Small Cap Value Report (Thu 29 April 2021) - CCT, ITS, XSG, PHD, STVG

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

Timing - TBC

Agenda -

Paul:

In Style (LON:ITS) - trading update for FY 03/2021 which is very light on numbers, and vague re profits. I'm sceptical.

Xeros Technology (LON:XSG) - pitiful 2020 results from this serial disappointer & big cash burner. More jam tomorrow is promised for 2021, with licensee products about to launch. So fingers crossed it might finally succeed, after 7 years of failure on AIM. Has enough cash to end 2022, after another placing in March 2021.

Proactis Holdings (LON:PHD) - a quick look at interims from this software company. Signs of improvement, but the big issue is the awful balance sheet. Management hint at a fundraising. I'm steering clear until the debt is reduced through a placing.

Jack:

Character (LON:CCT) - strong recovery from the Peppa Pig and Goo Jit Zu toymaker, with FY underlying profit before tax expected to be materially ahead of £10.5m market consensus.

Stv (LON:STVG) - advertising recovery 'ahead of expectations' & advertising revenue for 5m to be 'broadly' in line with 2019 levels. Interesting market position as one of Scotland's biggest free-to-air TV channels, but viewer habits are evolving and the group has struggled to generate meaningful top line growth over the years.

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Paul’s Section

In Style (LON:ITS)

259p (up 4%, at 08:36) - mkt cap £136m

29 April 2021 - In The Style, the fast-growing e-commerce womenswear fashion brand with an innovative influencer collaboration model, is pleased to announce an update on trading for the 12 months to 31 March 2021 (the "Period") following its successful Admission to the London Stock Exchange's AIM on 15 March 2021.

This is laughably called a trading update but it’s more of a PR release, cherry-picking some positives, and not telling us anything specific about profitability.

Strong momentum and strategic progress continued since IPO to deliver very strong FY21 performance

What does “very strong performance” mean? With no numbers on any profit measure provided, then we’re in the dark. What one person might consider very strong, someone else might be disappointed with.

I had a quick look through the AIM Admission Document and reported here on 15 March 2021. My take on things was sceptical, since ITS had previously been loss-making every year, and in my view too small to compete effectively with the Boohoo (LON:BOO) (I hold) multi-brand behemoth, plus other much larger competitors such as MissGuided (also rumoured to be preparing a float).

ITS admission document showed that it had performed exceptionally well in the 9 months to 31 Dec 2020, generating £35.4m revenues and a maiden profit of £2.0m for that 9 month period - benefiting from lockdowns of course, and also I reckon probably a big boost from a TV documentary profiling the company, called “Breaking Fashion”, which was highly entertaining, and showed the fast-moving chaos and competing egos which are so typical of this sector, as I know only too well!

A similar TV documentary on MissGuided provided a major boost to sales, hence why I think the same may be true of ITS. That’s a big risk factor, as it could mean that the boost was a one-off, and could prove to be unsustainable growth. Hence why I’m sceptical. That hunch is reinforced because the company took advantage of this bumper period of trading to do a well-timed IPO which involved mainly (£49m out of £60m IPO proceeds) going to a selling shareholder. £11m was raised for the company, which had never previously generated any meaningful cashflow itself.

This is such a crowded space, it’s very tough for smaller companies to compete - they can’t afford the best social media influencers, or the big marketing spend. No barriers to entry, but huge barriers to achieving scale, in online fashion.

Also, how will ITS hang on to the best staff, when there are far better financed competitors on its doorstep, who can poach the best people with remuneration that ITS would struggle to match? Staff loyalty only goes so far.

Going back to the trading update -

Strong sales momentum ahead of prior expectations since the Group's Admission to AIM…

Turnover for the Period, subject to audit, expected to be no lower than £44.5m, an increase of more than 130% from the prior year (FY20: £19.3m)

I don’t know what those expectations were.

Digging deeper, deducting £44.5m turnover for FY 03/2021 from the £35.4m reported in the admission document for the 9 months to 31 Dec 2020, gives £9.1m turnover for Q4. That’s down from the £11.8m average sales in the quarters 1-3. This was a period when physical shops were closed, in lockdown 3, so it doesn’t strike me as a particularly strong Q4, although Jan-Mar is the quietest quarter of the year in fashion retailing, and there were no events to go to, plus the weather was cold & miserable for most of that time this year.

Overall then, despite the big PR effort to talk things up, I’m not particularly impressed with this update.

Various other points are mentioned, the one that stands out to me is the dramatic move to customers using its App - up from 19% last year, to 55% this year. Suggesting that fast fashion customers are browsing & buying on the move, anywhere, and at any time.

Cash (net? we’re not told) is £11.9m at 03/2021. It raised £11m before fees in the recent IPO, so not much difference there. In my view, ITS is way too small to be generating any meaningful cash for some time, if ever.

The lovely Stacey Solomon (here are her best bits, including unfeasibly bright, bleached teeth, possibly visible from space!), and ASDA, are the latest influencer & commercial tie-ups. I think this helps demonstrate how ITS goes for a softer, less edgy (I was going to say “tarty” but might have got into trouble for using that word, not sure?) type of product & customer, than the BOO brands & Missguided. So maybe there is a niche for ITS?

Furlough monies repaid to the Govt - well done!

Outlook - vague -

"We look forward to building on this momentum into FY22 to deliver our growth plans and create further value to all stakeholders"

My opinion - a poor update, with lots of positive talk, but hardly any specifics. The market expects better than this. The company needs to grow up, and look to the gold standard of reporting from Next (LON:NXT) - that’s what it should be emulating, not buffed-up PR releases. The risk is that they’ll talk up the share price to unrealistic highs, suck in gullible investors, and then see the price crash if they disappoint. That’s not the right way to do it. Companies should under-promise, and out-perform, giving realistic guidance. That’s the way to build trust with investors.

I remain sceptical about InTheStyle. There has only been one decent year in the company’s history, so I’m waiting to see if it can build a sustainable track record. The upside case is that, if this becomes another Boohoo (LON:BOO) (I hold) or Asos (LON:ASC) (I hold) then it could be a 50-bagger from here. What’s the likelihood of that actually happening though? Pretty slim, I would say, and it would take a long time to grow from £44m turnover, to >£1bn.

I’ll keep a watching brief on it, but at the moment, am not tempted.

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Xeros Technology (LON:XSG)

275p (down 1% at 11:28) - mkt cap £65m

Audited results for 2020

Xeros Technology Group plc (AIM: XSG, 'the Group', 'Xeros'), the developer and licensor of platform technologies which transform the sustainability and economics of clothing and fabrics during their lifetime, today publishes its audited results for the 12 months ended 31 December 2020...

major licensing progress...

There’s no sign of any progress at all in the actual numbers.

Xeros has been promising jam tomorrow since it floated on AIM in March 2014. The original business model of burning through large amounts of cash & trying to manufacture these low water washing machines (that use polymer beads I understand) didn’t work, so they pivoted to a licensing model.

Revenues for 2020: a paltry £0.4m!

Post-tax earnings: loss of £(7.0)m, down from £(20.6)m in 2019, includes the benefit of a £0.7m negative tax charge

Placing of £9.0m done recently March 2021, so post year end cash position looks OK for now -

As of 31st March 2021, the Group held cash of £11.7m with our ongoing rate of cash expenditure fully reflective of that of the asset-light and IP-rich licensing company that we are. We believe that this level of funding is sufficient to reach month on month cash breakeven by the end of 2022, assuming current and future prospective license partners activities go to plan without further major disruption from the Covid-19 pandemic…

Cash burn run-rate down to £0.4m per month in second half of 2020.

2021 is make-or-break time, I think. It remains to be seen if these licensee product launches are going to make XSG a viable business, or not -

Multiple licensees entering/ready to enter markets with XOrb™/XDrum™ technologies….

£9.0m raised to execute current license contracts and win additional contracts in targeted geographies.

My opinion - I’ve watched Xeros disappoint time & time again since it floated in 2014. It’s also burned through a large amount of investor cash. Will it finally work, with the imminent launch of products by licensees? I’ve got no idea. If it flops again, then the company would probably be thrown out of the last chance saloon.

Why would I want to gamble on a serial failure, suddenly succeeding?

We're in a bull market though, when people like gambling on this kind of thing, but to me, the story feels very stale now. Good luck to holders though, every now and then something blue sky like this does actually work. Not often though.

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Proactis Holdings (LON:PHD)

44p (unchanged, at 12:08) - mkt cap £42m

A shrewd friend recently told me that I should have a look, with fresh eyes, at Proactis. His idea is that the client losses due to a botched takeover, have now happened, and it could return to growth.

Interim Results

I’m running out of time, so won’t regurgitate the detail here.

Interims are in line with management expectations.

There does seem to be some sign of progress, with churn rate normalising, and EBITDA up 10% to £6.2m in H1.

There’s a gulf between EBITDA and profits though, with a profit before tax of £(3.0)m loss.

Capitalised development spend in H1 was £4.2m

Balance sheet is still the deal-breaker for me, it’s just awful, when you eliminate the intangibles - heavily negative, and with far too much bank debt.

My opinion - I’ve seen enough to work out that it’s too risky for me.

I’d want to see a major sort-out of the balance sheet, through a big placing, to repair the damage from poor acquisition(s). Management says in the outlook section that it wants to “address the capital structure”, which is code for an equity fundraising, I’d say.

Might be interesting, once the necessary equity fundraising has been done, but too risky for me before.

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Jack’s section

Character Group (LON:CCT)

Share price: 485p (+2.75%)

Shares in issue: 21,379,781

Market cap: £103.7m

Character (LON:CCT) is a toy company. The Ranks have always been strong here but an obvious risk comes in the form of its toy licenses.

It does not own some of its biggest hits and shareholders were reminded of this when Hasbro announced plans to buy Entertainment One, which raised questions over Character’s ability to retain one of its most important toy licenses.

Since then, it has announced the extension of its Peppa Pig wood products licence until the end of 2023 - that’s still not a great deal of clarity but perhaps that’s just as good as it gets here. In which case that should be factored into the valuation of the company.

The shares have recovered strongly, so investors have been rewarded for keeping faith.

There were other dynamics that contributed to profit warnings back in 2019/20: the collapse of its largest Scandinavian customer, Brexit uncertainty, and a weaker sterling against the dollar were all quoted as reasons for underperformance.

My impression is that Character is well run. The managers bought shares at the time of these warnings and so presumably believed these issues would pass. But the business model will always bring risk with it and future operating volatility should be expected as the group continues to tend to its portfolio of licenses.

Half year results

The group says:

We expect the 2021 full financial year's underlying profit before tax will be materially ahead of the published market consensus of £10.5m.

First half highlights:

• Revenue +44% to £74.5m,
• Underlying operating profit +168% to £6.1m; underlying diluted EPS +140% to 22p,
• Profit before tax +245% to £7.6m, diluted EPS+235% to 28.67p,
• Dividend per share up from 2p to 6p,
• Cash and equivalents has more than doubled to £34.9m, net assets +21% to £39.6m.

There is also a £2.02m profit on sale of property (the Vernon Mill freehold, in January 2021).

This looks like a strong comeback from Character Group.

The Scandinavian business has returned to profit and the group also says it has ‘one of the strongest portfolios that it has ever taken to both domestic and international markets’ and is therefore hopeful of a strong second half into the all-important Christmas period later in 2021.

Character's top brands have all shown significant sales growth. These include Goo Jit Zu (now the group's number one brand and is ‘penetrating all major markets’ with distribution in over 40 countries to date), Peppa Pig, Pokémon, Little Live Pets, Shimmer 'n Sparkle Instaglam, Stretch Armstrong, Fireman Sam, Scooby Doo.

All of these names, according to the group, are out-performing expectations. Either the group’s current portfolio is just head and shoulders above the competition, or there may be a lockdown-related tailwind to consider. Parents and kids both at home for weeks on end… I’d be buying a few more toys to keep the peace.

You’ve got to appreciate the bizarre names often associated with Character: it has been appointed Master Toy Partner by Moonbug Entertainment for its My Magic Pet Morphle brand. If anybody knows what a Morphle is, please do enlighten us.

Aside from that, it’s business as usual with new product range launches planned throughout the summer and into the autumn in order to keep the toy portfolio fresh.

Conclusion

This isn’t the most robust business model in some senses but the UK is the fourth largest toy market in the world and Character is one of the best in its class. And it is very cash generative. The cash pile is now some 163p per share and the average shares in issue are trending down over time.

With finances like that, I would back CCT to be able to navigate future tricky periods.

I was hoping to buy some before the recovery, but I’d been waiting for evidence of buybacks at lower levels over the past year.

The group has a history of buying back stock, and it makes sense that the team would take advantage of short term weak prices to ramp up this programme a bit. That never happened and I took that as a potential sign of ongoing struggles.

It looks like that couldn’t be further from the truth. There will always be risks and volatility here but there’s a good management team that has been in place for quite some time.

The growth seen in these results is forecast to continue through to and beyond Christmas 2021 and Character is ‘on target to deliver the best performance in any calendar year in the Group's history.’

Hopefully, that performance will be further enhanced with the reopening of non-essential retail shops in the UK in the months ahead.

STV (LON:STVG)

Share price: 351.5p (+0.57%)

Shares in issue: 46,723,000

Market cap: £164m

Stv (LON:STVG) is Scotland’s leading digital media brand. Its free-to-air broadcast channel reaches 3.2 million viewers each month and is home to the likes of Coronation Street, Emmerdale, and I’m a Celebrity... Get Me Out of Here.

As with so many stocks right now, we are seeing a concerted share price recovery here.

STV is worth monitoring due to its content and market position. It’s in a privileged spot as one of Scotland’s main free-to-air channels.

There’s a brief trading update today, so worth quickly touching on.

Trading update

Advertising recovery ahead of expectations; positive future outlook

It’s a brief update so we can summarise it pretty much in its entirety:

• Advertising trends are improving and STV's January-April total advertising revenue (TAR) is +10%, ahead of previous guidance of +7-9%.
• STV-controlled advertising continues to outperform the wider market, with regional advertising revenues up 12% in the first four months of the year.
• Video on Demand advertising on the STV Player continues to see strong growth, up 26% across January-April. 8 consecutive months of growth since August 2020.
• STV's record viewing performance has continued into 2021, with TV viewing up 12% in Q1 and STV now the most watched TV channel in Scotland for the first time since 2006.
• Online viewing was up 73% in Q1 and streams up 98%, with STV Player the fastest growing broadcaster streaming service in the UK.
• In terms of the outlook, STV expects advertising revenue for the first 5 months of 2021 to be ‘broadly in line’ with the same period in 2019.
• STV will broadcast over 20 live and exclusive Euro 2020 matches featuring both Scotland and England this summer.
• STV Studios also remains on track to deliver its most successful year yet, with revenues of £20-25m already secured for 2021.

Conclusion

This looks potentially interesting, with advertising revenues expected to quickly return to 2019 levels.

Meanwhile, the group has taken share and has the most watched TV channel in Scotland, along with the fastest growing broadcaster streamer service in the UK.

After months of lockdown, I’m sure we’re all painfully aware of the rise of Netflix et al and a fundamental shift in television consumption habits. Is this a risk to the group’s older free-to-air broadcast advertising revenue model, or is it more of an opportunity for its growing streaming service?

These streaming services are a potentially attractive way to more effectively monetise old content. They do say content is king and STV Player-only content has made up 40% of all streams so far this year. STV Studios is also currently producing 15 series for 11 different networks.

There are some interesting names on the Major Shareholders list - Slater Investments for a start - and it’s (just about) got a single digit forecast PE ratio, along with a useful c3% forecast yield.

Probably worth a closer look, although STV’s position in an evolving market requires some thought, and the group has struggled to generate meaningful revenue growth for a long time.