Small Cap Value Report (Tue 10 Jan 2023) - SOS, MORE, CHH, CARD, AO., TGP, WAND, TM17, SCS, SHOE

Good morning, it's Paul & Graham here today.

Okay, all done for today. We've got a list of backlog items, so will try to circle back later this week, if time permits. 

Top 20 value/GARP ideas - this article I published yesterday went down well, with 187 thumbs, so clearly subscribers like the idea of me flagging the most interesting value/GARP shares I've come across whilst writing these reports. Also, I'm delighted to see subscribers answering the call to list your own favourite shares (with reasons) in the comments. So that's well worth a read, if you haven't already looked at it. Lots of interesting share ideas for us to research.

There are loads more good shares on my watchlist, so I'll write up a second article, with the runners up on it. Not sure on timing, but some point this week, maybe the weekend? Also I'm planning a third article with 20 more speculative ideas (it's half done already, on the same spreadsheet).

It will be interesting to measure how these lists of share ideas perform. Although of course short-term, the market can do anything, so I won't be surprised if there's a say 10-20% drawdown at some point during the year, we have to expect that in volatile macro/market conditions, which suggests that keeping a bit of cash on the sidelines for buying the dips, and top slicing big bounces, might be sensible, if you think you can time the market - but easier said than done!

A lot of it also depends on whether value, or growth will be the dominant theme this year. Growth has certainly been skewered in the last year, as higher interest rates caused high PERs to crumble, puncturing the latest tech bubble.

So anyway, more lists of share ideas to follow, from me! And keep yours coming too, I always find it very interesting to look at what companies you rate highly, and it's a great way of finding new ideas to research, when we share our top shares lists.

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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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Agenda

Paul's Section:

Sosandar (LON:SOS) - [quick comment] - trading update out promptly on its busiest season, Q3 (Oct-Dec 2022). It continues to shrug off the consumer downturn (affluent customers, so not likely to be impacted by cost of living squeeze?), with +30% revenue growth for Q3 - slower than previous outstanding growth rate, but still remarkably good (and all organic too). Main point is it continues to trade in line with expectations for FY 3/2023 (co. guidance: revenues £42.8m, and PBT £2.0m). Cash position sounds OK, at £4.6m (up slightly in Q3) - I think it won’t need another placing, now it’s profitable. Last sentence suggests international expansion (via partners) is next on the agenda. My opinion - looking good, I remain very positive on this company, whilst recognising there is macro/fashion risk. (no section below)

Hostmore (LON:MORE) - [quick comment] - CEO resigns - probably for the best. COO Julie McEwan (COO) becomes interim CEO, as search begins for permanent replacement.

Trading for H2 (Jul-Dec 2022) - revenue trend for H2 overall is unchanged at -14%, as reported previously 22 Sept 2022 update I reviewed negatively here. This is in comparison with pre-pandemic 2019 numbers, which is hopeless - decent revenue growth is necessary to cope with higher costs (esp wages), so a decline is really bad. Net bank debt now £29.5m - better than guided, but worryingly high for a company that is performing badly. Finncap reduce forecasts this morning, now expecting a £(5.0)m loss for FY 12/2022. As I’ve mentioned before, FY 12/2023 forecasts don’t look realistic to me (too high). I reiterate my comments in Sept, that this share is now high risk due to combination of poor performance & high bank debt. Too risky - it might need to do an emergency fundraise, or worse. It’s gone horribly wrong unfortunately, so the sceptics were right. (no section below)

Card Factory (LON:CARD) - [quick comment] - we’ve been increasingly impressed with the trading updates from this greetings card retailer as 2022 has progressed. Risk receded, due to strong trading combined with renegotiated bank facilities. Today’s update is for 11m to end Dec 2022. Store revenues +7.1% LFL (impressive, up from +6.2% when last reported in Nov 2022!). Online hurt by Royal Mail strikes, down 28% on LY.

New guidance: £48m PBT (includes £3.5m one-off gains, so £44.5m underlying PBT). This is up from last guidance (Nov 22) of £37.5m PBT.

Net bank debt £46.5m (usefully down from £60m a year earlier). Outlook sounds confident - as a value retailer, it’s seeing good demand. Favourable hedges on energy (Sept 2024), and currency (for most of calendar 2023) at better than current forex rate.

My opinion - the strong share price looks fully justified to me, and valuation still reasonable based on my calculations (can’t find any broker notes). I mystery shopped a store yesterday, and impressed with the 5 for £1 cards - tons better than previous 10 for £1 cards, and staff told me the 5 for £1 cards in the doorway draw customers in. Thumbs up from me, well done to holders, you’re onto a winner here I reckon. If I owned CARD, I’d probably be holding, resisting the urge to top slice, because the improving fundamentals & reduced risk fully justify this recent big move up in share price. Well done to holders! (no section below)

Tekmar (LON:TGP) - Tekmar [quick comment] - this has cropped up on the top daily risers list, up 32% to 17.5p. It announces a M.East contract win of £8m, which should fall into the current FY 9/2023. I flagged this share here on 22 Dec 2022 at 10.25p, on a big contract win announcement (Dogger Bank wind farm), saying that it’s risky, but starting to look interesting as a possible recovery. More contract wins today reinforces that view. So I’m flagging it again, as something that more risk tolerant micro cap investors might want to do more research on. It looks an interesting company in a good sector, but there are risks over potential dilution, which would need careful scrutiny. (no section below)

WANdisco (LON:WAND) - [quick comment] in a similar vein, WAND announces another contract win for $6.6m, with a telecoms company, for a one-off data migration. It sees this industry as “being a core and growing market”, with a “healthy pipeline of further opportunities”, and “potential for significant expansion opportunities with this customer”. I have no idea how to value this share, but the newsflow seems exciting. For that reason, it’s on my list of speculative share ideas for 2023 (not finished yet, it's WIP). (no section below)

SCS (LON:SCS)  - [quick comment] - worth noting that it has bought a (predominantly) online competitor (Snug Shack Ltd - co no 11397728) out of administration for only £875k. Yet this bolts on revenues of £20m pa (for FY 12/2022). SCS expects it to be profitable from its FY 7/2024. This looks a really good deal, as it’s complementary products, differentiated, with online expertise, and potential to include the new brand as concessions within SCS stores. This is a reminder that during downturns, cash-rich companies can absorb competitors for peanuts, which powers the next round of future growth. SCS shares are a value favourite of mine, and continue to get thumbs up from me. (no section below)

Shoe Zone (LON:SHOE) - our only big section today, as I run through the FY 9/2022 final results - see below. An enthusiastic thumbs up from me, I think this share is likely to do well again in 2023.

Graham's Section:

Churchill China (LON:CHH) - (£131m pre-market) [no section below] - this maker of ceramic products issues a brief full-year trading update for 2022. “Sound performance” continued over the final months of the year so that PBT will be “at the upper end of analyst expectations” (helpfully provided by the company as having a range of £8.0 - 8.8m). Both export markets and the home market are mentioned positively, and margins, while still lower than previous years, have improved in H2 (probably through higher selling prices as the company passes higher input costs onto customers?).

Paul covered this stock in detail in September. 2022 was very successful, but I share Paul’s concern that 2023 might be a bit trickier: the company previously said that their energy costs were “largely hedged well into 2023”. So at some point not very far away, the hedges will expire and the company will be exposed to probably quite significant cost increases, on top of the other cost increases (e.g. materials) that have already taken a chunk out of margins. More positively, demand appears to be holding up for now as incoming orders are said to be “satisfactory”. Most investors consider this to be a high-quality stock and I tend to agree. Trading at a PER of around 16x, with some headwinds on the horizon, I suspect that it’s fairly priced at this level. [no section below]

AO World (LON:AO.) (£401m pre-market) [no section below] - I wrote in November that AO was now “acting like a proper company, being run on behalf of its customers and its shareholders”. This was in contrast to the prior cash-burning strategy which seemed destined to end in disaster. At some point last year, perhaps when cash started to run low and things looked a bit shaky, AO’s management had a Road-to-Damascus moment and realised that life would be easier if they stopped messing about with their previous plans, and instead did whatever they could to earn profits and generate cash (!). After closing their German operations, they found many other ways to reduce costs and improve margins.

These actions are “gaining traction” and profitability is now running ahead of expectations. Adjusted EBITDA for FY March 2023, instead of being at the top end of a £20 - 30m range, will instead be somewhere within a £30 - 40m range. I’m still not sure that the company’s £400m market cap is justified but I wouldn’t want to bet against it as I think the company now has a great chance of repairing its net debt position and generating sustainable returns for its shareholders at last. Kudos to management for changing strategy and improving the performance of this former basket case. [no section below]

Team17 (LON:TM17)   Team17 (LON:TM17) (£644m) [no section below] - we covered two profit warnings from the video games sector yesterday, as both Frontier Developments and Devolver Digital missed expectations. In each case, I saw stock-specific reasons for the disappointment. In the case of Frontier, a flagship title had failed to capture the imagination of fans. In the case of Devolver, I viewed it simply as a poor-quality IPO.

Team17 is one of the few other London-listed video game stocks, and its shares were down intraday by 17% yesterday afternoon. It therefore decided to reassure its investors and published the briefest of trading updates, confirming that “trading for the year ended 31 December 2022 will be at least in line with market expectations”. A scheduled trading update will be published next week (hopefully with more detail!). Team17 shares are still 6% lower than they closed last week, despite the reassurance given, so anyone who had this on their watchlist may be interested to take a closer look now.

As I said yesterday, the video game industry has its own cycles that are distinct from the economy as a whole, and each video game company has its own idiosyncratic performance based on its release schedule and the success of its individual titles. Solid results from the likes of Team17 should, I think, help to cast doubt on macro excuses provided by any other video games companies.

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Paul's Section:

Shoe Zone (LON:SHOE)

217p (up 6%)

Market cap £106m

This share has done so well, more than tripling since Oct 2021 when the bull run began. We’ve reported on it loads of times here, since it keeps putting out positive trading updates, cleverly pitching guidance a bit below what looks achievable, but also genuinely enjoying strong demand (and high gross margins) by offering value for money products when consumer incomes are squeezed. So I like this company a lot, and also the founder management still has a lot of skin in the game. A strong balance sheet provides downside protection & ability to pay healthy divis. Lots to like here!

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Today’s announcement -

Final Results

Shoe Zone is pleased to announce its audited results for the 52 weeks to 1 October 2022

Revenue £156.2m (up 31% vs LY)
Adj PBT £11.2m (up 18% vs LY)
(adjustments exclude profit on sale of freeholds, and forex gains)
Adj EPS is 17.9p (per Zeus note) - so PER is 12.1x (at 217p per share)

Stores - a striking fall in the number of stores, 360 at period end (down 50 in the year). What it calls “Hybrid” stores is the growth area -

o 45 Big Box (2021: 51)

o 44 Hybrid (2021: 16)

o 271 Original (2021: 343)

Very short average leases (good) of 1.8 years, and an average reduction of 30% in rent on lease renewals. This flexible lease portfolio is I think a key advantage.

Digital revenues - £26.4m is only 17% of total revenues, and down 13.4% on last year. So the stores generate the bulk of revenues, and are more important. Also, with covid receding, there was a shift back from online to stores. Note that the online returns rate is amazingly low, at just 11.3% (up from 8.4%), and are often returned to the physical stores. This makes online an unusually attractive proposition for SHOE, so I’d like to see them driving that side of the business harder, as the economics of it (high gross margins, low returns rate) should make it very profitable, compared with say the fast fashion eCommerce companies, which face returns rates of c.50%, and hence struggle to make any profit.

Dividends - are generous - proposed final divi of 3.3p (LY: nil), plus a special divi of 8.2p (LY: nil), comes on top of an interim divi paid in Aug 2022 of 2.5p. That lot totals 14.0p, giving a yield (incl. special) of 6.5%. Bear in mind also that these are the initial divis after a pandemic-related hiatus (divis last paid in 2019), so I tend to find that when divis initially resume, they tend to be pitched at a fairly low level, which can then be raised in future. That looks likely hare, and judging from the healthy balance sheet & cashflows, I’d say the future divi paying capacity looks healthy. So this is a nice income share.

EDIT: I've just remembered to mention that it's currently doing share buybacks too, which enhances EPS.

Also, Zeus has total divis for FY 9/2022 at 17.0p, so it looks like there was another 3.0p divi to include which I missed, sorry about that.

I can't see why management would want to hoard any more cash, so it looks as if pretty much all future earnings are capable of being paid out in divis - very encouraging for shareholders I think! After all, future dividend paying capacity is more important than actual short term divis.

Balance sheet - looks very healthy to me, particularly as the context is a decently profitable & cash generative company (where investors don’t generally need to rely so much on balance sheet downside protection).

I won’t go through all the detail, because it’s all very healthy, with £24.4m net cash (all loans now paid off). Inventories are up, but a sensible reason given (earlier intake of stock to be sure of no supply chain disruption - that’s fine, as it should unwind back into cash in future).

There’s about a £10m deficit on the lease entries, which surprises me, given how short the leases are - implying it still has some loss-making sites - these are likely to be closed I imagine, giving upside to future profits?

Note the small pension deficit has disappeared. The commentary says it’s now an accounting surplus of £1.8m, which is not shown on the balance sheet. I wonder if it might become possible to offload the pension scheme, as TTG and RBN have recently done via insurance companies?

Cashflow statement - is nonsense, due to IFRS 16. However, the bottom line is that cash rose by £5.4m, which is after repaying £4.4m of bank debt in full, and absorbing £5.2m capex. So this is a genuinely decent, cash generative business. Although cashflow did get a boost from selling £3.6m worth of 14 freehold properties - sounds like a shrewd move given valuations have probably since fallen at a guess.

Outlook - I can’t see anything on current trading or outlook,so if I’ve missed it, please post a comment to correct me.

My opinion - this looks really good. I think the valuation has probably caught up with events, but I can also see good longer-term potential here. In particular, the online side of things looks ripe for development, and having just 11% returns rate is a stunning advantage over fashion eCommerce. Also the stores are being revamped and relocated to maximise profits.

Overall, I can’t fault this, and give it an enthusiastic thumbs up, particularly as the forecasts for FY 9/2023 look modestly set - hence I reckon we’re likely to see a repeat of the established pattern of trading updates that beat expectations, as 2023 progresses. It’s value for money product too, exactly what lower income families need right now.

Risk? Sourcing from China is the only major thing I can think of, but that affects many businesses.