Small Cap Value Report (Tues 31 Aug 2021) - MCLS, SYME, LAM, RAV, PEN

Good morning, Roland's back this week!

Today's report is now finished.

Agenda -

Paul's section:

Mccoll's Retail (LON:MCLS) (I will hold after placing completes) - a lukewarm reception to the open offer, but it's not material to the overall fundraising. I recap on the bull & bear points. A speculative, risky, special situation is how it's probably best viewed. Not for widows or orphans!

Supply@me Capital (LON:SYME) - I remain deeply sceptical about this jam tomorrow share. There's nothing in today's trading update to change my mind.

Pennant International (LON:PEN) - H1 trading update. Loss-making, but better performance expected in H2 (as happened in 2020 & 2019). Moved from net cash into net debt. A reduced order book, but still provides decent visibility. I'm tempted to have a small punt on this, because it's looking potentially cheap at £10m market cap.

Roland's section:

Lamprell (LON:LAM) - A balance sheet update from this offshore engineering group, which appears to be close to financial distress despite ending last year with a net cash position. Is this perennial turnaround of interest?

Raven Property (LON:RAV) - This Russian commercial property boasts a forecast dividend yield of around 8%. Today’s half-year results have received a warm reception - one to consider for income hunters?

---

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.

---

Paul's Section

Mccoll's Retail (LON:MCLS) (I will hold, after placing completes)

20.8p (pre market open)
No. shares: 140.3m before + 165.0 new shares = 305.3m
Mkt cap £63.5m

Note above how the share capital is more than doubling in this current, discounted fundraising. It’s a good example of how shareholders get clobbered when companies with weak balance sheets have to raise fresh equity (often under pressure from their banks), and there’s not much appetite from major shareholders to provide more money. The result? A deep discount in price for the issuance of new shares, thus diluting existing holders who don’t stand their corner by participating in the fundraising, or buying in the market at a slightly higher price currently.

It's a lottery as to how fundraisings will turn out. Sometimes existing institutions want to defend the share price, and they stump up more money at close to the existing share price. Other times, they insist on a deep discount. It's the institutional shareholders who set the price in placings. We're completely at their mercy hence why I so dislike investing in companies that need to raise fresh equity. This risk hangs over quite a few companies, Card Factory (LON:CARD) and Carclo (LON:CAR) spring to mind as examples of weak balance sheets in need of eventual repair with fresh equity. It could work out fine, or it could be horrible for existing shareholders, we just don't know. Why take on that high level of risk by buying whilst the balance sheets are so weak?

We're in completely artificial times, with interest rates at zero. Banks are happy to roll over debt for now, as the interest cost is so low. However, once interest rates rise (which they have to, once QE stops - if it ever does!) then weak balance sheets would become more of an issue.

This morning we have news that there’s been a lukewarm reception to the open offer element of MCLS's fundraising, with take up of only 37%. That increases to 60% once excess applications are added. Still, at least the share price has remained slightly above the 20p fundraising price.

The bulk of the fundraising, £30m, was a placing with institutions, so that’s in the bag already, once the technicality of a shareholder vote has been passed. The open offer raised £3.0m on top of that, from a potential maximum of £5.0m. Therefore the £2m shortfall is not material to the overall £33m raised.

My opinion - this is a share I’ve consistently avoided in the past, because I don’t think McColl’s is a very good business, and the balance sheet was an obvious avoid, with far too much debt, and a deeply negative NTAV. Very easy to spot, and avoid.

However, a friend sent me some interesting analysis on it, showing that there could be speculative upside, looking at it as a special situation - i.e. something to possibly trade for a turnaround, rather than hold long term.

These are the bull points -

• Conversion of McColl’s stores into Morrisons stores is relatively cheap, and is generating a good payback, with the placing helping to fund a fresh wave of store conversions
• Operating Morrisons branded stores makes MCLS an obvious takeover target for Morrisons
• Directors have put £3.2m into the placing - a serious sign of commitment to the turnaround
• Fundraise reduces the risk of insolvency, although still more funds will be needed in future
• As more stores are converted, this should benefit sales & profits

Overall I think this is still quite high risk, and I’m not planning on investing a lot in this share, because I fundamentally don’t like it. However, as a special situation I thought it was marginal, and only put in a starter sized amount of money (c.1% of my portfolio). Hence if I’m already going a bit wobbly on it, then am not entirely sure this was a good decision or not, it needs more pondering. I’ve just checked the balance sheet, and there is £22.7m of freehold property, which helps, although it is reducing through sale & leaseback deals - a classic sign of financial distress.

Note also that MCLS warned of growing supply chain problems, something we're hearing from many companies at the moment. That could impact trading over the autumn if it worsens. Although as we've seen with used car dealers, and James Latham (LON:LTHM) recently, it is also providing opportunities for some companies to profiteer from big rises in selling prices (and hence profits), as high demand meets constrained supply. So this is a complex issue.

.

.

---

Supply@me Capital (LON:SYME)

0.32p (down 16%, at 08:32) - mkt cap £109m

I last looked at this peculiar share here in Feb 2021, including a review of its Admission Document, and came to the conclusion that there was nothing there of any significance - it was little more than a shell, valued at £167m at the time.

Mind you, in this current bull market, you only have to call yourself a platform, tell people you’re doing something disruptive & new, and they punt on the shares to sometimes unbelievably high valuations. This is commonplace at the moment, mainly in the US. Very obvious bubble conditions, and as we know, sooner or later, bubbles tend to burst in a big way. It’s only a matter of time in my view. Although a similar tech boom in 1998-2000 lasted longer than people thought possible at the time, so I have no idea how long this current boom is likely to continue, your guess is probably better than mine.

Today we are updated -

Strong increase of inventory monetisation revenues expected through an evolving multi-business line FinTech strategy

Since I last looked at SYME, it’s made an acquisition, and seems to be focused on managing investment funds targeting working capital financing, i.e. higher risk commercial lending, taking a small % fee.

Revenue figures provided today for the 6m to 30 June 2021 are trivial, but to be fair the main acquisition wasn’t completed until after that period end.

Outlook - full year guidance is provided, and the revenue figures here are also quite small -

As result of internal analysis, the Board of Directors expects to generate consolidated revenues for the year ending 31 December 2021 in the range of £3.8m - £4.9m...

We’re not given any indication of what costs are likely to be, nor profits (more likely losses). Hence this share remains impossible to value.

My opinion - why anyone would buy this share is beyond me. Calling yourself a fintech platform doesn’t mean that it’s a guaranteed way to attract a multi-billion valuation. Although having said that, some people have successfully pulled off that trick (for now anyway).

As far as I can see, SYME is a tiny business, managing investment funds. The announcements seem to be jam tomorrow in nature. The valuation looks entirely based on hype at this stage. I’ll happily review the future accounts, to see if anything interesting is emerging, but at this stage, it looks like hot air to me.

Stockopedia agrees, with a StockRank of just 1

.

---

Pennant International (LON:PEN)

28.5p (down 12%, at 10:01) - mkt cap £10.5m

Trading Update

I’ve followed this minnow for many years, and generally thought of it as a reasonably good company, but the problem is that performance is quite lumpy & unpredictable. As you can see from the graphs below, it makes about £2m in a good year, but then loses it in a quieter year. Maybe it’s not a good company after all? What’s the point in being stock market listed? Do the costs justify a listing, when the market cap is only £10m?

.

Pennant International Group plc (AIM: PEN) (the "Group" or "Company"), a leading global provider of training technology and integrated product support solutions, announces the following trading update ahead of the publication of its Interim Results for the six months ended 30 June 2021 (the "First Half", or "H1 2021") which are scheduled to be released on 22 September 2021.

I can see why the share price is down today, this seems uninspiring -

In a financial year that is again predicted to be second half weighted, the Group expects to report revenues for the First Half of approximately £7.4m (2020: £6.3m) resulting in a loss before interest, taxation and amortisation of £1m (2020: EBITA loss of £2.5m).

Checking back to prior years, we can quickly see the H1/H2 split, which you can do with this handy feature here, there was indeed an H2-bias to profitability in both 2019 & 2020.

Or to be more accurate, H1 was loss-making, and H2 was slightly profitable in 2019 & 2020, incurring full year losses in both years.

Net debt - seems to have worsened considerably in the last year -

Net debt at the end of the period was £1.9m (2020: £2.0m net cash), reflecting the expected cash outflows from materials purchasing and production activities during the period.

I prefer loss-making companies to hold net cash, not debt.

Management says H1 performance was satisfactory

Cost-savings beginning to feed through

IPS division performance “strong”, with £2.6m H1 revenues, and £3.2m H2 revenues expected

Technical Training division - mostly good, but one problem contract with General Dynamics has “significantly impacted” performance - trying to address the issues with GD

Order book is down, but still a decent amount given that it’s contracted, so provides some visibility -

The contracted order book scheduled for delivery over the next three years stood at £25m at the end of the First Half (31 December 2020: £31m)...

The Group is working hard to accelerate pipeline conversion wherever possible and active negotiations are ongoing in relation to multiple new opportunities, including several potential sales of substantial software and services packages through the IPS division and significant bid activity within Technical Training division predominantly comprising software solutions for rail and aviation sector customers.

This is blamed on covid issues, and a UK defence review delaying orders.

Outlook - this sounds reasonable to me -

The Company anticipates that its financial performance will improve significantly in the second half (as programme deliveries continue and forecast pipeline is converted) and expects to make an EBITA profit for the current six months to the 2021 year-end. On this basis, the Company's trading remains in line with market expectations for the year as a whole.

There’s always a risk with H2 weighting, that it doesn’t turn out as expected, but given the last years did see an H2 weighting, the above is believable.

Diary date - 22 Sept for interim results.

My opinion - clearly the company isn’t doing particularly well, but that’s reflected in a dirt cheap valuation of just over £10m. I wonder if the company might have some strategic value, as defence & aviation related companies seem in demand at the moment?

Overall, this share looks quite tempting to me, just for a small punt, rather than a core portfolio holding. Although the de-listing risk does concern me. It’s clearly got considerable expertise in specialised areas, and that could attract a bidder maybe? Although maybe it’s too small for that, I don’t know.

Also, it sounds as if there's a good pipeline of potential new business, so if that can be converted, then future RNSs might contain news of decent contract wins, which could turn the share price momentum positive, possibly?

.

.

---

Roland’s section

Lamprell (LON:LAM)

37.6p (pre-open)

Market cap: £128m

Update on balance sheet recapitalisation

Lamprell (LON:LAM) is a main market-listed engineering company based in Dubai. Historically, the group’s main business has been building jack-up rigs, predominantly for Middle Eastern national oil companies. This remains an important line of work, but Lamprell is now also expanding into offshore wind. The group is involved in a Saudi-led project to create a new Middle East engineering hub.

If memory serves me correctly, Lamprell was briefly a FTSE 250 stock in the past, but those days are over - for now at least. Progress in recent years has not been good for shareholders:

As you can probably guess from the share price chart above, progress in recent years has not been straightforward. The group’s 2020 results warned of “severe liquidity constraints” and said $120m-$150m of new financing - including an equity raise - would be needed by the end of the third quarter to maintain a going concern position.

The equity raise portion has since been pushed back to Q4 and is expected to be $30m-$60m - material dilution for a £128m market cap.

Lamprell has provided a refinancing progress update today. As there’s not much news in our small-cap universe, I thought I’d take a closer look at this turnaround situation.

Balance sheet recapitalisation update: Management are in “detailed discussions with three regional banks” to secure $90m of Export Credit Agency-backed working capital facilities. These are needed to fund the completion of two IMI rigs. These loans are expected to become available in Q3 and Q4, in two equal tranches.

Plans continue for an equity raise of at least $30m in Q4 2021. It’s worth noting that if the company doesn’t raise the money needed from its banks, it plans to raise the full $120m-$150m through an equity raise instead.

Net cash at 28 August was $79.3m, although based on past reports, I’d expect most of this to be restricted (e.g. project bonds and guarantees).

What’s the problem? Today’s update highlights the capital intensive, low-margin nature of this business.

The two IMI rigs are said to have a value of $350m and are expected to generate a significant proportion of group revenue in 2021. But they aren’t likely to generate any meaningful profit.

According to a previous update, the IMI rigs were bid at “minimal margins to enable the monetisation of USD 70 million of equipment that had been purchased in 2015”.

In other words, Lamprell appears to have been bidding for work at uneconomic rates simply so that it can keep its expensive facilities busy. This can happen with capital-intensive businesses, but it’s not a good way to generate returns on capital employed for shareholders.

Management guidance is for “broadly breakeven EBITDA” in 2021. That suggests to me the margin on the IMI rigs really is close to zero.

I’d hazard a guess that Lamprell may not be offered very attractive terms on these new working capital facilities. If I was lending money to fund projects that had been bid at “minimal margins”, I’d be more concerned about repayment risk than if the projects had been priced profitably. What if there are cost overruns or delays?

I think this situation puts Lamprell’s net cash balance in context. In my view, this is a business that really needs substantial net cash just to be able to fund its obligations to customers. When combined with low margins, I don’t see this as an attractive business model.

I think there are parallels here to UK infrastructure and construction companies like Costain (LON:COST) and £MGNS. Both run with a lot of cash, in order to have the credibility they need to win new work.

However, while Morgan Sindall has maintained its financial strength without diluting shareholders, Costain has raised new equity twice since 2013, quadrupling its share count in the process. Not great for shareholders.

Trading is improving: The good news is that Lamprell’s working capital needs are rising because its order book is growing.

Revenue has been rising steadily since hitting a low of $234m in 2018 and this is expected to continue. Broker forecasts suggest the group may report a profit in 2022, for the first time since 2015!

CEO Christopher McDonald says that changes made to the business should improve margins and profitability on future projects. The bid pipeline is said to have risen by 15% to $6.9bn during the first half of the year. Decisions are expected on several renewable projects before the end of 2021.

However, I wonder if the company’s financial weakness may deter potential customers. If I was in charge I’d want to complete the capital raise as soon as possible - and while oil prices remain fairly high. The fact the equity raise has been delayed suggests to me that major shareholders may be reluctant to provide fresh cash without evidence that the company is winning profitable new contracts.

My view: I have owned Lamprell shares in the past, but have avoided it in more recent years. I’ve come to the conclusion that while Lamprell may be good at building oil rigs, I’m not convinced that it’s a good business for outside shareholders.

Top executives appear to be well remunerated - Mr McDonald was paid $1.5m last year, up from $1.0m in 2019. However, Lamprell has not generated a positive return on capital employed since 2015 and its revenue remains a long way below the $1bn+ level achieved in the years up to 2014.

This remains a speculative turnaround, in my view. I can see some upside potential if IMI rigs are completed successfully and the group can secure a reliable stream of renewable projects. However, Lamprell’s balance sheet weakness means it’s not something I’d invest in at the moment.

---

Raven Property (LON:RAV)

30p (+12%)

Market cap: £169m

Half-year report

Modern warehouse property is in strong demand at the moment, for reasons we’re all familiar with. Most London-listed property stocks operating in this sector are trading at a premium to net asset value, but FTSE-listed Raven Property remains at a discount of 40% to NAV.

The company’s former name, Raven Russia, gives us one clue as to why this might be. This business owns warehouse property in major Russian cities. Russian firms tend to attract discounted valuations on the UK market, rightly or wrongly.

However, today’s half-year results suggest to me that the same strong demand dynamics apply to Russian logistics property as is currently the case in the UK.

Here are some of the main highlights:

• Portfolio occupancy 96% (June 2020: 93%)
• Underlying earnings: £17.3m (H1 2020: loss of £10.4m)
• Property revaluation surplus of £29.5m (H1 2020 revaluation loss of £12.5m)
• Net assets £264.5m (FY20: £233.7m)
• Diluted net asset value per share +25% to 50p (FY20 40p)
• Cash at bank unchanged at £53m

The increase in NAV per share appears to have been aided by buybacks, including nearly 10m shares bought back and cancelled as part of a larger placing by shareholder Invesco at 21.6p in January. Raven’s management and UK fund managers Schroders and Quilter were all big buyers in this placing, too.

This deal has left the joint venture vehicle created by the company and six senior executives, Raven Holdings Ltd, as the company’s largest shareholder:

This arrangement suggests to me that management interests should be closely aligned with those of shareholders. However, the financial arrangements behind this JV seem somewhat convoluted, so potential shareholders might want to research this in more detail.

According to Stockopedia, founder and Deputy Chairman Anton Bilton still has a 7% stake in Raven Property, too. That’s nice to see.

Portfolio: I’ve not looked into the company’s portfolio in much detail, but my impression is that tenants are generally large ecommerce businesses and logistics companies, including some international names (e.g. DSV).

Similarly, the lease maturity profile appears to be reasonably evenly spread, with 30%-50% due to expire in 2025-2032, depending on whether break clauses are exercised.

Net debt: Gearing appears to be quite high. Total borrowing was said to be £673m at the end of June. Subtracting cash of £53m gives net debt of £620m. The average loan maturity is 3.8 years.

Based on the reported investment property carrying value of £1.15bn, my sums suggest a loan-to-value ratio of 54%.

Interest rates are higher in Russia than in the UK, and this is reflected in a weighted average cost of debt of 6.37%.

For contrast, UK group Tritax Big Box Reit (LON:BBOX) recently reported a LTV of 30.3% and average cost of debt of 2.18%.

I don’t see the group’s gearing as a dealbreaker, especially given management share ownership. But high gearing (and higher interest rates) could become more of a worry if the bull market in warehouse property ever starts to show signs of cooling.

My view: As far as I can see, Raven is enjoying similar tailwinds to companies such as Tritax Big Box in the UK.

The opportunity to buy warehouse property at 40% discount to NAV is tempting, although for me this discount reflects Raven’s ‘Russia risk’, higher gearing, and the significantly higher financing costs that appear to apply in this market.

Even so, consensus forecasts suggest Raven shares could offer a 7.5% yield after today’s share price gains:

It’s not clear to me if this is likely to be paid as a cash dividend, or through a tender offer, as was the case in 2019.

I don’t generally share the view that buybacks are equivalent to dividends. But when a buyback is structured as a tender offer (i.e. a fixed price and no trading costs) I guess it can be seen as a reasonable alternative to a dividend.

I’d need to do more research into the company’s portfolio and financing arrangements before making a decision. But I can see some things to like about this business.