Small Cap Value Report (Tue 27 July 2021) - MOTR, ERGO, ITS, SLP, RST, RWA

27th Jul '21 by Jack Brumby

57 comments 10835 reads

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

Timing - TBC

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:

Motorpoint (LON:MOTR) - shares rerated recently after the company communicated ambitious expansion plans to the market, but plenty of upside remains assuming the experienced management team can hit targets.

In Style (LON:ITS) - results for FY 03/2021 are as flagged in the last trading update. Very impressive growth rate of +132%, but I have some reservations about this share - can it scale up enough to consistently take on dominant brands like Boohoo and others?

Restore (LON:RST) - notes from my chat with management this morning. Taking into account net debt, and negative NTAV, I think the current share price looks about right.

Jack's Section:

Ergomed (LON:ERGO) - the transition to a services model is complete, growth continues to be strong, and the order book gives confidence on future prospects. But, at these levels and in the short term, 'in line' updates are unlikely to push the share price much higher.

Sylvania Platinum (LON:SLP) - sentiment has shifted recently due to social unrest in South Africa. Today the PGM producer reports a quarter-on-quarter decline in financials owing to a spike in rhodium prices in the previous quarter but year-on-year trends remain favourable. Share price volatility and commodity price risks remain but if you believe that the outlook for PGM prices is positive then SLP continues to look cheap.

Robert Walters (LON:RWA)…

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777driver

27th Jul '21

I’m looking at getting into the recycling, seems to be a growth sector with chance of consolidation/ take overs. Restore and Renew look interesting and have had good runs, but both have a some debt. Does anyone use a fag packet method to determine when debt is too much?

Donna1

For anyone interested, I thought I would flag there are prelim stock rankings up now for Supreme (LON:SUP) (as it has been mentioned here numerous times over the past week). When Paul wrote about it initially, there was nothing much on the Stocko page. So we have more skeletal and indicative information inc. rankings.

Stockrank = 51

No position.

Rusty2

Debt 3x Operating Profit is one rule I have used when screening stocks. Also watch out for pension deficits, some stocks do have large ones such as De La Rue (LON:DLAR).

doublelutz

Certainly a PE of 8 based on their adjusted results but less if you adjust for some of their adjustments! Jim Mullen states that positive cash flow is expected to substantially reverse over the second half of the year. Anyway, you are right, it does eventually have material upside potential.

abtan

Reach (LON:RCH)

Hi David

I don't hold, but I do keep an eye on this one as I know it's a Stockopedia favourite and there's always that FOMO following me around.

When I looked at the cash flow statement today, it looked like a big chunk of the cash inflow - c£43m - came from favourable working capital movements, including a big increase in payables.

There wasn't much detail on this, though I recall seeing a comment that this would reverse in the second half of the year.

At the moment the company doesn't actually seem to be making much cash, if any at all.

But once the deferred payments finish, which I believe is in about 1.5 years, and the pension payments are completed in about 5 years then, all things remaining the same, this will be a cash cow.

It would be great to see more detail on the profitability of the digital segment, but until then I can't bring myself to invest, which is a shame given how high the share price has risen over the last couple of years.

Cheers

davidjhill

correct the excess will unwind but I still expect cashflow to be around £50m in H2. The £80m is an anomaly but this business throws off £100m+ cash p/a so I think we are looking at net cash circa £90m by year end.

"At the moment the company doesn't actually seem to be making much cash, if any at all."

That's completely wrong. Whilst there was an extra £30m of cash in this period that will indeed unwind, but this business throws off a huge amount of cash.

If you go back to the start of 2019 post their last asset purchase net debt was £40m. Move on 3 years and it will be net cash of £90m so it is averaging a net increase of cash of around £45m p/a and that's after tax, dividends, deferred payments and extra amounts in the pension deficit, which is now considerably lower, and also includes the impacts of Covid.

It is already a cash cow - but that will also increase substantially over the coming couple of years.

"Whilst there was an extra £30m of cash in this period that will indeed unwind, but this business throws off a huge amount of cash."

But if you take this £30m cash away, then it barely made any cash this period, even accounting for the £13m dividend payment.

If you check out the 2020 cash flow statement, helpfully included in today's report, or directly in Stockopedia, then the business actually used £10.4m of cash, or £16.5m if you exclude the favourable £6.1m working capital movement.

https://www.stockopedia.com/sh...

No dividend was paid in 2020.

In any case I must be missing something as I seem to be the only person who doesn't understand the upside here.

Best of luck with it.

Yes, the cash flow only shows an increase in cash of £12.7M for the period but that is after deferred consideration of £16M and a pension deficit payment of £37.1M. I haven't got the time to look at the pension scheme. I will leave it to someone with better knowledge!

Hi doublelutz

Yes, that's my point. As per my earlier comment:

"But once the deferred payments finish, which I believe is in about 1.5 years, and the pension payments are completed in about 5 years then, all things remaining the same, this will be a cash cow."

The pension payments are fixed during this time period.

Hi David,

I can see what you mean about 2019, though it's worth noting that this was an "unusual" year in that the Express and Star were bought in 2018, but no deferred considerations payments were actually due until 2020-23.

Why this gap in 2019 was agreed I have no idea, but if you look at the Annual Report, it works out at c£70m cash generation, which is pretty close to what I envisage the cash generation will be in a few years time all things being equal (I was thinking £60m.)
EDIT: In theory, cash generation in the future should be higher than £70m using those 2019 figures as it includes the pension payment too, whereas my £60m assumes that it has already paid off. END OF EDIT.

Of course this helped the net debt/cash position in 2019, though a chunk of this stealthily just moved over to Payables.

Personally I wouldn't mind paying £900m for a good company generating £60m-70m per year - it's a decent return - but again, I'd prefer seeing that digital profitability first.

They paid a chunk of money up front for Express & Star which took them from a net cash position to around the £40m net debt at end 2018. Deal was structured to include deferred consideration, based on minimum performance threshold criteria I think (tho that's from memory). Most likely the 2020-23 period was to ensure the integration had happened and there were no gremlins they might need to rely on warranties for. You don't want to pay upfront and then have to try and claw back - it's a nasty process.

Also, I think the pension contributions are for the next 2.5 years (ie 5 payments of £27m) but I need to confirm that. That would be £135m contribution against a deficit of £115m so basically would leave scheme in surplus by around £20m all things being equal and would make more sense.

Assuming I'm correct then cash by end 2022 should be £90m and then growing at £60m+ p/a though I imagine they will do something with that rather than hoard it.

The trick with this trade has been that so many investors completely underestimated how long this business can throw off bucketfuls of cash for and could only see the demise of print so spent far too long on the pension rather than understanding the longevity of the business and its opportunities to morph towards digital. For me this was just a fundamental flaw in investor thinking - content is king and Reach (LON:RCH) has it in abundance.

Digital should have higher margins than print. Q2 grew at over 60% YoY but in reality this is masked by the covid lockdown. In reality they are growing digital at around 25% on a more consistent basis.

So - you get a business where print circulation / revenues have stabilised (slightly up) and digital is growing at around 25%+ p/a with EPS around 40p and will have prodigious cashflow increasing incrementally from 12-30 months with a pension fund in surplus. At a PE of 8 and a FCF of circa 12% and valuable content IP it just still looks the wrong price to me.

timarr

Well, I was looking at this earlier and from the last half year results the pension contribution schedule seems to be quite a lot higher than that:

You'd expect that the discount rate would have risen by 2027 and the pension deficit extinguished, but obviously we can't know that for sure.

Db47

I suppose based on the share price of it’s peers in the same field - some of which have brought no revenue in yet, unlike Love Hemp (Life Science Developments (LON:LIFE)) who do currently supply Ocado, Sainsbury’s, Holland & Barrett and soon Amazon as well as having their own online presence. But don’t get me wrong I wish I’d sold when the share price hit circa 14p earlier this year !!

Boon

Indeed, and if you read the update closely Motorpoint (LON:MOTR) give plenty of red flags on margins to come soon as they buy used cars at high prices to replace the stock they just sold.

Harry Hindsight

Sylvania Platinum (LON:SLP) - but brown envelopes (tax, special dividends etc) to what is effectively a failed state means it is outside the normal metrics. Ride the rhodium tiger tail but keep an eye on the exit point.

Ricardo (LON:RCDO) - lets see 500p before getting over excited and Mr MACD on the up with some volume.

Johnsy

I'm a fan of the James Montier Cooking the Books screen. Debt sometimes might not seem too much, but this warning indicator flags up companies that on the surface might seem OK, e.g. Wizz Air Holdings, which has Stockpedia rating of "Neutral".

Paul Scott

28th Jul '21

Thanks Cliff, we try our best, with the occasional mishap from me.

You seem very certain about the car industry's future, Zipmanpeter - which is an almost guaranteed sign that you'll be completely wrong! ;-)

My main point is that, if you compare Cazoo and Motorpoint (LON:MOTR) (I hold) websites & business models, they're similar, and I would say MOTR is better - they already have cheap, very efficient, large sites to store & prepare the cars, but also sell to the public from them.

I don't believe that Cazoo has any competitive advantage at all. It's just got pots of cash, from gullible investors, which they're likely to spend on blitzkrieg marketing (as you suggest, to be fair). Will that lead to a sustainable business model that wipes out the competition? Very unlikely in my view.

We have to remember that internet disruption works better in some sectors than other. Most people buying cars will want to inspect, and test drive. That's how you build an emotional connection with a new or used car. So Cazoo's market looks limited. Meanwhile MOTR is doing exactly the same online offers, plus it's selling from efficient car supermarket sites too. It's a much better business model, in my opinion. To dismiss it as "incrementalist" is ... well I won't say any more, we've had enough controversy here of late.

Best wishes, Paul.

Small Cap Value Report (Tue 27 July 2021) - MOTR, ERGO, ITS, SLP, RST, RWA

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Jack Brumby

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