Small Cap Value Report (Wed 6 April 2022) - SOS, AVON, MOTR, EPWN

Good morning! It's Paul & Jack here for Wednesday's SCVR.

StockSlam - I was really sorry to hear that tonight's StockSlam (register here) is to be the last for a while, due to lack of interest from private investors. What a great contrarian signal though! People were queuing up to enthusiastically talk about their favourite shares last year when they were over-priced, but now many shares have dropped in price by half, or more, people are in hiding! In my experience, when investor sentiment is this negative, it lays the groundwork for excellent future gains. Remember BLASH (buy low, and sell high) - easier said than done of course.

Director buying - something I've noticed of late, is that lots of smaller caps are putting in strong rebounds, often after some Director buying. There have been lots of examples recently. Just yesterday, Victorian Plumbing (LON:VIC) (which is on my watch list) shot up about 17%, after a Director bought a decent amount of shares. It was immaterial to his total holding, but  seemed to trigger a stampede of buying from other investors. I reckon this is a nice theme right now, and worth taking note of. Buying on the opening bell, after a big Director buy, could be lucrative, either as a trigger for a possible turning point, or just for a short term trade, whatever floats your boat & makes money! So it's worth scrutinising the RNS for Director buys right now, as they seem particularly price-sensitive, more so than usual I think.

Agenda - 

Paul's Section:

Sosandar (LON:SOS) - a cracking trading update, ahead of expectations, moving into EBITDA profits in H2. Plenty of cash, so another fundraise looks unlikely. I think this is looking very good as a long-term hold.

Motorpoint (LON:MOTR) (I hold) - an in line update for FY 3/2022. This car dealer is differentiated, in operating online, and from physical car supermarket sites, selling nearly new cars only. Fwd PER pf 12 looks cheap, considering its ambitious expansion strategy.

Jack's section:

Avon Protection (LON:AVON) - another hit to investor confidence with a profit warning today as a result of weaker sales mix and increased manufacturing costs. The Ukraine conflict is leading to more customer enquiries, which could boost FY23, but FY22 will likely come in below expectations. I view the shares as uninvestable right now. Where’s the director buying? Management was happy to commit company funds to a buyback ahead of today’s update.

Epwin (LON:EPWN) - record revenue and adjusted EPS slightly ahead of Stocko’s consensus normalised expectations. Epwin qualifies for the Free Cash Flow Cows screen and the valuation is undemanding. It appears to be winning market share and investing in growth opportunities and, while inflation is a concern, the outlook seems fairly positive.

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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:

Sosandar (LON:SOS) (I’m not currently holding)

24p (yesterday’s close)

Market cap £53m

Trading Update (and new third party arrangements)

For full disclosure, I don’t currently hold SOS. It was held in a spread bet account, but unfortunately the account plummeted in the big market sell-off triggered by the invasion of Ukraine, which meant I had no option but to close lots of positions. Disappointing, but there we go, it’s my own fault.

This update looks good today -

Sosandar, the online women's fashion brand, is delighted to provide the following trading update for its financial year ended 31 March 2022. FY22 ahead of market expectations. Revenue +138% yoy and every month EBITDA positive in H2…

… it now anticipates reporting revenue and EBITDA for the full year ended 31 March 2022 ("FY22") ahead of recently upgraded market expectations*.

*Prior to the release of this announcement Sosandar believes that current market expectations:  
(i) for the year ended 31 March 2022 are revenue of £27.1 million and an EBITDA loss of £0.9 million
(ii) for the year ending 31 March 2023 are revenue of £38.5 million and EBITDA of £1.7 million
(iii) for the year ending 31 March 2024 are revenue of £52.5 million EBITDA of £2.6 million.

That’s seriously strong revenue growth, well into triple digits, you don’t see that very often. All organic too.

EBITDA is very similar to profits at this company, so I don’t understand why they always report EBITDA, which a lot of private investors (rightly) are suspicious of.

EBITDA in H1 was £(1.0)m negative, so moving into positive EBITDA in H2 is encouraging.

Actual revenue for FY 3/2022 is £29.0m, well ahead of £27.1m forecast noted above in a helpful footnote (above).

The FY 3/2022 EBITDA loss is c.£(0.6)m (down c.80% on LY). That implies a £0.4m positive EBITDA in H2. It’s great to see the company break through into profitability - many investors didn’t think it would happen, but it has.

Also noteworthy, is that many online fashion retailers saw terrific growth in the pandemic, which then stalled. Sosandar has continued very strong growth, so there’s something very good happening here - the brand is clearly gaining strong traction with customers, and taking market share.

Net cash of £7.0m at 31 March 2022 looks healthy. The last fundraise was in May 2021, and it’s increasingly looking as if no further fundraising will be required.

Supply chain - as mentioned by the company before, it seems to have managed this well, and margin gains (from placing larger orders with suppliers) have offset other cost increases. The gross margin of 56% is strong, and much improved.

Third party sales - the key partners for Sosandar seem to be M&S, Next, and John Lewis, as we already knew. The relationship with Next is obviously going well, as it’s being extended to include “Platform Plus” -

'Platform Plus' allows Next customers to order items picked from Sosandar's own warehouse, which are then delivered via Next's distribution network. This agreement builds on the success of Sosandar's existing relationship with Next, which has gone from strength to strength since it was established 18 months ago. Sosandar will launch its new activity with Next Platform Plus during Q1 FY23, allowing for an extended Sosandar product range made available to Next customers and accelerating Sosandar's sales.

Popular website “Very” has approached Sosandar to buy SOS products, commenced in Mar 2022 - good news that should help drive growth - which is doing well -

… with strong sales and quick repeat orders being placed.

My opinion - another superb update from Sosandar. This share now looks largely de-risked, in terms of solvency. 

How do you value it? PER isn’t appropriate, given the extremely rapid growth (which is bound to moderate in % terms). Given the stellar growth, and move into (modest) profits, I think a £53m market cap looks undemanding. Sosandar looks set to grow into a much bigger business, and is now a really credible, differentiated brand. This could be a multibagger long term from here, in my opinion, providing nothing goes wrong. In a bull market, I could see this being a £100m+ share.

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Motorpoint (LON:MOTR) (I hold)

265p (down 2% at 09:19)

Market cap £239m

Year End Trading & Strategy Update

Motorpoint Group PLC, the UK's leading independent omnichannel vehicle retailer, provides the following update on its performance for the full year ended 31 March 2022 ("FY22").

Revenue growth of +82% vs LY (last year) is strikingly good.

Grown market share of nearly new cars market to 3.0% vs 2.6% LY - impressive considering all the me-too internet-only competitors (e.g. Cazoo, Cinch, and others)

Higher spending on growth initiatives, but despite that -

… the Group anticipates reporting Operating Profit and Profit Before Tax for the year in line with the Board's expectations.

Strategy update - is reiterated, “making good progress”.

The plan is to accelerate growth, and reach >£2bn sales “in the medium term”, through increasing online sales to half the total, and opening 12 new branches (car supermarkets)

Outlook - sounds cautious, but we’re hearing similar caution from other car dealers too -

The impact of rising inflation and worldwide vehicle supply challenges is likely to affect our markets and our company performance, but its extent is difficult to predict in the short term. However, we expect rising inflation will place further pressure on discretionary spending power and consumer sentiment. In this uncertain environment Motorpoint will continue to invest in revenue and market share growth, in strategic future capabilities and in providing an exceptional omnichannel customer experience.

"Despite the uncertain consumer outlook, the Group's continuing confidence allows it to invest in its future growth strategies across multiple initiatives. The expansion of our technology team dramatically increases our capability to innovate and scale our Motorpoint.co.uk and Auction4Cars.com platforms which both have huge future growth potential.

My opinion - I think MOTR has an excellent business model, combining a successful online business, with a physical car supermarket business. Most people want to see & test a car before buying. So online-only business models strike me as fundamentally flawed. MOTR seems much better, combining online with large physical sites in cheap, out of town locations.

I wonder which online-only competitor could go bust first, once they’ve burned through all the private equity or VC cash provided for saturation marketing (which generates a tiny conversion rate apparently)?

Stockopedia shows the forward PER as only 12.0, which strikes me as good value for a company which is growing fast. Recent data from the trade body SMMT, shows there are still serious supply constraints for new cars, thus secondhand values (and high margins) could continue for some time.

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Jack's section

Avon Protection (LON:AVON)

Share price: 1,056p (-20.12%)

Shares in issue: 30,449,775

Market cap: £321.5m

Half year trading update for the six months to 31 March 2022

Stockopedia has Avon aptly classified as a Falling Star. This formerly well-regarded stock shocked the market with news of its poorly performing recently acquired armor business line which, in my view, calls into question the company’s due diligence procedures, capital allocation policies, and transparency with the market.

The collapse in share price suggests to me that a sense of loss of trust is shared by others. The company has since been buying back stock, but in light of today’s update, that only casts further doubt on the group’s capital allocation abilities, and I note that directors haven’t been so generous or confident with their own money.

Trading in the first half reflects a continuation of some of the challenges seen in FY21, but with performance accelerating through the second quarter.

In light of recent developments, I’m taking talk of an improving Q2 with more than a pinch of salt.

Revenue for the Period was in line with expectations and ahead overall by c. 4%, with organic year-on-year performance broadly flat… Profitability has however been impacted, in broadly even proportions, by a weaker than expected sales mix in the first half and additional manufacturing costs, notably in the helmets business, due to supply chain and process inefficiencies. As a result, the adjusted EBITDA margin for the period is expected to be approximately 10%.

Another profit warning, then.

Progress has been made on the implementation of a $15m overhead cost saving programme (half of which relates to the armor business and half to the rest of the group). Regarding the armor business:

In the period, as expected, armor revenues were in the low single digit $m pending final sign-off of first article testing of the DLA ESAPI body armor product. Combined with overheads, this business therefore operated at an EBITDA loss in the first half. We have continued with our steps for an orderly exit of this business once existing contracts are satisfied.

Avon was awarded the US DLA contract for the second-generation Advanced Combat Helmet in February and delivered the next-generation Integrated Head Protection System for first article test, scheduled for Q3. So the business hasn’t totally stopped in its tracks, some parts are still performing and armor is a small part of group revenue.

Outlook

Ukraine is resulting in an uptick in customer enquiry activity, although the benefits of this won’t be seen until FY23:

While these discussions remain ongoing and the quantum and timing of resultant orders are still to be determined, the impact of this growth in demand is most likely to be seen in FY23 and beyond, and as such the Board continues to have a range of expected full year revenue outcomes for FY22 consistent with market expectations.

No mention of what those expectations are. Edison has FY22 revenue of $278.4m penciled in but I’m unsure of others, so it depends on the range of outcomes across analysts.

Profitability in H2 is expected to improve versus H1 but will not offset the weakness experienced in the period. Full year underlying earnings will therefore be lower than previously expected.

Conclusion

I could well believe there is renewed interest in Avon’s products in light of the Ukraine conflict.

But events at the armor business cast a long shadow, and the fact that the group is coming out today with a profit warning, having been busy buying back shares, does not particularly allay my concerns over capital allocation.

This unfortunate episode must be put into context, I suppose. Future growth rates are diminished with armor facing a managed closure over the next two years, which obviously impacts valuation, but there is still a healthy, functioning business responsible for the lion’s share of group revenue that is winning contracts from customers.

There’s a major rebuilding job to do though in terms of regaining investor trust though.

Edison has EPS forecasts of 85.1 cents in FY22 rising to 116.3 cents in FY23, valuing the shares on a prospective PER of 20.2x falling to 14.8x. Does Avon warrant such a punchy growth projection given the armor business and today’s profit warning? I’m skeptical for now but management does note increasing interest in its products.

Surely now is a good time to see heavy director buying if management is correct in its assessment.

Ultimately, I view the shares as uninvestable for now. I was wary before today’s update, and that stance has (at least for now) been vindicated, so I’m not compelled to jump in. The issues, in my view, stretch beyond valuation.

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Epwin (LON:EPWN)

Share price: 88.8p (+1.49%)

Shares in issue: 144,917,993

Market cap: £128.7m

Final results for the year to 31 December 2021

This is a leading manufacturer of low maintenance building products, supplying the Repair, Maintenance and Improvement ("RMI"), new build and social housing sectors.

I’m using 2019 as the comparative period in the figures below.

• Revenue +16.8% to £329.6m,
• Underlying operating profit -12.7% to £18.5m (underlying OP margin down from 7.5% to 5.6%),
• Statutory operating profit up from £6.3m to £17.7m,
• Basic earnings per share +15% to 8.61p,
• Total dividend up from 1.75p to 4.1p,
• Pre-tax operating cash flow has recovered to £34.9m, with 189% underlying operating cash conversion,
• Covenant net debt to adjusted EBITDA down from 0.6x to 0.4x.

The tax charge seems unusually low for now. Taking the adjusted profit figure and using a 19% tax rate (noted as the standard in the group’s accounts), gives an adjusted normalised EPS of 7.66p, ahead of the Stocko consensus normalised FY21 EPS figure of 7.41p.

Net debt has reduced significantly year-on-year, from £18.5m to £9.4m, and revenue is at record levels. The group is implementing price increases and surcharges to negate the ‘significant inflationary and availability pressure on material and labour costs’, but these measures lag cost inflation.

That aside, Epwin is progressing with business. Construction has been completed on a new Telford distribution and finishing facility, with inventory to be relocated to this facility this year. The group has also acquired three well-established regional independent distributors of plastic building products, has invested in new product development (with aluminium window systems and PVC decking sales growing ahead of expectations), and ‘continued market share gains’.

Current trading and outlook

Strong RMI demand expected to continue in 2022, albeit at slower growth rate than last year

Epwin will continue to focus on actively managing supply chain and inflationary pressures. There’s a pipeline of further M&A opportunities and ‘positive medium and long-term RMI market drivers’.

Current trading is in line with the board's expectations, with 2022 revenue to date ahead of 2021.

Conclusion

The valuation here looks attractive - Epwin qualifies for the Free Cash Flow Cows screen and appears cheap across a range of multiples, making for a Value Rank of 84. Not bad, when coupled with a Quality Rank of 92.

FY21 was a difficult year for many businesses but Epwin looks to have performed well. Inflation is having an impact on profit margins - the group is passing on costs, but is lagging, so margins are affected. Top line growth in FY22 might be harder to come by as people return to spending money on holidays, although cost headwinds could subside at some point as well, which would be a tailwind for profitability.

It’s the leading player in its market with market share of around 20%, and the valuation has come down. There’s a strong forecast dividend yield too, of 4.95%, and cash generation could see the group return to net cash over the next few years.

I’m not up to speed with Epwin, but research from Edison suggests that it ‘has quietly gone about enhancing its manufacturing/logistics platform and increased its distribution presence over recent years’, with much of this progress obscured by external events such as Brexit and Covid-19.

The share price performance doesn’t reflect such progress, so it could be worth putting on the watchlist.