Small Cap Value Report (Mon 7 Dec 2020) - GAW, TED, VTU, VP., M&A

Good morning, it's Jack and Paul here with the SCVR for Monday.

Although it’s too big to be a company typically covered here (with now a £3bn+ market cap), Games Workshop (LON:GAW) has released its half year update. It’s a particularly interesting company and many will already be aware of its fantastic performance over the past few years.

The group last updated with another ‘trading ahead of expectations’ announcement on a Friday afternoon in early November: unusual timing for an unusual company.

Now the group reveals that half year sales are c£185m (up 25%) and profit before tax is at least £90m (up 52.5%), with a 60p dividend declared for the period. Games Workshop continues to generate impressive growth as it takes its products to new markets. It looks like it will make more in first half profits this year than it did in the entirety of FY19/20.

The shares peaked recently at some £114.60 but have since fallen back to £98.75. If it can turn in a similar performance in the second half and bring in full year profit of £180m then the shares don’t look overly expensive. Apply a 20% tax rate to £180m for profit after tax, divide by the shares in issue and you get around £4.40 in earnings per share, which would make for a PE ratio of 22.5. Not bad at all given the rate of growth.

But the share price has been softer recently, so it will be interesting to see what happens to it this morning.

Anyway, onto the small cap news.

---

Ted Baker (LON:TED)

Share price: 141.21p (+5.38%)

Shares in issue: 184,605,541

Market cap: £260.7m

Interim Results Announcement for the 28 weeks ended 8 August 2020

The turnaround of Ted Baker (LON:TED) is probably one of the most closely watched stories in retail. If management gets it right, then there could be good upside - but there is plenty of work to do.

On first half progress, CEO Rachel Osborne comments that Ted’s balance sheet is ‘materially stronger than we had envisaged this early in the plan and operational cashflow will be positive for the full-year… and are on track or ahead of our operational KPIs for the first year of our plan.’

There are, however, some legacy issues that are ‘being amplified by COVID-19’, with city centre and travel store performance particularly affected. Group revenue is down 46%, gross margin is down by 550bps, and the group reports a pre-tax loss of £39m. The reported numbers look pretty stark.

Online has been predictably strong year-on-year (up 42%) and there is hopefully some good value in the brand that could translate well into digital retail. Payroll cost savings of £31m and rental cost savings of £7m in FY21 should both help free cash flow generation, which was £19m in the period.

Conclusion

The shares have had a strong run since early November, up from 85p to 140p, so some degree of successful execution was arguably already being anticipated by the market.

The combination of a strong brand and a capital-light digital strategy is promising - if the company can successfully derisk and continue to rationalise its retail estate and drive down costs. On that note, there is probably plenty to do in terms of extricating itself from bad sites and management says that ‘the shape of the estate will remain a lag by FY22’.

And there does appear to be a bit of a mismatch between concrete financial performance in the year-to-date and the related management commentary. Reported loss before tax fell to some £86.4m in the period, compared to a loss of £23.0m in the prior year.

It is upgrading its FY23 guidance to free cash flow generation of at least £30m. Post-placing, Ted has 184,586,562 shares in issue, so that would be about 16p of free cash flow per share. Ted fell a long way, it is still early on in the turnaround, and there has been heavy shareholder dilution. At 140p or so, it feels like a lot is priced in.

But this is a stock where an informed investor can quite reasonably take a much different view. The share price is up slightly on the news, the StockRanks are improving, and there are buyers of this share who can presumably see good upside from here. It also sounds like, strategically, Ted is doing the right thing in bringing in more accessible price points.

A revitalised, online-focused Ted Baker could be a much bigger and more profitable business, but the question is what price to pay to take on the execution risk and, right now, I don’t think that ratio of risk to reward is as attractive as it has been in the past. I’ll be happy to change my mind on evidence of a more entrenched turnaround, and best of luck to holders in the meantime.

Vertu Motors (LON:VTU)

Share price: 27.26p (-2.49%)

Shares in issue: 367,160,497

Market cap: £100.1m

Trading update and acquisition

Vertu Motors (LON:VTU) , the automotive retailer with a network of 146 sales outlets across the UK, says that trading for the nine months to 30 November is ahead of budget and it is now c15% above last year’s adjusted profit before tax level.

While the second lockdown has impacted trade, it looks like business rates reductions, furlough schemes, and internal cost cutting have managed to offset much of the disruption.

The company is very cheap, but then again it barely registers a return on capital and operating margins are extremely thin:

While trading sounds resilient, more time is given to the acquisition of 12 BMW and MINI sales outlets located in York, Sunderland, Teesside, Durham and Malton for £18.7m (together with the assumption of manufacturer used vehicle stocking finance of £8.9m). Also included in the business is a BMW Motorrad motorcycle operation in Sunderland and a used car operation located in York.

The deal includes £16m of freehold and long leasehold properties. Vertu’s asset backing is a plus and gives it funding options, as seen in its decision to finance this deal with a combination of a new £12.76m 20-year mortgage facility ‘secured on the acquired freehold and long leasehold dealership properties at a fixed interest rate of 2.9% for the first 5 years.’

We can see in the graphic above that Vertu trades at comfortably less than tangible book value.

Generating profitable growth appears to be the concern here, given the historically thin operating margins and the currently negative return on equity. Such economics deserve a low price multiple, although that’s not to say there aren’t quality operators in this space.

But take this latest acquisition, for example: for the year ended 31 December 2019, the business achieved revenues of £305m and made a loss before tax of £6.0m. That’s worse than ‘low margin’.

Vertu says it has a clear operational strategy to drive improvements over a three year period and the acquired business is expected to be ‘at least earnings neutral by the year ending 28 February 2023’ and that ‘The incremental return on invested capital is anticipated to exceed cost of capital from FY24.’

Still though, it sounds like a lot of hard graft.

Conclusion

The above aside, Vertu might be worth a look for the patient, value-orientated investor. In such a brutal industry, economies of scale and prudent management could prove to be vital, and it looks like Vertu has both of these.

In fact, Robert Forrester (CEO) says:

As the Group enters its 15th year of trading, this acquisition reflects a further milestone in both its scale and maturity. The Group now represents 32 franchises in the UK, more than any other UK automotive retailer.

So there could be a longer term market consolidation opportunity here. If Vertu can oversee earnings growth and market share gains in a recovering market, with a slight multiple expansion as well, then there is upside potential.

The share price chart doesn’t look too hot right now, but there is asset-backed value here for the patient contrarian and so on that basis Vertu is worth a closer look.

VP (LON:VP.)

Share price: 798p (+5%)

Shares in issue: 40,154,253

Market cap: £320.4m

This is a specialist rental business that aims to deliver sustainable shareholder returns by providing products and services to end markets including rail, transmission, water, civil engineering, construction, house building, oil and gas.

It’s not one I’ve looked at before but I see that the folks over at Equity Development have reinstated forecasts with a target price of 900p versus today’s share price of 798p.

VP (LON:VP.) was founded in 1954 but exited its historically core general plant business to focus on higher return specialist activities in 2000. Since then, it has made a number of acquisitions and now reports across a range of specialist lending operating divisions:

• UK Forks - one of the UK's leading specialist hirers of telescopic handlers and tracked access platforms.
• TPA Portable Roadways - one of Europe’s largest suppliers of temporary access solutions.
• Brandon Hire Station - a leading provider of tools and specialist rental products to industry, construction and home owners across the UK.
• ESS Safeforce - a specialist provider of safety, survey, communications and test & measurement equipment
• Groundforce - the market leading rental provider of excavation support systems and specialist products for the water, civil engineering and construction industries.
• MEP Hire - provides mechanical and electrical press fittings and low level access products to the UK construction, fit out, mechanical and electrical markets.
• Torrent Trackside - specialist suppliers of rail infrastructure portable plant and related trackside services.
• Airpac Bukom Oilfield Services - an international business supporting a wide range of oil and gas markets, servicing well test, pipeline testing, rig maintenance and LNG markets worldwide.
• TR - Australasia's leading technical equipment rental group providing test and measurement, communications, calibration and audio visual solutions.

The StockRanks are middling but the forecast PEG in particular is interesting, suggesting that good earnings growth is anticipated for this company.

It’s classed as a Contrarian stock and the share price is unmoved today, so perhaps this one is not so much on investors’ radars right now.

Interim results

Highlights:

• Revenue down 24% to £142.1m
• EBITDA down from £51.8m to £34.1m
• EPS before amortisation and exceptional items down from 52.5p to 17.4p
• Statutory loss before tax of £6m and statutory EPS of -17.8p
• Special dividend of 22p
• Net debt reduced by £41.1m to £118.7m
• Capital investment in rental fleet down 45% to £14.6m

No surprises then that business has been heavily impacted by Covid, but the net debt reduction and special dividend payment should allay some fears. That’s nearly £9m in special dividends. Per the company:

In April 2020, as many of our markets closed completely or only operated on severely reduced levels of activity, Group monthly revenues dropped by almost 50% compared with the prior year. On a more positive note, many of our businesses were categorised as essential service providers to such sectors as transport, utilities, telecommunications and health and here we were able to maintain a certain level of business functionality.

I wonder if that special dividend money would be better spent on making up the bulk of the decline in capital investment? On the other hand, perhaps such a disrupted trading environment led management to believe capital investment might not be the optimal use of cash for now.

In fact the company does say:

In response to these sharp reductions in activity the Group ceased all but essential capital investment and recruitment... The Group continues to operate a young, well managed fleet and our rental assets remain of the highest quality and well matched to supporting customers with our long term focus on service and product excellence.

So it sounds like the estate is in good condition.

In terms of outlook, the group says that trading is slowly normalising and the medium term outlook for its markets are positive.

Conclusion

This looks potentially interesting, but there is a fly in the ointment: the Competition and Markets Authority is investigating three businesses within the temporary groundworks sector of suspected anti-competitive behaviour. This includes a part of VP's excavation support systems business ('Groundforce Shorco'), which represents about 9% of group turnover.

Previous accounts included a provision of £4.5m in respect of this matter but this has been increased to £15.37m. The directors consider it highly unlikely that we’ll see further increases in the provision, but this ongoing situation is still something to be aware of.

That aside, VP gets around 40% of its sales from infrastructure, which governments might target in order to boost economic growth post-Covid. So that could be a useful tailwind.

VP generates solid, double digit operating margins and returns on capital. If you compare it to Ashtead for example, you can see it trades on quite modest multiples, so it could be worth a closer look if you are anticipating some form of post-Covid recovery.

UK M&A

A quick word on acquisition activity: some commentators have observed that the UK equity market appears to be cheap at the moment, and it does seem as though we’re seeing more M&A activity.

RSA and Codemasters have recently been bid for, and then today we have two notable announcements: a bid for Imimobile (LON:IMO) by Cisco Systems at a nearly 50% premium here, and an updated bid for Countrywide (LON:CWD) at 325p per share here.

Countrywide shares were trading at less than 50p in April. Congratulations to holders in these companies, but is there more M&A to come I wonder? It’s a tricky thing to anticipate but an intriguing talking point nonetheless.