Small Cap Value Report (Mon 4 Dec 2017) - MCLS, MYSL, Toys

4th Dec '17 by Graham Neary

33 comments 13557 reads

McColl's Retail (LON:MCLS)

Share price: 280p (-3%)
No. of shares: 115 million
Market cap: £323 million

This is a chain of newspaper and convenience stores which has been listed since 2014.

I've tended to be a bit sceptical of it, because it screams "no economic moat" to me.

The PE multiple afforded to it by investors has generally been on the lower end of the scale, and that remains the case today. But to be honest, this PE ratio still looks possibly on the generous side to me:

This year, it has been integrating 298 stores acquired from the Co-op, which bring the total estate to over 1,600 now, most of these being convenience stores rather than newsagents.

Because of that acquisition, the headline growth numbers aren't too important here. What matters is like-for-like sales, which are up 0.1% for the full-year, i.e. effectively unchanged.

Q4 LFLs were down 0.4% due to category mix and unfavourable weather. Weather had been a positive factor earlier in the year, so maybe the full-year result is neutral weather-wise?

Either way, it adds up to an in line with expectations update for the full year.

And the plan for next year is to continue refreshing its convenience stores with the goal of selling more of the higher-margin categories (food rather than newspapers and cigarettes).

My opinion

I'm not sure why this has re-rated so strongly this year, but clearly investors approve of the Co-op acquisition, and it has been executed well so far.

That deal was mostly financed by debt, which stood at £111 million (net) at the interim results.

With the company being significantly more leveraged than it was before, I would have put it on lower valuation multiples than it enjoyed before, to take into account the increased risk.

This is a fiercely competitive sector. Indeed, McColl's announces today that one of its main suppliers has gone bust as of last week.

I don't know the specific circumstances of that company, but if a huge supplier has been squeezed to the point where it can no longer continue, it's a bad omen in terms of McColl's being able to defend its own thin margins for the long-term. Alternative arrangements will have to be made, with a supplier who gets paid…

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fwyburd

4th Dec '17

Thanks for the encouragement Graham. So far 44 readers have participated (what an amazingly responsive readership there is here) which indicates real interest in the findings. Thanks to everyone who has done this so far.

peterthegreat

Response to runthejoules about VERSARIEN.
Firstly, thanks to those contributors who recently discussed Versarien as it drew my attention to the company before the recent share price rise. In answer to your question, I think Versarien's graphene technology is validated by its agreements with UK universities so I think it could be another IQE, although earlier stage and with plenty of volatility to come. Having seen the CEO in action, I also believe he knows how to handle corporate types and academics which is a major advantage. The nearest I can find to another Versarien is AIM-listed Ilika, but Ilika is a disappointing company owing to its slow progress so I am not positive about it. However, like Versarien it is a materials technology company exploiting UK academic research through global agreements with some major companies so, having seen what happens when this type of company captures the imagination of investors, I have taken a very small stake in Ilika and will monitor closely. Versarien is a long term holding for me.

Michael Billingham

Concerned to see the fall in Ramsdens Ramsdens Holdings (LON:RFX) - down more than 7% this afternoon for no apparent reason.- lots of 'stop losses' being triggered perhaps.

PS - re the above - I hold.

FREng

MXC Capital (LON:MXCP) reported its full year results this morning. Lots of detail - I'm not sure whether or not it deserves the Sucker Stock label from Stockopedia's snooty computers.

Samsgrandad

Maybe Liberty Global don't read stocko FREng, I'm sure they must know what they're doing having a joint venture with MXC Capital (LON:MXCP).

Gromley

Interesting point Graham about McColl's Retail (LON:MCLS) lack of economic moat.

In some sense this is clearly true, the are a number of chains essentially doing the same thing and countless independents and to set up as a independent is comparatively easy (not sure what the capital requirements are in terms of stock).

But for many of the individual stores have a significant moat - Location and Demographics.

I haven't researched them, so I do not know what there mix of stores is between town centre and "housing estates" but certainly the latter have a significant moat IMHO. In many cases there is a lack of suitable retail premises in the location to set up a competitive venture in the vicinity.

Closeness I think is absolutely key, on a council estate nearby me there is a thriving (I believe) McColls and despite there being a Morrisons within a 15 minute walk and recently an Aldi within 20 minutes there are a large number of people who seem to buy a significant proportion of their "groceries" from the McColls.

No doubt there is an opportunity there to comment about the money management skills of the less well off - whatever - the fact is that this can be an important driver for the store. There is a store run by one of the other chains in a nearby (more "well heeled") village and whilst I'm sure they rely much more on the "open all hours" (not really) convenience aspect, they still stock quite a range of groceries so clearly there must be some business.

Location is essentially the moat for both of these stores, both in terms of the limited availability of retail premises from which to launch a competitive venture but also from the market - it seems to me that the best business case a potential new entrant could come up with would be one that shows both themselves and the incumbent going bust (unless of course they have the capital to trade through a protracted loss making period or some other USP and I can't really think of one to be honest).

Certainly any stores that already have a viable competitor could be vulnerable. In fact the first store I mentioned previously had an independent for competition - plus a local off-license, but when the shopping parade moved as part of a redevelopment it was only the McColls that re-emerged and is probably now unchallengeable. In other instances of course they might be the loser in any "consolidation", but that I would expect remove the least profitable stores from their portfolio.

So actually I think there is a not insignificant moat and I don't even see the tech disruptors challenging it - far more likely that if my kids want to make cakes on a Sunday evening and I am out of eggs that I'll trip off down to "the corner shop" rather than ask Amazon to deliver a dozen eggs by drone! (Delivery by teleportation I'll grant would tip the balance, so I'll keep an eye on the tech research for that!)

Anyway, that's quite enough of that - no position in McColl's Retail (LON:MCLS) at the moment, but something I'll now put in the queue for further research.

Roger Lawson

Re McColl's Retail (LON:MCLS) , as someone who purchased shares in the company back in 2016 which are now showing an overall gain of 75%, I think there are good explanations for the reappraisal of this company by the market. Effectively a new manager, after the founding Chairman departed, has taken some simple steps to improve the business, plus done some good deals to take it to a higher level. Yes it is operating in a mature and price competitive sector and we all know purchasing power of their customers may have been dropping, so a static like-for-like figure is not surprising. In addition they have been transitioning away from the traditional fags/newspaper stores to better growth areas like food-on-the go (like Greggs incidentally who are also being rerated by the market). Finding good sites, and getting planning permission for new ones, is a barrier to entry to some extent. But pricing power and volume when size increases also helps. I would not rule out holding all retailers shares simply because there is no obvious "moat".

Howard Marx

" I would not rule out holding all retailers shares simply because there is no obvious "moat"."

Clearly an economic moat is required to sustain a high level of profitability (margins, ROIC)

But I'd agree that when a business like McColl's Retail (LON:MCLS) earns such low levels of profitability (6% ROIC & sub-2% EBIT margins), then in the short term there is an asymmetric risk of upside vs downside, assuming of course that the management are competent.

ricky65

Agreed, especially with the last sentence. I think people pay too much attention to "moats" due to the Buffet association.

McColl's Retail (LON:MCLS) may not have a moat but it was still a profitable trade. It hit my buy alert when it brokeout to an all time high at 204p on 7th April. Hit my sell alert at 263p when it broke below 50 day MA on 11th Oct.

ricky

your successful trade reads like a triumph for the technicals rather than for/against an economic moat?!

Hi Howard

The point I was making is that if you require a company have an "economic moat", you can miss some good trading opportunities. My goal in this game is to make as much money in the shortest possible time - moat or no moat!

Richard Goodwin

Hi @Gromley, I'm no expert on the length of retail leases (or whether McColl's Retail (LON:MCLS) owns freeholds) but if location is key then ultimately doesn't the competitive advantage belong to the site owners? Ultimately (perhaps over too many years to be relevant) they will extract any location-based gains?

Paul Scott

5th Dec '17

I can't see any appeal in McColl's Retail (LON:MCLS) shares. It has a tiny profit margin, and a large fixed cost base. Plus it will be facing the same upward cost pressures that other retailers face. So it really wouldn't take much bad news to push MCLS into losses, and even potential insolvency, if the economy goes into recession. So the PER is largely meaningless, as it's based on such a tiny & potentially volatile earnings figure. The balance sheet is awful too.

Lots of shares have gone up in the last year or two, good and bad, so I wouldn't get too comfortable just because you're sitting on a paper profit with this one. The valuation looks far too generous to me, for a pretty poor quality business.

Regards, Paul.

Graham Neary

Sorry I didn't get around to the reader requests here, will try harder next time! Versarien (LON:VRS) share price doubled in less than a week. V. interesting.

MXC Capital (LON:MXCP)

Palace Capital (LON:PCA)

The Third Man

FWIW Tempus in The Times today is very positive re £MCLS

Why didn't my McColl's Retail (LON:MCLS) turn the name blue?

Albertos

McColl's Retail (LON:MCLS)

Find it extremely strange that people still consider investing in companies with an on-going operating margin of +/- 2%.

Phil

Rusty2

That's what put me off Morgan Sindall (LON:MGNS) but it has not done so badly.

Touche! - but perhaps not so much lately.

Phil

Small Cap Value Report (Mon 4 Dec 2017) - MCLS, MYSL, Toys

McColl's Retail (LON:MCLS)

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Graham Neary

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