Small Cap Value Report (Mon 7 Feb 2022) - LOK, K3C

Good morning! Paul & Jack here with Monday's SCVR.

If you'd like to catch up on last week's news, we recorded another podcast last Friday - it's only 20 minutes long so do give it a listen.

In other news, there's a bumper Mello event tonight with presentations from the likes of Centralnic (LON:CNIC) , Rbg Holdings (LON:RBGP) , and Belvoir (LON:BLV) . David's got more details in his post here.

Agenda -

Jack's section

Lok'n Store (LON:LOK) - good results, H1 revenue up 34.1% (driven by price and occupancy increases). 12-strong new store pipeline with plenty of opportunities beyond that. It’s smaller than some of its peers and so could offer superior growth. There have been repeated forecast EPS upgrades here, but the stock continues to look pricey, so you’d need to get comfortable with a c30x forecast PER.

K3 Capital (LON:K3C) - in line update, with record revenue and profits across all three divisions. Profit is strongly up, but big differences in adjusted and non-adjusted results by way of remuneration and amortisation of intangibles. Cash from operations is down, too, and the balance sheet carries a lot of intangibles now, so there are a couple of avenues to investigate, but the operational performance is strong.

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Explanatory notes -

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Jack’s section

Lok'n Store (LON:LOK)

Share price: 1,030p (+1.73%)

Shares in issue: 29,978,055

Market cap: £308.8m

This is a self-storage company - it’s shares are highly rated, but everything I’ve seen on this sector suggests there is a strong growth opportunity, with self-storage penetration levels in the UK ahead of Europe but well below those seen in the US.

Broker earnings per share forecasts have been repeatedly and materially upgraded.

Trading update for the half year to 31 January 2022

Excellent revenue and pricing growth with new stores on the way

H1 self-storage revenue is up 34.1% on the previous year, driven by significant improvements in both occupancy and pricing. Price per sq. ft. of occupied space was up 18.5% and unit occupancy was up 6.0% over 12 months.

The group’s 12-strong new store pipeline ‘is progressing well’ and the Warrington ‘landmark’ store is now open. Lok is on site at another five stores, with Wolverhampton and Stevenage to open in the coming months. This secured pipeline should increase owned trading space by some 49.2% and there are ‘many opportunities beyond this’.

Last week Lok'nStore announced the sale and manage back of four stores at a significant premium to July 2021 valuations. That could mean the price to tangible book of 2.01 understates the group’s property, which makes up around 95% of the £266m of total assets.

The £37.2m of cash generated from this transaction will be re-cycled into new, faster growing Landmark stores.

Diary date - interim results will be announced on Monday 25 April 2022.

Balance sheet - looked fine as of July 31st 2021, with total debt of £74.8m (including £9.91m of capital leases) set against £266m of net PPE. Interest cover looks good at 10.11x, so the company is covering debt payments with profits - presumably the debt is fairly cheap, given the asset-backing and relatively defensive nature of the business but something to check.

Conclusion

A couple of these self-storage operators look interesting, if expensive on the face of it. It is annuity-like revenue and there appears to be ample scope for new openings. I suppose it’s that perceived quality of revenue and earnings that is pushing valuations up to such a degree, but I do wonder what is preventing a flood of competition from rushing in to meet market demand. Where are the barriers to setting up a self-storage facility?

That makes me hesitate at these levels but, in the meantime, the expansion strategy is relatively low-risk and the medium term growth prospects look positive. Price per sq ft is up 18.5% - well ahead of inflation. I wonder how much pricing power there is here? If the market is underpenetrated then perhaps this is a lever it can call on again in future.

It’s slightly more expensive than Big Yellow (LON:BYG) and Safestore Holdings (LON:SAFE) (forecast rolling PER of 30.1 vs. 28.1 and 26.6; trailing twelve month price to tangible book value of 2.02 vs. 1.94 and 1.52) but is smaller and can presumably grow more quickly.

The share price has nearly doubled from when I first looked back in April 2021 - but then so too have EPS forecasts.

Lok’n’Store does look like quite a quality operation with solid growth prospects and good market dynamics. At some point, competition might intensify but for now that doesn’t look like an issue. My instinct is to wait for a better entry price, given the gains seen across these stocks, although I see major Shareholders have been increasing their holdings.

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K3 Capital (LON:K3C)

Share price: 339.99p (+3.03%)

Shares in issue: 73,200,033

Market cap: £248.9m

K3 Capital is a professional services group advising UK SMEs, with three key operating divisions: M&A, Tax, and Restructuring.

Half year report for the six months to 30 November 2021

Strong foundation of H1 coupled with fast start to H2 gives confidence in delivering market expectations

• Group revenue +73.3%, strong organic growth,
• M&A revenue +66% to £9.8m and EBITDA +72.4% to £5m,
• Tax revenue +84.6% to £4.8m and EBITDA +71.4% to £2.4m,
• Restructuring revenue +74.7% to £16.6m and BITDA +30.4% to £3m,
• Group adjusted EBITDA (excluding acquisition costs) +62.1% to £9.4m,
• Net cash down from £10.1m to £8.8m,
• Adjusted earnings per share +30.6% to 9.4p,
• Dividend per share +33.3% to 4p.

That’s record revenue and EBITDA across all divisions with ‘excellent’ organic growth, although there have been acquisitions as well. EPS growth is behind group figures due to higher shares in issue following the acquisitions of Knights businesses.

New service line launches are starting to contribute, with resulting cross-selling opportunities. Headcount has increased to c550.

Diluted unadjusted earnings per share are closer to 5p, so there’s a significant gap, with the significant adjustments being £1.9m of deemed remuneration and £1m of amortisation of acquired intangibles. This is an area to check more closely assuming acquisitions will continue to be a feature.

Cash from operations has fallen from £4.2m to just £47,000 due largely to working capital changes.

Balance sheet - net assets up from £45.8m to £62.7m. Nearly all of the group’s fixed assets are intangibles (£54.8m of £57.8m), so net tangible asset value is low at £7.9m. That’s not too much of a surprise given the nature of the businesses, but still something you’d want to consider. The current ratio has moderated from 1.73x to 1.67x

Outlook - M&A division continues to see strong levels of KPI performance, with growing transaction fee pipelines underpinning expectations for H2 and beyond.

The Tax division now offers broader service lines and greater scale following the acquisition of Knight R&D and the launch of K3 Tax Advisory. The pandemic is causing temporary reductions and delays in R&D claim processing though.

Restructuring division - the insolvency market is showing signs of recovery following the withdrawal of Government support and the unwinding of legislative changes. K3C is building its market share and fee earner base in order to take advantage of the returning market.

The group anticipates paying 12.1p in FY22 and 15.5p in FY23, so a yield rising from 3.6% to 4.6%, which is attractive.

CEO John Rigby:

The Board remains confident that the outlook for the remainder of the financial year, and beyond, is positive and is pleased to report a strong start to H2 FY22, with December delivering £6m of revenue and £1.7m EBITDA during a traditionally quieter festive period. We continue to evaluate acquisition targets which could be additive to overall product offering and allow further diversification of Group revenues.

Conclusion

The momentum is clearly positive here, with record revenue and profits across K3C’s divisions and a strong December, which is usually a quieter period.

I continue to have a favourable impression but haven’t taken that next step of taking a deeper look at this company, so comments are welcome. Tracking down a couple of management presentations would be useful.

While other companies might boast better ‘quality’ or ‘value’ from a factor perspective, you can’t deny this company’s growth over the past few years.

There is acquisition risk. Shares in issue have increased from 42m in FY19 to 73m today, so acquisitions need to add value on a per share basis. That aside, the only negatives right now are a slightly light balance sheet, the fall in cash from operations, and talk of temporary delays in R&D claims processing.

It’s a strong operational performance on the whole though, one that suggests K3 Capital is worth looking at a little more closely.