Small Cap Value Report (Fri 26 Nov 2021) - SCS, MOTR, STU, DX., HEAD

Good morning! It's Paul & Jack here with the SCVR for Friday.

Agenda -

Paul's section:

Scs (LON:SCS) - I hold - trading update shows a sharp slowdown in order intake over the last 7 weeks. However, year-to-date order intake is still slightly ahead of pre-pandemic levels, and in line with broker forecast, which are unchanged today. So this is NOT a profit warning. Valuation now well below the company's cash pile, and a PER of 7. Seems crazily cheap to me.

Studio Retail (LON:STU) - I hold - a mild profit warning yesterday on completely predictable sector-wide issues (supply chain, cost inflation), with EPS guidance lowered 18%. Hardly a disaster, and the business looks adequately financed. Very low PER now.

Dx (group) (LON:DX.) - heavily marked down on a 'corporate governance inquiry' which will delay full year accounts and likely lead to a suspension of the shares. Hard to gauge the seriousness of the situation, but it's a low margin business in a tough sector anyway, so not of interest.

Headlam (LON:HEAD) - positive update given supply chain issues and labour shortages reported by others, with profit 'marginally ahead of expectations'. Self help initiatives are making for a more efficient enterprise, and the balance sheet remains strong, so the high StockRank looks well deserved.

Jack's section:

Motorpoint (LON:MOTR) - positive results yesterday from a vehicle retailer that is working hard on its online offering and appears to be taking market share. It is valued at a premium to more 'traditional' retailers in the space but it has set itself some ambitious growth targets and the PEG is just 0.5x, so there could still be upside. As with others, much depends in the short term on how long restricted new vehicle supply boosts used car margins.

---

Paul's section

Scs (LON:SCS)

(I hold)

186p (down 24%, at 08:18) - mkt cap £72m

Trading Update (AGM)

ScS, one of the UK's largest retailers of upholstered furniture and floorings, provides the following update ahead of the Company's Annual General Meeting….

Year to date performance ahead on two year like-for-likes

The PR message at the top is trying to put a positive spin on things, but I think the key message from this update is that order intake has slowed in the last 7 weeks -

As previously reported, the Group had a strong start to the year, resulting in two year like-for-like order intake growth for the first nine weeks. However, over the last seven weeks, the Group has seen a reduction in store footfall and conversion with consumers spending less on big ticket discretionary purchases...

Checking back, SCS last updated on current trading with its FY 7/2021 figures, which I reviewed in detail here. That update said like-for-like order intake was up 11.9% on pre-pandemic numbers, for the first 9 weeks to 2 Oct 2021.

Today we’re told that this +11.9% has turned into +0.9% order intake for the 16 weeks year to date. Thus the most recent 7 weeks must have been sharply negative, to pull down the +11.9% to +0.9%. I’m ignoring the 1 year comps, as there was so much distortion from closures, then booms on re-opening, etc.

Total two-year like-for-like order growth of 0.9% for the 16 weeks ending 20 November 2021, with a one-year like-for-like order reduction of 10.6% following an unprecedented period of pent-up demand at the beginning of the prior year.

My sector expert points out that the broker forecast only requires flat LFL revenues this year, so the company should still be trading in line with full year expectations. Quite an important point.

The update today doesn’t mention anything on this, which implies the company is still on track to meet current year expectations, otherwise they would have been required to say so. However it does obviously raise the risk of a profit warning in future, if reduced order intake continues.

Why has demand suddenly slowed? My sector expert (who has run businesses in this sector) reckons it’s because there’s usually a pre-Christmas spike in orders around Oct-Nov, where furniture retailers promote “buy now for Christmas delivery”, which of course they can’t offer this year, due to backed up supply chains.

Order book - has shot up, it was £103.5m at 31 July 2021 for comparison. This is the latest position -

At 20 November 2021, the Group's order book was £131.9m, £71.5m above the same point two years ago

That’s both good and bad. Deposits received will be piling up even more cash in the bank account, which will now be considerably more than the market cap. Also it means that there’s plenty of future revenue backed up.

However, the already large order book rising even more, suggests that they’re not delivering as much as the order intake. Therefore supply chain disruption is clearly a worsening issue.

As the company did not actually warn on profits today, suggests it thinks it can catch up with deliveries by the year end July 2022.

Online - growing well, but it’s only a small part of the business -

Our online business, which is a key part of our ongoing strategy for growth, continues to perform well, with two-year like-for-like order growth for the first 16 weeks of the year of 38.5%.

Outlook -

The Group is now preparing for the winter sales trading period, and whilst it remains difficult to predict shopping habits and consumer engagement, the business is planning to approach this key period in a manner co nsistent with that which has proven successful in previous years. W e continue to work closely with our existing suppliers to mitigate current supply chain challenges. To broaden our customer proposition, we have recently partnered with new UK suppliers so that we can offer furniture on shorter lead times .

We believe our continued focus on a promotional, value-led proposition will remain attractive to our target market and the Board looks forward to the future with continued confidence.

My opinion - obviously I’m disappointed that order intake has slowed sharply in the most recent 7 weeks. However, this share is all about an absurdly low valuation. At £74m, the market cap is now well below the cash pile.

Forecasts are still intact, many thanks to Shore Capital for publishing an update, leaving EPS at 26.5p for FY 7/2022. That means at 186p, the PER is now just 7.0, and of course the cash pile is considerably more than the market cap now.

Dividends have already resumed, and there’s scope to pay out massive amounts with the surplus cash.

This looks a temporary disappointment, which we’ve seen with lots of companies recently. However, for me this is a long-term holding, and bumps in the road are to be expected.

The starting price was absurdly low, because the market clearly anticipated problems ahead, so we’ve seen a double impact - selling before the news, and more selling today.

Taking a long-term view, I think this share could even provide a dividend yield of over 10%, and buyers at this level could do very well.

As you can see from the Stockopedia graphs below, the trend is for EPS of about 30p, once the peaks & troughs of the pandemic are evened out. It’s even more way too cheap after today’s disappointment, in my view. Not a time to panic, in my opinion, the market is throwing lots of bargains our way at the moment.

---

Studio Retail (LON:STU)

(I hold)

183p (down heavily yesterday) - mkt cap £159m

Interim Results

SRG, the digital value retailer, today announces its Interim Results for the 26-week period ended 24 September 2021 and gives an update on its performance in its peak trading period.

Interim numbers look pretty good -

.

Although the increased profit seems to have mainly come from a reduced bad debt charge going through the P&L -

Bad debt charge £5.3m lower than prior year, due to improved recovery rates and lower default fees being charged to customers

Outlook - this is what clobbered the share price yesterday, which is quite surprising, given that the company is reporting on well-known cost pressures that must be causing problems for everyone.

We’re in a strange market right now, where share prices have been heavily marked down in anticipation of supply chain/inflation issues. Then they get smashed down again, when companies confirm that they are having issues like this. That just doesn’t make sense to me. Still, today’s panic selling, is future profits, if we buy shares in fundamentally sound companies.

Guidance is reduced, but not by much, and certainly not enough to have triggered such a large share price fall. The fall looks considerably overdone to me -

We will give a further update on this key trading period at the end of January but our current expectation for the full-year outturn of Adjusted PBT is now in a range of £35-40m (previously £42-45m). Despite these short-term headwinds, many of which are impacting the wider market, our strategy for growth remains intact and we maintain our £1bn revenue goal in the medium term.

Balance sheet - I won’t go into all the detail again, which we’ve covered here a lot in the archive. You can easily check the archive for any company by going to its StockReport then clicking on “Discussion”.

It’s a hybrid business model, online retailing, combined with an instalment finance business.

This means a very high receivables book of £291m, financed mainly through £264m of long term bank debt.

NAV is £99.3m, less intangibles of £27.1m, gives NTAV of £72.2m

Note also the pension scheme is shown as a surplus of £30.3m - that doesn’t reflect the commercial reality, in that it remains a drain on cashflow - e.g. this explanation take from the last Annual Report (page 24) -

Pensions The net valuation on the Group’s legacy defined benefit scheme at the end of FY21, measured in accordance with IAS 19, reduced from a surplus of £31.7m at March 2020 to £20.8m at March 2021 due to reductions in the assumed level of future returns. The IAS 19 valuation has no bearing on the contributions made by the Group to the scheme, which is instead derived from the triennial valuation of the scheme. The most recent valuation measured as at April 2019 concluded during the year leading to a continuation of contributions totalling £5.0m p.a. until September 2023. The lump-sum contribution of £13m and lower contributions noted in the FY20 accounts relating to the proposed sale of Education to YPO did not occur as they were contingent upon completion of that sale, which did not occur. As part of the subsequent agreement to sell Education to Endless LLP, the Group made an additional contribution of £9m into the scheme in May 2021. This has brought the valuation of the scheme measured by reference to the actuarial targets into surplus. The Company is therefore working with the scheme’s trustees to explore options to remove this potentially volatile liability from the balance sheet, including the potential use of insurance

Forecasts - many thanks to Singers for updating its forecasts, via Research Tree.

The new EPS for FY 3/2022 is down 18% to 32.8p - a PER of just 5.6 - which looks an extremely pessimistic valuation.

The 3-5 year target of 100p EPS is clearly being disregarded by the market as pie in the sky. But imagine if that was achieved, and the PER rose to say 10-15, you’d be looking at a pretty serious multibagger from this level.

My opinion - a deeply unfashionable share, in a deeply unfashionable sector that has seen a vicious across-the-board sell-off this year.

I can’t see anything particularly wrong with the business, although I’m not keen on high cost finance companies.

It all depends on how temporary you think the current supply chain/inflation issues are, which impact everyone, not just STU.

At some point this share could be a great buy, but it depends whether it can mitigate, then recover from supply chain & cost inflation, or whether this is the thin end of the wedge? We don’t really know, do we? If earnings recover in 2022 or 2023, then this share could multibag. If they don’t, and we get a string of profit warnings, then the price is likely to remain under pressure. I wish I could state with certainty which is the more likely, but it’s completely unknowable at this stage.

Personally I’m sitting tight, because it’s a relatively small position in my portfolio, and I don’t see any worries about solvency. The profit warning was only mild, and the price now seems extremely cheap, providing profitability doesn’t completely collapse.

.

---

Appreciate (LON:APP)

Clarification

I commented recently that a webinar from Appreciate management had not impressed me. This is just to clarify that the presentation I was referring to was from June 2021. There’s been a very recent webinar which I wasn’t aware of, which I am told is much better! Happy to clarify this point.

---

Dx (group) (LON:DX.)

21.2p (down heavily yesterday) - mkt cap £121m

Update on Publication of Annual Report and GM

This is a very strange situation.

DX, the provider of delivery solutions, including parcel freight, secure courier and logistics services, provides the following update regarding the publication of its Annual Report & Accounts for the financial year ended 3 July 2021 ("Annual Report").

Preliminary results have already been issued, so this relates to the audited figures & annual report.

Reversing the order of the update yesterday, it says that current trading is as expected -

The Group's trading remains in line with the Board's expectations, consistent with the commentary provided in the announcement of the Group's preliminary results for the period ending 3 July 2021, which was notified on 8 November 2021. The Board remains confident that DX is well-placed to continue to increase its market share and make progress over the new financial year. The second major capital investment programme, which will see investment of between £20m - £25m in the business over the next three years, underlines the Board's positive view of the Group's prospects.

Although that form of wording does not say anything about the preliminary results for the 53 weeks ended 3 July 2021. Will they be revised? Who knows, we’re not told either way.

This is what has gone wrong -

The Company is not in a position to publish its Annual Report ahead of the Annual General Meeting ("AGM"), which is taking place later today. The Company's Audit & Risk Committee has recently raised a corporate governance inquiry relating to an internal investigation commenced during the financial year ended 3 July 2021. The inquiry has yet to be concluded, and the process will delay the completion of the audit, but will be expedited as quickly as possible. However, it is not anticipated that the Audit & Risk Committee and the Company's Auditors will conclude their work before 2 January 2022, being the date that is six months from the end of the financial period ending 3 July 2021. If, as currently expected, the Annual Report is not published by 2 January 2022, trading in the Company's ordinary shares will be suspended in accordance with AIM Rule 19 on 4 January 2022, being the first business day following 2 January 2022. Suspension from trading will be lifted with the publication of the Annual Report.

What on earth are we meant to make of that?

What is a “corporate governance inquiry”?

My opinion - I’ve been over this numerous times, and still can’t work out what’s going on.

If something is serious enough to delay the audit, and cause likely suspension of the shares, then it’s worrisome.

The waters became even more cloudy, when later during the day (yesterday) Directors bought a decent wad of cheap shares. This has come in for justified criticism, since the explanation given of the problems was so vague that no indication was given of its financial implications. Then Directors bought shares which had dropped by about a third, causing a temporary, partial rebound yesterday afternoon, which looks to have run out of steam today (hardly surprising when almost everything is plummeting today).

Apparently, bulletin board posters are saying that the company is playing down the seriousness of the situation to anyone who rings them up querying it. That’s not right either - information should be provided via the RNS to everyone at the same time.

Is it a buying opportunity? Possibly, I just don’t know. Without being told the seriousness, and financial impact of this unspecified problem, we’re completely in the dark.

Also, I’m not interested in owning this share in the first place, as it seems a very low margin business, in a really tough sector.

What do readers think?

.

.

---

Headlam (LON:HEAD)

448p (up c.2% at 12:20) - mkt cap £382m

Trading & ESG Update

Headlam Group plc (LSE: HEAD), Europe's leading floorcoverings distributor, is pleased to provide an update on trading, and Environmental, Social and Governance ('ESG') actions.

On track to deliver profit marginally ahead of expectations

This is self-explanatory, and comes across positively I think, given the well-publicised problems facing many companies re supply chain & labour shortages/costs -

Revenue for the year to date is tracking broadly in line with current market expectations* which were significantly upgraded in July 2021. A robust performance in the residential sector has helped to offset a persisting subdued commercial sector, with other features of the market being the ongoing industry wide supply issues, and associated inflationary pressures, all of which the Company has been largely able to mitigate.

Profit performance has been pleasing and reflects the previous and ongoing actions to improve operating efficiency and margin. As a consequence, the Company expects to deliver underlying profit before tax for the year ending 31 December 2021 marginally ahead of current market expectations*.

*Company compiled consensus market expectations for 2021 revenue and underlying profit before tax are £684.8 million and £35.0 million respectively (on a mean and post IFRS 16 adoption basis).

To me this suggests that Headlam’s self-help programme to make the company more efficient must be at least absorbing cost increases elsewhere, clearly a positive thing.

My opinion - is positive. It’s not a share I currently hold, but would be interested in buying back at some stage. It had to be culled, due to margin calls caused by other positions falling, unfortunately, these things happen.

I wish the company would get some broker research out there for private investors to see.

Current consensus estimates look light to me, so we could be looking at a possible beat against the 31.4p EPS forecast shown on the StockReport.

Remember also that HEAD has a fantastic balance sheet, with large freehold property asset.

There’s also the considerable reassurance of a high StockRank -

End of section.

---

Jack's section

Motorpoint (LON:MOTR)

Share price: 347.5p (pre-open)

Shares in issue: 90,189,885

Market cap: £313.4m

This omnichannel vehicle retailer has seen a significant rerating after the publication of its “New strategic objectives” on 16 June 2021. These include a target of achieving £1bn p.a. In online sales, and over £2bn total revenues, in the medium term. MOTR also demonstrated that its business was resilient during lockdowns, with sales moving online.

There’s a big divergence in valuation between traditional car dealers and ‘disruptive’ online competition like Cazoo, even though many of the old guard are building their own online offerings. You could argue MOTR has a superior business model in that it’s doing well online, plus it has large, efficient, low cost physical sites too, selling nearly new cars at competitive prices.

Interim results

Highlights:

• Revenue +56.1% to £605.2m,
• Gross profit +56.8% to £55.5m,
• Operating profit +36% to £15.1m,
• Profit before tax +39.2% to £13.5m,
• Earnings per share +34.1% to 11.8p.

Gross margin has improved to a record 9.2% due to vehicle value appreciation, strong buying and pricing controls, improved finance penetration, and continued efficiency improvements, all despite the introduction of vehicles more than three years old. Motorpoint has also quickly gained a 2.2% share of the three to four year-old market, which is impressive.

Retail volume growth of 46% in the period outperformed the overall used SMMT car market, which grew 31%. Total online units were over 60% of overall volumes ‘demonstrating the growing strength of our E-commerce offering’.

Online retail sales increased by 53% against the same period last year and website traffic improved by 24%. The group has invested in people, technology upgrades and marketing, with data science now helping to influence buying patterns and targeted marketing.

Further lowered APR finance rates to 8.9% from 1 October 2021 ‘as we reinforce our position as the best-value car retailer in the UK’. In the period finance penetration improved significantly to 51.7% in September (H1 FY21: 42.1%).

The number of sites has increased from 13 to 15, including the opening of a branch in Manchester. Motorpoint now has agreements for further branches in Maidstone, Milton Keynes and Portsmouth, with a number of other strategic locations in the pipeline.

Current trading and outlook -

Despite the ongoing constriction in the supply of new vehicles, which is expected to continue into 2022 and beyond, in recent weeks we have been able to use our market position to access more stock to satisfy customer demand, both online and in branch. This increased demand reinforces our belief that our customer-centric, omnichannel proposition remains the most appropriate business model for the used car market.

Revenue and profit in October continued to be well ahead of the same periods in FY21 and FY20. As a result, the Board is confident of delivering revenue ahead of plan for the full year, and therefore full year profit before tax significantly ahead of its expectations.

The Group is well placed to deal with any uncertainty or potential headwinds and continues to invest further in growth. The Board looks to the future with confidence, as the Group transitions to a digitally led business with huge potential.

Conclusion

Looks like a good management team here, with a clear vision and a differentiated business model. It suffers from the same low margins as others in the sector, but the tailwinds remain favourable and I suspect Motorpoint can gain share from competitors.

It’s focused on delivering a market leading proposition of ‘Choice, Value, Service and Quality’ to customers and generates an impressive amount of repeat purchases. The group’s H1 Net Promoter Score ('NPS') further improved to a record breaking 84 (H2 FY21: 83). It is good at what it does.

The strategy to more than double revenue in the medium term remains on track and there are clear growth initiatives including:

• Rapidly upscaling E-commerce capability;
• Increasing customer acquisition and retention;
• Expanding wholesale and E-commerce channels; and
• Continual improvement in operational efficiency through technology and innovation.

Online retail sales increased by 53% against the same period last year and total online sales were over 60% of overall volumes (H1 FY21: 62% - inflated due to lockdown induced branch closures). An online car buying service was launched in July 2021, and during H1 12.6% of retail vehicles were sourced from consumers (H1 FY21: 7.6%).

Clearly, Motorpoint is in a good place, as are other used car retailers at the moment. I have other holdings exposed to this part of the market but this company does bring its own attractions and innovations, with strong online progress balanced against a higher forecast PER than many of its competitors. The market continues to benefit from reduced new vehicle supply and higher used car margins. This dynamic will normalise at some point, but Motorpoint expects it to last for at least another year.