Small Cap Value Report (Wed 30 June 2021) - PDG, WYN, CAR, STU, SAGA, CBOX, SAA

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

Agenda -

Paul's section:

Studio Retail (LON:STU) (I hold) - impressive results for FY 03/2021, and encouraging outlook comments. Seems strikingly cheap on a PER of only 6.6 - scope for a re-rating? I think so

Saga (LON:SAGA) (I hold) - tender offer for old bonds is over-subscribed, and scaled back to the £100m maximum. Finances now look much more secure.

Cake Box Holdings (LON:CBOX) - strong results, despite the pandemic. Looks a smashing business, and the big rise in share price seems fully justified.

M&c Saatchi (LON:SAA) - late 2020 accounts finally published. Strong H1 2021 trading is more important. Good news re reduced potential dilution. Could be worth a fresh look, by readers, but it's not for me.

Jack's section:

Pendragon (LON:PDG) - Pendragon confirms its peers' comments. Trading is strong for car retailers right now. These shares are often cheap due to their low margins but it's possible that the industry-wide rerating has further to run. Potential H2 supply disruption is flagged as a possible concern, however.

Wynnstay (LON:WYN) - record underlying profit before tax for this prudently managed supplier to the UK agricultural industry. Low margins and slow growth in the past might put some off, and the shares are not the bargain they were six or so months ago, but Wynnstay has a solid expansion strategy, strong finances, and a good dividend track record.

Carclo (LON:CAR) - turnaround situation that has rerated aggressively. Results probably not as bad as initial market reaction suggests (this has been a tough year for most operators) and there is potential upside from here - but there are also material risks to consider as well.

Timing - today's report is now finished.

Disclaimer -

A friendly reminder that we don’t recommend any stocks. We aim to cover notable trading updates & results of the day and offer our opinions on them as possible candidates for further research if they pique your interest. We tend to stick to companies that have news out on the day, and market caps up to about £700m. We avoid the smallest, blue sky type companies, and a few specialist sectors (e.g. resources, pharma/biotech).

A central assumption is that readers then DYOR (do your own research) and discuss in the comments below. The comments, incidentally, sometimes add just as much value as the articles. We welcome all rational views, whether bull or bear!

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Paul’s Section

Studio Retail (LON:STU)

(I hold)

296p (up 2% at 10:03) - mkt cap £256m

Final Results

SRG, the digital value retail business, today announces its full year results for the 52-week period ended 26 March 2021.

PR title -

A transformational year for the Group

Financial highlights look stunningly good, I’m already intrigued -

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I’ve highlighted the very large rise in adj EPS. This looks to be a small beat against 43.71p consensus estimate shown on the StockReport. Although note from the graph below that this forecast was raised substantially quite recently, in April 2021.

Clearly this is a very decent performance, and I’m very surprised the share price has not risen more - it’s similar to where it was in Jan 2021, which seems odd to me - could be a buying opportunity, as the share price seems to be lagging the strong performance. Also the PER is only 6.6! What on earth is going on? Why that derisory rating? That implies profits are not sustainable at this level, which seems wrong, given the guidance is for profit to be only a little down this year.

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Unfortunately, I didn’t make a diary entry, so have missed most of this morning’s Capital Markets Day, having just caught the tail end of the Q&A. Hopefully they might publish a recording later? The strategy is to raise sales to £1bn in the medium term (currently £579m). If anyone else attended the CMD, perhaps you could add a comment about it below?

Findel Education business was sold for £30m in April 2021. So it’s now a simpler business, focused on the sale of a wide variety of home & clothing products through websites mainly

https://www.studio.co.uk/

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Current trading & outlook - I see from the reader comments that this sentence has confused people -

The first quarter of the new financial year has seen Studio's product sales in line with the same period at the start of the pandemic last year, which in turn represents an increase of 51% on the first quarter of FY20...

Unpicking that, Q1 of the current year is April-June 2021. Product sales in that period are flat against April-June 2020.

FY20 is the period April 2019-March 2020. Therefore Q1 of that period would be April-June 2019. It’s probably easier to explain if I put it in a table using a notional starting figure of 100:

• April-June 2019 - notional level of 100 sales
• April- June 2020 - up 51%, so 151 sales
• April-June 2021 - flat vs last year, at 151 sales

I assume the 51% growth in sales in Q1 last year would have benefitted from lockdown 1, hence was a tough comparative for this year.

Therefore, matching that high sales level again this year, when lockdown was being eased, strikes me as an impressive performance.

Current trading - gross margin is significantly higher in Q1 of FY 03/2022 - this is important, because STU does seem to have a low product margin, which management indicated was c.35-36% at the moment. Remember the business model here is very similar to N Brown (LON:BWNG) - in that product is sold online, with the main focus being making profit from high interest/high default lending. Like an old school catalogue business, but moved online.

Product margin rates are c.340bp higher than last year due to the non-recurrence of Studio's significant discounting of clothing and footwear ranges seen at this point last year.

Although it doesn’t sound like the higher margins are expected to stick -

We expect that there will be a resumption of more competitive market conditions later in the year, alongside inflationary impacts on some raw material and shipping costs.

Outlook for financial services income -

Financial services revenue is up 15% in Q1, although this is expected to moderate later in the year. Studio is implementing changes to some elements of its financial services products this year to improve outcomes for customers.

Profit guidance - admirable clarity here, I wish all companies would provide profit guidance in this way -

At this early stage of the new financial year, we anticipate that Group adjusted profit before tax for the 52 weeks to 25 March 2022 will be in the range of £42m-45m.

Directorspeak sounds upbeat -

"The Covid-19 pandemic showed the resilience and agility of Studio, and we emerge from it a much stronger business.

"The changes over the last few years, to transform Studio into a digital value retailer with integrated financial services, meant we could react quickly to changing market conditions, and deliver record levels of growth in sales, profit and customer numbers...

"With the strong performance last year, and having sold the Findel Education business, Studio is in a stronger financial position and is now focused on pushing forward with a well-defined purpose that delivers great value, affordable products for our customers. The business has a clear growth strategy, fuelled by its digital capabilities, service enhancements, and ability to utilise data to drive better customer targeting, credit underwriting and product offers. All of this bodes well as we emerge from the pandemic and I am confident Studio can go from strength to strength and benefit all stakeholders."...

We have set out strategic plans to grow the Studio business towards achieving revenue of £1bn in the medium-term. The encouraging start of our current financial year against last year's challenging comparator gives us confidence in those plans.

Balance sheet - very similar to N Brown (LON:BWNG) the key concept to understand is that STU gives its customers expensive (APR 29-59% according to the conference call today) credit terms, hence there’s a large receivables book. This is funded with cheaper, longer term bank borrowings. There’s a high default rate on the lending to customers. High cost: high default in other words. That does come with regulatory risk, as every now and then the authorities decide to attack high cost lenders. You could argue it’s exploitative as well, which makes me a little uneasy.

Pension scheme - it says this today -

The Group is working with the trustees of the legacy defined benefit pension scheme to explore ways of removing any residual pension liabilities, for example by potentially acquiring insurance cover for some or all of its sections.

In the bizarre world of pension scheme accounting, this is shown as a £20.8m surplus on the balance sheet.

NAV is £84.9m, and if we deduct £22.8m intangible assets, NTAV is £62.1m. Personally, I don’t think that’s strong enough, and I would like to see the business retain profits for a few years, to make the balance sheet bulletproof.

That said, given strong trading, having a slightly weak balance sheet is not really a problem.

Dilution - during the pandemic? The number of shares in issue seems to have remained static, so looks like there was no dilution from an equity raise. That’s really good. Unlike N Brown (LON:BWNG) (I no longer hold) which did dilute with a fundraise. BWNG also failed to deliver growth, despite excellent market conditions, whereas STU grew strongly. It’s becoming very clear which is the better business!

Dividends - not being reintroduced just yet, but the company says it now has moved from a deficit into positive reserves at group level - which sounds like it now has dividend paying capacity. Personally, I’d rather they focus on driving growth, and strengthening the balance sheet.

My opinion - I’m really struck by the contrast between these excellent figures, and decent outlook, compared with the quite soft numbers and lack of growth recently reported by N Brown (LON:BWNG) . As previously discussed here, I started to worry about the big legal case BWNG is embroiled in, so decided it was too risky, and sold my shares. Buying STU instead looks like it was a good move.

I’m not really keen on these businesses which sell product online, in order to make a profit from charging customers high interest rate finance. I much prefer Asos (LON:ASC) (I hold) and Boohoo (LON:BOO) (I hold), Gear4music Holdings (LON:G4M) (I hold) which just sell product online, and have none of the complexities of managing an internal bank effectively.

Also, the default rates are so high on this lending. STU and BWNG seem to have very poor underwriting, in that they have to make massive bad debt provisions. Surely with all the data & information available, they could better work out which customers are actually likely to pay, and which ones are ripping them off for free stuff?

Overall though, I’m struck by how cheap STU looks on a PER of only 6.6 - that seems the wrong price to me.

Management plans to grow the business significantly seem to be working, and there’s a good buying opportunity here I think, for a re-rating. It’s priced like a bombed out, declining business, but is actually growing nicely and has ambitious management who sound like they’re doing the right things.

Who would have thought you could buy a strongly growing eCommerce business for a PER of 6.6?! There’s got to be upside on that valuation, providing nothing goes wrong of course.

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Saga (LON:SAGA)

(I hold)

404p (down 1%, at 13:24) - mkt cap £565m

Final results of tender offer

This looks to be the last element of the recent financial restructuring.

This tender offer relates to the old £250m bond. SAGA has offered to buy back £100m of it, and has issued a new £250m bond (at a higher interest rate of 5.5%), but with extended maturity to 2026. Therefore once completed, this arrangement means SAGA will have £400m in total on its bonds. Bank debt will have been eliminated (although an unused bank facility continues), and plenty of cash on hand for any eventuality. Separately, its owned cruise ships are financed with ship loans.

Detail of the tender offer -

• £173.5m were tendered by holders
• The maximum SAGA wanted was £100m
• 57.261% acceptance, ie. tenders are scaled back to this level for everyone
• Repurchasing them at par

That all seems straightforward. It would make obvious sense for holders of the 3.375% bonds to tender them, and apply for the new 5.5% 2026 bonds, because they’ll get paid more interest.

My opinion - I much prefer bond funding to bank funding, so this is a good arrangement in my view. Bonds provide secure, long-term funding, without the potentially onerous covenants of bank financing. Our resident bond expert always pulls me up when I describe the bonds as free of covenants. Covenant-lite is probably a better description - so whilst there may be some covenants for specific things, it’s nothing like the financial covenants that banks impose. Therefore it’s much lower risk.

Clearer the new/old boss, Sir Roger de Haan, doesn’t want a repeat of the emergency refinancing in 2020, even if covid continues to be a problem.

The share price of SAGA is so volatile, I have long since given up trying to fathom why it moves in such large swings, up and down. It must be a stock that traders like dipping in & out of maybe? None of that matters. The reality is (see note from Numis for the figures), sooner or later, when travel is back to normal, this is likely to be a highly profitable business, priced on a single digit PER. Therefore it’s just a question of being patient, for what I believe is a probably 2-bagger or more from the current price.

Short term the price goes all over the place, probably due to newsflow about the pandemic, but it’s really just background noise. SAGA can tread water fine, since the insurance division generates enough cashflow to subsidise the travel division, for however long it takes.

Meanwhile with this latest bond/bank refinancing, management has greatly de-risked things, probably excessively in my view - this seems a belt and braces refinancing, which removes any doubt about solvency and dilution. Both look very solid & safe now. Yes the interest cost has gone up, but it’s now insulated from any interest rate rises for the next 5 years, locked into a fixed rate. That could look a smart move if inflation & interest rates do rise.

Lots to like here, looking post pandemic.

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Cake Box Holdings (LON:CBOX)

334p (up 3.4% at 12:53) - mkt cap £134m

Full Year Results

The principal activity of the Group continues to be the specialist retailer of fresh cream cakes…

This is done via franchisees, who operate & finance the shops. Hence the revenues for CBOX itself look small, as you often find with franchise businesses, because it’s just the franchise fees, not the revenue at the shops.

PR title -

Another period of strong growth in an unprecedented year

These results look excellent - so good in fact that you’d struggle to spot that there had been a pandemic, demonstrating what a resilient business model this seems.

Key numbers for FY 03/2021 -

Revenues £21.9m (up 17%)

Adj pre-tax profit £4.7m (up 25%) - note that a £486k charge is adjusted out, for the cyber-security breach the company suffered

Adj EPS 9.6p (up 23%) - giving a PER of 34.8 - a punchy rating, but arguably justified because this is now a proven, resilient, roll-out of a successful retail format.

Dividends resumed with 3.7p final declared

157 franchised stores operating as at 31 March 2021

9 new stores opened in Q1 FY 03/2022, with 18-24 total expected this year - expanding at quite a clip

Kiosks now up to 21 - after successful initial trial

Online sales made up 22% of total revenues at franchisees - not bad

Balance sheet - looks strong, no issues that I can see.

Cashflow statement - looks fine, I can’t see anything untoward

My opinion - every time I look at this share, I like it more. As mentioned before, I do wonder how much profit is generated from initial sale & setup of new stores, since a substantial fee is payable by the franchisees? I reckon that’s where a hefty chunk of the profits come from. Therefore, once expansion stops, then profits could fall. That doesn’t seem a problem for now though, with expansion continuing.

Overall, this looks a very nice business. I think the big rise in share price is justified, with the share price currently looking about right to me. How much further upside is there from this level though? Probably not much, at least in the shorter term.

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M&c Saatchi (LON:SAA)

159.5p (up 8%, at 13:40) - mkt cap £195m

Unaudited 2020 final results & trading update

The Company today announces its unaudited results for the year ended 31 December 2020. The Company demonstrated resilience and agility in a challenging environment during 2020 and announces that trading is ahead of expectations for the first five months of 2021.

The 2020 numbers are so late, and impacted by the pandemic, that I can’t see any point in poring over the detail. Key numbers for FY 12/2020 -

Revenue £225.4m (down 12%)

Headline (i.e. adjusted) profit before tax £8.3m (down 52%)

PR groups nearly always make a lot of adjustments to polish up the headline numbers, so it’s always worth checking the statutory (unadjusted) profit before tax, which was a loss of £(8.5)m in 2020, on top of a similar loss of £(8.6)m in (pre-pandemic) 2019. Not good.

Guidance - unusually it provides profit guidance for H1 2021 -

Trading ahead of expectations for first five months of 2021. Half year Headline profit before tax expected to be in excess of £10m.

Management expects full year results to be ahead of consensus

Dilution risk - I’ve flagged this before, as a potentially major issue. Some ridiculous options scheme went wrong, risking large dilution. The good news is that the company seems to have got on top of this problem, which is greatly reassuring, and it no longer looks a serious problem -

Potential to reduce dilution from future share issues from c.19% to c.5%.

My opinion - not really something that interests me personally, because the historic accounting problems (and late 2020 accounts) still irk me.

That said, the greatly reduced dilution risk does look a potential game-changer. Plus strong current trading. So this share could be worth readers taking a fresh look at, maybe, if you can tolerate sloppy accounting.

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Jack’s section

Pendragon (LON:PDG)

Share price: 18.43p (pre-open)

Shares in issue: 1,396,944,404

Market cap: £257.5m

This is a quick pre-close update from Pendragon, a car retailer that de-merged from Williams in 1989 and focuses on specialist and luxury franchises. The group has grown since through a number of acquisitions. Marshall Motor Holdings (LON:MMH) and Vertu Motors (LON:VTU) have also updated recently, both reporting strong trading conditions, so this seems to be a useful part of the market to keep tabs on.

There are probably other areas of the market worth paying attention to at this point in time - freight and logistics come to mind, but if the present global logistical logjam is just a temporary issue then perhaps the window there is limited? On the other hand, companies suffering from supply issues might be overly optimistic on the situation.

Let us know if there are any other particular market sectors to monitor over the next year or two, in your opinion. For now, back to car retailers - these stocks are closely tracking each other, suggesting an industry-wide improvement.

As with the others, Pendragon appears to offer good value with a forecast PE ratio of 9.3x, a forecast PEG of just 0.2, and a Value Rank of 72. It actually trades at a slight premium to its peers, however, while suffering the same unavoidable low-margin characteristics that ensure these stocks will likely never trade at particularly high multiples.

Pre-close update

Pendragon says it has outperformed in its new car markets in the second quarter and has ‘capitalised on favourable trading conditions’

Supply constraints in the used vehicle market and pent-up demand have increased vehicle pricing, driving higher margins. Marshall Motors recently made a similar comment.

Pendragon now expects to report underlying profit before tax of c.£30m for the first-half of FY21 (H1 FY20: underlying loss before tax of £31.0m).

Uncertainty remains heading into the second-half of FY21 with potential further disruption from Covid-19, an expected realignment of used vehicle margins and the risk of both new and used vehicle supply constraints. In fact the group comments:

Whilst the extent of the impact of the well-publicised semi-conductor chip shortage is not yet clear, it is becoming increasingly apparent there is likely to be some restriction of supply during the second-half of FY21, with vehicle order times already being extended.

Nevertheless Pendragon feels able to reinstate guidance. It expects group underlying profit before tax for FY21 to be in a range of approximately £45m to £50m (FY20: £8.2m).

Conclusion

So unless the group is building in some beatable assumptions, it foresees a less strong H2. Still, an underlying full year PBT of £45m would be good going for a £260m market cap. Applying a tax rate of 20% to that figure would give £36m of underlying net income or 2.58p per share. That would make for an FY21 PE ratio of just 7.14x.

Which would be comfortably ahead of consensus normalised FY21 EPS of 1.8p. Brokers have been nudging up their forecasts so perhaps more upgrades are to come.

The group does carry a fair chunk of debt. £181m of debt (ex-leases) at the last balance sheet date, set against £56m of cash. The business model is very capital intensive as well, so it lives on the edge and must be well run in order to survive, let alone flourish.

In fact, given the group is habitually cash flow negative, that is a concern. Particularly given that it paid dividends up until FY18. Yet there was no equity dilution or notable increases in net debt in this period.

Heading over to the cash flow statement, it appears that dividends were at least partially financed with the sale of businesses and assets. Divis have been halted, so perhaps this is an historical issue, but if Pendragon was to assume similar habits going forwards it would make me uneasy as an investor.

Still, no doubt the current trading environment is good for car retailers - probably better than what is presently priced in by the market - although we would also do well to be mindful of repeated warnings of H2 uncertainties and potential supply issues down the road.

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Wynnstay (LON:WYN)

Share price: 501.33p (+8.98%)

Shares in issue: 20,137,949

Market cap: £100.9m

Again we find ourselves in good value, low margin territory with Wynnstay.

I would argue, however, that this is a superior longer term investment due to its consistent cash generation, rich dividend history, an operating track record stretching back to 1918, and a more robust business model (albeit one prone to short term cyclical swings).

This is a major supplier of products and services to the UK agricultural industry and the rural economy. It aims to grow steadily both organically and via bolt on acquisitions in what it says are fragmented markets.

A critic might say that growth has been too pedestrian in the past:

But there are not enough truly conservative investments out there in my view, and Wynnstay with its heritage, dividends, and rock solid balance sheet appears to fit that mould.

Shares were cheap for much of 2020 but have since rerated. I myself held until that sudden rerate but then sold to free up funds for similar opportunities in what were exceptional market conditions.

I suspect though that this could be a situation where buying and holding for a long time works out quite well. The question now is whether Wynnstay is in good enough shape to seriously test its share price highs of 650p or thereabouts.

The margins will likely cap short term upside beyond a certain point but this is a positive update nevertheless and the shares are up 8% or so.

Interim results

Record pre-tax profit as sector confidence returns

• Revenue +9% to £249.71m, with c65% of the rise coming from commodity price inflation and a combined first-time contribution of £5.5m from two bolt-on acquisitions,
• Underlying PBT +23% to a record £5.53m; reported PBT +25% to £5.36m,
• Basic earnings per share +24% to 21.62p,
• Net cash (ex-leases) up from £1.28m to £4.01m,
• Net assets up from £4.87 per share to £5.04,
• Interim dividend +8.7% to 5p.

The group’s Agriculture division generated £180.72m of revenue (up 8.6%), with operating profit up 13% to £3.4m. Favourable weather conditions and farmgate prices drove a strong performance in Feed Activity, although Arable was weaker due to the prior year’s poor planting season. Wynnstay’s Glasson (a producer of blended fertiliser and supplier of feed materials and other products up in Lancaster) also performed well.

Specialist Agricultural Merchanting saw revenue grow from £62.83m to £68.88m, with operating profit before non-recurring items +13% to £3.4m. This is much the higher margin division and so good growth here has the potential to really drive the investment case for the company. Here, Wynnstay notes strong demand for bagged feed and a recovery in hardware sales ‘as farmers returned to investing in their businesses’, which is good to hear.

A commercial sales & marketing director has joined the group, ending a period of reorganization at the senior management level, and two strategic bolt-on acquisitions were completed on the eastern side of England.

Regarding the outlook, Wynnstay notes that ‘strong trading conditions support a good outturn in H2, with farmgate prices firm and 2021 harvest on track to revert to more normal yield and tonnage’ and is ‘very confident’ about longer term prospects.

Conclusion

Wynnstay continues to look like a sensible long term hold for the conservative investor. It has been around since 1918 and it has a reasonably low risk strategy of growing organically and via bolt-on acquisitions in a fragmented market that it has now specialised in for over a century. It has a broad spread of activities and a strong balance sheet.

While progress in the past has been slow and its business will always be subject to cyclical factors, the weather, and relatively low margins, the fact is it is currently generating record results so something is going well.

The group also references ‘clarity provided by the EU settlement’ - and Brexit concerns are something that have weighed on the shares over the past couple of years. Sentiment in the UK agricultural sector has greatly improved and trading conditions are very encouraging.

At some point, conditions will become less favourable but Wynnstay has the financial strength and sector expertise to ride out any such periods and has a good chance of growing profits and dividends attributable to shareholders over the long term.

The group continues to invest in its manufacturing capacity, it hopes to improve production efficiencies, and is already looking for further complementary acquisitions, so a good update.

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Carclo (LON:CAR)

Share price: 53.57p (-7.16%)

Shares in issue: 73,419,193

Market cap: £39.3m

This is a turnaround situation that has been on a stellar run of late, outperforming the wider market by some 540% over the past year.

It’s a global supplier of fine tolerance, injection moulded plastic components, mainly for medical products. About a year ago the group offloaded a troublesome loss-making business called Wipac. Another driver of value has been net debt reduction which stands it in better stead to handle its pension deficit payments.

The subsequent rerating has been exceptional, with the company graduating from ‘nearly bust’ to ‘in recovery’ but you can see it has also resulted in a degree of profit taking so far this year.

If you’d followed the director buys at the time, you’d have done very well out of it. Buying into the dramatic improvement in StockRank would also have worked out well (all easy to say in hindsight, of course!).

Preliminary results

Highlights:

• Revenue from continuing operations -2.7% to £107.6m,
• Underlying operating profit -33.8% to £4.8m; statutory operating profit up from £1.8m to £9.3m, with £4.5m of exceptionals,
• Underlying earnings per share -51% to 2.4p,
• Net debt excluding leases is down from £22.1m to £20.5m,
• Pension deficit marginally reduced from £37.6m to £37.3m.

Both the Technical Plastics and Aerospace divisions saw a reduction in both revenue and profits. Technical Plastics revenue -0.6% to £102.5m with underlying operating profit -0.4% to £9.2m (margin of c9%).

Aerospace was more heavily affected, unsurprisingly, with revenue -31.7% to £5.1m and underlying operating profit -66.7% to £0.55m.

Turnaround - new board recruited, simplified group following LED Technologies business disposal, and 3Y agreement on financing and pension contributions ‘provides a stable platform for the business to move forward’.

On 14th August 2020 Carclo concluded a restructuring with its main creditors to secure support through to July 2023.

Debt facilities comprise a term loan of £34.5m, of which £3.0m will be amortised by 30 September 2022, plus a £3.5m revolving credit facility maturing on 31 July 2023. Repayments amounting to £1.6m have been made in the period to 31 March 2021 (not part of the £3m due to be amortised). As repayments are made, the term loan facility reduces first, meaning that, at 31 March 2021, the term loan facility available is £32.1m.

A schedule of contributions has been agreed with the pension trustees through to July 2023. Beyond 2023 a schedule of contributions for £3.5m annually is in place until 31 October 2040, but is reviewed and reconsidered at each triennial actuarial valuation, the next being after the results of the 31 March 2021 triennial valuation are known. That is worth keeping an eye on. The defined benefit section is closed to new entrants.

Carclo aims to eliminate the deficit over a 20 year period, including £2.8m in FY21, £3.9m in FY22, and £3.8m in FY23. Beyond 2023 a schedule of contributions for £3.5m annually is in place until 31 October 2040. That’s quite a large proportion of operating profits at these levels so this is still a risky investment, in my view.

The 2018 actuarial valuation showed a deficit of £90.4m. The accounting valuation has generally been more generous, with the most recent accounting valuation a deficit of £37.3m.

Growth - Carclo is continuing to invest in the Technical Plastics business.

Despite the challenges presented by the COVID-19 pandemic, Group performance has enabled significant capital investment to be made whilst retaining a stable financial position, with net debt excluding lease liabilities as of 31 March 2021 falling to £20.5 million (2020: £22.1 million).

Commenting on the results, Nick Sanders, Executive Chairman said:

Despite a challenging period for the Group, the continuing businesses performed strongly in 2020/21 and ended the year on an improving trend… the Board believes that the operating businesses within the Group have attractive long-term growth opportunities, particularly within the medical diagnostics market where the CTP business is well positioned.

Conclusion

Despite the good progress and refinancing, financial health remains a concern.

There’s no doubt that holders have done extremely well here, though. The financial situation reminds me of Premier Foods (LON:PFD) a couple of years ago, which is now further along in its recovery. De-risking the pension scheme and reducing net debt does translate quite directly into increasing equity value (assuming no deeply discounted placings to dilute the upside).

It’s a very risky situation though, and the worst-case scenario is generally a permanent loss of capital, so that must be factored into the investment decision.

And operational turnarounds, even without serious financial considerations, are a source or risk themselves as they can be difficult to execute. To highlight this point, Carclo says:

The residual impact of the divestment of the Wipac division and related restructuring, refinancing and rationalisation of activities continued to be felt in the first half of the year, consuming significant Board and management time as well as incurring a high level of advisor costs.

It does add though:

This is now behind us, with the second half of the year benefiting from the Group's new streamlined and simplified structure and a clear focus on operational and strategic improvement.

With improving operational momentum and emerging from what has been a rough year for many, there is still potential here - particularly if Carclo can keep a lid on equity dilution. The initial market reaction this morning may have been a tad harsh.

This is a delicate situation with upside potential and no small amount of risk. There is the net debt and the pension scheme, plus the execution risk of the turnaround itself. It’s not a ‘sleep soundly at night’ investment. That can be fine, as long as you understand what you are getting into and can afford the risk.

There’s an investormeetcompany presentation on 2nd July, which could be worth signing up for in order to hear more from the management team.