Small Cap Value Report (Mon 23 May 2022) - CNIC, CREO

Good morning, it's Paul & Jack here today!

Tomorrow is the first physical Mello event in a long time. This will be a great chance to meet up with fellow investors so if you can get to Chiswick, London then there are some free tickets going for the first day if you register with the code LAST30. David’s got some more information in this post.

Jack's section:

CentralNic (LON:CNIC) - I hold - positive quarterly update and the group is confident of meeting upgraded FY expectations. This is a quickly growing tech stock on 10.7x forecast rolling earnings, so it’s interesting from a valuation perspective. That’s in part because the group is only just reaching profitability after years of acquisitive activity and operational investment.

Creo Medical (LON:CREO) - not familiar with this stock. Revenue is up but the group burns a lot of cash and has yet to make a profit. It does spend on R&D, and it seems to be able to get a decent amount of funding from shareholders, which shows that some investors think its products are worth backing. It’s not my area though and the StockRank is low, so I’m passing for now.

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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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Jack's section

CentralNic (LON:CNIC)

Share price: 135.8p (+3.66%)

Shares in issue: 288,660,084

Market cap: £392m

Q1 results for the three months ended 31 March 2022

CentralNIC is a global internet platform that generates recurring revenue from operating a marketplace model for online presence and online marketing services. That’s things like online advertising, as well as more fundamental online tools such as websites and domain addresses.

Both revenue and adjusted EBITDA have increased year-on-year, driven by a combination of acquisitions and underlying organic growth.

• Revenue +86% to $156.6m,
• Gross profit +43% to $39.9m,
• Adjusted EBITDA +83% to $18.5m,
• Operating profit up from $1.4m to $10m,
• Net debt -18% to $61.3m.

The group has moved from a loss after tax of $1.4m to a profit after tax of $4m, with adjusted earnings per share up 42% from 3.17c to 4.51c. That’s more than it made in the entirety of FY21, or any other financial year by the looks of it.

After a period of acquisitions and operational consolidation, the group may be at an inflection point in terms of profitability. It’s good to see non-core operating expenses down by 63% to $1.1m. Cash conversion remains very strong at 128% this quarter (compared to 163% in the previous year). Signs of scaling and operating leverage too, with EBITDA as a percentage of net revenue (gross profit) increased from 36% to 46%.

Organic growth accelerated in the period to c53%, driven by investments in management, staff, and systems.

Online Marketing grew at a faster rate, with revenue +158% to $116.9m (organic growth of 83%), driven mainly by the TONIC media buying business. The number of visitor sessions increased by 54% from 0.7 billion in Q1 2021 to 1.0 billion in Q1 2022 and revenue per thousand sessions ("RPM") increased by 105% from $48.00 to $98.20.

Importantly, none of the group’s platforms make use of third-party cookies, which insulates it from evolving privacy regulations.

Online Presence revenue grew modestly, from $39.1m to $39.7m. Organic growth for this segment was 7% for the trailing twelve months ending 31 March 2022. CentralNIC has been working on improving the quality of revenue here, moving away from discounted bulk sales and increasing average revenue per domain by 11% to $9.50.

Acquisition of VGL for c$65m in the period, plus a £42m equity raise, 21m euro bond placing and £3m open offer in the period. The group also acquired Fireball and the .ruhr TLD for $0.7m.

The directors are confident that the company is comfortably trading in line with the recently upgraded forecasts.

CEO Ben Crawford comments:

​​CentralNic has enjoyed a strong start to the year with year-on-year organic growth now reaching north of 50%, gaining market share in a growing market. At the same time, we have continued to add scale and capability through the completion of three strategic acquisitions in the period, including VGL, our largest acquisition to date, funded by an oversubscribed equity placing and tap bond issue. With notably reduced leverage and a healthy cash cushion, CentralNic remains well positioned for the future .

Diary date: H1 trading update on 18 July 2022.

Conclusion

CentralNIC has been named by the FT as one of the 250 fastest growing companies and among the top 50 fastest growing technology companies in Europe, and these results show why. The group has a sense of ambition.

We are confident in continuing our trajectory towards joining the ranks of the global leaders in our industry.

The group is growing quickly, partly through acquisitions, which can be risky - but the nature of these acquisitions (recurring revenue, minimal key person risk, completed from a market position which offers good visibility on targets) makes it preferable to some other similar strategies. The pipeline of future acquisition targets remains strong, net debt levels are comfortable, and cash conversion remains healthily above 100%. It should continue to do so.

What is required is for all this activity to translate into shareholder profits - forecast to happen over the next year, which is partially borne out by these quarterly results. In fact, if the group carries along its current trajectory then we could see earnings upgrades in coming periods.

Happy to hold here, a fast-growing tech company trading on 10.7x forecast rolling earnings. It looks like institutional investors are also buying into the vision. There’s acquisition risk, but management has so far done good job and has invested in its acquisition team.

As the company scales, the recurring revenue and cash conversion will really come to the fore, while investment levels are expected to plateau. Assuming the group continues to grow well organically, I’m anticipating a step change in profitability this year.

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Creo Medical (LON:CREO)

Share price: 97.81p (+1.89%)

Shares in issue: 180,901,186

Market cap: £176.9m

Final results for the year to 31 December 2021

Creo Medical is a medical device company focused on the development and commercialisation of minimally invasive electrosurgical devices.

These final results are quite late. Perhaps there’s a good explanation for this, but it’s not usually a good sign in terms of a company’s financial function. If Creo is on top of its reporting, why does it take nearly six months to prepare a full year report? A recent broker note commented that the group was ‘scheduled to publish FY21 results in early May 2022’, which is late enough, but here we are on the 23rd.

The StockRanks give more warning signs, so it’s not a good start.

Results:

• Total sales in the period of £25.2m (FY 2020: £9.4m)
• Cash and cash equivalents of £43.5m at 31 December 2021 (FY 2020: £45.1m), including £34.3m net raised through Placing and Open Offer in September 2021
• R&D expenditure in the year was £12.9m (FY 2020: £10.2m)
• Operating loss of £29.9m for FY 2021 (FY 2020: £23.5m) including £2.6m share based payments (FY 2020: £0.7m), in-line with management expectations
• Net assets of £73.3m at 31 December 2021 (FY 2020: £62.8m)

That’s quite a good chunk of cash on the balance sheet. With a net operating cash outflow of c£26m, it seems like the company needs it.

Conclusion

Historically loss making, and a fair amount of equity dilution here.

The shares have fallen heavily recently. It goes to show there’s not much supporting the price, with some revenue growth but ongoing losses and cash burn.

Net tangible assets of £46m, but how secure is that? A high level of R&D suggests scope for change, but I would rather the company could fund that cost itself.

My view here is that if you don’t have much of an edge in the sector, picking pre-profitability winners is hard and the odds are against you.

It’s not the kind of profile I typically look out for so I’m not going to spend longer on Creo, but if anybody has anything to add in the comments please do. This kind of share requires sector specialism and a deeper knowledge of the products, in my view.

Three brokers list it as a strong buy, but the group is forecast to remain loss-making which raises the prospect of further dilution a couple of years out, unless the profitability improves.

It does seem to be fairly well-funded so the IP must be reasonably credible, but there’s not much concrete underpinning the share price right now. Liquidity is not great (spread of c500bps) and the market cap still prices in a decent amount of growth. There may be upside potential, but I’d be worried that the shares could fall further.