Small Cap Value Report (Tue 15 Dec 2020) - PURP, CYAN, TED, TSTL

Good morning, it’s Paul & Jack here with the SCVR for Tuesday.

Timing - today's report is now finished.

There are a couple of stragglers on my pad, that I'll try to look at later this week, e.g. Driver (LON:DRV) . A couple of readers mentioned K3 Capital (LON:K3C) which does look an interesting company, but it's quite complicated to analyse, so would take me too long.

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Mello

Well done to Jack for his appearance in last night’s online Mello investor meeting, it was really excellent. As always Jack was fluent & talked sense, not always easy when the spotlight is on you. David Stredder, who organises Mello events, says that nearly 400 investors joined the event on Zoom.

As a follow-up, there’s another Mello Zoom today at 13:15, to fit in another presentation that there wasn’t time for last night -

Don't forget last night's Gamechanger, Accrol Group, will be doing a full one hour session with Q&A today (Tuesday 15th) at 2pm. Here is the link to tune in and hear from the Directors and ask any burning questions you may have but please note we are recording this one so you will need to be there! [Paul: looks like a typo, I assume they mean they are not recording it? Otherwise it doesn't make sense]

You can click here to access all research notes and investor presentations from Accrol.

We will be starting early (from 1.15pm) to cover unanswered questions from last night's Double Up on Smartspace, so feel free to join us when you like.

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US Election

Thanks to the friend who alerted me that Betfair has just paid out on Biden winning the US Presidential Election. What a pathetic spectacle Trump is making of himself, refusing to concede defeat, stirring up trouble. It makes me feel that, despite its faults, our system here in the UK does at least provide stability, and clean handovers.

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Book recommendations

Which prompts me to give a book recommendation. I’m enjoying John Kampfner’s “Why the Germans Do It Better: Notes from a Grown-Up Country”. It’s an easy listen on audiobook (Audible), and is an interesting run through of post-war German history, economics, and culture. He almost lost me in chapter one, with some snide, sweeping criticism of the UK’s political system, whilst praising Germany to the utmost - a bit ironic if you think about pre-1945 history. Also his arrogant & superficial dismissal of Brexit, permeates and undermines the book. So it’s the type of audiobook where I mutter expletives occasionally whilst walking along Bournemouth seafront after work, to sometimes slightly alarmed looks from passers-by! Still well worth a listen though.

Also, I might have mentioned this before, if you want to have everything you learned about economics at school/university turned on its head, then I recommend Stephanie Kelton’s “The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy”. I’m not convinced by MMT, but nobody can deny that it has worked for the last 12 years or more. This makes things like the crowding out theory, now look completely wrong - e.g. Governments of advanced economies can borrow at high levels, at any interest rate they want, even below zero, something previously thought impossible.

How long can MMT continue before inflation sets in? Nobody knows. MMT’s main flaw seems to me to be that it suggests Governments should simply stop printing money once inflation sets off. Trouble is, that’s not likely to be done. History shows that, once Govts are addicted to deficit spending, financed by money printing, then it’s almost impossible to stop, since that would involve plunging the economy into a deep, self-fuelling depression. Hence they keep printing, until the currency becomes worthless with hyper-inflation, and has to be replaced, with strict conditions attached to bail out loans from e,g, the IMF. This is glossed over in MMT. The messianic zeal of MMT is a bit troubling - if you raise any objections, then you don’t understand - that kind of thing. A fascinating topic though.

I wonder if QE is fuelling various asset boom/bubbles? Things like Bitcoin, Tesla, seem troubling - there are clear pockets of irrational mania in parts of the US markets. Could this be due to huge QE and deficit spending? Seems likely to me. After all, if people are forced out of Govt bonds, they're just going to buy other investments, not spend the cash. Maybe MMT eventually ends with a gigantic financial markets crash, at some point in the future? Who knows!

It seems to me though, that if interest rates are now permanently low, and the money supply constantly increasing due to QE, then UK equities look (selectively) good value.

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Today's agenda

Purplebricks (LON:PURP) - half year results (Paul, done)

Cyanconnode Holdings (LON:CYAN) - brief comment on interim results (Paul, done)

Ted Baker (LON:TED) - belated comments on interim results from 7 Dec (Paul, done)

Tristel (LON:TSTL) - AGM Statement (Jack, done)

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There wasn't any more time available today, so that's it I'm afraid, both Jack & I have other things to attend to.

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Paul's Section

Purplebricks (LON:PURP)

Share price: 75.5p (last night)
No. shares: 306.8m
Market cap: £231.6m

Half Year Results

Purplebricks Group plc (AIM: PURP), a leading UK technology-led estate agency business, announces its half year results for the six months ended 31 October 2020 ("H1 21" "H1" or the "first half").

This well-known, market leading online estate agency has delivered decent interim figures today. Key points;

• Profits ahead of upgraded expectations
• Pots of cash, £75.8m and no borrowings - so it has tons of firepower for increased marketing, if required, technological developments, and/or acquisitions
• Strong balance sheet
• H1 revenues only down 6%, to £44.2 - not bad in the circumstances, in my view
• H1 Profit after tax of £3.9m from continuing operations (plus £2.9m from discontinued)
• Gross margin is high, at 67% - providing strong operational gearing if growth resumes
• Marketing costs reduced by 27% to £9.0m, demonstrating the flexible costs of an online business, a topic we looked at yesterday for another company
• Marketing costs per instruction down 32% to £254. Revenue per instruction is £1,392 - so a payback on marketing spend of 5.5x which looks good to me - assuming that the marketing spend does trigger the instructions, and they weren’t people who intended instructing PURP anyway?
• Administrative costs also cut by £2.0m
• Very well known brand name, with 4.8% market share (by properties sold) - I don’t know how many of the proliferation of competitor startups are still going?
• Disposal of Canadian business has strongly boosted cash (by £35.9m), and freed up management time to focus on the UK market
• £0.7m claimed under Govt furlough scheme - not significant

Outlook - is good -

Whilst there are reasons to remain cautious on the economic outlook, we are confident in the levers which are under our control, and we currently expect adjusted EBITDA for the full year to exceed the upper end of the current range of consensus 7.

7 As at 14 December 2020, the Group's compiled full year 2021 consensus for adjusted EBITDA is £7.0m, ranging from £5.0m to £10.6m.

Thank you to the company & its advisers for including footnote 7 - very helpful, as it saves us so much time, and avoids confusion, so much appreciated. Everyone should do this please! Friends in the City tell me that some brokers resist inclusion of a simple note explaining what market expectations are. Why?! How ridiculous. If a broker doesn’t want to help investors understand trading updates fully, then maybe it’s time to find a more relevant broker? If the numbers are explained clearly, then investors are more likely to buy the share. It’s not rocket science. Sorry, but this issue really rattles my cage. Anyway, in this case, PURP’s advisers do seem investor friendly, being Zeus, Citi, Peel Hunt, and Buchanan.

Results presentation - this is also excellent, I’ve signed up, so will report back if there’s anything interesting in the results presentation, or you can tune in yourself if reading this before 9am -

Results presentation and conference call

Vic Darvey, CEO and Andy Botha, CFO are streaming a video presentation of results via webcast at 9.00am today followed by a live Q&A session for analysts and investors.

The video webcast link is via the webcast registration page and on the website. A replay will also be available on the Purplebricks website following the Q&A session at http://www.purplebricksplc.com/investors/latest_results .

Clearly Purplebricks is an investor-friendly company, good stuff!

Other points;

• Share based payments, a £1.9m credit (due to leavers), and a £2.5m credit in cashflow statement, I think this might flatter profits?
• Finance expense - I don’t understand why this is so high, at £2.7m in H1, given that the company is cash rich? Does anyone know, if so please leave a comment
• Cash generation is good - helped by a £7.1m increase in deferred income - this looks like the benefit of receiving cash up-front from customer instructions, a good business model
• Capitalised development spend was £0.9m in H1 - quite modest for an online business, so not a problem

My opinion - I’m impressed. This is the clear market leader in online estate agents, and a brand name almost everyone knows. It’s got pots of cash, is profitable now, and the market cap doesn’t strike me as excessive.

I seem to recall there was some question mark over its tax liabilities, re treating some staff as self-employed. Unless I missed it, there doesn’t seem to be anything in the update today about that, so perhaps it’s a red herring, or not material? If you have any information on this issue, please leave a comment.

Here's the chart since PURP listed - lots of hype for global domination, and it's now back down to where it started - an opportunity now, maybe, as the finances look better than ever before?

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Cyanconnode Holdings (LON:CYAN)

5.05p (up 10%) - mkt cap £9m

Interim results

• Revenue in H1 up 48%, but only to £1.5m
• Receivables on balance sheet of £3.9m, that’s over a year’s revenues! So there has to be doubt over the collectability of all of this
• Loss before tax of £1.7m
• Cash position looks tight, and Directors provided £400k loan in Dec 2020
• Upbeat commentary about contracts resuming, after covid pause

My opinion - looks way too risky, and given the very poor track record, this share needs to be treated as a complete punt. Another placing seems inevitable, but on what terms? It’s difficult to see why anyone would be keen to pour in more cash here.

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Ted Baker (LON:TED)

114p - Mkt cap £210m

Interim results were announced on 7 Dec. I’ve been meaning to look at them, sorry for the delay. Jack wrote up a nice piece here, when the price was 140p - it’s now down 19% since results day, and with good cause - the P&L figures are diabolical.

The “underlying” loss is £(39.0)m, and the loss before tax is £(86.4)m - just for a half year - admittedly an unprecedented one, covering the covid lockdown 1 period (28 weeks to 8 Aug 2020)

However, businesses don’t go bust because they make losses, they go bust if they run out of cash. Hence I’m focusing on TED’s balance sheet, and it’s actually rather good news, it’s much better than I expected. So the company lives to fight another day. The commentary explains it well -

A critical component of stabilising the Group's foundations was strengthening our balance sheet, which had seen net debt rising steadily over several years. We engaged with all our stakeholders to rebuild the balance sheet and in aggregate we raised a gross £105.0m from the issuance of new equity, agreed to an additional £25m facility from our lending banks, sold our London HQ for £77.8m gross proceeds, stopped all non-essential capex, renegotiated payment terms across our suppliers and took advantage of available government schemes.

The aggregate result of these measures and ongoing active cash management is our net cash position of £60.8m at the end of the first half and £58.5m as of 28 November.

Based on our latest cash flow forecasts, our cash headroom at the low point in our cash flow cycle of September/October 2021 will be materially higher than previously expected.

That’s really good news, and gives management time to turn the business around (no guarantees they will succeed of course).

It’s really all down to product with designer brands. If the designs are right, the product sells itself. But at high price points like TED’s, the designs have to be perfect, not just good. If they’re not perfect, then they have to be sold at deep discounts to clear, which undermines the brand, in a downward spiral. Superdry (LON:SDRY) has similar issues. If customers can see that product is not selling out, then they just wait until the price is reduced.

Licensing - a valuable income stream, usually very high margin too, which could be worth more than the market cap (effectively putting a negative value on the physical stores) -

Our licencing business is another key driver for delivering asset light growth. Licencing delivered £19.1m of gross profit in FY20 and has immense potential for us. Building on the momentum we had last year, we have signed 2 new product licence deals since the start of the financial year. Building on the successful start to our new Childrenswear licence, NEXT has been appointed as our new licence partner for lingerie and nightwear. Second, we have appointed Baird Group as our new licence partner on men's formalwear for the UK & Ireland. This deal mirrors the successful relationship we have with Jack Victor in North America. Following the start of this agreement with Baird, Ted Baker will no longer supply formalwear, thus reducing our inventory risk for this product category and leveraging our partners' expertise in sourcing and distribution.

Cost-cutting has been deep, at £31.0m annualised, higher than previously outlined.

Lease liabilities - a major ongoing headache & cash drain, as they’re mainly prime sites in city centres. Rent reductions are being achieved, but it doesn’t look enough to me. Maybe a CVA is the only viable option?

My opinion - I thought this was a basket case before going through the latest accounts. However, I’m impressed with the balance sheet strength, which looks tough enough to withstand continuing difficult conditions.

Can it survive until covid is hopefully dealt with through vaccinations (mid-2021 maybe)? Yes.

Is risk:reward on the shares, at a £210m market cap (114p per share) attractive? No, not to me it isn’t.

The trouble is that a lot of TED's net cash is likely to be consumed over the next 6 months, and when creditors have been paid up to date (I think there’s evidence of creditor stretch, because trade payables has only reduced slightly, whilst inventories have reduced a lot.

I did short this share (on a small scale) a while back, but I wouldn’t short it now. The brand is still valuable, and it has a fighting chance of survival and turnaround. What would happen if the turnaround doesn’t work? It would probably be sold to Mike Ashley or Boohoo (LON:BOO) (I hold) for maybe £50m-ish? With the proceeds going to pay creditors rather than shareholders (that’s the worst case scenario).

Talking of shareholders, Toscafund has 27%, and is an aggressive & deep-pocketed investor, that I observed had previously taken one of its mistakes private, rather than admit defeat. So I wouldn’t bet against them, as unusual or even irrational things can happen.

Ray Kelvin holds 11.8%, with 2 other big shareholders, see below.

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It’s a good thing to have a concentrated, and supportive shareholder base during difficult times. So my thinking is that, if TED needs another fundraise in say 2022, then I think they would get it. Although remember that the last fundraising was at a hideous discount of 51%, although there was an open offer too. So dilution could be nasty again, if things don’t go to plan.

Overall - it’s not likely to go bust, due to balance sheet strength. I like the actions management is taking to turnaround the company. I’d have a punt on it if the share price was about 50p, but not above that level, as there are still massive headwinds to overcome. I'll keep it on the watchlist though, as potentially interesting if there are tangible signs of performance improving.

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Jack’s section

Tristel (LON:TSTL)

Share price: 513.64p (+1.11%)

No. shares: 46,519,194

Market cap: £238.9m

A brief AGM statement from Tristel (LON:TSTL) today - this is an exciting but expensive company that uses its proprietary chlorine dioxide formulation to make high quality disinfectants for medical devices and other products.

There’s a big potential catalyst for the share price in the form of its planned expansion into US markets, but access here depends on regulatory approval. Once you’re in, this is a useful barrier to entry so it’s a situation worth keeping an eye on.

You can see the PE ratio has drifted up over time as the market cottons on to the quality at Tristel.

But that raises the question of price: was the best time to buy Tristel five years ago at a lower price multiple and with more scope for organic earnings growth? And how much potential upside is left now?

Today the forecast PE is 36.1 and the forecast PEG is 2.5 times. It might be that brokers are downplaying Tristel’s earnings forecasts or not factoring in US and international market potential, but today’s valuation is still quite a premium.

Nevertheless, Tristel is clearly a high quality operation with strong cash generation and double digit returns on capital over time. Its patents, expertise, and regulated markets suggest it has every chance of carrying these attractive characteristics forward.

AGM statement

Revenue for the trading period is expected to increase by 10% and profit before tax is also set to increase by 10% to no less than £3.3m.

This is lower than budgeted due to deferred patient procedures as a result of COVID-19 restrictions although there has been a ‘substantial’ recovery in demand since October driven in part by Brexit preparations and ‘continued significant growth in our newer markets of France, Belgium, Netherlands, Italy, and Malaysia.’

Sales of our new Cache product range will be approximately double their level of the first half last year. Here Tristel aims to become a global market leader in the hospital environmental hygiene market.

And regarding the US expansion, Tristel says ‘very encouraging progress has been made in our FDA test programme for Duo for Ultrasound, and we have received positive feedback from the Canadian regulator on our Duo for Ophthalmology submission.’

The group also expects to conclude distribution arrangements for its Duo product range in India before Christmas.

Conclusion

All sales growth has been organic and, although less than budgeted, chances are that attractive long-term growth trends remain in place. Tristel is aiming for global expansion and there is probably plenty of room to grow if it can win approval from regulators.

Its products are protected by patents and look genuinely superior to the competition due to its proprietary chemistry. There are clear barriers to entry as well.

For now, my view remains that I would want a lower valuation before buying in given the multiple expansion over the past few years. It could be that I’m underweighting the international potential here though. It’s firmly on the watchlist in case we get a more attractive entry point in future.

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All done for today, see you tomorrow!

Regards, Paul.