Small Cap Value Report (Thur 20 Feb 2020) - STAF, ALY, DEV, GAN, MCB, NXR, PHD

Good morning everyone!

Thanks to Paul for manning the fort here so incredibly well, while I've been busy with some other projects.

In terms of my own portfolio, the most interesting development recently was the small acquisition by Volvere (LON:VLE) - which I think looks promising.

On the RNS feed today we have:

• Staffline (LON:STAF) - CEO resigns
• Laura Ashley Holdings (LON:ALY) - interim results
• Dev Clever Holdings (LON:DEV) - traded below expectations in H2
• GAN (LON:GAN) - update on growth of internet gambling in the US
• McBride (LON:MCB) - half year results
• Norcros (LON:NXR) - trading update and impact of coronavirus
• Proactis Holdings (LON:PHD) - trading/sales process update

Finished at 2pm.

---

Staffline (LON:STAF)

• Share price: 46.5p (pre-market)
• No. of shares: 69 million
• Market cap: £32 million

Resignation of CEO

Paul covered Staffline's profit warning on 31 January. The industrial recruitment company's CEO has now tendered his resignation.

It sounds like he is jumping of his own accord, but as ever we don't know what sort of pressure he was under from the Boad.

I note that Staffline's CFO jumped ship in December. A Director who was also Chair of the Audit Committee left in January. And now the CEO.

As a reminder. Staffline has had serious financial and accounting problems.

Last year, PWC resigned from its position as auditor to the company. In giving reasons for its decision to resign, as it is legally obliged to, it merely cited the company's 2018 audit report, without being any more specific than that.

If you ever find yourself with more time on your hands than you can put to good use, check out Staffline's audit report from 2018. It's a classic example of a disastrous audit report - it has everything from a warning about the company's ability to continue as a going concern, to anonymous whistleblower accusations of wrongdoing, goodwill impairment and breach of national minimum wage legislation.

In the midst of this horror show, PWC disclosed that there were "failures by management to fully disclose to us and to account for certain customer claims and other disputes". Perhaps this is why PWC fired its own client?

And the former CEO, CFO and Chair of the Audit Committee have followed not far behind.

PWC was replaced by Grant Thornton, of Patisserie Holdings (LON:CAKE) fame. The head of Grant Thornton made headlines last year for saying "we are not looking for fraud, we're not looking at the future, we're not giving a statement that the accounts are correct". It sounds like they are a good fit for Staffline.

For background, it's important to bear in mind that Staffline was built by a very long-standing CEO, Andy Hogarth, who was in charge of the company for 15 years (2002 - 2017).

It's fair to say that since his departure, the wheels have well and truly come off.

Mr Hogarth sold Staffline shares worth £10 million in January 2018, shortly after resigning. The share price was 1020p at the time.

With the shares now languishing at 5% of that level, two years later, we have another lesson in why a healthy dose of cynicism is necessary in these markets.

If anyone could have predicted that Staffline was about to run into serious difficulties, it was Mr Hogarth. Whoever bought his shares off him has paid a heavy price for this informational asymmetry (about £10 million).

Would I want to buy shares in Staffline today? No prizes for guessing that the answer is no. Indeed, I'm giving this share the bargepole treatment.

The accounts are a sham - only three weeks ago, it revealed that more provisions and write-downs were necessary. The new problems weren't quantified, except to say that they would cause profits for 2019 to be "materially below guidance".

Debt - Staffline has "a constructive relationship with its lending banks and consequently the Board does not anticipate any covenant issues" - this is code for "we expect the bank to forgive us for breaching our covenants".

Today, Staffline says that "revised terms will remove the risk of covenant issues". Net debt at the end of December was £60 million, or twice the market cap.

Having debt issues and serious accounting problems puts this in the premier league of bargepole shares.

---

Laura Ashley Holdings (LON:ALY)

• Share price: 2.21p (+17%)
• No. of shares: 728 million
• Market cap: £16 million

Interim Report 2020

Directorate change

It's a legacy retailer that's recently found itself in financial difficulty. I could leave it at that, but let's see what else is going on...

Firstly, I note the announcement yesterday that lender Wells Fargo has agreed to lend sufficient amounts for the company "to meet its immediate funding requirements". The company is reviewing how much money it will need on an ongoing basis.

Secondly, Mr Kwan Cheong Ng will retire as CEO in April.

He was originally the CEO from 1999 - 2003, and then again from 2011. He'll be replaced by Laura Ashley's recently-appointed COO.

Thirdly, these interim results are about as bad as you'd expect. in the circumstances. "Market headwinds" and "weaker consumer spending" are blamed for reducing the sales of bigger ticket items (beds, sofas, dining tables).

Like-for-like retail sales fell 10% and inevitably made it impossible for the company to earn a profit, despite cutting costs. The pre-tax loss is £4 million.

Sales fell both on the retail side and online. The fall in e-commerce sales would be particularly worrying to me, since online is such a great channel for growth at so many other retailers!

Net borrowing was only £1.8 million at 31 December 2019 - the debt position was protected by a very significant (£7 million) reduction in year-on-year inventory.

Number of stores is down by only two to 153, and one store opening is planned for 2020. To me, this is complacent - why not plan to shut down stores, given the market environment and the probability that it's only going to get worse?

Product - no category performed well, although fashion sales were at least flat year-on-year. Big ticket items in furniture were down 6.2%, and decorative items (curtains, wallpaper) were down a massive 20.9% (like-for-like). ALY admits that its range is the problem:

"...our design teams are in the process of reviewing the mix of our decorating product offerings based on customer feedback and research."

My view

Taking a look at the raw numbers, I see that gross margin is down by c. 100 bps (to 37.3%).

Indeed, it's amazing to me that the company managed to keep its loss so low for the period! With declining sales and margins, only cost cuts helped to prevent a bigger disaster.

Also, the company benefited in H1 from an absence of "exceptional items". It's a clean set of accounts, this time around.

Balance sheet equity has more than halved to just £16 million. This is not helped by IFRS 16, since the "right of use asset" is considered to be worth less than the company's lease liabilities. And of course, losses have taken their toll on ALY's retained earnings.

Financial matters aside, this share is a bet on whether the brand can be revived. I've tried to

The elephant in the room is probably Cath Kidston. CK itself is not very profitable (according to filings at Companies House), and it's still catching up with Laura Ashley in terms of total revenue, but it has supplanted its older rival in the public eye.

As noted by a sector specialist several years ago:

Cath Kidston “doesn’t have the same baggage... it has managed to be seen as cool as well as traditional. It’s like the Laura Ashley of the Eighties but smarter.”

For a share like this, maybe you can throw financial analysis out the window and simply focus on the fact that the Laura Ashley brand is tired. If that's true, and it's unlikely to change, then how on earth can the company become a financial success story of the future?

---

Dev Clever Holdings (LON:DEV)

• Share price: 3.45p (-9%)
• No. of shares: 432 million
• Market cap: £15 million

Trading statement

Dev Clever, a leading developer of career development platforms and customer engagement solutions, is pleased to offer this preliminary trading update.

I've not looked at this one before, and it has not been discussed in the SCVR.

The company's website is here.

It makes a curious mix of software products, including both games and career guides.

The games are promoted in partnership with corporate clients, to help corporates promote their brands. For example, one of its games was branded by Bosch.

Today's brief update says that DEV is negotiating with "a leading worldwide technology manufacturer", which could result in the mass adoption of DEV's career training robot and career matching service.

Because of the negotiations, the UK roll-out of these products in the UK has been deferred. So we get an unquantified profit warning for recent and current performance.

However, it is expected that this strategy will enable the Company to more rapidly exploit an accelerated roll out of our products, into multiple territories around the world, starting in the US from April 2020.

My view

Revenue is still very small (£264k in H1).It's a typical speculative start-up company - though it has a main market listing (similar to Bigdish (LON:DISH)).

The algorithms call it a Sucker Stock but I'll be a little gentler and take no view. It has only been listed since last year - let's see if anything good comes out of these negotiations.

---

GAN (LON:GAN)

• Share price: 193p (+0.2%)
• No. of shares: 85 million
• Market cap: £165 million

PA Gambling Growth for January 2020

These shares have captured the attention of many investors and are now up about 300% over the past year.

Revenues have been growing at a terrific pace and the company has plenty of cash and is now profitable, so the bull argument is not without some merit!

Most revenues are derived from the US, where there has been a wave of online gambling legalisations in various states.

That's the basis for this RNS. In Pennsylvania, which is "a key market for GAN", we get the following statistics:

Internet Gaming Win was $14.0 million in January, reflecting an increase of 31.4% from the prior sequential month. This compares to:

- $10.6 million for the month of December;

- $9.7 million for the month of November; and

- $4.9 million for the month of October.

These are turbo-charged growth figures - the type of growth you only see when there has been a fundamental shift in an industry (e.g. thanks to legalisation).

Sports wagering statistics are given too, and are also very impressive.

It's an exciting story. I don't feel qualified to judge the value of GAN's turnkey internet gaming ecosystem, so I won't be having a flutter, but I wish it well.

Finally, I note that GAN hopes to have a US listing "as soon as reasonably practical".

US markets are currently in a state of euphoria, with large swathes of the population (including Millenials and Generation Z, still at university) betting on the stock market. Stocks which capture the imagination of the US investing public are now, in my view, completely untethered from normal measurements of valuation and risk.

GAN's share price rally makes more sense when you consider the audience of investors, across the pond, who will soon be looking at the stock.

---

McBride (LON:MCB)

• Share price: 64.1p (-3%)
• No. of shares: 183 million
• Market cap:£117 million

Half-year Report

Paul covered this company's H1 trading update last month. It announced that H1 revenues were down 8% and that full-year revenues were expected to decline 2% (thanks to an anticipated second-half weighting).

McBride is a private label manufacturer of household products (laundry powder, kitchen cleaners, etc.)

Today, it claims to have earned a return on capital employed in the 12 months to Dec 2019 of 13.4% .

That calculation is based on adjusted figures and the adjustments are material.

The outlook based on current trading is in line with expectations.

Net debt (ex. leases) is £113.5 million. The covenant relating net debt to EBITDA says that this multiple must not exceed 3x; it's currently at 2.2.x. I applaud McBride for the clarity of its disclosures.

My view

While the ROCE performance isn't bad, I share Paul's lack of enthusiasm for this share. It's simply hard to imagine that it has any long-term competitive advantage. It's not a bad business, it just looks like a very ordinary business.

Ordinary businesses don't deserve high multiples of earnings and book value, and I reckon the current market cap for McBride is very fair.

So does Stockopedia, giving it the distinctly lukewarm rating of 65/100.

---

Norcros (LON:NXR)

• Share price: 253p (-13%)
• No. of shares: 80.5 million
• Market cap: £203 million

Trading update and impact of the coronavirus

I've not said all that much about the coronavirus, because a) it's not easy to analyse, and b) ten years from now, I don't expect it to be something I'll wish I spent more time studying.

It (or rather the response to it) does clearly have a short-term effect on trade. Norcros, a supplier of bathroom and kitchen products in the UK and South Africa, says that it expects some disruption:

...we do now envisage that the supply chain disruption is likely to have some impact on the seasonally important remainder of this financial year and early next. The situation however remains fluid and is being closely monitored and actively managed.

Today's RNS from Norcros is a profit warning.

FY March 2020 will be ahead of last year, but below expectations (I can see an existing PBT forecast for FY March 2020 of £35.8 million).

The coronavirus is not the only issue. UK domestic performance is still fine, but exports are "subdued". And in South Africa:

...we have seen no market improvement in the second half of the year, with activity levels in the construction sector in particular markedly lower at the start of our fourth quarter.

My view

This stock has certain concerns attached to it which we've discussed before. But net debt has been reduced significantly (the existing forecast is for it to fall to c. £33 million). And Paul has noted that payments into the pension deficit aren't overly burdensome.

The other major issues we have flagged are:

• geography - not everybody has been to South Africa, and it's hard to feel confident investing in a place you are unfamiliar with.
• growth - organic sales growth is underwhelming, to say the least.

These concerns have been reflected in a dirt cheap valuation. Although as noted by a shareholder in the comments section below, the valuation perked up recently and made it to a P/E multiple of more than 8x (prior to today's drop).

I think the current valuation is probably about right, to reflect the geographical risk and lack of organic growth.

---

Proactis Holdings (LON:PHD)

• Share price: 44.5p (+11%)
• No. of shares: 95.5 million
• Market cap: £42.5 million

Trading and FSP updates

This software company has been in turnaround mode for a while, after some M&A activity went bad.

It focuses on "spend management" (procurement/budgeting) and B2B sales processes.

Let's skip ahead to the outlook section:

Following the significant improvement in new business performance and retention of existing customers, the Board expects that the Group will return to revenue growth for the second half of the financial year resulting in a likely full year outturn of approximately £50.5m for the year ending 31 July 2020 (as compared to the Board's expectations prior to the announcement of the FSP of £53.5m)... The Board then anticipates the rate of revenue growth to accelerate into next financial year and future periods.

Along with its revised growth strategy, it has also been undertaking a Formal Sale Process since July 2019. Today's RNS confirms that this process is ongoing, with "further inbound interest from credible parties".

CEO comment is optimistic; he says that revenue has "bottomed out".

My view

The way the company presents its "annualised recurring revenues" (ARR) is a bit unusual.

ARR has declined over the past six months (from £44.3 million to £43.4 million), however the company says that ARR grew if you exclude the effect of those customers which it expected to lose. That's a new one!

I've never found this share appealing but I do agree with Stocko that it may offer quantitative value at current levels. Stocko calls it a Value Trap - how cynical!

---

It's definitely lunch time now. Thanks for reading.

Cheers,

Graham