Small Cap Value Report (Thu 30 April 2020) - SHOE, NANO, UPGS, CNKS

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

Estimated timings - I'm running late today, so will keep going until about 6pm. Apologies for any inconvenience. Edit at 20:05 - I'm wondering why I put in estimates for timings. Anyway, today's report is now finished.

De-listing risk

In the small caps world, we always have to be wary of the smallest companies, as they sometimes (often without warning) announce their intention to leave the stock market and become private companies (known as de-listing).

This usually does instant, and major (typically about -50%) damage to the share price. For this reason, it's vital to avoid buying micro/small cap shares where there's a risk of de-listing.

Off the top of my head, these are the main reasons (hence risk) of a micro cap de-listing;

• Running out of cash, and no appetite from the market to provide fresh equity funding
• Story stock that has gone stale - i.e. everyone's heard the story, and it's never worked, so impossible to get even gullible investors to back it again
• Little to no liquidity in the shares - hence there's no point in being listed
• Costs - often linked with the other points above - all the various costs of a listing can mount up to £100-200k, even for the smallest companies - e.g. broker/NOMAD, listing fees, PR, NEDs that probably wouldn't be employed at a private company, regulatory burden, wasted mgt time, etc. If there is no discernible benefit from being listed, then why continue with it?

It's worth checking our existing holdings, to see if any micro cap holdings display those traits. Covid-19 & the recession it's triggering, could well accelerate the de-listings of some micro caps. Hence why I mention it - this is an increased risk that could us money.

Getting rid of bad investments

It's tempting to allow bad investments to languish at the bottom of our broking account. I had one situation like that this week, Malvern International (LON:MLVN) which issued an update that sounds terminal. Without refinancing, it says cash will run out in May, i.e. imminently. I had previously bought quite a lot in a 4p placing during the bull market, but the turnaround plan didn't work. Thankfully I got much of my cost price back, by top-slicing when it initially rose to about 7p. However, the rest are now almost worthless compared with what I paid. It looks like Covid-19 could finish off the company. I had about 1m shares left, and had mentally written them off. Anyone refinancing the company probably wouldn't want their money wasted on listing costs.

Then yesterday, I worked out that even at a share price of barely over nil, my shares could still be sold for about £500 before commission. I thought to myself, that I wouldn't toss away £500 if it was cash, sitting in front of me! So why throw away £500-worth of shares, to a very likely £0 outcome? Or a refinancing that dilutes existing shareholders so much that my £500 became say £50, or £5? Therefore, after pondering this, I bit the bullet, and instructed my 2 brokers to both sell "at best" (i.e. for any price you can get), which recouped at least c.£500 from this failed investment.

The chances of such investments (a basket case) ever recovering, are minimal, therefore clinging on in the hope that it might recover, is nearly always the wrong strategy. It's actually stubbornness that stops us selling, not any real belief that the share would recover.

I can also recommend the therapeutic benefit of a horrible loss disappearing forever from the portfolio statement I see every day.

Shoe Zone (LON:SHOE)

Share price: 90p (down 1% today)
No. shares: 50.0m
Market cap: £45.0m

Result of GM and interim update

This is a chain of shoe shops, selling cheap, Chinese-made shoes on the High Street and from retail park "big box" stores - which are obviously all closed at the moment, due to lockdown restrictions.

My report here on 3 April 2020 reviewed the situation - with SHOE saying it had to cancel its proposed dividend, and secure a new bank loan, in order to survive (that's how I read it anyway). As mentioned at the time, I was tempted to buy some at 60p, but decided that risk:reward wasn't quite right for me personally. The share price has since risen 50% to 90p - which is fine, it has rewarded people who took the risk when things were uncertain. I don't regret not buying it, because I've had similar 50% gains over the same period, from other shares where there was probably less risk. It's remarkable how many share price charts look the same right now. So big winners in the last month have not really been down to good stock picking, it's more a general market move up. Which could easily reverse, so congratulations are premature.

Yesterday's update - contains good news. The special resolution to cancel the unaffordable final dividend, passed almost unanimously. Some idiot with 25,891 shares voted against, but 99.94% of shares voted in favour. This outcome was never really in doubt, but it's good to have confirmation.

The company has a FY 09/2020 year end, so details of the first 6 months are given. Since Covid-19 and store closures kicked it right at the end of H1, then the H1 figures are now irrelevant.

Liquidity - this is the all-important question of whether SHOE will survive?

As at close of business on 28 April 2020, the Company has a net cash balance of approximately £5.4m, having utilised the existing £3.0m bank facility.

That seems to be saying that it has £8.4m in cash on hand, and £3.0m bank debt.

A new bank/Govt loan has been agreed -

This morning, the Company received formal notice that its application for a £15.0m loan utilising the Coronavirus Large Business Interruption Loan Scheme, has received credit committee approval from its primary lender, Natwest. Shoe Zone welcomes this support from Natwest and the Government, however there is significantly more to be done to protect the Company's financial position.

The last line worries me. Surely £8.4m cash on hand, plus a new £15m loan should be ample to protect the company? If not, why not?

It does go on to reassure with this comment -

...the Board consider the Company's current level of funding will be sufficient to secure the future of the business, assuming that stores are allowed to open gradually during the summer months and return to a high proportion of previous sales over the next year.

That seems consistent with what we're seeing in other countries - i.e. shops starting to be allowed to re-open, subject to social distancing, mask wearing, etc. The question is whether it is worth retailers opening stores if they're only likely to achieve modest revenues? I think we might see retailers cherry-pick, and only re-open their most profitable sites. Many others, in loss-making or marginal sites, probably won't re-open whilst restrictions on footfall remain.

Dividends - always the main attraction of this share, are now off the table for some time, by the looks of it. Very sensibly, the company wants to not only re-build, but increase its future cash position -

Over the forthcoming financial periods, Shoe Zone will focus on rebuilding cash balances to a higher level than previously carried, repaying debt, and fulfilling other statutory obligations. The Board believes that this focus is necessary to ensure the long term viability of the business, and the Company will therefore only recommence the payment of dividends to shareholders once these objectives have been met.

The Group therefore cancels its previously announced dividend policy and a new policy will be announced when the board believes the Company is able to resume making dividend payments to shareholders.

This is of wider read-across. We now know that many companies were running far too lean on cash reserves (something I've been going on about for many years!). The risk from a virus, leading to shutdown, was out there, but ignored by practically everyone. Things have now changed, and companies generally will need to bolster their balance sheets, and have higher cash reserves, and lower debt.

For this reason previously high yielding shares such as SHOE may not pay any divis for several years to come - making things much harder for income-seeking investors, such as the retired.

My opinion - the company's survival now seems secure. However, with no divis likely for several years, I don't see any attraction to this share right now. It's rallied nicely from the lows, and is probably high enough for now, in my opinion.

Looking at the long-term chart, and given the uncertainty surrounding High Street retailing (will it ever get back to how it was, and it's been in long-term decline for years, even before Covid-19), then I wonder how much upside there is now on this share? 50% perhaps, over several years, if we're lucky? Also, I wonder if income-seeking investors may decide to bail out, which could create an overhang of sellers in future, perhaps? I just don't see enough upside potential in this share right now, to get excited about.

.

Nanoco (LON:NANO)

Share price: 10p
No. shares: 286.2m
Market cap: £28.6m

(I currently hold a long position)

Termination of formal sale process

No offers have been forthcoming from interested parties. Onset of Covid-19 disruption means no attractive outcome likely, so talks have been terminated.

Patent infringement lawsuit against Samsung - in "advanced stages" of securing third-party funding to progress the case.

Commercial progress - no figures given, so not able to ascertain if this is significant or not -

Nanoco also continues to explore commercial opportunities, with purchase orders having been placed for existing and new materials for sensing applications and a new joint development for R&D services being currently documented with an existing customer.

Covid-19 & liquidity -

...management has taken action to reduce costs and maximise its cash resources while preserving its production and R&D capabilities. The Group's cash runway now extends to the second quarter of 2021.

The Board continues to review all the strategic options available to the Company, including possible sources of additional funding for the Company, with contingency plans in place if needed.

Given that we already knew the company is in poor shape financially, then having enough cash until Q2 2021 (subject to commercial agreements being signed) seems OK for now. That's an improvement from previous position of cash running out in July 2020.

Interim results - a second announcement.

First, I've refreshed my memory by re-reading a section I wrote about NANO here on 4 Mar 2020, where I concluded that it looks high risk, but possibly worth a fun money punt. I can't remember buying any, nor why, but as disclosed in the section header above, there's a small NANO long position in my spread betting account.

Nanoco Group plc (LSE: NANO), a world leader in the development and manufacture of cadmium-free quantum dots and other specific nanomaterials emanating from its technology platform, announces unaudited Interim Results for the half year ended 31 January 2020 ("the Period" or "H1 FY20").

As with most companies, at the moment the historic results are only of passing interest. It's what happens in this new, Covid-19 world, that matters in two ways - 1) will a company survive, and 2) will it be able to achieve commercial success at all, or again? All the evidence suggests that economic recovery from Covid-19 could take several years. This is what many CEOs are saying, when interviewed in the USA on CNBC.

With NANO, it looks much more specific: it has to win new business. In the past, it apparently only had one specific customer, in the USA. This is obviously therefore a special situation. If it wins the Samsung legal case, then that could provide upside, although I don't know what the size of the claim is - do any readers know?

For the record, 2019 looked like this:

• Revenues £2.9m
• LBITDA -£1.1m
• Cash £4.2m
• Loss after tax is -£1.9m (it looks as if NANO gets R&D tax credits, hence the after tax result is the most relevant)

Going concern - as you would expect, given that this is a special situation, the risk of insolvency is highlighted in a going concern note -

However, given that a degree of uncertainty exists in respect of future revenue and management's ability to implement the necessary cost savings in a timely fashion, there exists a material uncertainty in relation to the going concern basis adopted in the preparation of the financial statements.

Clearly then, this is not a share for widows or orphans.

My opinion - this is just a complete punt. Must admit, I'm wondering why it's valued at £28.6m, which seems quite high for a company that's not far away from the last chance saloon. But the technology does look interesting, and has generated some (albeit small & lumpy) sales. There could be speculative upside from a no-win-no-fee case against Samsung too.

Overall, I can't assess what the most likely outcome could be, hence it's just a total punt for me. I should probably sell them actually, but today's news (in particular extending cash into 2021) gives me some comfort that it won't be a 100% loss this year, probably.

Up Global Sourcing Holdings (LON:UPGS)

Share price: 50p (down 6% today)
No. shares: 82.2m
Market cap: £41.1m

Interim results

Ultimate Products, the owner, manager, designer and developer of an extensive range of value-focused consumer goods brands, announces its interim results for the six months ended 31 January 2020.

This company sources product from China, to sell to UK & European retailers.

I published an audio interview here with its Managing Director, Andy Gossage, on 20 Feb 2020. At that point Covid-19 was only a problem in China, and our main concern was China supply chains. Obviously everything has since changed, with 90% of UPGS's China suppliers now back to normal output, but demand now being the big issue, from UK/Europe retailers, many of whose shops are currently closed. However, UPGS also sells to supermarkets, and online, which have remained open.

Another worry, is whether customers are paying up for previous deliveries? There must be some withholding payment until they can re-open and get some revenues coming in again.

Incidentally, my occasional interviews are for our general interest, are not recommendations, and are independent because I don't charge companies anything - I just wouldn't feel comfortable charging anyone a fee. Have done so in the past, but it didn't work for me.

H1 results to 31 Jan 2020 clearly only tell us how the business was peforming before Covid-19 had an impact. The answer is, that it was trading fairly well -

H1 revenues up 2.8% to £67.7m

Underlying PBT up 4.8% to £6.2m - note the decent profit margin of 9.2% - which is around the level I like - a c.10% margin tells me the business is doing something well, but not so profitably that it's likely to attract competition or repel existing customers.

Covid-19 impact & outlook - this is the bit that matters, and UPGS confirms that it has been hit by a reduction in demand -

...the Group has seen customers defer and cancel existing orders and delay placing new orders since the lockdown started.

That's very obvious, so no surprises there. More detail is given further down today's statement -

We are continuing to make sales via online and to retailers that remain open, albeit at a reduced level. Total invoiced revenue for FY 20 as at Friday 24^th April 2020 was £85.9 m (FY 19: £90.6 m) and there was an order book for the remainder of FY 20 of £18.1 m (FY 19: £27.0 m), although further deferrals and cancellations remain a risk.

Working through those numbers, H1 revenues of £67.7m, and YTD revs of £85.9m, means that H2 to date (Feb,Mar, and up to 24 Apr) was £18.2m,

The same figures for LY are: H1 £65.8m, YTD £90.6m, giving H2 to date LY of £24.8m. That's down 27%, but includes Feb and about half of March, which was before lockdown was imposed. Therefore, clearly the run rate in April must be far worse than -27%.

How might this impact the H2 results in due course? I reckon H2 revenues could be half H1, which would reduce gross profit from £16m to £8m (NB. See "EDIT" section further down, as this looks too optimistic!).

The big advantage UPGS has, is that operational gearing isn't such a problem, because it is selling on low gross margins (only 23.6% in H1). Therefore even if admin costs are unchanged in H2, at £9.4m, then a halving of turnover would only result in a move from an H1 profit of £6.5m, to an H2 loss of £-1.4m - not a disaster.

Actually, I might be under-stating the H2 loss, as it looks like there's some seasonality, with H1 being stronger than H2. There's an update out from Equity Development, which I've not looked at yet. I'll probably use their estimates as a base, but adjust them for myself to be more pessimistic. However, I've not taken into account cost-cutting in my figures, which goes the opposite way.

For this reason, I reckon UPGS should be able to survive this crisis. It depends how much its balance sheet is stretched by customers withholding payment? That worries me more than the downturn in sales.

Action taken -

Stopped capex (but it's light on fixed assets anyway, so probably not a big issue)

Deferring tax payments using Govt schemes

Short term tweaks to bank facilities (will this be enough, I wonder, if customers are not paying enough of the receivables?) -

Further to the renewal of bank facilities on 1 October 2019 with HSBC (see below), the Group has received credit approval for a £4.0 m increase in its RCF facility, amortising over the period to 31 January 2021. In addition, the Group has already effected an increase in the percentage of receivables advanced via the invoice discounting facility and an extension of the funding period of its import loan facility with HSBC from 120 days to 180 days.

Interim divi suspended

Purchase orders reduced

Upside - possibility of acquiring new brands, at attractive prices

Some employees put into furlough, but no figures given

Director pay cuts - CEO & MD have taken 100% pay cut until things return to normal (very impressive show of commitment), other Directors taken 20% pay cut

Profit warning - as I was expecting, but I wonder why the company has left it this late (2 months) to confirm it?

Until early March, the Group was trading well and in line with expectations, despite the supply chain challenges in China. However, the prevailing issues on the demand side mean that the Board is anticipating a significant drop in revenue in H2 FY 20 compared to previous expectations which will impact the overall profitability for FY 20. The overall picture remains volatile and unpredictable making it difficult to forecast.

The share price has only moved slightly today, so clearly the market had already worked this out! You would have to be living on the moon not to have worked out that H2 is likely to be poor.

Balance sheet - looks OK to me, but the company is clearly reliant on bank support.

There's a question mark over receivables - these could take longer to collect, and there might be some write-offs for customers who go bust.

My opinion - I don't see any immediate risk of insolvency, but I can foresee working capital getting tight.

It all depends on when lockdown is eased, and how much customers order & pay for,

For me, there's still too much uncertainty, so I'm happy to keep a watching brief on this one. Hence I'm neutral on this share for the time being, and the price looks about right given the current state of play.

EDIT: I've now had a look at the latest ED note, and they're even more cautious than me. Their updated figures for FY are;

Forecast revenue: £93.0m - this implies £67.7m H1 (actual), £25.3m H2 (forecast) - a huge fall in H2 of 56% vs prior year.

Forecast adj PBT: £3.6m. Given that it made £6.2m profit in H1, this implies a £-2.6m loss in H2 - not good, but not disastrous either.

End of edit

Cenkos Securities (LON:CNKS)

Share price: 49p (up 2% today)
No. shares: 56.7m
Market cap: £27.8m

2019 Results

Cenkos Securities plc (the "Company" or "Cenkos" or the "Firm") today announces its results for the year ended 31 December 2019. Cenkos is an independent, specialist institutional securities group, focused on small and mid-cap companies and investment funds. The Group's principal activity is institutional stockbroking.

Here are the key financial highlights, as chosen by the company. For me the stand-out features are that despite a big fall in revenues (expected), it still managed to breakeven, not make a loss. I think a lot of that is down to flexible costs - i.e. staff get big bonuses in good years, but nothing in bad years. Also noteworthy is the 1.0p divi proposed - giving 3.0p in total - very significant for a 49p share, and at a time when many companies are pulling their divis due to Covid-19 uncertainty.

.

.

Another remarkable figure for a 49p share is this;

Since being admitted to trading on AIM in 2006, the Company has returned £114.1 million of cash to shareholders, equivalent to 176.3p per share, before the payment of the proposed 2019 final dividend of 1.0p per share.

Although a lot of that was down to a highly lucrative relationship with Neil Woodford, when he was flying high. Apparently, to get a big IPO away, signing up Woodford would then pretty much guarantee other fund managers would follow suit. That made bumper fees for Cenkos, which may never be repeated.

Management changes at Cenkos, could mean it has another period of success, who knows? Also bear in mind that huge numbers of listed companies are & will need to repair their balance sheets with equity fundraises. Not as lucrative as big IPOs, but still decent fees to be earned. I note that Peel Hunt & Liberum seem to be doing plenty of business in equity fundraisings right now.

Outlook comments are upbeat -

The outlook for 2020 is clouded by the, as yet unknown, economic impact of COVID-19. I am however, pleased to report that we have started the year well, completing the largest IPO on AIM so far this year and despite unprecedented market circumstances have also executed a number of secondary fund raisings.

We are continuing to work closely with our corporate clients to assess the impact of COVID-19 and the disruption that many of them are currently experiencing. We have a good pipeline, a cost base that is significantly below the 2019 level and a strong balance sheet, so I look forward to 2020 with tempered optimism. We are well placed to face the challenges ahead."

.

Balance sheet - bear in mind that the market cap is only £27.8m, you're pretty much getting the business for free. That's because net current assets (working capital), including £18.3m cash are £24.3m, or 87% of the market cap. I find that remarkable.

Note that a new, £5.2m longer term liability has appeared. This must be linked to the £4.5m right-of-use asset that has also popped up this year. Therefore these are IFRS16 figures, which I tend to look at with interest, and then cross out. Although in this sector IFRS 16 disclosures are more useful, because brokers may not need glitzy city offices in future, given how well things have continued in the mainly work at home situation currently.

City offices - talking to my friends who work in the City normally, I'm detecting a subtle change. Initially they loved working from home, seeing more of their kids, avoiding the hassle & wasted time of commuting, having to wear ironed shirts and trousers, shaving, etc. Now they're mainly telling me that the novelty is wearing off, and they're itching to get back into their City offices, not every day, but for 2-4 days per week. Providing the bars & restaurants are open, and it's safe to mingle again. Which sooner or later, it will be of course.

My opinion - I'm warming to the idea of buying back into Cenkos - I've held it before, for a recovery in share price that never really happened, although some nice divis popped into my accounts while I waited.

Many companies will need to raise fresh equity. Therefore fees are rolling in for brokers.

My main problem, is I don't trust this recent market bounce from the lows in March. So Cenkos remains on my watch list.

All done for today. As usual, apologies for the painful slowness of today's report. See you tomorrow.

Best wishes, Paul.