Small Cap Value Report (Mon 23 March 2020) - Extreme levels of uncertainty, FUL, TED, GYM, FA., MOSB, TAST, ALT, VRS

Morning!

Boris Johnson announced the forced closure of pubs, bars and restaurants on Friday evening.

Calls are growing for some form of 'lockdown' (e.g. as seen in Italy) to slow down the spread of the virus further.

The FTSE is currently (7am) set to open down 4% at 4940.

More to follow.

Cheers,

Graham 

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Wow!

The RNS feed is crazy today, I've never seen anything like it before.

Dozens of companies have felt the need to update the market with their latest situation, given the ongoing human, economic and financial calamity. Announcements today fall under a number of broad headings:

• delayed results (per FCA guidance)
• cancelled dividends or share buybacks
• trading updates

I'm not sure where to begin so I will focus on those companies we have commented on before, to maintain continuity.

• Fulham Shore (LON:FUL)
• Ted Baker (LON:TED)
• GYM (LON:GYM)
• Fireangel Safety Technology (LON:FA.)
• Moss Bros (LON:MOSB)
• Tasty (LON:TAST)
• Altitude (LON:ALT)
• Versarien (LON:VRS)

(This list is provisional.)

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Extreme Uncertainty

In this extraordinary time, when vast swathes of economic activity have been cancelled, who would be an investor? It's impossible to predict what will happen in six weeks, let alone in six months.

And now the Financial Conduct Authority has made the strange decision to request "a moratorium on the publication of preliminary statements for at least two weeks".

I don't understand the rationale. If some companies feel unable to publish their statements, due to the rapidly changing situation, they are free to delay. I don't see why all companies should delay? Surely this will mean investors have even less information with which to make decisions?

The FCA says "the audit profession are facing unprecedented practical challenges during the Coronavirus crisis". That's probably true, too - but again, why does it mean that all companies should delay the publication of their preliminary statements?

Less information means that companies are worth even less, since we have to deal with even more uncertainty.

Having so little information to work with, and in a situation where the economic outlook is shrouded entirely in darkness, I don't blame investors who are selling at these levels. It's very hard to hold your nerve and stay invested through a crisis like this.

This website is for company investors (as opposed to fund or index investors), and therefore I think the best course of action for us is to understand our individual companies and their individual prospects for survival.

I'm staying fully invested because I believe that my companies, or nearly all of them, will get through this mess and emerge on the other side. Their value (to someone who holds them for a very long time) hasn't collapsed by as much as their share prices have, in my view.

But it's definitely far from easy to stay invested.

Strong reasons people might have to sell:

• margin calls due to excessive leverage
• unwilling to hold companies which have no earnings forecasts
• unwilling to hold companies which don't publish their results in a timely manner
• needing the cash due to loss of employment income during the crisis
• time horizon (e.g. to retirement) not long enough to withstand further losses
• a belief that economic depression is about to ruin the value of many or most companies

While these are all excellent reasons to sell, they do leave a potential opportunity for cash-rich buyers, with long time horizons, to mop up shares on the cheap.

Except if we do have another virus-induced economic depression, then earnings really are going to take a big hit, and it could take a long time to recover.

A senior figure in the US Federal Reserve said yesterday that US unemployment could hit 30% in Q2, and GDP could fall 50%. He wasn't joking - he actually thinks these numbers are possible under a "planned, organised partial shutdown of the US economy".

If we get numbers anything like that in the US, and/or in Europe, then everybody is going to suffer from the economic contagion and the road to recovery will be highly uncertain. Uncertainty, once again, is the key element of the current situation.

Chin up!

Looking for solace isn't easy. For what it's worth, nearly everybody's equity portfolio has taken a beating. We are all hurting. You're not alone!

My own portfolio is down by 20% this month. And worse than that, year-to-date (not sure I want to look up the precise figure!)

But forget about me. What about Berkshire Hathaway ($BRK.B), where I'm a shareholder?

The share portfolio overseen by Warren Buffett at Berkshire is down 34.5% year-to-date (pre-tax), according to rationalwalk.com. By these calculations, the portfolio was worth $242 billion at the start of the year and is now worth just $159 billion (it is impossible to calculate precisely).

The Berkshire Hathaway year-to-date performance is worse than the S&P 500 (minus 28.7%).

There are only a few equity investors who haven't been crushed. These include hedge funds and individuals who routinely hedge out their market risk. These investors face their own challenges - hedge funds unperformed the market for the entire bull run.

This market is a rotten place to be if you enjoy capital gains (and let's be honest, most of us do!)

But the markets will be open again next year, and the year after that, and I believe that most companies will survive. For new money, there are some remarkable entry points to be had. The median trailing P/E multiple in the FTSE-350 is 10x, and I believe most of these companies will survive and eventually return to their former glory.

Maybe over the last few years, we just forgot how risky equities can be. We had the longest bull run in history, and we were lulled into a false sense of security. This recent human tragedy has shocked us and made us aware once again of financial risk.

Anyway, on with the news...

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Fulham Shore (LON:FUL)

• Share price: 5.5p (unch.)
• No. of shares: 574 million
• Market cap: £31.5 million

Trading update

Back in the days when eating out was a thing, I enjoyed some lovely meals at Franco Manca and The Real Greek.

There is a lot to be said for sourdough pizza. Today is not the day to say it, however.

The majority of the group's restaurants are closed as of last Friday. The rest are doing delivery, take away and "click and collect". 

The key sentence is:

Our lenders are supportive and we have sufficient undrawn facilities available to manage the business through any anticipated period of closure.

Survival is the best-case scenario, in this situation!

FUL says it will benefit from the business rates holiday and the job retention scheme.

Let's remind ourselves of FUL's balance sheet. At the interim results, it had net debt of £8.8 million.

If staff costs go to some number approaching zero, and if rates are reduced, the other important cost is rents.

Landlords do get a mention in this update, in passing. They are one of the groups FUL is working with, "to reduce our outgoings to the basic minimum".

I was asked in the comments last week how I would model the survival of companies in this environment.

It's hard to generalise an answer to this question. I look at operating expenses and try to understand what a zero-revenue performance looks like.

Take FUL for example. In H1, it had "headline" operating expenses of £11.9 million (excluding some non-cash expenses and site pre-opening costs).

It also had interest on lease liabilities (part of the rental cost from an accounting point of view) of £1.16 million.

So there are roughly £13 million in fixed costs every six months.

In here you have things like staff costs, business rates, and rents.

I'm not close enough to the company to know what percentages these specific categories amount to, but let's suppose for the sake of argument that FUL is able to cut its operating expenses by more than half, to a run rate of just £1 million per month. This doesn't seem impossible, if it is using both the rates holiday and job retention scheme. I'm guessing it will still have to pay rents and central staff costs.

My understanding is that restaurants in London pay around 20% of their turnover on rent. Applying that percentage to FUL would imply that it spends more than £1 million per month on rent alone. But I will assume that it can cut its total spend to around £1 million, perhaps with the help of its landlords.

My next port of call is to check the headroom on a company's lending facilities (or simply the size of its remaining cash balance, if there is no lending facility).

According to last year's annual report, the size of FUL's lending facility was £15 million.

At the interim report, cash was £1.7 million and gross borrowings drawn from the facility were £10.5 million. I make that financial headroom of 1.7 + 4.5 = £6.2 million.

This is just for the purposes of illustration - I don't know how much of its costs FUL can slash, or what its latest balance sheet looks like. My numbers give an extremely rough estimate that the company could survive for six months without any meaningful revenue:

• £6.2 million financial headroom divided by £1 million monthly costs = 6 months of survival time

It's important to highlight that I have no idea what the actual length of survival time might be. FUL says it could survive "any anticipated period of closure", but I do think there is a limit on that.

I should also emphasise that "survival time" is based on a company's existing facilities. It might find new sources of debt, or expand its existing facilities. Or it might be able to raise some equity, without too much dilution, in order to keep going.

Conclusions

I am surprised that its market cap is still measured in the tens of millions, if I'm honest. While I do think that most companies will survive this crisis, my optimism does not extend to leveraged restaurant chains facing an unknown period of closure.

If closure lasts for just 1-2 months, then my feeling is that it will be fine. Longer periods of closure would raise doubts in my mind as to whether the existing equity of this company (and similar ones) will prove to be worth anything.

The problem is that we don't know how long these conditions will last for.

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As an aside, I note that betting shops, casinos and bingo halls are currently excluded from the rates holiday. Terrible news for the bookies and casinos which are now closed, and still paying tax.

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Ted Baker (LON:TED)

• Share price: 138.33p (-20%)
• No. of shares: 44.6 million
• Market cap: £62 million

Sale and leaseback, loan facility, COVID-19 update

A big RNS:

• net proceeds of £72 million (more than TED's current market cap) to be received from the sale of TED's head office at a huge premium to its book value.

Net borrowings were reported at £141 million as of August 2019. The proceeds from the sale will be used to take a big bite out of this.

• bank lending facilities increased by £13.5 million. 

The total size of TED's lending facilities, as of September 2019, was £180 million. Today's increase is relatively minor but it does highlight TED's heavy reliance on debt to survive the current crisis.

Many readers will be aware that TED had been in crisis mode for a while. Its share price is down 95% from its peak. The market appears to doubt that the existing equity will be able to survive the latest crisis.

Speaking of which, here's the trading update:

• "all available opportunities to agree rescheduling or reduction of payments are being explored" with HMRC, landlords and suppliers. 
• vast majority of stores globally are now closed (responsible for 68% of sales)
• small consolation with 16% revenue growth online over the past 8 weeks ("albeit with some variability across recent weeks")
• no guidance can be given for FY 2021

My view

Selling the London property makes perfect sense.

It's now all about keeping the banks relaxed, and stretching out payments for as long as possible. Liquidating valuable assets such as London property is the right thing to do here.

Like many other shares, TED is now in "punt" territory. 

It might survive, but there are forces beyond its control which are directing events.

At some stage, it might make sense to buy a basket of 10 of these leisure and retail shares, on the basis that 1 or 2 of them might survive and go on to become a multi-bagger.

It's not something I'd want to do personally. But I acknowledge that many of these shares are now priced as cheap-ish options on the company's survival.

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GYM (LON:GYM)

• Share price: 80p (-16%)
• No. of shares: 138 million
• Market cap: £110 million

Update

All 179 gyms are shut.

Net debt at year-end was £47 million, and it had £20 million of headroom on its bank facility.

Total expenses last year were £140 million (excluding tax and exceptional items), or £11.5 million per month.

Many of these expenses can be avoided in the current circumstances, but again I don't know what a reasonable guess in terms of the proportion might be - half?

That would give a survival time of around four months before additional funding was needed.

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Fireangel Safety Technology (LON:FA.)

• Share price: 9.5p (-5%)
• No. of shares: 76 million
• Market cap: £7 million

Unaudited Preliminary Results

Open Offer and Placing to raise £6.1 million

This maker of connected home safety products has been a disaster for investors in the last few years.

Last month, I gave it the bargepole treatment.

Today's results are predictably awful - mountains of red ink. There is a loss even at the "underlying EBITDA" level.

The only bright spot is that the Directors forecast FY December 2020 to be in line with expectations. I'm not sure if that is worth anything, however, given this company's track record of negative surprises.

In a separate RNS, the company announces £6.1 million raised at 12p, through the issuance of 50.6 million shares, to help repair its balance sheet.

My view

FireAngel shows a weak balance sheet for December 2019, featuring:

1. £3.5 million in provisions for warranties
2. £7 million in invoice discounting facilities (usually an expensive form of finance).

However, after raising net proceeds of £5.8 million, I am happy to withdraw my "bargepole" rating, since it will be better able to manage this debt.

Based on its track record, I would still be extremely cautious about making an investment here.

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Smaller sections now, to allow me to cover more ground.

Moss Bros (LON:MOSB)

• Market cap: £19 million

Trading statement

There has been "a significant reduction in footfall" and in orders for Hire.

Seeing as all major events (including things like weddings) are being postponed, it's not hard to imagine that the market for formal menswear has collapsed.

All Moss Brothers shops are now shut, in any event. It is still possible to buy online, but how many men are going to order suits online in these circumstances?

It's helpful that Moss quantifies its survival time:

The Group is debt free and retains cash in the bank. It is managing the business to protect profitability and is taking all necessary action to reduce costs and conserve cash. With these actions, the Group believes that it has the ability to withstand significant revenue decline through to the beginning of the 2^nd half of FY21.

H2 of FY 2021 begins in July. That gives around 3-4 months of survival time.

When the merit of an investment depends on the timing of a government decision, we've moved beyond the realm of investment and into pure speculation.

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Tasty (LON:TAST)

• Market cap: £1.5 million

Statement re: restaurant closures

This share price is down 40% today:

• all 56 restaurants are closed
• working with landlords and suppliers, using Government supports re: VAT, business rates and employee pay.

The share price collapse is puzzling if you believe the RNS:

Given the Company's existing cash position with no debt, the Directors confirm that during the period of shutdown and assuming it is successful in implementing the cost cutting and cash preservation measures referred to above, it has sufficient financial resources for the foreseeable future.

Checking the recent results statement, I see the cash balance was £4.6 million.

I didn't want to invest in this company when its restaurants were open, so I don't feel enthusiastic about buying into it when its restaurants are closed. But perhaps it could offer speculative value, for the very risk-tolerant?

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Altitude (LON:ALT)

• Market cap: £12 million

Trading Update and Board Change

Guidance is withdrawn for FY March 2021.

Trading up to December 2019 was "on target to achieve market expectations", before the onset of the crisis.

Cash plus receivables as of 31 March 2020 is estimated to be more than £5 million. 

I noted last week that cash plus receivables was a reasonable input to use when estimating survival time, for companies whose receivables convert to cash in good time.

It claims to have a "low overhead model" with c. 95 employees across the UK and US.

I'm bullish on websites and software companies - even if their customers are temporarily suffering, it should be fairly straightforward for the websites and software companies to cut costs.

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Versarien (LON:VRS)

• Market cap: £41 million

Subscription to raise £6 million

This is a very strange (some might argue ridiculous) fundraising exercise.

Versarien is "raising" £6 million, except it's not really.

What it is doing is issuing 15.75 million shares (more than 10% of the current share capital).

In exchange, it will receive monthly payments for the next two years.

If its share price is on average more than 53.33p each month, it will wind up receiving more than £6 million from the investor.

On the other hand, if its share price is less than 53.33p (latest share price: 26.7p), it will receive less than £6 million from the investor.

For example, if the share price is stuck around its current level, Versarien will only receive c. £3 million over the two-year period.

Such a scheme would, I imagine, cause the management teams at most small companies to obsess over their share price.

Thankfully, in Versarien's case, we can trust that won't happen.

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Out of time for today. Paul should be back tomorrow, if he's feeling better.

Cheers!

Graham