Small Cap Value Report (Fri 19 Nov 2021) - WIN, MORE, VANL, CAR

Good morning, it's Paul here with the last SCVR for this week. Today's report is now finished - have a lovely weekend!

Agenda -

Wincanton (LON:WIN) - impressive growth in profits in H1 results. Solid trading update, and it looks set up for a possible earnings beat for FY 3/2022 maybe? I like the firm grip the company has on supply chain/labour issues, with higher costs being passed through to customers. Balance sheet is still weak, and don't ignore the pension scheme - which is currently absorbing half free cashflow. Overall though, WIN looks good value to me.

Hostmore (LON:MORE) (I hold) - the demerger from ELTA (I hold) has been a disaster in the short term, with an obvious failure on the part of Numis to line up buyers - an essential part of a demerger! I think that's created a very good buying opportunity, because the fundamentals of the business are unchanged, it's just that hardly anyone seems to know it's listed! I give my current opinion, based on the fundamentals, not emotions or short term price, and flag up an InvestorMeetCompany early next week, which might interest you.

Van Elle Holdings (LON:VANL) - a solid trading update for H1. Confirms expectations for the full year, although I think it might be limbering up to beat forecasts which look modest. Strong balance sheet pleases me, so there's no insolvency risk in my view. Probably priced about right, with a big increase in next year's earnings already anticipated in forecasts.

Carclo (LON:CAR) - previously an over-indebted basket-case. Interim results today show a dramatically improved picture. Bank debt now looks more reasonable, given a strong improvement in profits. However, the pension scheme is sucking out £4.0m p.a. in cashflow, and rules out dividends for some time to come. Hence why the equity looks cheap - because the large pension deficit has first dibs on the cashflows.

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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Wincanton (LON:WIN)

381p (pre market open) - mkt cap £475m

Half- year Results

Wincanton plc ("Wincanton" or "the Group"), a leading supply chain partner for UK business, today announces its half year results for the six months ended 30 September 2021.

The headline H1 figures certainly grab my attention in a positive way -

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The adjustments in arriving at “underlying” figures are small, and look reasonable to me, so no issues there.

Driver pay/shortages - this is clearly the biggest current problem facing logistics companies. WIN seems to have a particularly good grip on things, with contracts mostly set up so that increased costs can be passed through to customers, e.g. -

The Group has been tackling the issues together with its customers and working collaboratively to mitigate further risk and optimise service levels. Over 70% of the Group's revenue is derived from open-book contracts which provides the Group with significant direct protection against cost pressures.
We have secured initial price increases or exits on approximately 90% of our closed book transport revenue and we expect further increases will be required in the second half of the year in some contracts. Where customers have been unwilling to agree price increases, we exited contracts as they are no longer viable and so divert resources to more profitable contracts.

Maybe the company could explain this better? Some investors may not be familiar with the phrase “open-book contracts”, so I think explaining it in simpler, everyday english would be a good idea. Many companies make this mistake, of using industry jargon & abbreviations, which can lead to confusion amongst investors who are not necessarily industry experts.

Even though WIN is a fairly low margin business, the above commentary suggests to me that it probably has good pricing power currently. It’s ditching customers that won’t accept price rises, which is a very strong position to be in. Customers generally must be extremely anxious about logistics, with all the supply chain issues currently happening. Therefore paying up, for a really good & reliable logistics partner, is probably something that most are happy to do. I hadn’t really thought about this before, but it’s a bullish point to consider for WIN shares, and not something that’s likely to be fixed overnight.

Outlook - the main bit says -

Our high growth markets remain eCommerce, public sector and infrastructure and our activities, propositions and pipelines have all developed further during the first half of the year. The acquisition of Cygnia towards the end of the first half provides a platform from which to drive a step change in mid-market eFulfilment customers, expanding the target market within which we operate and extending the reputation and reach of the Group.

The Group remains on track to deliver full year profits consistent with market expectations and the Board is encouraged by the sales pipeline and remains confident in the Group's future growth opportunities.

Acquisition - a small acquisition called Cygnia was made on 10 Sept 2021, so will only have contributed 20 days trading in H1.

Cashflow - the summarised cashflow table below is very useful. I’ve highlighted some key items, namely:

1. EBITDA of £50.8m is a red herring, because of IFRS 16. It really needs to be reduced by the £13.5m of “Repayment of obligations under leases” lower down the table, because these are real world cash outflows. The sooner IFRS 16 is scrapped, the better. Accounting standards should be useful for accounts readers, not require manual adjustments to delete accounting rules which cause problems, and distort reality
2. Note how the free cashflow in H1 of £17.9m is split roughly half & half between paying dividends to shareholders, and servicing the pension deficit, which is a major drain on cashflows & is set to continue for years to come. So we cannot just ignore the pension scheme deficit payments, they’re large cash outflows - half of free cashflow in H1.

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I’m happy with profitability and outlook, so let’s check my main area of concern in the past -

Balance sheet -

Bank debt - looks fine, and the company has plenty of headroom on its bank covenants, so no issues there. Also, as trading has been so good, debt becomes less important.

Pension scheme - another area where accounting standards are utterly ridiculous. In this case, the balance sheet shows an accounting surplus (i.e. an asset) for the pension scheme of £67.6m. Yet in the real world, there’s an actuarial deficit, which is currently consuming half the company’s free cashflow. How on earth does that make sense?

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As highlighted above, the “98% hedged against the actuarial liabilities” sounds very encouraging, and I presume means that the risk of the pension deficit soaring for whatever reason (e.g. higher inflation) should be eliminated.

Another point is that the £53m estimated actuarial deficit, might result in the current c.£18m cash contributions from the company being reduced in future, maybe? These things are recalculated every 3 years, so a negotiated reduction in cash outflows looks a possibility.

To be safe, I would cross out the £67.6m pension asset from the balance sheet, and replace it with a £53m liability, thus reducing NAV by £120.6m, to better reflect reality.

Looking at the balance sheet as a whole, NAV is only £15.0m. I would adjust out the goodwill of £109.2m, and £120.6m adjustment referred to above re the pension scheme. That takes NTAV to £(214.8)m. That’s a very weak balance sheet. However, the question is, does it matter?

Arguably, with the business trading well, maybe not. Also, it has a favourable position whereby customers pay up-front, which allows it to operate normally despite having a very weak working capital position - the current ratio is extremely low at 0.63 - however, there’s almost nothing in inventories, which explains why that position is not necessarily a problem.

Overall, I think investors should at least be aware that this remains a weak balance sheet, and the company is probably reliant on bank facilities - although that’s difficult to ascertain, as we’re not given the average daily net debt - which could be worse than a snapshot on the year end date.

That said, WIN got through the pandemic without needing to raise fresh equity, so it clearly has a supportive bank, and is providing essential services to customers, so there’s no question of it ever being forced to shut down, no matter how severe any possible future lockdowns. Hence this is undoubtedly a resilient business, which makes me more comfortable with its weak balance sheet.

My opinion - I think WIN is looking increasingly impressive. Looking back through my previous notes, as the performance of the company improved, my reviews became increasingly positive, as you would expect. Investing for me isn't about forming fixed, emotional views, it's about following the facts & changing your mind when they change.

My view on WIN has moved up another notch for me today, with these strong numbers, and it looks set up for a possible beat against full year expectations.

What would we value the company at, if there was no pension scheme? A PER of 15-20 probably. Yet here we are, with a PER of about 10. To me, that is now looking an anomaly - i.e. the market seems to be applying an excessive discount for the pension scheme.

Hence I see good potential upside on this share at 388p. I reckon it’s worth maybe 25-50% more than that. Divis are increasing, so there's an income to be had whilst investors wait for a re-rating.

There was a legal claim against the company, I seem to recall, and note 16 (contingent liabilities) mentions a new possible claim, so that would be an area to clarify.

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Hostmore (LON:MORE) (I hold)

108p (up 3%, at 09:36) - mkt cap £136m

Company Presentation

I’m flagging this because quite a few readers also own this share, which was demerged from Electra Private Equity (LON:ELTA) recently.

As shareholders will be painfully aware, the demerger has been a flop so far, because Numis and other advisers completely failed to do what was required - namely drum up buying interest in the demerged companies. Instead we’re seeing daily selling, possibly driven by short term traders bailig out because there were no expected rises on demerger, and we already knew that the shareholder base contained willing sellers. In particular, Electra Private Equity (LON:ELTA) (the rump with Hotter Shoes in it) is far too small to interest most institutions, so they’re dumping into a market where there are currently few buyers.

None of this will matter in the long-term of course, but apologies from me that I didn’t anticipate this short-term disappointment. I wrongly assumed that Numis would have used its extensive contacts list to have lined up buyers, to take the stock from willing sellers. They’ve dismally failed at this, yet advisers collectively relieved us (shareholders) of an extraordinarily excessive £11m in fees.

Infuriating though it is, it’s the company fundamentals that matter, and always shine through in the long-term. We’re just at the painful point where there’s clearly a mismatch between buyers & sellers, and the price just tanks to whatever level buyers find irresistible. I’ve no idea what that price will be, but suspect we could be near the bottom, as the fundamentals on both MORE and ELTA (to be renamed “Unbound”) look really attractively priced now.

Remember nothing has changed (other than being legged over for £11m in fees)- we just now have 2 shares, instead of 1, containing the same businesses. The valuations will sort themselves out sooner or later.

Sorry if people were expecting an instant profit, although it’s really Numis who should be apologising.

Valuation - discarding emotions, and looking at the facts & figures, there’s a useful note here from Edison, which runs through forecasts which seem on the conservative side. Pre-IFRS 16 EBITDA of £29.5m for FY 12/2022 looks set up to be beaten, in my opinion.

Forecast EPS is 10.2p for FY 12/2022, so at 108p, we’re only being asked to pay a PER of 10.6 times. That’s very cheap for a self-funding roll-out of 2 brands, in a very attractive market, where lots of competition disappeared during the pandemic, and high quality sites are now available on attractive terms. It’s the ideal time to be expanding a proven format.

My opinion - the fundamentals are unchanged. Therefore, price dislocations on the demerger logically strike me as a buying opportunity. That’s assuming that you find the TGIs and Hotter Shoes businesses attractive on fundamentals or not. Some investors will, others won’t. Although I’ve found that nearly all negative views on MORE shares seem to be based on a negative personal perception of the brand, rather than analysis of the numbers. A lot of work has been done behind the scene to improve TGIs, which is one of the key things that make the shares attractive to me.

There’s a good opportunity to “meet” management, and become acquainted with the facts and figures, then you can make up your own mind, with this presentation early next week -

Hostmore plc ("Hostmore") is pleased to announce that Robert B. Cook, CEO, and Alan Clark, CFO, will provide a live presentation titled 'Hostmore: the new home for Fridays and MORE', via the Investor Meet Company platform on 23(rd) November 2021 at 12:00pm GMT.
The presentation is open to all existing and potential shareholders.

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Van Elle Holdings (LON:VANL)

45p (up c.6%, at 11:15) - mkt cap £48m

Trading Update

Van Elle Holdings plc (AIM: VANL), the UK's largest ground engineering contractor, today provides a trading update for the six months ended 31 October 2021 (the 'Period') ahead of announcing its half-year results, which are expected to be released on Monday 31 January 2022.

The text reads positively, but the conclusion is in line with expectations -

The Board is pleased with the progress delivered in the first half of the year and continues to be confident that FY22 full year performance will be in line with market expectations.

Summarising the other points -

H1 revenues £60m - up 56% on last year H1 (badly impacted by lockdown 1 remember), and up 24% on H1 before covid - so a good result by the looks if it, at least at the revenues line

“Good capacity usage across all divisions”

Residential construction is most active segment

Rail least active segment, but improving now

Management focused on improving margins - good

Cash down by £2.2m, to £6.3m in H1- due to higher working capital, and capex

Hire purchase debt reduced (no figures)

Order book £34.5m at end Oct 2021, almost unchanged in last 3 months

Supply chain - vague, but sounds OK -

The Group has continued to experience the effects of industry-wide supply chain challenges, salary inflation and short-term employee availability. These challenges continue to be mitigated at an operational level.

Outlook -

… remains confident that the strong market recovery and divisional performance will underpin an improved outlook…
The Board is pleased with the progress delivered in the first half of the year and continues to be confident that FY22 full year performance will be in line with market expectations.

My opinion - broker consensus forecast seems too low, at £100m revenues, given that £60m was achieved in H1. I’ve checked the seasonality, and pre-covid, it was sometimes H1 weighted, and other times H2 weighted, so no obvious pattern there.

I’ve checked the last reported balance sheet, which has £40.2m in NTAV - very strong for a £48m market cap company. Effectively, the company owns most of its fixed assets outright, which I very much like. That de-risks the business model almost completely, in my view - i.e. there’s not really any insolvency risk, even in a deep recession.

Thanks to Zeus, putting out a fresh note this morning. It expects 1.9p EPS in FY 04/2022 rising strongly to 3.5p next year. That puts it on PERs of 23.6 and 12.9 respectively.

I can’t get excited about this valuation, because this type of business is cyclical, and likely to be on a lowish rating permanently. Overall then, probably priced about right. There might be upside if it beats forecasts, but next year EPS is already forecast to rise by 84%, so much stronger performance is already priced-in. Hence why I can't get excited about the valuation.

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Carclo (LON:CAR)

43.8p (up c.5%, at 12:25) - mkt cap £32m

Half-year Results

Carclo plc, a global provider of value-adding engineered solutions for the medical, diagnostics, optical, electronics and aerospace industries, announces its results for the six months to 30 September 2021 ("H1 2022").

It’s been a while since I looked at this heavily indebted group, which seemed to teeter on the brink of going bust in the pandemic. However, things have moved on, with economies improving a lot, and banks seemingly more relaxed, as they see some highly indebted companies recovering, and bank debt reducing. So I’m keen to take a look at Carclo with fresh eyes, and see if things have improved, and risk reduced.

Some key H1 numbers -

Revenue £58.7m (continuing operations only) - up 17.5% on H1 LY, and up about 2% on the previous half year (H2 of FY 03/2021)

Underlying operating profit in H1 is £3.7m, up from £1.5m in H1 LY

An additional profit of £2.1m has come from one-off US grant income

Finance costs are hefty, at £1.4m, which needs to come off operating profit

Underlying H1 EPS from continuing ops is 3.25p - much better than breakeven H1 LY

So far, so good! These are very much improved numbers, and remember that’s only for H1. Could we be looking at c.5.0p EPS for the full year, by simplistically doubling the H1 number?

I can’t find any broker research notes.

Broker consensus on Stockopedia shows £114m revenues for FY 03/2022, and 3.8p. Those figures look beatable, given the H1 performance, so my crude guess of 5.0p might be possible?

Moving on to the previous concerns over the balance sheet -

Net debt has reduced to £21.6m, is down 12% from a year earlier - not a huge reduction it has to be said. That’s excluding lease liabilities. However the important point is that the business is now much more profitable, so in better shape to carry this level of debt. Hence I’d say the bank debt is now close to being sustainable.

Pension deficit - this is the other big issue. The accounting deficit has reduced a lot, but is still large, and as we know, can often be the tip of the iceberg -

IAS19 Retirement Benefit liability down to £33.4m, reduced by £24.7m since September 2020 (and reduced by £3.9m since March 2021) from improved asset returns, additional employer contributions, and initiatives progressed with the Trustees

The more important actuarial deficit calculations are not provided, so we’re in the dark about what future deficit recovery payments might be -

No initial data has yet been released on the triennial actuarial valuation of March 2021.

The current cash outflows for deficit recovery are very substantial relative to the size & profitability of the business, so ignore this issue at your peril -

In accordance with the recovery plan agreed by the Pensions Regulator and pension scheme trustees, total contributions paid by the Company (for deficit recovery contributions and scheme administration costs) for the six-month period were £2.1m (H1 2021: £1.1m). Total contributions for the six-month period to 31 March 2022 are expected to be £1.8m.

That’s £4.0m this year, giving no realistic scope for divis, and not a great deal of scope for major bank debt reduction either. Especially as capex is also quite high at £3.5m in H1. Those are big competing demands for limited cashflows.

They can’t pay divis for now anyway -

Under the terms of its financing agreements the Company is not permitted to make a dividend payment to shareholders up to the period ending in July 2023.

Outlook -

Our first half performance is ahead of our expectations even after the impact of one-off benefits is removed.

Subject to there being no significant deterioration in trading conditions as a result of supply chain or Covid-related disruption, the Board expects the positive commercial momentum seen in the first half to continue, with further product sales growth in H2. Trading margins for the second half are expected to be slightly lower than H1, reflecting the current higher cost environment.

Nevertheless, the Board currently anticipates full year underlying trading will be slightly ahead of expectations, with the one-off benefits of the Covid-related grant income and contribution from discontinued operations incremental to this.

My opinion - Carclo looks dramatically improved from when I last looked at it, when a dilutive equity fundraising (or even insolvency) seemed inevitable.

I think the position is now much better, with bank debt looking more manageable, providing improved profitability can be maintained.

The trouble is though, as things stand, the pension scheme is still such a large cashflow burden, arguably that offsets much of the value of the business.

Hence this share is mainly a geared play on the pension problem reducing, and the trading of the business improving further.

Taking into account the bank debt & pension deficit, the valuation looks about right to me.

There could yet be an equity fundraise, but I think the risk of it being hugely dilutive may have receded.

Overall then, much better than it was, but still a bit too risky for my personal taste.

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