Small Cap Value Report (Fri 26 April 2024) - LGRS, DARK, CAR, REC, BRCK

Good morning from Paul! 

Today's report is now finished.

Quarterly doom & gloom report from Begbies Traynor (LON:BEG) is published today - saying that insolvencies are heading upwards, particularly in consumer facing sectors. It calls the UK economy "troubled". Expects "thousands of businesses failing in the coming months...". I'm sure they're right, but remember BEG only focuses on the small minority of companies that are in serious financial trouble. It's not necessarily a good indicator of the future outlook for the economy as a whole, in my opinion. The overwhelming number of companies we report on here are hitting, some even beating, expectations.  

I've been a little distracted this morning, watching company webinars, here are my brief impressions -

Tortilla Mexican Grill (LON:MEX) (I hold) webinar on InvestorMeetCompany - 

• New CEO comes across a lot better than I was expecting. Former CEO felt it was time to step back, at 60, and after 10 years in the role. So looks like it was amicable handover to former CFO as new CEO - who seems energetic & full of good ideas/strategy I think. 
• CFO confirmed that it should move back into profit this year, due to consumer recovery and fixing a lot of costs (energy & food) favourably in H2 last year, helped by increased scale. 
• Big operational gearing when demand recovers. 
• Funding roll-out from own cash (so hopefully no placing!) with focus now on capital-light franchising deals (5 new stores this year), and intention to expand into Europe via franchising route. 
• Little good competition, MEX is way ahead of competition in UK & Europe, and purchase of Chilango has done well -took out the best competitor, and a good way to grab some decent London sites at lower cost than doing from scratch. 
• More effective marketing to be done this year, as brand awareness is way too low - opportunity. 
• Revised delivery strategy is working - negotiated deals with Uber Eats and JustEat only, dropped others (mostly overlapping customers). 
• "London is coming back strongly". 
• Customer loyalty system, and kiosk ordering both working well, opportunity to expand both. 
• Labour deployment being improved. 
• Supply chain & inflation easing. 
• Food is no.1 priority - best food at best price - good to hear from a bean-counter! 
• CEO has taken up running, completed a marathon in under 3 hours (wow!), and did a run round all 28 London sites (shown pictures), good promotional activity and I think demonstrates he's a good leader - prioritises spending a lot of time in stores, seeing how things work, and what can be improved, motivating teams, etc.  I like that - this type of business needs a hands-on, energetic manager, not a visionary risk-taker, in my opinion. 

Overall - I'm impressed and very happy to sit tight on my shares. I think the bears on this stock are clearly wrong. It's too cheap given the opportunity in a recovering economy, in my view. I'm keeping my personal 100p+ price target. Obviously I'm biased, as I own some shares, but that's my thinking on it, right or wrong.  I'm much happier this week than I was last week, that I've got this one right, but only time will tell!

Focusrite (LON:TUNE) - I missed the first 20 minutes, but what I did catch, and in particular the Q&A struck me as very good. 

• Both presenters CEO & CFO came across really well to me - absolutely straightforward, they answered questions honestly & directly. Didn't try to gloss over things that had gone wrong (eg problems with new product launch, and resulting excess inventories). 
• I asked about excess inventories, suggesting they should get stock turn down to 1-2 months, not >6 months presently. CFO gave good answer, saying yes stock needs to come down, but 3-4 months is their target, as they carry some raw materials at some manufacturing subsidiaries, and supply chain benefits from supporting distributors with more stock. 
• All the other answers were clear and seemed fair & balanced. 
• I mainly watch webinars to decide if I trust management or not, and to assess their ability & strategy. Being a slick presenter doesn't matter to me, and can actually be a turn-off sometimes.
• TUNE came across well on my criteria, so I'm feeling a bit more positive about its recovery potential than I did yesterday when reviewing the numbers.

I recommend watching both of these webinars when the recordings are up on IMC, as they're both interesting & useful. Let me know what your views are too, I find it interesting to hear opposing views, as they make me think more!

---

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 (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).

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.

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. 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),

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.

---

I've chosen the order to do these sections according to the "Most viewed in the community" widget on the home page here.

Other mid-morning movers (with news) -

Darktrace (LON:DARK) - up 19% to 614p (£4.31bn) - Recommended Cash Acquisition - Paul - PINK (takeover)

Buyer: Thoma Bravo LP (US private equity)

Price: $7.75/share in cash (620p at £1 = $1.25)

Premium: only 20% to last night’s close, but 148% above April 2021 IPO price. Share price had settled at c.350p in last 6 mnths, so this is a 75% premium to that.

Valuation: 34x adj EBITDA for 2023.

Irrevocable undertakings: low, only 14.4%, so it’s not a done deal yet, by any means. Needs a 75% shareholder vote.

Zooming in -

Carclo (LON:CAR)  - up 49% to 11.1p (£8m) - Full Year Trading Update - Paul - RED

Today, Carclo plc, a global leader in delivering high-precision critical components to the life sciences, aerospace, optics, and technology industries, provides an update on trading for the financial year ended 31 March 2024 ("FY 2024").

Encouraging performance, ahead of expectations in H2, and up on H1 (no figures provided). Margins improved, and has restructured. Cash generation also better than expected. It has £9.2m cash/debt headroom, but I see net debt as a big problem at £30.4m (down from £34.3m a year ago) - although it discloses net debt including leases. Excl leases, it’s about £19m I think. Complied with covenants throughout the year - which the bank relaxed in 2023 to expiry in June 2025. It doesn’t mention the giant pension scheme deficit.

H1 results show accounting pension deficit of £37m, with the 2021 actuarial deficit a gigantic £83m! Cash contributions by the company are currently running at c.£3.6m pa. It made a £(2.5)m loss before tax in H1.

Paul’s view - today’s perky sounding update glosses over the seriously bad financial situation. Although that might be an opportunity, possibly? If trading were to strongly recover, then it could further reduce bank debt. Note that it has £23m of land & buildings in fixed assets, which is actually higher than the bank debt. This could explain why the bank has given it a lifeline to turn itself around by June 2025. If that doesn’t happen, then the risk is the bank pulls the plug, and forces the sale of the freeholds to recover its money.

This remains a very high risk special situation. There’s a huge range of potential outcomes for equity, from zero if it ends up in administration or is forced to sell the operating businesses at a value below debt. Or upside cases could be a significant multibagger, if the business starts trading much better, and the bank & pension scheme can be placated. Equity is only a stub at £8m market cap. It has to be a RED here due to the high risk, and massive scale of its financial problems (bank debt and huge pension deficit), which make it very unlikely that shareholders are likely to ever receive any meaningful divis. I’ll keep an eye on it, as this could have exciting leveraged upside if trading improves a lot. So far I can’t see any evidence of that. It’s got breathing space though, so has an opportunity to turn things around over the next year. Clearly shareholders are going to get tapped for a placing, if/when it becomes possible, and the clock is ticking with bank facility expiry in June 2025. Can they pull a rabbit out of the hat, I wonder? I imagine stale bulls likely to snuff out upward price spikes, as has happened before.

---

Summaries of main sections

Loungers (LON:LGRS) - 231p (pre-market) £240m - Year End Trading Update - Paul - AMBER

Ahead of expectations update for FY 4/2024, with Liberum raising forecast EBITDA by 4% (but no change to EPS), and EPS up 8% for FY 3/2025. I see LGRS as a best in class operator, and an attractive self-funded rapid roll-out of new sites. However, it has little balance sheet support, and only achieves a low 4% PBT margin, whilst shares are priced at over 20x earnings. So it's the valuation that fails to appeal, despite it being an impressive business (albeit in a very tough sector).

Record (LON:REC) - up 3% to 63p (£126m) - Q4 Trading Update - Paul - GREEN

AuM have risen again this latest quarter, to a new record high. Although we're not told how trading overall is performing vs market expectations, a glaring gap. The main attraction is the lovely 8.0% yield. I'm a little concerned that forecast profit has been slipping, despite AuM reaching new highs. Is there an underlying problem possibly?

Brickability (LON:BRCK) - down 3% to 66.2p (£211m) - Trading Update [in line] - Paul - GREEN

A reassuring update. No signs of recovery yet in the building supplies sector, but at least things haven't got any worse. On balance, I think risk:reward could now be looking favourable, for a recovery later this year or early 2025, so I'm shifting up from amber/green to GREEN, in anticipation of cyclical recovery.

---

Paul’s Section:

Loungers (LON:LGRS)

231p (pre-market) £240m - Year End Trading Update - Paul - AMBER

Loungers, a leading operator of all-day café/bar/restaurants across the UK under the Lounge, Cosy Club and Brightside brands, today announces a trading update for the 53 weeks ended 21 April 2024 ("FY24").

Why have a year end on 21 April? Bizarre, but it doesn’t really matter.

This looks good, ahead of expectations - seems to have been nicely anticipated by the buyers in recent days who have taken the share price higher in advance of this positive update -

Continued strong like for like sales growth allied to an accelerated site roll-out, with 36 new openings in the year, expected to deliver EBITDA ahead of expectations

Key points -

Revenue £354m for the 53 weeks, up 24.7% on LY, or 22.2% excluding the distortion from 53rd week.

LFL revenues up an impressive +7.5% over the 53 weeks (similar to +7.6% LFL reported for first 32 weeks of the year).

“...continued easing of inflationary cost pressures” 

“EBITDA for FY24 to be ahead of market expectations.”

(no detailed footnote unfortunately)

Balance sheet - once again LGRS claims it is strong, which in reality it isn't. NTAV was £34m at 2/10/2022, and included only £5m in freeholds. Modest net bank debt of £9.7m, so gearing isn’t a problem.

Self-funding a rapid expansion, with 36 new sites opened (that takes some doing!) - total now 257 sites. New sites have traded well (that tends to happen, as they’re shiny & new).

Diary date - 9 July 2024 for FY 4/2024 preliminary results.

Outlook - encouraging noises about the UK consumer -

"As we start the new financial year we are looking ahead with optimism. Our experience suggests that the UK economy is holding up well and we are well positioned to deliver continued growth."

Broker update - I’m grateful to Liberum for updating us this morning, this helps us quantify the out-performance. Analyst Anna Barnfather increases EBITDA forecast by 4% for FY 4/2024, together with 6% and 7% increases for the subsequent year.

I don’t trust EBITDA, as it’s so deeply flawed after IFRS 16, and ignores a ton of real world costs. However, in the hospitality sector, pre-IFRS 16 EBITDA is actually quite a good proxy for steady state (ie. if no new sites are opened) cash generation.

To demonstrate how ridiculous the post IFRS 16 EBITDA figures are, FY 3/2024 forecast is £54.8m EBITDA, and £13.7m PBT! (adj PBT strips out the rather generous share options costs, and is £17.7m).

I prefer adj EPS as the main measure to value shares, and wish more companies would disclose this figure in their trading updates. It’s 8.9p, which is unchanged on the old forecast, strangely.

This goes up to 10.9p forecast FY 3/2025, and a large jump to 14.1p in FY 3/2026.

What valuation multiple to use? I’d say 20x forward EPS is sensible, for a successful, well-managed business that is self-funding its own store roll-out. That gets me to a target share price of 218p.

It’s already above that, so I don’t see value here. It would need to strongly out-perform forecasts in future to get me interested in wanting to buy the shares.

Paul’s opinion - this is a well-managed business, sector experts have been telling me that ever since it listed, and they’ve been proven right. Self-funding roll-outs of a successful format are often nice investments.

However, this is a very difficult sector, where net profit margins are currently very low. What’s going to change to improve that? Some costs (eg energy) are falling back from elevated levels, and food/drink inflation has moderated. But wages costs are still soaring, with now 2 years of c.10% increases in living wage, which hits hospitality the hardest as it’s by far their largest cost, at typically about 30-35% of revenues. Even though it’s trading well, LGRS is still only going to make a c.4% PBT margin this year, which is a lot of work (257 sites) by lots of people, to only generate £13.7m in PBT.

So I’m struggling to see why I would want to invest in this difficult sector, unless the valuation was extraordinarily cheap, which LGRS isn’t.

Long-term it should do well, but the price doesn’t appeal to me currently. So I’ll go with AMBER.

I’m not sure about its Brightside reincarnation of Little Chef - are these any good? Has anyone mystery shopped them? If so, do leave a comment!

---

Record (LON:REC)

Up 3% to 63p (£126m) - Q4 Trading Update - Paul - GREEN

Record plc ("Record", the "Company" or the "Group"), the specialist currency and asset manager, is pleased to announce its trading update for the three months ended 31 March 2024 ("Q4-2024") and the financial year ("FY-2024").

This struck me as good (in the context of a persistently weak share price) -

The quarter-on-quarter AuME figure is also good - rising from $99.5bn at Dec 2023, to $102.2m at Mar 2024.

Performance versus expectations? Not stated, which is a glaring gap in what they call a trading update.

Outlook -

AUME continues to grow and now exceeds USD$100 billion for the first time in our 40+ year history… the outlook for our business remains strong…  

"Building on our existing proposition and the demand we observe for our services as a specialist asset manager, we are now refining our product range to focus on a select number of best-in-class products which present attractive and meaningful opportunities for us, making Record a stronger, less concentrated, and more robust business.

Paul’s opinion - I would have preferred a clearer overview, saying how the business is performing vs market expectations. Instead we get quite granular detail, which I’ve not repeated here.

There are no broker notes available to us either. Clearly REC needs to improve its communications with investors. With most institutions not interested below £250m market cap, and existing institutional holders possibly facing redemptions, REC needs to focus on selling the shares to private investors - but we’re not getting the information we need (clearer trading updates and broker research). Although to be fair, it is good to see that REC results presentations are available on InvestorMeetCompany.

Note the broker consensus forecasts have been declining -

REC is a capital-light, niche business model, that reliably pays out nearly all earnings in divis (8% yield), which is obviously attractive to investors.

I’m going to stick with GREEN, although I’m a little concerned that the positive news on achieving its highest ever AuME has happened alongside falling forecast profitability. Is that telling us that fees are under downward pressure maybe? I recall that some readers might have mentioned that before when we’ve previously discussed REC here, so any reader feedback is welcome.

---

Brickability (LON:BRCK)

 Down 3% to 66.2p (£211m) - Trading Update [in line] - Paul - GREEN

Brickability Group plc (AIM: BRCK), the leading construction materials distributor, provides a trading update for its financial year ended 31 March 2024.

Reassuring -

Full year performance in line with expectations

But depressed conditions continue -

Trading in Q4 was delivered in line with management expectations, and continued to reflect the lower levels of demand in Bricks and associated building products experienced in the first nine months of the year.  

Group revenue for the full year is expected to be approximately £594 million, a decrease of c.13% over the prior year (FY23: £681 million) or c.18% lower on a like-for-like ("LFL") basis.

Guidance -

Full year adjusted EBITDA1 is expected to be at least £44.8 million, in line with previous guidance, demonstrating operational resilience with margins consistent with the prior year performance.

What does EBITDA turn into in real money? Isn’t it daft that we have to go to the trouble of finding a broker note, to discover what proper profit is? There’s nothing available, so I’ll have to fall back on the broker consensus numbers on the StockReport -

This tells us that the original forecasts about a year ago where somewhat too optimistic, but at least we seem to have found a floor in performance in the last 3 months. Little recovery forecast for FY 3/2025 is also quite encouraging, in that this reassures me expectations are quite grounded, hence any recovery that might begin in late 2024 or early 2025, could be positive for the shares. Risk of another profit warning probably quite modest I’m thinking.

Hence at 66.2p/share, we’re being asked to pay c.7.5x FY 3/2024 earnings, and a slightly lower PER for FY 3/2025. That seems pretty reasonable to me, and this might even become the low point in the earnings cycle. Quite attractive, but buyers/holders at this stage have to take the risk that trading might deteriorate further, if poor macro continues into 2025.

Outlook -

Despite activity levels in the sector remaining subdued, the Board believes that with leading positions across a diverse portfolio offering, the Group enters the new financial year well positioned to benefit materially from a recovery in its end markets.

Balance sheet - it’s done a lot of acquisitions, so this needs careful checking. H1 results showed net bank debt of £30.9m at Sep 2023. That looks fine to me. NAV was £181m, less intangible assets (goodwill, etc) of £149m, and deferred tax of £17m, gives me NTAV (as I calculate it) of £49m. That ‘s fine I think, because note BRCK does a lot of drop-shipping (direct from manufacturer to customer), with BRCK not actually needing to handle or own the inventories during that cycle. Clever! So it only had £34m in inventories at Sep 2023. This is what a relatively light balance sheet actually works fine here, it’s a surprisingly capital-light business model.

Note that debt will have risen somewhat since Sep 2023, due to 2 more recent acquisitions (going well, it says). It says today that leverage is expected to be 1.25x EBITDA at Mar 2024, which is OK I think. Personally I wouldn’t want to see debt go much (if any) higher.

Paul’s opinion - I quite like this, and reckon risk:reward looks quite favourable now, as indeed is I think true for the building supplies sector (if you pick carefully within that). It’s currently seeing soft demand, but that should improve in future. I have no idea when these companies will start reporting the green shoots of recovery, but BRCK is still making pretty decent profits in a depressed market, which I find encouraging, for investors who are prepared to be patient and wait for a recovery.

Downside risk is that things do another lurch down, if demand fails to recover later this year. Although I’d be surprised if that would do lasting damage to the share price, because surely the bad news is already in the price? I like that BRCK is diversifying through acquisitions, so has a wider product range now, not just bricks.

I stuck my neck out and went AMBER/GREEN at 46.5p, when it warned on profits on 11/10/2023, and the price is now up 42% from there without any actual improvement in trading or outlook. This reinforces my view that some of these shares have overshot on the downside, and now present bargain, cyclical upside opportunities.

There was another mild profit warning on 27/2/2024, which only dealt a glancing blow, with the shares down 12% to 67p on the day. Today’s price is almost the same, so this reinforces my impression that the bad news is in the price, and given time, this share looks like it could start rising.

Hence I’ll be bold, and up my view from amber/green to GREEN. After all, we need to get into these things before the green shoots of recovery appear, to bag the full benefit. Caution can mean losing out on a nice initial surge, as people dash to buy on signs of recovery.