Good morning, Paul & Jack here with the last SCVR for this week, then 4 days off, due to the Easter bank holidays, yippee! Today's report is now finished.
Given how awful this year has been for small caps, I think we deserve a rest from it all. That said, in my experience these horrible sell-offs pave the way for the next bull market, and we'll be wondering why we didn't buy more aggressively when shares were dirt cheap. The only bit I can't predict, is the timing.
Agenda -
Paul's section:
Vertu Motors (LON:VTU) - has acquired a key freehold for £7.1m. This demonstrates that a boom in trading has given car dealers plenty of firepower from stronger balance sheets, to make acquisitions and do other things to improve long-term shareholder value.
Peel Hotels - now a private company, but a local paper reports it is selling assets to repay all bank debt, due to bank unwillingness to renew facilities. This alarms me, and looks a warning that we need to avoid highly indebted companies in cyclical sectors, as lenders look to be perhaps going into tightening mode.
Renold (LON:RNO) - an excellent update. Shares have shot up c. 26% today, which looks fully justified.
Norcros (LON:NXR) - a positive update, ahead of expectations. There's a lot to like about this share, which is now looking cheap. Pension fund risk is greatly reduced, the only remaining worry is exposure to South Africa. Overall, this strikes me as an attractive entry price, even allowing for a possible reduction in earnings after pandemic boost recedes.
Porvair (LON:PRV) - a reassuring-sounding update, but it omits to tell us how the company is performing vs market expectations! Valuation looks toppy, unless you think it can beat forecasts.
Quickies (brief mentions with no sections below)-
Totally (LON:TLY) - a very quick mention, before I shut down for the long weekend. There's a brief trading update today, saying that based on draft numbers for FY 3/2022, it expects to " report performance ahead of FY22 consensus market expectations." . We quite like Totally, here at the SCVR. It has an interesting (albeit low margin) business model, providing outsourced health services for the NHS. Well worth a closer look for readers not familiar with the company. Management strike me as the right type of people to be running a business serving the NHS - i.e. focused on getting the services right, not squeezing out maximum profits, which augurs well for the long-term I think, as a trusted provider that can grow. (No section below).
React (LON:REAT) - I'm hearing complaints today from existing shareholders, some of whom are appalled at the terms of a fundraising announced this morning. The company is doing a placing at 1.2p, a 33% discount, to almost double the share count, with no open offer - i.e. existing private shareholders are excluded. This is terrible! No wonder people are cross. Take a look at the chart - they should have raised money when the shares were ramped up to 3-4p last year, not now that they've lost most of their (inflated) value. The acquisition being planned needs to be amazing to justify shafting its private shareholder base. I didn't buy into the story here before, and today's news puts it on my avoid list. (No section below).
Explanatory notes -
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Paul’s Section:
Vertu Motors (LON:VTU) (I hold)
Just a quick comment here. This car dealer announces today it is paying £7.1m for a key freehold site, of 5.5 acres, from which it has operated 5 “successful sales outlets”. Buying the freehold obviously secures the long-term future, with no worries about lease expiry, or upward rent reviews. Commercial leases are awful, it's so much better to own the freehold of important sites.
My opinion - this is a reminder that car dealers are laden with freehold properties, particularly in the case of Vertu, where you’re paying little premium over tangible book value, hence arguably buying a very profitable business almost for nothing. That’s an obvious valuation anomaly, which has been evident for several years now. Eventually, I reckon a bidder might appear, tempted by the freeholds. We’ve already seen a couple of takeover bids in the sector.
Car dealers have made bonanza profits in the pandemic, due to supply constraints pushing up their gross margins (especially on used cars). We all know that won’t last forever, and profits will surely drop considerably, which is already priced-in to broker forecasts and low PERs.
However, every profitable month feeds through to increased balance sheet strength. This is because the way double-entry bookkeeping works, is that the profit after tax usually has to balance with a corresponding increase in balance sheet net assets.
This means that car dealers currently have plenty of firepower, to buy freeholds, make acquisitions of other businesses, do share buybacks, pay big divis, etc..
So it remains a very attractive sector, in my view, even allowing for profits normalising at a lower level in future.
Talking to an IT company last week, they told me the problem with shortages of chips is getting worse, not better, with lead times on some tech products extending to a year. So maybe boom times for car dealers could continue, who knows?
Anyway, Vertu Motors (LON:VTU) looks a lovely hybrid of property company, and decently-managed, profitable car dealers. Therefore it remains highly attractive to value investors.
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Peel Hotels - bank lending warning
Some readers might remember this quirky little hotels group, which de-listed a few years ago. It often traded below book value, probably because a lot of its assets weren't very good (older, smaller hotels, that needed constant expenditure to keep them half-decent).
It popped up in the Bournemouth Evening Echo recently, saying that its Norfolk Royale Hotel near Bournemouth Pier, is up for sale at about £9m. It’s a nice enough hotel, but as with most older hotels, needs constant, large capex to refresh it. The holding company in 1990 was called "Leading Leisure", and it went bust due to the surge in interest rates at the time. I worked on the receivership, which was interesting experience that I've never forgotten, hence my aversion to companies with high bank debt - things can quickly unravel in a downturn.
The reason I mention it though, is because Peel Hotels said that its bank has indicated that facilities need to be repaid in full by end 2022, as the bank doesn’t want to continue lending to this hotels group. The total bank debt is only c.£5m, so Peel only needs to make one disposal (it has other hotels on the market too) to clear group debt in full, which the 75-year old Chairman said he wants to do anyway.
Hence I don’t know the full circumstances, but the news jumped out at me, for possible read-across to other companies & sectors. Are banks starting to draw in lending to cyclical companies, like hotels? If so, this could spell real trouble for overly-indebted companies & sectors.
I’ve seen what happens before, in several recessions, when banks decide to withdraw lending for sectors they suddenly perceive as high risk. It can prompt plummeting valuations of assets such as hotels, and other properties, as companies rush to sell up to cash buyers, who sit on their hands and wait until the seller is desperate, before naming their price.
Overall then, I shall redouble my efforts to flag up weak balance sheets, and problem gearing, because it looks as if we could be entering a tougher stage, where companies cannot necessarily rely on the bank manager being accommodative. Banking relationships mean absolutely nothing. That can result in emergency placings (sometimes at big discounts), or even insolvency.
I see that Mccoll's Retail (LON:MCLS) is still teetering, with no refinancing yet agreed. At the very least, a refinancing there is likely to lead to heavy dilution, or a complete wipe-out of existing equity. People are taking crazy risks punting on that share at the moment, but you often see a short-term speculative mania developing in companies when their shares are close to zero.
Hence this is a general warning to be sure you check the balance sheets, and the bank facilities, of every company before buying any shares in what might look like a bargain, but which could be vulnerable to heavy dilution or insolvency, if the bank debt is high, and unlikely to be renewed, or maybe covenants breached.
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Renold (LON:RNO)
25.5p (up 26% at 10:02)
Market cap £57m
Unfortunately I’m not holding this share any more, as it was in my geared account, which plummeted in the March 2022 rout, meaning that I had no choice but to close a lot of positions right at the low. The dangers of gearing once again giving me a hiding, when will I learn?! (Never, probably!)
Anyway, well done to people who held on, this strong update today is a reminder that the market sell-off in small caps has been indiscriminate, and in some cases has nothing to do with company performance, or prospects. It’s not easy to identify in advance which companies are going to be the winners or losers though. If it was easy (as everyone on Twitter seems to say it is), then we’d all be billionaires.
Here at the SCVR, we’ve been reporting positively on Renold (a maker of industrial chains & similar) for a while now, having spotted a slow but sure turnaround (cost-cutting, efficiency gains), tempered by the uncertainty & cash outflows related to a large pension deficit. This meant Renold hasn’t been able to pay divis for years - a good decision as it turned out, because it enabled the company to get through the pandemic without needing to dilute shareholders. Production facilities have also been modernised from internally generated cashflows, and debt reduced. All whilst funding big deficit recovery payments too.
That’s the background as I see it, now on to today’s update.
Renold, a leading international supplier of industrial chains and related power transmission products, today issues a trading update covering the year ended 31 March 2022 ("FY22"), ahead of the announcement of the preliminary results for the year expected to be announced on 13 July 2022.
Today’s update is so clear, I don’t think there’s anything to be gained from summarising it, so here it is in full -
The Board is pleased to report that the strong momentum in order intake and turnover experienced in the first half of the year continued, delivering revenue for the full year of £195.0m, a year-on-year increase of 18.0% on a reported basis, and 21.7% at constant exchange rates.
The level of the sales to Russia and Ukraine during FY22 were insignificant at c. 0.5% of Group turnover.
Group order intake during FY22 was £223.7m. This represents a year-on-year increase of 31.6% on a reported basis and 35.6% at constant exchange rates. Excluding the recently announced £11.0m long term military contract, order intake for the period increased by 25.2% or 29.2% at constant exchange rates. The current order book of £84.1m is a record high for the Group (31 March 2021: £53.6m).
As a result of the stronger sales, benefits of cost reduction and efficiency programmes, and the successful implementation of price increases running ahead of raw material and energy cost increases, the Board is now expecting underlying trading profit for FY22 to be materially ahead of the previous upwardly revised expectations.
In addition, there are a number of material one off, non-recurring items which will, subject to audit, contribute to an increase in full year statutory operating profits, of c.£4.0m. This includes gains from new lease arrangements on sub-let properties and US PPP Covid loan relief, of which £1.2m was previously recognised and disclosed in the half year results.
Careful management of working capital resulted in net debt at the end of the FY22 of £13.8m (30 September 2021: £13.9m), a reduction of £4.6m during the year.
The Group has strengthened its financial position significantly over the last two years, providing funding capacity to support its strategic growth objectives. These include both further capability investments as well as value-accretive acquisitions, with a developing pipeline of opportunities.
My opinion - that’s a terrific update, I can see why the share price is up strongly today, on big volume.
Valuation is tricky, because it depends how you account for the pension deficit. Some pension deficits seem to be reducing at the moment, as bond yields rise (thus lowering the present value of liabilities). Although higher inflation might apply pressure in the other direction, possibly? Pension scheme accounting is so complicated and only the experts seem to know how all the moving parts fit together, so I wouldn’t want to make any bold assumptions about what the future holds. The bottom line is that Renold’s pension scheme has been sucking a lot of cash out of the business for years, so it cannot just be ignored. This is why the PER is low, because pension deficit recovery payments do not go through the P&L remember.
Just like my late grandfather’s legendary reports of his fishing trips, every time he returned home with little to nothing, reporting that “the big one got away!”. That’s how I see Renold today, i.e. my analysis was right, but I’ve not managed to hold on to the position to benefit from it. Ah well, it’ll just have to be tinned mackerel tonight, instead of succulent fresh salmon!
More seriously though, should I be buying back in? Probably yes, but (a) there’s no spare cash available, and (b) I don’t want to sell anything else to raise cash, and (c) I’ve noticed that big moves up at the moment are often triggering profit taking, so it might drift back down again if I’m patient. Who knows?
For long-term holders (the sensible ones, who didn’t use gearing!) this looks a very pleasing update, and if I held, I’d definitely be happy to continue holding.
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Norcros (LON:NXR)
258p (up 8% at 11:51)
Market cap £209m
Norcros plc ("Norcros" or the "Group"), a market leading supplier of high quality and innovative bathroom and kitchen products, will announce its preliminary results for the year ended 31 March 20221 on 9 June 2022. In advance of this, the Group is providing the following trading update.
Impressive performance for FY 3/2022 -
Full year trading performance ahead of expectations
The Group has continued to trade robustly, acting decisively to counter unprecedented cost inflation and navigate exceptional supply chain challenges.
The Board now expects underlying operating profit for the year to 31 March 20221 to be at a record level and ahead of its previous expectations.
More details, summary (with my comments) -
Revenues for FY 3/2022 c.£396m, 22% up on LY, and well ahead of pre-pandemic level too.
UK and S.Africa both performed well.
Inventories increased, to get round supply chain problems - makes sense to me.
Net cash of £7m, so no worries about bank debt.
New bank facility of £130m+ agreed - let’s hope they don’t spend too much of that if there’s a recession coming, as Norcros has got into trouble with excessive debt before.
Pension scheme - good news here, with an agreed, reduced actuarial deficit of £35.8m, with £3.8m (plus inflation, capped at 5%) payable between 2022-2027. For context, that’s only about 10-15% of post-tax profits, so it’s now only a smallish problem. The strategy to dilute the pension deficit by expanding the business through sensibly-priced acquisitions, has worked a treat, well done to management.
Last onerous lease gone - another legacy problem resolved.
My opinion - Norcros strikes me as a really well-managed business, with management having executed a sensible long-term plan, very well.
The pension scheme used to be a huge problem, now it’s minor.
The main risk now is South Africa, which is a big part of the overall business, and from the news, and talking to South Africans I know, the overall position there is not a happy one. Although that risk has been around for a long time now. It’s just a potential risk to bear in mind, when considering valuation, and position sizing, and everyone can make up their own minds, armed with the facts.
I can’t find any broker notes, but Stockopedia shows market consensus forecast at c.35p. That might end up nearer 40p, given today’s update. That’s a PER of only 6.5 - very cheap, if you think earnings are sustainable at that level.
There could be an element of demand pulled forward by the pandemic, so if we assume that EPS might drop back to say 30p, then the PER would still be cheap, at 8.6.
On that basis, I think Norcros shares look attractively priced.
There’s also a well-covered (so could be increased) dividend yield approaching 4%.
Norcros also has plenty of firepower for further acquisitions (to drive up earnings more), and the ones done so far have been very sensible, so the risk of mgt screwing things up with a bad deal looks low. In this type of niche, the companies all know each other, so I suspect Norcros will already know which companies are worth considering as acquisitions, and which are best avoided. Companies where, e.g. the owner wants to retire, will know Norcros is a consolidator, hence approach them if they want to sell, I would imagine. A nice position to be in for Norcros, to gradually build shareholder value over the years.
I think people could do well on this share long term, providing S.Africa doesn’t blow up.
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Porvair (LON:PRV)
627p (unchanged, at 12:50)
Market cap £290m
A reassuring update today, but it doesn't mention performance vs market expectations - a glaring omission. Here it is in full -
Porvair plc, the specialist filtration, laboratory and environmental technology group, will make the following trading statement today at its Annual General Meeting:
In the four months ended 31 March 2022, revenue growth was 14%, supported by the timing of the Kbio acquisition in February 2021. Without acquisitions and at constant currency, revenue was up around 10%, with all three divisions showing growth. Near-term supply dislocations and inflationary pressures continue but the Group has avoided major problems thus far. Order books are in some cases flattered by extended lead times, but looked at on an underlying basis remain healthy.
The Group will announce its interim results for the six months ending 31 May 2022 on Monday 4 July 2022.
My opinion - a forward PER of 22.8, and a dividend yield of under 1% just doesn’t interest me, at a time when we can buy many other companies growing faster, at a cheaper rating.
The aerospace division of Porvair could do better than expected, as travel returns, but presumably the analysts would have already baked that into the forecasts?
I do like Porvair as a business, as it has pricing power with niche products, where demand is repeating. Long-term, the share price rise has been superb - it’s 10-bagged since 2010.
I think it boils down to whether you think forecasts might be beaten? If your analysis of the company & its products/markets, suggests that broker forecasts might be too pessimistic, then I can see a reason for investing. Without that though, I’m happy to sit on the sidelines.
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