Small Cap Value Report (Fri 4 Jan 2019) - JSG, G4M, CAMB

4th Jan '19 by Paul Scott

47 comments 12793 reads

Good morning, it's Paul here!

There are 3 company updates today of interest to me (and hopefully you too).

Johnson Service (LON:JSG)

Share price: 116p (pre market open today)
No. shares: 367.6m
Market cap: £426.4m

JSG, a leading UK textile rental provider, is pleased to provide a trading update for the six months to 31 December 2018.

This group has a 31 Dec year end, so it is reporting today on H2, and the full year.

The key takeaway is this;

We remain positive about the future prospects for the business and we expect to announce full year results in line with market expectations.

Other points;

Investment of £3.3m in its London laundry has completed on time & on budget
Aug 2018 acquisition of South West Laundry - is being successfully integrated
Signed contract to build a new laundry in North of England. Coming on stream in early 2020 - to increase capacity

Valuation - it looks quite attractive value on a PER basis.;

Balance sheet - it's always worth looking at the Price to Tang. Book field above, which in this case is 24.2. That's not very good - i.e. the market cap is 24.2 times NTAV on the balance sheet. I've had a quick look at the most recent (interim) balance sheet, and it only has £16m in NTAV.

It's dominated by about £160m in intangible assets - reflecting acquisitions made, to expand the group. There's quite a bit of bank debt too.

My opinion - trading seems to be going fairly well.

Debt is not at alarming levels, but in current market conditions, I'm inclined to steer clear of companies with debt.

Note that this sector, of textile hire, has historically done badly in recessions. I recall in the past that big write-downs in the value of rental textiles had to be made, for customers which go bust.

It's difficult to see any particular reason to want to get involved with this share, in current wobbly market conditions. If the PER went into single digits, then it might make more sense to look at it.

Gear4Music

Share price: 255p (down 50% today, at 10:14)
No. shares: 20.9m
Market cap: £53.3m

(at the…

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HornBlower

4th Jan '19

Paul

if you take as given that a business can grow revenues 5x and margins 3.5x in 5-10 years I think fairly obvious market cap will explode but not only AO but also ASOS show that growing margin is not that easy. even Fevertree margin has plateaued for the last 3 years, albeit it a very high level. don't see what makes the G4M model that special. I think valuing businesses at high multiples of revenue and not looking too much at profit growth or cashflow might be out of favour for a while

with due regards

HB

Zipmanpeter

Not sure £AO is such a close fit to £G4M based on products and market structure. AO mostly sells high value, large white goods that should last a customer 10yrs - so high delivery/service costs and little chance of repeat purchase anytime soon. G4M sells to music buffs who can "consume' not 1 but 5 guitars or expand from a keyboard into amps etc. So once acquired they provide multi-year income.

Smaller sized products are also much easily to distribute effectively over large distances unlike white goods so 4-5 distribution hubs can cover Europe effectively and they already have 3 (UK, Nodic and Germany); 1 in say Spain and Italy will be enough and will 'localise' sales . (Note - Europe also 50% of current revenue already so a hedge vs UK).

I also think it will be easier to make better margins on own label trumpets/guitars than fridges. Own label is around 25% of G4M now but can hope to rise to over 30% in time. A typical migration might become for example, an entry level guitar (sale 1) bought as a gift followed by a better, branded guitar (sale 2), with some going on to buy other guitars/kit.

Finally, white goods are also very largely the province of big players whereas much of the market share growth for G4M is going to come from local music shops as few will have the marketing muscle to compete as a large chunk of current sales migrate online. They will need to fight with Amazon etc but there is space online for music specialists.

Given price has dropped 50% today on 1 year's EBITDA being a bit below forecast, I have bought a small holding today at 241p and will wait 2-3 years by when the fundamentally positive business case should have outed. Here's hoping!

GavinT

Someone mentioned before that an indication a company will do a share placement is the appointment of a new NOMAD/broker.

G4M announced today the appointment N+1 Singer as the joint NOMAD/broker, along with Peel Hunt. A harbinger of things to come?

PhilHofGrowYourDough

G4M sells to music buffs who can "consume' not 1 but 5 guitars or expand from a keyboard into amps etc. So once acquired they provide multi-year income.

I agree that some guitarists will have 5+ guitars but very few serious guitarists would buy a guitar without playing it. I'd suggest that this would hold for many other non-digital instruments.

Wimbledonsprinter

I don’t hold 7 Digital, but looked at it quite closely a while ago. The market seemed to take a very benign view in the summer when the shares were suspended for a couple of months, given the late filing of accounts. Today, in a not very clearly worded RNS, they seem to be saying that they can’t say what the outcome for 2108 will be with any precision because they are not clear yet of the impact of IFRS15 (contracts); and then drop the bombshell that HMRC has served a winding up petition on a subsidiary company (apparently not the main trading subsidiary) for non-payment of £417,000 - but then say don’t worry because the 7DIG will be able to repay this sum ahead of the date of the court hearing (although I presume from the wording that it does not have the cash today).

I think this is another clear warning to be wary of companies that are not prompt on producing financial results.

Paul Hill

Is Gear4Music going to recover in the same fashion as Boohoo (today 165p) did, when it released a profits warning after worse than expected Xmas trading and the shares fell to 25p back in Jan'15?

Alex Rackwitz

The argument seems to me about whether marketing expenses should be classified as 1) growth capex or 2) operating expenses. For SaaS businesses and potentially even retailers like Amazon, I can understand the "growth capex" argument. You spend $100 in marketing expenses to acquire a customer and due to repeat purchases the net present value of that customer might be $400. As the company starts maturing, the value of the customer base starts showing.

But with G4M I struggle to see the value of customers after the first purchase. These are larger ticket items which are purchased infrequently (not repeat custom). Most likely the consumers will scan the whole market before each future purchase i.e. will not just return to G4M (unlike my Amazon buying pattern). So if the NPV of the customer isn't in the current numbers, I don't think it will show in the numbers in 3-4 years.

A second argument might be that marketing efforts can scale with increased size. e.g. $1 can reach 1 customer but $2 can reach 3 customers. However, with today's cost per click models and search result, I think marketing spend is highly variable. So I think if $1 reaches 1 customer, $2 reaches 2 customers etc and again I dont see any leverage there.

DYOR - I am just starting to look at G4M

Sample size of 1 but anyway:

I am in the market for a digital piano. Not super pricey by the standards of some guitars etc but nonetheless £400-600. I have looked on Ebay, Amazon, and G4M as well as some search results.

Once I buy (best results so far on Amazon and Ebay), I will probably not be in the market again for at least 5 years.

herbie47

But they also supply pro music studios with monitors etc. They are probably more likely to order lots of gear from one supplier rather than from Amazon. Ebay I would watch you may not have any warranty. There do also have shops where you can try gear out.

I don't agree with the comparisons with £AO they just sell white goods to the public.

Re: G4M

See my other post about pricing up an amp, pedal and wireless transmitter ...

Three people have now reported that they aren't competitive on price.

I just looked at the accounts. Repeat custom is below 25%. I would say that is very low and doesn't allow them to "switch off" marketing because they would immediately lose conversion on the remaining 75% i.e. business would go backwards. Marketing is not discretionary.

Which presumably means their margins are larger.

Jono109

I'm looking to upgrade from my existing digital piano. G4M were competitive price wise, but this does not outway the fact that I want to go to a store that specialises in pianos where I can try different models by different manufacturers, talk to experienced staff, and have the possibility of part exchanging my old piano or upgrading to a better second hand model, or an ex demonstrator at a discount. Specialist stores offer these options.

Interesting discussion on G4M especially regards Marketing. As an ex Mkting director, I absolutely agree that Marketing is not discretionary (!!) and that, in today's digital world, the benefits of scale are not what they were. However, they do still exist (eg CRM costs) and higher budgets permit different media choices not available to smaller players. Perhaps a reduction from >8% of sales now to 6% is more reasonable than Paul's 4%.

The benefits from brand building and recognition also build over time. G4M has spent <£20Mn on Marketing since online launch in 2004 but will be spending that every 2 years going forward - all targetted at musicians. That's a potential moat.

Relative price is also mentioned and clearly a driver but is often overstated as long as any premium is not big as Trust (from brand recognition) and Convenience weigh out - that's partly why Tesco and Sainsbury's are still outselling Asda and Aldi depite most people knowing it costs more to shop there.

I also accept some/most musicians will want to try instruments before they buy but (based on G4Ms numbers) only 24% of UK spend is yet online - this will surely grow as a % of the total.......and the % is much lower in Europe. G4M are now already well established in both UK and Europe and should benefit as the market consolidates (in line with their strategy). With this platform other, high margin opportunities may open up as time goes buy. In investing we never know but with the price 50% of what is was yesterday, the odds in the long run must be better!

Thanks for your insights.

To be fair to G4M, we have seen some scaling of their marketing budgets. Looking at how much marketing spend was required to drive revenue growth in the same period, the figures are:

Fiscal year
2015 36.9%
2016 27.4%
2017 22.6%

This decreased marketing as % of sales from 10.0% to 8.4% over the same period and we saw the explosive op profit growth that led to the premium rating before recent missteps.

Unfortunately, this trend has recently reversed.

2018 27.9% (back to 2016 levels)
H1'19 31.0% (vs 26.4% in H1'18)

So marketing productivity has decreased the last 2 years which has crimped profits. On top of this, we have seen gross margin erosion unlike any period since the financial started.

Perhaps gross margin erosion and marketing productivity are related. The intense competition for one-off customers of large ticket items in a market with price transparency is probably to blame (I am sure there are some logistical inefficiencies too given the huge growth). If there strategy is simply to squeeze the competition out of the market, it does not bode well over the next few years...

Beginner

I have posted this before here, but was put down quite sharply last time. A relative is in the business. He says of £G4M 'the good stuff isn't very cheap, and the cheap stuff isn't very good'. I personally see the business as now perhaps fairly priced.

sharesurfer

In the recent market turmoil, Ive switched from being a primarily a momentum investor to a Quality/Value Investor guided by Momentum. G4M I would not invest in because they dont have much of a moat. Thats not subjective. Tne typical characteristics of 'moat' businesses (high Op Margins, Returns on Capital) are just not there. They operate in a the commodity space. The ones making the products have the moat. If they had First Mover Advantage and could become the the Music Retailers answer to Amazon then there may be an investment case but there are larger rivals and even smaller ones that undercut on price. As an internet retailer, the items they are selling (excluding the own brand of course), are commodities that are sold on price alone.

IMO As a long term investor, you'd be better off buying some of the makers of the equipment. TUNE for example has a 'moat' because they own the IP and are not selling a commodity. They can charge a premium for the differentiation their IP creates. And they trade on a lower PE than G4M even after the fall today (though granted their growth forecasts aren't as high). Bu whats the point of growth if your margins are wafer thin? Yes they might rise as marketing reduces as a percentage of sales but that might not even happen. What if they, as a 'smaller' player have to keep spending on marketing just to keep market share?

I think, given the choice, I'd buy TUNE rather than G4M.

Effortless Cool

5th Jan '19

Jimbonambo41, I have a degree of sympathy with you regarding Cambria Automobiles (LON:CAMB) trading updates. To answer one of your concerns, however, the 2015 interims show them as having paid £2.25m for the Royal Wootton Bassett freehold, so they will hopefully be booking a gain of £0.5m.

TQ12

6th Jan '19

Re: post 42 of 46
What is the source of your numbers below ...

"To be fair to G4M, we have seen some scaling of their marketing budgets. Looking at how much marketing spend was required to drive revenue growth in the same period, the figures are:

Fiscal year
2015 36.9%
2016 27.4%
2017 22.6%

ken mitchell

Paul Welsh.

Yes, it was me. Unfortunately warrants and subscription shares and covered warrants are on their last legs, with only 4 ordinary warrants and subscription shares left, and SG have run down their covered warrant offering to very few too.

In case you or any other readers are interested, the only remaining Investment Trust Suscription share currently well worth a look (and I hold) is FASS - Fidelity Asian Values Investment Trust Suscription share. This one expires on 30th November this year. Exercise price is 393p and current share price 415p. So FASS is currently worth 22p and on Friday could be bought for 21p. So it’s very good value with nothing extra to pay for the time value despite another 10+ months before it expires.

Target a 10% share price gain to around 450p and FASS would be worth 57p which is more than double the current FASS price. So a very good punt IF this Trust and Asian markets do OK this year. The obvious risk is a bad year and the share dropping below the 393p exercise price. Note by the way that the average PE for their portfolio holdings is a very modest 9!

Small Cap Value Report (Fri 4 Jan 2019) - JSG, G4M, CAMB

Johnson Service (LON:JSG)

Gear4Music

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Paul Scott

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