Small Cap Value Report (Fri 24 June 2022) - DVRG, TWD, RPS

24th Jun '22 by Paul Scott

42 comments 6260 reads

Good morning, it's Paul here on my own today. Fridays are usually quiet, so Graham's here Mon-Thu, just so you know what to expect. Today's report is now finished.

Agenda - hopefully not too many bombshells today, as I'm hoping to catch up on a couple of things from earlier this week.

Deepverge (LON:DVRG) - readers were yesterday discussing apparently encouraging FY 12/2021 results. I had a dig under the bonnet last night, and discovered a Citroen 2CV with worn big ends, needing an overhaul, not a Rolls-Royce! I would steer well clear of this. In particular the £10m placing monies have gone in less than a year, and it's now using desperate-looking short term loans.

Trackwise Designs (LON:TWD) - readers asked me to look at a trading update today (revenues down, but profits in line with expectations). I was expecting to conclude it's another jam tomorrow share, but from an initial review have come away intrigued. This looks worthy of further research, and do please post a comment if you know the company well. Speculative, but looks potentially very interesting I think.

RPS (LON:RPS) - a positive update, and broker raises FY 12/2022 forecasts, for this international consulting group. Valuation maybe about right? I wouldn't be inclined to chase this one, given the macro situation. Although RPS does seem to operate in sectors that could be resilient. Gross debt is a bit higher than I would like, and there's negligible NTAV backing.

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…

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Paul Scott

24th Jun '22

Hi rmillaree,

As you know, I place huge emphasis on balance sheets & avoiding excessive debt. Hence I wouldn't have touched SAGA (I hold) if there was any chance of solvency or finance problems.

The debt is medium-dated, and it also replaced all the bank debt with another bond issuance fairly recently, which is now looking very smart indeed. There's also a cash pile which is (from memory) not far off the size of the remaining, part-repaid earlier bond.

I think if you look into the detail of the borrowings (expiry, terms, etc) you'll better understand that solvency risk is extremely low, because SAGA doesn't have to worry about bank covenants, or imminent repayment of anything.

I agree with your general point about debt, but you're ringing an alarm bell on the wrong company, which is not at risk. SAGA has deliberately set up all the debt safely, so that it won't have to call on shareholders again. It looked over-cautious at the time, but is now looking a master-stroke.

Leave it to me, to flag up the companies with problem debt, as I'm all over that issue, more so than ever! :-)

Regards, Paul.

Gostevie

Lamprell (LON:LAM) That's a horrible profit warning. It's not often a share price falls by 70% in a morning.

BlueFrew

Hi Paul, the information is buried very effectively within the £DVRG financing RNS (17th March), but the important bit is this:

"The Company may elect not to repay the Advances that fall due (see below) and, in such circumstance, the Lenders will have the option to convert the Advance's principle and interest and any relevant outstanding fees into the Company's Ordinary Shares at a price equal to the lower of (a) 80 per cent. of the average of the two lowest VWAPs in respect of Ordinary Shares during the 10 business days immediately preceding the date of the Conversion Notice and (b) Fixed Premium Placing Price up until the Maturity Date."

The 40% premium and the warrants are clearly just spoofs, so they can pick them out as highlights at the head of the release. The actual details get buried way down in the weeds.

Hi BlueFrew,

Brilliant, thank you (and well done!) for your further research on the death spiral at Deepverge (LON:DVRG)

rmillaree

Saga (LON:SAGA)

I think we will have to agree to disagree here - to be clear here i do not see any imminent concerns about the business being able to survive - but i do stand by my comments that from my viewpoint there is no shareprice floor here is the company may need to back to the market cap in hand at some stage - you cant argue that the position is not continually worsening too ref prospects (details below) . Its not the worry of insolvency just the worry that at some stage they might have to raise some cash if curent trends continue to worsen.

I do hold this share at present (losing position) so the fact there is risk does not mean i think the worse case will actually happen. You just have to look at the revolution bars situation where by the time they raised finance the shareprice was shot to pieces - so my fear would be similar.

2023 eps was expected to be 68p in january and is now expected to be only 25p !

2024 eps was expected to be 86p in january and is now expected to be only 44p

Lower profits will directly flow through to less ability to service their debt - so its clear the "safety net" that did exist back in january simply isnt as big now as it was and i like a decent safety net where there is big debt - the numbers have clearly changed for the worse and therefore risk is up imho. There are covenants in place too so not sure what they need to book to be fine in that regard - they have reasonably shiny new ships here and there should be plenty of cashflow coming in to pay off those ships so hopefully you are right that this is a complete non issue with peeps on ships the debt should be manageable- i personally do see an element of risk here that company could raise more funds "if" things take a further turn for the worse and if that were to happen my specific worry is teh price would tank in advance of that news.

Michael Tee

I have always considered Deepverge (LON:DVRG) in the most basic schoolboy terms to be Deepshit. Hope nobody is offended.

Hope you all enjoy the sun this weekend.

Michael

cmpeckham

"... in such circumstance, the Lenders will have the option to convert the Advance's principle and interest ..."

Hmmm, that could be an even bigger problem then, because even if they convert the principle, the principal will still be outstanding. Say that one of the Lender's principles is to never invest in a company that doesn't know the difference between "principle" and "principal". According to Deepverge, the Lender can convert this principle in to a holding of ordinary shares. Niiice! This would be a good deal for the Lender as it comes at zero financial cost and leaves Deepverge still obliged to repay the principal. On the other hand, this isn't really such a good deal for Deepverge shareholders, poor sods.

Forgive me for not taking this entirely seriously, but it sounds like Deepverge is verging on the deeply ridiculous.

MH1

Saga (LON:SAGA) ( I hold)

I saw this comment from Investec yesterday.

UK motor insurers – Inflationary pressures to drive industry turn? - Industry pricing has lagged claims inflation ytd, but ONS data suggests price momentum is improving. Separately, consultants EY forecast an 18 point worsening in industry combined ratio in 2022, arguing a 25% increase in rate is needed to return the industry towards profitability.

Clearly this may account for some SAGA weakness but also suggests an inflection point on the insurance side. At least they have insurance!

As for cruises they should clearly generate a lot more than last year. Will it be as much as initial forecasts, I think unlikely. On heavily reduced 2023 numbers its not even on 5x pe now. The airlines are seeing strikes and staff shortages so if people want to go away, the relative attractions of cruises have probably increased.

It clearly has headwinds but the Roger de Haan last paid circa 292p for 1m shares. Personally, I think the possibility of Saga being taken private is quite real.

supermac

There are many companies mentioned here that have large pension deficits. Presumably those that have a link to RPI are going to take a hit or are about to.

Re Saga (LON:SAGA) (I hold)

You're right that lower earnings estimates will mean lower (but still positive) cashflow, so slower debt reduction. Fair point, and we agree on this.

Due to the bond refinancing, the liquidity position is very strong - at the last update, on 27 Jan 2022, SAGA said (my bolding) -

Strong financial position following actions taken over the last 12 months:

o At 31 December, Available Cash of £151m and £100m undrawn revolving credit facility.

o Available Cash at 31 January 2022 expected to be broadly in line with the half year.

[note that this implies a rise in available cash to £175.3m, which is what the interim results said as at 31 July 2021]

So SAGA is sitting on a big cash pile, which is surely way above what it would require, even in the gloomiest scenario.

As regards the bonds, the first one is repayable in May 2024, so that's 2 years for it to raise the money. But actually, it already has the money to repay it in full!

The original £250m debt was £100m part-repaid (see RNS dated 22 June 2021) in a tender offer, so there's now £150m outstanding, to be repaid (or refinanced in May 2024). The remaining £150m bond costs 3.375% p.a. fixed rate interest, so annual cost of £5.1m. My notes, from when I went through all the detail, say "no covenants" on this bond. I think our resident bond expert said there were some technical covenants, but there's nothing related to the group's actual trading, which is what matters.

Ship loans - the lender proved very accommodating during covid, deferring repayments, but restricting payments of divis until up-to-date (perfectly reasonable, and SAGA doesn't want to pay divis for now anyway).

I've dug out my old notes, only got notes on the first 2015 ship loan, but it's also fixed rate, of 4.31%

My apologies, I'd forgotten that there actually are covenants on the ship loans.

The main one is Trading EBITDA: Debt service costs has to be above 1.2 (as at 31 July 2020, it was 3.8). I think this is interest, and capital repayments?

I'm not sure if debt service costs is just the interest, or the capital repayments too? I think it's probably the total repayments, which would be about £43m p.a. from my rough calculations. So the covenant of 1.2 times that means EBITDA needs to be above about £52m p.a.

H1 results seem to show "Trading EBITDA" of £29.3m. But that period includes mostly the second lockdown, when cruise & your were both heavily loss-making. Hence that should be a low point fro EBITDA, but would still (annualised) be enough to meet the ship loan EBITDA covenant.

The two ship loans total £516m as more recently reported at 31 July 2021. At 4.3% interest, the annual interest charge would be about £22.2m.

The interest cover covenant on the ship loans (not the bonds) says that Trading EBITDA must be above 2x, which means over about £45m, so a bit below the above level of about £52m for the other covenant (these are all just rough figures, as I don't have bang up-to-date facts/figures).

Put all that together, and it seems to me that the ship loan covenants are set at a level where PBT would need to be negative, which you can see from this table in the last interims results (doubling the figures to annualise them), in order to possibly trigger a covenant breach -

Would it matter if the ship loan covenants were breached? It would hurt sentiment for sure, but the lender would almost certainly give a covenant waiver again, as it did twice in both 2020 and 2021.

Remember that the ships are now in use, generating cashflow. Latest broker consensus is for net (of tax) profit of £35.7m, adding back corp tax of 25% and that's £47.6m PBT. Add back depreciation & interest charges (of about £60m p.a.) and EBITDA comes out at over £100m for the current year.

Hence it would take a profit miss of about £50m this year, against lowered forecasts, to risk breaching the ship loan covenants. That seems unlikely.

Put all that together, and I think it's very unlikely that SAGA would need to return to shareholders for more cash. The only scenario where that might happen, would be if covid became a major problem again, requiring a long shut down of cruise, and no Govt support.

Anyway, thanks for cajoling me into looking again at the numbers, it was a useful exercise. I'd forgotten about the cruise loan covenants, but don't see that as a problem, having stress tested it above, unless covid returns.

On balance then, an equity fundraise at SAGA looks highly unlikely, which is my main point. In a recession, I think there are many other companies, dependent on bank financing (which of course SAGA isn't), which would need to tap shareholders.

McBride (LON:MCB) springs to mind, which I think could be in serious trouble now with its heavy bank debt, and collapsed share price.

There are plenty of companies which loaded up with cheap debt in the zero interest rate period, which may come to regret it now things are tightening. SAGA shouldn't be one of them though, as its borrowings are fixed rate, and the bonds don't have trading covenants. (ship loans do, as it now turns out! Sorry again for missing that earlier, but they're set at a level which is highly unlikely to be breached).

sharw

Thanks Paul for your thoughts on Trackwise Designs (LON:TWD)

This has been on my watchlist for a couple of years but the sp had always looked too high but now it is a quarter of the price last November. Today's drop on a warning regarding revenue but not profit at first seems to give me a good chance to take a toehold but two things hold me back:

1) Results to 12/21 - previously late - 23/6/20 with notice on 12/6 and 22/6/21 with notice on 9/6 - but this morning's RNS, an opportunity to give notice says nothing. I don't want to buy shares today if they will be suspended next Friday.

2) Yes, it says "adjusted operating profit, and adjusted profit before tax, in line with market expectations" but does not quantify these. The problem here is that it is quite a spread: Edison gives eps 1.6p whereas finnCap goes for three times that at 5p, hence the 3.3p average shown by Stocko. This may be pedantic but they do not use the word 'consensus' there, so is anything between 1.6 and 5 in line?

For those wanting to do more research there are presentations on IMC and the best for a general introduction is the one not on results but on the need to increase capacity (27/11/20) https://www.investormeetcompan...

wolfspirit

@paul , thanks for covering!

The tech sounds interesting - but it would come down to electrical performance issues.

The PCB length seemed to be the main feature, but I also liked the medical use. Being able to get micro circuits and antenna in one production cuts out joins. The promise of the tech is high. However it is a design level change, not a replacement - that embeds them with OEMs but increases the sales cycle. I am hoping this current market amplifies the negativity in the short term. I'll wait for the results next week - a 20% increase in profit gets smashed these days - so "on target" with a rev drop is surely worth another 20-30% drop in SP?!?

eParo

Liontrust Asset Management (LON:LIO) up over 6%

Chunky dividend in the offing soon

MrContrarian

Trackwise Designs (LON:TWD) did a plaing and token OO in Jan at 80p, a disgusting 45% discount. The rev f/c at the time (and until yesterday) turned out to be fantasy at £21.5m. Now the SP is 50p

Holders should not be surprised to be shafted again.

£Saga

oustanding post Paul thanks for taking the time to highlight the salient points - i would agree there appears to be no imminent dangers here particualrly . - at least if saga can get its mojo back or tickover enough for debt issues to ease then hopefully tthese concerns will subside - despite holding company are still in my bad books for coppiong out ref providing an estimated range of earnings this yearb - however sketchy imho they are of such size that we should have been given something to work with - not sure if them saying nowt while winking at the brokers is enough to ensure that brokers have "downgaaded sufficiently" that does leave a bad taste in my mouth as i would be 100% certain they had a target range in mind when they told us they couldnt/woruldnt tell us.

Looking briefly at the "debt" as that is the elephant in the room

Looking at the annual report it appears the ship loans are being paid in "equal installments" between now and 2031/2032 (with covid catchup) - so presuming thats 10% lower debt each year i am happy with that - sometimes with "fixed cash repayments covering capital and interest" the loan doesnt come down much to begin with so nice to see that 10% of that debt will be gone each year (presuming my presumptions in that regard are correct) - basically long hp at decent rates and interest should presumably come down 10% each year other things being equal so thats al fine and dandy.

Ref the the bonds - that is kinda the noose around the neck of the company - £400 mill is quite a wad - albeit as you say they have the cash wad - i think a bit like SCS they really ideally need to keep that cash wad handy just to stop everyone hyperventalating over the debt. I would be much happier if this was lower - we are where we are though and it should certainly be serviceable. Note in total though with ship loans and bonds they do have £572 mill to pay betwen 2-5 years - hopefully bond rollovers wont be a problem and hopefully insurance will churn out enough "clean profits" that they can eat into that debt. At present i would be happy having nil dividends with debt being paid down even if they are in a position to resume divis.

Roger Baron

rmillaree " I stand by my comments that from my viewpoint there is no shareprice floor here..." I think at times like this it is best to remember that all companies have a share price floor! The worry is it might be zero

Thanks for the reply. I think we've done a good job between us, thrashing this out! Useful exercise, so thanks again.

Cuddlesticks

I previously held, including through the heavily discounted raise. This was frustrating as I'd bought in after the previous fund raise believing that was sufficient to get to profitability....

Anyway, there are 2 divisions:

The Integrated Harness (IHT) division - this is where the growth potential is. It has one key EV customer, Arrival, with whom they have a take or pay contract. Arrival, a UK company, listed in the US via a SPAC, is making progress bringing their buses and vans to market and has customers signed up. The journey to live production has had many delays but is now due to start later in the year.

An acquisition last year helped to scale the small and slightly profitable Integrated Circuit Board (ICB) division. This seems to be a bit of cash cow (on a very limited scale).

My concern is that whilst they describe multiple exciting use cases with lots of customer interest for IHT, very little progress, in terms of agreements being signed/pilots etc, has been made in the last 18 months. This is despite past pilot studies with large car OEMs. In addition, the factory and fit out is months behind schedule, so much so, that the costs escalated. This drove the equity raise.

In summary, I agree completely with MrContrarian's wise council.

Harry Hindsight

Begs question why we are interested in duds in this time. Are there no serious good companies that have been beaten up and now very good value. Not random subscribers having bought some story and trying to get insight into their naivety.

I'm underwater with lots of SCVR hopefuls Volex (LON:VLX) for instance and jury is well and truly out - sorry don't have 5 years retire by investing - well not with Volex anyways.

Stock does lots of screening tools so lets pick some winners and not random RNS losers.

Boon

I wonder if the broker forecasts have been coming down not because of the cruise and travel side of the business, but the insurance side?

There's a recent Bloomberg article that said that insurance premiums in Q1 2022 has been the lowest ever in 6 years.

Also that as used car prices go up, spare parts cost more, labour costs more, longer wait times for repairs (so courtesy cars paid for longer), that car insurers are facing unprecedented cost increases.

Along with that, Aviva warned that bogus insurance claims could be increasing, due to cost of living squeezes.

I am re-evaluating my Saga (LON:SAGA) holdings at the moment, albeit it still seems very cheap, on a long term horizon. But it could always get cheaper based on short term headwinds.

(I hold in the Boon Fund)

Small Cap Value Report (Fri 24 June 2022) - DVRG, TWD, RPS

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Paul Scott

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