Small Cap Value Report (Wed 4 May 2022) - WYN, JOUL, MPAC

Good morning, it's Paul & Jack with you today.

Agenda - 

Paul's section:

Joules (LON:JOUL) (I hold) - yet another profit warning, from this very disappointing share. The CEO is leaving, probably a good thing - I think it needs a more hard-nosed rag trader to sort out the basics here, and strip out bloated overheads. Net debt is under control. I'm obviously frustrated with poor performance at Joules, from self-inflicted wounds. But with a tiny market cap, this could multibag on a recovery, or bidding interest. 

Jack's section:

Wynnstay (LON:WYN) - I hold - ongoing conflict in Ukraine and the disruption of supplies from Russia means Glasson Grains continues to experience substantial one-off gains. As a result, FY22 profit should be ahead of expectations. These conditions won’t persist forever though, and the stock is close to all time highs, so valuation is a consideration.

Mpac (LON:MPAC) - increasing operational challenges due to macro conditions, but trading is in line and the prospects pipeline is ‘significantly above the previous year’. Longer term prospects remain positive. The shares spiked down recently before recovering, so perhaps one to watch in case something similar happens again.

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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).

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Paul’s Section:

Joules (LON:JOUL) (I hold)

36p (down 33% at 08:20)

Market cap £41m

Board, Strategic & Trading Update (profit warning)

This must be the third profit warning in the last 6 months, so unsurprisingly the CEO Nick Jones has fallen on his sword, in what sounds an amicable way - staying on for an orderly handover, and receiving unusually warm comments in today’s update, for an outgoing CEO. I think it’s a good idea to have a change of leadership, because too many basic things have gone wrong in the last 6 months.

Profit warning - after 2 downgrades previously, which have led to a collapse in the share price, we’ve got another one today. I don’t know how much more the share price is likely to drop, because a bit like Superdry (LON:SDRY) (I also hold) the bad news is already factored in so much, that I can’t see why anyone holding would want to sell now. Both are excellent brands, and both could attract bidding interest (like Ted Baker (LON:TED) ), with both trading around breakeven it seems. As long as they don’t need to raise fresh cash, then long-term investors should be fine. My main worry is an emergency fundraise, but that doesn’t seem necessary as liquidity looks OK at both.

What’s gone wrong this time?

Discounting - I’ve noticed that my almost daily emails from JOUL seem to have permanent discount offers, typically 30% off. In my opinion, this moves the (very nice) product from way too expensive, to reasonably priced. So I’ve bought loads of stuff from JOUL website in the last 6 months, and am very happy with all of it - the product really is lovely, and I also like the brand image. Hence I see this as a brand with considerable appeal, but the business really needs a good sort out, by a more commercial new CEO. Give it 2 years, and I think this share could be a multibagger. The downside, is that if things don’t improve, then it might be forced to dilute shareholders with an equity raise. No sign of that today though, but we can’t ignore the risk.

Why are they discounting so much?

• A mixture of over-stocking, which was mentioned last time, so clearing excess stock.
• Also customers are becoming more price-conscious due to the cost of living squeeze, so they say, but in my view the main reason is -
• The product isn’t good enough to justify the excessive full prices. I think a complete re-think is needed, with prices permanently lowered, generating higher volumes at lower margins, and keener prices extracted from suppliers.
• Too much old stock, so customers are seeing "a lack of newness"

Clearly a lot needs to be done to streamline the business. I also feel the central overhead is insanely high. If you google Joules’ Head Office, it’s enormous, was a new build in recent years, and looks a vanity project to me. That's not even a warehouse, which is outsourced to Clipper.

Recently I compared the staffing levels at Joules HQ with Superdry (from the notes in their Annual Reports). They were similar, despite Superdry generating more than double the revenues of Joules - confirming my view that Joules needs a root & branch restructuring, to slash its excessive central overhead. That’s a big profit opportunity. The army of designers, etc, just aren’t earning their keep at the moment.

On the plus side, Joules owns the freehold, in the books at cost of £21.7m, and mentioned on page 30 of the last Annual Report that a sale & leaseback is one option for alternative funding, if the bank gets difficult -

Alternative sources of financing, including sale & leaseback of freehold property and asset financing that might reasonably be assumed to be available to the Group – noting that any financing from these sources has not been included within the forecasts that support the going concern assessment

Net debt - probably more important than profit at the moment, is cash/debt headroom, which looks OK -

The Group continues to focus on accelerating its plans to improve profitability and cash generation through cost restraint and clearance of aged stock. As at 1st May 2022, net debt was approximately £22m with liquidity headroom of £11m, in line with expectations.

As you can see, that net debt of £22m could potentially be eliminated with a sale & leaseback at book value for the HQ. So it doesn’t look anywhere near a crisis to me, although it depends on how trading goes in future. Banks don’t like funding losses, so a fundraise of say 10-20% dilution, combined with a sale & leaseback of the HQ looks possible to me, which would be unwelcome but not a disaster.

Revised forecasts - many thanks to Liberum’s analyst Wayne Brown for providing an update on numbers this morning.

He’s reduced forecast for FY 5/2022 from £5.0m profit, to £(1.5)m loss. Clearly a rubbish performance in H2. It made a £2.6m profit in H1.

He’s moved FY 5/2023 down to just above breakeven, which looks sensible - we need to see evidence of a turnaround being undertaken, before hopefully starting the positive cycle of upgrades. Or things could get worse, who knows?

Strategic Update - I won’t repeat this section, there’s nothing earth-shattering in it, just common sense basics to improve the business, such as shortening lead times, turning away uneconomically small wholesale orders, cost savings, etc. Basic things, which makes me wonder why they haven’t already been done?

My opinion - another profit warning doesn’t surprise me, given that we knew it was over-stocked, and has been in permanent sale for months now - hence lower margins.

The market cap is now so low, that the upside from a turnaround is very appealing, in my opinion. It’s likely to attract bidding interest too, at this level, in my opinion. So this is best seen as a special situation, not a regular investment.

There’s no getting away from the reality that management has made a right hash of things. The 3 profit warnings are not really due to macro factors, they’re mainly down to self-inflicted wounds from not properly managing supply chain, product, and logistics - all clearly weak points at Joules.

I very much question the performance of the army of people at JOUL HQ, and think deep cuts should be a priority for the new CEO, to restore profitability. This is meant to be a premium brand, so the product has to be spot-on to command high prices, which is just not happening.

We all know that inflation is a problem, supply chains remain problematic, and that some consumers are feeling the squeeze. So people want value for money. 

The question is, with JOUL now down about 90% from its all-time high, has valuation overshot on the downside? It depends if the new CEO can deliver a convincing turnaround or not. Consumer stocks are being savagely priced down, but the way I look at it, is I’m not buying just this year’s earnings, I’m buying all future earnings, and consumers always recover from downturns. Whether the market is ready to look beyond the current squeeze on incomes seems currently doubtful, but it’s going to happen at some stage.

I’m staggered that JOUL is now only 38p per share, but being brutal, poor performance probably justifies a harsh market reaction in the short term. Very disappointing. Setting aside the emotional reaction, I do think this could now be a value opportunity at just £41m market cap. Time will tell.

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Jack's section

Wynnstay (LON:WYN)

Share price: 620p (+2.31%)

Shares in issue: 20,311,177

Market cap: £125.9m

(I hold)

Trading update for the four months to end of February 2022

Wynnstay is a UK-based manufacturer and supplier of agricultural products reporting across two segments: Agriculture and Specialist Agricultural Merchanting. It provides feed for farmers at its depots, as well as other related products across its shops.

This is a slightly neglected company, probably dismissed as too boring, low margin, or tied to external factors such as the weather.

Look a little more closely though and I think you find a steadily growing, cash generative enterprise with solid expansion prospects and a relatively resilient (‘balanced’ as the management says) business model. Its track record of dividend payments is excellent, which goes some way to showing its priorities for shareholders and confidence in the future.

Events in Ukraine have been impacting Wynnstay’s business (positively), with fertiliser operations at Glasson continuing to experience substantial one-off gains.

This was as a result of sharply rising fertiliser commodities prices, caused by significant increases in the world price of natural gas, which is used to produce ammonium nitrate fertiliser. Since then, fertiliser commodities prices have remained abnormally high, reflecting the consequences of military conflict in Ukraine, including the disruption of supplies from Russia.

Glasson is a trusted supplier to the agricultural supply trade based at Glasson Dock on the Lancashire coast. Its activities include feed ingredient supply, fertiliser manufacture, grain trading, provender supplies, agronomy and shipping services.

Trading across the group’s core activities is in line with management expectations.

The Board therefore now expects the Group's pre-tax profits for the year to October 2022 to exceed current market expectations. Group revenue will also be significantly increased by commodity price inflation across all activities, including feed, however it should also be noted that the Group's absolute unit margin model means that Group operating profit will not benefit proportionately.

The last bit is understandable - Wynnstay’s absolute unit margin model also provides it with a degree of stability in less positive environments so it’s an acceptable tradeoff as it results in a more secure long term enterprise.

Diary date - Interim results will be reported at the end of June or in early July.

Conclusion

Weather, commodity prices, and farmer confidence all vary over time. At the moment things are good but there are cyclical elements here and the conditions will change at some point as they always do. Obviously, Wynnstay is benefitting right now but that can’t be expected to last indefinitely (indeed, let’s hope some of the current dynamics end sooner rather than later).

The shares certainly aren’t expensive versus the wider market, but they do trade at the top of their range and so the stock is not as obviously cheap as it has been in the past.

It’s a tricky one. If I wasn’t already holding for the longer term, I would be hesitant about buying a stock benefitting from one-off gains which trades at close to all-time highs, given the current wider market mood. A reversion in short term trading outlook and a derating in share price is certainly within the realms of possibility over the next year or two. That could present a compelling opportunity.

Longer term, Wynnstay has a sensible growth strategy, supported by low-risk bolt-on acquisitions, and is investing in its existing operations. That leaves it well placed in its industries to take share and expand beyond shorter term cyclical fluctuations.

It might not shoot the lights out, but this is a proven operator that has been around for more than a century, paying dividends to shareholders, with a clear vision of where it is going. The business is well balanced across arable, feed, and retail and its absolute unit margin model should be a plus in a volatile and inflationary environment.

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Mpac (LON:MPAC)

Share price: 480p (+0.52%)

Shares in issue: 19,929,396

Market cap: £95.7m

This is a packager focusing on high-speed and automated solutions for customers.

A very short AGM update now that I look at it, so I’ll just paste the important section and move on.

The Company is pleased to report that trading in the current financial year has been in line with the Board's expectations. In addition, the prospects pipeline remains strong, and the current orderbook is significantly above the previous year, providing extensive coverage over forecast revenue. Supply chain uncertainties and operational challenges have increased, amplified by transportation delays at global ports and increased macro-economic uncertainty following the Russian invasion of the Ukraine. However, mitigation measures have been implemented and the Group's prospects remain positive due to the strength of the orderbook, the prospect pipeline and the end markets we serve.

Conclusion

Mpac continues to impress, in my view, although I have yet to take a closer look at the company. Its Switchback acquisition a couple of years ago in the US looks to be a canny bit of business, and the group’s wider ‘One Mpac’ strategy is creating a more integrated and efficient enterprise.

There’s also an intriguing clean energy battery manufacturing angle here (FREYR), although this remains in its early days and is not mentioned in the update.

The share price is treading water after a strong rerating a couple of years ago.

Who knows with these markets, we may be presented with an attractive entry at some point if the shares spike down to the £4 level again. For that reason it’s on my watchlist awaiting further research.

It’s worth noting that there has been no equity dilution, and the valuation looks undemanding on the face of it.

Operating cash flow took a hit in FY21 due to a swing in working capital - presumably to manage inbound supply chain pressures.

The clear risk for now is the ‘increasing’ operational challenges in the short term, possibly alongside expectations management as it transitions from turnaround to growth. And Mpac does have some interesting growth opportunities, so I think it’s worth monitoring in the event of further share price volatility. That’s just my take, so DYOR and do share any views/insights in the comments.