Small Cap Value Report (Fri 27 Nov 2020) - BOO, SAGA, LOOP, RCH

Good morning, it's Paul here, with the SCVR for Friday. Jack's busy with other work today, so this is all my work.

I'm hoping for a quiet RNS today, as is usual on Fridays, so I can have a big catch-up day - with a long list of things on my note pad from earlier this week, that I still want to look into. So I've cleared the decks today, got up early, and have the whole day allocated to writing this report.

I saw there was some bickering in the comments yesterday, over a subscriber chasing me on De La Rue (LON:DLAR) . Relax, he's a friend, and he didn't mean to sound abrupt! I will be looking at DLAR, because it's an interesting company, and I'm wondering whether to put it back on my personal buy list or not. I try to prioritise companies that look like they may be profitable investments, that's what it's all about after all! Although obviously I have no idea what short term share prices are likely to do, that's down to market sentiment. We just stack the long-term odds in our favour, if we buy strong companies that are growing, and are priced attractively. Although markets have been chasing growth at any price in recent years, so valuation doesn't seem to matter that much at the moment.

Agenda -

Boohoo (LON:BOO) - quick comment re valuation, and forecast from Zeus (done)

Saga (LON:SAGA) - safety accreditation of cruise ships (done)

Loopup (LON:LOOP) - Trading update (done)

Reach (LON:RCH) - Trading update

After that, I'm hoping to cover backlog items from earlier this week.

Frustratingly, I got bogged down in today's announcements, and didn't managed to make inroads into the backlog. It takes a lot of time & energy to unpick complicated & ambiguous updates like the ones today from LOOP & RCH. Hounding me because I haven't got round to covering some other company, is really unhelpful, so please don't do it. Today's report is now finished.

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Update on Paddy

My little canine friend had an operation yesterday, to have a large cancerous lump removed. He's feeling a bit groggy, but survived the operation, thank goodness (he's about 13 years old, so it was risky. He has to wear the "cone of shame" for a fortnight! So I'm mightily relieved, and should be able to focus a bit more on shares now.

I know we're not meant to let personal worries affect our work, but in reality, we're all human, and sometimes these things do.

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Boohoo (LON:BOO)

300p - mkt cap £3.7bn

(I hold - Paul - my largest position)

An update note from Zeus, the firm which originally floated BOO, came through on my email yesterday (via Research Tree, so available to all). It's titled "Actions not words", to emphasise how meaningful the "Agenda for change" programme is. The appointment of Sir Brian Leveson PC is the latest, highly significant step in the right direction.

I spoke to the company, and commented that surely nobody can now question BooHoo's commitment to completely cleaning up its supply chain. The response was (I hope they don't mind me publishing this);

I don't understand why anyone doubted why we weren't serious about fixing it. We will be the next Zara, and to achieve that, we must fix anything & everything on our journey. Very simple.

Forecasts - from Zeus are higher than the broker consensus. They know the business better than any other brokers, I would suggest, since they floated it originally. BOO has a track record of beating forecasts.

FY 02/2021: 8.2p EPS

FY 02/2022: 11.4p - a PER of 26.3

I suggest to subscribers, that being able to buy one of the best growth companies out there, for a PER of 26.3, is a tremendous bargain. Particularly as the issues which have caused the relatively low PER (for a rapid growth eCommerce business) are being comprehensively fixed.

It's only a matter of time before the press, and brokers, recognise reality, and start looking forwards, not backwards. Then the ESG fund managers are likely to want to buy back in, when they see the strong growth ongoing.

I note from a Telegraph article today, that even they (one of BOO's harshest critics) seem to be softening their stance a little. That article also points out that a previously bearish analyst from Shore Capital is softening his stance (behind the curve, in my view). Why on earth would anyone sit on the sidelines, to wait and see how the supply chain reforms progress, given that the likelihood is you would then have to pay more for the shares?! That doesn't make any sense to me at all. Surely the time to buy is when the shares are artificially cheap because of ESG concerns, but those concerns are being addressed seriously?

As mentioned yesterday, I see this as a superb ground floor investing opportunity, and make no apologies for vigorously flagging it to readers. I want us to make money! At 300p I see BOO shares as a golden opportunity, and have personally filled my boots (my largest holding). That sounds rampy, but it's the truth as I see it. No speculation, just facts. A superb growth company, on a PER of 26. What's not to like? Obviously you need to do your own research, e.g. take a look at the bearish view too.

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Saga (LON:SAGA)

Share price: 270p
No. shares: 140.1m
Market cap: £378.3m

(I hold - Paul)

Saga awarded industry-leading accreditation

This is quite an important announcement, because worries about covid, and cruise ships, are key to the valuation of Saga, since it owns 2 brand new mid-sized cruise ships, which cost roughly £300m each (funded by c.13 year ship loans, costing about 4.3% p.a. in interest). Therefore the share price is highly leveraged to the resumption of cruising.

If you’d done your research, then you would already know from the recent presentations, that extensive work has been done by Saga to make its ships covid safe. Remember it's not just covid. Other outbreaks of viruses are quite common on cruise ships. Floating petri dishes, as they are sometimes described! Saga's 2 ships are brand new designs - e.g. all cabins having balconies, and fresh air ventilation systems (not recirculated air) are key advantages.

Here is today’s announcement in full, which is self-explanatory -

Saga awarded first industry-leading COVID health accreditation

Saga has become the first cruise operator to be awarded new COVID-19 health assurance accreditation by Lloyd's Register, the maritime safety experts. The move is a crucial step ahead of the planned return of cruise operations in spring next year in a COVID-secure environment.

Lloyd's Register has awarded Saga the Shield+ accreditation, the highest category of health assurance they have. The new framework has been created to reduce risk and provide greater confidence in the safety procedures of operators against the introduction of infectious diseases onboard cruise ships, including COVID-19, Norovirus and common flu, as the industry works with government to restart an industry that employs 88,000 people and is worth £10bn a year to the British economy.

Being awarded the accreditation demonstrates that Saga exceeds the compliance criteria in every category set out by the UK Chamber of Shipping in their guidance for COVID Secure Cruising, which has been supported by the government.

The safety accreditation is assessed against six key categories covering every aspect of ship safety where health risks are elevated: medical, policy, food, ventilation, accommodation and water.

Award of the accreditation follows months of detailed planning from Saga, designing and putting in place detailed new procedures to meet the highest standards of health and safety. Saga's ships have been surveyed and inspected in all key areas and the accreditation has been awarded for both the Spirit of Discovery and the Spirit of Adventure, Saga's brand new ship, which is due to set sail for the first time in May 2021.

My opinion - an important announcement I think. As mentioned before, demand for cruising is not the problem - customers are itching to get going again, and forward bookings are high. It’s just a question of when they will be allowed to sail. Saga’s website says they’re looking at April to May 2021 to re-start, which ties in well with what the Govt, and other companies are saying - i.e. there should have been good progress in vaccinating the elderly by then, we hope.

As well as being positive news today for the safety of customers & crew, it’s also clearly a significant marketing opportunity, to trumpet that Saga’s ships are best in class for health & safety.

Another important marketing advantage that Saga has, is that it’s changing over to putting customer funds in a completely segregated account, i.e. there is no risk to customer deposits in the case of insolvency. Therefore Saga is also in a position to give cash refunds immediately to any customer that wants them - key for reputation & customer service. Given how problems are emerging with customers struggling to get refunds from some other travel companies & airlines (e.g. being pressurised into accepting a credit note instead of cash), then I see this as being a key advantage that Saga can capitalise on. A slightly stuffy image could be a big plus, when other sector companies may be struggling with solvency.

For investors who are prepared to be patient, then I think there could be a serious re-rating on the cards here, once the ships are earning their keep again. In the short term, maybe it needs to pause for a bit, as we had a spectacular rebound on the covid vaccine news, and I suppose it’s inevitable that some holders might want to bank a short term profit. There’s an institution selling down too (see holding in company RNSs recently). Having strong nerves, to get through the recent irrational low, certainly helped!

The price volatility doesn’t bother me, as I focus on the medium to long term with nearly all my holdings.

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Loopup (LON:LOOP)

Share price: 92p (down 41%, at 10:32)
No. shares: 55.4m
Market cap: £51.0m

(I hold)

Trading update

LoopUp Group plc (AIM: LOOP), the cloud platform for premium external communications, provides the following trading update.

I read this announcement first thing, and thought it didn’t sound too bad. How wrong I was! The price has taken a battering this morning, and bottomed out c.77p. I also note that there has been huge volume printed already, in a normally illiquid share, 8.1m shares, or nearly 15% of the company, probably with more large trades yet to be printed (as bigger trades can be disclosed on a deferred basis). That looks like one or more institutions bailing out.

Previous updates from LOOP looked fantastic, which was why I picked up some shares in it between July and November this year. My average buy price is now 173p, so am currently sitting on a very unwelcome 42% loss. It happens. Small cap investors need to get used to profit warnings, it’s an occupational hazard. Keeping a clear head is vital, to avoid compounding errors.

What to do, buy, sell or hold? Well I’ve already picked up a few more today, which is usually a rookie error of catching the falling knife. Sometimes I just can’t help myself! To put it into perspective though, the total position is only about 1% of my portfolio now. I’m mentioning this, because it might cause unconscious bias in what I write below, but hopefully not.

Here are my notes, summarising today’s profit warning -

• Previously stated that unstable market conditions made guidance challenging
• Core business PS (Professional Services) has “continued to trade robustly versus pre-pandemic levels”
• Strong momentum in Cloud Telephony business since July 2020 launch
• Remain confident in growth prospects for the above
• Non core business seeing accelerated churn rate - due to greater competition - but this is only 14% of revenue

Revised guidance for FY 12/2020 -

In light of this, the Group now expects FY20 revenue to be no lower than £50 million (c.18% growth on FY2019) and EBITDA to be no lower than £15 million (c.134% growth on FY2019), moderately below current market expectations.

That’s hardly a disaster.

However, it looks as if 2021 revenues could be lower, although I’m not sure how ARR would compare with actual revenues?

The Group's annualised revenue run-rate (ARR) currently stands at c.£34 million, made up of c.£28 million of LoopUp Platform capabilities (Meetings, Cloud Telephony and Event) and c.£6 million of Cisco resale, which represents an estimated entry ARR for FY2021 trading

Some KPIs are then produced, which show that the business seems to be sharply diverging, with PS doing well (compared with pre-pandemic), and but non-PS doing badly. I think what this is telling us, is that the non-PS business is falling away, due to competitive pressures, but PS business (the core business) seems to be doing OK, or well even. Hence it looks as if LOOP is becoming a top end, niche player in the market.

Our decision to focus our strategy on PS sectors remains the right choice, demonstrated by the increase in demand for LoopUp Meetings in those verticals. Looking forward, our priority is to cement and grow the strong position we have built in our core PS market, where external communications are business critical and warrant a best-in-class capability.

Cloud Telephony - detail is provided on why management is optimistic about this new service. It says the sales pipeline for this specific product has grown rapidly, up 68% to £84m total contract value - sounds interesting, but a pipeline is just that, it’s not actual sales yet. Sales cycle is expected to be 6-8 months. A private banking group is trialling (for 3 months) the product globally from next month. This all sounds potentially interesting.

Outlook & cash position -

While trading is expected to remain challenging in the non-PS part of our Meetings business, this now represents just 14% of our total LoopUp Platform revenue, and with a continued focus to drive forward our PS business, it is expected this will have progressively less impact on overall trading going forward.

By contrast in our core market, we remain confident in our ability to drive attractive, sustainable and profitable growth of our premium external cloud communications platform, and therefore plan to invest to maximize growth and shareholder value creation within the constraints of our strong £11.6 million cash balance (at end October 2020).

That sounds like costs might be increased. Hmmm.

The cash position is is misleading, because the company fails to mention its bank borrowings, which were £13.6m as at 30 June 2020. So if we assume that borrowings might be unchanged now, then the £11.6m cash balance is actually net debt of £2.0m. Modest, so it probably won’t be a concern. But I would have preferred clearer disclosure (unless I missed it, in which case I'll happily correct this article).

Broker downgrade - there’s been a savage downgrade from Numis, which likes to keep the facts away from private investors, so that institutions & HNW individuals only get privileged information. This is totally unacceptable, given that the broker gets its information at least in part, directly from the company. Therefore house broker notes really should be publicly disclosed. This issue really annoys me, as it’s so blatantly unfair, why is it allowed?

Everyone should see the revised forecasts, for a level playing field, so here they are;

FY 12/2021:

Revenue forecast reduced from £55m to £35m

EBITDA forecast down from £13m to £6m

PBT from £5.8m to £1.3m

2021 cash outflow of £3.5m, vs previous forecast of £3m inflow

My opinion - I think there’s enough positive stuff in the update to motivate me to continue holding, or maybe even buy some more, given that the core business is doing OK. There seems little doubt that LOOP enjoyed a bumper period during lockdown 1 that’s not likely to repeat. So I can see why some investors would want to bail out.

That said, the high end (Prof Servs) side of things seems to be doing well still, and I like the section about cloud telephony premium services, integrating into MS Teams.

Overall, I’m leaning towards holding, because it doesn’t look as if solvency would be a problem (LOOP could cut costs if necessary). A £50m market cap could make it an acquisition target possibly? It’s not an enthusiastic hold though, so I can’t really say that I’m positive about this share, neutral and too stubborn to sell, is probably more accurate. However, on reading the RNS again, it's made me want to buy more! Therefore "genuinely perplexed" is probably my overall view on this share at the moment.

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Reach (LON:RCH)

Share price: 149p (down 3% at 14:51)
No. shares: 312.1m
Market cap: £465.0m

Trading Update

Reach plc is today issuing a trading update for the 52 weeks ending 27 December 2020, covering the period from 29 June to 27 November 2020 ('the period').

The headline says -

Digital momentum drives performance ahead of 2020 market expectations...

Strong digital growth, resilient circulation

I’m surprised the share price hasn’t risen today, but it’s had a spectacular run recently, and the rest of the update does sound some notes of caution. As you can see, it’s tripled in price since August;

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Digital is growing, and print is falling fast. I do wish they would put the actual numbers in a table, rather than giving percentages;

Overall Group performance has exceeded market expectations, with continued strong digital revenue growth of 16.2% for the five months to 22 November 2020, assisted by increased customer engagement.

Circulation sales have remained resilient despite the recent lockdowns, supported by management action on availability and increased cross-promotion of national and regional titles. Overall, for the five months to 22 November 2020, a decline in print revenue of 19.6% contributed to a Group revenue decline of 13.9%.

Assuming that print, and digital, are the only two categories of revenue, then we can work out the split, which drops out as follows;

Last year
Print revenues 84.1% of total
Digital revenues 15.9% of total

This year
Print revenues 78.5% of total
Digital revenues 21.5% of total

If my spreadsheet has worked out the figures correctly, then on this year’s forecast revenues of about £584m, it looks as if digital revenue might be around £126m this year - a significant sized digital business then. Although I would like to know the split of profits between the two divisions. There are likely to be a lot of shared overheads, so that might be difficult to calculate.

Costs - are being constantly cut, over many years now. This means an improved operating margin, vs. H1, impressive. Further cuts are in the pipeline, with consultation started on possibly closing 2 of 6 printing plants.

Customer sign-ups look impressive, this is on the digital side;

Customer registrations have now exceeded 4.25m, and the company is on track to deliver the 10m registrations it is targeting by the end of 2022. Reach retains its leading scale audience in the UK with 42.1m unique monthly visitors accessing its sites during October.

The idea seems to be to accumulate information on each customer, then sell more targeted & expensive advertising to them, like a mini-Facebook. As the bulls point out, that could be very valuable, if it works.

Cash & cashflow are described as strongly positive, and healthy, respectively.

My opinion - no strong view either way. I can see the merit in the bull case, with RCH becoming potentially a valuable digital advertising platform. Although digital marketing experts have told me that the ROI from advertising on Facebook and Instagram is so much higher than anything else, that these are the only platforms worth using. Facebook/Instagram can apparently localise ads right down to individual postcodes, so I'd need some convincing that Reach can beat that.

However that needs to be offset against the newspapers gradually withering away to nothing, in the coming years. There’s then the negative value of the pension schemes, which look fine on an accounting basis, but could be eye-wateringly large on the next actuarial valuation (apparently it was over £700m last time, and interest rates now seem near-zero permanently, maybe even turning negative?). It depends whether the pension scheme assets have gone up enough to offset the increased liabilities caused by ultra low interest rates? This matters more than ever, because it’s looking more likely than ever that interest rates could be near-zero forever. Therefore the pension deficit is not likely to just melt away, as they have done in the past.

At this stage, I feel RCH shares are a leap of faith, that the digital business could become worth a lot - i.e. over £1 billion. It would need to be, just to justify the £465m current market cap, plus the maybe £500-1000m pension deficit (actuarial), and writing off the newspaper business as worthless in the long run.

We’re not given the information we need to value the digital business. I think the company needs to start reporting them as 2 separate divisions, with a P&L for each division. Only then could we meaningfully value the shares. Until that happens, then it’s largely guesswork in my view.

It’s a good story though, which has caught the imagination of lots of investors recently, as the chart above shows!

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That's it for today. I hope you have a lovely weekend, and looking forward to seeing you again here next week.

Best wishes, Paul.