Small Cap Value Report (Fri 2 July 2021) - CMOStores, POLR, GYM, FCAP, CBOX

Good morning, it's Paul & Jack here with the last SCVR for this week.

Timing - I'm going to type up my notes on the Cake Box Holdings (LON:CBOX) webinar today, which was good. Should be finished by c.1:30 pm.. Today's report is now finished (14:06)

Disclaimer -

A friendly reminder that we don’t recommend any stocks. We aim to cover notable trading updates & results of the day and offer our opinions on them as possible candidates for further research if they pique your interest. We tend to stick to companies that have news out on the day, and market caps up to about £700m. We avoid the smallest, blue sky type companies, and a few specialist sectors (e.g. resources, pharma/biotech).

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Agenda -

Paul's Section:

CMOStores - It's a quiet news day, so I take an initial look at a forthcoming (next week) new float. This is an online only building materials company, with a drop-shipping model. I like the concept, but generally avoid new floats.

Gym (LON:GYM) - a £31m equity placing, to accelerate new site rollouts and (I suspect!) calm the bank down. Good business model, and this seems a great time to be opening new sites, due to favourable property market opportunities. My main issue is the market cap - it looks far too expensive to me.

Cake Box Holdings (LON:CBOX) - my notes from today's interim results webinar. Very positive - management are exactly what I look for - hands on entrepreneurs, with tons of skin in the game.

Jack's Section:

Polar Capital Holdings (LON:POLR) - results from yesterday for this active fund manager. A record year for inflows, with scope for organic and acquisitive growth, plus a dividend yield of close to 5%. Tech continues to dominate assets under management and inflows remain sensitive to market conditions.

Finncap (LON:FCAP) - a year to remember for this growing broker and financial advisory business. FY22 pipeline also appears to be strong, but these businesses are cyclical and earnings can be volatile.

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Paul’s Section:

CMOStores.com Ltd

Intention to float on AIM

This looks potentially interesting.

The link above is the initial RNS on 25 June, giving some bare bones information about the company, which caught my eye. It is trying to disrupt the traditional builders merchant market, by selling online only. Goods are mostly dispatched by the manufacturers, on a drop-shipping basis, a capital-light model for CMO.

It has 7 websites:

The Group currently operates seven specialist websites,

Roofingsuperstore.co.uk
Drainagesuperstore.co.uk
Insulationsuperstore.co.uk
Doorsuperstore.co.uk
Tileandfloorsuperstore.co.uk
cmotrade.co.uk and
Totaltiles.co.uk.

There must be websites operated by traditional builders merchants, so I don’t think CMO is doing anything unique, but it does claim to be the largest online-only supplier of building materials.

It’s been going since 2008.

Current trading - strong like-for-like growth of >30%. Total growth (including acquisitions) of >70%. Both figures are the 5 months to 31 May 2021. Impressive! But for online businesses, growth is largely driven by how much they spend on marketing.

Placing and proposed admission to trading on AIM

This announcement came out today. The company’s investor website is not working at the time of writing, but there should be an admission document up there shortly.

Placing details:

• Liberum is the broker
• 34,090,909 shares have been placed at 132p, raising £45m
• Market cap will be c.£95m on admission (total of 71,969,697 shares in issue)
• Raising £27.3m for the company, and £17.7m for selling shareholders
• Looks like a private equity part disposal, with Key Capital Partners retaining 26.8%, founders 10.4%, and senior management 6.4% on admission. So I expect a lot of the cash raised will be used to pay down private equity debt, so in effect nearly all the money raised in the float is going to selling shareholders
• Diary date - shares are expected to commence trading on 8 July 2021 (next week)

My opinion - I quite like the sound of this, and will check out the Admission Document when it is published.

With new floats, I like to search the Companies House website for the historic numbers, and nearly always find that the historic profitability is nothing like as positive as presented in admission documents! These things do get buffed up for sale to the stock market.

CMOStores group accounts (company number 10710953) only go up to 31 Dec 2019, which shows revenue of £45.0m, and an operating loss of £(464)k. The tell-tale signs of private equity ownership are there (tons of debt, and high finance charges). The loss before tax was £(2.2)m for 2019.

Net asset value was horribly negative, at £(13.5)m, mainly due to £17.8m of long-term debt. Therefore the new money raised in the float is almost certainly mainly to pay off this private equity debt - in effect therefore the float is almost all money going to selling shareholders.

As I would expect for a float, the historical losses have transmogrified into EBITDA profits for 2020! So it could have been a beneficiary of the lockdowns last year. It’s also a reminder that private companies tend to not like making profits (as they don’t like paying too much corporation tax), whereas public companies tend to maximise profits to please investors. Which does beg the questions how real, and sustainable, are the reported profits at the time of flotation? Also, profit warnings in the first year or two post-floating, are quite common, as the aggressive forecasts to maximise the float price unravel. Hence why personally I rarely buy new floats. Better to monitor them for a couple of years, and see what track record emerges.

CMO has a proven record of revenue growth, profit growth and cash generation. The Group generated pro forma revenue of £67 million and pro forma adjusted EBITDA of £4.4 million in the year ended 31 December 2020 (including Total Tiles, which was acquired on 31 December 2020) and has demonstrated consistent growth before and during the COVID-19 pandemic through a combination of organic growth and acquisitions.

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Gym (LON:GYM)

279p (down 2%, at 09:10)
No. shares: 166.2m before placing + 11.35m placing shares = 177.56m post placing
Market cap: £495m (post placing)

Proposed Placing

This announcement was issued just after the market close, last night. A reader GBValue flagged it up in the comments below, so thought I’d take a look, because there’s a lot of interesting information about expansion & strategy in the announcement.

The Gym Group plc (the "Company" or "The Gym Group"), the nationwide operator of 187 low cost 24/7, no contract gyms, announces its intention to conduct a placing of new ordinary shares of 0.01p each ("Ordinary Shares") in the capital of the Company to raise gross proceeds of approximately £31 million (the "Placing").

• Funds to be used for accelerating roll-out of new sites - targeting 40 new sites in 18 months
• Attractive property deals available currently
• Potential to double number of sites ultimately
• Revised terms on £100m bank facilities linked to this placing - which does raise the question whether the bank might have pushed the company to raise more equity? Particularly as it was about to breach a covenant by the sounds of it below -

The revised agreement provides permission for a total of £10m of third-party finance leases, increased capex spend limits and waives the June 2021 covenant test due to the extended lockdown in early 2021.

Targeting 30% Return on Investment (NB. this ignores the first 2 years of trading! So it’s a buffed up figure really) - good business model, but remember there’s a fair bit of ongoing replacement capex, once heavily-used equipment & fittings wear out.

Current trading -

• Membership numbers continuing to rise, reaching 734k by 28 June 2021 (vs 794k pre-pandemic Dec 2019) - doesn’t seem to be like-for-like though, due to new site openings this might be flattered.
• All members now paying again, since freeze on fees ended in April 2021 re-opening
• Summer is seasonally quiet for new memberships
• Stronger membership growth expected in the autumn & new year trading peak (all those new years resolutions. Been there, done that, have many lapsed gym memberships under my belt!)
• Pricing remains firm. Note that GYM is at the value end of the market (no swimming pools, hence cheaper)
• Net debt £62.6m at 28 June 2021. £7.2m in stretched creditors, hence underlying net debt is £69.8m. This has almost maxed out the £70m normal bank facility, but there is a £30m extension to £100m available until June 2022.
• Cashflow positive in May 2021 (before expansionary capex) - first full month of reopening.

Result of Placing - an update at 7am this morning.

Numis & Peel Hunt have successfully placed the new shares, details:

• 11,350,000 placing shares - an increase in share count of 6.8% - fairly modest dilution, so not a problem to my mind
• Price - 275p per new share, a modest discount of 3.5%. Although note that the share price dropped almost 10% in the week before the placing was announced - could be a coincidence, but when hundreds of people are taken inside, the information can leak out. This is why shares really should be suspended a week before a placing is done, and before anyone is taken inside. Otherwise it’s a false market. Apparently that’s what they do in Australia, and we should adopt the same system here.

My opinion - given that the company was effectively maxed out on the regular part of its borrowing facility (£70m), then I reckon this looks a hybrid fundraising - ie. partly for more rapid expansion, and partly to keep the bank happy. There’s nothing wrong with that, because it’s been well-executed - only 6.8% dilution, and a modest price discount.

There’s no open offer, but they’re not really needed with a c.£500m market cap company, and a smallish fundraising with minimal discount. Small shareholders can buy in the market, at close enough to the placing price, if they want to top up.

Accelerating the roll out of new sites makes complete sense to me, given favourable market conditions in the property market.

Overall, I quite like the business model of GYM, but it’s not doing anything unique - there are plenty of other low cost gyms. Also, I question the valuation, which strikes me as much too high. The story tends to be that gyms generate lots of EBITDA. But that ignores the heavy maintenance capex, which gets a lot heavier over time, as sites age & everything wears out.

There’s also the issue that plenty of people have found other ways to exercise during the pandemic (e.g. pelatons, or running around the park, cycling craze continuing), so it will be interesting to see how long the pent-up demand of returning to the gym settles down longer term?

As you can see below, on the 3-year chart, it's already fully recovered to pre-pandemic levels, when it was richly rated. Is there scope for even further multiple expansion of the PER? Remember that new sites take time to build up into decent profits. I think the easy money has already been made on this share in the last 14 months. Further gains might be harder to come by, possibly?

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Cake Box Holdings (LON:CBOX)

325p (down 2%, at 13:42) - mkt cap £130m

Webinar today

This results presentation webinar was held from 11am, arranged by Equity Development. It was excellent, so I jotted down some key points. The slide deck & the recording of the webinar will follow in due course.

I reviewed the interim results earlier this week here. So I won’t duplicate that here.

Here are my notes from today’s webinar (NB. not comprehensive, just key points that jumped out at me).

Lots of applications for franchisees, but only 3% make it through the selection process - after quality, not quantity

Franchisees earn on average a positive EBITDA of £89k p.a., making it an attractive income, and growing

CBOX manufactures cake sponges at its in-house bakery, high margin of 70%

Actually seeing input cost price deflation, due to rapidly rising volumes

Music to my ears - the company buys freehold property “Rather than paying extortionate rents” - NB this relates to central functions, not the shops which are leased by franchisees, not the company.

Inventories rose in H1 due to buying packaging from the Far East. Increased stockpiles to avoid any possible supply interruption.

Support fund of £1.5m to help franchisees start up, but no longer needed because Nat West have recently started lending for the fitout costs, to franchisees

Home delivery - great progress from selling via UberEats & JustEat at start of pandemic, so set up their own website sales a few months later. All delivery is current run rate of £6m p.a. Gone down slightly since shops re-opening, but many people still ordering online & collecting in store.

CBOX was born in the 2008 recession, and proven highly resilient in pandemic.

New distribution centres in Midlands & North have greatly reduced road miles for deliveries to franchisees.

Pandemic has triggered high quality people applying to be franchisees - career changes, redundancy money, etc. “Never waste a good crisis!” quipped the CEO.

Kiosks - similar in revenue & profits to stores. Smaller, but higher footfall. Typically operated by a franchisee, who operates nearby shop, and delivers twice per day to the kiosk.

A major supermarket approached CBOX to do the kiosks, so was able to strike an attractie deal. Identity currently confidential, to be publicly revealed soon (but easy enough to find out, as they’re already operating LOL!)

(I think the kiosks could be very good business, and highly attractive to franchisees, potentially doubling their profit)

My question - how much profit is booked from sale of each new franchise? Answer - it averages £40k per site.

Store numbers - what’s the limit? “We always think about Greggs” - so what’s that, maybe 2k+ potential sites in the UK? Hence there could be a lot more growth to come, over the long-term.

International expansion? Not for the moment, but it’s possible, watch this space (Paul: and would suit the franchise model)

Cyber-security attack - possible fine from the ICO estimated at £14-250k. Fully provided for. Systems now secure.

Current trading strong - June 2021 LFLs in double digits

Capacity of bakeries? They only run 1 shift, so could double up if needed.

Vegan cake is in development, should be ready soon.

Red velvet product doing particularly well.

Lucky to have no direct competition nationally, although some similar companies at local level.

Average weekly sales per shop (franchises remember) has gone up from £6.3k to £6.9k.

Brexit - not much impact, as don’t buy much product from EU. Also all customers are UK-based so no impact on sales.

Recording of the webinar will be available soon.

My opinion - very positive. I’m really kicking myself for not having bought this share before, as it ticks so many of my boxes.

It’s subjective of course, but I watch as many company webinars as I can, because there’s nothing like hearing management talk about their business, to get a feel for what they are like.

In this case, the CEO and CFO made a very positive impression. I’m not looking for slick presenters, or polished pronunciation & charm. I just want to see hard-working, hands-on entrepreneurs, who know their business inside out, and can rattle off facts & figures. Also I like honest, open answers to questions, not pauses, and deflection.

CBOX passed my tests with flying colours, and I think this management seem very backable.

Even better, the CEO & CFO own 42% of the business, which is plenty of skin in the game.

Overall then, I have a positive view of this business, and regret not having bought in the past when it was good value. Unfortunately, the price is now too high for me. I’ll put it on my watchlist, as the sort of thing I would buy on a general market panic sell-off, which we get from time to time.

Well done to shareholders here, I think you’re on to a winner. Very much a coffee can, tuck away and forget stock, in my view.

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Jack’s section

Polar Capital Holdings (LON:POLR)

Share price: 860p (+0.35%)

Shares in issue: 100,113,855

Market cap: £861m

(I hold)

Polar Capital is a specialist fund manager with a particularly strong reputation for its Tech fund, which is by far its largest. Compared to other managers, it is overweight in this sector. Nearly half (49%) of its assets under management (AUM) are in its Technology strategy, up from 43% in the previous year.

It’s been a great performer over the past few months - one of the more obvious opportunities in hindsight. This is because back in January or so the group was paying out a 5.31% forecast yield despite its strong reputation, improving momentum, cash generation, and very strong profitability figures over time.

Even today, after months of steady rerating, that yield stands at an attractive 4.76%.

I've a position not because I made that connection but because somebody else pitched it for the Stockopedia Investment Club - and I’m glad they did! Here’s the more in-depth stock pitch from January. The company’s getting a little big for the SCVR but it’s a slow news day, so it looks like we have time to circle back to yesterday’s update.

Full year results

The outlook is positive with our diversified range of fund strategies, enhanced digital marketing footprint and broader distribution reach.

Highlights:

• Assets under management (AUM) +71% to £20.9bn; average AUM +18% to £16.7bn,
• Net inflows of £2.1bn and £1.7bn in acquisitions; net inflows for Q4 of £517m,
• Pre-tax profit +49% to £75.9m,
• Basic EPS +54.5% to 67.2p; adjusted diluted EPS +53% to 62.2p,
• Total dividend for the year +21% to 40p.

The results value Polar shares at 13.8x adjusted diluted FY21 earnings and are ahead of the consensus forecasts on Stockopedia. A 40p dividend makes for a yield of 4.7%.

That seems good value, given that this year has seen ‘the highest single year of growth [in AUM]’, up some 71% to £20.9bn. Trends continue to be positive - from 31 March through to 25 June, AUM increased to £22.7bn.

A total of 11 of the group’s UCITS sub funds saw positive net inflows over the reporting period, with the largest inflows recorded by Global Technology (£1.7bn), Biotechnology (£379m), Emerging Market Stars (£243m), Global Insurance (£187m) and UK Value Opportunities (£181m).

Net outflows continued from the North American Fund, however, totalling £545m over the reporting period. The rate slowed in Q3 2020 and turned positive in Q1 2021.

While core operating profit increased by 24%, strong fund performance and performance fees drove profit before tax up by 49%. No doubt Polar holds more than its fair share of ‘Covid winners’ in its overweight Tech strategy. There’s a chance this might go through a period of underperformance at some point.

The acquisitions noted above include the International Value and World Value equity team from the Los Angeles based asset manager First Pacific Advisors on 16 October 2020 and Dalton Capital on 26 February 2021 (European equities). A joint venture, Phaeacian Partners LLC has been established and a new thematic team is joining in September 2021.

Polar is focused on growth and diversification, by both channel and geography, and it sees ‘significant opportunities outside of our home market of the UK’, particularly in Continental Europe in key markets, such as Switzerland, Germany, France and Spain.

Conclusion

Despite the challenges of the pandemic and lockdowns, Polar Capital has had a very successful year. It will always be sensitive to the health of the market though, and things could have turned out quite differently.

The early stages of the COVID-19 pandemic had a significant impact on stock markets, resulting in the European funds industry's worst ever outflows in March 2020 (-£197bn). There’s been a remarkable recovery since then of course but the point remains that Polar would not be exempt from a major downturn. It does have a strong balance sheet to mitigate this, with net cash in excess of £100m.

So there’s a big exposure to Tech here, and a sensitivity to market conditions, plus the ongoing industry headwinds of margin pressure. Most players attempt to offset this with M&A and increasing scale. Polar says it has plenty of the market to aim for in this regard.

The group is diversifying into new teams and across new markets, which should in time alleviate some of the dependence on Tech as well. This can be seen in the past year’s trading, with Polar noting that ‘the vaccine induced rotation into value and cyclical stocks further benefited our value style strategies’.

The group enjoys a strong reputation, having been recently ranked 2nd for Brand Preference, 2nd for Product Quality and 4th for Account Management. Maintaining this reputation could be a key differentiator in terms of attracting inflows. To this point, Polar places great stock in its liberated culture of autonomous investment teams which allow specialists to thrive. Employee turnover is low.

Reputational risk is still a consideration for investors, should Polar’s standing deteriorate. Performance is measured in quarters in the fund management world after all.

That aside, the group expects to pay an annual dividend within a range of 55% to 85% of adjusted total earnings, so shareholders can expect to be well compensated for holding the stock. Even after a strong run, Polar qualifies for three Guru Screens and has a StockRank of 92. It’s getting flagged for good reason in my view.

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Finncap (LON:FCAP)

Share price: 38p (-3.8%)

Shares in issue: 176,585,014

Market cap: £67.1m

It’s been a bumper year in the capital markets - think of all the placings and IPO fees. Things go from feast to famine here and we’re firmly in ‘feast’ mode. Assuming societies continue to reopen, would that lead to renewed momentum in corporate activity?

It’s possible that the next year or two will continue to be strong, but I wouldn’t depend on it as a long term sustainable dynamic. It’s always been cyclical.

FinnCap has its own growth strategy in place however, which means its growth is not purely predicated on the state of the markets. Although they certainly help a great deal.

Since IPO in December 2018 the group has busily been evolving into more of a financial advisory business. Before that it was just small and mid cap equities. With more diversified operations, the business model could be improving.

Preliminary results

Highlights:

• Total income up 84% to £47.6m,
• finnCap Capital Markets revenue up 84% to £34.5m; finnCap Cavendish revenue up 66% to £12.1m,
• Adjusted PBT up from £1.6m to £9.6m; PBT up from £1.2m to £8.4m,
• Adjusted EPS up from 0.8p to 4.80p; basic EPS up from 0.49p to 4.41p,
• Total dividends 1.5p,
• Cash of £20.4m at 31 May, down to £17.2m at 29 June 2021.

The figures are ahead of Progressive Equity’s forecast of 4.4p adjusted diluted EPS and put the shares on a multiple of 8.3x. Clearly that’s low and signals a degree of skepticism that current levels of activity can be maintained.

It has been a bumper year. Total deal and advisory fees of £33.4m (FY20: £16.0m), with 76 transactions completed and £723m of equity raised via 36 public market placings and 4 IPOs. £124m of debt raised across nine completed mandates. 16 public and private M&A transactions advised on, with an aggregate value of c.£600m.

In light of this strong market, FinnCap has invested in its human capital across sales, corporate broking, and ECM. It’s targeting new sources of capital across Family Offices and Private Growth Capital, and has set up finnCap Analytics, which is focused on servicing larger hedge funds and institutional investors.

FY22 has started well with revenue ahead of last year. The deal pipeline remains strong, ‘subject to equity market conditions’, with a number of IPOs and equity fund raisings already scheduled and the expected completion of a number of private M&A transactions.

FY22 outlook: revenue to be in the £40-£50m range; staff costs (excluding share-based payments) c.58-62% and non-staff costs c£10m.

Conclusion

Funny to think of brokers providing research for other brokers. The company is well placed to take market share from… well, us.

Still, business is business and Progressive Equity (which also does a good job for PIs) is happy to give credit where it’s due regarding FinnCap’s ambitions. It does forecast a reduction in revenue and profits for FY22. Whether that reflects one-off activity levels in FY21 or is another example of prudent forecasting that can be upgraded is a point to consider.

No doubt the company’s in a sweet spot right now but, while there may well be longer term sustainable growth potential here, there’s also a risk that the share price currently reflects an unsustainable environment. The markets are forward looking, so perhaps sellers are foregoing some potential upside to ensure they can take profits while the going is good.

That said, the group says its deal pipeline remains strong so it looks like the supportive conditions are set to roll on in FY22. Anecdotally, it’s hard to escape FinnCap’s presence these days in terms of research notes and house stocks, so it does have the feel of a company making moves and taking share.

I’m slightly wary of brokers as a business model - when the times are good they can look excellent, but if you look at the share price chart of Cenkos Securities (LON:CNKS) or Numis (LON:NUM) over a period of years, you’ll see the shares can be a punishing ride when conditions turn.

I do have a favourable impression of FinnCap as a company that provides for retail investors though, and the markets it operates in are ripe for disruption, so hopefully the momentum continues.