Small Cap Value Report (Tue 1 June 2021) - CHH, SAA, GHH, SPR

Good morning, it's Paul here with the first SCVR for this bank holiday week.

Timing - update at 14:09 - I'll leave it there for today, as Tamzin wants to chat to me for PIWorld at 3pm, and I want to have a cup of tea & soak up some sunshine before we get stuck into that. Therefore, today's report is now finished.

Agenda -

Paul's Section:

Churchill China (LON:CHH) - in line with expectations trading update. Healthy order book. Upbeat-sounding, but noticeable for a complete lack of figures! This is a good company, but the share price now fully prices-in a recovery to 2019 performance.

M&c Saatchi (LON:SAA) - shares are up today, on a strong trading update. This one is a bit too complicated for me, with previous accounting issues, I'd rather leave it alone. Although macro conditions now seem to be good for PR/marketing companies, so it could have further upside perhaps?

Gooch & Housego (LON:GHH) - improved H1 profits, but that's due to excluding restructuring costs, including them gives a result barely above breakeven. Solid balance sheet, and upbeat outlook. I'm struggling to justify the valuation though, it does look as if upside is already priced-in, as with many shares I look at currently.

Springfield Properties (LON:SPR) - strong trading update, significantly ahead of expectations. Looks good.

---

Paul’s Section

Churchill China (LON:CHH)

1708p (pre market open) - mkt cap £188m

AGM Statement (trading update)

Churchill China plc (AIM: CHH), the manufacturer of innovative performance ceramic products serving hospitality markets worldwide, will hold its Annual General Meeting at 12 noon today. At the meeting, Alan McWalter, Chairman, will make the following statement...

It’s upbeat-sounding, but in line with expectations -

Whilst the Company is currently trading in line with the Board's expectations, we remain mindful of the potential for further impact on our revenues and operations from future market restrictions and therefore continue to maintain operating flexibility and a sound financial base…

… We believe our decision to maintain operating levels will stand us in good stead and that the level of momentum within the business will allow us to meet our target performance levels both in the short and longer term."

• Quiet Q1, due to lockdown
• Growing evidence of recovery (as reported on 19 April 2021)
• Increased activity has continued in last 6 weeks
• Healthy order book (no figures provided)
• UK leading the recovery, export markets also now improving

My opinion - I would have preferred to be given some actual numbers, instead of this rather vague update with no figures. Bottom line, it’s trading in line with expectations, so that’s OK.

Key question at the moment for all companies we look at - did CHH dilute its shareholders with a fundraising during the pandemic? No, it doesn’t seem to have done - the great benefit of having a strong balance sheet. The share count seems to have remained static at 11.0m in issue, the same since 2015 according to the StockReport (see “Average Shares” row on the table of figures, then the most recent position is at the bottom of the StockReport, “Shares in Issue”).

In 2019 CHH reported 80.8p normalised EPS. Assuming it recovers to the same level in due course, then the PER would be 21.1 times - i.e. full recovery is already fully priced-in. How does that make sense, given that full recovery hasn’t happened yet, and there are still risks?

Nice company, but I don’t see risk:reward being attractive at this price, unless you think the company can achieve better than pre-covid profits. I'd say the re-opening trade has now happened, with the smart money buying 6 months ago, not today.

.

.

---

M&c Saatchi (LON:SAA)

142p (up 11%, at 08:51) - mkt cap £174m

Trading Statement

We navigate complex change, to create new opportunities with technology and creativity, and to lead the way forward. We Navigate, Create and Lead Meaningful Change for our clients and the world.

[from mcsaatchi.com]

Or the way I look at things, it’s a PR company.

Positive trading -

Trading in the first four months of the year has been stronger than anticipated. As a result, the Board now believes the financial results for the full year will be ahead of consensus expectations.

No asterisk provided, to tell us what those expectations are. So not very good communications there, from this communications company.

Stockopedia shows 0.49p forecast EPS for FY 12/2020, and 2.65p for FY 12/2021.

See the graph below, for how drastically lower the broker consensus forecasts are now, than pre-covid. Hence today’s update needs to be seen in the context of stepping over a very low bar.

.

Other points in today’s update -

• New business performance is robust, with example client names given
• Diary date - results for FY 12/2020 due end of June 2021 - a very slow reporting timetable again
• Refinanced bank facilities, from £38m to £47m NatWest/Barclays, 3-year term
• Liquidity - currently holds £30m net cash - impressive

Dilution - yes, it has raised fresh equity during the pandemic. The latest share count is shown as 122.3m on the Stock Report, which compares with c.90m in 2019 (pre-pandemic). Hence pre-pandemic earnings need to be adjusted for this c.35% increase in share count. I would divide previous peak earnings by 1.35, to get to the equivalent figures now, with the larger share count - that’s quite a material adjustment, and I wonder how many people might overlook this point and hence over-value the share?

Put options scheme - I tried to unpick what’s going on with this ill-fated options scheme, here whilst covering the reasonably good interim results published on 28 Oct 2020. This shows how put options could cause large dilution, although the rising share price since has reduced the potential number of shares to be issued. At that time, the company was negotiating with holders of the put options to get them to switch the cash payments instead. I’m not sure what the current status is of this issue, but am flagging it here as a material problem, which anyone considering buying the shares needs to be aware of, and properly investigate for yourself, to ensure you’re happy with things. I see from an update on 4 May 2020, some of the new shares issued are due to conversion of put options. Another similar announcement was made on 20 April 2020. It would be good to find out how many put options remain.

My opinion - checking back through my notes here, there have been big problems at SAA in the past, which the market seems to now be happy to ignore. Its shares were suspended, due to a delay in publishing 2019 accounts, then resumed trading on 7 Dec 2020.

There’s also the material issue of the put options, mentioned above.

Positive current trading, and a more favourable macro environment are bull points. I can see why people would be keen to invest in PR companies, as the general economic situation seems to be improving strongly, as a V-shaped recovery appears underway in the UK, and USA, and presumably Europe, when their vaccination programmes allow re-opening.

Overall, I’ll just say I’m neutral on SAA.

I prefer simple, clean accounts, and don’t really want to invest in companies where you have to make guesses about key issues, and where there have been accounting issues previously.

Note that highly regarded investor Vinodka Murria holds 12.5% of SAA shares, a big vote of confidence, so she must have investigated the above issues and been happy with the situation, I assume.

.

.

---

Gooch & Housego (LON:GHH)

1330p (up c.2% at 11:00) - mkt cap £332m

Interim Results

Gooch & Housego PLC (AIM: GHH), the specialist manufacturer of optical components and systems, today announces its interim results for the six months ended 31 March 2021.

Sustained recovery in industrial lasers contributes to profit growth and positive outlook.

We’re just starting to catch the start of the pandemic in prior year comparatives, with 31 March period ends, so that needs to at front of mind from now on - i.e. as the prior year comparatives get softer (from lockdown 1), performance this year should be much stronger. Comparisons with 2019 are also useful, to give a comparison with the last normal year, so I very much encourage City folks reading these reports to bear that in mind when advising your clients.

The highlights section contains some positives (that’s what it’s there for!) - revenue only slightly up, but profits & EPS are strongly up (although note most underlying profit comes from excluding £4.2m restructuring costs). H1 statutory profit is negligible, at £670k, only 2.1p EPS.

Net debt mostly paid off, and divis resuming, all good -

.

.

Points of note -

• Restructuring to deliver £1.75m profit benefit in FY 09/2022
• Order book up 1.3%, or 7.9% at constant currency - note the difference is quite significant there, due to the considerably strong pound I suppose
• Full year expectations unchanged, despite currency headwinds
• Good demand, apart from commercial aerospace (I’m guessing that is likely to improve, as travel opens up again)
• Growth in contribution from new products
• Investment in capex, R&D, “moving up the value chain”, and possible acquisitions

Balance sheet - looks strong. NAV £111.4m, less intangible assets of £51.6m, gives NTAV of £59.8m, which strikes me as more than adequate.

Working capital is strong, with the current ratio a very healthy 3.42, although there is £19.95m borrowings lower down, in non-current liabilities.

Overall, no issues here, it looks fine to me.

I doubt very much GHH would have needed to raise fresh equity in the pandemic. Sure enough Stockopedia figures show the share count static for years, at 25.0m - that’s what I like to see.

After all, as a shareholder generally, I want to benefit from the future upside, not see myself diluted every time there’s a financial downturn of any kind.

Valuation - as always, this is the tricky part. GHH seems a nice enough business, but the Stockopedia graphical history below shows that it wasn’t really demonstrating any profit growth pre-pandemic.

An (expensive at £7.5m anticipated full cost for FY 09/2021) recent restructuring programme to deliver £1.75m profit growth, doesn’t jump out at me as necessarily money well spent, but management must know what they’re doing.

.

My opinion - I always think of this company as a really high quality outfit, but am starting to wonder if that’s correct? The history isn’t particularly special, although it has proven resilient throughout the pandemic.

Finncap has put out an update today, 36.4p EPS for FY 09/2021, and 42.9p next year. At 1330p current share price, that’s a PER of 36.5 and 31.0 times - a rating that is hard to justify.

Although as David Thornton of Growth Company Investor (which is very good actually, I’ve recently subscribed after being impressed with David’s commentary on PIWorld interview) points out, many broker forecasts are currently way too pessimistic, misleadingly so, to use his words.

It all therefore boils down to whether you think GHH could thrash existing forecasts or not. I have no idea, as I cannot reliably predict the future. I’d rather pay a PER in say the high teens, and then out-performance against forecasts is my upside, if it happens. Here, we’ve being asked to pay up-front for future out-performance against at least this year & next year’s forecasts. I’m reluctant to do that, but good luck to holders.

Mind you, look at the long-term chart below - staggering gains from the March 2009 low in particular. Maybe it's worth paying up for companies with superb long-term track records? There's a lot to be said for that.

.

.

---

Springfield Properties (LON:SPR)

168p (up 12% at 13:44) - mkt cap £171m

This is a housebuilder in Scotland. I’ve only looked at it once, here on 23 Feb 2021, and quite liked it, concluding: It’s got a solid balance sheet, outlook comments sound upbeat, and valuation seems reasonable..

Trading update today has put 12% on the price, so must be good.

SPR’s year end is 31 May 2021, hence this is a year end update.

Strong build & sales activity has continued in H2

Sold 200 plots of land to national housebuilders

Overall - contradictory messages here. It’s ahead, then significantly ahead -

... the Group expects revenue and profit to be ahead of market expectations, reflecting significant year-on-year revenue growth....

... the Group expects to report revenue and profit for full year 2020/21 significantly ahead of market expectations, reflecting significant year-on-year growth. The Group has also continued to substantially reduce net debt throughout the year.

There’s lots of green on the Stockopedia growth & value section, which I like very much. Also earnings forecasts will be raised after today’s strong update. There’s also a high StockRank.

.

.

My opinion - looks good, I like the numbers here, and it’s worth readers taking a closer look.

Obviously we know that the housing market is benefiting from Govt stimulus measures, so that might need to be factored into calculations.

Much larger housebuilder Barratt Developments P L C (LON:BDEV) is on a forward PER of 10.2, with a 4.9% dividend yield, so it’s worth bearing in mind that the sector looks cheap overall. How SPR compares, would be worth considering - if they’re all cheap, then I’d lean towards a larger share, as it’s easier to go in & out of, for a minimal spread. Although smaller companies might have faster growth potential possibly? Your money, your choice!

.

.