Outlook - it says today guidance for FY 3/2024 (it falls into the first few days of April 2024) is for adj operating profit of £2-6m. However, I think this is really going to be nearer breakeven due to this -

We also anticipate incurring one-off cash costs of the order £5m in H2 to drive inventory and cost reduction initiatives

Recent trading and outlook

Since we gave an update on trading patterns on 7 November, performance has been satisfactory. November and December are critical trading months given the high levels of sales in advance of the holidays. Customer order volumes in November and December to date have been consistent with our forecast. Net cash (excluding lease liabilities) at the end of November was £7.1m, up from £2.8m at the half year reporting point.

Within the going concern statement it says -

However, we will continue to report a material uncertainty in our going concern assessment as trading remains volatile and we still need to conclude some supplier discussions, but I'm confident we have the headroom to weather any plausible future scenario from here.

This relates to possible breach of bank covenants -

The directors' baseline case forecast, and their severe but plausible downside scenario forecast indicate that the covenants will be met throughout the going concern period. However, the headroom on the severe but plausible downside scenario forecast is limited and actual financial performance has been adverse to budget in recent financial periods. Factoring in the potential reoccurrence of this variance into the severe but plausible downside scenario would result in a covenant breach. In addition, the Group's ability to continue to generate sufficient cash flows and complete the planned actions with external stakeholders in the forecasted period continues to give rise to uncertainty over the Group's ability to meet its covenants in the going concern period.

It is hoping to refinance on more favourable terms, sounds like possible asset-backed borrowing.

Inventory reduction - this is encouraging, and suggests it might be able to gradually get inventories down to levels that don’t stretch the balance sheet so much -

Paul’s opinion - this is best seen as a complicated, quite risky, special situation. I'm not a psychic fortune teller, so I cannot predict how things will turn out in future here, it could go either way.

I’ve tried to cover the main points above, but there’s a lot more detail in the interims. Summarising, I think the balance sheet is still solvent, with decent NTAV of £83m, way above the market cap of £34m. However, it has far too much tied up in inventories, so this is the biggest issue. If WINE can turn a lot of its wine lake into cash, then that would straighten things out nicely.

The material uncertainty in going concern is a major worry, and it sounds as if a refinancing is necessary, which may or may not be successful.

Is there a decent business in here, struggling to become visible? Not really. In reality I think it’s trading around breakeven this year, and revenues are falling because of customer attrition not being replaced with new customers at anything like enough pace.

Is it likely to go bust? I don’t think so actually, but it’s one of a range of possibilities.

Could it become a bid target? Again, that’s possible, if some private equity firm imagines it could overhaul the strategy to make the business more profitable.

My view remains that this share is an interesting, high risk punt, but only for gamblers really.

Overall, the H1 numbers are not as bad as I was expecting, and there’s a chance management could turn things around, if they’re successful in turning bloated inventories into cash. Although with revenue falling at 20%, this could be a business in danger of gradually withering away. I wouldn’t want to guess whether the outcome is good, bad, or something in between, it’s too uncertain. Hence due to the high risk, I’ll stick at RED for now.

The pandemic boom you can see below was driven by Yanks, who imagined that WINE had invented a global platform, or was it an ecosystem, I can't remember -

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