Small Cap Value Report (Tue 24 Aug 2021) - IGR, ESYS, BVC

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

Agenda -

Paul's Section:

Ig Design (LON:IGR) - trading update today flags cost of sea freight, and supply chain disruption - no surprise there, everyone is experiencing problems in that area. Strong demand & cost mitigation have kept things on track to meet market expectations. So a reassuring update today I think.

Batm Advanced Communications (LON:BVC) - outstanding interim results caught my eye yesterday, but two thirds of the profit is from a one-off disposal. Also there seem some one-off contracts from covid - ventilators and testing kits. Looks an innovative group, but I've no idea how to value it, given the difficulty in ascertaining future profit levels.

Jack's Section:

Essensys (LON:ESYS) - fairly robust results over a disrupted year. The group's SaaS products are well-positioned for the growing flexible work market and the US sounds like a big opportunity. The recent fundraise gives the group c£37m of net cash to accelerate growth plans, but for now this appears to be reflected in the valuation given revenue of £22m and a market cap of more than £200m.

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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), 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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Paul’s Section

Ig Design (LON:IGR)

522p (pre market open) - mkt cap £506m

Trading Update

IG Design Group plc, one of the world's leading designers, innovators and manufacturers of celebrations, craft, gifting, stationery and creative play products, today issues a trading update for the four months ended 31 July 2021.

Strong revenue growth but challenging cost headwinds

IGR has a 31 March year end.

Good start to the financial year

Comparable revenues up 25% on 2020, and up 10% on 2019 (the more meaningful comparison)

“Challenging cost headwinds” - especially in sea freight, as is being reported by many companies at the moment

“Operational disruption” from continuing impact of covid

Strong demand & cost mitigation measures have kept trading in line with expectations (that’s how it reads to me, but wording is a little ambiguous)

Full year FY 03/2022 outlook sounds OK

Looking forward the Group's orderbook for the year continues to be ahead of prior year, underpinning a full year sales outlook ahead of expectations, and as a result the full year forecast earnings remain in line with current market expectations, albeit with the ongoing issues associated with the current supply chain and Covid-19 related challenges.

Net debt - reduced, and now insignificant. Although note that this group does have large seasonal swings in working capital, so a snapshot in time may not tell the full picture -

At 31 July 2021 the Group had net debt of $5 million (31(st) July 2020: net debt $29 million) reflecting the strong cash generation in the prior year and ongoing robust cash management in the current year.

My opinion - we’re all aware of current supply chain problems, which raises the risk of profit warnings, if things get worse.

IGR seems to have a buffer from higher demand, and today’s update strikes me as reassuring.

Although it does call into question the wisdom of so many UK companies having supply chains that seem so dependent on China, an increasingly externally hostile one-party dictatorship.

That raises a major risk, if or when tensions flare up seriously over Taiwan, South China Sea, etc. Investors do need to bear this in mind, as it could lead to a complete shutdown in trade at some point in the future. How do we avoid that risk though, when China is now the workshop of the world?

It would be good to see companies diversifying their supply chains, and onshoring production closer to home, but even then the raw materials would probably come from China! Personally I’d like to see fewer companies in my portfolio so dependent on Far Eastern supply chains. Maybe that means looking more at services companies, rather than companies which shift physical goods from the Far East?

In terms of valuation - IGR looks priced about right to me.

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Batm Advanced Communications (LON:BVC)

88.6p (unchanged at 13:41) - mkt cap £387m

This is an Israel-based company with telecoms and medical divisions, which has been listed on the main UK market for about 25 years - impressive staying power. Apart from a brief flurry between 2009-2011, there have not been any divis.

I wouldn’t normally take things any further, as experience has taught me that it’s generally best to avoid overseas small caps that list in the UK. However, the 25 year history of its London listing, and really impressive headline results numbers yesterday have caught my eye.

Interim Results

Revenue of $71.4m in H1 - a meaningful amount, but down 7.7% on H1 LY

Gross margin notably higher, at 36.0% vs 29.7% H1 LY - although still quite low in absolute terms

Humongous increase in adj operating profit from $2.8m to $20.5m - there are clearly some one-offs in that.

Bio-medical division is the main part of the business, with H1 revenues of $55.1m, and an adj operating profit of $9.4m - an exceptional contract for ventilators is mentioned, so I don’t know how sustainable the profits are?

Diagnostic test kits for covid-19 are also mentioned, so that could again be a variable factor.

Disposal of NGSoft (non-core business) generated a one-off profit of $13.0m, so that makes up about two thirds of the reported operating profit.

Outlook/Guidance - more detail is given, but this is the key bit -

As a result, the Group expects revenue for full year 2021 to be approximately 5% ahead of market expectations. With the greater than expected ongoing demand for the Group's COVID-19 diagnostic solutions, which are higher margin products, combined with the capital gain from the sale of NGSoft recognised during H1 2021, the Group anticipates full year EBITDA to be more than 20% ahead of market expectations, reflecting growth in EBITDA of over 40% year-on-year.

Balance sheet - looks very strong on paper, including $62.2m in cash. Receivables of $38.9m, and inventories of $33.8m both look rather high to me.

Dividends - given the strong balance sheet, and cash pile, why isn’t it paying divis? This cropped up in the webinar which I listened into yesterday. Previously the company had indicated its intention to distribute surplus cash to shareholders, which was reiterated in the webinar. When asked about timing, management replied that it needs to be approved at the AGM in Oct 2021, at which time they will also announce the amount of the dividend.

It will be interesting to see how much cash is paid out in due course.

My opinion - neutral. I don’t normally invest in overseas small caps that list in the UK. Too many of them have gone wrong in the past.

That said, Israeli companies listed in the UK have a mixed performance. I did well on a thing called Pilat Media a few years ago, which was taken over at about 3x the previous price. Then Plus500 (LON:PLUS) has been a rollercoaster, and ran into regulatory problems, but survived and prospered. Tremor International (LON:TRMR) has also had a very bumpy journey but seems to be thriving now. Xlmedia (LON:XLM) also went all over the place. So it’s a strange area. Israeli companies seem very good at tech, and innovation, but you don’t always necessarily get what you think you’re buying! Mind you, we can say that about lots of other companies from other countries too, including the UK!

Management did a good presentation on the webinar yesterday, and there certainly seem to be some interesting parts within BATM. It struck me as being mainly an innovation company, which seems to have done well with some covid-related products. Mgt also talked about a new lollipop they are developing which is lemon flavoured, and makes covid testing much more pleasant, e.g. for children, which sounds like a good idea.

Overall, it’s much too complicated, and difficult for me to analyse, so I’ll leave it there. I just review the numbers, and with one-off, exceptional contracts & profit on disposal, trying to work out future profits is too speculative for me to form any view on the shares. Good luck to holders!

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Essensys (LON:ESYS)

Share price: 315p (+2.94%)

Shares in issue: 64,385,219

Market cap: £202.8m

Essensys provides software to the coworking industry. It’s got two platforms: Connect and Operate. Both aim to reduce the costs and operational challenges of day-to-day management of these flexible workspaces.

The business was actually founded back in 2006 at a time when the flexible workspace market was fairly mature in London. It took four years for the group to refine its product and customer adoption quickly followed. With a London base secured, the group has more recently set its sights on the US market, which has been a significant growth engine for the business.

Flexible workspace in the US is at 2% and is forecast to grow to 30%, so management is enthusiastic about the opportunity there, with brokers citing a £2.5bn addressable opportunity in total.

The share price chart looks as you might expect given all that’s happened, with a recent doubling to all-time highs as the market anticipates an accelerated structural shift towards new ways of working.

The market cap is now nearly £200m on forecast FY21 revenue of £22m. Revenue is growing but, at a CAGR of 16.7%, is it growing fast enough to justify that price to sales ratio?

The company is not yet earning reliable profits but cash generation per share looks to be more robust. Still a high multiple though, with price to trailing twelve month cash flow some 61x (and negative free cash flow after investment).

Trading update for the year to 31 July 2021

Highlights:

• Group revenue -2.22% to £22m, of which 87% was recurring (FY20: 86%),
• Adjusted EBITDA ‘in line with consensus market expectations’,
• US recurring revenue +20% to $12.15m,
• Constant currency annual recurring revenue run-rate in July +4% year-on-year to £20.5m,
• Net cash at year end of £36.9m (£5m pre-fundraise).

Essensys closed the financial year with 474 live Connect sites, up 13% year-on-year. The majority of the 28 new Connect sites are to be delivered in H1 FY21.

Around £32m of net proceeds were raised in July via an over-subscribed placing and open offer. This will be used to pursue the group's growth plan over the next three years, accelerating its global go-to-market activities and product development roadmap.

As part of this new plan, Eric Schaffer was appointed CEO of the newly established Asia Pacific business. This expanded capacity appears to be driving decent growth in the US.

Mark Furness, CEO commented:

essensys has made great progress this year, delivering results in line with expectations, continued growth in recurring revenues, and the addition of a number of new strategic customers. This reflects the long-term structural drivers for flexible real estate offerings, which have been accelerated by Covid-19. We have a clear plan to capture this market opportunity, reflected in our recent placing to raise £32m and early progress with our expansion in Asia Pacific.

Conclusion

Essensys is well-placed to trade into a potentially structural growth trend, there’s been some senior hires, a strategy revision, and a significant fundraise. The office real estate area is changing rapidly with a renewed desire for flexibility at the heart of that change. It’s still run by its founder-CEO Mark Furness, who is also the largest shareholder.

Essensys has been supporting a substantial shift in working habits for around 15 years and it seems as though its software-as-a-service solutions are widely used in this exciting space, allowing building owners and landlords to scale up their flexible working footprints.

But the valuation seems steep to me. It does look like the fundraise and linked growth plan are feeding into broker estimates, with FY22 revenue expected to jump from £22.4m to £28.3m. So it’s all about whether or not Essensys can capitalise on the pipeline opportunity in the medium term and justify a high growth rating.

There is a risk to the downside though if the group can’t match the anticipated growth rates. Some notable institutions increased their stakes in the recent fundraise: BlackRock, Amati, Canaccord. No doubt they see a significant opportunity, but I’d need to be much more confident of that opportunity myself before buying in at these levels.