Small Cap Value Report (Thu 24 Nov 2022) - HEAD, XPS, MBH, HRN, CTO, MACF, DOCS

Good morning from Paul & Graham! I got the date right, that's a good start! Right we'll leave it there for today. Thanks for reading & commenting, some interesting discussions today.

Agenda

Paul's Section:

Headlam (LON:HEAD) - a very mild profit warning, with FY 12/2022 results now expected to be slightly below expectations. Not a cause for alarm in  my view, although it might put a stop to the recent bounce in share price, maybe? Volumes are down, as consumers retrench, but commercial is partly offsetting this. Plenty of self-help measures are also helping. I remain a long-term bull on this share, with some shorter term uncertainty due to macro. The tremendous balance sheet means little to no solvency risk, even in a recession. Good divis. Still a thumbs up overall from me, on fundamentals. No idea what the short term share price will do, that's just down to market sentiment.

Michelmersh Brick Holdings (LON:MBH) - this is becoming a brick-themed week, with me taking a positive view of larger competitor Forterra (LON:FORT) in Tuesday's SCVR. I also like MBH today, with a share buying, acquisition, and positive trading update announced today. It also has a lovely balance sheet. Despite macro conditions, brick manufacturers seem to be in a good position. Thumbs up from me.

Macfarlane (LON:MACF) - in line with expectations, although the revenue growth rate has moderated a little from H1. This looks a resilient company, and has shown it can pass on cost increases to customers. Valuation seems undemanding. I like it, a thumbs up from me.

Dr Martens (LON:DOCS) - brief comment below, in reader comments section, as too big for main report.

Graham's Section:

XPS Pensions (LON:XPS) (£279m) - the outlook for the full-year is slightly ahead of expectations at this provider of pensions services and investment advice. Revenues are up thanks to acquisitions, inflationary price increases, and higher levels of client activity. While I’m always cautious in the professional services sector, XPS appears to offer more to investors than your typical advisory business: it also provides a range of non-discretionary services, and its contracts allow for annual, inflation-linked price increases. The balance sheet offers no support but cash flow is not bad and there is a dividend yield of nearly 6% to keep investors interested.

Hornby (LON:HRN) (£47m) - this model railways (and Scalextric) company publishes H1 results which don’t read particularly well: revenues only up 3% and an increased operating loss (both on a statutory and an “underlying” basis). It’s still all to play for, however, with the key Christmas gifting season just around the corner. The company acknowledges that they can’t predict how it will pan out, but at least the supply chain problems that plagued them last year have abated. They have a new CEO from January and it will be interesting to see what new ideas he might have. I remain positive here, but I want to see Hornby raising prices and getting revenue growth at least in line with inflation.

Tclarke (LON:CTO) (£50m) (-6.5%) [no section below] - this building services group issues a profit warning for both this year and next year. This is despite saying in May that it was “very confident” of meeting market expectations for the full year, with EPS of 21p. Today it says it is “pleased” to report revenues for 2022 “in the region of £410 million”, despite the prevailing expectations being £450m. Some £40m of expected 2022 revenues have slipped into 2023, but the company’s 2023 broker forecasts have not improved: the 2023 revenue forecast is unchanged (£500m), and the company’s 2023 adj. PBT and adj. EPS forecasts are each cut by 18.5%, to reflect “an increase in its underlying cost base”. Unfortunately, this is a case where you need to find the company’s broker note to get the real news, which cannot be found in the RNS. I think this reflects poorly on management’s attitude to their shareholders.

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Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review trading updates & results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it's anybody's guess what direction market sentiment will take & nobody can predict the future with certainty. We are analysing the company fundamentals, not trying to predict market sentiment.

We stick to companies that have issued news on the day, with market caps up to about £700m. We avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed - please be civil, rational, and include the company name/ticker, otherwise people won't necessarily know what company you are referring to.

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Paul’s Section:

Headlam (LON:HEAD)

291p (pre market open)

Market cap £243m

Trading & ESG Update

Headlam (LSE: HEAD), the leading floorcoverings distributor, today provides an update on trading, and Environmental, Social and Governance ('ESG') strategy and progress.

The current financial year is FY 12/2022.

It’s a very mild profit warning -

The Company, therefore, now expects underlying profitability for the year to remain ahead of 2021 and to be marginally below the low end of the range of market expectations¹.  
¹Company-compiled consensus market expectations for revenue and underlying profit before tax, on a mean basis, are available on the Company's website at www.headlam.com

It’s frustrating that they always give that same link, and you then have to waste time trying to find the actual page, buried in their website. It’s here, to save you time. This shows a range of underlying PBT forecasts for FY 12/2022 between £38.0m and £41.8m. Last year was £35.8m.

Putting that together, the company is saying the new guidance for FY 12/2022 is above £35.8m (last year) u/l PBT, and “marginally below” £38.0m.

That looks to be about 35p EPS.

At 291p/share, I make that a PER of 8.3 - a very reasonable valuation, given that profitability seems to be holding up pretty well considering the weakening macro picture.

Other points -

Seeing a reduction in demand for residential, due to cost of living pressures.

Commercial growth is partially offsetting this.

Europe doing better (but this is only a small part of HEAD’s business)

Revenue for 10 months to end Oct 2022 slightly below last year (despite price rises, so this must mean volumes being well down on last year)

Seasonal uplift in Nov 2022, but below historic levels.

This bit is important, and encouraging that HEAD should be able to weather the storm -

The Company's strategy of driving new revenue to gain market share from a more efficient operating base has helped provide a countermeasure against the market weakness, and will continue to do so during 2023.

Energy costs - good for ESG and the bottom line -

A total upfront capital investment of £3.2 million will be made in solar panels in 2023 helping to offset energy costs that will be approximately £2.4 million higher in 2023 against 2022 due to the previously highlighted expiry of a fixed price energy contract in October 2022.

Cost increases - this is another headwind for 2023 & beyond -

The Company's people costs are anticipated to be 6.9% higher in 2023 than 2022, mainly due to wage inflation through the cost of living pay award.

ESG - more detail in the RNS, quite interesting, and all sounds sensible to me. It’s easy to be cynical about these things, but in my view most ESG things are good for everyone, and probably improve things like employee loyalty & retention, so could have commercial benefits for investors too.

Diary date - 19 Jan 2023 for a FY 12/2022 trading update.

My opinion - this share has bounced nicely from a ridiculously oversold position, like a lot of small caps.

Note that broker forecasts for 2023 have been reducing since July, with 2023 now expected to be below, not above 2022. Is that process complete? Possibly not. I would tend to assume 2023 could be worse than this -

For that reason, in the short-term, HEAD shares have probably bounced enough for now.

Longer-term though, I think this is an excellent cash-generative business, with lots of self-help measures having been undertaken in the last couple of years to make it more effective & efficient.

So far, it seems to be doing enough to absorb most of the impact of negative macro factors.

The balance sheet is wonderful, with big freehold property assets, and it also discloses average daily net cash, which is such a useful measure, showing us the true cash position throughout the year, not just a balance sheet one-day snapshot, which is easy to manipulate upwards (hence why Enterprise Value is such a flawed concept - it should be calculated on average daily net cash/debt, not on the balance sheet date alone).

Overall then, HEAD gets a thumbs up from me again, although I’m not inclined to chase the price any higher for now, given the macro headwinds. Longer term, it should be a very good investment. Plus there are generous divis too. So it really depends on your investment timeframes.

Nice high StockRank.

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Michelmersh Brick Holdings (LON:MBH)

88p (up 12% at 08:45)

Market cap £84m

3 announcements today -

Share buyback launched - starting today, for 3 months. Up to £3m maximum, based on today’s share price that would be about 3.6% of the total shares in issue.

LTIP - this looks a bit unusual. The company says it’s going to settle 2m nil cost share options from 2017 in cash of £1.58m, instead of shares. The beneficiaries are the joint CEOs. I suppose it’s commercially the same as granting them shares and them selling in the market. But I thought the whole point of share options was to enable management to build up meaningful stakes in companies, not to be a bonus to go off and spend. I can imagine a lot of PIs will be PId off with this! In times of austerity, Director greed is even more inappropriate than ever, and I’ve never seen any evidence that schemes like this do much good. Let’s move on before this turns into a full-on rant.

Acquisition of Fabspeed Holdings - for £6.25m cash, plus £2m earn out. Valuation is 5.3x EBITDA, and about 10x PBT (ignoring earnout), so that would be a PER of c.12 - sounds OK. The products look a good fit (things like prefabricated chimneys). I always think that when a specialist company in a sector buys another specialist company in the same sector, then they should know what they’re buying. Hence acquisitions risk in my view comes mainly when companies try diversifying into areas they’re not familiar with, and get stitched up by canny sellers. Hence this acquisitions satisfies my thinking about being sector-relevant.

Trading Update - for FY 12/2022.

Michelmersh Brick Holdings Plc (AIM: MBH), the specialist brick manufacturer, today announces a pre-close trading update ahead of its final results for the year ending 31 December 2022. The Group intends to report its full 2022 results on 29 March 2023.

A good headline from the company-

Continued Robust Performance Surpasses Market Expectations

Following the half year results announcement on 6 September 2022, the trading performance of the Group has continued to be positive into the final quarter of the financial year and we continue to see robust demand in our end markets.

I might as well copy the rest of the RNS, as it’s short, and all relevant -

Despite continuing to operate in a more challenging environment, the Group is managing its supply chain and energy costs in line with management expectations. As a result of the ongoing robust trading and careful management of the Group's cost base, the Board is pleased to announce that it expects revenue and profit for the Group to be ahead of market expectations for the 12 months ending 31 December 2022.

Further, the Group continues to have a strong and well-balanced forward order book, a strong balance sheet with cash reserves post acquisition of Fabspeed Holdings Ltd as announced today of £8.5m, giving management confidence as we look into 2023.

That’s really impressive. The brick sector caught my eye two days ago, when I reviewed Forterra here. There are some interesting dynamics going on - namely an industry shortage of supply, resulting in good pricing power for manufacturers, and inferior & more expensive imported bricks plugging the gap. This suggests that even in a downturn for housebuilding, demand for UK brick producers could hold up better than expected due to replacing imports. That’s what Forterra said anyway, so I assume similar conditions might apply to MBH too.

Balance sheet - is it strong? I always have to check when management claim it is. A resounding yes here - the last reported balance sheet is excellent, so no worries at all over financial strength.

My opinion - share prices for both FORT and MBH have fallen a lot this year, as we might expect with concerns about going into a recession. In my view, both look like potential buying opportunities, as they’re trading well, have pricing power, strong balance sheets, and should see demand more resilient than might be expected due to the shortage of supply. There are big barriers to entry, as it’s a capital-intensive sector, uses a lot of energy, and the product is very heavy, hence transporting long distances is costly. So I think this looks good, and it gets a thumbs up from me.

Excellent StockRank too -

.

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Macfarlane (LON:MACF)

105p (up 2% at 11:58)

Market cap £165m

I’ve got a positive impression of this company, and wrote up a positive section on it, with a thumbs up, here on 25 Aug 2022. The summaries at the top of the SCVRs are an incredibly quick way to get up to speed on what’s been happening at any company we cover, even if I do say so myself.

Today we’re updated on the latest.

Trading Update

Macfarlane Group PLC ("the Group"), the protective packaging specialist, today provides an update on trading for the period 1 January to 31 October 2022.

Trading in line with expectations

Key points -

Revenues for the 10-months so far are up 11%. They were up 14% in H1, which implies a slowdown into high single digits in H2.

Weaker volumes, offset by price rises, but we’re not given the figures.

Productivity improvements being implemented.

Net bank debt is now insignificant vs the profitability & cashflow, at just £5.0m (down from £9.7m at H1 end). Although I would prefer all companies to report average daily debt/cash, not just a snapshot on one day, as these numbers can move around a lot in the normal course of business.

Director comments sound fairly upbeat to me, given the tough macro environment -

"Given the well-publicised adverse market conditions we are pleased with the performance of the Group so far in 2022 and confident in meeting our profit expectations for the year. Whilst challenges will continue to persist, with the experience of our management team, resilience of our business model and strong acquisition pipeline, we are well placed to maintain the Group's positive progress."

My opinion - remains positive. So far MACF is weathering the storm very well, it seems.

It has a very good 10-year track record, over which time the share price has quadrupled.

MACF looks cheap, on a forward PER of 8.9, and more acquisitions are on the cards, which is its main use for internally generated cashflow.

As with so many small caps at the moment, I’ve no idea what the short term share price will do, but could foresee this share being significantly higher once the economy has returned to normal.

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Graham’s Section:

XPS Pensions (LON:XPS)

Share price: 134.5p (pre-market)

Market cap: £279m

This stock doesn’t attract much commentary but it offers a yield of nearly 6% and historic financials look solid:

I suppose it’s not the type of thing that tends to light up the bulletin boards:

We are specialists in pensions actuarial and investment consultancy and administration, providing a wide range of advisory services to trustees and sponsors of pension schemes.

Big players in this sector are the likes of Mercer, Willis Towers Watson and Aon.

Services from XPS include the National Pension Trust, a defined contribution pension trust with £1.3 billion of assets from 175 employers. They also have a SIPP and SSAS pension service.

Here are the key numbers in today’s interim results:

• Advisory revenue +15% to £43.2m.
• Total revenue +14% to £77m.
• Adj. EBITDA +15% to £17.8m
• PBT minus 4% to £6.8m

The revenue growth is partly driven by inflationary fee increases. There are also “high levels of client activity”, and some small acquisitions helping to boost the numbers.

On the other hand, the decline in PBT is due to higher “exceptional and non-trading items”, and higher interest rates charged on higher net debt.

Balance sheet: net debt has risen to £72.9m, and the leverage ratio has risen to 2.09x, due to M&A activities (these activities are also partly responsible for the increase in exceptional items).

Also there is zero balance sheet support due to £218m of intangible assets.

Awards: like many of you, I tend to ignore awards unless I know they have been awarded on merit. But these awards for XPS sound impressive:

'Pensions Actuarial Consulting Firm of the Year', 'Investment Consulting Firm of the Year' and 'Third Party Administrator of the Year' at UK Pensions Awards. Also ‘Best SIPP Provider’ at the Investment Life & Pensions Moneyfacts Awards.

Outlook: slightly ahead of expectations

The continued resilience and predictability of the XPS business model (including inflation-linked revenues) is very encouraging with momentum in the first half continuing into the second half of our financial year. We continue to experience strong demand for our services in a wide range of activities, particularly in Advisory against the backdrop of the significant changes in the financial markets and have made a very strong start to H2.

Adding to our recent announcements, combined with the recent bolt-on acquisition of Penfida, the Board are confident of achieving full year results slightly ahead of their previous expectations for the year.

There is “good visibility due to a high proportion of our revenues being non-discretionary and recurring”.

And inflation is automatically and contractually passed onto customers:

…for many of our contracts, core fees increase on the anniversary of the contract meaning that there is a lag between high headline inflation figures, and these being reflected in our fees. We will therefore continue to see the benefit of the recent high headline inflation in H2 and beyond as we pass through more contract anniversaries.

My view

I’m mindful that the demand for investment advice might be elevated in the aftermath of recent events in the pension industry: XPS says that “hedging arrangements and LDI needed attention”, which sounds like an understatement!

Is the recent strong demand for advice sustainable? Personally, I would bet that it is: a new era of higher interest rates does cause challenges but it also brings opportunities, and it will take years for pensions to adapt to the change. Over this time, they will need advice from specialists such as XPS.

As for the overall investment merits of XPS, I’ve already noted that the stock has no balance sheet support. The cash generation is not bad, and this has enabled a stream of dividends.

Quality is not bad: many of XPS’s services are non-discretionary, and contracts with customers provide for recurring, inflation-linked revenues.

Therefore, I see this company as being of higher quality than your typical professional services business, and I’d be willing to pay a higher valuation multiple for it.

The adjustments in the accounts are a little high for my liking but perhaps they can reduce over time as acquisitions bed in?

Overall, I think this one is worth researching in more detail.

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Hornby (LON:HRN)

Share price: 27.85p (-2%)

Market cap: £47m

I covered this one in detail back in June.

Before I get into these interim results, I should note that about 90% of these shares are owned by Phoenix and Artemis (they aren’t working in concert, they are simply the two largest shareholders).

H1 highlights:

• Revenues +3% to £22.4m
• Underlying loss before tax £1.5m (H1 last year: loss of £0.3m)
• Actual loss before tax £2.9m (H1 last year: loss of £0.7m)
• Net debt £4.9m

There are no forecasts for this stock but it’s important to understand that there’s always a seasonality with this business around Christmas - H2 is more important than H1.

Performance has been held back by a variety of increased costs: these include share-based payments, FX losses, staffing costs, “general inflationary increases”, and more focus on direct selling.

As you may recall from previous coverage, last Christmas was a disaster as products arrived too late from China.

The comment from the Chairman provides reassurance on this point::

"Revenues have marginally increased in the first half of a difficult 2022/23 trading period. A year ago, sales in the second half were held back by supply chain disruption, but we are now in a stronger position, having taken strategic decisions to raise stocks to support sales and avoid shortages. As we are heading into our key Christmas trading period it is hard to predict the outcome for the full year results, but we are well-placed, with our order book very strong and higher than it was a year ago."

Shipments are currently running 40% ahead of last year, and container rates are falling. So there has been some recovery back to pre-Covid normality.

Digital sales - are up 50% year-on-year from a very low base.

New CEO - starting in January. Previously at Paperchase, Rank (LON:RNK) and Ladbrokes Carol.

At Paperchase, he has 

“led the business through an administration and driven the turnaround strategy that culminated in the successful sale of the business in August 2020”. 

I wonder if a sale of Hornby might be on the cards?

My view - there is little change to my view expressed last time, although the deterioration in H1 performance is a concern. Hornby needs to raise its prices, and how difficulty might that prove to be? Perhaps the mature buyer of model railways will find the recession less painful than the younger generations?

I continue to have a positive view of this stock, even though it already prices in a degree of recovery. I’m not quite as confident as I was last time I looked at it, however: I want to see Hornby raising prices, to keep up with inflation.