Small Cap Value Report (Fri 29 April 2022) - BEG, SAA, UPGS, AO., CAR

29th Apr '22 by Paul Scott

59 comments 8088 reads

Good morning, we have Paul & Roland here today, reviewing small cap trading updates & results. Today's report is now finished. We hope you enjoy the long weekend!

Agenda -

Paul's Section:

Begbies Traynor (LON:BEG) - Reuters reported yesterday that insolvencies have soared, as expected, with the withdrawal of covid support measures meaning large numbers of zombie companies are likely to need restructuring or insolvency. I haven't read it yet, but today sees Begbies publish its Q1 Red Flag Alert Report, always an interesting, if depressing read. It strikes me as illogical that BEG shares have sold off along with other small caps lately, given that it is limbering up for a probably multi-year bonanza of work. So at 110p per share, I think readers could do well on this one, and get a 3% divi too. I don't currently hold, due to lack of available funds, unfortunately. [No section below].

Up Global Sourcing Holdings (LON:UPGS) - I have a good rummage through its interim figures out today. Decent results, boosted by a large acquisition last year. I'm not so keen on the big increase in bank debt, which has continued in H1 despite the acquisition financing going through last year's accounts. The low operational gearing is interesting, and should mean profits being resilient, even in a downturn. Very interesting comments about supply chain/shipping improving. Overall, I like it.

Carclo (LON:CAR) - a mixed update, which is in line with exps for FY 3/2022, but with some negatives in the outlook comments. Not enough detail to help me form a firm view. Bank debt & pension scheme are still problems. High risk.

Roland's Section:

M&c Saatchi (LON:SAA) - a strong set of 2021 results from this advertising group. Trading performance seems strong and management have issued confident profit forecasts suggesting double-digit growth in 2022 and 2023. The valuation doesn’t seem unreasonable to me, either.

Ao World (LON:AO.) - a major profit warning from this appliance retailer, as customer demand weakens and the rising cost of living starts to bite. Liquidity concerns are growing and AO’s founder-CEO has decided to start selling his shares. One to avoid, I think.

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…

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harrymunro

29th Apr '22

Thanks Paul for the analysis on Ao World (LON:AO.) (I hold)

I highly recommend the analysis of them by Gary Channon on page 3 of the latest Aurora Investment Trust factsheet: https://www.aurorainvestmenttr...

This prompted me to look at John Robert's a little closer. I found listening to this recent interview persuasive that John Roberts is somebody I would want at the helm of a company I had shares in.

TheFloatingInvestor

"I suspect that there is not a positive read across for K3 Capital (LON:K3C) from £BEG" (I hold both) - not sure I agree, although holding both is a safe option!

K3 Capital (LON:K3C) I wonder what the future economic outlook will do for the restructuring division which is the biggest in terms of size and growth? H1 2022 : GDP 16.6m (H1 2021 : GDP 9.5M)

As margins are squeezed companies will look to become more efficient and streamline which often means cutting staff.

Their last RNS states - 'Restructuring Division is pleased to see that the insolvency market is showing signs of recovery following the withdrawal of government support and the unwinding of legislative change'.

Perhaps K3 Capital (LON:K3C) portfolio gives them more balance, but they currently appear weighted towards restructuring which could be a tail wind from current lows?

Time will tell.

Paul Scott

Hi mojomogoz,

Good points! As you suggest, sometimes there are good reasons for companies to increase working capital, it's not necessarily a bearish sign. I worry more when companies report negative cashflow, year after year.

Paying its Chinese suppliers more quickly looks very sensible, as factories will almost certainly priritise faster paying customers, in hard times, as you say.

The other thing is that the acquisitions will have only contributed part of the year, but the full balance sheet values are reported. That can distort things too.

Regards, Paul.

topvest

Agreed. I think the net debt increase on receivables is explained well and should reverse fairly quickly in H2: "Increased trade receivables are attributable to higher overall revenues, the later timing of these revenues with December 2021 being a particularly strong month compared to normal, and higher debtor days due to the increased mix of supermarket business, where payment terms are typically longer." The business is highly cash generative, so with the Salter deal done, net debt should fall quite quckly. I think the CEO is fantastic here and he's built a great business and team. Lots of potential still on numerous fronts. Petra sounds very promising in Germany.

mojomogoz

Yeah. In some respects its return to normal pattern with trade related finance being used again -> £11m invoice discounting from zero H1 last year and import loans up to £7m from £4m -> this explains the debt increase.

In general, when trade finance goes up for Up Global Sourcing Holdings (LON:UPGS) it's an indication that business is growing. (Note I believe they insure near 100% of this too) though in current environment it could also be due to rise in shipping times.

I believe the concerns expressed in comments above re debt by some are missing the point particularly with trade linked finance. The risk to UPGS is an economic softening that sees retailers stop ordering. The post IPO hiatus was linked to this (and that they had a lot of channel stuffing in discount retailers who had been growing like a weed so UPGS stocking store openings and then paused eg B&m European Value Retail Sa (LON:BME) ).

Resource Man

COO has now also bought shares at 95p. Really feels like an interesting company to look at again. they only need to land a contract with Europe - France ideally and Eqtec could really fly again.

Yes. I like mgt and the model they've made. I think its quality/durability and 'category killer'-ness is underestimated. The world just thinks they are a dressed up market stall trader ;)

There's going to be some volatility to revenue (no forward purchase agreements from customers but the upside of that is it protects their margin as they are not squashed into the margin demands of retailers) -> so price will have volatility too.

But I HODL on in the belief that this business will grow meaningfully over time and mgt/founders are entrepreneurial and young enough to have many years of drive and hunger.

cmpeckham

I agree with much of that, but one reason for my original comment was that their restructuring division relies on the ultimate success of their clients e.g. K3 provides funding to them. In contrast, with BEG it's a question of the more basket cases the better. With restructuring in a downturn, there may be more potential customers but there may equally be more risk. Personally, if I was taking on a troubled company as a customer, I would rather do it in a growing economy than a shrinking one. How this translates for K3 probably depends on how they select their customers and how they secure payment.

Hi harrymunro,

The Ao World (LON:AO.) section today was from Roland, not me. If I'd written it, my conclusion would have been similar to Roland's, that the share is now uninvestable, although I'd have expressed it more emphatically I think!

It's a terrible update, and it looks to me as if the business could be heading for serious trouble. So I would definitely not want to hold this share, it looks to me like something to get out of, whilst you can.

You commented -

John Roberts is somebody I would want at the helm of a company I had shares in.

I assume you're being serious? My view is the complete opposite - over the years I've followed AO he's struck me as delusional, and now with a terrible track record. In my view, the whole business could need a restructuring, to strip out a lot of costs, and maybe a refinancing, so equity dilution probably.

Definitely not one for me!

MrContrarian

Nightcap (LON:NGHT) has char grilled £1.8m in just 14 weeks. Also the Q3 LFL rev up 28% on 2019 is not adjusted for the 5% VAT rate which has now ended.

gmtrader

Agree with you Roland and Paul about Ao World (LON:AO.) I wouldn’t touch it. Besides the facts that the ceo is selling and that the business model is poor where the only time it has managed to make a profit was because of lockdowns due to covid, the retail sector is bound to take a knock in the coming years as people start to tighten their belts due to a recession coming.

rmillaree

Sales are up 52% on the 2019 comparatives - fast growth costs money - so i dont think anyone should be surprised they are burning through the cash at a fast lick at specific times of the year - opening up new sites costs wonga. They have £7 mill cash in the bank and expect to be profitable this year and next if stocky is to be believed (keep an eye out for exceptionals !!) - to me they seem reasonably adequately funded to keep pushing forward. The great thing about pubs is that once they are up and runing the cashflow will likely be better than the reported profits medium term (presuming its not fake ifrs profits that exclude lease costs)!!

Adjusting for lower vat rate or not 28% LFL growth aint too shabby !

Equity Development

I see a few other sensible comments on Begbies Traynor (LON:BEG) to add to Paul's, and there was an ED note published on Begbies a few days ago - it covers the UK Govnt insolvency stats and keeps a fair value of 165p/share. Here if you missed it: https://www.equitydevelopment....

mighunter

Are you not missing out that K3 Capital (LON:K3C) own Quantuma?

Source: Begbies FY20 Results Presentation.

JohnDoe2378

I see Headlam (LON:HEAD) has been drifting down, ex div next Thursday for 26p final and special divis.

Was expecting a nice rise in to next week, looks like i was wrong again! Markets may be up past couple of days, but most of my small caps treading water or dropping. Just no volume or liquidity out there for most...

Same boat John, the FTSE rise defies my portfolio.. down 2.5 percent this week, and as you say poor liquidity.

shanklin100

With Up Global Sourcing Holdings (LON:UPGS) and the rise in inventories, is the company necessarily in possession/control of all of this, or could a significant proportion be in transit, perhaps closer to China than the company might like? No idea whether this is the case.

Entirely serious from my end - good to hear your perspective :)

Boon

30th Apr '22

Interesting that the top 5 most shorted companies (caveat: declared shorts) are now all Consumer Discretionary type companies. The shorters are really bearish on UK Consumer discretionary spending this year.

(Caveat, some on the list like Cineworld and Boohoo have been on the top list for months, even before the latest bearish stats on UK consumer confidence and inflationary impacts on spending).

3rd May '22

I'm confused on your K3 Capital (LON:K3C) comments....there is not a great difference between Begbies Traynor (LON:BEG) and Quantum and both have countercyclical properties. In addition, both Quantuma and BEG broker finance to companies but neither do it directly on book (its purely part of advisory services). Quantuma has shown great growth in a tough environment too. Simplistically it looks a superior operator to the big legacy BEG. IMO BEG is over liked for its 'countercyclical' properties but it always seem a touch mañana waiting for the good times -> I know its been decent operational and stock price performer in recent years but the expectations seem to always run ahead of it a bit IMO. And now with earning estimates high based on 'tough times' being here the stock is a clear buy the idea sell the fact risk as it needs to be in a cycle of beating estimates to sustain multiple and push into the teens on p/e.

By comparison, the restructuring biz of K3C is not highly priced despite its very impressive underlying growth (and they have invested in that growth so short term deflating margin) and then the tax and corporate finance divisions are higher margin and both growing. The rating on these high margin growing businesses is very low. Maybe this reflects expected cyclical headwinds? For tax they are likely to be very muted at most to likely non existent (policy around R&D tax breaks more important and that is likely to be supportive). For corporate finance its harder to predict but a combo of brexit and covid has acted as a long term hinderance already and there is probably a decent supply of people wanting to sell small businesses (very different dynamic for listed M&A). K3C management say they think they can have good environment for corporate finance and restructuring going forward and I think this is a reasonable expectation.

The thing that probably weighs on K3C shares is that they have acquired quite a lot in recent years and they have ambitions for more. I believe management have shown they can do this well and that it is a good strategy for this business....but it's a short term environment where scepticism wins. I've got a hunch that they are going to expand overseas in near future and I see this as a good thing as I believe their financial services model to be a category killer.

I own and have bought on weakness. I might wear some more short term pain if they go for a big acquisition and dilute to do so (paying dividends and share issuance to finance acquisitions really does irritate me -> British disease!...plus a couple of founders own a lot of stock and no doubt like the big pay day). Regardless of negatives and short term market volatility I feel confident that I will have meaningful gain on my holding.

Stocko comparison between two is interesting and I believe understanding the underlying dynamics shows K3C to be far superior prospective investment

https://www.stockopedia.com/co...

Small Cap Value Report (Fri 29 April 2022) - BEG, SAA, UPGS, AO., CAR

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Paul Scott

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