Small Cap Value Report (Tue 20 July 2021) - SDG, GTLY, SOS, WIL, SDI

Good morning, it's Paul & Jack here with the SCVR for Tuesday, a very busy day for updates.

Timing - today's report is now finished.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to cover 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 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) - don't blame us if you buy something that doesn't work out. Reader comments are welcomed - please be civil, rational, and include the company name/ticker.

---

Agenda -

Paul's Section:

Preamble about current market volatility.

Sanderson Design (LON:SDG) (I hold) - a strong trading update for H1. Cash rich, trading well, and priced on a PER of 14 (before today's rise). Looks good, and modestly valued.

Sosandar (LON:SOS) (I hold) - Results for FY 03/2021 show decent revenue growth, and slashed costs, but still loss-making. However, I focus on the superb 256% revenue growth in Q1 (April-June 2021), suggesting Sosandar should now be at breakeven or better, for the new financial year FY 03/2022. Looks like a game-changer, if current stellar growth can be maintained.

Sdi (LON:SDI) - I review the in line results for FY 04/2021. Excellent figures. Finncap flags that one-off large orders completing could cause earnings to fall next year, so this is a key point to be aware of. Although more acquisitions are likely, and could offset this headwind, with management very experienced in M&A. Taking into account the one-off orders, I think the valuation looks a bit too high maybe.

Jack's Section:

GTLY - solid results from expanding professional services firm. This has been a year of consolidating existing acquisitions and ensuring safe passage through lockdowns, but management is optimistic of the acquisition pipeline going forward.

Wilmington (LON:WIL) - resilient results and net debt is down. There are signs of quality in the education businesses, but the balance sheet could be stronger.

.

---

Preamble for Tuesday - market conditions

Lots of people have emailed me (Paul), and asked for some market comment.

As a value/GARP investor, I’m not really interested in market fluctuations. I tend to just research things in as much depth as I can, then buy & hold for several years. Some of them work, some don’t. If the results & trading updates disappoint, then I chuck them out. There shouldn’t be any emotion involved at all, and buy prices are best ignored & forgotten, because the market doesn't know or care what we paid for our shares. It’s the occasional multi-year, multi-bagger, that makes the money & mops up all the mistakes.

Where are we now? This is what I see -

• Takeover bids - loads of them, especially from overseas, suggesting that the UK market is cheap - which is bullish.
• Low broker forecasts - results are mostly ahead of expectations, and there are many forecasts being raised a lot - this is bullish
• V-shaped economic recovery, based on the economic data - this is bullish
• Companies are generally reporting that they have adapted to covid, stripped out costs, profits are rising - this is bullish.

Set against that -

• Momentum arguably carried many share prices too high in the anything & everything rally since Nov 2020
• Balance sheet weakness was ignored by some punters - with inevitable consequences when reality comes home to roost & fundraisings are needed (I got caught on Revolution Bars (LON:RBG) in this regard, and there are plenty more banana skins out there - watch out!)
• Stretched valuation multiples
• Naive punters, new to the market, don’t know how to value anything, so prices are highly volatile
• Thin summer markets, with little volume = extreme volatility
• Mixed messages from central banks over interest rates
• China threatening to nuke Japan
• Profit-taking snowballing
• Blah blah blah
• Take your pick, it’s all nonsense to a certain extent!

Lots of people have emailed me, asking what I’m buying. The truth is, when you’re 100% invested, there’s not much cash on hand to buy anything. Although I have eked out a little cash to buy what I think are terrific bargains: SAGA at 303p. JOUL at 235p. BOO at 275p. As usual, just my personal opinions, and DYOR. We’ve discussed them all at enormous length here, so just search the archive for the bull & bear cases, if you’re interested.

As I always say to people who email me with great concerns about price movements - just try to work out your own strategy. Are you a trader? Or an investor? Most people think they are investors, but are actually traders - flitting in & out of things, trying to time the market, losing confidence when prices fall. Not many people can do that well, consistently, in my experience, and it’s a horrible way to live, being permanently on tenterhooks - who wants to live like that?

I think that, if we seek out great companies, with entrepreneurial management, they usually do well over the long-term. Nearly all the self-made multimillionaires I know, have made their money from a handful of major multibaggers - typically about 4 big investments over their career that have made them the really big money - which usually means holding, for a long time, often when the share was unfashionable. Everything else was a sideshow.

.

---

Paul’s Section

Sanderson Design (LON:SDG)

(I hold)

147p (at close, last night) - mkt cap £116m

AGM Trading Update

Sanderson Design Group PLC (AIM: SDG), the luxury interior design and furnishings group, will hold its Annual General Meeting ("AGM") at 9.00am today. Ahead of the AGM, which will take place as a closed meeting as detailed in the Notice of AGM, the Company provides the following trading update in respect of the first 23 weeks of the current financial year ending 31 January 2022.

Recovery continues with forward momentum

It’s more good news from this convincing turnaround situation -

The positive trading in February, March and April 2021, outlined in our full year results announcement on 18 May 2021, has continued throughout the 23-week period with the result that profits for the six months ending 31 July 2021 are expected to be ahead of Board expectations.

Total group sales for the 23 weeks are up 39.8% vs LY, and up 1.4% vs the previous year (a more meaningful comparison, pre-pandemic).

Pandemic has still had an impact this year, so recovery is good in that context.

There's lots of detail in today's update, here are some points covered -

North America is the best performing region, and makes up 20% of total brand product sales. The UK is the largest market, at 52% of brand product total sales

Figures for the manufacturing division are shown in a separate table, and look very good, up 52% on LY, and up 21% on the pre-pandemic year

Licensing income is also up strongly

Collaboration with Next (LON:NXT) (Morris & Co designs for clothing) has performed “very strongly” in the first few weeks - note that deals such as this tend to be short-lived, so it’s a bonus rather than anything to get too excited about, in my view

Liquidity - net cash of £13.9m on 16 July 2021, down from £15.1m on 31 Jan 2021, due to seasonal factors & payment of corporation tax

Dividends - objective is to resume divis, more details with the next results

Diary date - mid-October 2021, for half year results

Employee engagement survey now 78% positive, up strongly from 58% two year ago - an important factor, often overlooked by investors, the staff are the business, so we should want them to be happy

Positive external factors are mentioned, which are quite interesting -

The Board believes the Group is benefiting from the convergence of three positive impacts:
(1) pent up demand for home interiors,
(2) the trend towards maximalism, and
(3) the post-Brexit increased demand for British design and manufacturing.

“Maximalism” - there’s a new word for me!

Outlook - caution is expressed, but I don’t think that’s anything in particular to worry about, it sounds more a generic thing - supply chain issues are affecting almost everyone at the moment it seems -

"Whilst the Covid-19 pandemic and potential cost inflation continue to create some uncertainties for the near-term outlook, our focus remains on mitigating the potential impact of those uncertainties and continuing to progress the Company's strategic development.

My opinion - the newish CEO Lisa Montague has worked wonders here, modernising the company’s operations (e.g. product launches & sales are done online now), reducing costs, and halving the product lines to focus on best-sellers (thus reducing inventories & boosting cash).

A strong balance sheet means no need for equity to be raised during the pandemic. There’s plenty of scope to resume divis, due to the recovery in profitability & bulging coffers.

I can’t see any broker updates today, but on existing consensus forecast, this share is only on a multiple of 14.0 times. With a cash rich balance sheet, and an ahead of expectations update today, that’s great value. Mr Market has thrown an impromptu mid-season sale in recent days, which in my view is a good buying opportunity here.

High StockRank too.

.

A little more detail on the X-axis below would be helpful, but each blob is a month, so it’s easy enough to see what period this covers. Note that forecast EPS was reducing last year, but this year forecasts have shot up, and what’s the betting they’ll be more positive earnings upgrades? Seems likely to me.

.

.

---

Sosandar (LON:SOS)

(I hold)

24.75p (up 3%, at 08:50) - mkt cap £55m

Final Results

I’ve got to pop out shortly, so can’t go through the numbers at the moment. However, I do want to flag up remarkably strong current trading, which looks like a game-changer to me.

A few key numbers from FY 03/2021 first -

Revenues £12.2m (up 35%) - this needs to be seen in the context of the business conserving cash during the pandemic, slashing marketing spend, etc. So it’s actually not bad.

Big reduction in EBITDA loss from £7.7m in FY 03/2020, to £2.9m loss in FY 03/2021 - still bad, but a lot less bad than previously, due to costs being slashed.

Year end net cash of £3.9m - the company surprised me a lot by being able to trade for a year at negligible cash burn - showing the big advantage eCommerce businesses have, in that costs are variable, and can be slashed in an emergency, unlike fixed costs physical retailers.

Recent trading - this is what we need to focus on.

.

Revenue of £5.7m in Q1 suggests to me that the full year revenues could be in the ballpark of £25m - double last year, and enough to take Sosandar to breakeven or modest profits I reckon. That is highly significant in my view, and means the business model has moved from struggling to get anywhere near to breakeven, into profits.

Cash position - is now very good, with £9.1m in cash at 30 June 2021. Moreover, it looks like the operational cash burn is now likely to be eliminated, so the cash pile can be used to build up inventories for the successful & growing third party sales through Next, John Lewis, and Marks & Spencer.

My opinion - I’ll do some more work on this later, but just wanted to flag up the importance of tremendously strong revenues in Q1 (April-June 2021), which I think greatly improves the investment case for Sosandar shares, and largely removes risk now. It’s probably around breakeven on a run rate now, and has plenty of cash, which shouldn't deplete as it did in the past with operational cash burn.

Today’s update tells me that the business model is now proven, which makes the shares much more attractive than before when it was highly speculative.

.

---

Sdi (LON:SDI)

182.5p (up 5%, at 14:27) - mkt cap £180m

Final Results

SDI Group plc, the AIM quoted Group focused on the design and manufacture of scientific and technology products for use in digital imaging and sensing and control applications, is pleased to announce its final audited results for the year ended 30 April 2021.

Sparkling results out today. Key numbers -

Revenue up 43% to £35.1m, of this 19% is organic growth, which is very impressive, the rest obviously from acquisitions - the core business model at SDI is to grow from acquisitions, and so far it doesn’t seem to have put a foot wrong. Looking at slide 3 of the results slide deck, the Board has a lot of finance, and M&A experience.

Adj profit before tax of £7.4m, up 71%, and note this is a very impressive profit margin of 21% of revenues, indicating quality businesses with pricing power, and seems to have been very resilient in the face of the pandemic.

Adj diluted EPS up 74% to 5.97p - a PER of 30.6 times - not unreasonable, given the growth, with the key point being whether growth continues or not - the company did mention some one-off orders previously, I recall.

Two acquisitions made during the year.

Outlook comments mention one-off orders -

The outlook, thanks to our agile business model, is positive and we are planning for further organic growth, including from one-off COVID-19 related orders, and appropriate acquisitions during 2021-22. Trading in our 2021-22 financial year remains in line with market expectations and we look to the future with confidence."

Broker update - a very useful note from Finncap is out today, which helpfully gives us an idea of what performance might be like once the one-off orders are completed.

This shows EPS of 6.4p in FY 04/2022, falling to 5.0p in FY 04/2023. Shareholders need to hope those forecasts are comfortably beaten, because they don’t support a share price of 182p in my view.

Finncap does mention that more acquisitions are expected, which should provide a boost to earnings.

Dividends - it doesn’t pay any, which is fine for an acquisitive group, in my view. People are in this share for capital appreciation, not income.

Cost increases are mentioned, but it doesn’t sound alarming -

Due to the increase in the price of raw materials, labour and logistical costs, our costs of goods sold are increasing. However, our operating expenses are not yet at pre-pandemic levels. We intend to continue reviewing all costs and will where appropriate pass on cost increases to our customers to maintain profitability.

Balance sheet - acquisitive groups often become top heavy with intangibles. SDI has £26.2m in intangibles, not excessive. It has modest tangible fixed assets, so doesn’t need a particularly strong balance sheet.

NAV is £26.8m, deduct the intangible assets, and NTAV is only £0.6m - so quite a lean balance sheet. There’s only modest gross debt, offset by year end cash, and given the high profits & positive cashflow, I think this balance sheet looks OK. More acquisitions would turn NTAV negative though, unless more equity is issued to part-fund them.

Cashflow statement - favourable working capital movements helped boost cashflow by £2.8m, but the post-tax operating cashflow is impressive at £10.3m, of which about 27% comes from working capital movements.

Capex is modest at £667k, and only £367k development spend was capitalised, so this is a good business model - high profit margins, from a capital-light balance sheet.

Cashflow was mainly used for funding acquisitions, a good thing since management seem good at M&A, and debt reduction.

My opinion - this looks very good.

I can’t see anything of concern in the numbers, it all looks fine.

The main issue here is that current profitability is being boosted by one-off orders. Hence I think a PER of 30 times is probably too high, given the risk that earnings could plateau or even fall once those orders complete.

Therefore, I think it’s probably high enough for now. The risk is that earnings could run into a brick wall for FY 04/2023, with investors being disappointed by growth stalling from those big orders completing. It’s a potential headwind, which the company has been very open about.

On the positive side, more good quality acquisitions could outweigh any issues over one-off orders. And one-off orders could repeat, who knows?

As long as everyone is aware of the one-off orders issue, then people can make a fully informed decision about valuation.

High StockRank too.

.

.

---

Jack’s section

Gateley Holdings (LON:GTLY)

Share price: 210p (-0.94%)

Shares in issue: 117,888,007

Market cap: £247.6m

Gately is a legal and professional services group. It listed in 2015 following changes to the law to adopt an Alternative Business Structure (ABS), allowing non-lawyers to own and invest in law firms. There are a couple of similar listed plays now, including Rbg Holdings (LON:RBGP) which we discussed at the Mello BASH last night. There’s a consolidation and disruption opportunity in this part of the market.

Since floating in 2015, the group has acquired:

• Capitus and Hamer Associates in 2016,
• GCL Solicitors, Kiddy & Partners, and International Investment Services in 2018,
• Persona Associates and T-Three in 2019, and
• Paul Tweed and The Vinden Partnership in 2020.

More specifically, the group has built a ‘platform’ of market-facing structures on which complementary legal and consultancy services are aggregated.

Unlike RBG Holdings however, 90% of group revenue still comes from legal (for RBG it’s something like 66% of FY20 profits from legal and an expected 50% of FY21) so it is more concentrated but this could change pending further acquisitions.

This was last covered in the SCVR earlier this month by Paul, noting the delay to accounts.

Preliminary results

High levels of activity, strong trading momentum, overall sense of optimism and confidence… have continued into the new financial year and the Board is confident in the outlook for FY22.

Highlights:

• Revenue +10.5% to £121.4m,
• Underlying profit before tax (PBT) +7.1% to £19.3m; PBT +10.5% to £16.3m,
• Adjusted diluted EPS +5.8% to 13.17p; basic EPS +8.1% to 11.18p,
• Net assets +32.2% to £59.3m; net cash +£20.5m to £19.6m.

Non-legal revenues increased by 27.3%, thanks in part to a £14m contribution from Gateley’s consultancy businesses. Cash generation looks very good, with Covid cost savings and working capital management allowing for the repayment of all bank debt.

Net cashflows from operating activities was £25.4m (FY20: £13.3m) representing some 193.2% of profit after tax. That’s arguably not sustainable, but cash conversion in the prior year was an encouraging 113.5%. Free cashflow was £20.8m.

Staff bonuses and dividend payments have been resumed. Total personnel costs increased by 21.9% to £77.5m (FY20: £63.5m) - that’s 64% of revenue. No surprise given the business model, which relies on retaining and recruiting human capital.

Other operating expenses reduced by £2.7m or 11.5% to £21.0m as the cost of travel, marketing and premises reduced following a full year of remote working.

The second half of FY21 was ‘extremely strong’ with high levels of activity, which more than compensated for the impact of the first National Lockdown. The turning point arose just before the half year-end, when activity levels returned and the group’s pipeline strengthened significantly.

Outlook - Strong trading in the first two months of the new financial year with good pipelines of new work and acquisition candidates. The latter is to be ‘widened and enhanced’ in FY22 and beyond.

The dividend policy remains to distribute up to 70% of profit after tax (PAT) to shareholders, typically one third following its half year results and two thirds after the full year results are known.

Conclusion

The above values GTLY shares at 16.3x adjusted diluted earnings, 19.2x basic earnings, and about 12x free cash flow. Not obviously cheap, but not expensive either if you believe in the growth prospects.

Gateley took a conscious decision not to make any acquisitions during FY21, and instead focused on integrating its FY20 acquisitions. It intends to resume acquisition activity now.

There’s a consolidation and expansion opportunity in this space that a couple of players have identified. Gateley’s own strategy of creating a market-facing ‘platform’ to which it can bolt on complementary professional services businesses looks to be sound. The key will be in identifying appropriate acquisitions, purchasing them at attractive prices, and successfully integrating them.

I’ve a favourable impression of a couple of these legal and professional services firms. The opportunity should reward entrepreneurial operators with a deep history in the space, Gateley being one of them.

Is there a ceiling to the strategy, I wonder? It’s a fragmented market but how big can these platform companies become before they begin to get unwieldy? Perhaps there’s more to aim for before that becomes a serious consideration.

---

Wilmington (LON:WIL)

Share price: 214p (+2.88%)

Shares in issue: 87,569,384

Market cap: £187.4m

Since floating on the London Stock Exchange in 1995, Wilmington has evolved from a UK publishing business to a global company with information, education and networking services. Acquisitions and developments over the years include:

• 1999 - First training business acquired: Central Law Group (CLG),
• 2000 - healthcare data and market-intelligence services Binley’s
• 2001 - creation of ​​International Compliance Association (ICA) in response to growing importance of compliance regulation in financial institutions,
• 2007 - sale of non-core trade magazines in move away from advertising revenues,
• 2010 - Axco Insurance Information Service acquired
• 2015 - Financial Research Associates LLC (FRA), expanding US healthcare presence
• 2016 - Wellards acquired, since rebranded as Digital Learning Academy and is part of Wilmington Healthcare. SWAT UK purchased and integrated with Mercia.
• 2017 - HSJ added and combined with Wilmington Healthcare

Education businesses can be attractive, but the consistent acquisitions does mean that £97.6m of Wilmington’s £166m total assets are goodwill and intangibles. Meanwhile, total liabilities of £123m include £48.5m of debt. The current and quick ratios are tight.

The group appears to be solidly cash generative however, and interest cover is a comfortable 4.8x.

Wilmington has struggled to grow in recent years and this is reflected in its rangebound share price.

Year end trading update

Wilmington ended the year ahead of expectations for revenue, Adjusted PBT and net debt.

(Adjusted (PBT) is calculated as PBT after adding back amortisation of intangible assets except computer software and profits/losses on disposals and business closures.)

Trading in both the Information & Data, and Training & Education divisions was strong in H2 resulting in group revenue for the year being unchanged, despite the lack of face-to-face training or events.

Revenues excluding events have grown year-on-year in both divisions.

Full-year adjusted profits are ahead of FY20 as a result of the digitisation of its products and services, strong revenues, tight control of overheads, and actions taken to reduce less profitable lines of business.

Cash flows have been strong with group net debt at 30 June 2021 down to £17.7m (30 June 2020: £27.7m).

Conclusion

A short update, but a positive one from a trading perspective I would say.

This could be a collection of nice, defensive businesses with predictable revenues and cash flows.

Falling net debt levels is a good result. You can argue there’s a weak balance sheet here if you strip out goodwill and intangibles, which results in negative net tangible assets. But then again Wilmington generates solid cash flows from its business franchises, which comfortably covers debt payments. The working capital position looks unnecessarily tight.

All in all, the company can work on strengthening the balance sheet in my opinion.

That aside, a lack of positive growth CAGRs stands out on the StockReport. There are some hints of quality and potential here, but it would be good to see that coupled with more definite signs of profitable growth and greater financial security.