Small Cap Value Report (Monday 10 May 2021) - GRG, BEG, HOTC, MIDW, SMRT

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

Mello Monday

Starts at 17:30 this evening. Click here for more details.

There are some interesting companies giving presentations. Of particular interest to me tonight is Smiths News (LON:SNWS) (I hold) which is developing into a good turnaround, as recently reported here. With divis set to resume later this year, I reckon buying now could lock in a 5-10% future dividend yield. Management present very well (but you can be the judge of that!), and now have a very clean business that generates reliable cashflows, now that the problem division, Tuffnells, has gone. Also the pension scheme problems have been resolved, with the possibility of repayment to the company of a surplus in the scheme. Debt is set to reduce quite quickly from now on. The current PER of about 4.5 is obviously the wrong price, in my view, when you factor in that debt is set to reduce to 1x EBITDA in the coming 2 years, on top of divis.

Also presenting are Smartspace Software (LON:SMRT) which Jack has written about below, as well as Panoply Holdings (LON:TPX) and Vr Education Holdings (LON:VRE)

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Timing - TBC

Agenda -

Paul:

Greggs (LON:GRG) - positive trading update - quick comment, as not a small cap, but could have interesting read-across to gauge the health of the High Street.

Begbies Traynor (LON:BEG) (I hold)- acquisition of a finance broker. Highly geared (to future profits) earn-out looks interesting.

Hotel Chocolat (LON:HOTC) - positive trading update.

Midwich (LON:MIDW) - another company reporting trading ahead of expectations.

Jack:

Smartspace Software (LON:SMRT)

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Not a small cap but…

Greggs (LON:GRG) has issued a positive trading update this morning. Key points -

Strong recovery in sales levels following easing of restrictions

Delivery is now 8.2% of sales - quite significant

Considerable uncertainty remains but profits for the year could be around 2019 levels, materially higher than the Board's previous expectation

As the company points out, it doesn’t have a lot of competition at the moment, so it will be interesting to see how things fare once all the other cafes/restaurants open up in about a week.

It’s good to see Gregg’s using 2-year like-for-like (LFL) sales comparisons. I.e. they’re comparing 2021 weekly sales with the normal comparatives from 2019, not the lockdown-disrupted comparisons from 2020. I hope all companies do this, as otherwise the comparisons are largely meaningless.

My opinion - I’ve been scratching my head over why Greggs (LON:GRG) share price has been so strong, when many people are still working from home, and some footfall on High Streets has arguably been lost forever. Today’s update goes a long way to justifying the strong share price. Overall, the stock market seems to be bullish about retail/hospitality returning to normal. I’m not so sure. As Next (LON:NXT) pointed out last week, it doesn’t expect the short term bounce, on pent-up demand, to last.

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Quite surprising to see Greggs at/near all-time-high, considering how much damage has been done by covid/lockdowns. I'm struggling to see how risk:reward makes sense at this level.

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Begbies Traynor (LON:BEG)

(I hold)

Acquisition

I’ve followed this share for many years. It started out as a pure play insolvency practitioner, but has since done a series of sensible acquisitions, to offer a broader range of professional services, such as property valuations.

There’s another acquisition announced today - MAF Property Ltd - a finance broker, which arranged £150m of finance for its clients in 2020.

The initial consideration is very small, £2m cash, and £1m in new shares.

What stands out though is that this deal is highly leveraged to future performance - the earn-out is structured as follows (additional consideration, ⅔ in cash, ⅓ in new shares):

• Average profit of £1.0m in years 1 & 2 would trigger a £2.0m earn out
• Average profit of £2.0m in years 3 & 4 would trigger an additional £6.75m earn out.

It’s unusual to see an acquisition where the consideration is so heavily skewed to earn outs.

That should certainly keep the existing management motivated to generate those larger profits. Let's hope the big earn out doesn't motivate them to cook the books. Most of the earn out would be generated by the acquisition itself, so this deal looks well set up.

Existing acquisitions, plus the likelihood of plenty of corporate restructuring work for the core business for years to come (especially when Govt covid support schemes end), should be good for earnings at BEG. As you can see below, broker consensus has been rising, and there’s probably more to come. The PER is only 13.3 - which strikes me as a significant under-valuation.

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My opinion - I like the core business at BEG, but think I’ve spotted another opportunity here - namely that the stock market doesn’t seem to have realised that BEG is now growing quite strongly through self-funded acquisitions.

Therefore, at some point (I have no idea when), I believe this share could re-rate onto a higher PER, to reflect that it is growing faster, and offering a wider range of services. If the PER were to re-rate from 13 to say 20, then that’s about 50% upside on the share price. Everything else seems to have re-rated upwards, so could this be one that catches up?

Of course there’s no guarantee this will actually happen, I’m just saying it’s a possibility.

So far BEG doesn’t seem to have put a foot wrong with its acquisition strategy, and we’ve seen from Judges Scientific (LON:JDG) and Sdi (LON:SDI) how acquisitive groups that buy cheap & well, can be seriously good investments in the long-term.

I’m not sure why the StockRank has reduced from the green zone, to middle ranking?

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Hotel Chocolat (LON:HOTC)

380p (up 8.5%, at 10:25) - mkt cap £477m

Hotel Chocolat, the premium British chocolatier, today provides an update on its trading performance for the eight-week period ended 25 April 2021. The period includes Mother's Day and Easter and represents the second-largest seasonal peak for the business.

That’s a useful reminder from HOTC that it has a big seasonality between its H1 & H2 results. That’s nearly caught me out before, when I once foolishly doubled H1 profits, to arrive at a completely false estimate of the full year’s performance, before realising my error just before hitting the publish button here (hence narrowly averting making myself look a wally)!

As mentioned above, with the trading update from Greggs (LON:GRG) we’re now getting into a very difficult period for prior year comparatives, due to the complexity of inconsistent lockdowns & re-openings in both the current, and the prior year. That makes it very difficult for us to understand the underlying trends.

Despite physical retail locations in England being closed for six weeks during the period, including for both Mother's Day and Easter, the Group's revenue increased 60 percent compared to the prior year (during which physical retail locations were closed for 5 weeks, however, were open for Mother's Day). The Group's revenue for the eight-week period is also 19 percent higher than the comparative eight-week period in 2019, being the most recent comparable pre-Covid trading period during which all physical retail locations in England were open.

Thankfully, HOTC has also followed the same path as Greggs, and given us the 2-year prior comparatives - i.e. comparing 2021 with 2019, to give a more meaningful comparison.

I remember when HOTC previously reported, it was doing very well with online sales, and that seems to be continuing -

The Group's revenue growth during the eight-week period ended 25 April 2021 was driven largely by its digital channels and subscription products which further demonstrates the strength of the Company's omni-channel sales model.

Re-opening of physical stores - also going well -

Since the re-opening of physical retail locations in England on 12 April 2021, sales across all the Company's channels have been encouraging.

Overall trading - positive -

The Board now expects trading for the full year ending 27 June 2021 to be significantly ahead of expectations.

Furlough - HOTC has decided to repay the £3.1m Job Retention Scheme funding received from the taxpayer. I’m amazed at how many companies are doing this, seemingly voluntarily.

Unless I’m being naive in some way, it does seem to demonstrate the sea change in corporate attitudes in the last couple of years - that maximising profit seems to be taking a back seat to doing, and being seen to do the right thing.

Maybe all that money which has flowed into ESG funds could be making a difference in how companies behave? Although I think HOTC seems the type of company where the brand is partially built on eco credentials, etc, so this type of business would probably want to do the right thing, rather that being cajoled into doing so.

Repaying furlough monies does stand out to me as a thoroughly decent thing to do, and makes me view the company more positively. Do readers agree or not? I’d be interested in what you think.

My opinion - this share very much needed an out-perform trading update, because on existing forecasts the valuation makes no sense at all (being way too high). Therefore today’s strong update makes the shares look less over-priced.

I’m wondering if it might be better to look at pre-covid forecasts, and assume that the company could get back to 10-15p EPS which was previously forecast? After all, its shops are bouncing back, and the internet sales have been particularly impressive.

Personally I would never buy this share, because I just don’t like the product - which plants the seed of doubt in my mind as to whether growth & profits could be maintained in the long run.

Maybe the lowish StockRank (below) might improve once higher forecasts come through?

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Midwich (LON:MIDW)

499p (up 7%, at 11:45) - mkt cap £442m

AGM & Dividend Statement

Midwich, a global specialist audio visual distributor to the trade market…

As with lots of companies reporting at the moment, it sounds like the latest lockdowns are having a lot less impact than the original lockdown from March 2020 -

Despite further significant lockdowns in early 2021, trading in the first four months of the year has been ahead of the Board's expectations, and significantly ahead of the comparative period last year.

Although a number of the Group's end user markets are expected to remain subdued for some time, good progress has been made in the rest of the business and all government employment support has now ceased.

Should vaccine programmes continue to progress successfully in the Group's key markets, the Board now expects that revenue and profit for the full year will be comfortably ahead of its original expectations.

Dividends - are to resume, starting with a modest special dividend of 3p (<1% yield), with further divis to follow in Oct 2021 and June 2022.

Checking back a few years, the company seemed to pay out most of its earnings in divis pre-covid, so a reasonable yield could be in the pipeline perhaps?

My opinion - neutral. I’ve never really seen any particular reason to get excited about this share. The obvious question is, how much will corporates want to spend on audio-visual technology, now that at least some people are likely to be working from home more often, and using Teams or Zoom instead of physical meetings?

Today’s positive update does seem to suggest there’s good demand, even with the latest lockdown.

Stockopedia seems to mostly rank it in upper-middle StockRank level -

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Jack’s section

Smartspace Software (LON:SMRT)

Share price: 143p

Shares in issue: 28,931,234

Market cap: £41.4m

Smartspace Software (LON:SMRT) is a fast growing software-as-a-service (SaaS) company that helps make workplace real estate ‘smart’ and more efficient with services such as cloud-based room and desk management.

It’s a potentially in demand suite of services as colleagues return to work in a more flexible and remote post-lockdown world.

As with a couple of other SaaS businesses, Smartspace is transitioning away from a lumpy contract model towards recurring revenue, which means its trading results are in flux.

Final results for the year to 31 January 2021

Highlights:

Recurring revenues increased by 64% to £2.4m (FY20: £1.5m)

• FY revenue from continuing operations of £4.6m (FY20: £5.1m) due to Covid-19 lockdowns,
• Exit ARR as at 31January 2021 +50% to £3.0m thanks to strong growth in SwipedOn,
• SaaS revenue made up 49% of total revenue (FY20: 26%),
• Total gross profit increased by 28% to £2.6m,
• SaaS transition has driven a 16% improvement to gross margin to 57% driven by the increase in high margin SaaS revenues,
• Loss per share from continuing operations was 7.54p (FY20: 8.05p) and total loss per share of 7.89p (FY20: 41.7p)
• Cash and cash equivalents at 31 January 2021 of £4.5m (FY20: £2.6m).

Priced at about 9x FY revenue, it’s fair to say that a good amount of growth is already priced in here. There are some early signs that this might be justified.

The group has sold SmartSpace Global for an initial cash consideration of £4.6m, with a further deferred payment of £0.3m received in May 2021. This is in keeping with its strategy of focusing on SaaS revenue.

SwipedOn performance has been strong. This visitor management software was acquired in October 2018. Annual recurring revenue (ARR) grew by 43% to NZ$5.2m in the period (about £2.7m).

Customers here grew 21.5% to 4,735 and the number of locations was up 27.7% to 6,741.

Average revenue per user (ARPU) grew by 18% to NZ$92. Operationally, the group looks to be making good headway and is focusing on higher value mid-market customers. A price increase implemented in the year could drive further ARPU growth in FY22.

Space Connect (acquired in November 2019) offers a full range of cloud-based space management software. Distribution agreements have been signed with 22 partners in the UK, Australia, Far East, Canada and Central America.

Space Connect is collaborating with Evoko, a leading manufacturer of meeting room panels for its next generation meeting room panel 'Naso'.

This was launched in December 2020 and revenue is now being recognised. The prospect list ‘includes a number of significant deals with well-known international brand names’.

Anders & Kern (a specialist distributor and integrator of workplace technology) also looks to be bouncing back.

Conclusion

A lot of the investment case here comes down to the quality of Smartspace’s newly assembled suite of software products and the subsequent scale of demand from customers.

For now, with revenue of £4.6m, the company strikes me as fairly valued in an expensive tech market.

But if it can grow strongly then we might look back on a market cap of c£40m as cheap.

Smartspace does have an intriguing market opportunity in a post-lockdown working environment, and the underlying growth rates are impressive.

The group is loss making but its transition to recurring revenue is progressing rapidly and the substantial improvement in gross margin is also promising.

The group updates on post-period performance (Q1 FY22):

• SwipedOn ARPU +8.3% to $99.32 ($91.90).
• SwipedOn ARR +9.1% to $5.7m.
• 180 new customers and 318 locations in Q1 April 21.
• SpaceConnect sales pipeline has grown from £556k in February to £1.2m at end of April driven by Return to the Office (RTO) campaigns.

These are encouraging quarterly results, and, although the valuation suggests that a fair amount of progress is already priced in, recurring revenue SaaS businesses like this can achieve high multiples.

The growth rates on show here do suggest it’s worth a closer look.