Small Cap Value Report (Wed 18 March 2020) - CV19 Estimates, SOS, JDG, ALT, RBG, AIR, ANP, CNCT, SIS

Good morning!

Today we have updates from:

• Sosandar (LON:SOS)
• Judges Scientific (LON:JDG)
• Altitude (LON:ALT)
• Revolution Bars (LON:RBG)
• Air Partner (LON:AIR)
• Anpario (LON:ANP)
• Connect (LON:CNCT)
• Science in Sport (LON:SIS)

Cheers,

Graham

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These are shocking times. Does it remind you all of 2008-2009, when a general catastrophe affected nearly every company?

We continue to see unscheduled updates from all sorts of companies, to tell us how the Coronavirus situation is affecting them. Few, if any, parts of the economy are left untouched.

CV19 Estimates

Let me preface this analysis by saying that every death is a tragedy. I want to look at some of the numbers.

Yesterday, the Government's Chief Scientific Adviser said the "best-case scenario" was for 20,000 people in the UK to lose their lives to the new coronavirus. It would kill two or three times as many people as the seasonal flu.

For context, 540,000 people were recorded to have died in England and Wales in 2018. So there are probably around 600,000 deaths across the UK as a whole every year, including Scotland and Northern Ireland.

In this "best-case scenario", therefore, the virus would  increase the total number of deaths in a year by only around 3.3% (excluding the double-counting effect, where another underlying illness would have caused death instead). 

More bearish projections were issued by academics from Imperial College. Assuming the virus is allowed to spread rapidly, they predicted that 250,000 people could lose their lives, i.e. about half the number of total deaths per year from all other causes.

That scenario would involve a "single, relatively short epidemic". I guess the rapid spread of the disease would bring about a faster immune response from the population.

However, I'm not sure if that 250,000 number is possible. The Chief Scientific Adviser appeared to agree with Jeremy Hunt that there could be roughly 1,000 cases for every 1 death.

If that's true, then the mortality rate is only around 0.1%. So given the total population size, the maximum number of deaths in the UK is around 66,000 - assuming that it infects everybody.

If around 70% of the population was infected - still a very large estimate - then the number of additional deaths would be more like 46,000. This is 7.5% - 8% of the average number of deaths in the UK per year (again, excluding the double-counting effect).

I hope these estimates help to put some context on the overall threat posed to life.

Investing psychology

The economic threat is very different, since preventative measures can ruin businesses and jobs while preserving life. There is a clear tradeoff between preventing the rapid spread of this disease, and allowing businesses to function in a normal way.

There are many unknowns - including the severity and duration of the government's response to the crisis - and this is why shares are so cheap. Nobody knows what is about to happen, and it's extremely unsettling.

As I said on Twitter the other day, you can take comfort in the knowledge that the businesses you own shares in are still there, even if their share prices aren't in the same place. Unless they become insolvent or need fresh equity (and it's definitely worth checking if that is the case), these businesses will still be there tomorrow, and next year. Their profitability may in time recover. I continue to expect normal life to return, but I don't know if it will take three months or a year.

It's an impossible situation in which to make short-term forecasts but I would definitely prefer to be a buyer than a seller, if I can find robust companies in this environment.

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Sosandar (LON:SOS)

• Share price: 7.18p (-36%)
• No. of shares: 192 million
• Market cap: £14 million

Trading and COVID-19 Update

This one was at 15p at the start of the month. 

It's a serious profit warning:

• "challenging and volatility trading environment".
• sales "substantially weaker than expected", margins impacted too.

FY March 2020 revenue will be £9 - £9.3 million (consensus was previously £10 million), net loss £6.5 - £6.8 million (consensus was previously £5.8 million).

There is less than a month's impact from the Coronavirus situation in these figures.

I wonder what the monthly loss might be?

It looks probable to me that loss in March is well over £1 million. This based on the fact that the company was loss-making anyway, and is going to miss its profit forecast by £700k - £1 million (unless those consensus numbers are outdated).

It reports cash of over £5 million, which means that it shouldn't immediately go bust or need or another fundraising straight away. 

But yet another fundraising is surely inevitable, later this year.

The business has relatively low levels of committed expenditure and, as a dynamic business, management has decided it is appropriate to focus on cash preservation during this challenging period. The Company will therefore substantially reduce its planned marketing spend in order to focus on repeat orders from the Group's existing customer base rather than new customer acquisition in the short to medium term. This, alongside other cost saving measures available to the Company, will help preserve cash for when market conditions improve.

Without a big marketing spend, and thanks to the impact of the virus, sequential growth could be set to collapse. The company will have to rely on the repeat orders which it has claimed will vindicate its business model.

But it wasn't expecting to have to rely on them so suddenly, and in an economic environment where people aren't leaving their house.

Supply disruption - Sosandar says it "is not experiencing any significant disruption to its manufacturing". Implying that there is some disruption, but it's not huge at this stage.

Demand is a much bigger problem than supply at this moment in time.

My view 

Readers will know that I've always been unsure as to whether or when Sosandar was going to reach "escape velocity" and be able to fund itself, instead of regularly going back to the market for more funds.

And the reason I've always highlighted this is as very important is that you can't predict on what terms future fundraisings might be arranged. Getting diluted is no fun at all. It can wreck the value of your investment in a business.

And barring a miracle, I think Sosandar is going to need more funds again this year.

It had net cash of £4.2 million at the end of December.

It then raised £5 million (gross) in mid-February. Let's call it £4.5 million in net proceeds. So the total funding of old cash and new cash is £8.7 million.

If the cash balance at the end of March is just over £5 million, simple arithmetic suggests that around £3.5 million was burned in the last three months.

Not buying any more TV ads will help a lot, but if Sosandar doesn't make it to profitability very soon (and there is little reason to suppose that it will), then I don't see how its £5 million cash balance is going to last long.

With more fundraisings on the horizon and a questionable route to profitability, I'm really unsure as to whether this company's equity has any value.

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Judges Scientific (LON:JDG)

• Share price: 3225p (-5.1%)
• No. of shares: 6.2 million
• Market cap: £200 million

Final Results

Lovely results from Judges. It's a great example of a quality company which is currently "on sale".

• 5.6% organic revenue growth
• operating profit up 32% to £14.1 million
• dividend up 25%, still covered 4.5 times by adjusted earnings (this approach can be defended on the basis that the main adjusting item is the amortisation of intangible assets)

There was only one small acquisition in the year: the £2.3 million purchase of Moorfield Nanotechnology.

One of the best arguments against Judges is that it has grown too big, and won't be able to make purchases that move the needle in future. That thesis certainly held true in 2019.

And in November, the company announced its first special dividend.

Judges is becoming a cash cow - a big dividend payer - rather than a compounding machine.

Perhaps the current crisis will through up a few buying opportunities, so that Judges can invest instead of paying out large dividends?

Outlook is robust:

It is impossible, at this stage, to quantify any impact on current year trading as the duration of the pandemic is unpredictable. We are currently in a strong financial position with high cash balances and low gearing together with a robust order book, however, the only guidance your Board can provide on trading performance is that the effect will be limited if the outbreak lasts only a further two months and will have a progressively growing and more significant impact thereafter.

My view

Judges is one of the very few companies which is disciplined enough to focus on its ROIC (Return on Invested Capital), though it calls it the ROTIC.

It calculates its ROTIC at 31.4% in 2020 - superb, and better than the 27.6% achieved in 2018.

I don't know if Judges will be able to make needle-moving acquisitions but I do trust that it will act responsibly and will measure its performance in an appropriate way. If it can't make good acquisitions, I expect that it will continue to do the right thing and, to the greatest extent possible, will give its profits back to shareholders.

This share is definitely worth researching in more detail.

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Altitude (LON:ALT)

• Share price: 18p (-16%)
• No. of shares: 69 million
• Market cap: £12 million

Proposed disposal of AdProducts

Altitude is an unusual company, mostly active in the US, where it is developing a marketplace for promotional products. Here's the website seen by customers.

This RNS sees the company parting ways with its UK-based subsidiary and one of its UK-based directors, whose wife is making the purchase.

The UK-based subsidiary was making very little money, if any, and is being sold for up to £0.8 million.

There is a trading update too:

• Altitude withdraws guidance for the next financial year
• too early to establish the impact of the virus ontrading

My view - conceptually, a marketplace for promotional products sounds like a wonderful business idea. My main difficulty with Altitude is that it's a US micro-cap, listed in the UK, and it's hard to do due diligence on it from over here. So I'll probably stay away. Those who take the plunge might yet be rewarded.

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Revolution Bars (LON:RBG)

• Share price: 20.5p (-16%)
• No. of shares: 50 million
• Market cap: £10 million

COVID-19 Update

RBG shares had already been decimated before today's announcement. They dropped all the way from 60p-70p down to 25p, as of last night.

Today, we have confirmation that the situation has rapidly deteriorated. Trading will be "very challenging for the foreseeable future". The UK Government has advised the public to stay away from bars, so this is not really a surprise.

Pubs can go belly-up very quickly under their fixed costs, and RBG isn't starting from the greatest position with net debt of £10.5 million (now bigger than the value of its equity).

To me, this sentence suggests a refinancing is already being considered:

The Board continues to monitor the Group's funding requirements closely and is proactively exploring all the options available.

Actions being taken to preserve cash:

• reduction in payroll costs
• reduced opening hours ("reduction of unprofitable trading sessions")
• reduction in other variable costs
• suspension of rent and deferrable of business rates
• requests to defer PAYE and VAT payments

I've highlighted the last two because they strike me as last-resort measures which are typically used by companies in financial distress.

If the taxman isn't getting paid, then all the other stakeholders need to worry, too.

RBG says:

...we hope that there will be further measures in the coming days to provide assistance with payroll entitlements to gain surety for our employees, amongst other things.

Can anyone translate this? Is there a question mark over employees getting paid?

CEO comment:

Whilst we face a very challenging period in the current financial year, we are determined to make the right choices for the Group, employees, shareholders and all other stakeholders.

My view

The reference to other stakeholders is what you hear from a company whose creditors are unsure about their position. Landlords, the bank and the tax man will try to take what they are owed from RBG and I see very little left for existing shareholders.

Unless business goes back to normal very soon, a major refinancing will be needed to keep this afloat.

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Air Partner (LON:AIR)

• Share price: 18.83p (-33%)
• No. of shares: 53.5 million
• Market cap: £10 million

Air Partner Statement - COVID19 Update

Commiserations to anyone holding this through its rapid sell-off.

The share price more than halved over the past week, in anticipation of this update.

Key points:

• guidance withdrawn for this year (FY January 2021)
• "costs are being tightly managed to preserve cash and to maintain sufficient working capital"
• no more dividends for the time being

The prospective yield had exploded to 21% - the market correctly forecast that this dividend would have to go.

AIR's charter flights business is experiencing lots of cancellations and delayed orders. This "could be mitigated" by an increase in evacuation and aid work.

The private jets business (which provides smaller aircraft) is still strong in the US, but the UK & Europe are "severely impacted" by the virus.

Freight has also temporarily slowed.

My view

AIR made a £10 million acquisition in December, which in hindsight looks poorly-timed. The acquired company provides aviation security and training.

£8 million was paid upfront, nearly all of which was in the form of cash rather than share issuance.

Prior to that, in July 2019, gross cash was £9.8 million and headroom on its Natwest borrowing facility was £3.5 million.

So total cash plus headroom on the bank facility in July was £9.8 + £3.5 = £13 million.

Most of that was spent in December on the acquisition. 

AIR hasn't expressed any regrets about the purchase, and to the contrary says today that the acquired company is "proving its strategic rationale far earlier than we could ever have expected".

But I think the company needs to tighten its belt now, to work its way back towards a more comfortable financial position.

As noted in today's RNS, the company "owns no aircraft and does not operate as an airline". It provides aviation services. It should be able to manage its costs more easily than an airline - and we are about to find out if it can.

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Running out of time, so a few snippets to finish off.

Anpario (LON:ANP)

• Share price: 230p (+2%)
• No. of shares: 23 million
• Market cap: £53 million

Final Results

Anpario plc (AIM:ANP), the international producer and distributor of natural animal feed additives for animal health, nutrition and biosecurity is pleased to announce its full year results for the twelve months to 31 December 2019.

This niche business has put together a decent track record of profitability over the past decade.

For FY Dec 2019, it reports a 3% increase in revenue. PBT declined slightly to £4.4 million, but this is after a £0.6 million hit from foreign exchange movements. The underlying performance seems fine.

Let's skip to the outlook statement:

There may be some disruptions to shipping around the world but as most of our raw material supplies come from Europe, we expect to be able to fulfil orders effectively. With governmental financial support offered to the agriculture industry to ensure continuity of food supplies, Anpario is well positioned to take full advantage of the situation during the recovery period from Covid-19 and beyond... While we have not yet experienced any material impact on our business, we continue to monitor the situation closely.

This is pretty good evidence that panic buying of meats was unnecessary. The agricultural industry is not directly affected by the crisis - and governments agree that anti-virus measures which would reduce the production of food are a terrible idea. 

I can't see any major problems here. Anpario is debt free and had cash at year-end of £14 million.

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Connect (LON:CNCT)

• Share price: 14.15p (+2.5%)
• No. of shares: 248 million
• Market cap: £35 million

Trading update

Well done to this newspaper distributor/logistics group for issuing a very clear trading update, and quantifying the impact of recent developments.

Trading is "relatively robust". Smiths News and Tuffnells are in line with expectations.

Euro 2020 cancellation - without football magazines and trading cards, profit in H2 will be hit by £1 - £1.5 million.

Travel business - expectations are now for DMD to be hit by around £1 million, for a breakeven result.

Conclusion - adjusted pre-tax profits for the group as a whole will reduce by £2 - £2.5 million.

My view

The only thing we are missing in the RNS is a statement of what the prior expectations were.

As far as I can tell, the previous forecast for adjusted PBT was £23 million.

You have to factor in net debt of £74 million, too (as of August 2019).

CNCT is still recovering from a failed acquisition strategy but its shares will turn out to be absurdly cheap at the current level if it can put in a few good years and pay off its debts. Not for the faint-hearted.

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Science in Sport (LON:SIS)

• Share price: 33p (+1.5%)
• No. of shares: 123 million
• Market cap: £40.5 million

Final Results

SIS reports a small loss for FY 2019 that is in line with expectations.

So far in 2020, trading continues to be in line.

Last year, SIS acquired a profitable company, PhD Nutrition, and the addition of this business definitely appears to be helping.

Outlook:

While we are seeing sharply reduced revenue in Italy, China revenues have recovered in March and we have received strong forward orders. We are working with key customers to ensure their inventory protects the next weeks of consumer demand.

Preparations for Covid-19 related disruption have been in place for some weeks...

Is this a glimmer of hope? If Chinese revenues are already recovering, does that mean Europe can recover soon, too?

SIS is forecast to reach breakeven this year, and then to make its first profit, after many years of waiting, in 2021. This has been a long time coming and is long overdue.

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Calling it a wrap there for the day.

Take care of yourselves, especially your mental health. These are trying times for everyone, and it's a privilege to be able to invest in the first place.

Cheers

Graham