Small Cap Value Report (Tue 19 May 2020) - DTG, SCPA, BWNG, QXT, RNWH

Good morning, it's Paul here with the SCVR for Tuesday.

Today's report is now finished.

As regulars know, things are always a bit random where I am involved. Typically, I try to write something interesting (hopefully) here, then go for a brisk walk in the afternoon, to rebuild my strength after a (highly probable) Covid-19 attack in March & April.

Whilst on my brisk walks, my latest audiobook is like a glimpse into the past, being the memoirs of IG Index founder, Stuart Wheeler. Improbable though it may seem, this helps me detach from the markets, and start to relax a little. I am enjoying this audiobook, albeit still in the early stages. Stuart was shot in the lip in Egypt, and things like that, make me pretty glad that National Service had stopped by the time I was of an eligible age.

As I began to relax, in a more calm world of socially-distancing paranoid people in Bournemouth this afternoon, I gently sipped my can of Carling, teetering down one of the lovely "Zig-Zag" pathways which take everyone down from the East Overcliff, down to the beach in Bournemouth. I paused to catch my breath at a beauty spot. The view was spectacular, of the beach, east and west. The sun was shining today. It was so lovely. I'll put up some photos later.

I glanced down at the painted sky blue bench next to me. Then I noticed a beautiful plaque on it, saying "Timothy and Joan loved this place". As I caught my breath, I wondered who Timothy and Joan were, and what lovely memories they had of Bournemouth in years gone by, maybe the post-war years? The moment was shattered, when a crudely-written marker pen message next to it caught my eye, stating, "Julie Davies is a slag!"

What a pity.

As I descended the zig-zag, my bladder started to nag at me. This is what happens when you're over 50. Several visits to the en suite become automatic at night, and one quietly has to find somewhere to go when the idiots in charge of the country decide to lock us all down.

In their infinite wisdom Bournemouth Council had closed all the toilets to stop the spread of covid! Whatever. On my typical evening walk, call me old fashioned, I like to have some lager, and then recycle the cans, and go behind the beach huts.

I had got this down to a fine art, when a cackle of girls must have noticed me and instead of being discreet, MapMyRun App decided to choose that exact moment to announce how many miles, split miles, and all the rest of the data I had accomplished on my run (walk), and with all passersby laughing out loud at me. Such is life. Two miles, and 4 litres!

As my Aussie friend says to me, after a pause, Well that was a boring story!"

I happened to notice today that one of the public toilets along the front in Bou'mth seemed to be open. I nonchalantly observed to the chap in front of me that I'd spent the last few weeks urinating behind beach huts, and didn't realise that the toilets had actually been opened. Anyway, that was that.

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Let's see what results there are tomorrow.

Scapa (LON:SCPA) (I'm long) looks really interesting actually., I nodded off on the hammock, but beforehand, noted that Dirs pay was disgustingly high. Also, one of those awful so-called "Value Creation Plans" - so mgt were, or are greedy. That's not a deal-breaker for me though.

I'm not sure there is necessarily a correlation between executive greed, and share price performance, either way. It would be an interesting study to undertake actually. I started such a project a few years ago, but it was incredibly time-consuming, because the structure of share options is such that measuring overall Director pay, on a comparable basis, is quite tricky. When you work out the total cost of the Board, and compare that with profits and dividends , it's often the case that small caps exist mainly for the benefit of the Board!

I've increased my position size at Scapa to medium-large now, because it looks strikingly good value, for a nice quality niche business, if revenues do recover later this year, as budgeted for. I like the re-shoring angle too, which could be an interesting investment theme to think about - companies particularly with operations in USA could come under pressure to increase manufacturing there, instead of importing from China. So Scapa's actual and potential customers could come under pressure to buy more from US manufacturers, and possible increases in tariffs to keep cheap Chinese imports out? So this could be a potential opportunity maybe, for other companies too?

Scapa has some operations in the USA, and I wouldn't be surprised if a takeover bid were to emerge for it, from an American competitor. The major shareholder list is fragmented, with the biggest holder owning 9.9%, and institutions are usually happy with takeover bids & agree them, as it provides a premium-priced liquidity event for them.

Scapa major shareholders (source: Scapa's website);

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I'd like to find out more about the legal action Scapa is pursuing against ConvaTec, which is huge - a claim for $83m. There doesn't seem to have been an update lately. A previous update says that the American court threw out ConvaTec's counter claim against Scapa, which is clearly a positive. The issue seems to be that Scapa apparently made an acquisition which ConvaTec said violated a non-compete clause in their contract, which they used as a device to withdraw from the contract. I suspect that ConvaTec might have really wanted to exit the contract once they realised how lucrative it was for Scapa, but that's guesswork on my part.

I'm having a quick look at Convatec (LON:CTEC) so see if there any clues in its statements. It is capitalised at £4.2bn. Revenues are about £1.8bn, with profits in the range £97-269m in the last 6 years (taken from the StockReport here). I like the way news is displayed on the new Stockopedia site. You can scroll down the RNSs for a company in the left hand pane, then click on any item to read it in the right hand pane. Makes quickly reviewing news stories easy.

I see that CTEC said in its prelims on 28 Feb 2020 that Scapa's claim for $83.8m is without merit, and no provision has been recognised as at 31 Dec 2019. The auditors must have looked into this, and been satisfied that no provision needed to be made, hence it sounds like Scapa's claim may be weak. Therefore, I shall regard any recovery of funds from CTEC to be a bonus. Let's hope Scapa doesn't run up too large a legal bill in the meantime.

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Dart (LON:DTG)

This has shot up today, on no company news. Googling it, and the only rationale I can find seems to be hopes for a vaccine. This propelled a 900-point rally in the USA yesterday. Thank goodness I closed my index shorts on Friday, but I reopened them after yesterday's rise, as I still think the shorter term economic outlook seems horrific. It seems far-fetched to me that investors would just ignore diabolical earnings & balance sheets for 2020.

If any readers know anything specific as to why Dart has risen 19% today, then please leave a comment below.

In the short term, the UK Govt's 2 week quarantine policy sounds terrible news for airlines. That effectively kills inbound tourism stone dead. Australia has a similar policy, and an Aussie friend of mine who was planning on visiting family there has cancelled the trip, because he didn't want to spend 2 weeks at home, unable to leave his family's house. Understandable.

Dart does look securely financed now, but I think the accounts from airlines are likely to be so bad (it's hugely expensive having aircraft grounded) that people might get a rude awakening when they next report numbers.

I was hoping to get another opportunity to buy Dart shares nearer the 300p level. I'm actually not bothered at missing the flight, because there's still so much uncertainty.

Re a vaccine for covid-19, experts seem to say it's possible towards the end of 2021. Or we could never have a vaccine. An American company called £MRNA has said its phase 1 trial for a vaccine was successful. Looking at its StockReport here, it only reported $60m revenues in 2019, and seems to be running at losses of about $500m p.a.. Hence certainly not a Roche or AstraZeneca.

Without state aid, I don't suppose many airlines could survive having flights grounded until end 2021. Mind you, some people would be happy to fly. I would, if the procedures at airports weren't too draconian, and there was no quarantine at the destination.

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Talking about results pushing share prices down, I see that large cap £cpg has dropped 9% today, on publication of results, and withdrawing guidance. This, along with other companies reporting, and falling in price, reinforces my view that the market has not yet factored in just how bad 2020 results are likely to be.

Nicotine purveyor, £imb is also down 8% today on publication of results/outlook. It would be interesting & useful to keep a daily note of all companies reporting, and the movement in share price on the day. That could provide some clues as to whether we should be cautious. The time to be bullish is when share prices don't fall on bad news - then you know the downside is priced-in, and the next big move is probably going to be up.

Looking at the top risers, I see that Hardide (LON:HDD) is up 23% today on publishing results.

Quixant (LON:QXT) is up 17% on a trading update, so that's next on the list.

Renew Holdings (LON:RNWH) is up 14% on putting out interims.

N Brown (LON:BWNG) is up 13% on a trading update.

Mcbride (LON:MCB) is up 9% on a trading update. - see tomorrow's report

There I've just disproven my own theory about results triggering share price falls! Back to the drawing board.

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N Brown (LON:BWNG)

Share price: 21.25p (up 13% today, at 11:36)
No. shares: 285.2m
Market cap: £60.6m

Trading Update

This is an online retailer of outsized clothing for tall and fat people. I think it has Freddie Flintoff on the Jacamo page here. Not a very flattering shot, without his Top Gear makeup, and with poor lighting. Nice suit though. Its brands include SimplyBe, Jacamo, and JD Williams. I've seen TV ads for the first two. It is unusual in that the core business is really providing consumer credit, on instalment plans, that's where it makes its profits. The share price fell out of bed in Jan 2020, before covid, on a profit warning which I wrote about here. I'm just re-reading my notes to get up to speed. Amazingly, the market cap was £303m last time I looked at it, now only £61m. Revised guidance in Jan 2020 was for FY 02/2020 profit of £71m - that's more than the market cap now!

23 March update - There was another profit warning here on 23 March. It said that product sales from mid-March fell 40%+ - "very significant & sudden". Action taken - reduced marketing spend, stopping all capex, defer taxes, stopping stock purchases, freezing recruitment & reviewing operations, exploring Govt funding schemes.

Borrowings as at 20 March - almost maxed out;

£414.7m drawn on a receivables securitisation facility, being the maximum possible out of a theoretical £500m limit

RCF facility of £125m (committed to Sept 2021) fully drawn down

Overdraft of £27.5m, of which £9.0m drawn.

Cash held of £46.3m

Covenants will need to be adjusted, in downside trading scenario

The gearing is high, but remember that it has a huge receivables book, of customer instalments owed, i.e. an asset. This was £619.5m in the last accounts, as at 31 Aug 2019.

The crux here is therefore being able to maintain the confidence of the banks. Given the size of the receivables book, I don't see why that would be a problem.

Freehold properties with an original cost of £58.3m - are unencumbered, but it is now exploring options - i.e. looking at selling or borrowing against them. This helps protect the downside risk - because banks like secured lending against freeholds. Part of the receivables book is ungeared, so options there are being explored.

Divis suspended for "foreseeable future"

Profit for FY 02/2020 to be lower than previous guidance of £70-72m. Bad debt provision may need to be increased.

Guidance withdrawn for FY 02/2021 - covid-19 will have a "very significant impact".

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19 May trading update - this is taking ages, sorry! What does the company say today?

Trading - down 25% in most recent 6 weeks. Bad, but improved from -40%+ reported above in March. The company regards this as "creditable". I disagree. With the High Street closed, online retailers like this should be making hay, but it isn't.

Cash collections - performed well, broadly in line with LY. Will trend lower in coming months, due to 3-month payment deferral offered to struggling customers, per FCA guidance.

Operations continuing but at lower throughput, marketing spend down 80%, capex reduced significantly,, furloughed 30% of staff,Board & mgt voluntary pay cuts, agreed with HMRC to defer taxes.

Borrowings - £512m drawn down on securitisation facility + RCF. Overdraft repaid. This is down nicely from £548.7m equivalent debt at 23 March, a reduction in debt of £36.7m. Cash is down by £1.0m to £45.3m. The debt reduction is very positive I think. Although bear in mind that receivables will also be falling, since existing customer accounts are paid (those that don't default), but new sales are at a 25% lower rate than prior year.

New facilities - new 3-year loan of £50m, under Govt scheme (CLBILS). Not allowed to pay divis whilst this facility is in use.

Relaxation of covenants & terms of the largest facility, the securitisation lending. Specific details not provided.

Relaxation of covenants on RCF facility until end 2020.

Facilities expire in Sep & Dec 2021, which are expected to be renegotiated "well in advance".

Stress-tested a "severe but plausible" downside scenario (details given, which is good). It doesn't categorically say the enlarged facilities will be enough, instead using weasel words here, which introduces doubt;

Under these scenarios the new financing arrangements provide the Group with a strong basis from which to continue to service its customers and to manage appropriately the challenges faced by the Group.

Continuing to pay suppliers on contractually agreed terms - good as this shows it's not under financial distress and having to stretch payments.

Guidance - "not appropriate" to provide guidance. Bit of a cop-out. Surely it could give base case, good case, and bad case figures? It just doesn't want to! Confident in long term future of the business, so I assume that means the short term is likely to be bad then!

My opinion - this looks reasonably stable financially now. Hence I think there is scope for the beaten down share price to recover somewhat. Risk has greatly reduced, now that the borrowing facilities have been increased & terms relaxed.

Bad debt risk is probably the main worry. How many customers might default, if they lose their jobs?

This is not a share for the feint-hearted, but overall, I think risk:reward looks quite good now. It's not likely to go bust, yet the share price could potentially double or triple from here, if business continues improving.

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Rattling through these next few items quickly, because I want to go to the beach again.

Quixant (LON:QXT)

Up 22% today, so the market must like today's update.

It warned on profits in January - see my notes here - due to reduced demand from the gaming sector.

Today it says -

• Gaming industry largely closed down, so demand impacted, and customers are paying more slowly.
• "Positive signs of recovery" started from w/c 11 May - first reopening of US venues, with "robust attendance" from gamblers.
• Densitron (acquired, previously independent business) is trading well.
• Net cash of $14.8m at end April, very healthy. Its balance sheet is good, as I reported in January.
• Overheads reduced by 10%.
• Board have taken 25%+ pay cuts - good
• Working capital is sufficient to withstand a prolonged slowdown, if needed.

My opinion - this is a decent update, but we're completely in the dark as to what profits might look like for FY 12/2020. It's easy to say, oh just ignore 2020 results, we should value it on a future recovery in earnings. But I'd want to at least have a rough idea of what 2020 might look like.

However, this uncertainty is why the share price is low.

It's not going bust, because the balance sheet is genuinely strong. So it might be an interesting share to tuck away for a year or two, and I imagine it would probably be worth more than it is now. But there could be bumps in the road, if 2020 results are really bad.

Overall then, I'm leaning towards being mildly positive with a long-term view, at the current price of 110p.

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Renew Holdings (LON:RNWH)

Share price: 476p (up 14% today)
No. shares: 78.6m
Market cap: 374.1m

Half Year Report

Renew (AIM: RNWH), the Engineering Services Group supporting UK infrastructure, announces its interim results for the six months ended 31 March 2020.

These interim figures look good - all metrics are up. H1 was in line with expectations. Adj EPS for H1 was 20.1p. Double that for a full year (ignoring any seasonality) and we're maybe looking at 40p, so a PER of about 12 - looks about right for a contracting business. Although H2 is bound to have some impact from covid, so maybe H2 earnings could be lower than H1?

Covid- about 80% of its projects have continued. Looking at remobilising the other 20%.

Balance sheet - still weak, with NTAV negative at £(37.8m).

My opinion - this group has performed really well over quite a few years, successfully increasing its margin to a respectable 6%+.

Would I want to own a contracting business? In a word, no. The sector is horribly risky, which is why so many contracting companies have gone bust. Renew seems to be very well managed, and a rare bright spot in a horrible sector.

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All done for today. I cover Portmeirion (LON:PMP) and Mcbride (LON:MCB) updates from today in tomorrow's report.

Regards, Paul.