Small Cap Value Report (Fri 21 June 2024) - FRAN, NCC, XPS, KETL. Brief: BVIC, TIDE

Good morning from Paul! Here's something I prepared earlier...  (isn't that from Blue Peter?! For a 1970's reference).

Hardly any news today.

By the way, it's fine to disagree with my opinions, we welcome courteous debates. Do remember that these articles are just one person's quick review, and are intended as conversation starters.

---

Explanatory notes -

A quick reminder that we don’t recommend any shares. 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 (usually) between £10m and £1bn. We usually avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech, investment cos). Although if something is newsworthy and interesting, we'll try to comment on it. Please bear in mind the "list of companies reporting" is precisely that - it's not a to do list. We typically cover c.5 companies per day, with a particular emphasis on under/over expectations updates, and we follow the "most viewed" list of readers, so if you're collectively interested in a company, we'll try to cover it. Obviously with the resources available, we can't cover everything! Add you own comments if you see something interesting, and feel free to discuss anything shares-related in the comments.

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, if they are using unthreaded viewing of comments.

What does our colour-coding mean? Will it guarantee instant, easy riches? Sadly not! Share prices move up or down for many reasons, and can often detach from the company fundamentals. So we're not making any predictions about what share prices will do.

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. And/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.

Links:

Paul & Graham's 2024 share ideas - live price-tracking spreadsheet (2 separate tabs at bottom), Video update of results so far, June 2024.

Frozen SCVR summary spreadsheet for calendar 2023.

New SCVR summary spreadsheet from July 2023 onwards.

Paul's podcasts (weekly summary of SCVRs & macro views) - or search on any podcast provider for "Paul Scott small caps" - eg Apple, Spotify.

Phil Hanson's data analysis measuring performance of our colour-coding system in the SCVRs, from July 2023- Mar 2024 (with live prices). My video explaining/reviewing it.

My other video (June 2024) - How to screen for broker upgrades on Stockopedia.

---

Companies Reporting

---

Summaries

Franchise Brands (LON:FRAN) - down 11% to 152p (£295m) - FY 12/2023 Results - Paul - AMBER

Fires its CFO. Results are quite late. Major acquisition has resulted in debt being a bit too high for my liking. FY 12/2023 profit up strongly, but EPS flat. Cashflow looks inadequate to reduce debt fast. Overall, I don't have a strong view either way. Shares look fully priced for now.

NCC (LON:NCC) - up 8% to 156p (£490m) - Trading Update - Paul - AMBER

It's a slight beat against expectations, but these have been greatly lowered from the original forecast. Balance sheet weak. Poor long-term track record, so I'm underwhelmed by this cybersecurity company. Shares have partially recovered from a profit warning in 2023, so seem to be in an up-trend now.

XPS Pensions (LON:XPS) - up 5% to 283p (£588m) - FY 3/2024 Results - Paul - GREEN

I'm really impressed with this quality business that provides various services to the pensions sector. Impressive results for FY 3/2024, following a strong prior year too. Not cheap, but I think the valuation is justified. Positive outlook suggests more growth is in the pipeline. Debt almost cleared from a disposal. Looks good!

Strix (LON:KETL) - up 1% to 85p (£195m) - AGM Statement - Paul - RED

Trading in line with expectations. Some progress on debt reduction, including a recent 80p placing (nil discount), 5% dilution. However, debt will need refinancing in 2025, and is still way too high. Cashflow poor. I'm wary of this share until it's properly refinanced. Maybe RED is harsh, but there's dilution/insolvency risk here if the lenders don't play ball, so why get involved?

---

Paul’s Section:

Franchise Brands (LON:FRAN)

Down 11% to 152p (£295m) - FY 12/2023 Results - Paul - AMBER

Franchise Brands plc (AIM: FRAN), an international multi-brand franchise business, is pleased to announce its audited results for the year ended 31 December 2023.

CFO Mark Fryer seems to have been fired, with immediate effect. A former CFO, and then COO, Andrew Mallows, becomes interim CFO.

FRAN shares have done OK since floating in Aug 2016, being about double that level now, although all the 2024 gains have now been given up -

FRAN has grown rapidly through acquisitions, and the share count has almost tripled from c.70m to about 194m now.

A fairly recent acquisition was large, and in my view involved taking on too much debt, with leverage multiple looking a bit high for comfort -

Adjusted net debt**** of £74.7m at 31 December 2023 (31 December 2022: net cash of £9.8m), 2.48x Adjusted EBITDA.

Profitability rose decently in FY 12/2023 -

Adjusted profit before tax increased 55% to £19.7m (2022: £12.7m*).

Although no increase in adj EPS -

Adjusted EPS*** increased by 1% to 8.42p (2022: 8.34p*).

That gives a PER of 18.1x

Dividends total 2.2p for the year, a yield of only 1.4%

Major acquisition - management are certainly ambitious here -

“Another year of momentous change for the business with the acquisition of Pirtek Europe Ltd for £210.8m*****, funded by £100m of bank debt and £114.3m of equity, which has again doubled the size of the Group.”

It seems to have worked OK -

“During just over eight months of ownership in 2023, Pirtek traded at record levels, contributing as expected to the Group's results.”

Some areas of concern in the outlook -

Balance sheet - NAV is £214m, but that includes £305m of goodwill, less £34m deferred tax, so I make that NTAV (my method of calculating it) of negative £(57)m. Not great, but since this is a franchising business, the working capital is mainly on the shoulders of the franchisees. So I wouldn’t expect there to be much capital in the franchise owner group.

As mentioned above, debt looks too high, so I think FRAN needs to demonstrate it can pay down debt from cashflows in future.

Cashflow statement - it’s only really generated about £10m of positive cashflow from operations, after finance costs and leases. That’s not enough to make a major dent in the debt pile. So I think the jury is out here about ability to reduce debt in a reasonable timescale.

The big numbers are all acquisition-related, being large debt and equity raises.

Paul’s opinion - I don’t have a strong view either way, and am happy to sit on the sidelines to see how things pan out. AMBER feels about right for now, as we watch to see how the acquisitions bed in, and debt changes. As VCP mentioned in its recent results, it’s a lot more expensive to fund acquisitions with debt now. This makes it much harder for acquisitive companies to demonstrate that acquisitions add value. 

Back in the zero interest rate era, I remember every acquisition announcement from every company said it was earnings accretive, as the alternative was cash in the bank earning nothing. That’s changed now, so I think investors should be asking much tougher questions about whether acquisitions really make commercial sense, or have squandered shareholder value from management chasing share option incentives? (that's why I generally prefer owner-managers, with interests aligned).

---

NCC (LON:NCC)

Up 8% to 156p (£490m) - Trading Update - Paul - AMBER

NCC Group plc (LSE: NCC, "NCC Group" or "the Group"), a leading independent global cyber security and resilience provider, presents the following unaudited post-close Trading Update for the 12 months ended 31 May 2024 in advance of publishing its unaudited 12-month results on 1 August 2024.

We’re overdue a fresh look at this acquisitive cybersecurity group. I last reviewed it on a profit warning here on 31/3/2023. It took a while, but since then shares have gradually formed a base, then risen c.50% from the lows more recently. Although the long-term track record is not good, with the share price currently about where it was 12 years ago. Have acquisitions added value? Doesn’t look like it to me.

On to the latest update, which sounds a bit mixed -

Revenues - at £324m there’s no growth, down 1% at constant currency (down 3% reported) for FY 5/2024.

Profits look good, although I prefer higher profits from growth, rather than cost-cutting -

“Adjusted Operating Profit1 expected to be ahead of consensus2 at c.£31m driven by delivering targeted efficiencies in both gross margin and operating costs. Group gross profit margin has improved by +c.2% YOY, supported by an improvement in H2 2024 in Cyber Security gross profit margins of c.800bps to c.38% as a result of strong utilisation and operational efficiencies.”  

2 Consensus as at 12 June 2024 and as outlined on https://www.nccgroupplc.com/investor-relations/results-media/. Adjusted Operating Profit consensus amounted to £29.7m and Net debt (excluding leases) amounted to £50.4m.

That’s about a 4% profit beat - helpful, but no great shakes.

Net debt looks OK - this looks comfortable -

Net debt (excluding leases) to be better than consensus2 at c.£39m, c.£11m improvement from FY 2023, after consistent strong cash conversion and disposal gross proceeds of c.€9m from the DetACT non-core disposal as described in December 2023.

Leverage (excluding IFRS 16) as at 31 May 2024 to be c.1.0x Adjusted EBITDA (excluding IFRS 16) (H1 2024: 1.9x).

Outlook - a change of year end muddies the water, and makes it harder for investors to ascertain how a business is performing -

Paul’s opinion - I’m a bit underwhelmed by this. Cybersecurity is obviously a fashionable area to invest, for obvious reasons. However, NCC’s track record is distinctly blotchy, as you can see both from the lacklustre share price, and erratic fundamentals -

The last reported balance sheet was weak, with heavily negative NTAV.

It seems to have spent a lot on acquisitions over the years, with not much to show for it. So I worry that management are maybe just not very good, in particular at acquisitions?

It’s a slight beat against expectations, but look at the trend for expectations! -

Overall, I’m struggling to avoid the impression that NCC looks a bit of an also-ran, in a sexy sector, hence possibly priced at an undeserved premium?

I wonder what competitive advantages, or proprietary technology it has? I don’t feel motivated by these numbers to do any deeper research.

So for me, it’s at best AMBER. Tell me if I'm wrong! We necessarily have to flit from one thing to another with these reviews.

---

XPS Pensions (LON:XPS)

Up 5% to 283p (£588m) - FY 3/2024 Results - Paul - GREEN

XPS Pensions Group plc ("XPS" or the "Group"), the leading Pensions Consulting and Administration business, is pleased to announce its audited full year results for the year ended 31 March 2024 ("FY 2024").

Graham normally covers XPS. Checking back, he liked its H1 results on 23/11/2023, concluding GREEN at 227p/share. Previously he was also GREEN in June 2023, at 170p/share. Interestingly, he thought it looked good, but pricey (for a consultancy business) on both occasions, but forecast upgrades mean that it’s not only grown into the valuation, but actually now looks reasonably priced (in my view) despite a lovely rising share price -

Results for FY 3/2024 look excellent to me. A few key numbers -

Revenue up 21% to £197m, said to be due to strong demand and inflationary price increases (demonstrating pricing power).

High margins, with adj PBT up 37% to £44.5m

Disposal for £35m of NPT, has eliminated most of the group's net debt.

Adj EPS up 24% to 15.1p, a PER of 18.7x

Dividends total 10p for the year, yielding 3.5%

Recently announced - XPS will join FTSE 250.

Outlook - excerpts of key points -

We have seen continued strong demand of our services since the beginning of the year and maintain an active new business pipeline. We have continued to grow market share, but with this still under 10% there is considerable scope for us to grow further… 

The strong momentum from FY 2024 has continued into the new financial year and we remain confident in delivering against our expectations for the current year.

This looks a business on a roll - see the lovely trend on the broker consensus forecasts -

Balance sheet - NAV is £186m, but that includes intangible assets of £208m, which checking back to the 2023 annual report this is nearly all goodwill and similar relating to multiple acquisitions. There’s also £16m in deferred tax, which we usually find at companies with a lot of goodwill on the balance sheet, so I’ll write that off too. Which arrives at NTAV of £(6)m. So there’s no asset backing. Is that a problem? In a word, no! That’s because this is a people/knowledge based business, so is capital-light - ie no need for any significant physical fixed assets, and no inventories. So even though there’s no asset backing, the balance sheet looks fine to me. Negligible net debt, after the NPT disposal, means I think it has the firepower to fund more acquisitions from debt, if it wants to. I don’t have any worries about the finances, and would say dilution and insolvency risk are almost nil.

Cashflow statement - looks healthy in both FY 3/2024 and the previous year. I won’t go into all the detail, but the stand out numbers are disposal proceeds from NPT eliminating most of the bank borrowings. This looks a good, genuinely cash generative business, no funnies here!

Paul’s opinion - I’m really impressed with these numbers. Yes XPS looks a bit pricey for a consultancy business, as Graham always says when he reviews it, but I think the valuation looks fully justified. Also this is a high margin business, so it clearly has some kind of moat, and pricing power. So why wouldn’t it be on a decent PER? Hence I’m happy to run with GREEN.

FY 3/2024 results showed smashing profit growth, and that’s on top of strong prior year results. Personally I wouldn’t be buying after such a strong run, but am happy to have this one my watchlist as something to possibly buy on the dips. Trouble is, it’s this kind of instinct that caused me to never buy Warpaint London (LON:W7L) so sometimes it’s best to just pay up for a good growth company and add more on the dips, rather than stubbornly waiting for a big pullback that never comes!

---

Strix (LON:KETL)

Up 1% to 85p (£195m) - AGM Statement - Paul - RED

Strix Group Plc (AIM:KETL), the AIM quoted global leader in the design, manufacture and supply of kettle safety controls and other complementary water temperature management components…

• Tentative signs of recovery in its markets.

• FY 12/2024 profitability is in line with current market expectations (no explanation of what those are)

• Cash generation slightly ahead of expectations (no numbers).

• “anticipated net debt leverage position of less than 2.0x” (When? Year-end Dec 2024 presumably?)

• Recent placing has helped discussions with lenders (£8.7m [before fees] fresh equity raised at 80p, nil discount, 5% dilution)

• Bank facilities refinancing hoping to be done in 2025 (I see this as a considerable risk).

• Restructuring re cost-cutting and efficiency underway.

Paul’s opinion - I’ve never been comfortable with the figures at Strix. I’ve just taken another look at its H1 results, and this reinforces my scepticism. In particular, cashflows are poor, once heavy finance charges (from excessive debt) are taken into account, and £4.1m capitalised R&D in H1 alone, earnout payments, etc. This resulted in a very weak balance sheet with NTAV negative at £(34)m by June 2024, and £93m net debt (excl. leases). The remedial action taken to date only makes a small dent in those numbers.

I’m wary of this company, which is clearly financially distressed, so I think it’s safer to sit on the sidelines and wait for it to refinance the bank borrowings in 2025. The £195m valuation, and strong share price recently, do not make any sense to me. The whole thing doesn’t “smell” right to me, so I won’t be getting involved at pretty much any price. Opinions differ though, so good luck to bulls, I hope it works out for you.