Small Cap Value Report (Tue 9 April 2019) - Mello 2019, SOS, CBOX, LUCE, DEB, TPFG, BILN, PAM

I’m a bit surprised about the comments that the gross margin at Sosandar (LON:SOS) is good because it is higher than might be normally expected.

The first thing that occurs to me is that as it is the gross rather than net margin it very much depends on what is included in cost of product.

But looking at it another way high margins do not stay high for long in markets that are highly competitive. They get competed away as the “me too” competitors realise there is money to be made in that area, unless the company has a sustainable competitive advantage. In this particular case, it is too early for the brand to be a competitive advantage, the links to influencers is not a great advantage (competitors will simply link to alternative influencers), and the targeted marketing towards a supposedly underserved segment can be copied easily. Arguably, by going public so soon the company has revealed its strategy and tactics in detail which makes it even easier to copy.

It seems that the only competitive advantage that may be sustainable is the fashion and design insight of the two founders. But in my view that is terribly weak. To be significant it needs them to get it right every season and for the inevitable lookalikes that will crop up to be clearly inferior.

So, nice to have the high gross margin in the short term but even if it is real it’s not going to be sustainable over the longer term in such a competitive business and so I would not place all that much store by it.

Hi Graham, the discount code STOCKO40 doesn't seem to get me any discount. I was wondering if you might know what the problem is. I can only make it for the Thursday would that be the problem? Best

In reply to post #467661

Hi Camtab, please tweet to carmensfella or visit this thread:

https://www.stockopedia.com/content/mello-2019all-you-need-to-know-452333/

In case there is a problem with big caps, you could try Stocko40?

Graham

Hi Graham thanks for another great review of the day's news

Regarding your comment "Competitors include Belvoir Lettings (LON:BLV) and M Winkworth (LON:WINK). They look like good companies in their own right, too, though they don't have the hybrid offering that TPFG does."

Can you comment any further on Belvoir vs TPFG (I just bought into Belvoir Lettings (LON:BLV) today before reading your review of Property Franchise (LON:TPFG) )

I note that belvoir do both sales and lettings also is that what you mean by the hybrid offering? (Or does that mean that they are online only?)

I went for Belvoir Lettings (LON:BLV) mainly because of lower PE and PEG when compared to Property Franchise (LON:TPFG)

Paul: Re Sosandar (LON:SOS)
"Gross margin improved to 57.7% in Q4, which I've calculated on a spreadsheet using the H1 numbers, and the Q3 trading update, plus of course today's update."

Not being critical, but I have a VERY slightly different figure to you, so wanted to see which of us (me most probably !), has an incorrect calculation.

When I now analyse a company, I start with the AR financial notes then build a P&L, BSheet, CFlow etc. up from there (as best I can) - this way, I'm hoping that any 'red flags' in their accounts or my calcs. show up earlier as opposed to me trying to work out where I've gone wrong :o)

Anyway, from SOS: (sorry, but not sure how to do a table on here !)
H1
£1,844k Revenue
£834k C of Sales
£1,010k Gross Profit
54.77% GM

Q3
£1,600k Revenue
£747k C of Sales
£853k Gross Profit
53.30% GM

Added give:
Q1-Q3
£3,444k Revenue
£1,581k C of Sales
£1,863k Gross Profit
54.09% GM

Todays Y/E update
£4,440k Revenue
£1,998k C of Sales
£2,442k Gross Profit
55.00% GM

Take Q1-Q3 from the Y/E (to hopefully give Q4 alone)
£996k Revenue
£4178k C of Sales
£579k Gross Profit
58.15% GM

As I said, only a very minor difference, and if you have time, please let me know where my calc's have gone wrong - That 0.45% could be worth a lot if SOS takes off :o)

I was once told that if a B/S was £1 out it could be £1,000,001 and £1,000,000 out in each side ;^) - Patisserie Holdings (LON:CAKE) school of accounting I believe ! lol

In reply to post #467646

Thanks for the reply Paul appreciated.

Call me a cynic but think they've been pretty shrewd with their fundraising - it's clear that if they hadn't raised £3m in Oct 18 when approached they'd need to raise more urgently now. So they managed to get funded without any alarms or giving the appearance of being 'needy'. Could certainly see something similar occurring next Autumn.

FWIW I think the website content is excellent & does differentiate itself from competitors with the magazine style narrative.

Petards (LON:PEG) announce their results tomorrow. Here is an extract from my blog (see my profile page):

Recent Events

Since September 2018 there have been no contract win announcements, and although during the same period in 2017 there was only one contract win announced, this will have been a disappointment to some.

For the past three years they issued their full-year results bang in the middle of March and there was some expectation they would do so again this year. It wasn't until the 25th March that they announced that they would come out tomorrow, 10th April. There is always the suspicion that bad results take longer to prepare than good ones and that perhaps they were hoping to soften the blow of missing expectations by being able to announce a contract win.

It is therefore unsurprising that the share price has been drifting down recently, however if results are in-line with a positive outlook then they look good value with Stockopedia reporting a forward PE of 10, a PEG of 0.5, potential for improving margins to improve their quality score and long term growth opportunities.

Current expectations

Expectations are for a turnover of £18m vs £15.6m in 2017, with an normalised EPS of 2p vs 1.78p.

Declaration

I hold shares in Petards and am likely to add on neutral or positive news tomorrow.

In reply to post #467696

Interestingly I had another Q4 GM figure for Sosandar (LON:SOS) - 56.7%
But I can see that you have used actual revenue and COS figures, whereas I used the published rounded % figures. Quite a difference!

So I agree with your numbers, but happy to be corrected.

Apologies for yet another Sosandar (LON:SOS) post. I had a few further thoughts that I don't think were mentioned above:

1. Last year revenue from Q3 to Q4 fell by 1%, this year the fall was 38%. That's quite a drop, and I imagine it is because Easter was so early in 2018 (first week of April/last week of March). This also explains why Q4 repeat order (c16.7k) was materially lower than Q3 (c20k).
   So one would expect a boost in Q1 of 2019-20.
2. I don't understanding the strong correlation between marketing spend and conversion rate. Marketing spend mainly gets people to the website. Conversation rate indicates what % of those people end up purchasing an item (based on how much they like the website, colour of the purchasing buttons used, items available to purchase, etc...).
   I don't think there's anything worrying about the fluctuations in conversion rate, but I do find it worrying that management are saying that conversion rates decreased because marketing spend decreased, as in my mind there is much more to conversion than just getting people onto the site.

As always thoughts appreciated!

Cheer

A

Thanks abtan. Perfect analysis of conversion rate and is does often frustrate that people automatically assume that by doubling the marketing spend then you’ll double the conversion rate. It’s importnant management realise that it doesn’t matter how many people you send to the site if the products/value and above all for me website ease of use is not up to it then no one is going to be ‘converted’. They all go hand in hand.

In reply to post #467816

On conversion it may be worth considering the impact of PSD2 on this come September 14th. Probably a lot of people have noticed that they're already getting popup messages asking for SMS one time passwords during the checkout process - that will increase after the deadline, because of the requirements on the banks to authenticate cardholders.

Today merchants can choose to opt out of this and take the hit if the transaction is fraudulent, but after the date they can't. It appears that quite a few merchants aren't ready for this, but even for those that are you'd expect this to hit conversion as it adds friction to the checkout process - and any increase in friction tends to cause an increase in abandoned transactions.

What's unknown is that because this is across the board it may not have a major overall impact - basically people have to go through this process to make a payment regardless of who their bank is or who the merchant is. And there are ways of reducing the friction if the merchant and their payment processors are switched on (although it seems that a lot of them aren't).

My guess is that a lot of online retailers will see a glitch in earnings in September, which will gradually recover. But no one really knows.

timarr

In reply to post #467696

Hi DJCP,

As I said, only a very minor difference, and if you have time, please let me know where my calc's have gone wrong - That 0.45% could be worth a lot if SOS takes off :o)

That's just a rounding difference I think, we're both saying near enough to 58% gross margin for Sosandar (LON:SOS) in Q4.

My calculations are as follows (as you can see, they're very simple);

Regards, Paul.

In reply to post #467731

Hi abtan,

Re Sosandar (LON:SOS);

1. Last year revenue from Q3 to Q4 fell by 1%, this year the fall was 38%. That's quite a drop, and I imagine it is because Easter was so early in 2018 (first week of April/last week of March). This also explains why Q4 repeat order (c16.7k) was materially lower than Q3 (c20k). 
   So one would expect a boost in Q1 of 2019-20.

I don't think that's a valid comparison. The reason being that SOS received the IPO monies late in 2017. Therefore, Q3 of FY 03/2018 would have only had partial benefit from placing monies, whereas the following quarter, Q4 would have had the full benefit of bigger marketing spend post IPO. That would have been a big benefit to Q4 revenues vs Q3 revenues last year.

Whereas this year, Q3 and Q4 reflect a constant level of available funding, but management made a strategic decision to greatly reduce marketing spend in Q4 - the house broker's latest note says that marketing spend was reduced 64% in Q4 vs Q3.

I think we're generally in danger of over-analysing the detailed numbers here, and forgetting that this is still an early stage business, where everyone (including management) is still learning about seasonality, impact of marketing spend, etc.. Therefore people are quite often drawing incorrect conclusions from not comparing apples with apples.

I prefer to look at Sosandar more in overview;

• Management is executing amazingly well - I don't think people realise how difficult it is to build a new fashion brand from scratch, and just how talented the team here is
• Target customers love the product - as can be seen from exceptionally good gross margin (indicating pricing power, and little discounting necessary to shift product), and very high level of repeat customers
• Low inventories - indicating rapid stock turn - i.e. product sells out fast, generally without need for discounts
• Test & repeat model working extremely well, with a 4-week lead time now on repeat orders, and customers pre-order via the waiting list functionality. High Street retailers simply cannot compete with that, it's a huge advantage of being small & nimble
• Celebrity endorsements which are off the scale in quantity & quality, yet SOS doesn't pay them anything (they just get the clothes free) - this is down to the skill & contacts of the joint CEOs, and their many years in the fashion magazine area - talk to management if you want to better understand just what a good job they've done on this
• Revenues have consistently beaten forecasts (£3m at IPO forecast for this year, £4.44m actual achieved)
• Costs running a bit warm, but that's because they want to grow the business as fast as they can. Does it matter? Not at all in my view
• Outsourced business model, so management don't need to worry about managing shops, warehouse, IT, etc. That's done by Clipper & Magento, leaving SOS management focused on what they're best at - product design, marketing, and customer service. In my experience, conventional retailers spend most of their time managing the shops & warehouse, leaving product design etc often badly overlooked - sowing the seeds of failure.

There is nothing else on the UK stockmarket like this, with such large potential % upside. The only other options are ASOS (LON:ASC) and Boohoo (LON:BOO) - but do either of those have the potential to be a 10+ bagger from here? Probably not.

It's not without risk, as it's still small, and loss-making. But it's becoming increasingly clear that Sosandar is (high probability) likely to be a major success, if you take a long-term view.

Regards, Paul.

In reply to post #467731

Hi abtan,

The marketing at Sosandar (LON:SOS) is becoming increasingly sophisticated, as they learn what works. It would be worth you having a chat with them, so they can explain this to you.

They track what return they get from every form of marketing. It's all targeted. They then learn from response rates, and quickly ditch online ads that don't work, and drive harder ones that do work well.

Same with other forms of marketing such as posting out catalogues - if customers don't respond, then they're dropped off the mailing list. Email marketing is important, as it contains fashion ideas, editorial, etc. This is a good way of promoting slow-selling lines, and highlighting best-sellers where a repeat order is in progress.

There's all sorts of stuff going on. If you talk all this through with management, it's a lot more data-driven than investors perhaps realise.

Putting this all together, it seems to me that we should get a big uplift in sales during Apr-Jun, as that's when the marketing machine will be cranked up again, to coincide with high seasonal demand. If you look on the website, a load of best-selling sell out lines have just come back into stock. Therefore, these will be pushed hard with marketing, over the busy Easter fashion selling period.

The revenue forecasts are high, set at over 100% y-on-y growth this year. I thought the forecasts were very ambitious last year, yet they beat them. So we'll see.

Regards, Paul.

In reply to post #467581

Nothing incorrect Graham but I felt it didn't take full account of the much improved 2H numbers. Operational performance is improving despite a challenging UK market. I also like the much clearer strategic focus on professional markets that I gleaned from the company presentation. Appreciate your analysis - perhaps I should counterbalance any criticism with gratitude for many great pieces of analysis you do.

In reply to post #467936

"Test & repeat model working extremely well, with a 4-week lead time now on repeat orders, and customers pre-order via the waiting list functionality. High Street retailers simply cannot compete with that, it's a huge advantage of being small & nimble"

Not sure this is correct Paul. The fast-fashion/'test & repeat' concept was pioneered by High Street retailer Zara in the 1990s. Zara/Inditex was the first to develop a method of quickly reacting to changing trends, using agile supply chains based on sourcing production close to headquarters to speed its "lead times" — from the beginning of the design process to a product reaching stores — to about three weeks. 

This business model has been copied by many UK online clothing retailers including BooHoo, Missguided & now Sosandar. It has also been copied by other High Street retailers, including H&M.

There is little that is new at Sosandar (LON:SOS) . Not the business model, nor the 'talented' management team nor the earnest optimism of its keenest shareholders. Hope burns eternal.

In reply to post #467691

Hi IV, you're welcome. By hybrid, I was referring to Ewemove which works a bit like Purplebricks (LON:PURP). TPFG owns that but I don't think Belvoir Lettings (LON:BLV) or M Winkworth (LON:WINK) have anything similar. Cheers.

In reply to post #467936

Hi Paul

Thanks for the detailed thoughts.

To add to your post, the 2018-19 growth is even more remarkable given that only a portion of Easter 2018 and none of Easter 2019 was included in Sosandar (LON:SOS) 's 2018-19 financial year.

In reply to post #467941

Hi Paul

Thanks again for the response.

I'm not questioning the Sosandar (LON:SOS) marketing strategy or conversion optimisation. They might both be very good at both.

I'm questioning the presumption that there is a correlation between increased marketing spend & increased conversion rates.

I used to work for an e-commerce company (now FTSE100), crunching the numbers on CTR's, CPC's, price elasticises, etc....

It was amazing seeing what small changes to the website did to conversion rates, from price increases AND decreases, to subtle changes to the colours of action buttons. From memory I believe bounce rates were even 14%-16% lower when customers landed on content pages as opposed to product pages.

So conversion was more influenced by on-site factors, rather than the marketing strategy, which, as you have noted, is mainly done off-site.

For what it's worth, I too see the bull case for Sosandar (LON:SOS) and hold a few.

Cheers
A

I'm v late on the Sosandar (LON:SOS) chat but here goes...

I think Q4 evidences a bit maturation in the business. For the first time they seemed to be pushing some discounting and an 'outlet' section to their website. This seems an inevitable thing as business grows. The reduction in sales Q4 v Q3 and season change is likely to drive some need for stock clearance no matter how well managed. Having an 'Outlet' seems a good idea as minimises the idea of permanent sales and also means the outlet kit on sale isn't current so less cache.

Q4 (first quarter of 2019) was a particularly tough time for UK retail. LK Bennett, Debs, Top Shop, Orla Kiely (franchised all over the place - not clothes but playing into the SOS demographic in house stuff), ASOS, Bonmarche, Superdry, Pretty Green, Select, etc all showing the strains out there. Boohoo decent results to end of Dec were more muted UK and stellar Europe and US. Will be interesting to see how they come out in Q1 2019.

Overall, it seems likely that SOS faced some headwinds. Very hard to benchmark it to past experience or expectations as so young and morphing in nature. Is the headwind a blip or something more persistent? Dunno.

However, if £1m is bad quarter with headwinds then assuming some ongoing growth perspective it seems that 50% growth on FY19 in FY20 is a decent-ish conservative base (there's nothing really conservative for a company this young and raw obvs!).

Looking at past online high gross margin growers it seems that if you can grow at 50%+ pa top line then 10x sales is a valuation that can be put on you. More generally, I think the window is 5-10x current revenue (so £4.4m currently means £22-44m versus actual of £30 currently). I'm not going to deny that this is a well dodgy valuation analysis...but its my reading of history for companies that succeed and don't die.

SOS seems to be growing above 50% pa with expectations at the 100% level and it has a business that should be higher net margin than Boo and definitely ASOS (though lacks the more mega scaling capacity of ASOS so duration of high growth).

This isn't what I'm usually comfortable with. However, last year I decided to test my boundaries on what I could invest in (I tend to be an awkward contrary sort looking for neglected value with growth drivers too...I don't like just buying asset or cash flow backing alone).

Generally, I'm looking for misperception and I reckon that SOS fits the bill. I can't argue its value though. I deal with this by only having about a 40% position in SOS. That means I can swallow a disaster and a zero. I couldn't go all in like Paul but he's a different sort of investor to me