Small Cap Value Report (Thurs 30 Sept 2021) - NUM, HSS, NWF, MEAL

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

Agenda -

Numis (LON:NUM) - H2 revenue up year-on-year (beating exceptional Covid comparative) but down slightly on the first half after a summer pause in corporate activity. Full year revenue of c£215m is expected to lead to 'significantly higher' profits this year, but are we approaching peak earnings?

Hss Hire (LON:HSS) - good trading results for this tools and equipment hire company, but, while the finances have improved, this has come at the cost of heavy shareholder dilution. The fact that it could have floated in such a condition makes me wary, but it is possible that improving market conditions will help fuel the ongoing turnaround.

Nwf (LON:NWF) - a quick AGM statement from a very steady and sensible dividend-payer. It's not the highest growth option out there, but it could play a useful role for investors more concerned about long term income. The valuation is undemanding.

Parsley Box (LON:MEAL) - c30% fall in share price today with FY21 revenue and profit forecasts reduced due to supply chain issues. Marketing spend is getting slashed, which will weigh on revenue growth in the short term.

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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), 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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Numis (LON:NUM)

Share price: 366p (pre-open)

Shares in issue: 114,367,448

Market cap: £418.6m

It’s been a busy period for investment banks and corporate brokers. First we had the emergency placings driven by lockdowns, and then there has been the recent raft of IPOs. Companies are also making more acquisitions following a period of substantial market disruption, so all in all conditions are very buoyant for businesses that collect fees from this type of activity. It’s no coincidence that Peel Hunt has just opted to list its shares on the stock market.

Numis has a good reputation in the city as a corporate broker, with a long list of clients and additional services including equity sales & research, debt advisory, and trading.

The group’s share price is more or less as high as it’s ever been.

And yet the valuation metrics seem very modest, which suggests the market is concerned about the sustainability of the group’s current levels of trading. Is the skepticism warranted, or are the shares merely partway through an extended rerating?

To be fair to Numis, it has generated fairly steady revenue growth over the years, barring a dip in FY19, so it’s not just a case of exceptional Covid conditions.

Trading update for ​​the year ending 30 September 2021

The group says it has maintained its positive momentum and the final quarter of the year has been strong. There has, however, been ‘an anticipated pause in IPO activity and more subdued markets in general over the summer period’ offset by the completion of a number of significant M&A transactions.

Revenue for the second half will exceed the level achieved in the second half of FY20, which benefited from COVID related capital markets transactions. That was revenue of £94m, which compares to £117m in the following six months, so sequentially that looks like a small drop (although up year-on-year).

Full year revenue is expected to be in the region of £215m (FY20: £154.9m), implying H2 revenue of £98m, ‘with operational gearing leading to profits significantly higher than the prior year’ (FY20 PBT: £37.1m).

Investment Banking revenues have grown significantly and will be in excess of £150m for the year (FY20: £101.7m). Alongside market share gains in our core UK capital markets business, there have seen material revenue contributions from M&A and private markets transactions.

The group is also seeing more international activity and has acted on a number of capital markets transactions, both public and private, for non-UK issuers, most notably in the digital consumer and fintech sectors.

Equities delivered a strong performance, although lower than the exceptional performance achieved in the first half.

Outlook - the pipeline is very strong, and the wider market outlook for Numis is positive. New IPOs can be expected in the coming weeks, the capital raising environment is active, and UK M&A ‘is likely to remain at elevated levels as we emerge from the pandemic’.

Conclusion

It’s no secret that conditions are buoyant for this type of business, with shares at close to all-time highs and competitors listing on the stock market. The real question is how sustainable current profit levels are. Even if they increase year-on-year for now, what about next year, or the year after that?

That’s not to say Numis is not a good investment, but it does raise the question of whether or not now is the right time to buy such a company on a long term view. You can sense this concern in the lowly PE multiple: 7.9x despite a strong net cash position and rapidly growing earnings. The forecast PEG is just 0.14x, with anything under 1x typically seen as offering growth at a reasonable price.

So even if today’s conditions are transient on, say, a three-year view, perhaps we can still argue that the share price has further to run despite that. There is some value on display, with around 25% of the market cap in cash. And the group’s revenue growth is not just tied to equity market health - Numis has been growing for some time now, presumably winning share from rivals.

And the group has a good track record for dividend payments over time, so it’s unfair to dismiss it solely as a feast and famine kind of company. That said, conditions pretty much since 2008 have been artificially supportive of equity markets with low interest rates and easy money, so you can argue that this performance has occurred over the course of one big bubble, but I’m not opening that can of worms right now.

On balance I remain on the sidelines - a good operator that looks to be winning market share and investing in headcount, but one that may also be at or close to peak earnings. I wouldn’t be surprised at all to see further positive updates but on a multi-year view things become much harder to predict.

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Hss Hire (LON:HSS)

Share price: 20.07p (+14.67%)

Shares in issue: 696,477,654

Market cap: £139.8m

HSS Hire provides tool and equipment hire and related services in the UK and Ireland through a nationwide network and its OneCall rehire business. It could be a good time to look at equipment rental companies.

HSS shares have fallen a long way since 2015 levels though, and shares in issue have ballooned in that time from 208m to 696.5m, which is a great shame as it implies value destruction due to a lot of equity dilution at historically low share price levels.

Half year report

Highlights:

• Revenue +22% to £150.5m,
• Adjusted EBITDA +37.2% to £38.3m,
• Operating profit up from a loss of £0.7m to +£22.6m,
• Profit after tax up from loss of £12.9m to positive £11.2m,
• Basic earnings per share up from loss of 7.55p to positive 1.61p
• Net debt leverage down from 2.9x to 1.7x (calculated as net debt divided by adjusted Last Twelve Months (LTM) EBITDA).

I’d rather not see the focus on EBITDA for this type of company as depreciation must be a significant and very real ongoing business expense. You can see in the cash flow statement that FY20 depreciation was nearly £45m, which is coming up to 50% of the group’s market cap.

Interestingly, capex levels are far less than depreciation charges. I know HSS has been desperately fixing its balance sheet, so is there a risk of an underinvested estate and pent up capex returning in the years ahead?

Cash generation has been very good. Net cash from operations was some £28.6m, while £38m of borrowings were repaid in the period, so these are significant moves for a c£140m company.

Compared to H1 2019, like-for-like revenue is up some 99%, with Q2 2021 at 102%.

Current trading -

Revenue, EBITDA and EBITA all above management expectations in Q3 2021 to date.

Management now expects full year EBITDA to be ahead of market expectations and EBITA to be materially ahead.

We started the year with strong momentum and trading continued to improve over the period, with Q2 21 revenues at 102% of 2019 levels, EBITDA and EBITA margins up and ROCE at a record level.

ROCE is calculated as Adjusted EBITA for the 12 months to 3 July 2021 divided by the average of total assets less current liabilities (excluding intangible assets, cash and debt items) over the same period.

Sale of All Seasons Hire completed 29 September 2021 for gross consideration of £55m, with proceeds to be used to further reduce debt. Leverage as at 3 July 2021 on a LTM pro-forma basis will reduce to c1.0x post this transaction. The group hopes to maintain leverage between 1.0x and 1.5x going forward.

Market conditions -

While some important end-user markets like retail, hospitality and airports continued to be adversely impacted by COVID-19 in H1, the lack of volume there has been replaced by strong demand in areas like housebuilding, home improvement, repair & maintenance and infrastructure… As more COVID-19 restrictions are removed we see further opportunities for growth in H2. The outlook for the market is positive with the Construction Products Association forecasting 6.3% growth in construction output for 2022 and the ONS publishing forecasts for GDP growth in 2022 averaging 5.4%.

Reorganisation

The group has now reorganised around two divisions.

Sales Acquisition comprises a directly employed field sales teams, 45 local sales branches, 50 HSS builders merchant hire counters and over 100 ProService managers. Its role is to drive revenue growth through generating enquiry volume and maximising conversion rates, while maintaining gross margins and improving digital penetration.

The Make It Happen division is made up of operations teams in 40 distribution centres, plus the operations teams of the 500 supplier partners which operate from over 2000 locations. This division is focused on fulfilment rates, customer service measures, utilisation, cost-to-serve and returns.

Balance sheet -

Further strengthening of the balance sheet with leverage reduced to 1.7x. This has been a source of weakness for the group and played a part in an extremely dilutive recent fundraising.

Net debt reduced further to £97.6m (FY 2020: £120.4m) and leverage is at a record low, ‘significantly ahead of previous FY 2021 target’. The sale of Laois completed April 2021 for €11.2m and a refinancing process is underway, which could lead to a ‘material reduction’ in group interest cost.

The biggest single line item is still borrowings, however, at £156.9m, followed by goodwill of £155.9m. So if this is what a much improved balance sheet looks like, I dread to think of what the picture might have been a couple of years ago. To be floating a company in that financial position seems poor.

Net tangible assets after stripping out the large goodwill line are -£34.6m. That’s actually an improvement but I still can’t get over the state HSS must have been in. What were the top level conversations like that allowed the financial health to deteriorate so alarmingly, and then to float the company to public market investors?

There’s been a huge level of equity dilution and the level of absolute debt is still more than the group’s entire market cap.

Conclusion

Financial health to one side for a second, the trading results do look good to me. With societies reopening, rental hire business should be expanding and profits could increase materially with a degree of operational gearing, so it’s worth looking over this sector in more detail.

It’s much better than the historic results. So HSS could be the highest risk, highest reward way to play a recovery in these markets.

The group has successfully reduced its leverage and it looks like good work has been accomplished in turning around the business. It could come just in time for strong market conditions. All the key profitability metrics are up year-on-year.

But I’m not tempted here on account of the poor historic trading track record, along with the equity dilution, and the condition in which this company was presented to the market. It’s no coincidence that the StockRanks give a Quality Rank of just 18.

It’s worth investigating for those with a higher risk tolerance that specialise in this kind of situation, considering the recent fundraise, the low share price, improved balance sheet, and potential scope for increased profits via revenue growth and operational gearing. With that mix of ingredients, the upside can be significant - the shares are up c14% this morning, for example. It could be that a period of sustained buoyant market conditions can help transform HSS.

But you’d need to be sure the company has turned a corner, and you’d need confidence in the management team to buck the historic trend. These results are positive, but it’s a shame it’s had to take so much equity dilution to get to this state - and there’s still more work to do on the balance sheet in my view, if the company is to survive the next lean period without further diluting shareholders.

It looks like liquidity is also an issue, with a c40% free float and an exchange market size of 15k suggesting about £3k worth of stock can be reliably bought or sold.

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Nwf (LON:NWF)

Share price: 197.44p (+3.92%)

Shares in issue: 49,134,163

Market cap: £97m

NWF Group is a specialist distributor of fuel, food and feed across the UK established way back in 1871. It works in:

• Fuels – NWF Fuels is a leading distributor of fuel oil and fuel cards delivering over 695 million litres across the UK to 127,000 customers.
• Food – Boughey Distribution is a leading consolidator of ambient grocery products to UK supermarkets with over 1,000,000ft² of warehousing and significant distribution assets.
• Feeds – NWF Agriculture has grown to be a leading national supplier of ruminant animal feed to 4,550 customers in the UK, feeding one in six dairy cows in Britain.

AGM Statement

Philip Acton, Chairman, comments:

Overall trading in the first quarter, which is typically our quietest period, has been consistent with the Board's expectations and ahead of the prior year, with a reduction in net debt compared to the same period last year.

Fuels has managed the expected increased level of commercial demand and traded in line with expectations over the quiet summer period. The price of Brent crude has fluctuated in a range between $66 and $78 per barrel.

The board continues to look at acquisition opportunities in Fuels for further expansion of the business.

Food has been trading ahead of expectations with robust demand across all sectors; storage has been fully utilised and operating efficiency has continued to improve.

In the Feeds division, volumes are lower given lower levels of merchant business and good forage conditions, resulting in a weaker performance against expectations over the quieter summer period.

Looking ahead, the strong milk price is supportive of demand from dairy farmers, which is the most significant customer segment. Commodity prices have remained elevated in the year to date.

Conclusion

A short update, but a fairly positive one. The current valuation appears modest but that’s fairly normal considering the group’s spread of businesses.

Growth rates are slightly pedestrian, but this is a solid enterprise that has been in business for a long time, and that brings some value for prospective shareholders. Particularly long term income investors. NWF has a great track record here.

Operating margins are very low - around 1.8% at the moment - but the group has proven it can generate profits quite robustly and has sailed through the Covid pandemic with barely a dint in performance. It’s a resilient business that’s largely immune from the economic cycle, because people will always need fuel & animal feed.

What’s more, cash flows comfortably cover earnings over time. It’s a decent business: a steady, sensible candidate for long term income, but I do wonder about the potential opportunity cost given recent growth rates.

You can find much worse propositions out there, that’s for sure - I just wouldn’t expect fireworks in terms of capital appreciation. Perhaps a potential acquisition for the Fuels business could change that.

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Parsley Box (LON:MEAL)

Share price: 68.02p (-31.01%)

Shares in issue: 42,186,882

Market cap: £28.7m

Thanks to Mojomogoz for flagging this one.

Parsley Box is a lockdown listing and, so far, not the best advert for IPOs. The shares were originally priced at 200p and around six months later they sit at 68p.

Anecdotally, I’ve been saturated with apps and companies asking to deliver things to my door in exchange for a subscription. Not all of these companies can become seriously profitable I feel, although a few will.

Brokers expected Parsley Box to turn a profit in FY22, after generating losses and building out the business.

The shares have been marked down by more than 30% today though, so it will be interesting to see if these targets remain once the dust has settled.

Trading update

The group has recorded 18% year on year revenue growth for the 8 months to 31 August with revenues of £17.8m (2020: £15.1m). Products shipped also grew by 18% in the same period to 7.8 million units (2020: 6.6 million).

But Parsley Box is experiencing labour issues throughout its supply chain and is struggling to source stock. The group is therefore reducing its investment in marketing, ‘and this is likely to continue until the expected short-term supply chain constraints recede’.

Full year revenue is now expected to be c£25m, slightly ahead of last year’s £24.4m, and this reduction will impact on the loss before tax. That’s a steep reduction in revenue guidance, down by about 22.8% from £32.4m. I imagine the loss before tax will be quite a lot bigger than FY20’s -£3.18m and more than the forecast FY21 -£4.6m.

FinnCap is penciling in an FY21 EBITDA loss of £8m now, with marketing slashed from £8.1m to £2m in FY22 and from £8.8m to £2.2m in FY23. That’s going to have some significant implications on the revenue growth trajectory.

The Group's cash balance at 31 August 2021 was £5.7m.

These supply chain issues should sort themselves out at some point but it’s hard to say when exactly, and it’s this kind of uncertain position where balance sheet strength and liquidity headroom really come into play, particularly for loss-making newer companies. So far annual cash burn at Parsley Box has been relatively modest at around £1.9m in FY19 and £1.6m in FY20.

Conclusion

There’s a growing list of companies getting caught out by these supply chain issues. That said, these well flagged dynamics appear to have hit Parsley Box particularly hard.

The company could survive for a couple of years without diluting shareholders, but cash that was earmarked for growth spend will instead be diverted towards maintaining operations, and that affects the group’s growth trajectory. Growth assumptions are obviously important for valuing companies like Parsley Box, and FinnCap has slashed its price target from 180p to 75p.

The broker says: We do not anticipate a recovery in the share price until supply has been restored. The sooner, the better. This is from a broker paid by the company to update the market, and the language is quite somber.

Quite a lot of work needs to be done here, with not a lot of cash and some extremely uncertain market conditions. On top of that, I’m not all too convinced about the size of the market opportunity.

The company has shown that it can grow revenue quickly, however (it jumped from £6.11m in FY19 to £24.4m in FY20) so perhaps in time it can resume that trajectory, but for now the story has changed and I wouldn’t be prepared to take the risk until there is more clarity.