Small Cap Value Report (Thu 5 August 2021) - SCS, TTG, BRCK

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

Today's report is now finished.

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Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover 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 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) - don't blame us if you buy something that doesn't work out. 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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Agenda -

Paul's section:

The IPO Survival Guide - in case you haven't seen it, this is a major research project, spearheaded by Keelan Cooper at Stockopedia HQ. It's fascinating stuff, and as always with Stockopedia, relies on data to arrive at important conclusions about IPOs. I won't spoil it by revealing any of the results here. You can download the eBook here. There's an introductory blog about IPOs here. Well worth checking this out. It confirms my thoughts on IPOs, which is reassuring!

Scs (LON:SCS) (I hold) - ahead of expectations trading update, for both FY 07/2021 and FY 07/2022. Tons of cash on the balance sheet. This looks far too cheap to me still.

Tt Electronics (LON:TTG) - decent interim results, I go through the numbers. Looks a good company, with a positive outlook. Valuation looks about right to me.

Brickability (LON:BRCK) - accounts for FY 03/2021 look resilient in a pandemic year. Decent margins, acceptable balance sheet, I can't see anything wrong with this. The valuation looks reasonable too.

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Paul’s Section

Scs (LON:SCS)

(I hold)

290p (yesterday’s close) - mkt cap £110m

Full Year Trading Update

ScS, one of the UK's largest retailers of upholstered furniture and floorings, today issues the following trading update for the 53 weeks ended 31 July 2021, ahead of announcing its preliminary results on 5 October 2021.

Preamble - This is one of my favourite value shares, which still looks irrationally cheap to me. As we’ve discussed here extensively before, the balance sheet is a thing of beauty, rammed with cash. Furniture retailers have favourable working capital flows, where cash from customers comes in before suppliers have to be paid, and inventories are low because most product is made to order. Receivables are also low.

Dfs Furniture (LON:DFS) demonstrates how it is possible to take advantage of this to operate with heavily negative working capital. Scs (LON:SCS) however operates with an overly prudent balance sheet, hence why I remain of the view that it’s a sitting duck for a takeover bid, because a bidder could load it up with debt, and strip out the cash pile (£91.8m at the interim results), which would largely pay for the acquisition of the company. If you don’t believe me, just compare DFS & SCS balance sheets side by side, which demonstrates the point.

The pandemic revealed to us how companies coped in extremely negative conditions. SCS showed that its very strong balance sheet provided a large margin of safety, and no equity raises were needed. Unlike DFS, which due to its stretched balance sheet, had to do an emergency fundraise, and was lucky to have supportive shareholders.

Another key takeaway was that furniture retailers proved highly resilient - enforced store closures obviously hurt, but some sales shifted online, and powerful pent-up demand quickly became apparent, with lost sales being quickly recouped on re-opening of stores. Lockdowns also encouraged many households to revamp their homes.

On the downside, sector-wide problems have been seen with supply chains, raw materials shortages & price inflation, and freight costs/delays.

Today’s update -

Summary -

Continued strong trading; full year performance for FY21 and outlook for FY22 ahead of market expectations

Order intake - there’s a slightly confusing table showing LFL order intake over the various lockdown-impacted periods. Remember that order intake is not the same as revenues, due to the time lag between taking an order, and actually delivering the goods, which can be weeks or months).

We like to simplify things at the SCVR, so the annual total is the key number -

This shows that LFL (i.e. stripping out effect of any new, or closed stores) order intake was down 1.5% compared with last year, and down 6.5% on the year before that (pre-pandemic year - the most relevant).

In my view, to have only lost 6.5% revenues, in a year when the stores were closed for long periods, seems remarkably resilient.

Despite our stores being closed for 17 weeks in the FY21 year, our full year like-for-like order intake was down only 6.5% on 2019.

Recent trading - the last 7 weeks of FY 07/2021 saw LFL order intake up 23.7% on pre-pandemic 2019 numbers. That’s well down from the +79% in the previous 3 months after re-opening, but I would expect demand to normalise once pent-up demand has been digested. +23.7% is still very, very good of course.

Comparisons with 2020 are meaningless in my view, as both this year, and last, were disrupted heavily by lockdowns, with different timings.

Order book - the large order intake after re-opening means that the year end order book is massive! £86.3m (I’ve stripped out the VAT, it’s £103.5m incl VAT). Remember that this is not all stronger demand, some of it will also reflect longer supply timescales.

Cash pile - is ginormous at £87.7m at 31 July 2021, and there are no borrowings. That is equivalent to most of the market cap, of £110m. As supply chains normalise eventually, who knows when, then I would expect cash to reduce somewhat. It’s the stand-out feature of this share though.

Outlook - ahead of expectations for both FY 07/2021, and FY 07/2022 -

The Board is encouraged by the strong trading performance since reopening and therefore believes that the Group is in a strong position as we enter the new financial year. The next few months still hold a level of uncertainty, with the tone of government messaging at present being one of caution. However, given recent trading and the strength of the current order book, the Board's expectations for FY21 and FY22 are ahead of current market forecasts.

Diary date - 5 Oct 2021, for FY 07/2021 results.

Broker consensus - I’ve been saying for ages to anyone that would listen, including here, that the broker forecasts looked way too low for SCS, and did not tie in with the resilient trading updates.

However, I hadn’t spotted this, but in the last couple of months, broker consensus has shot up, especially for FY 07/2022 (the lighter line). Around 28p EPS is now forecast for both years, FY 07/2021 and FY 07/2022.

Therefore, today’s update telling us that the company is trading ahead of both these raised forecasts, is really encouraging. If we guess that EPS might be say 33p, then at 290p per share, the PER is only 8.8 - that’s crazy, considering all the cash on the balance sheet too, which could safely be used for something else, due to the way working capital stays permanently favourable to the company - people miss this point when they net off all the creditors against cash, you don’t need to do that because it revolves permanently.

My opinion - it’s the wrong price! This share should be 400p+ based on the fundamentals, in my view.

EDIT: I forgot to mention dividends. With such a large cash pile, and strong trading, the company has tremendous capacity to pay divis in future, and historically was a good divi payer. There was no mention of divis in today's update. We could even get a special dividend, and/or share buybacks, because shareholders won't be happy with the company sitting on a huge cash pile forever. As long as it's not frittered away on something daft, then it should be fine. Again, I think existing broker forecasts are too cautious on divis. The company could easily afford to pay out 20p in divis, which would be a yield of 6.7%. Hence I'm perfectly happy to sit and wait, because patience should be rewarded eventually with both a re-rating of the share price, and a flow of generous divis in future.

A friend reminds me that SCS has already reinstated divis, see trading update on 16 June 2021. A 3.0p interim divi was declared.

Note also that SCS has repaid £3.0m furlough monies to the taxpayer, good for them!

End of edit.

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Tt Electronics (LON:TTG)

(I no longer hold)

276p (up c.3%, at 09:24) - mkt cap £482m

Half-year Results

TTG issued a positive trading update which I covered here on 13 May 2021 when the share price was 248p, I liked the look of this share at the time. Unfortunately, I closed my spread bet on TTG when hit by margin calls recently, which is a pity as it’s gone up to 276p since.

Interim Results for the half-year ended 30 June 2021

Strong momentum, good margin progression and further increase in full year profit expectations

As a general point, companies are now annualising against soft comparatives covering lockdown 1 last year. Hence I make a point of always checking back to last year’s results, to see how bad they were. That sets the context for stronger numbers being reported this year - i.e. this year’s numbers might look like strong growth has been achieved, but it’s often just recouping, or even partially recouping, last year’s shortfalls.

For TTG, last year’s interim results showed a 45% fall in both underlying (“u/l”) profit before tax (PBT) to £9.5m, and u/l EPS fell to 4.8p. Hence to recoup that this year would require a 83% increase just to get back to 2019 levels. It’s striking how percentages work - after a big % drop, you need a much larger % rise just to get back to the starting position.

Adjusted PBT is up 25% (33% at constant currency, note that forex movements are having quite a big effect at many companies at the moment). However, there are 2 complicating factors -

(1) Last year’s H1 numbers have been revised up from £9.5m adj PBT, to £11.3m. Taking the original £9.5m PBT then this year’s £14.1m is a 48% rise. Therefore, it has recouped most of last year’s shortfall in profits.

(2) There’s been an acquisition called Torotel, funded by a placing of 10m new shares at 200p. Therefore lots of moving parts here - H1 2021 revenue & profit will be boosted by the inclusion of Torotel, but the share count has gone up, so profit is spread over a larger number of shares. This is getting complicated!

Adjustments - are quite material here. If there’s a big difference between underlying profit and statutory profit, I always investigate to make sure I’m comfortable with the adjustments before buying any shares.

There’s a reconciliation provided between adjusted and statutory profits, and the adjustments look reasonable - relating to restructuring costs of £3.3m (was much higher in H1 LY at £11.4m), and acquisition-related costs & amortisation. It’s customary to adjust out these items when looking at the underlying performance of the business.

Divisional performance - the stand-out performer is Sensors and Specialist Components, which has almost doubled adj operating profit to £7.4m, and its adj operating margin is up from 7.0% to 12.8%.

We are seeing very strong demand from the automation and electrification market.

Outlook - I particularly like the measures taken to increase the adj operating margin (currently 6.7%) to double digits. Also very good visibility in H2 - full year revenues already in the bag it seems (could this lead to another positive surprise, if more orders are won in the rest of this year? Maybe not, because the commentary says all sites are fully booked for this year) -

· Order and sales momentum continue; 2021 expected revenues already fully covered

· Confident in medium term outlook and further modest increase in full year profit expectation

· Anticipate strong improvement in adjusted operating margin and cash conversion in H2

· Increased visibility in our path to deliver double digit Group operating margins

Materials cost inflation - another key point at the moment, is whether companies can pass on higher costs to customers. TTG reassures on this point -

Price increases are being put through to reflect the recent cost inflation and we are already winning material new orders at the higher price points.

Balance Sheet - NAV is £313.4m. Intangible assets total £209m, plus bizarrely the pension scheme is shown as a £65.4m asset, despite clearly being a liability that requires £5.4m cash injections each year. It really is long overdue for pension scheme accounting rules to be fixed, as they’re a complete nonsense at the moment.

For that reason, I would remove the £65.4m pension asset, along with the £16.2m deferred tax liability (which usually relates mainly to pension schemes).

Putting all that together, I get NTAV of £55.2m, which is OK.

The gross debt is very high, but partially offset by £100.6m in cash, which looks a bit odd.

Overall, I think it’s OK, and the working capital position looks very healthy, so no concerns here overall from me.

Cashflow statement - there’s quite a large £(18.9)m working capital movement, which might be seasonal perhaps, as it was £(11.2)m in H1 last year (“LY”)?

Capitalised development spending of £1.0m in H1 is not excessive.

Pension schemes gobbled up £2.7m in cash every half year, a material amount, so needs to be adjusted for in the valuation of this share.

Net debt - looks too high to me, at £107.3m. Although there is plenty of headroom on bank facilities, plus there is £75m of fixed rate loan notes over 7-10 year maturities, a much better/safer form of borrowing than bank debt, in my opinion. Cheap too, at 2.9% interest rate.

Valuation - Stockopedia shows 14.4p EPS broker consensus forecast for FY 12/2021. That’s been tweaked slightly higher to 14.6p by one broker this morning, so we’re in the right ballpark. Rising to 17.6p next year.

What PER to use? I think about 16 feels right, taking into account the pension scheme cash outflows, and the net debt. Which gets me to a 282p share price target as looking reasonable - very close to the current market price.

My opinion - I’ve only pulled out some key points, there’s loads more detail in the commentary, which reads very well I think.

This looks a good company, at a reasonable valuation. I like it.

The fact that its factories are already fully booked for 2021, and it’s successfully passing on cost increases to customers, suggests the company is in a sweet spot, making products that are in strong demand, or even in short supply. What competitive moat it has, longer term, I do not know.

The planned increase in operating margin is also attractive.

Overall I think the big rise in share price is fully justified, and this share still looks reasonably priced, given the positive outlook. Not sure I’d want to chase the price much higher though, for now.

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Brickability (LON:BRCK)

101p (down 3% at 11:51) - mkt cap £300m

Here’s our previous recent coverage of this brick distributor -

2 June 2021 - large Director selling (£38m) & placing (£55m) at 95p, to fund a big acquisition (£63m)

20 April 2021 - ahead of expectations trading update, but failed to mention that profits are down on last year!

9 Feb 2021 - positive trading update, raises guidance for FY 03/2021

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Moving on to today, we get the (rather late) accounts for FY 03/2021 -

Preliminary results for the year ended 31 March 2021

Brickability Group plc (AIM: BRCK), the leading construction materials distributor, is pleased to announce its preliminary results for the twelve-month period ended 31 March 2021.

Strong performance despite economic challenges

Considering all the chaos caused by the pandemic/lockdowns, these numbers look good to me.

• Revenue down 3.2% to £181.1m, although that’s flattered by acquisitions
• Adj PBT £15.0m, down 11.8% - not bad at all, considering pandemic disruption, so this looks a resilient business
• Adj EPS 5.56p (down 23.5%)
• Adjustments look fine to me, and are mainly acquisition-related amortisation
• Dividend held flat at 1.95p
• “Trading in first quarter of FY2022 encouraging”
• “Acquisition pipeline going forward looks promising”

Balance sheet - FY 03/2021 figures now pre-date the big placing,in June 2021, so the figures will have changed. However, given that an equity placing funded the big acquisition, then the basic structure of the balance sheet won’t have changed that much. Debt won’t have worsened, which is my main worry with acquisitive groups.

The stand-out number is how low inventories look. I’ve queried that before, and it’s because BRCK has a drop-shipping model, where customer orders are often fulfilled directly by the manufacturer. Very nice, if it can be sustained like that long term.

Overall the balance sheet looks OK to me. BRCK has managed to avoid the danger from multiple acquisitions of depleting its NTAV. In this case, that’s still positive, NTAV = £8.6m - not much, but the lack of need for inventories makes a big difference, meaning BRCK can operate with much lower working capital (and lower costs) than other companies which need to carry enormous inventories in expensive warehouses with lots of staff.

Broker update - many thanks to Cenkos for providing an update note on Research Tree.

Adj EPS is forecast to rise to 7.3p this year FY 03/2022, and 9.2p the year after.

So at 101p this share looks good value, assuming nothing changes in the macro outlook, or competitive pressures.

My opinion - I can’t see anything wrong with BRCK, it looks a good company at a reasonable price, based on the information I have today.

Major Director selling is a concern though, but they still retain big stakes.

Also it must be a helluva job to integrate and manage all the bolt-on acquisitions.

Assuming all that works out OK then, this share looks potentially interesting. High StockRank too.

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