Small Cap Value Report (Thu 12 Nov 2020) - SNWS, VLX, NWF, NXR, IDEA, TTG, CLG

Good morning! It's Paul & Jack here with the SCVR for Thursday.

Agenda - this is what has caught our eyes today;

Smiths News (LON:SNWS) - Jack covering its preliminary results (Jack holds, done)

Volex (LON:VLX) - Half year report (Paul holds) - webinar today at 11am on IMC platform (Paul holds, done)

Nwf (LON:NWF) - shares unsuspended, update on cyber-attack (Paul, done)

Norcros (LON:NXR) - Interims (Paul, done)

Ideagen (LON:IDEA) - Trading update (Paul, done)

Tt Electronics (LON:TTG) - Trading update (Paul, done)

Clipper Logistics (LON:CLG) - Trading update (Paul, done)

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Timing - looks like it will be an all day job, as lots of interesting stuff to cover. Today's report is now finished.

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NB. Jack writing this section

A changing of the guard or too soon to call?

This has been another defining week in the markets, with Monday’s vaccine announcement flipping 2020’s winners and losers more or less on its head. Is this a changing of the guard in terms of stock market performers or just a premature celebration set to fade?

I’m thinking about this carefully and am curious to hear what others make of recent developments from an investing perspective.

For a month or so now I’ve been looking for a bit more Value-Momentum - the idea being that we will at some point return to normal life (say on a two year view), and so those companies with bombed out share prices, promising strategies, strong management, and good upside potential might offer attractive risk:reward.

But cheap companies are never perfect and do tend to come with higher risk such as large pension funds, so DYOR. The below are not recommendations but might spark a bit of conversation.

I’ve held one Leisure stock through thick and thin: Fulham Shore (LON:FUL) . I did hold Marston's (LON:MARS) but sold on the spike up to 65p or so after the Carlsberg JV announcement. Now, with tangible (albeit preliminary) news of a vaccine I would buy back in if we saw some selling pressure there in the weeks ahead. I’ve also repositioned into Reach (LON:RCH) , Redde Northgate (LON:REDD) , and Smiths News (LON:SNWS) (but a small amount in the latter) over the past few weeks.

I bought some Novacyt Sa (LON:NCYT) on the steep drop on Monday but it’s a volatile stock so you do need to be able to handle that volatility.

Below is from an equal-weighted Folio watchlist of turnaround situations. This Folio dramatically underperformed in March and for a long period thereafter but the past three months show an interesting trend.

The watchlist is the blue line and the FTSE All Share is the grey line:

I do think the real deal lockdown winners will continue to be longer term winners. But I’m also keeping a closer eye on what have been losers, because the stock market is forward looking.

If there are continued signs of ongoing investment into COVID recovery stocks, I’ll devote more time to opportunistically playing this theme. Buy and hold quality investing is a great strategy - but the fact is being a nimble and responsive investor has served me well so far in what is clearly an exceptional year.

Risks remain and we’re not out of the woods yet of course, so there’s plenty to ponder - but I’m as curious as ever to hear how others are positioned.

(to avoid any confusion, this section was written by Jack)

Paul replies - very interesting, thanks very much Jack. I've been on what can almost be described as a buying frenzy this week, so I'm planning on writing a similar piece, giving my current market thoughts, and what I've been buying. Looks like that will probably have to wait until tomorrow though, as there are lots of other things for me to look at today.

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Volex (LON:VLX)

Share price: 254p (down 3.4%)
No. shares: 152.3m
Market cap: £368.8m

(I hold - Paul)

Board changes - abrupt departure of the CFO today, which sounds like there must have been some kind of disagreement. Hopefully nothing more to it than that - many investors get spooked by sudden departures of CFOs, as it can indicate something might be wrong.

Daren Morris, who initially joined the business in June 2014 as a Non-Executive Director before becoming Chief Financial Officer in September 2014, has today left the Board with immediate effect and will be leaving the business.

Jon Boaden, who joined the business in April 2019, as Deputy Chief Financial Officer, has been promoted to the role of CFO with immediate effect.

There’s a presentation on IMC at 11am this morning, so hopefully we’ll get to see the new CFO. At least he already works within the business so knows the ropes.

Half year report

Robust H1 performance - resilient business model responding well to Covid-19

Volex plc ("Volex"), a global provider of integrated manufacturing services and power products, today announces its half year results for the 26 weeks ended 4 October 2020 ("H1 FY2021").

These financial highlights look outstanding, considering the backdrop of covid/lockdowns;

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I’ve highlighted the most important numbers to me;

Revenues up 3.5%

I tend to ignore operating profit now, because IFRS 16 has rendered it unreliable. Hence underlying PBT and EPS are the figures I tend to work from, for valuation purposes, providing the adjustments are reasonable.

There’s a healthy cash pile too

Note the figures are all in US dollars, so EPS translates into about 10p for H1. Simplistically, if we double that to 20p for the full year, then the PER is only 12.7 - too cheap in my view.

Bank facilities - a big increase is announced, even though the group has a strong net cash position;

We have also signed a new, three-year $100 million multi-currency revolving credit facility to replace our current $30 million credit facility, increasing our capacity for investment in future growth. The facility consists of a $70 million committed facility with a $30m accordion feature and is effective from 12 November 2020

Acquisition - this is substantial, at Euros 61.8m, but only E37m initially, which Volex can easily afford from its cash pile, and borrowing facilities.

This looks an excellent acquisition, a strongly profitable, decent-sized, low cost producer based in Turkey. This should substantially increase EPS, and is a great use of the cash pile, which was otherwise sitting there doing nothing!

Outlook - sounds fine;

Having delivered a robust performance in the first half of the year, coupled with a strong forward order-book, the Board remains confident in delivering on full-year expectations, absent any material disruptions to our business that may be caused by Covid-19…

Balance sheet - is strong. NAV: $150.7m, less $40.6m intangibles = NTAV $110.1m. My only queries are what “Other receivables” of $4.59m and $9.158m pertain to? Also I wonder what $42.2m in “Other payables” are?

There’s a modest pension deficit.

Note that Volex does not capitalise development spend, which is good.

Share based payments - seem rather high. This was $4.0m in H1, or about 20% of adjusted profits. It was $8.7m last full year, so I’m not sure these should be adjusted out as one-offs?

There again, if we value the business on diluted EPS, then we’re taking into account all future planned dilution.

My opinion - on an initial, quick skim of the figures (I’ve not gone through all the commentary yet), I’m really impressed. The turnaround at Volex has been remarkable, with the operating profit margin now just above 10%.

I like the look of the acquisition announced today, which is going to considerably boost profitability and EPS, which the market doesn’t seem to have recognised yet.

Maybe the abrupt departure of the CFO today might have caused the share price to fall. On fundamentals, I think the share price should have risen considerably today, so for that reason I’m going to buy some more.

I’m becoming increasingly convinced that Volex is too cheap. The analyst at Small Company Share Watch, a long-standing tip sheet, which is often very good, came to a similar conclusion, with a very bullish write-up last weekend, suggesting c.400p is a sensible target. I completely agree. Once you add on the profits for the new acquisition, and that existing forecasts seem too low, then it could continue to rise to that sort of level, with a bit of patience, I reckon. Providing nothing goes wrong of course, as with everything.

I particularly like the impending boom in electric vehicles, as this plays right into Volex’s strengths. They need complex, critically important wiring looms, hence likely to be very much in demand, and at good margins, because manufacturers simply cannot risk using a cheap supplier that could render electric vehicles as write-offs if the wiring goes wrong.

Remember how Jaguar designed a beautiful vehicle, decades ahead of its time, the Jaguar XJS (disclosure: I hold), but they used cheap electrical connectors, which rendered the vehicles unusable after just 2-3 years. That and the rust of course. Such a pity.

I could see Volex becoming one of my largest positions at this rate, if progress continues to be this impressive.

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Volex - additional points from today’s webinar

As usual, this was a very interesting webinar on the IMC platform, today from 11am for an hour. There should be a recording of it on IMC in due course, so very worth watching for anyone interested in this company. I jotted down a few key points;

• Electric vehicles wiring components are starting to grow “exponentially”, already 15% of the power products division’s sales
• Opening a factory in Indonesia, lower tariffs than China for e.g. US customers
• DEKA acquisition in Turkey is “terrific deal”, leading power components maker for European customers, “opportunity for huge revenue synergies”, as well as cost savings, excellent European customer base, 2-year stretch targets for contingent consideration to kick in. Don’t expect any problems at all from competition regulators.
• H1 results benefited from one-off factors not expected to continue in H2, e.g. favourable forex, low copper price in Q1 since reversed, low tax charge due to utilising UK tax losses which allows them to recognise tax asset on balance sheet
• Hard to quantify impact of copper prices on H2 performance, partially hedged
• Q2 performance “very strong”, continued into Q3 so far
• “Incredibly deep” acquisitions pipeline, but won’t overpay, 3 potential deals at advanced stage, expect deals in Jan-Mar 2021.
• CFO change - outgoing CFO had indicated his wish to retire, 2 years ago. Hence why they recruited his ultimate replacement. Board decided that replacement performing so well, it was time to make the change. Hence nothing untoward, assuming that’s the full picture!
• New NED - is a fluent Turking speaker, and knows Turkey very well having been ambassador there. Also previous ambassador to USA & France, so beings very relevant skills to Volex
• Closing remarks - with the benefit of the DEKA acquisition beginning to kick in, we should be able to report “cracking results” to you in June next year.

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My opinion - that all sounds excellent, although I hadn’t picked up on the fact that H1 benefited from some one-offs. Written down, the content of management comments sound really positive, but the tone of the webinar was delivered in a rather sombre, downbeat style I thought. Maybe they were tired/stressed?

Anyway, I’m more comfortable with things now (especially reason for the CFO departure), so am ready to push the buy button, and increase my stake.

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** This section written by Jack **

Smiths News (LON:SNWS)

Share price: 26.68p (-8%)

Shares in issue: 247,700,000

Market cap: £66m

(Jack writing - I hold)

Smiths News (LON:SNWS) has recently refinanced but the share price is still cheap - that’s probably because, even post-financing, it operates in a shrinking market as the UK’s largest news wholesaler.

It’s very cash generative but you can see the direction of travel in recent times is all wrong:

So there’s plenty to do and the jury is still out. That said, you would think this year is about as bad as it gets for a lot of companies, and Smith News has remained profitable and cash generative through it all.

Shares are down quite a lot on the full year results - perhaps some relieved long term shareholders are gratefully offloading their stock, having previously been contemplating permanent loss of capital?

There has been a rerating over the past month or two.

Audited Preliminary Results

This is a long and involved update so keeping it short will be a challenge.

Headlines:

• Performance ahead of revised full year expectations
• Trading resilience throughout lockdown and good recovery in Q4
• All major publisher contracts now secured to at least 2024
• Robust cost control delivering sustainable operating efficiencies of £6.7m
• Disposal of Tuffnells removes a loss-making operation
• New £120m three year bank facility agreed in November 2020
• Bank net debt of £79.5m equivalent to leverage of 2 X EBITDA at the year end

There are some heavily adjusted results here - perhaps to be expected from a company with a distressed valuation but also a further confirmation that this is a risky turnaround.

• Revenue -10.7% to £1.16bn
• Adjusted PBT -25.8% to £27.9m; statutory PBT -51.2% to £14.8m
• Adjusted earnings per share -15.7% to 9.7p; statutory EPS -45.6% to 4.9p
• Free cash flow -67.2% to £10.9m
• Adjusted bank net debt +7.6% to £79.5m; statutory net debt +52.8% to £112.9m

So the adjusted EPS figure puts Smiths shares at 2.75x FY20 earnings.

Statutory PBT of £14.8m is impacted by a non-cash impairment charge relating to goodwill and assets in DMD of £5.7m and the impact of COVID-19 on trading of c£7.5m.

Continuing Free cash flow of £10.9m is after the temporary closure and return of unsold supplies from a significant number of retail outlets during the lockdown. It’s good, given what the company has had to cope with this year.

Refinancing

The Company's new banking arrangements provide facilities of £120m in three parts.

• Term loan A of £45m- amortising at £15m p.a. over three years

• Term loan B of £35m - non amortising but subject to agreed repayments from the deferred consideration due from the sale of Tuffnells and ‘any cash surplus arising from the proposed move to buy-out of the Company's defined benefit pension scheme’.
• A revolving credit facility of £40m

Bank Net Debt at year end was £79.5m (FY2019:£73.9m), up £5.6m but ahead of Smith’s revised expectations.

As of FY19, there were also two pension funds to account for: WH Smith (surplus of £24m) and Tuffnell’s (deficit of £2.9m).

Conclusion

These results should be judged in the context of a very cheap valuation and good forward revenue and cash flow visibility:

The company is still profitable in 2020 which I view as quite a feat but the results aren’t pretty and I view this as a high risk turnaround.

There’s no doubt that Smith News is in a structurally challenged industry characterised by declining revenue and market size.

This is a long and complex update, but some of the key points include:

• The group has high visibility of revenue and cash flows through to at least 2024.
• The sale of Tuffnells in May 2020 gets rid of a loss-making division and simplifies operations.
• Network restructuring and efficiencies in the supply chain should deliver ongoing savings
• A key focus on debt reduction
• The board expects to resume dividend payments in FY21

In terms of outlook, management thinks it can ‘continue to trade profitably with positive cash generation in all reasonably foreseeable scenarios.’

It will be a bumpy road though. The company is cheap for a reason and it anticipates core revenue decline in the range of 3% and 5% per annum. Not just that - it expects ‘year-on-year sales declines to be greater over the next 12 months’, as a consequence of the ongoing impacts of COVID-19.

It’s a mixed update for sure, but I don’t see anything here that is a surprise or makes me want to sell just now. On balance, I’m happy to keep the small position as a deep value stock given the good revenue visibility.

There’s been net director buying over the past year or so.

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Nwf (LON:NWF)

Share price: 192p (down 4%, at 10:55)
No. shares: 49.0m
Market cap: £45.1m

Restoration of trading - this share had been suspended when a cyber attack was discovered. Very sensible, whenever there is a potentially material uncertainty, then I think shares should be temporarily suspended. Shareholders can breathe a sigh of relief, as it’s only down 4% today, on very low volumes.

Cyber incident update

NWF Group plc ('NWF' or the Group), the specialist distributor of fuel, food and feed across the UK, provides an update regarding the impact of the cyber incident announced on 2 November 2020.

Following extensive investigations, supported by cyber security experts, the Group is satisfied that the incident has been contained and additional security measures have been applied to all of the Group's IT systems.

Here’s the most important bit;

...the Group is pleased to report that each of its three divisions has continued to operate with minimal disruption and the Board does not expect that the incident is likely to result in any material impact on underlying trading…. It is expected that the costs associated with the Group's response to the incident will be approximately £0.5 million net of recoveries under the Group's existing cyber insurance and as such the overall financial impact on the Group is not expected to be material.

My opinion - something like this can hit almost any company, so I don’t think we should be too harsh on management at NWF. One hopes that, having suffered such an incursion once, they’ll make sure IT systems are as near to impregnable as they can be, in future.

Is it a buying (or selling) opportunity? Not really, because the price hasn’t moved much. It looks an OK company - ex-growth, and modestly priced on a PER of about 11.

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Norcros (LON:NXR)

Share price: 185.5p (up c.1%, at 14:58)
No. shares: 73.6m
Market cap: £136.5m

Interim results

Norcros, a market leading supplier of high quality and innovative bathroom and kitchen products, today announces its results for the six months ended 30 September 2020.

'Marked recovery and strong financial position.'

The results presentation slides are on its website here (scroll down to “latest downloads” on the right hand side). I really like the video of its various subsidiaries’ products which plays when you load the page. Some lovely, stylish products there. I'd love a shower cubicle like that, as opposed to my one at home, with doors caked in limescale, and hanging off their hinges!

H1 results key points;

Revenues down 25.3% to £135.3m (at constant currency, and adjusting for 27 week period LY, it’s a fall of 17.3%)

Underlying profit before tax down 31.4% to £10.7m - not bad considering the environment

Received £4.9m in Govt assistance (furlough) in UK, Ireland, and S.Africa

Net debt has fallen very strikingly, down to only £7.3m (was £41.1m a year earlier) - there must be some creditor stretch here, so I’ll look into that. Yes, here we are;

The Group generated an underlying operating cash flow of £37.6m (2019: £20.0m) driven largely by a £19.9m inflow from working capital (2019: £3.1m outflow) reflecting a significant reduction in inventory and the deferral of VAT, rates and rent in the period.

It’s a pity the company has not disclosed the actual amounts of creditor stretch, as this is important information, creating an abnormally and temporary boost to cashflow. Clearly the net debt is going to rise again, once the company has paid up the deferred taxation, and once working capital increases again as business normalises (note that inventories levels are unusually low).

No interim divi (LY: 3.1p)

Strong recovery in Q2 trading

Outlook - nothing meaningful, but generally sounds upbeat, e.g.

...the Group remains well positioned to sustain the strong progress and recovery of the second quarter.

Forecasts/valuation - as you can see from the broker forecasts below, they’re starting to pick up. I can’t see any reason why, once things get back to normal, that previous levels of EPS of perhaps 25-30p couldn’t be attained once more. Plus, the DIY & home improvement sectors have proven quite resilient, as many shops were allowed to remain open during lockdown.

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Personally I wouldn’t want to pay more than a PER of about 8, given the huge pension schemes, and large exposure to S.Africa. That gets me to a valuation of 200-240p looking forward maybe a year or two. Given that the current price is 185p, then personally I don’t see enough upside to get me interested.

As you can see below, the share price hasn't really gone anywhere in 5 years, although reasonable divis have been paid. I think that's why this share has tended to have a revolving door type shareholder base. People buy because they think it's too cheap, sit and wait for a while, and nothing happens. Then eventually they sell up and move on.

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Ideagen (LON:IDEA)

Share price: 229p (down c.2% today)
No. shares: 226.9m
Market cap: £519.6m

Trading update & Board changes

Ideagen PLC (AIM: IDEA), a leading supplier of regulatory and compliance software, is pleased to provide an update on trading for the six months ended 31st October 2020.

This is the key bit;

The Board is pleased to report that trading for the first half of the financial year has been ahead of the same period last year and comfortably in line with the Board's expectations.
These results underpin the Board's confidence in the Group's prospects for the second half of the financial year

Increasingly strong recurring revenues;

The Board considers ARR as the Group's primary growth metric and the driver for long term value. ARR recognised during the first half is expected to be £24.4m (H1 2019: £20.3m), representing 83% of total revenues, up from 74% in the comparative prior period. The ARR book (being contracted revenue to be recognised over the coming 12 months) has increased by 13% during the first six months to approximately £54.8m (April 2020: £48.7m), arising from both strong organic growth of approximately 7% (14% on an annualised basis) and 6% of acquired ARR from the acquisition of Qualsys in August 2020.

H1 guidance -

The Group expects to report total revenue up 7% at approximately £29.2m (H1 2019: £27.3m) and adjusted EBITDA* to have increased by 25% to approximately £10.0m (H1 2019: £8.0m).

Net debt -

Cash generated by operations during the first six months is expected to be in excess of 90% of adjusted EBITDA* resulting in a gross cash balance as at 31 October 2020 of £12.1m and gross bank borrowings of £40.0m. Net bank debt at the period end of £27.9m leaves the Group comfortably within banking covenants and on a robust financial footing.

My opinion - I’m not keen on the balance sheet, or the valuation (very high, in my opinion). So it’s not something I would want to buy at anything like the current price.

I reviewed the last full year accounts here in Sept.

Bulls point out that high recurring revenues software businesses do attract a premium price, which is a fair point.

Long term holders have done very well;

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Tt Electronics (LON:TTG)

Share price: 213p (down c.5% today)
No. shares: 174.2m
Market cap: £371.0m

Trading update

TT Electronics plc ("TT", "the Group"), a global provider of engineered electronics for performance critical applications, publishes the following Trading Update on the Group's performance in the four-month period ended 24 October 2020.

Like-for-like revenue is 11-12% down on last year for July,Aug,Sept, Oct - a slight improvement on the -17% reported for Q2 (Apr, May, June)

Book to bill is improving;

The trends previously seen in TT's end-markets have continued. Order intake has shown signs of recovery with bookings for the four months running at 104 per cent of revenue and, as a result, the Group's order book has now almost recovered to where it was this time last year. The recovery dynamics in organic revenue and order intake have come from across the Group.

Cost-cutting to improve margins - these are quite big numbers relative to historic profitability;

We are making good progress with the Group's extended self-help programme, which commenced in the second quarter, with initial headcount reductions completed and transfer activity on schedule to support the site closure timeline. The project is on schedule to deliver the expected £11-12 million of run-rate benefits in 2023.

Outlook -

...We are continuing our journey to double-digit margins and expect to see further improvement in trading this year."

Virolens - I’m still smarting from this. I got suckered in by a very rampy RNS issued on 10 Sept 2020, which trumpeted possible orders of £280m relating to a covid testing machine that TTG is involved with. This caused a big spike up in share price. I bought right at the top, and then almost immediately press reports began to pour cold water on the credibility of TTG’s partner.

Then within a week, TTG announced a placing at 200p for an acquisition.

Look at the market chaos this badly handled chain of events caused in Sept 2020. This cost me, and other investors, losses;

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Today’s update on Virolens doesn’t mention any numbers;

In September we announced that TT had been appointed exclusive manufacturing partner for the commercial launch of Virolens®, a rapid COVID-19 screening device. There remains a wide range of possible outcomes but Virolens® is proceeding through regulatory approvals and devices have been shipped to initial launch customers for operational trials in a number of different jurisdictions.

We have also been working to prepare for volume production of Virolens® devices and testing cartridges at our facility in Hartlepool, UK.

Acquisition - of Torotel, for $43.4m, completed earlier this week.

My opinion - I’m steering well clear of this company for the foreseeable future, after the debacle re Virolens in Sept, just before a placing. That cost me a few grand, and has badly dented my willingness to trust management. That’s a pity, because I always thought this seemed a pretty good company.

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Clipper Logistics (LON:CLG)

Share price: 480p (up 4% today)
No. shares: 101.7m
Market cap: £488.2m

Trading update

Clipper Logistics plc ("Clipper", the "Group", or the "Company"), a leading provider of value-added logistics solutions, e-fulfilment and returns management services is pleased to announce a trading update for the six months ended 31 October 2020.

This sounds very good;

Clipper has continued to see strong trading across the business in the year to date, benefitting particularly from the continued structural shift to e-commerce that has been accelerated during the ongoing Covid-19 pandemic. The Group expects to report revenue for the period of at least £300m, an increase of almost 20% against the prior year comparative period, including e-fulfilment logistics growth of over 30% and non-e-fulfilment logistics growth of approximately 10%.

Nothing is said about performance vs expectations. Therefore I’m assuming this is in line with expectations. Stockopedia shows a +20% forecast for revenues this year.

If it achieves FY 04/2021 forecast EPS of 20.6p, then that gives a current year PER of 23.3 - rather a lot for a logistics company, but it does seem to be seen as a picks & shovel type share for eCommerce companies, and the growth rate is impressive.

Cashflow/net debt - have improved, but we’re not told how much of the gains are one-off, temporary effects from stretching creditors, eg. VAT/PAYE. Companies must report the numbers, otherwise they could be giving us a false impression.

Outlook - sounds reassuring;

This good momentum and the existing pipeline of new business opportunities is expected to give the Group continuing strong performance into the second half of the financial year.

My opinion - I’m not really interested in logistics companies, but if I had to buy one, it would probably be this one, due to how well it's doing with eCommerce clients.

Note how Clipper shares are doing extremely well this year, but the longer term picture is more mixed.

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I think we'll call it a day there. Thanks for tuning in!

Best wishes, Paul.