Small Cap Value Report (Mon 14 Feb 2022) - STU, VLX, UPGS

Good morning, it's just Paul here today, as Jack is busy doing other stuff.

Vox markets discussion - Paul Hill persuaded me to do another interview with him! As it's been such a tough market for small caps, I didn't relish the idea of talking about small caps, and said no initially. But as Paul Hill pointed out, it's when things are difficult that people like to hear how other investors are coping.

Podcast - I'm pleased to say that my audio quality is now much clearer. We've also shortened the format to just highlights of the week, so our latest podcast from Friday is only 14 mins. This link might work. If not, it's on Spotify under "Small Cap Value Report".

Agenda - 

Studio Retail (LON:STU) - bombshell announcement that the shares are suspended, and the company intends to appoint administrators. This probably means the equity is now worthless. We need more information, but clearly the problems at the company were far worse than reported. The only warning sign re solvency was on 31 Jan 2022, when the company reported a working capital shortfall.

Volex (LON:VLX) (I hold) - extended borrowing facilities, shows considerable confidence in the company from its lenders. There's also a reassuring trading update. I think this looks a good buying opportunity, given the forward PER is now only 13, and brokers have recently been nudging forecasts up.

Up Global Sourcing Holdings (LON:UPGS) - an in line with expectations update for H1 (to end Jan 2022). Shares look good value. Outlook comments about supply chain suggest there are early signs of improvement - reassuring for many companies.

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Investor Social - 

My investor friends David & Heather cordially invite everyone to an investor social in London, tomorrow (Tues 15 Feb 2022). The idea being that pandemic restrictions have left many of us missing the company of other like-minded people, and now we can safely meet up again, let's do it! I hope to see you there, and meet investor friends, old and new.

This is genuinely open to everyone, and we also urge investors to arrange your own informal events in your own area, which can be communicated easily on Twitter, etc, and by emailing friends & asking them to publicise things. Details of tomorrow's informal investor get-together -

It's an informal Meet-up Event open to all investors with no set format:

Tuesday 15th February from 6 onwards at the Cittie of Yorke Pub 22 High Holborn WC1V 6BN. The pub serves food until 8:30pm. It is an historic City Samuel Smiths' pub of remarkable character. Nearest Tube Station is Chancery Lane.

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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 opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it's anybody's guess what direction market sentiment will take & nobody can predict the future with certainty. We are analysing the company fundamentals, not trying to predict market sentiment.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed - please be civil, rational, and include the company name/ticker, otherwise people won't necessarily know what company you are referring to.

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Studio Retail (LON:STU)

Share suspended - intention to appoint administrators

This is a nightmare scenario for shareholders unfortunately.

A brief update has just come through, saying the company’s banks were not prepared to extend its borrowing facilities by another £25m. Therefore the company is intending appointing administrators.

This seems an astonishing development, given that in this type of situation, where there is a relatively modest shortfall in funding, you would normally expect a discounted placing to occur. The major shareholders would normally support such a fundraise.

Again, we don’t know the full details yet, but it has to be the case that shareholders were not prepared to support an equity fundraising. It’s incredible that they would throw away their existing investment, because usually shareholders get nothing from an administration process - the business is usually sold as a going to concern for less than the total liabilities, leaving shareholders with nothing.

As announced on 31st January, Studio has a surplus stockholding which requires additional working capital funding whilst this good quality stock is sold through to customers. The Company requested a short-term loan of £25m from its lending banks to fund the surplus stockholding which it believed was sufficient to enable it to sell through the stock to customers. Following detailed discussions with our UK lenders, the Company has not been able to reach agreement with them to provide the additional funding Studio requires.

We need more information before we can draw a firm conclusion here.

Checking back through our archive, I reported here on 31 Jan 2022 that I had lost confidence in management, because of the lack of control over its supply chain, and the reported shortfall in working capital.

But I never imagined it would be bust within a fortnight of that announcement. So it sounds to me as if the problems must have been far worse than disclosed.

We’ll have to wait for more information, but unfortunately I suspect the equity is probably now worth nothing. That’s because equity ranks behind all creditors, so the administrator’s job is to pay off the creditors for anything they can get from selling the operating business, and in this case, the wind-down of the customer loan book. In theory the loan book should be enough to pay off all the creditors, but when companies go bust, you often find that the reported figures are not accurate, with some sort of black hole in the numbers. Administrators also often sell-off assets at fire sale prices.

I'm sorry if any readers got caught out on this one. 

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Volex (LON:VLX) (I hold)

272p (down 2%, at 08:41) - mkt cap £430m

New, enlarged debt facilities support ongoing growth plans

Like many other small caps, shares in Volex have been drifting down, to such an extent that you can’t help worrying if something might be wrong, that hasn’t been disclosed.

Hence when I saw today’s announcement about new debt facilities, and growth, I was hoping to find some comments about current trading.

Pleasingly, the last paragraph looks to me like an in line update (see below), and this reassures me. Hence I’m very surprised the Volex share price is currently down on the day, when it should be up. That looks wrong to me, so this could be a good buying opportunity - probably due to a general market panic this morning about possible war in Ukraine -

The new facilities also strengthen our ambitions to deliver sustainable growth as we continue to perform robustly, successfully navigating the current supply chain challenges while demonstrating our ongoing ability to pass through inflationary cost increases."

That’s very encouraging actually.

New bank facilities - considerably enlarged at $200m+$100m accordion, and at an improved lending margin.

Other positive signs are that the lending margin makes it cheaper than the existing facility, although banks often seem to shift the costs onto heavy arrangement fees, which are not mentioned in today’s update.

A maturity date of Feb 2025, with 2x 1-year options to extend, is also a decent length of time, in banking terms, suggesting that Volex has a very strong relationship with its banks. Which could be a spin-off benefit from having Nat Rothschild running the show!

My opinion - this looks very positive to me, hence I‘ll stick my neck out here, and say I think 272p seems a good buying opportunity. I’m basing that view on today’s announcement effectively being an in line with expectations trading update, plus it indicates that supply chain and price increases to customers are in hand.

The fact that the banks have agreed a substantial extension (in time and amount) to the borrowing facilities, at a lower price, is telling us that the banks have a lot of confidence in the company and its management. The banks are very likely to have seen management accounts on current trading, and internal budgets, so again there’s a clear message of confidence here.

Looking at valuation stats, the forward PER looks excellent value, for a group which is making good acquisitions at reasonable prices.

Providing it hits these numbers, then a PER of just 13 really does look an excellent entry point -

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Note that EPS growth is distorted from an unusually low tax charge last year, so the underlying increase in earnings is better than it looks.

Together with the reassuring update on current trading provided today, I also check the broker consensus forecasts to see if early signs of trouble might be emerging. Quite often companies tip off the brokers early, to get forecasts lowered, if they’re struggling to meet budget. However, in this case, brokers have edged forecasts up in the last couple of months. They’re often miles out though, so we shouldn’t imagine that we can definitely rely on broker forecasts. But it’s one factor which can at least improve the odds in our favour, when these are moving in the right direction -

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Overall then, I don’t particularly want Volex to over-extend itself with bank borrowings (with STU giving us a stark reminder today of what can happen when banks lose confidence in a company, if it needs extra support). However, the fact the banks are prepared to offer considerably larger borrowing facilities, looks bullish for Volex shares.

A PER of 13 looks too cheap, so I reckon this could be a nice buying opportunity. Obviously we can’t be certain of that though, as always this is all educated guesswork, trying to predict the future from incomplete information. The signals we do have look positive though, which combined with a share price that has almost halved from a recent peak, looks attractive to me.

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Up Global Sourcing Holdings (LON:UPGS)

181p (down 2% at 09:29) - mkt cap £160m

Trading update

Ultimate Products, the owner of a number of leading homeware brands including Salter (the UK's oldest houseware brand, est.1760) and Beldray (est.1872), announces the following trading update for the six months ended 31 January 2022.

The company’s PR heading is interesting also for its wider read-across to other sectors -

Performing in line with expectations, with recent signs of supply chain improvements

I won’t repeat all the operational detail, since the key message is that UPGS is performing in line with expectations.

Outlook -

The Board anticipates a full year performance in line with current market expectations.

The well-documented global supply chain challenges continue to represent a headwind for the business. While the situation remains uncertain and subject to change, conditions have recently shown early signs of improvement and the Board is cautiously optimistic that the worst is behind the Group.

Since we have an in line update today, then we should be able to rely on the forward PER, with some encouraging stats below (low fwd PER, good EPS growth, and decent divi yield) -

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I’ve highlighted the “n/a” in the Price to Tang(ible) Book value field, as this usually means NTAV (the same as PTBV) is negative, hence a flag to check the balance sheet, which could be weak.

Diary date - 29 April for H1 results.

My opinion - a very interesting update, because UPGS’s whole business model is sourcing, and importing consumer goods from the Far East. Hence they’re supply chain experts. They confirm that we’re over the worst, which chimes with my general impression from other companies reporting, that at least things don’t seem to be getting any worse. Although plenty of other companies are suffering from the fall-out of badly managing their own supply chains - e.g. terminal for STU, and painful but not terminal for Joules (LON:JOUL) (I hold). Plenty of other companies have seen considerable extra costs, and delays.

As equity investors, we’re meant to think ahead, although it seems to me there’s little, if any evidence of that actually happening right now. Equity markets seem totally focused on short term issues. Hence that’s creating the buying opportunities now, for investors who look forward to later this year, and 2023, when supply chains easing could well provide a boost to profits, e.g. when container freight fees drop back from excessive current levels. I’ve no idea when, but it’s very likely (almost certain actually) at some point.

Offsetting that, we have higher input costs (again, no idea when those ease), and higher labour costs (and skills shortages).

Plus we’ll find out in due course which companies are able to seamlessly pass on higher costs to customers, and which ones struggle. So lots to think about, and attempt to forecast, if you’re brave!

However, my conclusion here is that it’s encouraging to hear from a specialist importer, that we’re over the worst re supply chain disruption.

I don’t see UPGS as justifying a premium rating, but at 12.7x fwd earnings, it looks solid value to me.

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