Small Cap Value Report (Tue 25 May 2021) - SOS, TED, PMP, MTC, DWF, LOOK, CLX

Good morning, it's Paul & Roland here with the SCVR for Tuesday. Sorry for the late start, Paul overslept & sleep-snoozed his alarm.

Timing - we have to be finished before noon today, as I have my niece & nephew to entertain for lunch at "Crabs" - Bournemouth's finest fish restaurant, a bit later. Today's report is now finished.

Agenda -

Paul's Section:

Sosandar (LON:SOS) (I hold) - fundraising - inevitable, but executed very well indeed - nil discount, and only 13.6% dilution. £5.24m raised pre-fees (£4.93m post net). Share option scheme being rejigged - suck it up, because the 2 founders are the business. My view - on the cusp of solvency, and they've done well to defer fundraising for a year, now raising from a position of strength. Well executed - this is how it's done - hats off to the ladies at Sosandar, and the team at N+1. I hear there was strong demand - as evidenced by speed, and no discount.

As we've seen with Staffline (LON:STAF) and several others, there are some nasty fundraisings coming through, where the institutions & high net worth flippers are demanding deep discounts. So brace yourselves, I've been tipped off that some horror stories are in the pipeline, but can't say any more than that at the moment. Be very careful - the days of easy fundraisings are over, I've been told. If anything looks financially distressed, and in need of a placing, it's pot luck whether private shareholders get diluted heavily or not.

What a terrible system - we need to campaign for reform in the UK to mimic the Australian system, whereby shares are suspended briefly, and fundraisings are done quickly, and openly - prioritising existing shareholders.

The UK system is inferior, and arguably corrupt - a false market exists whilst placings are being undertaken behind closed doors, yet hundreds of people must know that a discounted placing is being arranged. This has to stop.

Ted Baker (LON:TED) - bank facilities renewed.

Portmeirion (LON:PMP) (I hold) - a positive-sounding update. Looks a good recovery share, and still reasonably priced on broker forecasts.

Mothercare (LON:MTC) (I hold) - a reassuring update, but the pension scheme overpayments scheduled look to swallow up pretty much all of the future profits, on current guidance. Impossible to value.

Dwf (LON:DWF) - a good trading update - 15% ahead of expectations. Looks potentially interesting.

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Roland's Section:

Lookers (LON:LOOK) - a promising update from this car dealership group, which is trading ahead of expectations. But I feel there may be better choices elsewhere in this sector.

Calnex Solutions (LON:CLX) - maiden full-year results from this telecoms testing equipment provider, which floated last year. Strong numbers but some uncertainty over the outlook for the current year.

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Ted Baker (LON:TED)

New banking facilities are signed off today. I wonder if this was the real reason for audited results being delayed, as reported yesterday? Could be - auditors require secure funding for 12 months from the date of signing off the accounts, in order to meet the "going concern" requirement. I checked out the company's balance sheet yesterday, and it looks fine. It will be interesting to see how the company fares once Govt support measures (especially business rates suspension) are withdrawn., taxes all have to be paid up-to-date, and working capital normalises.

Ted Baker Plc, the global lifestyle brand, is pleased to announce that it has signed an extension to its revolving credit facility with its existing lending syndicate.

The new agreement extends the revolving credit facility maturity to November 2023 and amends the covenants. Combined with Ted Baker's strong net cash position of £66.7m at the end of the financial year 30 January 2021, this ensures the Group has the necessary cash and liquidity to continue the successful delivery of its transformation plan.

Under the new agreement, the existing RCF of £108m maturing in September 2022 and restricted RCF of £25m maturing in January 2022, will be replaced by a new RCF of £90m reducing to £80m in January 2022 until maturity in November 2023. The existing lending syndicate continues to show ongoing support to the Group.

The amended revolving credit facility includes among other changes amendments to the adjusted EBITDA covenant tests, providing further financial flexibility for the Group.

Banks might be supportive in a crisis, but they're going to want shareholders to take up the risk & repair balance sheets as the economy recovers. Banks are not charities, and they tend to avoid risk. Strong liquidity now, may not look quite so good once working capital has normalised, and stretched creditors repaid - that's a general point, not specific to TED.

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Portmeirion (LON:PMP)

(I hold)

680p (up 1%, at 08:38) - mkt cap £93m

AGM Trading Statement

Portmeirion Group PLC, the designer, manufacturer and worldwide distributor of high quality homewares under the Portmeirion, Spode, Royal Worcester, Pimpernel, Wax Lyrical and Nambé brands…

We are delighted to report that we have had an excellent start to the year. Our sales for the first four months of the year (to 30 April 2021) have increased by more than 50% on the same period in 2020.
On a like-for-like basis, our sales for this period are slightly ahead of pre-Covid levels achieved in the same period in 2019.

• Ongoing disruption from covid (“some” - so sounds annoying rather than disastrous)
• Reminds us of strong H2 weighting - almost all the profits tend to be made in H2, from memory
• Pipeline of exciting new products for launch in 2021
• Confident about growth opportunities globally

Dilution - it’s such a pity that PMP did a (panic?) fundraise during the pandemic, as the share count has gone up from 11m to 13.8m, thus curtailing the upside on the share price. Still, it’s easy for me to be wise after the event. In the midst of the pandemic, management must have been under great pressure & uncertainty, here and at most other companies for that matter.

It’s difficult to remember just how bad everything looked back in March 2020. Who could have predicted that we’d be looking at something akin to an economic boom now, just 14-15 months later?

Valuation - today’s update is a bit vague, not saying anything about profitability. Reading between the lines, the upbeat tone, and positive revenues suggests that we might be heading for in line, or above, market expectations, perhaps?

I can see why they wouldn’t want to push the boat out re commentary in the seasonally soft H1, but I imagine today’s upbeat comments increase the likelihood of forecasts being raised later in 2021. That’s guesswork though, on my part.

Many thanks to N+1 Singer, where Sahill Shan has written an update note published this morning. No changes are made to forecasts, but he suggests risk is to the upside.

Adj EPS is forecast at 36.4p for FY 12/2021, and 56.8p next year. This makes the 680p share price seem good value to me.

My opinion - I like the still fairly new, more ambitious management team here. The strategy to focus on eCommerce, and make the business more efficient, strikes me as the right way to go.

I’ve got a display cabinet half full of “Botanic Garden” crockery. Every time PMP emails me (rather too often actually), I can be tempted to buy more seconds (which look almost perfect to me). It’s not recurring revenue for PMP as such, but it’s definitely repeating revenue, and of course every now and then something is broken & needs replacing. Customer lifetime value must be pretty good.

On fundamentals, I think this share is worth more than 680p, and the chart looks promising too -

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Mothercare (LON:MTC)

(I hold)

16.0p - mkt cap £92m

A reader quipped the other day, that I seem to hold shares in practically everything! It’s fair to say that I have been recycling profits into buying more & more shares over the last 6 months or so, and a portfolio pruning is probably overdue. Trouble is, companies keep putting out good updates, and forecasts go up, and nothing in my portfolio looks over-priced, so I’m pretty happy with things, and the outlook seems good too.

For background, I did a fairly thorough review of MTC shares here on 6 April 2021. The pension scheme overpayments are massive, that’s the elephant in the room. More work is needed on that, when time permits.

On to today’s news.

Trading & Business Update

Mothercare plc ("Mothercare" or "the Company"), the global specialist brand for parents and young children, today issues a pre-close trading update for the financial year ended 27 March 2021.

The highlights are self-explanatory - this is copy/pasted (my bolding added), to save me re-typing it all -

• Unaudited net worldwide sales of £326 million for the year impacted by varied approaches to Covid-19 in franchisee markets
• Significantly reduced net debt of £12.1 million at the year end
• Performance over the recent period is in line with expectations and the Group anticipates reporting a small EBITDA profit for the financial year, against previous guidance of a small loss
• New asset light operating model providing ongoing financial benefits
• Further overhead reduction planned from a further reduction in distribution costs and a new ERP system
• Encouraging feedback to new, bespoke product strategy for international markets

Strange that they say it’s in line with guidance, then in the next bullet point, say they’re ahead of guidance! Confusing, but it’s positive anyway.

FRC review of last year’s accounts - concluded, with no material changes required.

MTC reminds us of the business model change, whereby products will be bought by franchisees direct from factories, a terrific idea which means that MTC won’t be funding inventories.

Outlook -

the Directors believe that Mothercare remains on track to return to profitable trading levels in the short to medium term…

... the steady state operation of our retail franchise operations in more normal circumstances could return to annual operating profits of £15 million in future years.

Pension scheme - notable by its absence from today’s update. A reminder of the cash over-payments as currently scheduled -

FY 03/2021: £3.2m

FY 03/2022: £4.1m

FY 03/2023: £9.0m

FY 03/2024: £10.5m

FY 03/2025: £12.0m

FY 03/2026: £15.0m

FY 03/2027: £15.0m

FY 03/2028: £15.0m

FY 03/2029: £15.0m

FY 03/2030: £5.7m

Total: £104.5m

That’s going to consume most/all of the cashflows generated by the business, as things stand. So I wonder what's left for shareholders?

My opinion - the opportunity here is if the pension scheme liabilities melt away, which is possible.

If they don’t, then the business is basically existing for the main purpose of funding the pension scheme.

Therefore, as things stand, I find it impossible to value this share.

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Dwf (LON:DWF)

101p (up 6% at 10:59) - mkt cap £329m

I’ve run out of time for today unfortunately, but just want to flag up this legal services business.

Shares are up 6% on what looks like a good trading update, including -

Adjusted profit before tax of £34m exceeds market expectations by c.15%1

1 DWF believes consensus PBT, prior to this announcement, was £29.3m

The PER & dividend yield look attractive on the StockReport, and with forecasts set to go up 15%, those metrics are going to improve further.

I don’t have a view on this share, but it might be worth readers taking a closer look at it, if you’re happy to invest in legal services shares.

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Roland’s section

Lookers (LON:LOOK)

64p (pre-open) - market cap £250m

Trading update

Car dealership group Lookers has provided a trading update today. It’s ahead of expectations and also confirms that the group - which is emerging from a difficult period - has been able to renew its banking facilities and is (finally) ready to publish its 2020 results:

Lookers plc ("Lookers" or the "Group"), one of the leading UK motor retail and aftersales service groups, today provides an update on trading, the renewal of its bank facility and notice of the announcement of its 2020 Results and AGM.

Trading

Lookers says that trading since dealerships reopened on 12 April has been “strong”. The company reports strong customer demand and “significant market out-performance”. Profitability has also improved, with higher gross margins as a result of cost cutting.

Although the company stresses that uncertainty remains due to Covid-19 and supply constraints, underlying pre-tax profit for 2021 is now expected to comfortably exceed current market consensus.

This chart shows sales for the first four months of 2020, versus the corresponding period last year.

Although the LFL numbers appear strong, I’m not sure these LFL numbers offer a very meaningful comparison.

Lookers’ retail sites were mostly closed from 23 March until May last year, and prior to that there was a well-documented slump in retail new car sales linked to the diesel emissions backlash. In contrast, click-and-collect trading remained strong through the lockdown earlier this year.

Even so, these figures do seem to show that Lookers is bouncing back.

Renewal of Bank facility

When Lookers’ shares were suspended due to accounting problems last year, Paul commented on the risk that the company’s banks might withdraw their support. Fortunately, this hasn’t happened.

The company says today that it’s been able to renew its banking facility with its existing lenders. The revolving credit facility (RCF) now runs until 30 September 2023 and is for an initial amount of £150m.

This is significantly less than the RCF of £238m reported in the 2020 interim results. This may indicate a reduction in lending appetite by Lookers’ banks. But it may also mean that the company’s requirements are lower, following a string of property disposals and site closures.

Net debt is said to stand at £4m currently, so the overall situation seems fine, as far as we can tell at this time.

Notice of results

The banking facility renewal appears to have been an important step towards getting the company’s auditors to sign off on Lookers 2020 accounts.

Audited results for the year ending 31 December 2020 are expected “in the second half of June”. That’s very late, but Lookers is still recovering from the accounting problems of last year and is also working with a new auditor, BDO, who I suspect is being very thorough.

Lookers didn’t manage to publish its 2019 results until November last year and the 2020 interim results weren’t published until January 2021. So I guess this year’s June date represents progress.

Reassuringly, the group plans to return to a more normal reporting schedule from now on, with interim results due in September.

My view

After last week’s strong update from Marshall Motor Holdings (LON:MMH), I’m not all that surprised to see another car dealership group reporting strong trading. Cars seem much easier to buy and change than they used to be, mainly because hardly anyone actually owns them anymore - PCP financing is all about paying the depreciation.

However, I have read some interesting commentary recently, suggesting that new and used car markets are starting to face serious disruption as a result of the global semiconductor shortage and unusually low defleeting volumes from the big rental companies (after last year’s slump).The concern is that this could cause shortages of both new and used cars, plus rising prices.

It remains to be seen how this situation plays out, but Lookers shares have had a strong run over the last year and are now trading ahead of pre-pandemic levels:

After today’s update, my sums suggest the shares are valued on around 9.5 times 2021 forecast earnings.

For contrast, Marshall Motor Holdings (LON:MMH) - on which we reported last week - is trading on about 8.5 times 2021 forecasts. Vertu Motors (LON:VTU) is on eight times 2021/22 forecast earnings. Both of these companies have been more reliable performers for shareholders than Lookers in recent years, with solid balance sheets and reliable dividends.

If the car market stays strong, I think Lookers could have further to go. But in my view, there’s better, safer value elsewhere in this sector.

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Calnex Solutions (LON:CLX)

116p (-1.7%) - market cap £102m

FY21 final results

Full-year results from one of last year’s more interesting IPOs, technology group £CLX. This Scottish company provides test and measurement solutions to telecoms network operators.

Calnex specialises in tools for timing and synchronisation and network emulation. Both are increasingly important areas for managing highly interconnected, physically dispersed networks.

Jack provided an excellent introduction to this business back in February.

Buyers who spotted this opportunity early have doubled their money since October’s IPO:

The shares aren’t as cheap as they were, but Stockopedia’s quality metrics suggest to me that if growth can be maintained, this business could justify a strong valuation:

With this in mind, let’s take a look at today’s results.

2021 results

Today’s results cover the 12 months to 31 March and appear to show strong growth on all the standard metrics:

EBITDA: I do not often say this, but I think that in this case, underlying EBITDA is a superior measure to the non-adjusted statutory EBITDA. The reason for this is that Calnex’s underlying EBITDA includes the amortisation of R&D costs (statutory EBITDA does not).

The amortisation of R&D costs reflects past spending that’s been capitalised to the balance sheet. It does not reflect profits from trading activity. Subtracting this amortisation gives us a more credible view of cash coming into the business, in my view.

Pre-tax profit: Once again, I think Calnex’s adjusted pre-tax profit figure is quite credible. The adjustments made to statutory pre-tax profit relate to one-off IPO costs and discontinued businesses.

Profit margins/ROCE: Today’s accounts show a statutory operating margin of 21% and a return on capital employed of 19%. Using adjusted operating profit, these numbers rise to a margin of 29% and ROCE of 26%.

Calnex appears to be an above-averagely profitable business. This suggests to me that its products have decent pricing power and some competitive advantages.

Net cash: The balance sheet looks strong, with net cash of c.£12m. There’s no mention of a dividend in today’s results, but the company does say that it will consider acquisitive growth.

Free cash flow: This appears to be a cash-generative business. There were some large and favourable movements in working capital last year. Excluding these, my sums suggest Calnex generated underlying free cash flow of £3.8m last year. This represents 110% of the company’s net profit for the year - a nice result.

Customer concentration risk: One thing that’s caught my eye in today’s results is that this business appears to depend quite heavily on a small number of major customers.

According to today’s report, Calnex’s top 10 revenue-generating customers accounted for 49% of revenue last year (FY20: 52%). The biggest “underlying customer” was said to be responsible for 12% of revenue.

Fortunately, customers do appear to be loyal:

• In FY21, 80% of revenue came from existing customers.
• The average length of customer relationship across the top 10 customers is said to be nine years
• 176 existing customers have placed repeat orders in the last five years.

I don’t see this risk as an immediate concern, but as the company continues to grow I would hope to see customer concentration reduce. As things stand, losing a top 10 customer could result in a big hit to revenue.

Outlook: The market reaction to today’s results has been fairly cool. I think the reason for this lies in the company’s trading commentary for the year.

Although the overall impact of Covid-19 is said to have been minimal, some customers pulled forward orders into FY21. As far as I can tell, these are not expected to be repeated in FY22.

According to CEO and founder Tommy Cook, despite expected underlying growth in FY22, overall results may be flat this year (my bold):

"We are confident that our breadth of product offering, depth of customer relationships and the strong underlying market drivers mean Calnex is well positioned and we anticipate that results in FY22 will be consistent with FY21, representing further growth when taking into account the impact of COVID-19 on FY21 through accelerated revenues and travel savings. We see a significant opportunity for both organic and acquisitive growth in the medium term and look to the future with confidence."

House broker Cenkos has published a new note this morning (available on Research Tree) which suggests that revenue could fall to £17.2m this year (FY21: £18m), while adjusted pre-tax profit could fall by 14% to £4.4m (FY21: £5.1m). Both measures are expected to return to growth in FY21.

If accurate, I’d imagine this outlook might limit the scope for near-term share price growth.

My view

Is this another well-timed flotation? Time will tell. I’m inclined to give Calnex the benefit of the doubt as a potential long-term investment. This business appears to have attractive products that enjoy consistent demand in a structural growth sector. This view is echoed by research cited by the firm in today’s results:

The global market for telecoms test and measurement equipment for mobile networks alone is forecast to expand at a CAGR of 11.5 per cent from 2020 through to 2024 (Frost and Sullivan). The Board believes this provides favourable market conditions for Calnex for the foreseeable future.

Assuming that Calnex’s product range remains relevant and competitive, I don’t see any reason why it shouldn’t benefit from these favourable market conditions.

I’m also reassured by the presence of founder and CEO Tommy Cook on the shareholder list. Mr Cook remains the company’s largest shareholder after flotation, with a 21% stake. Clearly he should be incentivised to deliver sustainable growth.

On balance, Calnex looks a little like a smaller, niche alternative to FTSE 250 firm Spirent Communications (LON:SPT).

Like Spirent, Calnex appears to generate high returns, selling products that are essential to network operators. On a medium-term view, I would expect Calnex to benefit from telecoms capex cycles but be prone to lumpy order flow at times.

If you’re interested in learning more about the opportunities the company can see, there’s plenty of detail in today’s results about the technical demands of 5G and cloud computing networks. It makes for interesting reading and seems to support the growth case for this business.

I like what I’ve seen of Calnex. What might tip the balance and make the stock a potential buy for me would be the introduction of a small dividend. The company’s cash generation suggests this should be affordable, and I would see a dividend as evidence of financial discipline and shareholder focus.

However, although I like this business, I’m not sure how much near-term upside the stock offers, given the cautious outlook for this year. At current levels, I’d say the stock is probably at a fair price. I think this might be a good stock to pick up on any market wobbles over the coming months.