Small Cap Value Report (Thurs 17 Feb 2022) - BVC, CKT, UBG, IHC

Good morning, it's Jack & Roland here with Thursday's SCVR.

Agenda

Jack's section:

Checkit (LON:CKT) - group revenue down, but annual recurring revenue is up by 43%. This transition will continue to weigh on results as the non-recurring side declines, but it could result in a fundamentally more valuable enterprise. It remains loss-making though, and forecast revenue growth appears modest, so I’m neutral for now.

Unbound (LON:UBG) - a positive update for Unbound given the valuation. The recent changes (this was Electra Private Equity) appear to have caused some shareholder churn which has driven the share price down. Trading is good, moving in the right direction, but FY profit before tax is a negligible c£0.2m. If management can execute on their medium term targets, then the stock looks cheap, although I’m waiting for more detail in the prelims.

Roland's section:

Batm Advanced Communications (LON:BVC) - this Israeli medical device and tech company has upgraded its 2021 guidance for the second time in six months. The commentary seems positive to me, but I’m struggling to get a clear picture about the outlook for 2022. More research may be needed to understand whether BATM will be able to hold onto its pandemic gains.

Inspiration Healthcare (LON:IHC) - medical equipment supplier Inspiration has upgraded its guidance for the year ended 31 January. I have a positive impression of this founder-led business. Although current broker forecasts suggest a cautious outlook for the next 18 months, my view is that this stock could reward patient investors.

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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.

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Jack's section

Checkit (LON:CKT)

Share price: 46.98p (+6.77%)

Shares in issue: 108,008,562

Market cap: £50.7m

This is an intelligent operations platform for the ‘deskless worker’ - hospital workers, lab technicians, restaurant workers and more who together account for a good chunk of the workforce. Checkit digitises this data, which is otherwise spread around various physical file copies in multiple locations, and brings it under one digital roof. The result is an app for workers that leaves them better informed, with better visibility over and context of their tasks.

There are endless examples of existing businesses being disrupted by more agile digital-native competition with better access to real-time data, so I can see why there could be a demand for something like this.

Checkit CEO Kit Kyte says there could be around £560bn of business technology spend in the deskless worker space over the next 3-5 years. I take that figure with a pinch of salt, but it does highlight a potentially attractive opportunity.

Trading update for the year to 31 January 2022

• Total revenue -7% to £13.3m,
• Annual recurring revenue +31% to £6.8m,
• Non-recurring revenue -29% to £6.5m

Annual recurring revenue as of 31 January was up 43% to a better-than-expected £8.2m, with bookings growth of 95% giving confidence in delivering strong ARR growth ‘in FY23 and beyond’.

The lag in recurring revenue percentage growth compared to ARR reflects the acceleration in ARR of contracts signed during H2, so presumably ARR is the more ‘current’ picture. Recurring revenue accounted for 51% of total revenue in the year, but was 75% of total in the last three months. That sounds like good momentum.

Non-recurring revenue declined in line with management's expectations.

Cash at 31 Jan was £24.2m, up from £11.5m, thanks largely to £20m of net proceeds raised in a placing.

Diary date - preliminary results to be announced on 28 April 2022.

Conclusion

The stock is down by about a third from its highs back in June 2021. Given the £24.2m of net cash, it is cash rich.

It’s still loss-making though, with poor relative momentum, and forecast revenue growth is underwhelming.

The group does talk a good game - there’s a big addressable market, which remains underserved according to the CEO.

The shift to recurring revenue might cause a short term hit to profits, but it could also make for a more valuable enterprise in future. Assuming, that is, that Checkit’s solutions are in demand. So there could be an opportunity if you have confidence in the longer term SaaS prospects. In fairness, the growth in annual recurring revenue does sound encouraging.

I’m not sure if the short-term optics of this shift to recurring revenue are priced in though. The shares are up this morning, so perhaps they are, but I also suspect there is scope to disappoint at some point in this transition if one declines by more than the other rises.

In the meantime it remains loss-making.

I think I’d rather wait until the group is further along in this transition, at which point the demand for its recurring revenue services might be a little clearer. The StockRanks seem to agree that, statistically, based on the existing financial data, it might be better to hold off for now.

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Unbound (LON:UBG)

Share price: 57.7p (+13.14%)

Shares in issue: 42,258,128

Market cap: £24.4m

Trading update for the year to 30 January 2022

Paul has covered this one extensively in the past, both Elta Private Equity and now the spun off Unbound. You can find his posts on the Discussions tab of the StockReport.

Unbound Group plc is the parent company for a group selling a range of brands focused on the 55+ demographic. Unbound Group will build on the solid foundation of Hotter Shoes, its current main business, to grow value through its curated, multi-brand retail platform supporting the active lifestyles of the 55+ demographic with a range of products and services.

Hotter Shoes, a digitally-led retailer of comfort shoes, has a growing database of 4.6m customers. Things seem to be going well here, and the group announces a partnership with Marks And Spencer (LON:MKS) to sell Hotter products on M&S’s Brands platform. Initially, Hotter will offer 32 products directly on M&S.com but this should increase to 75.

This follows agreements with other retailers including John Lewis, Next and The Very Group to sell Hotter products online as part of its digital-focused growth strategy.

That aside, trading for the year looks good. Q4 revenue is up 10% with a gross margin of 61%, despite supply chain challenges. That strikes me as a good gross margin, all things considered. The UK manufacturing facility provided a level of resilience here, and availability improved during Q4.

Revenues for the full year are significantly ahead of last year, up 16% to £51.9m and double-digit revenue growth across both digital and retail channels. This was helped by a 16% increase in average selling prices, suggesting all of the revenue growth is down to price increases and not volume growth.

The 63% gross margin is encouraging though, and the group’s database of email addresses is up 35%, from 767k to over one million.

EBITDA should be up from -£0.9m to around £5.5m and profit before tax will improve by c£6m to not less than £0.2m. Not much right now, so the company needs to grow. Net debt has also reduced by more than £6m to £8.5m.

Outlook

Management is confident in achieving the medium-term growth targets for both Hotter and Unbound as outlined on the Capital Markets Day in September 2021

Revisiting the capital markets doc, some of those targets are:

• Mid teen % annual growth in online UK direct to consumer
• Mid single digit % annual growth in offline UK D2C
• Double digit % annual growth in Hotter Digital Partnerships
• Mid teen EBIT margin over medium term
• Annual capex spend of £2.5m

From an Unbound Group perspective, strong progress has been made in developing the new multi-brand ecommerce platform with a launch planned for this summer.

Conclusion

This does look quite good at these levels, but the shares only look cheap if management can hit medium term targets. The forecast rolling PER is pushed up by negligible profits in FY22, but FY23 forecast is for 3.8p of normalised EPS, which would make a PER of 13.3x.

The historical financial data is clearly distorted by the group’s changing structure. What’s more important is that Unbound is well financed and growing. It’s not hugely exciting growth, but then again the valuation is undemanding.

It looks like sellers have pushed the share price down. That shareholder churn could be presenting us with an opportunity.

This is a £22m company generating more than £50m in annual revenue and targeting a mid-teen (let’s say 15%) EBIT margin. Even assuming no revenue growth, that would be £7.8m of annual operating profit and earnings per share of around 14.7p in the medium term.

It looks like it’s potentially the wrong price to me, execution risk aside. If you attach even a 10x earnings multiple to the medium target (my own, not company management, but it’s worth noting Edison has 8.3p pencilled in for FY24E), then that would imply a target price of 147p. As things stand, the company is barely profitable this year, so a lot does come down to execution in the years ahead.

It’s still early days for Unbound and there’s a lot to prove, but the current valuation seems undemanding so it’s worth doing some more digging here I think. I’m not familiar with the management team, and more of a track record would be good, but there are enough positives to make it interesting.

Unbound remains a Highly Speculative micro cap with a 606bps spread on the shares, so that’s also something to consider. The share price could move quite quickly in either direction.

I can’t see a date for the preliminary results, but they should be out in the next month or two.

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Roland’s section

Batm Advanced Communications (LON:BVC)

Share price: 49.3p (pre-open)

Shares in issue: 440.5m

Market cap: £217m

Trading update & notice of results

“Full year revenue and EBITDA for 2021 slightly ahead of market expectations”

Diary date: Full-year results due on 28 February

This Israeli tech company specialises in networking and cyber security solutions and medical laboratory products and services. The shares have traded on the London market since 1996. There have been some peaks and troughs along the way, so good timing has been required to make money from this stock:

The surge higher in 2020 reflected the investor rush for companies with exposure to Covid-19. Revenue from BATM’s medical division doubled to $129m in 2020 due to a surge in sales of Covid-19 test kits and critical care ventilators.

This strong performance continued into 2021, offset by weaker revenues from networking following the sale of one operating subsidiary in this division.

Today’s FY21 update does not mention Covid-19 specifically, but does refer to “significant growth in the Group’s Diagnostics units of the Bio-Medical division”.

Trading update: Today’s update guides for revenue and EBITDA to be ahead of market forecasts for 2021. This is the second upgrade in six months, as BATM also raised expectations alongside its interim results in August last year.

BATM seems to have achieved significant improvements in profitability in 2021, offsetting lower revenues. Here’s a snapshot from the half-year results:

Although revenue is expected to have fallen back towards pre-pandemic levels in 2021, earnings are expected to be higher than in 2020:

BATM’s medical division appears to have continued to drive strong results in 2021. However, I’m a little unsure how to interpret the guidance for 2022.

Outlook for 2022: Today’s update comes across as bullish to me. Management report “a substantially higher backlog from operations than at the same point last year”. Strong momentum from 2021 is said to have continued. 2022 is expected to see “significant growth in line with market expectations”.

What’s puzzling me is that as we can see from the graphic above, broker forecasts suggest that while BATM’s revenue will rise in 2022, its earnings will fall. I’m not sure how this squares with today’s guidance for growth in 2022.

More detailed broker forecasts I’ve seen elsewhere support this view, suggesting that both EBITDA and earnings could fall by 35%-40% in 2022, versus 2021.

My view: Ahead of today’s open, I estimate that BATM shares are priced at around 20 times 2021 forecast earnings, after factoring in a modest upgrade.

However, lower earnings forecasts for 2022 suggest the stock’s P/E multiple for this year could be close to 40x – perhaps too high, in my view.

BATM’s business has evolved significantly over the last two years.

• Medical growth has been strong due to Covid-19, but how much of this will persist beyond the pandemic? I’m not sure.
• The networking business suffered in 2020, which the company blamed on travel restrictions affecting sales. There’s been further change in 2021, with the sale of the NGSoft business. However, underlying performance excluding NGSoft appears to have weakened during the first half of last year.

I’d need to understand more about 2021 performance and the outlook for 2022 before I could take a view on this stock.

BATM’s 2021 results are due on 28 February. I hope to circle back then and take another look.

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Inspiration Healthcare (LON:IHC)

Share price: 102p (+5% at 09.20)

Shares in issue: 68.1m

Market cap: £69.7m

Trading update and notice of results

“The group is expecting to exceed market expectations for the financial year ended 31 January 2022”

Diary date: Full-year results on 4 May.

Inspiration Healthcare is a founder-led medical technology group that sells neonatal intensive care and operating theatre equipment around the world, through a network of distributors into over 75 countries.

The group’s products include a range of own-branded products used for respiratory management and thermoregulation (such as patient warming for newborns). Inspiration is also a distributor itself in the UK and Ireland, supplying solutions to support surgical procedures and infusion therapies.

Trading update: Helpfully, Inspiration’s board has provided updated numbers today, so we can compare these to existing forecasts.

• Revenue for the year to 31 January 2022 is now expected to be £41m, up 10.9% on FY21.
• Adjusted EBITDA is expected to be “not less than £6.2m”, an increase of 10.5% on last year
• Operating profit “is similarly ahead of expectations”

Looking at the Stockopedia broker consensus, this revenue guidance only appears to be marginally ahead of the existing consensus figure of £40.6m.

However, today’s guidance for adjusted EBITDA of at least £6.2m is significantly ahead of the £5.6m forecast by house broker Cenkos in October (available on Research Tree). So I think this could be a meaningful upgrade to forecasts.

2022/23 outlook: No financial guidance has been provided for the FY23 year today. However, chief executive Neil Campbell says “demand for our products remains high around the world and we enter our new financial year with confidence”.

Mr Campbell also confirms that Inspiration’s new manufacturing, tech support and R&D facility in Croydon is on schedule to become operational in April. This will bring many of the group’s operations together under one roof.

Continuing momentum? Inspiration’s revenue growth took a step higher in 2020/21, after several years of more modest growth:

Broker forecasts now suggest a further pause, although today’s upgrade suggests to me there may be room for optimism here.

It’s worth unpicking the FY21 gains to understand what’s changed in the business. One element of last year’s growth came from £7.3m of one-off Covid-19 revenues.

A more significant increase came from the acquisition of neo-natal ventilator manufacturer SLE Ltd for £18m in July 2020. SLE generated £16.1m of sales and a pre-tax profit of £1.5m in 2019. Its addition effectively doubled the size of Insipration’s business:

The SLE acquisition was funded by a placing, resulting in some dilution:

However, this strategy protected the balance sheet, which continues to show a net cash position:

The question now is whether Inspiration can deliver a return to growth, without the one-off benefits of Covid-19 sales or a big acquisition. Earnings growth has been inconsistent in the past, although the medium-term trend has been upwards:

Broker forecasts for the next couple of years seem to suggest caution. I’d guess this may reflect the impact of the loss of Covid-19 revenue, coupled with limited visibility on future growth.

Stockopedia’s algorithms are also taking a cautious approach. The stock is labelled as a Falling Star and has a very mixed set of factor scores – although note the high QualityRank.

My view: Inspiration’s share price performance over the last year has certainly not been inspiring. However,my feeling is that this may reflects the distortion caused by Covid-19 rather than any weakness in the company’s execution.

I think this may be a situation where shareholders have to decide whether they trust the long-term vision and execution of management. In this case, I think Inspiration probably deserves the benefit of the doubt.

If we dig into the 10–year accounts tab on the StockReport, we can see that turnover has risen from £1.7m to £37m over the last 10 years. Inspiration has reported an after-tax profit each year since its 2015 flotation on AIM.

I’m also attracted to the group’s steadily improving profitability and strong balance sheet (hence the high QualityRank):

Founder-CEO Mr Campbell has been with the business since 2003. He reversed the business into AIM stock Inditherm in June 2015 and still has a 6.5% shareholding today. I felt that Mr Campbell came across well, when I saw him at a ShareSoc presentation a few years ago.

Although acquisitions have helped to boost growth, my impression is that they’ve been well targeted and aimed at strengthening Inspiration’s presence in its core markets, rather than expanding indiscriminately.

Admittedly, the shares don’t look obviously cheap at current levels:

I can see some downside risk here if FY22 and FY23 performance disappoints. However, if I held the shares today, I would certainly continue to do so. My feeling is that this business could benefit from a return to normal conditions after the pandemic.

I’ll be interested to see the group’s full-year figures in May, but for now I have a broadly positive view.