Small Cap Value Report (Mon 25 April 2022) - MCLS, TLY, ZOO

Good morning, it's just Paul here today. Today's report is now finished.

Agenda - 

Paul's Section:

Mccoll's Retail (LON:MCLS) - as we expected, the company finally admits that existing equity is worth "little to nothing".

Totally (LON:TLY) - a positive trading update for FY 3/2022, with forecast EPS raised today from 1.8p to 2.0p. We like this share here at the SCVR, it seems to be performing well, growing quite rapidly, and the valuation looks reasonable, assuming nothing goes wrong in future.

Zoo Digital (LON:ZOO) - surprisingly, it's come out with another positive trading update, with FY 3/2022 forecasts raised again. I've generally been sceptical about this share, given poor performance over 22 years, but the bull case is definitely strengthening now that 78% organic growth, and a move into decent profit has been announced. 

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Mello Monday - the online investor event is tonight, starting at 17:00. Three interesting companies presenting, so this looks a particularly good one.

Mello Chiswick - the physical event is back! Details here, it's quite soon, on 25-26 May. It's going to be fantastic to see a lot of old friends again, after a 2 or 3 year gap.

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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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Paul’s Section:

Mccoll's Retail (LON:MCLS)

3.95p (pre market open)

Market cap £11m

Update

Trading has been mixed, but that’s irrelevant now.

This is what matters, and it’s (as expected) a wipe-out for shareholders -

Update on key stakeholder engagement   

The Group acknowledges and appreciates short term credit support received from its commercial partners and senior lenders. A potential financing solution is under active discussion with its key commercial partner and lenders which would resolve the short term funding issues and create a stable platform for the business going forward. It should be noted that even if such a successful outcome is achieved it is increasingly likely to result in little or no value being attributed to the Group's ordinary shares.

The writing has been on the wall for a while, which we covered here on 28 Feb, and again here on 24 Mar, making it clear that equity was almost certainly worth nothing.

The business is likely to survive in some form (especially the Morrisons Local refitted stores), but with new owners.

So that’s (almost) it, game over for MCLS as a listed share.

The shares are likely to be suspended soon, so anyone left holding, it’s still worth selling in the market if you can, and if the proceeds exceed the dealing commission.

Or, keep them and go down with the ship, to keep as a reminder that it’s not good to hold shares in companies which are obviously insolvent. Even if they’re only worth a hundred quid or something, that’s still real money, which could be donated to charity, or spent on a lunch.

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Totally (LON:TLY)

42p (pre market open)

Market cap £79m

Trading Update

The Board of Totally plc (AIM: TLY), a leading provider of frontline healthcare services, corporate fitness and wellbeing services across the UK and Ireland, today announces an update on trading for the 12-month period ended 31 March 2022.

Outstanding trading performance

This looks very good -

Based on unaudited draft numbers, the Group anticipates reporting EBITDA*, for the year ended 31 March 2022, substantially ahead of consensus market expectations of £5.4 million EBITDA and prior year of £5.0 million.  
This strong trading performance across the Group was driven by enhanced demand attributed to the impact of the global pandemic, which has increased demand for services and led to significant growth in waiting lists which has been regularly reported in the press.

The cash position is also healthy - note that TLY has a favourable working capital position because customers (mainly the NHS, I believe) pays up-front -

As at 31 March 2022, the Company was in a healthy financial position with £15.3 million of net cash (31 March 2021: £14.8 million) which is particularly pleasing given that £7.4 million in cash has been utilised to complete two significant acquisitions during the period, in line with the Group's stated 'buy & build' strategy. The Company has no debt financing**. During the period the Company secured a £5.0 million rolling credit facility, should it be required at any time in the future. To date, this has not been utilised.

Balance sheet - note that the last balance sheet showed NTAV slightly negative, so the cash pile has come from favourable advance payments by customers, therefore there’s a risk (however remote) that the cash could disappear if the NHS decides to slow down payments to suppliers. That sounds unlikely to me, but it’s my job to flag up potential risks.

Contract wins -

Over the course of the 12-month period the Group was awarded new contracts totalling c. £59 million and contract extensions worth c. £72 million.

Acquisitions - sections on the 2 recent acquisitions are a bit general & waffly, but one is said to have “made good progress”.

Forecasts - many thanks to Allenby for crunching the numbers for us today. It has upped EBITDA to £6.1m, from £5.5m, which Allenby sees as a prudent interpretation of the trading update.

EBITDA isn't a reliable number here, and it  translates into a much lower profit of £3.5m on an “underlying PBT”  basis, per Allenby.

Adj EPS is usually the best number to use for valuation purposes, and this is now forecast at (based on today's early price of 44.5p, up 5%) -

2.0p FY 3/2022, PER of 22 (probably about right)

2.9p FY 3/2023, PER of 15 (looking more tempting)

4.1p FY 3/2024, PER of 11 (attractive)

As you can see, it would take 2 years of achieving strong earnings growth to bring the valuation down into value territory. There’s the ever-present risk for all companies, that something might go wrong (e.g. big contracts lost), so we can never be entirely sure that forecasts will definitely be met, they’re only estimates after all.

My opinion - I’m becoming increasingly bullish on the fundamentals at Totally, as the company seems to be executing well, and making acquisitions to help further drive growth. It’s probably too early to ascertain whether the acquisitions strategy is going well, or not - today’s commentary seemed a bit sparse on that. I usually like to see more upbeat comments about acquisitions (e.g. exceeding expectations).

The valuation looks reasonable for a growth company that is performing well.

Also, I like the sector, where good outsourcing companies seem to be trusted by the NHS if they do a good job, and get paid promptly too, so little capital is tied up, and expansion shouldn’t require significantly more placings.

When looking at this company’s past, you have to remember it tried out different activities in the past, and then morphed into the current business of healthcare services in a series of reverse takeovers (where the target company is larger than the acquirer). Hence the substantial share issuance over 2017-2019. That large share issuance created the current business, through acquisitions. From this point onwards, with a significant & growing cash pile, the company looks to be fuelling recent acquisitions from internal cashflows, which is obviously much better.

I’d be interested to hear what previous experience management has in making acquisitions? So far it seems to be working well anyway. There’s always the risk with acquisitive groups that they buy something bad, or become overwhelmed with managing a more sprawling group.

I had a look back at the most recent results, and the cashflow statement looks impressive.

Overall, I think this share looks an interesting long-term buy & hold. Particularly because healthcare is a big problem at the moment, due to long waiting lists, hence likely to remain a focus for Govt spending in the UK, even if the rest of the economy deteriorates.

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Zoo Digital (LON:ZOO)

119p (up 5% at 10:18)

Market cap: £105m

Trading Update

ZOO Digital Group plc (AIM: ZOO), the leading provider of end-to-end, cloud-based localisation and media services to the global entertainment industry, today provides a pre-close trading update for the financial year ending 31 March 2022 in advance of full year results expected to be announced on 6 July 2022.

Upgrade to FY22 revenue and EBITDA; positioned for strong, sustainable organic growth  [company's bolding]

An impressive update today (below), with the company seemingly finding another $5m revenues more than expected in the last 9 days of the financial year, which is unusual!

Following the announcement on 22 March 2022, where revenue was forecast to be at least $65 million and EBITDA at least $6.5 million, the Group today further upgrades its expectations for the year ended 31 March 2022.

Revenue for the full year is now expected to be approximately $70 million (FY21: $39.5 million), a significant acceleration of organic growth over the prior year of 78%.  

EBITDA (adjusted for share-based payments) is also expected to be materially ahead of the previously upgraded expectations at approximately $8 million, an increase of approximately 78% on the prior year (FY21: $4.5 million).

Net cash on 31 March 2022 was $5.4 million (FY21: $2.9 million), which reflects strong cash generation despite significant investment to expand capability and underpin future revenue growth.

Organic growth of 78% is highly impressive.

Forecasts - Progressive have previously issued updated forecasts for ZOO, so I expect one might be in the pipeline. Looking back at the previous forecast for $6.8m EBITDA, this only translated into $2.6m adj PBT, so the EBITDA figures for ZOO need to be taken with a pinch of salt.

This should result in adj PBT for FY 3/2022  going up to  c.$3.8m. This seems to be the first time in ZOO’s history that it’s produced a meaningful profit. On the back of superb organic growth, this is starting to look like it might be a turning point from a serial disappointer, into something that could grow into the £105m market cap, and maybe beyond?

Cash - has been looking weak for a while, but there’s been a reassuring move upwards, which reduces the risk of it needing another placing -

Net cash on 31 March 2022 was $5.4 million (FY21: $2.9 million), which reflects strong cash generation despite significant investment to expand capability and underpin future revenue growth.

Outlook comments sound upbeat -

"It has been an outstanding year for ZOO with growth materially above expectations, with our last quarter being a record period. We continue to benefit from streaming launches in new territories around the world, while also increasing market share through new service offerings and seeing strong demand from customers across all of ZOO's operating segments.
The board has invested heavily in capacity to support further growth and the Group has expanded its international footprint in regions that are strategically aligned with our major customers. With a strong pipeline of projects in place, we are confident of delivering further sustainable growth in the year ahead."

My opinion - I’m certainly becoming less sceptical, after this positive trading update.

Organic revenue growth of 78% is an eye-catcher, and suggests a strong industry tailwind, from the increasing prevalence of TV streaming services. Although as we’ve seen with the recent large % fall in share price of Netflix, maybe we’ve passed peak streaming, given that Netflix is now seeing a decline in subscriber numbers? There’s a lot of competition now, and households/individuals which have several streaming subscriptions, might cut back some or all, if their disposable income is stretched, maybe? That might possibly impact ZOO, if it (in time) feeds through to ZOO’s customers having lower budgets for producing content. ZOO provides the localisation services for TV, e.g. dubbing, and subtitles.

The low gross margin at ZOO clearly shows that it doesn’t have much pricing power. That combined with a historic inability to make profits at all, still puts me off from investing. Although if it can increase gross margin, combined with strong revenue growth, then that could lead to an exciting rise in profits.

I suppose it boils down to these key points below - take your pick. I was previously more on the bearish side, but today’s very good update certainly strengthens the bull case, so personally I’m probably more neutral now -

Bull case:

• Stellar growth now underway
• Broken through into meaningful profits
• Positive industry tailwinds

Bear case:

• Poor track record, taking 22 years as a listed company to make meaningful profits
• Low gross margin, so a competitive sector
• Profitability could be a flash in the pan, from one-off projects, and unsustainable industry growth