Small Cap Value Report (Thurs 10 Feb 2022) - KCT, SUS, SOLI

Good morning, it's Paul & Jack here with the SCVR for Thursday. It looks like another quiet one after the January rush - here are some companies we've spotted so far, let us know if you've seen anything else out there worth covering.

• Kin And Carta (LON:KCT)
• S&u (LON:SUS)
• Solid State (LON:SOLI)

Jack's section:

Kin And Carta (LON:KCT) - H1 net revenue of c£85m and adjusted operating margin of around 7%. A notable year-on-year improvement, and FY22 organic revenue growth is expected to be in the range of 35%-40%. There are signs of progress but that is reflected in the share price at these levels even after the recent fall, in my opinion.

S&u (LON:SUS) - I hold - positive update, with FY profit before tax to exceed current consensus expectations. The group is now back to pre-pandemic levels, with excellent collection rates in motor financing and strong momentum in property bridging. A well-run company on a modest valuation and a positive outlook.

Solid State (LON:SOLI) - another strong update and further broker upgrades. The performance here has been impressive, and that is reflected in the share price. Supply chain issues have so far been well managed. All in all a good company, although the expanding PER means it stays on the watchlist for now.

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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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Jack’s section

Kin And Carta (LON:KCT)

Share price: 230p (+7%)

Shares in issue: 174,227,383

Market cap: £400.7m

Kin is a digital transformation consultancy, helping C-suite better understand market shifts and bringing a more data and tech-led approach to marketing.

Looking over the past decade of results, it’s clear that Kin is a company in transition.

It used to be called St. Ives, which, at one point, was Britain’s largest printer. So the shift to digital transformation looks to have been borne out of necessity.

Trading update for the six month period ended 31 January 2022

• H1 net revenue from continuing operations of c£85m,
• Adjusted operating margin of c7%, up from 3% in H1 2021,

Kin expects higher organic net revenue growth from continuing operations of 35%-40% in FY22, with stable adjusted operating margin expectations of 10%-11% for the full year.

H2 should be stronger than H1, in keeping with what the group says is its usual seasonality pattern here, although that’s pretty hard to see from the charts.

The group does show this table, which includes a stronger H2 2021.

Note the 2021 results are skewed by adjusted other income of £0.8m and £3.6m in H1 and H2 respectively, in respect of loan forgiveness under the US Paycheck Protection Program. Stripping those out, I make that 2021 adjusted operating margins of roughly 1.5% and 9.3%.

Still, it shows the H2 weighting and puts the H1 FY22 margin performance in a more positive light.

Conclusion

It’s a brief update, although FY22 guidance is provided and improved upon, so the direction of travel appears positive. The digital transformation ('DX') market is set to grow at a compound annual rate of 22.5% through to 2027 (bumped up by 4 percentage points in the wake of Covid), according to market research quoted by the company in its Capital Markets Day.

The lack of profitability in recent years requires further investigation, but the group has at least been cash generative in that time, and diluted normalised earnings per share are forecast to grow - although the exact level of profitability appears to be difficult for brokers to forecast.

The progress is interesting and the results are improving, but I don’t think there’s enough here to seriously interest me at the current valuation. It’s a company in transition, which is always a potential opportunity, but the shares have done well since the initial Covid crash and that leaves a fair amount of growth priced in.

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S&u (LON:SUS)

Share price: 2,807.50p (+3.22%)

Shares in issue: 12,145,260

Market cap: £341m

(I hold)

Trading statement for 9 December 2021 - 31 January 2022

S&U's profit before tax for the year is now set to exceed current consensus expectations.

Founded on an excellent collections and debt quality performance and the expected rebound in sales as the Covid pandemic gradually abates,

Meanwhile, the plans and foundations are in place for continued, accelerated and sustainable growth both at Advantage, our motor finance lender, and at Aspen, our property bridging business.

Motor Finance

Annualised live collection rates in the period were 93% of due, which is above budget and 9% ahead of last year, and was 98% in January. That’s a good performance and signals a recovering market. Perhaps as expected, bad debts and voluntary terminations have been less than budgeted, resulting in a lower than normal impairment charge this year.

The result will be FY profit before tax more than double that of last year’s £17.2m (which was impacted by a £36m Covid-related impairment charge, following £16.5m in the year to January 2020).

This means that Advantage's profit over the past two years of the pandemic is anticipated to be only slightly below our excellent pre-Covid level - a remarkable achievement.

Used car supply remains constrained, with new car production down 20-25% on last year, although this is ‘expected to gradually reverse from the second quarter of 2022’.

Net loan advances totalled over £140m in the year to 31 January 2022 (2021: £102.6m), a trend which is expected to see a return to normal transaction levels and growth over the next two years.

Investments in digital and the division’s self-service portal continue, the latter of which is driving both higher collections and customer satisfaction.

As a result, Advantage is poised for a profitable new era of expansion, firmly rooted in an admirable record during the pandemic, excellent debt quality and imaginatively expanded routes to market.

Property Bridging

Aspen is benefiting from a ‘thriving’ UK property market, with house prices up 7.4% in December and up 11% in January. Residential transaction levels have also recovered strongly in January, ‘being the highest since 2007’. This results in Aspen achieving 28 deals in the two-month period, worth over £20m of gross lending.

Credit quality remains strong, and Aspen is building on this momentum by recruiting, introducing a new Buy to Let product, and refining its product range.

The current net receivables loan book stands at c£64m - the highest ever, and Aspen’s record profitability this year ‘has greatly exceeded expectations’. Further record results are expected in the year to come.

Funding - group borrowing is £114m (2021: £99m) and gearing is level at 55%. Group facilities of £180m leave ‘ample room for growth’.

Dividend - a second interim dividend of 36p per share, up from 25p, will be paid on 11 March.

Outlook:

Whilst both political and economic uncertainty still clouds the horizon for the UK consumer, and supply shortages still inhibit the used car market, we confidently expect 2022 to gradually see a full rebound to normal motor sales conditions.

Diary date - FY results to be announced on 29 March 2022.

Conclusion

Unlike Kin, S&U has a long track record of established operations and increasing profitability (if you ignore the Covid impact in FY21).

It has been doing what it does for a long time, which provides the opportunity to go through an archive of past reports and somewhat derisks the investment case. I think that’s worth something.

You could argue that KCT, if it really capitalises on a growing digital transformation market, might offer the superior growth potential for those willing to take that position.

But on a slightly churlish valuation of 10.6x forecast rolling earnings and with a forecast yield of nearly 5%, there is plenty of scope for S&U to rerate should the market choose to reward its ongoing competent execution. And, with both divisions performing well, it looks like there are plenty of organic growth opportunities for the team to invest in going forwards.

There is a question mark around the tight used car market. Management expects this to gradually improve from Q2 onwards which, if so, would presumably facilitate more transactions and loans. The free float is also small (around 16%), with the Coombs family owning a good chunk, so that likely limits institutional interest.

A good update though, and one that gets a thumbs up for the level of detail and commentary provided.

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Solid State (LON:SOLI)

Share price: 1,179.6p (+2.13%)

Shares in issue: 8,546,504

Market cap: £100.8m

Trading update for December 2021 to end-Jan 2022

Following a continuation of the strong trading performance reported in the Interim Results in December, Solid State now expects to report revenues for the Period slightly ahead of current consensus expectations of at least £80.0m (2021: £66.3m) with adjusted profit before tax well ahead of current consensus expectations.

The group helpfully notes that analysts from WH Ireland, finnCap, and Edison expect 2021/22 revenue of £78.4m and adjusted profit before tax of £5.9m.

Trading is strong across both the Systems and Components divisions, bolstered by continued good margin mix from projects delivered across the group and very strong trading at the recently acquired Active Silicon business.

Due to Active’s performance, Solid expects to further increase the earn out provision by ~£0.5m which will be included in net debt at year end. The group had net cash with banks of £0.4m at 31 January 2022 and has retained its £3.0m overdraft and £7.5m Revolving Credit Facility which is committed until November 2022.

Forecast year end fair value of deferred contingent consideration is now £5.75m (Active Silicon + Willow Technologies).

Order intake remains strong, with a record open order book at 31 January 2022 standing at £74.1m (30 November 2021: £70.3m).

Regarding supply chain:

The global supply chain continues to present challenges for both Solid State and its customers. In many instances the risks are being mitigated through collaboration with the client and supplier, and through order management; complemented by continued strong Group cash generation to support investment in working capital to manage the potential shortages.

Conclusion

Solid State is another good business, one that came onto my radar at the £5-£6 level but the share price has run away from me.

The strong performance continues, and management appears to be doing a good job handling supply chain pressures, but it is no longer supported by such an attractive valuation.

Note the trailing twelve month free cash flow multiple though - perhaps the shares are not as expensive as the forecast PER suggests? The group does post some strong cash conversion numbers.

It’s a very positive update, ahead of expectations, and yet the shares have barely moved today. Those shares are still below the recent high of £14.05. There’s enough here to warrant further investigation, but the growth multiple must be justified.