Small Cap Value Report (Fri 17 June 2022) - Macro, BOO, HFD, ASC

17th Jun '22 by Paul Scott

132 comments 10801 reads

Good morning, it's just Paul here today. It's usually quiet for news on Fridays, so I'm planning on looking back at the carnage in the retailing sector yesterday.

Today's report is now finished. Lots of terrific reader comments this week, which is great to see, many thanks to all contributors.

Agenda -

Paul's thoughts on the current macro/markets.

Retailers that reported yesterday -

Boohoo (LON:BOO) (I hold) - an in line trading update was punished as if it had been a profit warning. Obviously ignore me, as I've been wrong on this share to date. However, there are lots of things being done behind the scenes to improve future performance. Now the last pandemic lockdown boosted prior year comparatives have washed through, we'll begin to see comparable performance on a like-for-like basis (i.e. against softer comps). This could result in a return to structural growth. Or it might not, we'll have to wait and see. I think the share price has overshot on the downside, whilst accepting fully that fundamentals have deteriorated considerably due to a variety of sector headwinds.

Halfords (LON:HFD) - strong results for FY 3/2022, but as I would expect, it's more cautious for FY 3/2023. The 27% share price fall yesterday seems excessive to me, given that we all know that consumer sentiment is softening. Could be a buying opportunity, for longer term investors. Balance sheet looks OK, but I'd prefer to see the company conserving cash going into a possible recession, rather than paying out generous divis & doing heavy capex.

ASOS (LON:ASC) - Profit guidance for FY 8/2022 is now only £20-60m. On £4bn revenues, that's effectively breakeven. Gross margin only 44% in Q3. Not good at all, but that's reflected in a dramatically lower market cap than when it was a growth darling. Some hefty Director buying today though.

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.

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About the Author

Paul Scott

Premium Member

I trained as an accountant with a Top 5 firm, but that was so boring that I spent too much time in the 1990s being a disco bunny, and busting moves on the dancefloor, and chilling out with mates back at either my house or theirs, and having a lot of fun!Then spent 8 years as FD for a ladieswear retail chain called "Pilot", leaving on great terms in 2002 - having been a key player in growing the business 10 fold. If the truth be told, I partied pretty hard at the weekends too, so bank reconciliations on Monday mornings were more luck than judgement!! But they were always correct.I got bored with that and decided to become a professional small caps investor in 2002. I made millions, but got too cocky, and lost the lot in 2008, due to excessive gearing. A miserable, wilderness period occurred from 2008-2012.Since then, the sun has begun to shine again! I am now utterly briliant again, and immerse myself in small caps, and am a walking encyclopedia on the subject. I love writing a daily report for Stockopedia.com on most weekday mornings, constantly researching daily results & trading updates for small caps. Cheese! more »

132 comments

The Phoenix

17th Jun '22

There's no shortage of oil there is thought a shortage of refiners a fund manager was telling we theres a huge refinery in Norway shut down as they can't cope with the quality of saudi oil by all counts russian oil is purer they are trying to refit it to enable them to work on the saudi oil but it will take time to complete the work to get up and running again.

Revs8

17th Jun '22

I think we need some positive news from K3 Capital (LON:K3C) to change the momentum.
They previously confirmed no known reason for the share price slide so presumably it is all down to consolidation in this weak market.
If the rising support line holds then I will too.

TheRaven

18th Jun '22

Pretty sure it's to do with the takeover of Pires Investments (LON:PIRI)

eParo

18th Jun '22

James Brumby (Langton Capital) tweeted:

Per #BBC's survey;

84% of consumers are planning to save money long term by spending less on #clothes for themselves

If you look at ASOS $ASC and Boohoo $BOO share prices - both are at staggering lows since lockdown heights, troubling consumer behaviour ahead...

#retail #stocks

Supposed 'lockdown winners' giving back their gains:

#Asos/#Boohoo - consumers are swapping fast fashion for durability, wearing #clothes until they wear out

#Car dealers - these are banking profits atm, but demand will drop off an edge as big ticket purchases are delayed

BattleOfBrit

18th Jun '22

I agree with you 100%.

The most valuable investment lesson that I ever learned was to quickly exit losing positions. If you don't do that, it's highly likely that you'll eventually lose a large amount of your capital. It seems like a simple thing to do, but I think it's the most difficult thing to achieve. I expect that 90% of people cannot do it - which explains why most people lose money when investing/trading.

What most people do not realise is that a 33% drawdown requires a 50% rise just to break even. While a 50% drawdown requires a 100% rise. This is why it is so critical to exit losing positions before the drawdown rises much beyond 20%.

Paul Scott

18th Jun '22

Hi johns54,

BOO HOO (BOO) Could you give more detail what are the lots of things behind the scenes?

I just meant the things explained in the article, i.e. things they're doing to improve the business, plus I've added some more below from my notes on the webinar a few weeks ago - e.g. -

Automating UK warehouse, expected to save £25m p.a. and make deliveries quicker.
Opening new distribution centre in Pennsylvania, which will cut US delivery times from a ponderous 7-10 days, to next day for most of US.
Total distribution capacity is being increased to £5bn annual sales, so anyone who thinks BOO has gone ex-growth (at current c. £2bn sales) seems to be barking up the wrong tree, which I think in itself is a good reason to expect the shares to re-rate.
Sourcing more product from Europe & N.Africa, which will be trucked into the UK, to reduce dependence on problematic Asian supply chains. "North Africa is now better value than China, factoring in China's high freight costs, also quicker".
Rebuilding Debenhams & other brands, which is requiring up-front costs & inventories build up, but which will benefit future periods as sales take off (remember Deb is a "marketplace", so has many third-party brands on it, like Next, Asos, etc). On reflection maybe they bit off more than they could chew, with multiple acquisitions? But this is getting sorted.
BOO has now lapped the last period which was boosted by the pandemic (closed competitors), therefore we should now see positive LFL revenues resume from Q2 (hopefully, not guaranteed of course).
Supply chain & distribution problems likely to naturally ease, as economies slow & companies unwind inventory build-up.
"All negatives are temporary, not structural", as the CEO said on a webinar about 3 weeks ago.
Unusually high marketing spend in FY 2/2022, of 11%, will return back to normal level of c.9% "in the medium term" (CFO), thus boosting profit margin. "We will recapture marketing efficiency when all brands scale up" (CFO)
Wholesale partnerships, "big potential" (CEO) - in Europe & M.East, a simpler & easier way to sell product, with the wholesale customer dealing with all the problems, and BOO getting a good profit margin.
PrettyLittleThing launching resale marketplace for secondhand clothes, to encourage sustainability.
ESG issues all dealt with through completed "Agenda For Change" programme.
CFO - EBITDA potential is £218m (removing one-offs and normalising costs). Actual was £125m (despite £60m of pandemic costs) - figure are for FY 2/2022.
"Invested heavily in new brands" (acquired, e.g. Debs, Dorothy Perkins, etc), £33m profit opportunity as they scale up. "New brands should scale up to breakeven this year".
Guidance - negative in Q1, will return to growth in Q2 - this was flagged well before this week's update, so should not have been a surprise to investors who were paying attention! Hence the spike down in price this week looks a mistake. Good to see half the drop recovered the next day (Friday) - coudl we have put in a bottom, I'm wondering, given that trading numbers should now start to improve, against soft/normal comps.
"Seeing an acceleration now, tough comps in Mar & Apr, now through those, in May" (CFO)
"Guidance for H2 is conservative", "Lots of factors moving in our favour for H2", "Cost pressures on core brands & Intl are baked into guidance already", "Strong H2 growth is coming from newer brands".
Core 16-24 customers want to go out & party, and are not really impacted by a lot of price rises ( Revolution Bars (LON:RBG) said a similar thing recently) - so demand might hold up better than people expect possibly?
Faster delivery is key for overseas markets, once this is fixed then expecting growth to resume in internationally.

I appreciate that management do tend to be positive all the time, so the above should be seen as them stressing the positives, and what they're doing to improve the business. But I think it does give a flavour of a management team & business on the front foot. They're focused on growth, and less on short term profitability, which doesn't help investor sentiment in the short-term. And as they say, the cost pressures are all due to external, temporary disruption. However, they're also realistic, in forecasting continued disruption & high freight prices for the rest of FY 2/2023.

I strongly recommend investors look at the very detailed results webinars that BOO does. If you go to BRRMedia website, then search for Boohoo, a page of them comes up. I recommend listening to the last 2, Q1 update, and Prelim results. My notes above are from the prelim results webinar on 4 May 2022. I'm about to listen to the Q1 update now, so will post up notes on it hopefully next week (I'm away this weekend, visiting family).

My overall view now (for what it's worth!) could be clouded by optimism of course, but I'm trying to be rational about this, and ignore the share price performance. I think there's strong evidence in the list above that performance of the business should start improving now it has lapped tough comps, and mgt are clearly doing so many things to improve the business, that I'm inclined to believe them. What with an extreme drop in share price, right now I see more upside than downside, hence why I'm bullish.

Regards, Paul.

Paul Scott

18th Jun '22

Hi danjamesbaker,

Maybe she and I should try to make some money going on a speaking tour? I could be the warm up, with my lost opportunity of £30m on Asos, and she can be the main act, about her winning lottery ticket for £182m which was rejected as her bank bounced the purchase price of £2.50.

Mind you, would me having £30m or her having £182m have actually improved our lives? Probably not. Many lottery winners go completely off the rails, and often lose the lot, then commit suicide. I think it's totally immoral giving such a ridiculous amount of money to ordinary people, who then won't know how to handle it.

Lottery winners also often lose family & friend relationships, then sit around, lonely, in a mansion wondering what happens next, and having to constantly make stressful decisions over what to do with the money, how to invest it, how to avoid being ripped off, etc.? Very bad. I'd give most of it away, to charities & friends/families. Indeed during my investing career, I've already given away about £1m to friends/family/charity. After all, what's the point of hoarding money you don't need, and seeing people you love going without things they need? As one of my investing friends says, "Who wants to be the richest corpse in the cemetery?!"

They should split lottery wins down into much smaller amounts, say £1-5m each, which will make a difference to so many more people, but without ruining peoples' lives. Or, make the prize a monthly payment for life, to allow a lavish lifestyle, but not introduce the risk of them blowing up. I cannot fathom why anyone would actually want £182m? I don't.

Anyway, my approach is, if something does go disastrously wrong, I can't undo it, so just find a way of moving on, and thinking about all the positive things instead. That got me through my personal disaster in 2008, which took about 8 years to recover from. There are whiffs of deja vu at the moment, with a disastrous portfolio year to date, which I am struggling to cope with, as I'm sure many of us are. Every day, multiple times, I get this wave of - what an idiot I've been, if only I'd done this, etc.... But those thoughts have to be banished, as there's nothing I can do to undo the mistakes. It's just a question of learning from the mistakes (again!) and structuring things better next time.

Above all though, I've got everything I need around me - a nice place to live, a job, lovely friends & family, and some savings, and above all reasonably good health. I can rebuild my savings, have done it successfully 4 times already in bull markets. The trick I still haven't learned is when to move into cash, and getting through bear markets.

All food for thought, but it's important to keep the thought process positive - what can I learn from my mistakes. Rather than, if only I hadn't done this or that, which is completely pointless, and self-destructive.

(by the way, this is at least in part, a memo to self!)

Best wishes, Paul.

Metatron

18th Jun '22

Understanding the racial or sexual biases managements may have (including inverse ones) can help spot bad managements

Silver Moon

18th Jun '22

Also for myself, plus a second bidder entering the ring for Go-Ahead (LON:GOG)

Silver

Silver Moon

18th Jun '22

Realising gains at this time might be equivalent to selling the family silver, eh what?

Silver

Silver Moon

18th Jun '22

More historically, food. Bounteous supplies of food frees up labour for use in creating wealth. An envious position to be viewed from the UK today

Paul Scott

18th Jun '22

Hi coniston,

Fair points, to which I would add these points:

Now that Govts have discovered QE (money printing) do we really think they will put this tool back in the box & never use it again? I don't. Nor does Fed Chairman Powell. As I've mentioned before, in a testimony to congress earlier this year, he was asked what the Fed's response would be to the next proper recession? He instantly replied, "Asset purchases" - which means printing money to buy up primarily Govt debt. Which brings interest rates right down again, and enables Govts to run big deficits, funded by money-printing.

So how long will it be, before the Fed cracks, and starts reversing its current tightening policy? I've never believed that QE would be unwound, as that's a pretty much guaranteed way to push the economy into a recession. That's electoral suicide for politicians.

It'll be fascinating to see how all this works out.

It still seems odd to me, that to deal with inflation caused by external supply problems, central banks are now inducing a recession. Sure that stifles demand, and scrubs off asset bubbles, but the markets/inflation are already doing that job. So will the central banks actually need to tighten much more?

There's continuing inflation (esp food) in the pipeline, but are oil & other commodities likely to continue rising in price as demand falls? I'm looking through commodity prices now, and many have fallen back a lot from the peaks. So surely the cure for inflation is already starting? If oil comes down a lot, and supply chains normalise, then we could see inflation easing at some point in 2023, at a guess?

You could argue that a softer labour market is also needed, to reduce wage inflation pressures. That's a nasty process though, with weaker companies going bust, freeing up labour, and reducing the bargaining power of staff.

Although I also understand the argument that such elevated inflation means central banks have no option than to raise rates, to stifle demand. It's a very blunt tool.

My hope is that as economies slow due to reduced consumer demand, as households focus on essentials, which are costing so much more (esp petrol/diesel, household utilities, and food), then that should do the job for the Fed, in reducing demand for other things, thus reducing prices as companies are forced to discount.

There's also the issue of excess inventories, as many companies have built up inventories to be sure of meeting demand, at a time of supply disruption. That's already led to some US big retailers saying they're over-stocked, and are now cutting prices.

It all looks horrendous for company profit margins, so profit warnings galore in the short term anyway seem likely, especially for companies with modest pricing power, and no particular product differentiation. But that's why share prices have fallen so much - the market is anticipating profit warnings. Maybe not enough though, I reckon profits could be really clobbered at some weaker companies, or even push them into losses & insolvency? So I'll be re-doubling my efforts on balance sheet warnings, and scrutinising debt more closely than ever.

I'm also looking for signs that stocks bounce after plunging on bad news, and there is already some sign of that starting in small caps. E.g. Motorpoint (LON:MOTR) (I hold) plunged on a profit warning & big reduction in forecasts, but the price recovered most of the losses within 3 days this week, checking out the intra day chart it was;

MOTR: night before profit warning, 222p (Tue pm)

Day of profit warning (wed) spiked down to low of 178p in the first hour of trading, then bounced to c.206p in second hour of trading.

Oscillated between 200-215p ever since.

Closed the week at 209p (down only 6% on pre-profit warning).

I think that's rather encouraging. It's telling me that the market seems to have largely factored in reduced earnings, at least for this company anyway. It could also encourage the many people holding cash to start putting some of that money to work, we'll have to see.

We also saw with retailers last week, that both Boohoo (LON:BOO) (I hold) and ASOS (LON:ASC) plunged on trading updates (ASC was a profit warning, but BOO wasn't, it was in line with expectations, but the market slammed it down in price anyway!), but then recovered half the falls the next day. Again, that could be a sign that we might be nearing a short term low on really bombed out smaller caps, perhaps?

I've got some fresh money in the pipeline, probably coming in some time in early 2023, and could accelerate the pace to deploy it earlier (later in 2022), but that feels too soon. I'm actually quite happy to sit and wait, because this feels more like 2000-2, when a period of exuberance & inflated valuations & bubbles ended with a prolonged bear market. Valuations were absolutely battered & investor sentiment was utterly crushed. Then of course from late 2002 onwards, the market absolutely exploded upwards, 2003 was probably my best year ever in % terms.

So I'm torn on how things stand now. Many small caps look really cheap, and I'm fairly sure selectively they could be 2-3 times current prices in say 2-3 years. However, with so many storm clouds gathering at the macro level, profits look very vulnerable indeed for many sectors - absorbing large costs (esp wages) at a time when demand is probably going to shrink, could devastate profit margins for some companies without pricing power.

All fascinating to discuss, especially at weekends when we're not distracted by RNSs and the markets! I certainly don't have the answers, because I don't have a time travelling spaceship to visit the future! But I love bouncing ideas around & hearing what other investors think too. All views are valid, because we're all guessing :-)

Regards, Paul.

P.S. Another thing to consider, is that when markets fall this much, fund managers start to see client redemptions. So open-ended funds come under pressure to sell holdings, even if they don't want to. I remember this happening in 2001-2 in particular. I was buying deep value shares at the time (things priced at less than half their own net cash, amazingly). These were nearly always dot.com junk that floated in the boom, with tons of cash that they were burning through with hopeless business models. I bought up shares in them, and launched shareholder action groups online, to pressure the companies in to distributing the cash to shareholders. All 4 of my shareholder action groups worked, and delivered 100%+ gains. It's how I got started as a professional investor. Anyway, my point is, why were fund managers selling these shares at below half the companies' own net cash? It didn't make sense to me, and I just assumed they were stupid. I recall my late friend Tony Brewer, a city veteran, telling me over lunch at the time that the sellers weren't stupid. They were just funds that were having to raise cash any way they could, to meet client redemptions (withdrawals).

It seems to me that unless something changes for the better soon, then we're likely to see a repeat of this, which could hit some small caps very hard, as the market liquidity disappears in a prolonged bear market. That leads to backed up potential sellers, who can't sell at all. I faced that in 2008 - being forced to unwind large spread bets, and often there were not any buyers at all! Or they wanted a deep discount (c.10%) to take a decent slug of shares in a micro cap (c.£100k+). Hence it's very unwise to be stuck in a tiny micro cap, if you think you might need to sell it. Chances are, if markets get worse, you won't be able to sell much, if any.

AcornInvestor

18th Jun '22

What a fantastic community this is. Thanks all for sharing your experiences and opinions in these difficult times.

The Phoenix

18th Jun '22

Great summing up Paul I often think money management is the most important and hardest part of investing its a bit like a football manager with a new team sorting out the defence before anything else.

I always try and ask myself what am I going to do if i'm wrong as we can always find hundreds of ways to hang onto a losing trade once hard earned is committed to it.

Like most I love reading your trips down memory lane with your adventures as a young scamp flipping books on the market a stand out, if you ever do write a book of your investing adventures personally I think it would be a far greater read just basing it on your life's investment journey the ups, the downs and back on the ups than a standard how to analyse stocks type book.

There was a great John Arthurs article on Friday saying if you bought after the Lehman bust you would have been down another 40% sharpish but up 400%+ now even allowing for the current worst time in the last decade.

Regards Andy

Revs8

18th Jun '22

Working on the weekend Paul? Giving us even better value for our subscription!

So many varied opinions appearing at the moment. As you say "we are all guessing".

IMO there is a significant rebalancing of public expectations underway and it is going to be uncomfortable.

I'm trying not to let macro headlines influence my opinions of individual companies. We are already starting to see some winners and losers in the same sectors so we can't assess them all with the same macro brush.

Johnnycomelately

18th Jun '22

Life is about love everything else is merely temporary.

Tommy H

18th Jun '22

It is all about Sulphur, but we do not talk such things.

abtan

19th Jun '22

Boohoo (LON:BOO) (no position)

I've read the comments and Paul's write-up at different points over the last few days so apologies if someone said this already, but I don't think Boohoo (LON:BOO) management will take the company private.

Their future capex commitments look huge and whilst cash generation is decent, I don't think it's anywhere near enough for their plans.

Even if they sold their expensive London HQ, I think they'll need more cash and will want easy access to the markets.

ASOS (LON:ASC) have spent hundreds of millions of £'s over the last 5-6 years getting warehouses set up around the globe, and still continue to spend as they continue to automate and optimise. The plan is for £200m capex in this financial year alone and they already offer next day delivery in all of the US and 85% of the rest of the world (my notes, November 2021)

Someone made an excellent point about many localised US retailers increasing their next day delivery/BOPIS (buy online, pick-up in-store) offerings as well.

I read a lot of updates from US retailers, many of whom I had never heard of 3 years ago, and can confirm that I've read as much. I imagine next day delivery is something that will very quickly be expected rather than hoped for.

Boohoo (LON:BOO) have a lot of catching up to do and they're going to need lots of cash to do it.

Richard Goodwin

19th Jun '22

I hold Manolete Partners (LON:MANO) and £bur for similar reasons. I worry though that Burford's business may suffer a little as cases are long term and inflation will eat at their values. I appreciate that awards usually include an element of interest but interest rates are lagging inflation at present.

topturkey

25th Aug '22

I also bought asos at 7p and sold at 10p happy with the 50%. Think I then rebought at 9p and sold second lot breakeven. Would have been worth £2m at the peak £70/share!!Still got the contract note somewhere

Small Cap Value Report (Fri 17 June 2022) - Macro, BOO, HFD, ASC

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Paul Scott

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