Small Cap Value Report (Fri 25 Mar 2022) - Webinars, WIX, EMAN, STAF, PEBB

25th Mar '22 by Paul Scott

69 comments 8964 reads

Good morning! It's just Paul here today, I think, not certain, can't remember, it's too early. Correction: Roland is joining me today, so we've decided to do some catch up reviews from earlier in the week, as there's not much news today in small caps. We'll get cracking, and there will be a full report up by noon (EDIT: make that c. 13:30!). Today's report is now finished.

Agenda -

Paul's Section:

Brief comments on some interesting recent webinars.

Staffline (LON:STAF) - results for 2021 are a whisker ahead of guidance given in Jan 2022, so no surprises there. Positive outlook. Balance sheet problem debt has been fixed with a placing last year. It's a very low margin business, but there could be a decent trade here, if you think it can beat guidance for 2022. My sector picks would be much higher quality, and reasonably priced Robert Walters (LON:RWA) and Sthree (LON:STEM) for the longer term, although STAF could be an interesting shorter term trade, possibly?

Pebble (LON:PEBB) - 2021 results were published on Tuesday, and are rather good - profit now exceeding pre-pandemic levels. Balance sheet is fine. Cashflow isn't great, with profit being flattered by capitalising development spend. Nevertheless, I think this could be an interesting growth company for subscribers to research further.

Roland’s section:

Wickes (LON:WIX) - 2021 results from this home improvement group show continued growth last year. But sales fell during the second half and one-off factors relating to Covid and the group’s separation from Travis Perkins (LON:TPK) are still distorting the results.

Everyman Media (LON:EMAN) - operating metrics suggest this premium cinema group is enjoying a strong recovery and could return to 2019 levels. But I think a lot of the good news is already in the price. I’d want to see concrete evidence of returning profitability before considering a purchase.

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…

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davidjhill

25th Mar '22

Personally I think you miss the point. What Fridays does is offer an experience. It's an American dinner with all the razzle, dazzle and bustle, very family and party friendly. The food is fine for what it is. If you are a foodie then you are going to be picky (me included here) but thats just not the point. Pizza Express by way of comparison is also very expensive for what it produces, there is much better out there cheaper but again it offers an experience. A trusted brand where you take the kids. We would never eat there on our own but when the kids were younger were there all the time. They loved both places.

I have to say every time I go past a Fridays it is busy. The fact that you consider it a crap restaurant doesn't mean that many others will. What will be interesting is to see how consumer demand plays out over the coming year. I would however pat the directors on the back for having the good sense to hedge energy costs, look after staff and have long term food deals in place. There are many out there that haven't. At a minimum it gives the board a high level of certainty over their cost base.

haha - thanks rmillaree.

Yes, I think Paul had the quote down correctly, but nonetheless it has the same effect. I agree that prodding and inferring is irritating though. I understand their reluctance for all the reasons Paul has outlined from the presentation earlier but it is annoying. If you are broadly comfortable with analyst expectations then just say so, or put a margin of safety around it.

Anyway - my take on it hasn't really changed. It's a 3 year play for me but as always depends on the world returning to some sort of normality. It feels like a long time now!!

Paul Scott

planetx,

Have a lovely weekend.

RutlandRam

Judges Scientific (LON:JDG) appears to be a very well run business with a great track record and very good at buy and build which is by no means common !
My concern over the medium/longer term is the situation with the CEO and 11% shareholder who is now 71. The business is still quite small ( £90m turnover) so it is possible that it is dominated by the CEO. Not in an aggressive/negative sense of the word but in terms of him being the main driving force behind the business and its business model. And if he moves on, and they lose that energy and expertise, could the business struggle to replicate what has previously been achieved ? I appreciate that the CFO and COO have been onboard a while and of course there are ways of mitigating the change. Perhaps this was mentioned in the presentation ?
My other concern is a short term one and not particularly significant, but I noticed that Trade Debtors over 90 days old had more than doubled from £1m to £2.1m. Hopefully this is not indicative that an important customer is in some trouble. It would be interesting to know the current status , given that these were numbers from almost 3 months ago ?

Epsilon

Re Hostmore (LON:MORE) and most other consumer facing businesses, the Morningstar publication 'The Little Book that Builds Wealth' is the one that I often refer to.

The simple truth is that some industries are brutally competitive and have awful economics. The book suggests that companies that 'cater directly to the consumer, like restaurants & retailers, often have a hard time building competitive advantages - the percentage of consumer service companies with wide moats is one of the smallest of all the market sectors. The culprit here is low switching costs.. walking down the street from one shop or cafe to another us incredibly easy, and popular concepts can almost always be copied with ease'

Given the squeeze on UK discretionary spend in 2022, now more than ever would appear a time to favour B2B over B2C. It's hard to see where the positive earnings surprises from B2C companies will come from?

BnB

re Staffline (LON:STAF)

Excellent coverage Paul. “Why would I want to own a business of such low quality” is a perfect summation of my view.

I would add in defence of the share that the new MD is a smart guy, more margin focused than his predecessors. And you are spot on with the point that the turnaround here could yield a bigger growth in profit- and therefore valuation - until the first sniff of a downturn, when investors should run for the hills (or to the quality two we both prefer?)

Have a good weekend.

Dicky Mint

Hi intuitive6191

My experience in all 5 was. Very poor attention to detail, huge delay in delivery of food and drinks, on 3 occasions the food took so long to come off the pass it was cold and we sent it back - only to wait another 40 minutes for replacements. In sone the staff have been just rude, tables scattered with debris from previous occupants and not being cleared. I'll stop there as it sounds like a rant - it isn't honestly - just my experience. Perhaps I expect too much - decent food, fair price, hot on delivery, attentive servers to name a few things.

The food is not of the same quality as it was when TGI Fridays was TGI Fridays of old - in those days my family and I went every week and happily spent a wedge of cash for great food, great service and an experience - someone said earlier that TGI Fridays is still an experience, it isn't at all based on my recent visits, nothing like it was back in its golden days.

As in all restaurants there are a few star servers but they are let down by the wider team. Great servers won't stick around long in these venues from what I can see ...

So as I said earlier - I'll watch this because there is potential in my opinion, if they sort out the basics.

Bronstein

26th Mar '22

Same here. I drive past our local Wickes regularly and carpark is always lose to empty. It's not scientific but without more numbers it's enough to put me off. Still watching though.

intuitive6191

Many thanks for the reply. There may be potential but would fear that it might be a some time coming.

It's a pity. It takes years to build a good brand and I think that the casual dining sector is just too competitive for any loss of brand focus.

I will continue to hold a relatively small number of shares as I don't think the situation is hopeless and there might be some management activity to improve the situation.

Thank you again for the response.

JCPr

Are Staffline really such a low margin business. Yes, if you look at their revenue being the pass through revenue for the contractors/agency workers, but that's a misleading way to look at the business. They are not like a consultancy company which needs to keep up the margins and utilisation rates to cover the cost of employing the consultants. Staffline don't employ these people. The moment the work stops the contractor/agency worker is told to sling their hook. There are no associated costs of employment (except when they mess up as they did back around 2018 or so). Their costs are the cost of selling and their revenue is really just their cut of the rates their customers pay. On that basis their margings are higher than they appear.

Rusty2

If you compare Staffline (LON:STAF) with Robert Walters (LON:RWA) and Sthree (LON:STEM), you will that their margins have been a lot worse, not just around 2018 either.

Retireyoung

28th Mar '22

A notice a very positive update from Phoenix Copper (LON:PXC) today... this really still seems to be a hidden gem while all conditions are converging for massive growth.

Are Staffline really such a low margin business. - JCPr

If you compare Staffline (LON:STAF) with Robert Walters (LON:RWA) and Sthree (LON:STEM), you will that their margins have been a lot worse - Rustbucket

I didn't describe Staffline (LON:STAF) as low-margin, I described it as a business of "low quality". And you can't directly compare operating margins of recruitment companies because the primary driver of overall margin is the split between temp/contract and perm placements, the former producing vastly lower margins owing to the pass-through element of the cost.

What you can compare is the fee percentage on either type of placement, which is an indicator of "moatiness", or quality, driven by the technical abilities and market knowledge of the recruiting teams. Because this varies from placement to placement it's a very hard number to pin down from company reports but the reliable rule of thumb is that specialist recruiters in tech etc earn the highest percentage fees while generalists are forced by the market to compete on price. Sthree (LON:STEM) has some strong brands with pricing power while Staffline (LON:STAF) is a price taker. That is what I mean when I describe the latter as being of lower quality.

Further on that description, the fundamental difference between a generalist hiring firm and a tech recruiter is cyclicality. As I have stated before, the structural shortfall of tech skills outweighs all but the most severe of downturns so that the more competent continue to thrive throughout the cycle, something you cannot say for the high street.

abtan

17th May '22

Hi BnB

I recall you having some background knowledge of recruitment firms, with one particularly insightful post a couple of months ago which I can't seem to find, so I hope it's okay to message here.

I'm working through my to do list and came to KForce ($KFRC), a Technology and Finance focussed recruitment company based in the States.

Their recent numbers look really good and I believe their offering is in a sweet spot right now.

https://www.stockopedia.com/sh...
https://investor.kforce.com/ne...

I wondered whether you had ever heard of them and/if you might have an opinion?

The cash generation looks excellent and their long term share repurchases are a big plus in my book. I can't imagine growth backtracking for a while now either given the area that they operate in.

There's not much cash on the balance sheet, which I'm fine with as there could be if management wanted there to be. There's a $200m debt facility which is essentially unused (there is a net cash position.)

It appears to tick a lot of boxes.

Any thoughts, if you have the time, would be much appreciated.

Cheers

Hi Abtan

Thanks for the approach. I’m flattered you ask. I don’t know the US market and hence neither the name. But the general principles are the same everywhere. I’d say any tech recruiter is a good bet today, particularly if, like SThree (LON:STEM), they are beaten down on recession fears. That doesn’t appear to be the case in the stronger US economy so I’d check for profile and quality of revenues. You’re looking for a balance of 65% contract at a gross margin of 15% for recurring and predictable revenues (earnings) and 35% perm at a gross margin of 17.5% for cash generation (dividends and buybacks). Hopefully you can find the granularity in the SEC filings or annual report.

I do play the IT resource shortage theme globally, but in the US I prefer the outsourcer/systems integrators. $ACN is the big daddy and offers the highest quality services. But my favourite today is EPAM which has been severely re-valued on account of the Russia/Ukraine conflict - 30% of employees are from these two countries. Impressively, delivery has been barely interrupted - see last week’s quarterly report - and the business is rapidly reconfiguring resources to eliminate any remaining conflict risk. Analyst have been rapidly re-upgrading target prices but the market has yet to follow suit.

Sorry for the rushed reply but I’m heading out now and I’ll add any further thoughts tomorrow.

To clarify, those margins are fee rates not profit margins. A top recruiter should deliver an EBIT margin of 10% + but you won’t find that easily in the listed sphere

Thanks BnB, insightful stuff - I'll be sure to keep it in mind when doing more in-depth research into KForce.

I have looked at $ACN in the past, but it always looked too expensive (for me.)
I haven't looked at $EPAM though so will have a look when I can.

Thank you again for taking the time to reply, it is most appreciated.

18th May '22

Looking again at the figures this morning, the margins suggest a 70/30 balance perm/contract - the wrong way round for extracting higher lifetime revenues per placement and thus making the business more cyclical. I’m also deeply unimpressed by the revenue profile in the 5 years leading up to the pandemic. Compare almost zero growth to double digit growth pa for Robert Walters (LON:RWA) and £STEM. I’m not seeing much to get me excited and certainly not especially good value.

Accenture is always pricey but has rewarded shareholders very well. EPAM is currently an interesting value proposition - with accompanying risks - and I do hold.

19th May '22

It's amazing how much has changed in the 48 hours since this comment :)
The supposedly strong US economy seems to be struggling more than many of us realised. In any case I remained intrigued by Kforce and have done some more work on it.

The short version:
I am actually quite impressed.

The longer version:
As a Technology and Finance recruitment firm they've been able to ride a growing wave for a number of years now, taking advantage of rising salaries and increased competition for workers in niche areas.

Beyond this, I feel their key strength over the last 5 years has actually been their cost
control. Check out the declining payroll costs since 2017, which have then fed through to higher OP% and NP%:

Beyond this focus on cost control, I am also impressed that nearly all excess cash is used to buy back shares:

You mentioned some other points that I also looked into:

Nearly all revenue (96%-97%) comes from flex working.
Is this a strength? I would assume demand would be "safer" here in a recession as firms might not want to recruit permanently.
Gross Profit is consistently between 29% and 30%, save for a dip to 28% during 2020.
There was a disposal in 2019 that resulted in a restatement of the 2017 and 2018 accounts. There has actually been growth every year, though I haven't compared before 2016 as those accounts still include the discontinued operation revenues.

Usually a 3%-4% top line growth wouldn't interest me, which is why I mentioned the decreasing SGA costs before. Combining these makes the company much more appealing.

---

It's on the watchlist for now. I have a feeling that the worst is not over yet and, as much as I like the fundamentals of the business, now might not be the best time to buy.

Thank you again for taking the time to reply.
Cheers
A

20th May '22

Hi Abtan

Let me try to comment on your points:

Cost control is always good but my read on this is that they might be commoditising their service, relying on brand rather than expertise, which always leads to disappointment in the service. Although it could mean a change in delivery mechanism or IT investment that has improved productivity. Hard to be sure.

It's the American way! And more tax efficient for UK investors than dividends currently

Nearly all revenue (96%-97%) comes from flex working.
Is this a strength? I would assume demand would be "safer" here in a recession as firms might not want to recruit permanently.

Beware this statistic. As perm business has a GP of 100% and contract/temp ("flexi") between 8% and 15%, a 50/50 balanced business will have a vast preponderance of contract/temp revenues. And yes, I prefer a bias to flexi GP as it increases the lifetime value of each placement and improves visibility - very much like a switch from annual licence to SaaS. However, a high emphasis on flexi can betray a low level of technical expertise and a market position in low skill, commoditised areas like first line support, call centre etc.
Gross Profit is consistently between 29% and 30%, save for a dip to 28% during 2020.

My back of the envelope calculation arrives at a split of 90/10 flexi/perm on a GP basis with a flexi margin of only 11%. This does not suggest a high quality operator, nor one in the more technical niches - but is consistent with the emphasis on cost control. In other words, I think you are looking at £Hays , not Robert Walters (LON:RWA) or SThree (LON:STEM) .
There was a disposal in 2019 that resulted in a restatement of the 2017 and 2018 accounts. There has actually been growth every year, though I haven't compared before 2016 as those accounts still include the discontinued operation revenues. Usually a 3%-4% top line growth wouldn't interest me, which is why I mentioned the decreasing SGA costs before. Combining these makes the company much more appealing.

Growth levels support my comparison with Hays. This business could be more cyclical than you hope.

My broader observation is that the shares have not fallen enough to discount the drop in demand that might accompany a recession - or equally likely, the drop that the market might soon anticipate even if it does not transpire. The UK names have fallen much further and look to be of higher quality - at rushed glance - so I would not rush to invest. I am a buyer of SThree (LON:STEM) in particular at today's levels but I don't think the market understands the company very well at all - so the wait may be longer than the earnings justify.

Small Cap Value Report (Fri 25 Mar 2022) - Webinars, WIX, EMAN, STAF, PEBB

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Paul Scott

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