Small Cap Value Report (Wed 23 June 2021) - BOOM, G4M, JOUL, VTU, MRL, MANO

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

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Timing - today's report is now finished.

Agenda -

Paul's Section:

Audioboom (LON:BOOM) - trading update from yesterday. Impressive revenue growth here, but no profits yet. Looks interesting, but how do we value it?

Gear4music Holdings (LON:G4M) - I had a short phone call with management, here's what I asked them.

Joules (LON:JOUL) (I hold) - trading update for FY 05/2021. Slightly ahead of market expectations. I plough through the detail. This is one of my favourite long-term holdings. Priced probably about right for now, but big increases in earnings are forecast. Strong growth from Friends of Joules ecommerce marketplace. Stores now re-opened and trading ahead of 2019.

Vertu Motors (LON:VTU) (I hold) - more profit upgrades. This looks astonishingly cheap, on a PER of c.8, and fully asset backed with freehold property. It's also up-to-date with eCommerce, and has twice as many cars for sale online as competitor Cazoo, which is currently valued on the NYSE at $7bn!

Jack's Section:

Marlowe (LON:MRL) - strong adjusted results and runrate revenue already comfortably ahead of FY21. Management is executing at pace but there's a lot to keep on top of at this buy and build operator.

Manolete Partners (LON:MANO) - good growth in case numbers and potential for more insolvencies as government support relaxes, but liquidity is an issue and there is a degree of subjectivity required in the accounts.

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Audioboom (LON:BOOM)

900p (up 2% at 15:18) - mkt cap £141m

Trading Update

Audioboom (AIM: BOOM), the leading global podcast company…

Revenue expected to be significantly ahead of current market expectations … and an increased adjusted EBITDA

Revenues, not profits note.

Key points -

High demand for ads has allowed a 22% rise in average ad unit pricing - sounds encouraging

Greater than 97% fill rate on the top 15 shows

Allenby has published an updated note today for FY 12/2021-

• Revenue $46.1m (up an impressive 72% on LY)
• Adj profit before tax £224k
• Net cash £1.57m

So really, it's trading just slightly above breakeven. Would I really want to value that at £141m market cap? Maybe, if that kind of revenue growth is likely to continue, and would result in operationally geared explosive upside to profits.

My opinion - it’s been hopeless in the past, but the current strategy does seem to be delivering very strong revenue growth. It remains to be seen if that can translate into meaningful profits.

A spectacular chart too. Will the big rise stick though, or is it a speculative bubble? Who knows!

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Gear4music Holdings (LON:G4M) - (I hold)

Chat with management

I was kindly offered a brief slot in the schedule yesterday, here’s what I asked (abbreviated) -

Q1. G4M develops its own, bespoke eCommerce software. Isn’t this costly, and unnecessary, with ready-made cloud software available (e.g. Shopify)?

A1. Definitely not. Bespoke software is key to our success - very flexible & we can design in whatever special features we want. Not particularly costly.

Q2. Recently acquired brands bought - how is this managed?

A2. Each situation is different. G4M can breathe new life into dormant or semi-dormant, or neglected brands, often with a long history, at modest cost. Won’t take on anything that the team can’t handle.

Q3. How accurately can you track the effectiveness of your marketing spending?

A3. Very accurately. It’s a sophisticated & specialised area.

Q4. Would you buy other online retailers, and be a consolidator?

A4. We’d look at specialised situations, which add something new to the group, but not interested in buying struggling competitors, as we can pick up their business gradually anyway, without having to buy them.

Q5. Repeat customers seem low.

A5. We do see a lot of large, one-off purchases, that’s the nature of the business. Customers are profitable from the first order. Cost of acquisition is only £9 per customer. Gross profit is c.£32 from first order. So it’s a good business model that works, even if people only buy once from us. Last year saw a lot of one-off customers, due to pandemic lockdowns.

Q6. You got a boost from lockdowns last year, but it must have hurt some product categories too, as musicians stopped live gigs & playing together in bands, etc. Is there upside this year from some product categories?

A6. Absolutely right. We’re seeing categories related to playing outdoors (e.g. large amplifiers), and bands playing together rising now.

Q7. I’ve heard that UK musicians have reported difficulties with deliveries from European competitors, such as market leader Thomann. Is this benefiting G4M?

A7. Thomann were already losing market share in the UK to G4M. Cross-border transactions are difficult, hence why we try to do as little as possible. Existing European hubs (Sweden & Germany) were set up for other reasons, but have worked very well since Brexit. We try to do as little cross-border transactions as possible. Product goes from Far East straight into European hubs, so no Brexit issues. New hubs in Spain & Ireland are quite cheap to set up, and will be important at improving service in those markets. Hoping to be operational in H2 this year.

Q8. What about further expansion internationally? USA market must be an eventual target?

A8. There’s so much more potential in Europe, so we’re going for that first. USA would involve a lot of investment, something for the future.

Q9. Southern & Eastern Europe look like an obvious gap on your map (in presentation slides) for fast delivery coverage.

A9. Yes, well spotted! We’ll get Spain & Ireland set up this year, then another European hub is likely in future.

NB. this is from memory, I didn’t take notes, so it might not be 100% accurate, but I think it accurately records the gist of what was said, if not the exact words.

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Joules (LON:JOUL)

(I hold)

285p (Tuesday’s close) - market cap £318m

Trading Update

We’ve enjoyed a spectacular rally since the vaccines were introduced in November last year. My feeling is that this strong rally became a bit frenzied, and looked indiscriminate. Lots of fundamentally quite challenged businesses with poor balance sheets, and existing problems (pre-pandemic) suddenly multi-bagged. Often the biggest % risers seemed to be the riskiest shares. A “dash for trash” as it’s been called - maybe that’s over-stating it a bit.

Where I think we are now, is that some big share price rises are sticking, if companies produce excellent trading updates. Whereas others are slipping back down again, especially the more speculative stuff, when it becomes clear that trading performance does not justify the large rise in share price since last autumn.

That’s a very healthy process, but it does mean that it makes sense to bank profits where we just got lucky, rather than picked good companies. I can see a lot of that going on at the moment, and reader comments reflect it, e.g. “Why has xyz plc, or the X sector, gone down 10% this week?” Probably because the prices got ahead of themselves, and people are banking the profits! Also this is a traditionally sluggish time of year, when a lot of traders switch off their computers and do other things.

With retailers, key things I’m looking for are -

• eCommerce growing strongly, and a major (ideally c.50%) proportion of sales
• Modest (or no) overhang of problem property leases (ideally solved with a CVA/pre-pack)
• Marketplace websites - i.e. earning commissions selling other brands too
• Decent balance sheet, with no need for equity fundraising dilution
• Distinctive brand(s) with pricing power
• Good at everything - "retail is detail"

My preferred list of retailers is therefore the online-only giants, Asos (LON:ASC) (I hold), Boohoo (LON:BOO) (I hold), and successful mixed physical/online companies Next (LON:NXT) , Joules (LON:JOUL) (I hold) - much smaller. At the more speculative micro cap end, Quiz (LON:QUIZ) (I hold) - which got rid of all its problem leases last year, and has an established online operation.

Marks And Spencer (LON:MKS) strikes me as an interesting one to keep an eye on. It’s also going down (late) the marketplace route, and has come under fire along with John Lewis recently (see Sunday Times last weekend) for excessive fees of c.38% charged to third party brands.

What’s the betting BOO under-cut this when they properly re-launch Debenhams online marketplace in the autumn? (it’s soft launched already, but with limited stock & not many outside brands yet). I think the city has not yet realised the potential of Debenhams as an online only operation. It was already a top10 eCommerce fashion site before it went bust, doing c.£300m sales online. With BOO breathing new life into it, I reckon this could be £500m+ incremental revenue (and 10% standard BOO group EBITDA margin). Bolt that onto the BOO forecasts, and you can see what the potential for big upgrades to next year’s numbers might be.

Back to JOUL. Note from the chart that the big recent rise has stuck (so far anyway, it’s been whippy this morning), because newsflow has been strong, and broker forecasts have seen very large increases. That’s often the case at the moment - shares which appear expensive on high forward PERs, sometimes turn out to be performing way ahead of forecasts - hence the valuation turns out to be not as toppy as it looked. Analysts are always way too cautious coming out of a recession, which provides us with opportunities to find companies which are likely to thrash overly cautious forecasts.

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This is what JOUL says today-

Joules, the British lifestyle group, provides an update on trading for the financial year ended 30 May 2021 (the 'Period').

PR headline -

Continued strong digital momentum combined with store sales ahead of expectations since re-opening

Key points -

Revenue up 4% to £199m in FY 05/2021 (despite store closures during the pandemic - eCommerce more than recouped the shortfall)

Positive contribution from acquisition of Garden Trading Company (from Feb 2021) - this is important, because through its marketplace (“Friends of Joules”), JOUL has the opportunity to monitor & offer to acquire the most successful third party brands.

Guidance - pre-exceptional profit before tax is slightly ahead of market expectations (1)

1. FY21 analyst expectations: £5.2 - £5.3m

Thank you for the footnote!

Excellent growth of +48% in Friends of Joules marketplace revenues (no figure given)

Stores re-opening (8 weeks ago) - better than expected, sales ahead of pre-pandemic comparatives 2 years ago - that’s excellent, many other High Street operators are still struggling to return to pre-pandemic sales levels.

Stores were closed for almost half FY 05/2021, with sales down 41% - making the overall group result of positive revenue growth all the more remarkable, although we already knew this, as it’s been previously announced.

Acquisition of Garden Trading - going well, sales growth of +78% vs LY - this looks to have been a very good acquisition, at an attractive price.

Wholesaling - impacted by customer store closures, so sales down -17% - I’m surprised it wasn’t worse than this, probably helped by demand from eCommerce wholesale customers.

Net cash of £4.7m, with £39m headroom on bank facilities - looks fine to me. Unusual ESG-linked bank facility, as previously discussed here.

New CFO, Caroline York, joining on 26 July.

Online - is now a remarkable 77% of retail sales. That could drop in future though, as shops hopefully trade without further interruption. Maybe we should be valuing JOUL as an online, growth business, not a retailer?

Outlook - upbeat, but no specifics -

As a result of the strength of the Joules brand and the increasing diversification of the Group's digital-led business model, we believe that the Group is very well positioned to continue to deliver its ambitious growth plans."

Broker update - many thanks to Liberum for publishing its notes on Research Tree, which is so helpful, as follows;

FY 05/2021 - 5.0p EPS (PER of 56, based on share price of 280p)
FY 05/2022 - 12.5p (PER 22.4)
FY 05/2023 - 18.0p (PER 15.6)

As you can see, the valuation looks reasonable on forecast earnings for this current year, and cheap on next year’s forecast. That’s assuming forecasts are met, of course.

My opinion - this is one of my favourite stocks, as a long-term, hold forever investment. Therefore I’m not too fussed about the short term valuation.

FY 05/2021 was heavily disrupted by the pandemic, but it’s good to see the company remained profitable thanks to shifting much of its sales online.

JOUL has all the characteristics I look for, so it remains a long-term hold for me. Maybe priced about right for now? I’m looking to increase my position size by +50% on any weakness.

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Vertu Motors (LON:VTU)

(I hold)

46.3p (up 1% at 10:23) - mkt cap £168m

AGM Trading Update

Vertu Motors is the fifth largest automotive retailer in the UK with a network of 149 sales outlets across the UK. Its dealerships operate predominantly under the Bristol Street Motors, Vertu, Farnell and Macklin Motors brand names.

Vertu Motors was established in November 2006 with the strategy to consolidate the UK motor retail sector. It is intended that the Group will continue to acquire motor retail operations to grow a scaled dealership group...

[from “Notes to Editors” in today’s announcement]

The current financial year is FY 02/2022.

Here are my notes from 12 May 2021, which I’ve just re-read to refresh my memory. I concluded that VTU looked extremely cheap, on a PER of only 7.9. The price has barely budged since then, so VTU seems to be fighting a headwind, despite putting out strong trading updates, and broker forecasts being raised substantially of late.

Today’s update is only about another 6-7 weeks since the last one.

Key points today -

• Strong trading has continued - driven mainly by used cars
• Strong H1 performance is anticipated (if current trends continue)
• Risks remain - covid, and vehicle supply constraints
• New vehicle supply problems (due to component shortages) “increasingly apparent”
• Elongated timescales from customer order, to delivery, for some brands
• Demand for used cars “remains very robust”
• Reduced supply of used cars causing “exceptional wholesale pricing environment”

Profit guidance -

In light of the strong trading performance to date, driven largely by the exceptional used car market environment, the Board now anticipates that the Group's full year adjusted profit before tax will be above current expectations and in the range of £28m - £32m.

Outlook - more strategic than specific -

The Board remains confident in the prospects for the Group. With its strong asset base, scale, Manufacturer relationships, well invested systems including the Click2Drive sales technology platform and experienced leadership team, the Board believes that the Group is strategically very well placed to capitalise on the changes and opportunities in the UK motor retail sector.

Broker updates - many thanks to Zeus and Liberum, both have issued updates today. Taking the average, we have latest forecast EPS of:

This year FY 02/2022 - 6.45p (PER of 7.3 [at 47p per share])
Next year FY 02/2023 - 5.75p (PER of 8.2)

Both brokers are assuming that this year’s bumper figures might soften next year. The share is still dirt cheap, even on that conservative forecasting basis.

My opinion - given the very low PER, and the freehold property backing, this share just looks the wrong price to me - far too cheap. Maybe I’ve missed something?

I’ve no idea what the catalyst would be to trigger a re-rating, and don’t really care. If it’s asset backed, and incredibly cheap, I want to own it, and the valuation should sort itself out one way or another at some point in the future.

I particularly like that VTU is hot on technology too, so it’s not some dinosaur business, but seems forward-looking. Check out its website, which offers similar online purchase capability (with delivery & 14-day money back guarantee) as Cazoo and Motorpoint (LON:MOTR) (I hold). Yet MOTR is valued far higher, and Cazoo is in the stratosphere with a $7bn valuation via a NYSE SPAC! Yet Vertu’s website currently has twice as many secondhand cars for sale, as either of those online competitors! This is an incredible valuation discrepancy, in my view. And an opportunity for Vertu to pivot towards faster online growth, and see a potentially large re-rating of this share. Lots to like in other words.

Stockopedia's StockRank system loves it too! StockRank is 98

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Jack’s section

Marlowe (LON:MRL)

Share price: 855p (+0.94%)

Shares in issue: 77,123,772

Market cap: £659.4m

Marlowe (LON:MRL) is a buy and build operator that owns a growing portfolio of businesses that provide clients with safety, risk management, regulatory compliance, and systems maintenance services. It hopes to become the UK’s trusted name in the provision of regulated safety and compliance services through a mix of organic and acquisitive growth.

The activity here in terms of acquisitions is breathtaking. It’s either highly impressive or quite risky, and whether that’s the former or the latter depends on the quality of the management team, ability to integrate businesses, and their M&A nous.

So far, this strategy has entailed fairly consistent equity dilution. A recent placing means shares in issue are now at 77m.

While this dilution is worth monitoring, so far total earnings per share has increased at a CAGR of 21.6%, so it looks like management has been buying profitably on a per share basis.

The share price has been strong recently, and now the group is valued at 28.6x forecast rolling earnings. The market is assuming ongoing growth.

Marlowe has a revenue target of c.£500m and adjusted EBITDA of c.£100m over the next three years. That’s against today’s FY21 revenue figure of £192m and adjusted EBITDA of £28.7m, so it’s quite ambitious.

And the recent placing to raise c.£100m before expenses means Marlowe can continue to grow in keeping with its established model.

Final results

Highlights:

• Revenue +15% to £192m,
• Adjusted EBITDA +30% to £28.7m,
• Adjusted operating profit +33% to £19.7m,
• Statutory operating profit -52% to £1m,
• Adjusted PBT +31% to £17.1m,
• Statutory loss before tax of £1.6m (FY20 PBT: £0.5m),
• Adjusted basic EPS +6% to 25p,
• Statutory EPS down from -0.8p to -3.1p

The difference between the statutory loss before tax and the adjusted profit before tax includes £2.2m of acquisition costs, £5.6m of restructuring costs, £6.5m of amortisation of acquisition intangibles, and £4.2m in legacy long term incentives.

Assuming the latter is executive remuneration, I’d add this cost back in. It’s real, and it’s material, and it’s not a one-off.

Marlowe introduced a new Executive Incentive Plan (EIP) recently that could lead to further dilution - 10% over 10 years above £6.90 per share assuming 10% annualised growth in the share price from the start of the Performance Period on 1 April 2021 based on an opening share price of £6.90 per share.

This is capped at a maximum aggregate award of 4,902,295 new ordinary shares but it seems like a big payout with a very achievable target given that the share price is already 23% ahead of this threshold price in a matter of months.

It makes me slightly more cautious on this company than I have been in the past. With all the (necessary) estimation in the accounts, why not tie ultimate management compensation to a more concrete and fundamental measure of value, such as operating profit growth? That would put me more at ease.

Marlowe continues to grow though, there’s no doubt about that. A flurry of recent acquisitions mean the current 12-month run rate revenue is now up to some £280m, with c83% recurring. Some 46% ahead of the FY21 figure.

Margins are also expanding, with divisional adjusted EBITDA margin up from 13.1% to 16.2%. This could be an important dynamic moving forward as Marlowe scales up.

Net cash generated from operating activities, before acquisition and restructuring costs, has grown from £11.2m to £28.3m. After acquisitions & restructuring, net CFO is up from £3.4m to £20.4m. So actual cash flows have also grown considerably.

This is dwarfed by a total of £71.9m spent on investing activities (£68m on acquisitions and a net £3.9m on capex). Of the £170m raised in share issues and £80m in new bank loans, £149.1m has been spent on repaying debt.

Fifteen acquisitions were completed during the year.

In terms of the current trading and outlook, the group says organic growth is in line with its medium term targets.

Eight acquisitions have been completed so far during the new financial year, with a ‘strong pipeline of earnings enhancing acquisitions’

Conclusion

This is perhaps the most active buy and build operator I’ve come across. Fifteen acquisitions in FY21 and eight already in FY22 is some going. There is execution risk here, and it leads to quite complicated accounts full of subjective adjustments, but that’s just the nature of the beast at present. This business model has done very well for Sdi (LON:SDI) and Judges Scientific (LON:JDG) in unrelated industries.

The notable gap between adjusted and statutory results could be more clearly and prominently explained in the results, however.

That’s not to say there’s anything untoward here, but when there are such large and frequent adjustments coupled with multiple acquisitions in any one year, that creates a great deal of subjectivity and human input across a variety of key accounting figures.

Buy and builds do often require trust on the part of the shareholder that management is providing an accurate representation of the underlying progress of what is a rapidly evolving enterprise. While Marlowe is busily acquiring now, I suppose the aim is that one day it will be in its final form, in which case restructuring costs and all the rest of it really will disappear.

That end state could be a highly profitable company that occupies a dominant position in defensive markets with attractive recurring revenue characteristics. The total addressable market is estimated to be worth nearly £7bn (growing at c3-4% per annum) and is highly fragmented.

So it’s all to play for and management appears to be executing well.

I think either you spend a long time going through Marlowe’s history, its acquisitions, and its accounting adjustments - or you trust in the management team, you are reassured by the institutions on board (who most likely have far greater access to management than PIs will ever get) and hold shares in what could be a far larger company in five years’ time.

The third option, of course, is to focus on other opportunities.

For now the wide gap between adjusted and statutory results makes me cautious, and the valuation at present seems full, although I accept that Marlowe has ambition, is growing revenue with scope for margin expansion, and could quite possibly grow into and beyond today’s share price.

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Manolete Partners (LON:MANO)

Share price: 241.90 (+0.79%)

Shares in issue: 43,571,425

Market cap: £105.4m

It’s rarely boring in the world of litigation financiers. Manolete Partners (LON:MANO) releases this trading update on the same day Litigation Capital Management (LON:LIT) announces its participation in the Comet Group liquidation claim. Then of course, prior to this, we have the Burford Capital (LON:BUR) - Muddy Waters short selling saga.

Very small free float here at 25% of shares in issue; the spread is 417bps and it looks like you can reliably buy or sell around £5k at market prices so liquidity is a consideration.

Manolete has a ‘grand old duke of york’ share price chart, marching up and then down the hill. That could mean the shares are due a rerating at some point, or it could also show that there are some holders waiting for signs of life so that they can sell down some of their stakes.

Full year results

Highlights:

• Total revenues +49% to £27.8m,
• Realised revenues +214% to £24.4m,
• EBIT -25% to £7.4m ‘reflecting lower level of unrealised profits due to exceptional Government measures, a more conservative assessment of the value of our in-process cases against the background of the pandemic and the full year effect of our expanded staff network’
• Profit before tax -26% to £7.0m,
• Diluted earnings per share -24% to 13p,
• Proposed final dividend of 1p; total dividend of 2.17p (FY20: 4.17p)
• Gross cash receipts from completed cases +61% to £12.2m

The group notes £2.8m of net cash from operations, but if you account for £5.9m of investment in cases, this falls to a cash outflow of -£5m. In fairness, this reflects good growth in case numbers.

Looking at the balance sheet, the group has £1.1m of cash and around £8m of debt. Of the £57.4m in total assets, £37.5m is made up of investments. The group defines these as ‘the costs incurred in bringing funded and purchased cases to the position that they have reached at the balance sheet date’.

A 214% increase in realised revenues to a record level of £24.4m sounds impressive, and a record 198 new case investments were made in FY21, with 135 cases completed. So the group sounds busy. Manolete adds that its investments yield an average Money Multiple of 2.7x and ROI of 168% on 388 completed cases since inception.

The group now has a new RCF with HSBC for £25m over an initial three-year period to 1 July 2024, with an option to extend by a further year and an additional £10m accordion if required.

Manolete comments:

The insolvency process will play a critical role in allocating capital and resources to truly sustainable businesses in the post-pandemic UK economy. With the widely reported large backlog of insolvency cases, we expect new case enquiries to increase over the foreseeable future and we will continue working hard to deliver outstanding returns to both the creditors of insolvent estates and our investors.

Conclusion

The results value Manolete at 18.6x FY21 EPS, with a yield of 0.9%. Earnings per share looks better than the broker consensus forecast, but is some way below FY20 normalised EPS of 17.2p.

If it can get back to that level, the PER would be 14.1x, and the company was growing strongly prior to Covid. So there’s an argument to be made here that the shares are undervalued.

But I struggle to reconcile the cash-hungry business model with the double digit returns on capital and returns on equity. Accounting standards in general seem ill-equipped to handle this business model. These litigation financiers require a different method of valuation.

And there is a good deal of subjectivity in its case valuations. Furthermore, the group talks about ‘cash latency in the Company's financial results’, with the large majority of the cash benefit of FY21's record realised revenues yet to be reflected in cash reserves. Is that not just an unfavourable cash conversion cycle by another name?

These companies require specialised knowledge - which I’ll happily admit that I don’t have - and there is a good deal of uncertainty and subjectivity in the accounts. It’s clear that the market shares this sentiment. The analyst forecast on the StockReport has a price target of 520p - more than double these levels. So some degree of uncertainty is priced in.

This is not necessarily the company’s fault - but the end result regardless is that there’s too much risk and uncertainty here for me as I struggle to value the company and its prospects. The lack of liquidity is an additional consideration, but it does also mean that if Manolete does well, the share price could rerate aggressively.