Small Cap Value Report (Wed 23 Feb 2022) - BELL, MADE, CBOX, NET, TED

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

Agenda -

Paul's section:

Belluscura (LON:BELL) - negligible revenues, and heavy losses are reported for 2021. It’s little more than a startup, yet is valued at £120m. Looks very high risk to me, but it has enough cash from the IPO to have a stab at becoming commercially viable - which would need a 40-fold increase in revenues just to reach breakeven!

Made.com (LON:MADE) - this online furniture retailer has lost two thirds of its value since floating in 2021. Is it a bargain yet? The abrupt departure of its CEO suggests to me that there could be more bad news. It’s an interesting business though, and at some stage could be worth considering.

Cake Box Holdings (LON:CBOX) - the share price continues collapsing. I give it the once over - is it a bargain yet? Possibly, but can we trust management if the auditors don’t? Also, all the major shareholders are dumping stock in the market, so where will the buyers come from?

Seraphine (LON:BUMP) - a disastrous profit warning, shares down 60% today. It’s still profitable, but beset by operational problems & cost increases that should have been better controlled & forecasted. New CFO joins shortly. I’m worried about the balance sheet - cash is tight, and inventories excessive, so too risky for now. Longer term, could be a good recovery though.

Jack's section:

Netcall (LON:NET) - double digit organic growth and good annual contract value figures provide confidence of meeting expectations heading into H2. The shares are less expensive than when we last looked in October but still not cheap by any means, so continued organic revenue growth is key. Quite a wide spread on the shares, 763bps.

Ted Baker (LON:TED) - group sales +35% year-on-year but remain down 28.6% on pre-Covid levels. Omicron has clearly had an impact, which is unfortunate. Ecommerce sales are broadly flat on pre-Covid levels and I would have been hoping for more here. There are some positive signs but I still think the level of execution risk is high, so I continue to wait for further signs of progress.

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Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review 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.

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Paul's section

Belluscura (LON:BELL)

105p (unchanged yesterday) - mkt cap £120m

Subscribers Nick Hewett and Derbion mentioned this company’s results in yesterday’s SCVR, which induced me to take a look. Here are my notes -

• Floated on AIM in May 2021 (buoyant market conditions, and high valuations pertained at that time)
• FY 12/2021 results show negligible revenue of $0.4m, and adj operating loss of $(4.2)m - so this is a commercially very early stage company, that has only just started selling its medical oxygen machines.
• Net cash of $15.6m at end Dec 2021, so it looks adequately funded from the IPO.
• Adam Reynolds is Chairman - who specialises in floating speculative, early stage companies. Some work, some don’t.
• Nigel Wray holds 11.8%, so clearly there must be a good story behind this share.

My opinion - it’s impossible to value at this stage. £120m market cap looks complete madness to a value investor, in current depressed market conditions.

I wouldn’t want to be holding any blue sky shares on eye-wateringly high valuations right now, no matter how good the story is. The market just isn’t at all receptive to this type of share any more, and it looks very vulnerable to a large drop in valuation, if bearish market conditions continue.

Forecasts from Dowgate assume that revenues will grow 40x over the next 2 years, and that gets it to… breakeven. Way too speculative for me, and this really isn’t a good time to be buying highly valued, speculative shares. They are the ones that have generally been dropping the most in the last year or so.

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Made.com (LON:MADE)

73p - mkt cap £285m

CEO Resignation

This is another aggressively priced 2021 float (on the main market) that has now lost about two thirds of its inflated valuation.

I’m re-reading my notes here from the 9 Dec 2021 profit warning, where I was inclined to forgive the company for predictable supply chain problems (product deliveries to customers slipping from 2021 into 2022). However, the stock market has not been forgiving, and you can’t fight the market, as I’ve learned to my cost with other shares in recent months.

The latest news is that the CEO has resigned with immediate effect, to look after his family (we are told). I hate speculating on the real reasons behind immediate CEO resignations, which are usually glossed over in official announcements. It could be genuine, or it could be a face-saving announcement, we don’t know. Generally though, CEOs don’t suddenly depart when things are going well.

The existing COO becomes interim CEO.

The announcement of the CEO departing does include an important comment which looks reassuring re profit guidance for 2021. Although it doesn’t say anything about current trading in 2022 - so there’s a chance there could be fresh bad news, possibly, we don’t know at this stage.

The Group's financial results for the year ended 31 December 2021 remain in line with the year-end trading update published on 6 January 2022. As previously announced, MADE will publish preliminary results for Full Year 2021 on 8 March 2022.

My opinion - we quite like MADE here at the SCVR, with both Jack and I seeing something intriguing in the business model. Supply chain problems in 2021 should gradually ease at some stage in 2022 and 2023, based on comments from shipping companies, and other importers. Hence I think there is a good opportunity for investors to benefit from market sentiment turning more positive on the furniture sector, as they work through order backlogs. I’ve got no idea on timing, your guess is probably better than mine.

How to value MADE? I’m reluctant to anchor to the inflated IPO valuation, so it doesn’t matter that it’s dropped by two thirds - so have loads of other eCommerce businesses, as growth slowed or stopped, and supply chain problems hit margins.

Those issues could ease though, and it’s starting to look as if there might be bargains out there.

MADE is quite tempting. But I don’t know how to value it, since there aren’t any profits yet.

It’s not a bargain to my mind, in bearish markets. But at some stage this could be an interesting share to dip into. Who can call the bottom though? We’ll keep it on the watch list.

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Cake Box Holdings (LON:CBOX)

157p - mkt cap £63m

I’m staggered how far this share has fallen. It’s a fascinating situation, where Maynard Paton wrote a superb article, flagging up numerous issues in the accounts, but above all a highly critical resignation letter from the auditors. Somehow, the market didn’t seem to notice the highly critical auditors letter, as it was slipped out without the text being published on the RNS.

No doubt the share price would have fallen somewhat anyway in current bearish market conditions, but look at this -

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Is it a bargain now? - tricky one this. The value metrics are now looking appealing, with a low PER for a growth business, and an attractive yield.

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The trouble is, management credibility, and by implication how believable the numbers are, has now been shattered. So how can we know if the numbers (and hence valuation) are real?

Once again, £multi-million Director selling was a big sell signal, in hindsight. This is happening so often now, that I think we need to be highly sceptical about big Director selling generally.

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My opinion - in all other respects, CBOX looks a decent growth company, so I am tempted to buy some.

But with major question marks over the financial controls, and even honesty of management (as clearly flagged by the auditors), should we even be thinking about getting involved in the shares, or just treat them as uninvestable at any price?

I don’t see a problem with solvency - it has a sound balance sheet. There seems strong demand from franchisees, and the roll-out of new stores (funded by the franchisees) is progressing well.

Is it cheap enough to take a punt? Not quite, but it’s close.

The key point here is position size. I would only ever risk money I could afford to lose, as cakes seem to be a particularly risky area for investors, strangely (e.g. Patisserie Valerie).

Actually, I’ve made my mind up now, to avoid this share completely. Why? Because practically everyone, including management is selling! So it’s likely to continue drifting down in price, due to constant selling by major shareholders. See the major shareholders page here on Stocko -

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Seraphine (LON:BUMP)

80p (down 60% at 09:01) - mkt cap £41m

Down 60% - this is one of the most savage market reactions to a trading update that I’ve seen in a while from a normal trading company (i.e. not a binary type of situation like small drug development companies whose trials fail, or junior resource companies that drill a dry well).

The market cap has fallen from £103m yesterday, to £41m today, so things must be really bad.

I’ve only looked at BUMP once, here in Sept 2021 - when it warned on profits just 2 months after listing, due to supply chain problems. Back then, the company made out that it had fixed its supply chain problems, but clearly that’s not the case now.

Let’s pick through the wreckage, to see if there’s anything worth salvaging -

Trading Update

Seraphine (LON:BUMP), an international digitally-led maternity and nursing wear brand, today provides an update for the second half of the financial year to date.

This is FY 3/2022.

My notes from the trading update -

H2 revenues (Oct 2021 - Jan 2022) were strong +45% against LY (last year)

Feb 2022 has been soft (no clear explanation given as to why)

Mar 2022 expected to improve, from new season launch.

Revenue guidance doesn’t sound too bad -

“... full year revenue marginally below current expectations”

That doesn’t justify a 60% drop in share price, so there must be bigger problems.

The company refers to margin & cost challenges, which include -

· Customer Acquisition Costs (CAC) impacted in February by weaker demand

· An underestimation of the level of sales tax and duties incurred on outbound and returned goods in our new markets of Canada & Switzerland

· Higher than anticipated promotional activity at the end of December and in January to clear the increased mix of seasonal product resulting from the delayed stock issues in the summer, impacting gross margin

· Inflation in warehousing & transport costs since the beginning of the calendar year

These strike me as fairly basic things which should have been planned, and budgeted for. So on the face of it, there seems to be an issue at Seraphine with basic management of the business.

Remedial action is being taken - see the RNS.

Revised EBITDA guidance -

FY22 Adjusted EBITDA pre-IFRS 16 is now expected to be significantly below current expectations at circa £4.5m.

Outlook - reassures, but how much can we rely on management, now that we know they have twice been overwhelmed by operational problems, in less than a year? -

Looking to FY23, we expect sales growth of 25-30% and EBITDA margins to start to rebuild.

The Group is experiencing no issues with inbound stock, with the mitigating actions taken by management since the summer resulting in the on time delivery of the spring summer collection.

New CFO - clearly a much needed recruitment. The new CFO is formerly from French Connection, where my impression is that he did a satisfactory job, in difficult circumstances -

Further to the announcement made on 22 December 2021, we welcome the arrival of our new CFO and Executive Director, Lee Williams, to the Board on 28 February 2022 and will support him in improving our forecasting and financial management information capability. John Bailey, Finance Director, will step down from the Board on the same date and, as previously announced, will remain with Seraphine for sufficient time to ensure a smooth transition.

Valuation - I’ve not got access to any broker notes, so will try to work out the figures myself.

BUMP achieved £3.0m adj EBITDA in H1, so FY 3/2022 guidance of £4.5m implies an H2 performance of £1.5m.

There’s hardly anything in tangible fixed assets, so depreciation would be negligible, and amortisation of intangibles is something I tend to ignore. Therefore, EBITDA isn’t that much higher than real world profits. So it’s still profitable, despite all the operational problems & unexpected cost increases.

Balance sheet - this was last reported as at 3 Oct 2021, and I do have some concerns.

The main issue is inventories look to be too high, at £9.2m. Given that this is a high margin business (about 65% gross margin), then inventories of £9.2m would represent revenue of £26.0m. That’s a good bit more than the entire H1 revenue of £20.8m.

Therefore there’s clearly way too much cash tied up in excessive inventories, and that could result in Seraphine running out of cash, when the suppliers want to be paid for those inventories.

Cash looks tight - with net cash of only £1.3m at 3 Oct 2021, being £3.3m cash, less £2.0m borrowings.

Overall then, given more operational problems, and a balance sheet that’s stuffed full of excessive inventories, I think there is heightened risk that Seraphine could run out of cash, and need an emergency fundraise from shareholders - which could result in heavy dilution.

My opinion - this looks to me a fundamentally good brand, in a high margin niche. It’s also generating strong growth, and going into new markets. Unfortunately, it looks as if the business’s growth has run ahead of management ability to control things.

To be fair, the company has accepted that, and recruited an experienced new CFO.

If the financial position was stronger, then I would wait to see where the shares settle in the coming weeks, and maybe have a punt on it.

However, I’m concerned that Seraphine might run out of cash, as it looks tight. Nothing is said about cash or liquidity in today’s profit warning.

Also, having hit the market twice with bad news in its short life as a listed company, then I suspect a recovery in the share price might take some time.

At this stage, I’ll put it on my watchlist, but risk:reward doesn’t seem attractive to me, despite today’s 60% fall. I need more reassurance that it won’t run out of cash, so would prefer to wait for a placing to be done, or clearer signs that it doesn’t need a placing.

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Jack’s section

Netcall (LON:NET)

Share price: 66p (+0.76%)

Shares in issue: 149,712,445

Market cap: £98.8m

Half year report for the six months to 31 December 2021

This is a provider of intelligent automation and customer engagement software. Customers span enterprise, healthcare and government sectors and include two-thirds of the NHS Acute Health Trusts and corporates including Legal and General, and Lloyds Banking.

The group's Liberty platform of modular and integrated solutions offers Intelligent Automation and Customer Engagement solutions, comprising four main categories:

Intelligent automation

• Liberty Create: helps clients create enterprise grade applications that drive and automate workflows and business processes. Can be integrated with other parts of the LIberty platform of third parties such as Salesforce.
• Liberty RPA: automates certain tasks, allowing workers to be more productive.

Customer engagement

• Liberty Converse: omni-channel contact centre solution (speech bots etc.).
• Liberty Connect: cloud conversational messaging and chatbot platform.

Head over to the group’s investor relations website, and presumably what pops up in the bottom right is Netcall’s chatbot in action.

The valuation remains quite steep even after accounting for a c20% pullback from last year’s highs of 82.5p.

I’m concerned that should the current market environment continue, this kind of company is at risk of a derating in the shorter term. There’s no guarantee of that happening, but I certainly think a forecast PER multiple of 25-30x is more realistic than one of 40-45x.

Still, Netcall looks like it is doing well. Here are the highlights of today’s report:

• Revenue +10% to £14.7m,
• Adjusted EBITDA +17% to £3.45m,
• Profit before tax +20% to £1.15m,
• Adjusted EPS +21% to 1.09p,
• Cash down from £12.9m to £10.7m, net cash £7.3m.

Cloud services revenue has risen by 21% to £4.93m and Cloud services annual contract value (ACV) is up 29% to £10.8m, with a net retention rate of 119% signaling growth. Total ACV has risen by 12% to £19.8m, with 24% of the total coming from cross- and up-selling opportunities.

ACV is the total of the value of each cloud and support contract divided by the total number of years of the contract. It’s something of a leading indicator for revenue growth.

So Cloud services seems to be doing well - the primary driver for the double-digit organic revenue and profitability growth - and demand for the group’s Automation and Customer Engagement solutions have grown across all key segments (financial services, healthcare, and government).

Outlook:

Trading in the early part of the H2 remains comfortably in line with expectations and the Board is confident of continued progress during the second half.

Balance sheet - as you’d expect, non-current assets of £32.3m are dominated by £30m of intangibles. Negative NTAV, and the current ratio is just 0.91x. The £10.5m of cash is useful though, and debt has fallen by £3.4m.

I’d like to see more strength here. Over two thirds of revenue is recurring, so that provides some security, but the £1.2m of net cash from operations is offset to a large degree by £980k of spend on software development costs.

Conclusion

A good performance, with double digit organic growth and an accelerated growth rate ACV boding well for the future.

Netcall is cash generative and investing in its platform. Several new enhancements were made to the Liberty platform in the period, with a focus on expanded automation capabilities, improved user experience, and new product functionality. This investment will continue in H2.

I can imagine there’s a good market opportunity here, with scope to continue organically growing via customer acquisition and up/cross-selling. Margins are currently low though and returns on capital are mediocre.

There’s the familiar transition to cloud too… While cloud ACV is growing, product and support ACV is expected to be lower. That’s still £9.1m of revenue, so it’s a material point to consider.

I can’t see much room for multiple expansion, but Canaccord has just increased its forecasts and has a punchy 110p price target. So much here comes down to future growth and the potential for operational gearing. If that is the path Netcall is on, then the PER could fall in short order.

The last time I covered the company, back in October, the forecast rolling PER was in excess of 50x. So the valuation is certainly more reasonable now, while positive trading momentum has been maintained. It’s more interesting at these levels, and probably worth a deeper look for investors that like to spot growing software companies approaching profitability inflection points, but we’re still a long way from bargain territory.

Right now I’m neutral, and it would take a lot for me to entertain a growth valuation in current conditions. I’ve just seen the spread is quite wide too at 763bps, so that looks painful.

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Ted Baker (LON:TED)

Share price: 101.57p (+15.49%)

Shares in issue: 184,610,683

Market cap: £187.5m

Q4 results for the 12wks to 29 January 2022

• Group sales up 35% (compared to +18% at Q3),
• Successfully navigated supply chain disruption, modest impact on product availability,
• Trading margin improved by 350bps, full price sales mix is up 800bps ‘re-establishing premium brand positioning’,
• Net cash at year end of £3m (ex-leases), £80m of bank facilities,
• FY23 targets of £30m free cash flow and 7-10% EBITDA margin maintained.

Compared to Q4 pre-pandemic levels, Retail sales were running at -10% before Omicron warnings, falling to -42% during the Omicron surge. That’s unfortunate. I’ve been wary of the TED turnaround in the past, at higher share price levels, when perhaps a little too much progress had been taken for granted. But there are some positive signs here, so it’s a shame that Omicron disrupted trade.

Here’s the sales comparison box. ‘Reported vs. LY-1’ is the comparison with pre-Covid trading. I would have hoped for more progress in eCom.

Breaking Q4 down, it began with an ‘encouraging’ recovery followed by a ‘material’ decline in demand during the Omicron surge, starting in mid-December. It wasn’t just Omicron though.

Retail sales growth rates were adversely affected by seven percentage points due to change in operating model relating to our Japanese and Chinese business moving from Retail to Licence and JV and from House of Fraser moving to Wholesale. These actions were strategic decisions made by the business to improve ROCE and drive capital light growth.

The jury’s still out there. Improving ROCE and returning to more capital-light operating methods could work out well, but we’ve yet to see this is the case.

The sales growth rate has declined as a result of moving away from the ‘aggressive promotional stance’ of prior years. Better margins as a result, but I still think there is a question mark around the actual demand for full price Ted Baker products. I’m not the most fashion conscious, so probably not best placed to comment!

The Group has made further progress on increasing the variable nature of rents and reducing lease length throughout the year, which will impact IFRS16 adjustments in FY2023 and beyond.

This has been a big issue, with plenty of work to do in both growing sales and reducing costs.

Conclusion

Shares in issue have more than trebled since FY20, so this is a fundamentally different investment proposition to what it was in its heyday. £30m of FCF by FY23 would be c16.3p per share, a 5.8x multiple.

That would be good value for a growing, healthy premium lifestyle brand. Burberry (LON:BRBY) is on a trailing twelve month FCF multiple of 12.7x for example. But I’m still not convinced that this turnaround is a sure thing. Online sales look flat on pre-Covid levels. I would have been hoping for more progress on that front.

Plenty of people clearly disagree with my take though, with the shares up c16% at the time of writing. Sequential sales are up and underlying retail sales were almost back to pre-covid levels before Omicron hit. And it’s certainly been a difficult time to execute a turnaround, so I have some sympathy for the management team.

But I see Liberum has actually reduced its forecasts for FY23E and FY24E, while maintaining a price target of 225p. Maybe the shares will reach that level in time, but I still don’t feel as though the execution risk is adequately reflected at the moment, so I’m going to stay on the sidelines until I can be more confident of an entrenched, sustained recovery.