Small Cap Value Report (Tue 10 May 2022) - SUP, NWF, TET

Good morning, it's Paul & Jack here with Tuesday's SCVR.

Chaotic market conditions continue. I'd love to have a pearl of wisdom to make everyone happy, but can't really think of anything.  We're not traders here, but are focused on the company fundamentals being reported. It strikes me (Paul) that the current panic sell-off seems overdone, and I'm just ignoring it because my shares are long-term investments. My SIPP is now down 28% year-to-date, and down 37% from the all-time high, but I'm very happy with all the positions, so it should come back up again in time, as has always happened in the past.

We've got a nice community here, so please do continue sharing your thoughts. I read them all, but wasn't really in the right frame of mind last night to reply, when I got back from my local.

---

Agenda - 

Paul's Section:

Supreme (LON:SUP) - a reassuring update, saying that it supplied only a negligible amount of products to McColl's, and it was supplied via Morrisons. Therefore SUP has no bad debt exposure to McColl's.  There's also a brief trading update saying SUP is "trading well".

Nwf (LON:NWF) - yet another upgrade to forecasts for FY 5/2022. That's at least 3 upgrades, just in the last 3 months! Although before we get too excited, NWF does say that conditions for its oil supply busiess are "exceptional", hence unsustainable. This looks a solid company, and its shares mainly appeal for a reliable divi yield & inflation protection.

Jack's section:

Treatt (LON:TET) - revenue up 9% despite a one-off first half last year, and forecast to be up by more than 15% for the full year, although profits are down after accounting for a net gain on property disposal. The group’s new UK facility is an important factor in the valuation as it could drive significant growth, but high valuation multiples are at risk of a derating in the current environment so I’m wary in the short term.

---

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.

---

Paul’s Section:

Supreme (LON:SUP)

135p (pre market open)

Market cap £157m

Sale of McColl’s Retail Group

Good news for SUP shareholders, as the company seems to have dodged a bullet re McColl’s being placed into administration yesterday (thus wiping out MCLS shareholders, as expected).

Breaking down SUP’s announcement into parts -

Supreme (AIM:SUP), a leading manufacturer, supplier, and brand owner of fast-moving consumer products, notes confirmation of the sale of McColl's Retail Group plc ("McColl's") to Alliance Property Holdings, part of the Morrisons Group ("Morrisons").

No bad debt exposure to SUP, it seems (not clear if this was by design, or an accident! -

The Company wishes to clarify that it has always served the McColl's store estate via a distribution agreement with Morrisons (meaning Supreme delivers and invoices to Morrisons directly).

Sales via MCLS were negligible for SUP anyway -

The Company estimates that the McColl's estate contributed approximately £350k in revenue to the Group (less than 0.5%) for the year ended 31 March 2022.

Trading update for SUP of sorts. I think we have to assume that it’s trading in line with expectations, why didn't they just say so?! -

The Company continues to trade well and looks forward to updating the market further at the announcement of its year end results in July.

My opinion - a reassuring update from SUP. It sells small ticket, repeat purchase type products, so I imagine should be fairly resilient in a higher inflation environment.

I remain of the view that this share looks good value, and seems to have a decent business model & entrepreneurial management.

The forward PER is now only 10.0, with a forecast dividend yield over 5.0%. Therefore the current share price plunge looks irrational to me, and down to market conditions rather than company fundamentals.

More generally, it’s still not entirely clear how the sale of McColl’s to Morrisons is going to impact trade creditors. Press reports so far have concentrated on the position re bank debt & pension scheme, but remember companies often have as much, or even more, trade credit outstanding - because suppliers typically give 30-60 days credit on the goods they send in to retailers. When McColl's last published its balance sheet, trade creditors was a frightening £187m, so this looks very nasty for the suppliers concerned, if they didn't have credit insurance.

I see from an announcement last night, that MCLS has confirmed administrators from Price Waterhouse Coopers (my old firm, 30 years ago!) have been appointed. I did hear suggestions that it might only be the plc holding company that goes into administration, but it seems to have been some subsidiaries too. 

The directors of the Company and of each of Martin McColl Limited, Clark Retail Limited, Dillons Stores Limited, Smile Stores Limited, Charnwait Management Limited and Martin Retail Group Limited have appointed Mark James Tobias Banfield, Robert Nicholas Lewis and Rachael Maria Wilkinson of PwC as Administrators of the Company and of the named subsidiaries.

This makes me speculate that MCLS trade creditors are probably likely to suffer bad debts. Normally trade creditors rank as unsecured creditors in insolvencies, which usually (but not necessarily) results in them getting nothing - because they rank behind secured creditors (banks usually), and preferential creditors. Shareholders are at the bottom of the pile, so they get nothing.

If that’s correct, then there are likely to be lots of other companies reporting bad debts to McColl’s, if they supplied it directly (i.e. not via Morrisons, which will obviously be honouring its trade creditors). Supreme is in the clear though, with no exposure.

.

.

---

Nwf (LON:NWF)

213p (up 7% at 08:39)

Market cap £105m

Trading Update

NWF Group plc ('NWF' or 'the Group'), the specialist distributor of fuel, food and feed across the UK, today announces a further trading update for the current year ending 31 May 2022.

We last looked at NWF here at the end of March 2022, with a positive trading update. This agricultural group is benefiting from the higher oil price & shortages.

Today we get another hike to forecasts -

Further to the trading update of 31 March 2022, the Group continued to experience exceptional trading conditions in the Fuels business, with very significant short-term volatility in oil prices and a supply constrained UK fuel market.

As a result, performance during the final quarter of the year, to date, has been materially stronger than anticipated with the full year result now likely to be significantly ahead of the Board's previously upgraded expectations.

As I whinged about last time, there is no broker research available. However, the StockReport here is picking up some consensus data. As you can see below, forecast EPS for FY 5/2022 has risen a lot, and this is before today’s further “significantly ahead” announcement. At a guess, we might be looking at say 35-40p EPS for this year, a PER in the range of 5-6, so very cheap.

However, as the company has said before, and repeats today, these are exceptionally (i.e. unsustainably) good conditions for NWF’s profit margins, hence it would be foolish to value any company on a normal multiple of earnings that are seeing a one-off boost for any reason.

Once earnings return to normal, then (as you can see above) a more normal level of EPS is expected to be c.18p - giving a PER of almost 12. That’s still OK value.

My opinion - this share has some appeal, mainly for its reliable & gently rising divis, not so much for capital gains (unless you got lucky and bought at the right price).

I can’t get excited about the repeated out-perform announcements this year, as these are one-offs in exceptional conditions. That said, it’s a nice problem to have - excess profits pouring in! This share is probably best thought of as an income generating investment, that should also have inflation protection built-in, and suitable as a very long-term, hold forever type of share.

.

.

---

Jack's section

Treatt (LON:TET)

Share price: 933.92p (-6.98%)

Shares in issue: 59,898,032

Market cap: £559.4m

Interim results to 31 March 2022

Treatt is a manufacturer and supplier of natural extracts and ingredients for the beverage, flavour, and fragrance industries. It’s a nice, high margin niche which requires specialist knowledge and technology.

But the issue for me is one of valuation - the shares rerated to all-time highs in 2021 and have been rangebound ever since, currently trading at around 33x forecast rolling earnings.

• Revenue +9% to £66.3m,
• Gross profit margin down from 35% to 27.5%
• Operating profit before exceptionals -37.8% to £6.6m,
• Profit before tax and exceptionals -39.4% to £6.3m,
• Adjusted basic EPS -36.5% to 8.21p,
• Dividend +20% to 2.5p.

Profit figures strip out the £3.3m net gain on disposal of Treatt’s old UK premises.

The group says that H1 2021 benefitted from COVID-19 related retail channel growth and significant product launches, and that these results return to a more normal H2 weighting. This has been flagged previously, and the weighting does come across in the interim EPS chart below but, given the valuation, it’s worth noting that H1 EPS was 8.3p in 2018, 8.2p in 2019, and 8.1p in 2020.

Edison’s last note has 32.2p of full year EPS penciled in. That would require Treatt’s strongest ever H2, but the group assures investors that it is on track to meet full year PBT expectations.

The group adds that the first half finished strongly, with momentum so far continuing and an order book up by more than 25%. Revenue growth for the full year is expected to exceed 15%.

Regarding the fall in gross margins, Treatt notes:

Gross profit margins were lower in the Period (27.5% vs 35.0% in H1 2021), reflecting the COVID-19 impact on our H1/H2 weighting last year, as noted above. Alongside the growth in serving our customers' retail channels, H1 2021 also saw some very significant new product launches which further skewed the comparable prior year period's performance. As a comparison H1 2020 margins, which were more reflective of our usual weightings, were 26.2%.

Operating costs increased by 8.9% to £11.7m, almost all relating to higher payroll costs after increasing headcount by 15% as Treatt prepares to capitalise on its new state-of-the-art UK facility.

Workers are currently being moved over, and the group comments:

The final transition to the new site, involving our most complex manufacturing processes, is on course to be completed by the middle of 2023. We now expect that the final costs incurred in relation to the UK site investment and relocation will be approximately £46m-£47m, being 5-6% higher than previously advised as a result of inflationary cost pressures and some higher than originally expected commissioning expenses. Three years post completion, we expect to be generating a 10-15% return on investment ('ROI') from this site. We believe the UK facility, along with our recently expanded US facility, will provide Treatt with the platform needed to support its ambitious growth plans.

Balance sheet

A net cash outflow from operations of £6.8m results from a working capital outflow of £15.1m and a strategic increase in inventory. A further £6.7m of capital investment means that Treatt’s net debt balance has grown from £9.1m to £19.8m. The direction of travel there is negative, but it’s not a concerning level of net debt for an enterprise of Treatt’s scale.

The group’s pension liability has declined, from £6.8m to £3.9m due to a higher discount rate.

Conclusion

This is a good, defensive business which should comfortably survive the macro headwinds buffeting the market right now. Branded beverages are seen as affordable luxuries, and so Treatt is well insulated against rising inflationary pressures.

Meanwhile, a strong order book means the group is confident of meeting expectations for the full year.

The question mark for me is valuation, and what kind of expectations are built into the share price. The stock has held up well recently and retains a lofty rating. That may well reflect the longer term growth prospects, new plant potential, and general sense of security around its operations, but I still struggle to see value here when looking at the rest of the market.

There is the new UK facility, which has the potential to drive expansion and enhance profitability. I get the impression that Treatt has a relatively stable and long-termist shareholder base, which is valuable if true and something of a rarity. On a five-year view it could really do quite well, but sentiment drives prices in the shorter term and so I’m personally wary of initiating a position at present.