Small Cap Value Report (Thu 28 April 2022) - SMV, SDG, HSS

Good morning, Paul & Roland here.

Agenda - 

Paul's Section:

Sanderson Design (LON:SDG) (I hold) - good results. Very strong balance sheet. Shares look cheap to me. CEO Lisa Montague has sorted out the business very well, with a commonsense turnaround now delivering decent results. Divis have resumed & should increase in future. Lots to like, if you think (as I do) that higher end products like SDG's may not be particularly vulnerable to disposable incomes/inflation.

Roland's Section:

Smoove (LON:SMV) - this conveyancing technology business was formerly known as ULS Technology. Today’s full-year update appears to show slowing momentum. I’m not yet convinced by the growth story here, although a cash-rich balance sheet should remove any near-term financing risk.

Hss Hire (LON:HSS) - this equipment hire group has finally shed its IPO debt burden. Today’s results show a return to 2019 trading levels, paired with a substantial improvement in profitability. I don’t think HSS is out of the woods entirely, but I’m very encouraged by performance last year. I can see some potential value here.

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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:

Sanderson Design (LON:SDG)  (I hold)

156p (down 5% at 08:17)

Market cap £110m

Full Year Results

Sanderson Design Group PLC (AIM: SDG), the luxury interior design and furnishings group, announces its audited financial results for the year ended 31 January 2022.

A year of strong trading, cash generation and strategic progress

The numbers for FY 1/2022 look good, so I’m not sure why the share price has slipped 5% in early (little volume) trades.

Revenues £112.2m, a whisker ahead of forecast (I’m using a Progressive note from Jan 2022). That’s a big improvement (up 19.6%) on FY 1/2021, and is slightly ahead of the pre-pandemic year FY 1/2020.

Adj “underlying” EPS is:

FY 1/2022: 13.75p (up 74% on LY, and up 47% on pre-pandemic)

FY 1/2021: 7.89p (pandemic year)

FY 1/2020: 9.35p (pre-pandemic year)

As you can see, EPS is now well ahead of pre-pandemic, reflecting an impressive turnaround under CEO Lisa Montague.

Adjustments - there’s a significant boost to earnings from the adjustments each year, so I’ve taken a look (excerpt from note 7b below).

I don’t think we should be ignoring the charges for LTIPs (options for mgt), nor the pension scheme charge, as these are likely to be ongoing costs. So I’ve highlighted the £11,566k profit figure that I’m more comfortable with. This is about 7% lower than the adjusted underlying PBT, so I’ll make a similar adjustment to EPS, lowering it from 13.75p to 12.8p for valuation purposes, which is a bit more conservative. That gives a PER of just 12.2. The PER is 11.3, if you use the company’s adjusted EPS.

Why so low? The market has clearly priced this share for a deterioration in trade in future. I’m not sure that’s justified, as these are high end products, unlikely to be sold to people who are worrying about household bills.

Or, the share price could just be irrational, as many seem to be at the moment, driven more by sentiment than fundamentals. Time will tell.

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Licensing is worth a mention, because it’s a lucrative part of SDG’s business. We’ve got the hidden value of all those massive back catalogues of e.g. William Morris designs. Licensing income recovered almost to pre-pandemic levels, at £5.2m - other companies pay a fee to use SDG’s designs, so this is very nice quality income, being largely profit.

For some examples of Sanderson bedding products, here’s a link to licensing partner Bedeck. The prices are surprisingly normal. I recently bought a Sanderson duvet set in TK Maxx, and am pleased with it - nice quality.

Browsing through products on SDG’s own websites, the wallpaper & fabrics look very expensive to me. So these are luxury products.

It’s also worth noting that SDG has said before that the long-running fashion for minimalism in interior design has changed, and it even used the phrase “maximalism” - i.e. that quite fussy, multi-coloured patterns are back again - which is a nice tailwind for SDG, because that’s what they focus on.

Dividends are back - a 2.75p final, making 3.5p for the year, a yield of about 2.2%. Doesn’t sound madly exciting, but I think we can expect that to rise - the company has much greater dividend paying capacity, which interests me more than the actual payout right now. These are the first meaningful divis for several years, because remember that SDG ran into problems before the pandemic, so needed a good sort out, which Lisa Montague has done.

Providing nothing goes wrong, we should expect a steadily rising divi in the coming years.

Current trading - sounds fine -

Trading in the first three months of the current financial year has performed in line with our expectations, with continued demand for manufacturing and strong brand sales, particularly Morris & Co. and Sanderson. Licence income has also performed strongly. As we carefully navigate another potentially challenging year, the Board remains confident in its strategy and the results that are being delivered."...

We are mindful of the cost, supply chain and geo-political issues that impact consumer confidence, along with specific inflationary pressures in our home market. We are monitoring costs closely and passing on price rises where appropriate. We suspended all trade with Russia on 24 February 2022, a distributor-based region that represented only around 2% of global sales for FY2022.

Balance sheet - is superb, very strong. For example, NTAV is £52.7m, nearly half the market cap. The current ratio is 2.69 - excellent (for this type of business, I was say anything over 1.5 is healthy). That includes £19.1m in net cash. Inventories & receivables look fine, and under control.

Note the pension deficit has disappeared, and is now showing a small surplus. Although the cashflow statement shows that £2.2m cash is being paid this year & last year. A new actuarial calculation is pending.

Cashflow statement - looks fine, nothing untoward in there.

My opinion - very positive. I think this is a well-managed group, performing well, with a superb balance sheet. The shares strike me as irrationally cheap, and I don’t see this company being particularly vulnerable to inflation or a consumer downturn, because it’s targeting more up-market customers who I reckon are less likely to be impacted by a squeeze on disposable incomes.

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My notes from analysts webinar

(not comprehensive, I only jotted down some key points)

Manufacturing division had "stellar" year - benefiting from Brexit, and customers want to on-shore production to UK.

Reduction in stock lines (SKUs) from 20k to 12k has been achieved ahead of plan, over the last 2 years.

Free cashflow less than last year, due to catching up with (agreed) tax arrears from pandemic.

Future capex will rise to £7-8m p.a. as production capacity increased, especially digital printing, which is highly efficient - production can run 24/7, with "minimal" staffing overnight.

Gross margins (very high at 68%) are being protected by passing on price rises to customers "as appropriate".  Historically, prices rose 3-5% each year on 1 Feb. This year prices went up 9%.  Some competitors are raising prices more than this.

Now looking to implement price rises twice per year, to avoid shocking the market with big increases.

Supply problems of key raw materials have emerged, but have been "expertly managed", with no impact on production to date.

Contract jobs (e.g. for hotels, hospitality, ships) not recovering yet, but signs of life in USA. Not expecting much to change this year, but provides future upside.

NEXT collaboration has been excellent.

Electric & gas costs mostly hedged for this year, and gas into 2023. So reasonably covered.

Overall - very impressive I think. We don't need to worry about inflation, as the company has pricing power, and is passing on price rises. It seems to me that with the expansion planned, this share should deliver earnings growth in the coming years. I need to buy more when funds permit. 

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Roland’s Section:

Smoove (LON:SMV)

Share price: 76p (+5% at 08.20)

Shares in issue: 64.9m

Market cap: £49m

Full-year trading update

“Growth in revenue and volumes”

Smoove is the online conveyancing business formerly known as ULS Technology. The group’s main product is eConveyancer, which allows mortgage brokers to find a guaranteed quote from a conveyancer. This service is especially popular with remortgaging cases.

We last covered this business in the SCVR in December, when I looked at ULS’s half-year results and took a cautiously optimistic view on this loss-making technology business.

Today’s full-year trading update gives us a chance to see what’s changed since then.

Financial highlights: Today’s update covers the year to 31 March 2022. So the comparative period was quite heavily affected by pandemic restrictions.

• Revenue up c.12% to c.£19m (2021: £17m)
• Year-end cash balance c.£20m (2021: £24m), no debt
• Conveyancing completions rose by 10% to 37,009
• Conveyancing instructions rose by 22% to 67,156

These numbers don’t seem all that strong to me. Revenue during H1 FY22 was £10.2m, so we can deduce that H2 revenue was just under £9m. This is actually a reduction on FY21, when the company generated £10m of H2 revenue (01/10/20 - 31/03/21).

As far as I can see, Smoove’s growth seems to have slowed over the last six months, perhaps reflecting the end of the Stamp Duty holiday and calmer conditions in the market.

However, as a growth business I’d want to see Smoove taking market share - i.e. growing ahead of the wider market. I’m not convinced these numbers show that, although we’ll have to wait for the FY results to be sure.

Fortunately, there doesn’t seem to be any risk of shareholder dilution. Last year’s implied cash burn of £4m should mean that the company has several years of runway left before it needs to raise funds.

Operational progress: The group is continuing to make progress, but again, I’m not that impressed by the rate of growth.

• Number of active brokers rose by 10% to 2,207
• Agreement to provide additional services to Lloyds relating to remortgaging
• “Several significant contractual wins”, including an exclusive partnership with website Moneyfacts
• 75,000 DigitalMove cases completed (2021: 40,000) - again, this growth doesn’t seem that strong to me, considering the impact of the original lockdown in April-June 2020
• Launch of digital estate agency product, Smoove Start
• Technology upgrades and new hires
• Acquisition of small law firm to use as live test bed

Outlook: Smoove says that it continues to see strong demand for its core eConveyancer brand and has added new partners to the platform. Over the coming months, the Smoove Start estate agency rollout will continue.

No detail is provided on trading so far in the new financial year.

My view: I’m a little disappointed by the rate of growth suggested by today’s numbers. Housing market activity has been frenetic over the last year and the pandemic accelerated the digitalisation of many financial and consumer services. I’d expect that Smoove might have profited from this trend more than it appears to have done.

The balance sheet seems bulletproof, with £20m of net cash. But today’s market cap of £49m values the business at 2.6 times sales. That seems ample to me. I’m not yet convinced of the investment case here.

Note: I think it’s worth pointing out that the broker forecast shown for Smoove in Stockopedia appears to be outdated, presumably from before the divestment of former subsidiary CAL. I don’t expect Smoove to report a profit this year, but I haven’t been able to find updated forecasts anywhere.

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Hss Hire (LON:HSS)

Share price: 16.8p (+4% at 08.20)

Shares in issue: 705m

Market cap: £120m

Preliminary results

“New operating model driving improved profitability”

Equipment hire group HSS Hire was floated in 2015 with a debt-laden balance sheet that made its survival a challenge. However, the group has refinanced over the last 18 months and continued its shift towards a more capital-light business model.

Today’s full-year results are ahead of broker forecasts on Stockopedia and suggest a potentially attractive level of profitability to me.

HSS shares have been a catastrophic investment to date, but I wonder if this business has now reached a turning point. The StockRank has also risen sharply recently.

Financial highlights: Today’s results cover the year ended 1 January 2022.

• Revenue +21% to £303.3m
• Operating profit of £34.5m (FY20: loss of £4,671m)
• Net profit from continuing operations: £7.3m (FY20: loss of £29.7m)
• Adjusted earnings per share: 1.5p (FY20: loss of 4.6p)
• Net debt: £104.6m (FY20: £194.6m)
• Leverage: 1.5x EBITDA (FY20: 2.8x)

There are several moving parts behind these numbers. HSS sold its Laois Hire Services and All Seasons Hire businesses last year for total proceeds of £64.3m. The group also refinanced its banking facilities, reducing the ongoing interest charge from £16.3m in FY20 to £3m.

These changes followed a highly dilutive £54m equity placing in October 2020.

On a like-for-like basis, HSS says today’s results show revenue growth of 20%, with sales back at 2019 levels.

Operational highlights: The improvement in HSS’s profitability suggests to me that CEO Steve Ashmore’s decision to focus on cutting the group’s capital intensity is delivering results.

HSS has scaled back its dedicated branch network and expanded its presence in builders merchants – much cheaper. The group has also moved a lot of customer interactions online. HSS says that its HSS Pro digital platform now handles 60% of transactions.

The group now claims to have a differentiated, technology-led proposition that sets it apart from rivals in the B2B tool hire market.

Profitability: There has certainly been a big improvement in profitability. Today’s results show an operating margin of 11% and return on capital employed of 11%, according to my sums.

HSS favours an adjusted ROCE metric which the company says shows a 22% return on capital.

Balance sheet: HSS’s biggest problem in the past was a near-impossible debt burden. That’s now improved and the company says that net debt leverage has been reduced to 1.5x EBITDA, from 2.8x at the end of last year.

That’s obviously a big improvement, but this still isn’t the strongest balance sheet I’ve ever seen.

Stripping out £148m of intangible assets from the balance sheet leaves HSS with net tangible assets of just £14m. Much of the company’s property, vehicle fleet and hire equipment is leased, rather than owned, hence the lack of asset backing.

I don’t see this situation as a pressing concern right now, but if I was a shareholder I would hope to see leverage reduced still further over the coming year.

Cash flow: Fortunately the group’s cash generation seems fairly robust.

I estimate that last year’s after-tax profit of £7.3m (continuing ops.) was converted into underlying free cash flow of £14m. Although this benefited from some favourable working capital movements, I expect the group to remain cash generative this year.

Outlook/current trading: HSS says Q1 revenue has risen by 13% and that EBITDA/EBITA has been in line with management expectations.

Full-year EBITA (operating profit excluding amortisation) is also expected to be in line with management expectations.

Capex is expected to rise this year as technology investment continues, but I think much of this increase should be offset by lower interest costs following November’s refinancing.

The impact of current supply chain disruption and the war in Ukraine is said to be limited. Cost inflation is being passed on through price increases.

HSS is targeting rental revenue growth in line with the market this year, with service revenue growth 10% ahead of the market.

My view: The combination of disposals, an equity raise and debt refinancing appear to have released HSS from the zombie state in which it spent many years.

The group’s balance sheet is still not the strongest I’ve seen, but I think the situation looks safe enough for now.

The main risk I can see on a short-term view is that a UK economic slowdown could have a knock-on effect on demand for HSS’s equipment and services.

Today’s results price the stock at 16 times trailing earnings. Looking ahead, broker forecasts appear to be suggesting earnings of 2.4p per share for 2022. That would leave the stock trading on just seven times earnings – potentially an attractive price, I think.

I’ve not been able to find an updated broker note on Research Tree, so I would treat this 2022 estimate with caution until updated consensus numbers appear. But I think it’s fair to say that HSS looks more attractive than it ever has done before as a listed business.

I’ll be interested to see how this situation evolves over the year ahead.