Small Cap Value Report (Fri 3 April 2020) - JOUL, SHOE

Good morning, it's Paul here, with Friday's SCVR.

Here is the usual 7am placeholder, for reader comments as I write the main report throughout the morningday. Edit at 14:01 - please accept my apologies, I'm running late today. Estimated time of completion is 5pm. Edit at 16:41 - apologies again, today is a bit of a struggle. I'm back at the keyboard, and will continue until 7pm, to add a few more sections. Sorry for the inconvenience to you, I know it's irritating when reports are late. Today's report is now finished.

I'll focus today on fundraisings, because we're going to see a lot of them. Indeed, in sectors that have been shut down, e.g. retailers, hospitality, and travel, then equity fundraisings along with extended bank facilities, are going to be the only way many of these companies can survive. I think it makes sense for companies to raise funds now, whilst investors have some willingness to support companies. That may not be the case in 3 months' time.

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Joules (LON:JOUL)

Share price: 80p (down 6% today, at 14:09)
No. shares: 89.4m +18.75m new shares = 108.2m
Market cap: £86.6m

(I no longer hold a long position in this share)

Placing of new shares

Joules is a distinctive fashion brand, which sells roughly 50:50 from physical stores, and online.

Last night the company announced that it intended to raise £15m in an institutional placing undertaken by Peel Hunt & Liberum.

This placing is going hand in hand with an extension of the bank facilities -

Agreement in principle from Barclays Bank plc to provide an additional £15m headroom on the Company's existing revolving credit facility ("RCF") for 12 months, conditional on the Company raising a minimum of £15m via the Placing, and subject to documentation.

That makes sense. If the bank is extending its exposure to the company, then it's perfectly reasonable for it to require shareholders to stump up fresh cash too. I think we'll see a lot of similar agreements in the coming weeks & months. After all, one of the key benefits of having a stock market listing, is to access the market for fresh funding. For this reason, banks tend to be more supportive of listed companies, than private companies.

Directors are putting in £1.2m, which is a decent level of support.

Covid-19 has obviously impacted the business to a huge extent -

... like many other UK retailers, the impact of COVID-19 has had a material impact on the business, including the Company having to close its entire store portfolio, in accordance with the UK Government's guidance. The Group's e-commerce channel has also been impacted, as consumers have shown increasing caution with their disposable income, although since the store closures online trading has been ahead of the Group's revised expectations. The Board expects COVID-19 to continue to have a material impact on the retail industry and its business over the coming months.

It's interesting to note that online trading has improved since the stores shut, which is what I would have expected for a very distinctive brand like Joules, with high customer loyalty.

Actions taken to mitigate the problems are as expected -

The Company has taken several mitigating actions already in order to conserve cash given the expected significant reduction in sales. These actions involve the cooperation of many of the Company's key stakeholders including stock suppliers, non-stock suppliers, landlords and employees and the Company continues to progress these discussions. All Board members have taken temporary salary reductions along with certain senior management, with some being compensated via the grant of share options.

The Company has also participated in several of the UK Government's support initiatives announced to date, including rates relief for its store portfolio, the Job Retention Scheme for furloughed workers, and the deferral of some payments due to HMRC.

These actions will result in permanent cash savings for the business of c.£53m, as well as the deferral of c.£21m of payments due over the next six months.

The last paragraph has me scratching my head. The "permanent cash savings" figure of £53m sounds enormous, so I think that must include mainly cancellation of purchases of inventories from suppliers. There would be a corresponding (and much larger) loss of revenues, so I feel the £53m figure seems misleading. I think the company should have provided a breakdown of that number, for clarity.

Guidance - the company has usefully provided us with some idea of what its forecasting assumes -

Assuming gross proceeds of £15m from the Placing, the Company believes it would have sufficient working capital on a COVID-19-related downside scenario and be able to emerge relatively stronger from this unprecedented situation. The Company's downside scenario assumes stores are closed for three months, and, whilst the Company is continuing to operate its e-commerce channel and UK distribution centre, in strict accordance with UK Government's guidelines, it has also reflected the impact of an eight week closure of the facility over April and May, resulting in almost nil sales across the Company over those two months. It then assumes a gradual recovery from the middle of June. If required, the Company has also identified a further c.£6.5m of additional cash levers which are not currently assumed to be required in its downside scenario but could be utilised if absolutely necessary.

It's impossible to say whether this scenario is going to be accurate or not. Nobody really knows at this stage. Maybe we're approaching the peak of infections, and it might start to decline. That could allow some resumption of economic activity. But what happens if covid-19 flares up again? My main worry is that we could see this come back in waves, and require longer shutdowns that would probably finish off retail/pubs/restuarants/travel companies for good.

Result of placing - another RNS out at 7am today. The deal has been done (they're usually already done when the ABB is announced).

A good price was achieved, of 80p per share. This indicates strong support from shareholders. It represents just under a 21% expansion in the issued share capital - which I suggest is a small price to pay to keep the company going. This has been handled well, by getting a rapid fundraising done whilst the share price was still reasonably strong. The longer companies leave a fundraising, then usually the weaker the result and hence greater the dilution. Leave it too long, and it can be impossible to get a fundraising away. Therefore, I feel time is of the essence, and by moving fast, Joules has secured its future.

Note that Tom Joule, the founder, still holds 27.3%

My opinion - coincidentally, I sold my JOUL shares earlier this week, as it dawned on me that a fundraising would be likely. I'm currently pondering whether to buy back, now that the company's finances have been strengthened considerably.

The problem is that, we know a lot of the new money will rapidly disappear in trading losses in the coming months. Therefore the finances haven't really been bolstered, it's more a case of disaster having been averted.

I like that JOUL sells half online, but it is mooting the possibility of closing down its online operations too (as Next did recently). Therefore a strong online presence may not necessarily be a redeeming factor right now.

If business returns to normal, then Joules will look cheap around 80p per share. At this stage though, there are still a lot of unknowns, and 2020 will without doubt generate a huge trading loss. Therefore I'm not convinced that this is yet the time to be assuming recovery back to former levels of profitability. I might sit on the sidelines here for a while, and see how things go.

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Carnival (LON:CCL)

I won't go into the detail, but note there is a big fundraising of bonds and equity going on there.

I wouldn't be bottom-fishing here for the equity. Investors need to remember the crucial fact that debt ranks ahead of equity. Therefore, when any company becomes financially distressed, then control effectively passes to the debt holders. In that situation, equity holders are often wiped out. If existing equity holders want to keep control, then they have to come up with fresh cash, and persuade debt holders to continue support - which is what's happened at Joules.

We've got to look at all our shareholdings in that light.

As the situation develops, I was initially bottom-fishing, buying shares that looked oversold. Over the past fortnight or so, I've become much more bearish. It seems to me that the market really hasn't fully appreciated just how bad this recession is going to be. There are some staggering GDP forecasts around, which are looking at a plunge in economic activity in the USA similar to the Great Depression of the 1930s. I'm not at all convinced that we'll get a V-shaped recovery either, as too much damage is likely to be done - e.g. many smaller businesses closing for good, and many millions made unemployed. History shows that recoveries from that kind of really extreme economic depression take several years.

For this reason, I'm holding back from buying shares that look temptingly cheap against the historic figures. The reason for my caution, is that I think the losses from a cessation of trading in 2020 could be ruinously high. I need to crunch some numbers on this over the weekend actually. Also, I think waiting on the sidelines with some spare cash (which is my current position) makes sense, as I can then buy into situations where a company has successfully refinanced (e.g. JOUL). That makes much more sense, than buying speculatively into a company which will almost certainly have to refinance, but hasn't yet done so. That entails considerably more risk, because what happens if they can't refinance on acceptable terms? That could result in an emergency placing at a few pence, wiping out existing holders. Or it could result in a collapse, as happened a couple of years ago with Conviviality, where existing shareholders effectively gave away the business, rather than pour fresh cash into it.

I can't stress enough how unusual the current circumstances are. We definitely need to mentally decouple from how we used to value shares, in my view.

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Shoe Zone (LON:SHOE)

Share price: 60p (down 19% today)
No. shares: 50.0m
Market cap: £30.0m

Covid-19 update & dividend cancellation

This announcement was issued after the market closed last night, so I've only just spotted it. Hence the 19% drop in share price today, so it's not going to be good news. This company sells cheap Chinese-made shoes from relatively short leases on High Street, and retail park sites, plus some online sales too. Clearly it's going to be in trouble, as all other non-food retailers are.

Final dividend - of 8p (costing £4.0m) is proposed to be cancelled. No surprises there, many companies are stopping divis in order to preserve cash. SHOE says it needs a special resolution (75%+ vote) in order to cancel the divi, at a general meeting, which I'm a bit surprised at. I would have thought than in current circumstances, Directors would have the discretion to cancel a divi, but apparently not. Anyone up-to-date on company law care to comment?

Current trading - it seems blindingly obvious that revenues will currently be close to zero, due to all shops being shut, so I don't understand why anyone would sell their shares on this news -

... it is now clear that the COVID-19 pandemic will have a material impact on the Company's performance in the current financial year ("FY19/20"), following the decision to close all of its stores on 24 March 2020, notwithstanding the improvement in revenues from the Company's online operations.

I seem to recall that online revenues for SHOE are not particularly significant. Certainly way short of the c.50% level that I generally look for with retailers.

Outlook - this bit below is a bit of a cop-out. I'm really looking for companies to give some guidance to the market, maybe on a range of 3 possible scenarios (base case, worst case, and optimistic case). We know that companies are doing that modelling internally, and they really should share this information (if not too commercially sensitive) with the owners of the company. My fear is that companies worst-case modelling would, in many cases, involve them going bust.

However, the Board expects a material reduction to its prior expectations for FY19/20. The scale of this reduction will depend upon how the situation develops, over what timeframe, and the impact of further public health, economic and business support measures being implemented by the UK and Irish governments. Previous guidance should therefore not be relied upon as an indicator of FY19/20 performance.

That's all bleedin' obvious! SHOE should be giving us more information, as should all companies. Just saying it's too early & uncertain, isn't good enough.

Funding update - clearly the most important point for all companies. Current year earnings are likely to be loss-making I would guess, so all that matters is whether companies can conserve enough cash to survive, and recover once the pandemic recedes.

As at 1 April 2020, the Group had net cash balances of approximately £4.7 million, and undrawn banking facilities of £3.0 million from which the 2019 Final Dividend of approximately £4.0 million would need to be paid.

Clearly then, there's no question of paying the dividend. The company has £7.7m in cash & facilities, which doesn't look that great to me, given that revenues will be running at near-zero, but rents are still payable, plus many other ongoing costs like utilities, insurance, etc.

Cost-cutting & cash preservation - it's good to see some detail on this, which all sounds sensible -

The Board is taking steps to conserve cash, maintain a satisfactory liquidity position and protect its employees. In particular, the Group has taken the following actions to date:

§ Placed the majority of the workforce, other than the digital teams and key workers, on Government funded furlough;

§ Ceased all capital expenditure;

§ ngaged with HM Revenue & Customs ("HMRC") with a view to deferring UK tax and VAT liabilities that arise during this difficult trading period;

§ Reclaimed £1.0 million of Corporation Tax payments on account from HMRC;

§ Sought the maximum Rate Relief Grant available from the UK Government of £0.5 million (€0.6 million), having already utilised €0.2 million previously on retail rates relief;

§ Minimised all other costs and expenditure to the lowest level possible.

Remember that SHOE is effectively a private company with a listing, so it's entrepreneurial & flexible, which I think counts to its advantage. Its leases are quite short too, giving more flexibility.

Bank funding - OK, I've found the bit of the RNS that has spooked investors -

The Group has a strong relationship with its lending bank and is in advanced discussions with it with respect to the provision of a new 4 year £10.0 million term loan (the "Term Loan"), to provide it with additional liquidity through the current disruption caused by COVID-19.

However, should the Term Loan not be provided, or the proposed quantum of the Term Loan be materially reduced, the Group would need to seek to take further cost saving measures and/or raise additional capital by early May 2020, assuming that the 2019 Final Dividend is cancelled and not paid to Shareholders.

OK, that is quite scary. They're basically saying that they're going to run out of funding in the next month, if the bank doesn't assist with the new, larger facility. Clearly that puts a lot of pressure on the share price.

My opinion - it could all be fine, because this is a quality business, which generates prodigious free cashflow normally, funding generous divis in the past. Therefore, once business normalises, it should be able to generate plenty of cash to pay down a £10m loan over 4 years. The cash requirement is not excessive. Shareholders may need to accept that divis would be withheld for a while.

It all depends what the bank's attitude to risk is? This to me seems a great example of an excellent business, that needs some temporary support, on a relatively modest scale compared with its previous cash generation.

But, banks hate risk. I always remember (when negotiating a new facility from HSBC years ago), that the bank manager said to me (I've mentioned this before, sorry for the repetition) - "If you guys go bust, that wipes out my profits from 50 other similar-sized clients". Hence why banks generally are comfortable lending to people/businesses that don't need to borrow anything!

In this situation, there might need to be a solution similar to Joules - e.g. if the bank ask SHOE to raise some fresh equity of say £5m now, with a commitment to raise a further £5m in a year's time. Then the bank could match that with the £10m term loan needed. Or, give the bank a sweetener, with some equity warrants, so that it makes a profit from its support in the hard times. It amazes me that UK banks are culturally so averse to taking equity kickers through warrants or options - they're missing out on a potential goldmine.

The other thing is that companies have alternative possible sources of liquidity - e.g. private equity might be interested in taking a stake?

All in all, I am tempted to take a position here, because I think SHOE is likely to get through this OK. But is the price sufficiently attractive to make risk:reward favourable? I don't think so. For me to get involved here, I'd want 3-4 times upside, to compensate me for the risk of (worst case) a 100% loss, or maybe a 50%+ loss on an emergency placing. The current price of 60p per share is too high to get risk:reward right for me personally.

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I have to leave it there for today, and the week. It's certainly been a week that I'm sure we're all glad is over.

Enjoy the weekend as much as you can.

Best wishes, Paul.