Small Cap Value Report (Weds 1 July 2020) - TPT, HMSO, LTHM, KIE

Good morning, it's Paul here, with the SCVR for Weds. Please feel free to leave your comments from the 7am start of the RNS, whilst I write up the main report throughout the morning and early afternoon.

See the header above for the company announcements I'll be writing about. I generally only respond to reader requests if you put up some compelling reason why the announcement is worth me looking at. I can't cover everything single-handedly.

To get you started today, here's the link to yesterday's SCVR, which significantly exceeded market expectations with 10 companies covered in total! I added 5 more after lunch, covering: STAF, WGB, TRAK, SYS1, and TST, in addition to the other 5 companies I wrote about in the morning (VNET, D4T4, SOLI, DRV, COG).

Estimated timing - a medium workload today from the RNS, so I should be finished by 1pm or a little later.
Update at 13:21 - today's report is now finished.

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Lookers (LON:LOOK) - shares suspended due to failure to publish 2019 accounts by 30 June. I might be mis-remembering, but I thought the company had secured an extension to the publication deadline? Maybe not.

Malvern International (LON:MLVN) - shares resume trading today, after a near-death experience. Small fundraising recently secured. New CEO brought in. Everything will hinge on how it can re-start operations. Very high risk, I'm not going to revisit this one, having got it wrong previously.

Walker Greenbank (LON:WGB) - a quick update. A NED has bought £19.4k-worth of shares. The CEO's husband has also just bought £20k of shares. That's helpful.

Also, Gromley and I were swapping our fag packet forecasts yesterday, in the comments section. I've now got an up-to-date broker note, which suggests a loss of £(5.5m) for FY 01/2021. This is based on a revenue assumption of -30% for the full year, which seems overly cautious to me, given that it was -35% in the first 5 months during covid. Although thinking about that, covid would have probably only affected about 3 out of those 5 months, so sales were probably down a lot more than -35% in April & May. Anyway, we have a range of forecasts, with a broker at £(5.5m) loss, Gromley at breakeven, and me at a £(3-4m) loss.

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Topps Tiles (LON:TPT)

Share price: 47p (up c.4%, but wide spread at time of writing, 09:32)
No. shares: 195.0m
Market cap: £91.7m

(I'm long at the time of writing)

Q3 Trading Update

Topps Tiles Plc (the "Group"), the UK's leading tile specialist, announces a trading update for the 13 week period ended 27 June 2020.

It's a Q3 update today because the company's year end is FY 09/2020.

This update looks surprisingly good to me;

Retail trading over the third quarter improved significantly as stores re-opened, with average sales per week growing from £0.8 million during April (when all stores were closed) to £3.9 million in the final week of June when all stores were trading, which was 5.4% below the same week in the prior year on a like for like basis. The Board is pleased by this performance, which was ahead of its revised expectations following the outbreak of Covid-19.

April sales must be online only, as the stores were shut. I've bolded the most important bit above, which is that last week, with stores open again, LFL sales were only down 5.4% on last year's equivalent week. That's very good indeed, in my view, given that plenty of people are still not going shopping.

• TPT stores are well suited to social distancing, with low footfall & spacious stores
• Better than expected customer demand
• Online sales going well, after recent investment
• Commercial - down 16% on prior year's Q3, but trend improving as builders return to work

Property - £18.1m raised from sale & leaseback. This is a great example of why I love freehold property on company balance sheets - because it's a hidden asset that can make all the difference in times of difficulty, which can be sold, or used as security for bank borrowings. Ted Baker (LON:TED) is another example of this, which recently completed a large sale & leaseback on its HQ, and might not have survived if it hadn't had that freehold asset.

Liquidity - looks ample, with £52.9m cash headroom, including a £10m CLBILS facility available. Net cash of £3.9m looks fine, and reflects benefit of sale & leaseback.

My opinion - this looks very good to me, and I think the share is offering good value still, at c.46p. I hold a long position, so may be subconsciously biased, although I try my best to be honest & objective about everything.

Risk:reward has improved significantly today. I'm encouraged by the strong sales recovery (only a bit below last year now), and the liquidity position is fine, so no risk of insolvency. Obviously results for FY 09/2020 are likely to look poor, due to the covid impact. But given the rapid recovery already seen, then I'm feeling more optimistic about the rest of this year. There's lots of anecdotal evidence that furloughed people have used the time to spruce up their homes.

Looking at the chart, I think we could see a return to say 60-70p given time, so there's useful upside here if I'm right. Thinking about that some more, as trading is returning to normal, and there's no need to dilute through a fundraising, then arguably this share should be gradually heading back towards its pre-covid valuation of c.80p.

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Hammerson (LON:HMSO)

Share price: 83p (up 4% today, at 08:32)
No. shares: 766.3m
Market cap: £636.0m

(for the avoidance of doubt, I no longer hold any position in this share)

Debt, liquidity, and rent collection update

Background from me - HMSO owns some mid-market shopping centres, in the UK and Europe. Following the demise of INTU, under an insurmountable debt burden, other retail property companies are very much under the spotlight now. Widely reported problems are that under lockdown, tenants cannot (or will not, in some cases) pay the rent. Also some tenants are going bust, leaving behind empty units. This is causing a financial squeeze, where property companies have to deal with falling capital values of their properties, and potentially onerous debt (e.g. possible breach of banking covenants).

My summary of today's update;

• Negotiated amended covenants with bondholders, until Dec 2021 (see RNS for more details). Bondholders would also get 30% (through an offer of prepayment at par) of the proceeds from disposals, in particular circumstances. Other conditions apply. This shows how the bondholders are asserting themselves, to protect their own interests. Shareholders need to hope that the company keeps on top of things (i.e. doesn't breach covenants), as bondholders can end up in the driving seat once covenants start being breached.
• Approved for £300m Govt loan under CCFF, increasing maximum liquidity to £1.5bn - that seems a lot of liquidity
• Drawn down another £300m on RCF
• Rent collections for Jan-June 2020: 73% for UK, 53% for France, 72% in Ireland
• Rent collections for Q3 (which were due on 24 June quarter date in the UK) - only 16% collected in the UK so far, no figures given for France or Ireland. Confident rent collection will improve as it negotiates with tenants. To be fair, it is very early days, only a week after rents fell due, plus a lot of tenants will have negotiated monthly payments. Hence I don't think this 16% figure is quite as alarming as it might initially seem.
  
  

Stress testing - I've run through the numbers to look at a negative scenario, of c.40% negative revaluation of the properties in future (to reflect falling rents, empty units from retail insolvencies, and incentives needed to attract new tenants on cheaper rents).

The figures below are taken from HMSO's 2019 Annual Report, with my adjustments to reflect the estimated impact of covid on property values;

£2,099m directly owned properties - write this down by say 40%, to £1.26bn

£3,017m JVs. These seem to mostly be debt-free, apart from Westquay (Southampton). Write these down by say 45% (to reflect the gearing on WestQuay), arrives at £1.66bn

£1,505m Associates. This is split: £2,114m property assets, £720m debt, £111m other. So if the properties are written down by 40%, then the overall total drops to £659m (a 56% reduction in NAV, due to the impact of gearing)

This arrives at;

2019 valuations = £7,087 property assets, less £2,505m debt = £4.6bn NAV, less £200m other = £4.4bn NAV, or 574p per share

My revaluations = £3,579m property assets, less £2,505 debt = £1.07bn NAV, less £200m other = £870m NAV, or 114p per share.

An alarming drop in NAV, as you can see. This explains why the share price is at such a large discount to 2019 NAV - it's because the market is pricing in a c.40% drop in asset values, which actually does look realistic.

What about Loan To Value (LTV)? On the 2019 valuations, LTV looks fine, at 35%. Once we write down asset values as above, by c.40%, the LTV shoots up to c.70% - well into danger territory.

EDIT: Just realised I forgot to add back the assets held for disposal of £466m, since that sale recently fell through. Therefore the total writedown in property values would be higher than as stated above, if we include these additional assets. End of edit.

My opinion - I think the RNS today is good in terms of liquidity - i.e. it sounds as if the group is not under any liquidity or solvency pressure, at the moment.

The problems are building up in the pipeline though. The big issue is that its property assets are likely to be written down in value very considerably, possibly for several consecutive years. When property assets fall heavily, but debt remains the same, then it can all unravel, as it did with INTU, and as demonstrated with my rough figures above.

Who knows at what level asset values might settle? I'm hearing that rents are coming down by as much as 45% for shopping centres. That's a gradual process, because rents can only usually come down on lease expiry, which are spread over years into the future. Or tenants can exit leases when break clauses are present, but each lease is different, with whatever terms the parties negotiated at signing. Of course, many leases are ending when the tenant goes bust, happening on almost a daily basis at the moment. I see TM Lewin, and Bensons/Harveys are the latest to go bust in their current form (then re-surface through a pre-pack, or move online completely as TM Lewin has just announced).

Looking at HMSO's 2019 results, it wrote down the value of its properties by £(295m), plus there were large losses of £(423m) relating to Joint Ventures. which is writedowns of asset values too. Overall, NAV at end 2019 was £4,377m, down 19.4% on prior year.

That equated to a very healthy 601p per share EPRA NAV. The current share price is only 83p per share, indicating that the market believes HMSO's assets are wildly overvalued, and that there's potential solvency risk too, otherwise the discount wouldn't be so huge.

As demonstrated above, if the property values do end up falling by as much as 40%, then the equity at HMSO would look very vulnerable. Bondholders are already flexing their muscles, as we've seen today. If future covenants are breached, then the bondholders could potentially force the group into administration. The assets are then sold, and bondholders are first in line to be paid. Equity might end up with little to nothing.

So, in a downside scenario of minus 40% property revaluations, then I think HMSO equity could be toast. However, it has got time to sort things out, as the liquidity position looks OK, and the bank debt seems to be unsecured (per today's RNS). What happens if the bank facilities are withdrawn though?

I think HMSO needs to do an equity raise, which might be possible if the re-opening goes well, and covid retreats once better treatments/possible vaccine, might be rolled out in 2021 perhaps?

Overall - this looks like the share price could continue to be volatile. It's one of the most heavily shorted shares in the market, which led to a lovely short squeeze not long ago, which was a very profitable trade for me (56p in, and c.120-134p out, in stages). Would I buy again at the current price? Probably not, but it depends on how retailing pans out in the coming weeks & months. If shoppers return to shopping centres en masse, then HMSO's rent collections would improve, and it could survive with asset values impaired less than in my stress tests above (which are probably worst-case scenarios). If people continue to avoid shopping centres, then HMSO could slowly unravel. It's not under any immediate threat, but the storm clouds over it are fairly clear, longer term, once those asset values are devalued to levels that reflect tenants inability to pay current rents.

Shopping centres seem structurally challenged assets. Would I want to part-own shopping centres? No - because divis look unlikely, as balance sheets either blow up, or are repaired. Is the move to online shopping going to reverse? Very unlikely. Going to a shopping centre at the moment is surely a joyless, stressful experience. So I cannot see footfall/revenues returning to normal any time soon. But who knows? Maybe the public will adapt to social distancing measures, wearing masks, etc,? After all, that's fairly normal in the Far East now, and people still go shopping there.

There's a lot of downside already priced-in. In conclusion, I'm probably neutral on HMSO at this level. Rather a long-winded way of arriving at that conclusion, but I wanted to work through the numbers & throw them out there to you, for your comments. I'm not a specialist in the property sector, so might have missed something. Therefore please treat my figures as only very rough estimates, which might contain errors. As always, doing your own research is essential.

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James Latham (LON:LTHM)

Share price: 840p (unchanged today, at 11:18)
No. shares: 19.9m
Market cap: £167.2m

Final Results

This is a timber products importer & distributor. It's still family-run, and a lot of us in the small caps world admire the way this business has been well-managed, with conservative finances, and a well-covered divi, etc. Having said that, looking at the 5-year chart, it's not actually been a particularly good investment, unless you happened to buy the dips, and sell the surges. The drawback to trading this share, is that the quoted spread is so wide, and it can't usually be bought or sold in any decent size. Maybe it's not as good as my preconceptions suggest?

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FY 03/2020 results - quite good. PBT up nearly 3% to £15.7m , on revenues up 5% at £247.1m.

EPS flat at 63.1p, or up 3.9% if we use the adjusted EPS of 64.0p - not much difference.

PER is 13.1 times on the adj EPS - good value, although the company is looking ex-growth, so I wouldn't want to pay a high multiple for it. That said, in a zero interest rate environment, a PER of 13.1 looks good value for a business that generates plenty of cash, and has a nice balance sheet. Providing earnings are not going to collapse of course.

Dividends - are still being paid. That's the advantage of having a strong balance sheet, and divis that are well covered. The final divi is down a bit at 10.0p (LY: 12.9p). Total divis for the year are 15.5p (LY: 17.9p), yielding 1.8% - better than nothing.

I think it's worth mentioning that a company's dividend paying capacity is arguably more important than what it actually pays out. LTHM could pay out a much bigger div yield, and at some point in the future, it might do so. And/or pay special divis, with the surplus cash. A short term downturn in trading doesn't mean that divis stop for several years, unlike highly geared companies. Mgt comments on divis;

The board considers this level of dividend to be prudent given the balance between the good results achieved in the year to 31 March 2020 and the difficult market conditions experienced during the first quarter of the current financial year caused by the COVID-19 pandemic.

Covid impact - usual actions have been taken, conserving cash, quick action to reduce costs, etc.

Sales in April were down 60% on LY, improving to down 40% in May. June improving further, expected to be down 20% on LY. Isn't it good when companies just give us the numbers, instead of a lot of waffle! Well done LTHM and its advisers.

The full impact of the virus and the effect on the wider economy are impossible to predict at this stage.

Maybe, but the company should be able to give guidance, even if it's a range of possible outcomes, from downside scenario, base case, and optimistic case.

Access to broker forecasts - this is a general point, not specific to LTHM. I am very unhappy with the widespread lack of access to forecasts at the moment. This information is currently generally being withheld from private investors, but the top brokers are giving forecasts for their esteemed clients only. It's all highly unsatisfactory, maybe even illegal - for brokers to provide forecasts privately to their top clients, which have been based on privileged information sourced from CFOs of the companies.

With no access to any forecasts for LTHM, I think it's best to just write off the results for this year. If business is already back to a run rate of only 20% down on LY, with the construction industry only recently having re-started, then I imagine trading might gradually return to normal. So maybe we should value it on next year's earnings instead, and assume they're likely to be similar to FY 03/2020? As long as I can see a fairly decent resumption of trading, to not too far below last year (as with TPT above, and LTHM), then I'm comfortable with this approach to valuation.

Outlook - the section titled "Development Strategy" in interesting. It talks about possible acquisitions, new products, etc. To me, this emphasises how strongly financed companies can think about expansion in a downturn, taking advantage of weaker competition. Whereas highly geared companies have to retrench, and focus on survival. Let's hope that more companies, and the City, learns from this crisis, that loading up on debt is potentially ruinous, whereas running a strong balance sheet, provides great benefits & security in the tough times.

Balance sheet - I'm so sad, that I actually get a tingle of endorphins when I review a strong balance sheet!! So, am I tingling now? Yes! With a couple of reservations.

NAV is £104.3m, including intangibles of only £2.7m, giving NTAV of a whopping £101.6m

What does that mean in practice? It means the fixed assets of £36.0m are owned outright. The same can almost be said of all the inventories of £44.3m, & the receivables book of £47.0m. Both look a little high to me - I wonder if customers are paying late? There could be some bad debts in that receivables book, if lots of builders go bust? I doubt it would be a big problem though, as the large builders are all very strongly financed.

There's only £29.9m of current liabilities, with the cash pile of £17.0m covering more than half of that.

Overall, it's bulletproof.

The only thing I don't like, is that £11.8m pension deficit, which has gone up 36% in the year.

My opinion - a very nice, solid business, at a reasonable price. Good value actually, in my opinion. It may not be the most exciting business out there, but I see it as a very safe, long-term thing that conservative value investors tend to like.

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Kier (LON:KIE)

Share price: 87.5p (down 10% today, at 13:00)
No. shares: 162.1m
Market cap: £141.8m

Trading Update

Kier Group plc (the "Group"), a leading construction and infrastructure services group, today provides an update on trading since 1 April 2020 (the "period").

It has a 30 June 2020 year end, so this update is for Q4 (and presumably the whole FY 06/2020).

The CEO says;

• "Underlying trading remained resilient"
• Decisive mgt actions are delivering significant benefits
• Good liquidity position

Covid - adversely affected revenue, and increased costs. 80% of sites remained open. Almost all sites now open.

Outlook - continues to win "high quality work". £7.6bn order book at 31 May 2020.

Whilst the Group anticipates that the effects of COVID-19 will continue to affect volumes and result in additional costs as the Group adapts to operating in a post-COVID-19 environment, the strength of the Group's orderbook, its expertise in managing complex projects and its long-standing client relationships enable the Group to remain confident in its outlook for the financial year ending 30 June 2021.

Cost-savings of £100m flowing through.

Various other points are mentioned, but it's all a bit disjointed. I'm only really looking for the overall picture, which is not clear from today's update.

Fundraising likely? - this is probably what's whacked the share price today;

Before COVID-19, the Group had made good progress in implementing a number of measures to reduce its net debt and strengthen its balance sheet. As a result of COVID-19, over the next 12-18 months, further actions will be taken, including: continuing to implement a range of self-help measures, driving a further increase in the Group's operating cashflows, continuing the process to sell Living and a potential equity issue.

Net debt -

... The Group's average month-end net debt for the current financial year is expected to be c.£440m.

Covenant waivers agreed with its bankers for 30 June 2020. In other words, it breached its covenants. In this type of situation, bank support often hinges on an agreement to raise fresh equity. Therefore, I would work on the basis that an equity fundraising is almost certain to happen. Not knowing what terms the funding might be raised on (it could easily be at a deep discount), then I'm not interested in looking any further at this share. Existing private shareholders are often excluded from fundraisings, and can end up getting diluted by instis buying at a discount in a placing.

Pension fund - in talks with trustees over recovery payments.

My opinion - it's too complicated, and given that an equity fundraising now seems almost certain, I can't see any motivation to buy the shares now. Would I want to own shares in a sprawling, low margin infrastructure group? Absolutely not. It's just an awful sector, where many similar companies have collapsed under too much debt.

I suppose the upside case here is that, with a strengthened balance sheet after a fundraising, the shares could re-rate.

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That's it for today. See you tomorrow!

Regards, Paul.