Small Cap Value Report (Wed 13 Oct 2021) - G4M, ANG, VTU, BRCK

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

Agenda -

Paul's section:

Vertu Motors (LON:VTU) (I hold) - stellar H1 profits announced, and another upgrade for FY 02/2022. Car dealers are experiencing a profits bonanza, due to very high used car margins (driven by a shortage of supply). VTU is striking in that it has a particularly strong balance sheet, with NTAV now actually above the share price. Even allowing for profits next year more than halving, this share still looks cheap.

Jack's section:

Gear4music Holdings (LON:G4M) - solid results, perhaps better than the market might have feared in light of widely reported supply chain issues. Trading in line with expectations of FY22 revenue of £156.6m and PBT of £7.3m. Strong levels of inventory ahead of peak trading period. More detailed interims due out in November.

Angling Direct (LON:ANG) - another niche ecommerce operator (although this one is omni-channel and its physical store estate plays a key role). There are ongoing concerns over its pricing power and long term profit potential but trading is positive and ahead of expectations. As with G4M, Europe is proving tricky.

Brickability (LON:BRCK) - Revenue and adjusted EBITDA up strongly at this building materials supplier, which is unsurprising given recent reports regarding heightened demand. Cost pressures too, and driver shortages, so it's a dynamic situation but overall positive.

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 are analysing the company fundamentals, not trying to predict market sentiment.

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

Vertu Motors (LON:VTU)

(I hold)

56.7p (up 4%, at 09:59) - mkt cap £208m

Interim Results

Vertu Motors plc, the automotive retailer with a network of 154 sales and aftersales outlets across the UK and a sector leading online presence, announces its interim results for the six months ended 31 August 2021 ("the Period").

"Record results delivered above market expectations, dividends resumed"

It’s difficult to digest these numbers, they’re so ridiculously good. We already know that car dealers are seeing bizarre, unprecedented favourable market conditions, mainly due to used cars having dramatically gone up in price due to supply shortages. This has led to listed car dealerships reporting wave after wave of big profit upgrades.

The downside being that these conditions are obviously not going to last forever, so it should be seen as a short term bonanza, hence valuing companies in this sector on current year earnings is not valid, since a PER has to be applied to sustainable earnings, to make sense.

That said, a boom in profits, even if only short-term, does leave a permanent benefit on the balance sheet. The way double entry bookkeeping works is that net assets on the balance sheet usually rise or fall by the year’s profit after tax. VTU points out that its NTAV per share has risen from 50.2p to 61.5p in just the last 6 months. At 56.7p, the share price is now actually below NTAV, which doesn’t make sense to me - i.e. the shares are too low in my opinion. It also makes VTU in particular a sitting duck for a leveraged buyout, since the large property assets could easily be leveraged (e.g. sale & leaseback) and bank debt applied (it currently has £57.3m in net cash).

H1 (6 months to end Aug 2021) saw an astonishing adj PBT of £51.8m

Free cashflow is reported at £63.6m

H2 has started amazingly well, with a record month in Sept 2021, generating a trading profit of £20m (Sept is a seasonally key month, with the 6-monthly number plate change occurring, bunching sales into the month)

Employment costs are rising a lot, with annualised £12m increases expected. My only worry with that, is that a permanent rise in wages could be harmful once the inevitable hangover comes along after this boom period ends. There again, people need to be rewarded, otherwise they leave to join competitors, and who could begrudge the staff having a slice of the delicious pie that car dealers are currently enjoying?

Cautious outlook, with guidance up again to >£65m for FY 02/2022 (previous guidance £50-55m), which looks too cautious, so expect further upgrades in the coming months.

Share buybacks resuming.

Divis also resuming, with a modest 0.65p, but I think that’s probably low because companies don’t want to attract negative attention, paying generous divis whilst benefiting from taxpayer support, I’ve heard that explanation from a number of other companies, when talking to management.

Balance sheet is very strong. NAV is £315.1m. I deduct intangible assets (goodwill, etc) of £101.4m, giving NTAV of £213.7m. That’s above the market cap of £208m, a very unusual situation for a company with assets which are generating large profits, not impaired. Freehold property is very large here.

My opinion - how to value this share? As mentioned above, PER doesn’t make sense, due to this being probably a one-off bumper profits year. Normalising earnings is the approach Liberum & Zeus take in their research notes (both available today on Research Tree, many thanks for that).

Liberum raises forecast again for this year to 14.1p, normalising to 6.4p next year. I think we can put that on a PER of 10-12, and add a bit on top for the very strong balance sheet (effectively surplus assets). I get to 70-83p valuation per share. That compares favourably with the current price of 56.7p, and I’ve been fairly cautious in my assumptions there.

Hence this share looks good value, and should have further upside, even allowing for profits more than halving next year.

.

---

Jack’s section

Gear4music Holdings (LON:G4M)

Share price: 765.8p (+2.11%)

Shares in issue: 20,976,938

Market cap: £160.6m

(I hold)

Gear4Music is a fast-growing online retailer of musical instruments headquartered in York. It’s been in the Stockopedia Investment Club since the end of May (see Pitch here) but the share price has recently come under pressure, likely due to rising supply chain fears across the market.

The group operates from a head office in York and has distribution centres in York, Sweden, Germany, Ireland, and Spain. It also has showrooms in York, Sweden & Germany. It sells own-brand musical instruments and music equipment alongside premium third-party brands to customers in the UK, Europe and the Rest of the World.

G4M has spent a lot of time and money developing its own e-commerce platform, with multilingual, multicurrency websites delivering to over 190 countries, and is looking to take market share across Europe.

It’s hard to do what Gear4Music is doing. You need to be highly efficient and organised in order to be profitable and good. The group itself ran into trouble trying to balance these two things back in 2019 or so, at which point it was choosing expansion, internal development, and service over profitability. It responded very well to criticism, enacting several concrete gross margin improvement initiatives and profitability has since then improved strongly.

Now the company is in an interesting spot: an exceptional lockdown-impacted 2020 was a record year for the group but forms tough comps going forward. Meanwhile, supply chain issues and recent profit warnings from Asos (LON:ASC) and Boohoo (LON:BOO) have impacted sentiment.

Half year trading update

Trading for the full-year in-line with consensus market expectations (current consensus market expectations for the year ending 31 March 2022 are revenue of £156.6 million, EBITDA of £14 million and profit before tax of £7.3 million.)

Highlights:

• UK sales level year-on-year at £36.7m; +48% on a two-year basis,
• European and Rest of the World (RoW) sales -16% to £28m; +14% on a 2Y basis,
• Total sales -8% to £64.7m; +31% on a 2Y basis,
• Gross margin of 28% (FY21 H1: 28.6%; FY20 H1: 25.2%),
• Gross profit -10% to £18.1m; +44.8% on a 2Y basis.

European sales down 16% due to ‘post-Brexit challenges’. G4M’s new distribution hubs in Spain and Ireland became operational in September 2021 and should go some way to addressing these challenges.

The group acquired AV Distribution on track to complete by December 2021. We might expect more acquisitions in the years ahead.

Encouragingly, G4M notes strong levels of inventory going into the peak trading period. That should partially mitigate supply chain concerns, although the current logjam could last some time and it is difficult to predict how the issue might evolve.

Conclusion

Sentiment has turned slightly on ecommerce stocks in recent weeks, with the lockdown boom subsiding, tough comps coming up, and reported increases in costs from multiple companies. Titans BooHoo and Asos have both disappointed the market.

Against that backdrop I view this update as quite positive for G4M, although more detail and commentary will be provided in the interim results in November to get a clearer sense of trading. Getting to the half year point in line with internal forecasts is a welcome result given the dynamic conditions investors and companies currently face.

The company has retained some of 2020’s exceptional performance. UK sales are steady and gross margins have held up. Investors might have reasonably expected the company to experience some pressure here in light of raw material price inflation and supply chain issues, combined with a return to physical shops.

It’s still well up on the levels experienced back in 2019 or so when the company had to initiate a range of margin improvement measures in order to resuscitate the share price.

The key point for me, in the short term, is the line referencing strong levels of inventory ahead of the group’s key trading period. Problems will likely persist beyond this point, so that’s not the end of the matter, but it’s clearly a positive rather than a negative.

There are post-Brexit challenges in Europe and RoW, although sales here are still up 14% on a two-year basis and the group now has two operational distribution hubs in Ireland and Spain.

AV remains an interesting purchase and paves the way for similar acquisitions in future, with scope for G4M to broaden its platform offering and leverage its proprietary ecommerce technology. It is aiming to launch AV.com in January 2022 after the Christmas trading peak.

Trading at roughly 1x trailing twelve month revenue, with a strong historic growth profile and a track record of market share gains across the UK and Europe, I believe G4M shares offer compelling value over the medium term. No investment is certain, however, and there’s no doubt conditions are difficult for many operators right now.

With market volatility increasing, it’s difficult to predict just what the share price will do in the short term.

---

Angling Direct (LON:ANG)

Share price: 68.36p (+6.8%)

Shares in issue: 77,267,304

Market cap: £52.8m

This is another listed specialist retailer with growing ecommerce operations - one with a similar level of revenue growth but that trades on a more modest valuation relative to sales than G4M.

Upon closer inspection it is a different animal to G4M though, operating a hybrid business model with an estate of physical stores that is an important piece of the business model. The reasoning behind its stores is intriguing.

Our colleagues are the face of Angling Direct to retail customers and are key to delivering an excellent service, both in store and online. They also play a key role in the angling community. We differentiate ourselves by providing expert help, trusted advice and inspiration for customers to get the most from their fishing.

Angling is probably not a huge market and Angling Direct has struggled on margin in the past - but I do wonder if there might be an opportunity here.

Half year results

Continued strong progress in H1, upgrading guidance for full year… the Board is now of the view that pre IFRS-16 EBITDA for the year ending 31 January 2022 will be no less than £5.0m, inclusive of the expected costs associated with opening the Group's new European distribution centre and comfortably exceeding current market expectations.

Highlights:

• Revenue +19.5% to £38.4m; +44.8% on a two-year basis
• Online sales +3.2% to £18.5m (+47.6% 2Y) and retail store sales +40.1% to £19.9m (+42.3% 2Y),
• Gross profit +33.7% to £14.4m (+68.8% 2Y),
• Gross margin +390bps to 37.4% (+530bps 2Y),
• Pre-IFRS 16 EBITDA +111.6% to £4.4m (+488% 2Y),
• Profit before tax +174.2% to £3.7m (+914.4% 2Y),
• Basic earnings per share +83.2% to 3.7p (+625.5% 2Y),
• Operating cash flow of £5.8m and net cash down slightly from £21m to £19.6m.

As with Gear4Music, Angling has been on its own journey to prove to investors the profitability of its business model. The two-year comps show a significant improvement in this regard.

Digital investment continues and UK online conversion increased by 80bps to 6.3%. AD+, a priority delivery subscription service, was launched in March 2021 to build customer loyalty and now accounts for 16% of all UK online orders.

The group has also recently invested in its UK distribution centre ‘to protect [its] supply position relative to [the] wider market’.

The new CEO has deep retailing experience and there might be low-hanging fruit in the store estate after a period of rapid expansion.

The new category management model is helping to deliver stock at good prices ‘in a short supply market, supporting gross margin growth’. Similarly, a store transformation programme is improving average transaction value by 3.8% and like for like sales by 32.2% at the revamped stores.

The group says:

We have established a two-year Retail Transformation plan which is now well underway. The plan is focused on radically improving our store shopping environment through improved layouts and merchandising, promotional messaging and, crucially, colleague interaction focused on customer satisfaction.

There’s a healthy property pipeline for underserved catchments and two further stores should be open by year end. One new store was opened in the period (Redditch in February 2021, while one in Sittingbourne was re-sited and another in Hull re-fitted.

International - Sales via the three native language websites fell by 34.2%. These sales comprised less than 5% of group revenue but that’s still disappointing. G4M does also note a drop in Europe and RoW revenue, but to a lesser degree, and from a higher and more established base. Brexit and restrictions on the export of bait are cited as key reasons, with conversion reducing by 90bps to just 1.6% (down from 2.5%).

Lead-times to customers in Europe have started to improve as new customs and border practices slowly start to stabilise. We have now also partnered with one of Germany's leading bait manufacturers to supply direct to our customers via Angling Direct websites. The Board anticipates the new European fulfilment facility will, in the medium term, greatly facilitate trading and the scale of the Company's online opportunity in Mainland Europe.

Angling’s proposed European distribution centre is moving to its execution phase, with terms agreed on a 3,900 square metre facility in the Netherlands. This is one of its five key European markets. Considerable management resource has been focused on Angling’s aim to become Europe's first choice omni-channel destination in its market and this in-region fulfilment centre will be an important piece of the puzzle.

This new facility is expected to provide the company with European growth capacity to 2027, with the board anticipating that it will be earnings positive by 2025. That’s quite a long time. At least the associated costs will be funded from existing cash resources.

Higher margin own brand sales in the period grew by 10.1%, whilst its proportion of total sales slipped modestly by 40 bps to 5.2%. Growing this as a proportion of total sales would help create a fundamentally more profitable business.

Current Q3 own brand sales as a proportion of total sales have improved to 6.8% following a refresh of our promotional activity. New own brand SKUs and ranges have been developed which, along with new packaging, are due to be launched by summer 2022.

Outlook

Sales in Q3 are anticipated to decline relative to the unprecedented levels in Q3 in the prior year (post lock down 1). It is not yet clear the extent to which the Company will track sales levels during Q4 against the comparative period, which included the second lockdown (all stores closed November 2020) and the beginning of the third lockdown (all stores closed January 2021). Post period-end, we have not experienced any material impact from supply chain disruption and continue to hold good levels of stock in mitigation. As with other retailers, we are not immune to increased raw material and freight costs, however, these will be offset by our margin growth and we are well placed to continue mitigating any impact.

Conclusion

There’s an increasingly efficient and profitable niche omni-channel business here, with growth opportunities in the UK and across Europe. The competition primarily consists of single and multi-site lifestyle businesses that lack Angling’s scale and finances to invest across both online and in-store operations.

That strong balance sheet must also be a significant competitive advantage during this period of global supply chain disruption, although the group will suffer from increasing costs just as others will. AD might emerge from this period in a significantly strengthened position relative to the rest of the market, though.

It is leading the way in its niche, although this is probably a smaller niche than G4M. An example of this is the upcoming mobile app:

During the first half, the Company invested in the development of a mobile web App, believed to be the first of its kind in our sector in the UK. The App is now in the final stage of testing, with launch date scheduled pre-Christmas, and will provide our customers with further choice, convenience and inspiration on the move, as well as the opportunity for us to improve online marketing efficiency.

And the group’s hybrid business model gives it some balance: while online growth has moderated sharply, it’s doing a roaring trade in its physical stores.

There will be ongoing concerns over the fundamental profitability of Angling Direct’s operations, but the group has gone some way to improving margins. Gear4Music found itself in a similar position just a couple of years ago and things changed rapidly there.

If you strip out the £19m of net cash, that’s a pre-IFRS 16 enterprise value of about £33.8m on forecast FY22 revenue of £72.5m, so trading on less than 0.5x revenue once you adjust for cash. FY EBITDA is expected to be no less than £5m. In fact, it’s already £4.4m at the halfway stage. Just taking that £5m figure for now though, that would be an FY22 EV/EBITDA ratio of 6.8x, which is not demanding compared to other retailers with growing online operations.

Adjusted earnings per share forecasts are fairly unexciting at 2.8p for FY22 and FY23, however, but perhaps these are overly conservative given H1 22 basic EPS already comes in at 3.7p. Still, it does bring us back to the point that Angling still has to prove to the market that it is an attractively profitable proposition in the long term.

---

Brickability (LON:BRCK)

Share price: 104.5p (+2.96%)

Shares in issue: 298,254,548

Market cap: £311.7m

Brickability’s businesses are focussed around three core product areas; Bricks and Building Materials, Roofing Products and Services, and Heating, Plumbing and Joinery.

The group distributes and installs building materials from major UK and European manufacturing partners, providing product solutions to both private and commercial specifiers, contractors, developers and builders. In particular, it is a market leading supplier of facing bricks, blocks, rainscreen cladding systems, architectural masonry, paving, roof tiles and slates to the construction industry.

These all seem to be services in high demand at present, so I’m curious to see if this impression is confirmed in the update.

The group’s shares are comfortably above pre-Covid levels but, with a forecast PER of 12.2x and a forecast PEG of just 0.4x, there might still be value here given the buoyant conditions.

Trading update for the six-month period to 30 September 2021.

Highlights:

• Revenue +300% to c£223m, +54% on a like-for-like basis (and +31% over two years),
• Adjusted EBITDA up from £8m to £17m.

The UK housebuilding sector remains in good health following a strong post pandemic recovery, driven by changing demographics, significant pent up demand and assisted by government incentives.

Q1 2021 saw the UK's highest number of homes built in a single quarter for over 20 years.

This trend is reflected globally, contributing to globally inflated building materials prices in almost all sectors.

Taylor Maxwell was acquired in July and the integration is progressing well. Its timber division has delivered exceptional revenue and profitability since acquisition, as material shortages drove unprecedented price increases. Timber prices in recent weeks have since reduced from this peak but remain higher than last year.

The order book remains ‘extremely strong’ and Brickability is well placed to supply UK's housebuilders as demand is expected to continue to strengthen.

Outlook

Brickability expects the current healthy housebuilding market conditions to prevail in both the near and medium term. The Group remains cautiously optimistic about the second half whilst recognising that market supply chains are under pressure due to a shortage of HGV drivers, construction worker wage inflation and increases in materials prices. Whilst not immune to supply issues, the Group's McCann logistics business, acquired in December 2020, has and continues to give Brickability an advantage in transporting materials from Europe and the UK. Despite these pressures the Board expects performance in line with market expectations for the full year.

Conclusion

It’s a very unusual and dynamic time in the markets right now. Most companies are being buffeted by a variety of headwinds and tailwinds as we navigate this volatile post-lockdown readjustment period.

Take Brickability: the highest number of new homes built in 20 years in Q1, but with supply chain pressures, driver shortages, construction worker wage inflation, and increases in materials prices.

It’s hard to knock a 31% increase in two-year like for likes though so on balance this seems a positive update from a company that’s probably worth doing a little more work on given the conditions.

It’s acquisitive too. The pipeline here remains strong but I wonder if overpaying in an overheating market is now a risk. Brickability is busy integrating Taylor Maxwell and Leadcraft but also sees near term acquisitions in the renewable energy products area.