Small Cap Value Report (Fri 24 Feb 2023) - KCT, CINE, ZOO, MTEC

Good morning! It's just Paul here today, with it being Friday.

I'm fizzling out into the weekend now, so will leave it there for today.

My SCVR summary podcast will be back tomorrow, after a break last weekend when I didn't have any inspiration, which happens occasionally.

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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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Made Tech (LON:MTEC)

33.5p - market cap £50m

I originally posted this as a reply to a reader query below, but am copying it here.

I did have a look at Made Tech (LON:MTEC) last night, and found it difficult to form a conclusion. H1 figures are poor as you know, but it reckons it can deliver a much better H2 performance. So there's a quite a lot of guesswork, and having to trust what management says, which is probably why the share price is volatile, and attracting traders as you say.

So there's not much value I can add by guessing as to whether it will achieve the FY outcome, or whether there's a risk of another profit warning. Big H2 weightings quite often do result in another profit warning.

What I can do to help is review the balance sheet. This looks fine. With £8.7m net cash, and NTAV of £11.9m, this strikes me as a solid balance sheet, with little to no risk of dilution or insolvency.

Share based expense looks excessive, at £1.5m in H1, and £2.4m last full year. That's taking the proverbial, given the share price performance.

Market cap of nearly £50m seems a lot for a company that has just reported negligible profit. What you're paying for is the hope that it will achieve a much greater profit in H2.

We had a good discussion about these IT consultancies a little while ago, with most readers agreeing that they're not necessarily a licence to print money, and that they quite often get into trouble with projects going over budget, inadequate staff expertise, etc.

Tpximpact Holdings (LON:TPX) was a good example of where things have gone horribly wrong, and with bank debt, its situation looks precarious. At least investors in MTEC can rely on a much stronger balance sheet with net cash, so it's a much safer bet on a recovery than TPX.

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Zoo Digital (LON:ZOO)

200p (£179m)

The positive newsflow here is gathering pace. ZOO announced another deal with a Hollywood studio earlier this week. Checking our archive here, I was sceptical on 23 Mar 2022, but turned positive on 25 Apr 2022 in response to strong trading updates. Graham was also previously sceptical, but reported here positively on ZOO on 8 July, 21 Sept, and 8 Nov 2022. The company is definitely on a roll, and broker forecasts have risen a lot. Although shares appear expensive, the excitement here looks justified because it’s got a wonderful combination of very strong organic growth, combined with increasing margins from the operational gearing. That can be an explosive mixture for profitability. Well done to holders, it looks like you’re on to a winner here!

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Cineworld (LON:CINE)

Down 33% to 2.65p 

As discussed in the reader comments below, this overly-indebted cinemas chain has made it clearer than ever today that its restructuring is almost certainly going to end with the shares being worthless. This has been obvious for a long time now, hence I cannot understand why its shares are still being traded. Surely they should have been suspended pending clarification of the financial position, which is what usually happens when a company becomes worthless? 

Anyway, we’ve warned readers away from this share for a long time, and this brief comment is just to reinforce that view - anyone dabbling with this share is almost certainly facing a 100% loss, so for goodness sake, please don’t be tempted to buy or hold any CINE shares. The equity is worthless because the value of the business probably falls short of its massive debt pile, which the company has confirmed again today. Once that stage is reached, then creditors control the situation, and just wipe out equity holders.

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Kin and Carta (LON:KCT)

148p (down 20% at 08:18)

Market cap £265m

Trading Update

Kin and Carta plc ("Kin + Carta" or the "Company"), the global digital transformation ("DX") consultancy, provides a trading update covering the six-month period ended 31 January 2023 ("H1"), ahead of the announcement of its half year financial results expected 15 March 2023.

If you think that’s a poor description of what the company does, then the “About Kin + Carta” section lower down the announcement is unadulterated gobbledegook.

Having read it all, I still have no idea what this company actually does, and am left feeling biffsquiggled! From memory, I thought KCT used to post out marketing material for banks, etc.? Although it might have disposed of that operation?

Anyway, today it’s issued a profit warning -

Following the impact of macro headwinds in late H1, the Company is reducing expectations for the year to reflect more cautionary client spending and elongated sales cycles seen across the industry…

As a consequence we expect adjusted operating profit for FY23 to be below market expectations.

We expect a return to a more normal level of growth with improved profitability in FY24 supported by the current levels of demand, increased nearshore delivery and improved cost structure.

Net debt is modest at £11.9m (under 0.5x EBITDA) - although that’s higher than the £0.5m reported at July 2022.

Previous accounts have shown enormous adjustments, which turn adjusted profits into statutory losses, so I’ve never been a fan of this company’s accounts. Too many acquisitions, and adjustments.

KCT claims to have a strong balance sheet, which is usually an amber flag. Sure enough, the NAV of £124m at July 2022 was mainly £97m intangible assets, and a £39m pension surplus. There’s not really anything in tangible net assets once these 2 items are deleted. 

Pension "surplus" - note that the last accounts explain that even though the pension scheme is in surplus, KCT is making £2.5m pa “voluntary contributions” into the pension scheme(s), plus £0.4m pa costs, until April 2025. That’s a peculiar pension scheme surplus, which is costing £2.9m pa to fund! Which is why I usually delete supposed pension surpluses from the balance sheet. The only exceptions being where a company has specifically stated that it expects to receive cash back from its pension scheme, something that is rare.

Profit guidance - There’s a fair bit of detail in today’s statement, but we have to go round the houses to work out the profit guidance. I'm totally confused by it. An 8% operating profit margin in H1 doesn't sound too bad, and seems to result in adj operating profit of £7.9m, slightly up on H1 LY of £7.7m. Why couldn't they just state what the revised number is for profit guidance, compared with the previous guidance provided?

There doesn’t seem to be any broker coverage available on Research Tree either, nothing since March 2020, so we’re in the dark for now, until revised broker consensus figures filter through next week hopefully.

Outlook - sounds more positive for H2 -

Demand remains strong heading into H2, with a strong sales pipeline of £166 million, up 45% year-on-year and record order backlog of £124 million, up 17% on prior year.

My opinion - this share has never interested me. Looking further back, it used to pay big dividends, but they were slashed after the 2008 financial crisis. The reduced divis were slashed again when the pandemic hit in 2020, and are forecast at almost nothing now. Although modest net debt, having de-geared in 2021/22, means it possibly could start paying worthwhile divis again, once trading has improved, maybe?

The accounts are really opaque, dripping with adjustments, with acquisitions and disposals muddying the water. It can’t clearly explain what it actually does, and today’s update doesn’t provide clear enough profit guidance. What investors needs is something telling us that the company expects to make £x profit this year, replacing previous guidance of £w profit. Or put that information out via brokers, ensuring that it accessible to all through Research Tree or commissioned research providers.

In this case, I’m in the dark, with inadequate information, so have no idea how to value this share.

All we have to go on, is the share price, which has dropped about 20% in early trades.

Given all the above, I have to give this one a thumbs down, mainly due to uncertainty, and the opaque accounts, rather than anything more worrying. I don’t think there’s any concern about solvency, given that net debt is low.

I’d welcome any reader comments, particularly if you’ve done more detailed research on KCT.

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Paul's SCVR Summary spreadsheet - sorry for the delay, but the summary sheet is now up-to-date. It's a hopefully useful tool, to enable subscribers to see at a glance a month's worth of SCVRs in one go. Hover over any cell to see a pop-up box with Paul/Graham's opinions on the shares, from a value investing perspective. Obviously we're not trying to predict what share prices will do, nobody knows that, we're just commenting on the fundamentals/valuation. Hopefully it might help you avoid some bad situations, and highlight some good ones too, but the detailed research is down to you - we're only doing brief reviews of companies remember.