Small Cap Value Report (Weds 2 Dec 2020) - BLV, LGRS, SAL, ANG, D4T4, EMR, TSCO

Good morning! It's Paul here with the SCVR for Wednesday.

Timing - I've got most of the day free today, so should be able to focus on this. As I mentioned in the comments yesterday, I'm a freelance writer here, and I publish what I can, when I can. It's not a full time job. Please bear that in mind, to keep expectations grounded. Maybe we should have made that clearer before, to prevent unrealistic expectations, if so, please accept my apologies. Today's report is now finished.

Agenda - these updates have caught my eye today;

Belvoir (LON:BLV) - share price up on a trading update

Loungers (LON:LGRS) (I hold, small position) - shares up on interim results

Angling Direct (LON:ANG) - shares up on a trading update

Spaceandpeople (LON:SAL) - huge % move up on this nanocap on an interesting announcement (I hold - a tiny position)

D4t4 Solutions (LON:D4T4) (I hold) - more contract extensions, building confidence for H2 outturn

Empresaria (LON:EMR) - solid trading update, low PER

Tesco (LON:TSCO) - readers are more cynical than me about it returning business rates relief monies to the taxpayer!

.

John Authers newsletter

If you don’t follow John Authers daily email newsletter on Bloomberg, then you should! I don’t read it every day, due to being permanently snowed under with things I have to read & interpret. But when I do, I’m glad I did. His comments this week on Bitcoin, and overall market valuations, are very interesting, and well balanced.

Too many commentators churn out the same stuff year after year, explaining why the economy is going down the pan, QE is folly, currencies will become worthless, etc.. The fact is, they’ve been consistently wrong for about 12 years now. It doesn’t seem to occur to them to question their own judgement, or base their comments on facts, rather than dogma.

What I like about John Authurs, is that his articles are so well researched, and balanced. His conclusions are based on reality, not what conventional economics suggests ought to be happening (but isn’t).
Highly recommended, here’s his latest article on Bitcoin & stock market valuation. You can sign up for a free daily newsletter, here (scroll down to John Authers).

.

Retailers - Arcadia & Debenhams

Big news this week has obviously been the administration of Arcadia Group, the former fashion retailing multi-brand powerhouse. I won't go into the various reasons for its demise, as that's been covered elsewhere. Was it inevitable? Not if they had prioritised the internet, as Next (LON:NXT) has done, thus continuing to prosper, with more than half Next's sales now online.

A story in one of the biographies of Philip Green, claims that Green rang up the CEO of Asos (LON:ASC) (when it was in its infancy), and harangued him about repeatedly poaching Green's best staff. Of course the best people at Arcadia were receptive to leaving, because of Green's bullying, abrasive (but sometimes very funny, in an un-PC way) behaviour. During this call, apparently Green told Asos that it was doomed, because fashion would never work on the internet, due to the 40% customer returns rate making it unviable.

Mike Ashley is well known for having a love-hate relationship with Philip Green, and both have egos the size of planets. Therefore I would say Ashley is probably front-runner to acquire some or all of the Arcadia brands out of administration, possibly partially motivated by the final humiliation this would deliver to Green (who I doubt is likely to get much sympathy from anyone).

Multi-brand online only fashion powerhouse Boohoo (LON:BOO) (my largest personal holding) is also mooted as a potential buyer for some of Arcadia's brands - with TopShop & TopMan being the obvious ones which would be a good match. Cheekily, I sounded out BOO about this, but got a vague, non-committal reply. Obviously they wouldn't be able to tell me anything as it's confidential. My feeling is that BOO is happy to buy up brands which have potential to be revitalised, if the price is attractively low. Given that BOO has already beaten brands that fail, then I don't think it rates them particularly highly as prized assets.

Will BOO take on physical stores? Almost certainly no, in my opinion. Why would they want all the hassle, and an inflexible cost base, that has brought down so many others? BOO's huge automated warehouse is capable of being expanded as each new brand is added. I've seen some videos of it in operation, and it's mightily impressive. It's staggering how fast retailing is changing.

Debenhams was linked to Arcadia, since the latter had many concessions (store within a store) in Debenhams large stores. The collapse of Arcadia seems to have triggered the failure of talks with Jd Sports Fashion (LON:JD.) to rescue some of DEB's stores out of administration. Drapers Record says that 124 Debenhams stores are going to close. Some bargains to be had then, in closing down sales.

When I go into a closing down sale, I only briefly say to staff that I'm sorry to hear the store is closing, and leave it at that. I once overheard a staff member at a closing down store say to a colleague, "I'm sick of people we've never seen before coming in here to pick over the carcass for bargains, and pretending to give a damn about us and our jobs". Fair point, well made!

Winners & losers? The closing down sales for Arcadia & Debenhams, in some or maybe all stores, might put pressure on other fashion retailers in the short term, due to heavy discounting. However, once they're closed down, probably in early 2021, then it should mean more market share for others. The obvious beneficiaries are Boohoo (LON:BOO) (I hold) and Asos (LON:ASC)

Physical retailers (listed shares) that should also benefit from the demise of Arcadia & Debenhams are probably Next (LON:NXT) and Marks And Spencer (LON:MKS) (I hold). Although there is a risk that some smaller towns might drop below critical mass, in terms of the number of interesting stores still open, and become wastelands, thus harming everyone that is left.

Frasers (LON:FRAS) is another one that could benefit, as it did seem to be making a go of things, before lockdown. Could MKS, NXT and FRAS be the last people standing, in terms of major fashion retailers? Getting a bigger share, of a smaller market? That looks a credible possibility to me.

.

Return of Crown Preference

This looks like a very important change. I’m grateful to the Telegraph for highlighting it, as others don’t yet seem to have picked up on something which looks of great significance.

This relates to insolvencies. Back in the day, when I was doing my accountancy training in 1990-93, there was a pretty bad recession in the private sector, so I was seconded to the insolvency department of Price Waterhouse for about half of my 3-year time there. It was wonderful experience learning something about how insolvencies work, which has served me very well in my investment career subsequently.

In insolvencies (administrations, then liquidations), there’s a strict order of who gets paid, until the funds (from asset disposals & sale of operating subsidiaries) run out. Back then “preferential creditors” got paid first I think, even ahead of secured creditors possibly? Examples were employee wage arrears, redundancy payments, and HMRC. I think the fees for the insolvency practitioner also ranked highly, but I’m foggy on the detail, as it was a long time ago.

I didn’t know this, but apparently in 2003, HMRC was downgraded to just being another unsecured creditor. Hence banks (secured creditors usually) would be paid before tax liabilities, and other unsecured creditors (mainly suppliers), I think (correct me if I’m wrong on any of this). Unsecured creditors often get paid little in insolvencies.

It turns out that, with effect from 1 Dec 2020, HMRC has once again become a preferential creditor in UK insolvencies, hence the principle of crown preference has been reinstated.

This strikes me as being a very big deal, which could have widespread ramifications for highly indebted businesses.

One of the key business support measures during covid, has been HMRC giving more time to pay, particularly VAT and PAYE/NICs. Some of the companies I cover, have run up very large stretched taxation liabilities, using this leeway. E.g. Staffline (LON:STAF) owes HMRC £45m in delayed VAT (more than its market cap!). It recently updated the market that the March 2021 cliff edge for repayment has been extended to allow instalments up to March 2022, all interest-free, giving it breathing space for now.

Now that crown preference has come back in, this means that the taxman would (I think) rank ahead of STAF’s banks, in the event of insolvency. At a stroke, this change seems to have therefore made bank lending very much more risky.

Most of STAF’s borrowings have now been shifted to invoice discounting, i.e. lending secured against specific invoice receivables. Would those now rank behind the £45m tax arrears in an insolvency? Probably not, because the invoices have been sold to the invoice discounting lender, and might then be outside the scope of recoverable monies for an administrator? I’m not sure on that point, if we have any insolvency experts on hand, maybe they could comment? The tax liabilities would probably rank ahead of normal bank lending secured by a floating charge though.

The general point is that, some bank lending now looks much more risky, therefore it stands to reason that banks would want to lower their risk, by reducing lending, restructuring it onto invoice discounting instead, and pushing companies with weak balance sheets into raising fresh equity.

For this reason, whilst I may be foggy on the detail, the general principle here seems to be that risk for investors probably just got worse, at highly indebted companies, particularly ones that have run up large taxation stretched creditors, which might now rank ahead of the bank in an insolvency.

The Telegraph also pointed out that the reintroduction of crown preference on 1 Dec 2020 was probably a major factor behind Arcadia going into administration the day before - thereby avoiding the secured creditors being pushed behind HMRC, which would have happened on 1 Dec.

Expect to see a tightening of credit after this change, which could have big implications for companies that have dangerously high bank borrowings.

As regulars here know, I place great emphasis on balance sheet strength, and try to avoid companies with lots of debt. That’s been highly relevant during covid/lockdown, and this reintroduction of crown preference probably makes it even more relevant.

There's a very good article here, which clarifies some of the detail, from experts, not my vague waffle! In particular, it seems that fixed charges (e.g. over a property) are unaffected, but floating charges (over the general assets of a business) would be impacted, and now rank behind HMRC. That's a big deal. An excerpt from it;

Who will be affected?

Floating charge holders and unsecured creditors will essentially foot the bill for these taxes, because the prior ranking of HMRC's claim will dilute the realisations available to pay their claims. However, HMRC's claim will still rank behind lenders in respect of their fixed charge realisations and expenses of the administration/liquidation, which will include the fees of the insolvency office holder.

The article also mentions mitigating actions that lenders might take, including a shift to using invoice discounting, since that removes assets (the receivables book) from being within the riskier floating charge security, to actually being owned by the lender (hence not at risk in an insolvency).

This explains why Staffline's banks recently changed its borrowings, so that the overdraft facility was greatly reduced, and an invoice discounting facility put in place for most of its borrowings. The penny has just dropped, this legislative change re crown preference must have been the reason. Clearly we're going to see a lot more of this, with borrowing facilities being re-jigged into receivables financing, instead of overdrafts & term loans.

Maybe companies and banks can mitigate this issue then, time will tell.

It's an important topic that we need to think about though. Also a good question to ask management of indebted companies, when we talk to them, would be, "How has the reintroduction of crown preference affected your bank's attitude towards your borrowing facilities?"

.

---

Belvoir (LON:BLV)

Share price: 152p (up 7%, at 10:00)
No. shares: 35.1m
Market cap: £53.4m

Trading Update

Belvoir Group PLC (AIM:BLV), the UK's largest property franchise, is pleased to provide the following encouraging trading update.

Trading ahead of pre-Covid expectations

There’s quite a bit of detail, but the most important bit says;

… the Board expects that the performance for the year, in terms of profit before tax, will be comfortably ahead of management's expectations.

Net debt - looks manageable;

Net debt is currently down to £4.3m (31 December 2019: £6.9m) having deployed £2.0m of cash in January to acquire the Lovelle network and deferred payment of £0.5m VAT.

Upbeat comments on property sales - which has interesting read-across for the wider market, boosted by Stamp Duty reductions of course;

The pipeline of agreed house sales is significantly ahead of the previous record level so, whilst the pipeline is slower to process than usual, franchisees are expected to report strong sales revenue during the last two months of the year.

The financial services division goes from strength to strength with a 18% increase in the adviser network since the start of the year. As with the property sales market, the pipeline of written mortgages is at a record level of which a significant proportion is expected to convert to banked income in the remainder of 2020.

Cost-cutting has helped profitability, with costs “significantly below the original budget”.

Reversal of pay cuts - staff are being reimbursed now - that’s a positive thing to do, as staff motivation & loyalty should get a nice boost from this kind of fairness.

Furlough & Govt grants repaid - another classy gesture here, Belvoir is repaying £250k in taxpayer support. Good for them! We need to see more of this from other companies that didn’t need support in the end.

Dividends - another catch up divi of 1.3p will be paid.

Outlook - sounds good;

The Board appreciates that we are not through the pandemic and the longer term economic impact is uncertain. 2021 will present further challenges, however, we will start the year with strong sales and financial services pipelines, and we have confidence in our business model and the entrepreneurial spirit of our franchisees and advisers to continue to deliver shareholder value."

My opinion - clearly this is a positive update, with multiple feel good factors! I’m very impressed with the company’s performance this year. As the management speak says, this year’s challenges have proven the resilience of its business model.

If we allow for forecasts to be raised on today’s news, then the shares still look reasonable value. A lot hinges on whether the Govt extends the Stamp Duty holiday or not. Based on actions to date, I think the pattern is that support schemes are generally being extended. Therefore it’s probably quite safe to assume Belvoir could continue trading well.

If I held this one, I’d be inclined to let it run. Management actions on reimbursing employees and the taxpayer are the right things to do, and makes me feel that management seem ethical, and therefore trustworthy. So, all good! There looks scope for this share to continue rising, based on the good update today, in my opinion.

.

---

Loungers (LON:LGRS)

238p (up 7% at 12:56) - mkt cap £243m

(I hold - a small position size)

Results for the 24 weeks ended 4 Oct 2020

Loungers (the "Group") is pleased to announce its unaudited results for the 24 weeks ended 4 October 2020. Loungers is an operator of 168 café/bar/restaurants across England and Wales under two distinct but complementary brands, Lounge and Cosy Club.

It seems strange to be reporting interims for a 24 week period, not a 26 week period.

The preamble reinforces just what a bizarre year 2020 has been;

The 24 week period being reported on includes 11 weeks of lockdown, four weeks of phased re-opening, four weeks of Eat Out to Help Out ("EOTHO") in August, and finally five weeks of relative normality, albeit this five week period included the introduction of the "Rule of 6", the 10pm curfew and local lockdowns in Wales.

Therefore, I don’t think there’s anything to be gained from going through the numbers in detail. All I want to know is that the company isn’t haemorrhaging cash, and that its balance sheet is strong enough to survive through to the post-covid period. Plus of course the outlook comments.

Here are some useful pointers - to save me re-typing them;

.

Taxpayer support - good transparency here, giving us the numbers, which are highly material. If the profits seem inexplicably resilient, that’s largely due to it receiving £17.2m in taxpayer support under the furlough scheme, plus of course no business rates to pay, and £5.6m received under the EOTHO scheme.

That's very substantial taxpayer support, but it’s done what it was intended to do - enabled the business to survive, retain jobs, and it’s planning on getting back to opening 25 new sites per annum in future.

Net debt - this is also a creditable disclosure, well done to Loungers & its advisers for the following transparency;

Reported net debt continues to benefit from deferred liabilities to landlords and HMRC. Adjusting to reflect these deferred liabilities as if they had been paid, net debt at 4 October 2020 would be £25.1m…. It is important to note that the timing of the interim results does not flatter the reporting of net debt, coming as it does immediately after the September rent quarter and month end payment runs. In the week prior to the half year end payments totalling £8.6m were made to suppliers, landlords and HMRC.

Outlook comments -

· In the short term we expect a more severe impact on sales. In England we have 60 sites that will remain closed under Tier 3, with 91 sites trading in Tier 2 and three sites trading in Tier 1. In Wales we have 14 sites that will be subject to increased restrictions from 4 December

· The strength of our brands and the manner in which they performed coming out of the first lockdown provides confidence for the future and we would expect a strong trading environment for our brands once Covid-19 restrictions are eased

· We anticipate returning to a run rate of 25 new site openings per annum during the course of the financial year ending April 2022

Balance sheet - not the best. It only has £10m NTAV, which I think is too light. This pandemic has shown that companies in this sector need much more robust financial reserves, to cope with unexpected shutdowns, something that was unthinkable previously.

There’s also the question of property leases. In future, it needs to be made explicitly clear in leases, who takes the pain in the event of future shutdowns. That could be incorporated within turnover rents, with a low base rent, which would solve that problem.

My opinion - Overall, I think Loungers looks an excellent business. I'm told that management are top drawer here. It’s proven to be resilient throughout covid, and importantly it out-performed once sites were allowed to re-open over the summer. It benefited from operating mainly off-pitch, suburban sites, which gained from people working from home, and avoiding city centres. However, that could go the other way, as we gradually emerge from covid in 2021, once vaccinations are widespread, will people flock back into city centres & offices again? Who knows, but there’s bound to be at least some movement in that direction.

The share price is back to where it was at the end of 2019, prior to covid, which is very impressive. Well done to holders who kept their nerves throughout the pandemic.

I’d like to see further expansion take more of a back seat to balance sheet repair, personally.

I only have a small position in my SIPP, but am happy to let it run for the foreseeable future.

.

.

---

Brief comments now, or I'll never get through this lot.

Spaceandpeople (LON:SAL)

(I hold)

A nano-cap, blast from the past, has shot up 223% today on a contract win announcement which sounds impressive - exclusive agreements of 4 large shopping centres (ex-INTU) for promotional sales and temporary retailing.

Nancy Cullen, SpaceandPeople CEO, said: "We are absolutely delighted to have been chosen to sell short term promotional and retail space at this prestigious group of shopping centres. This represents a significant opportunity for SpaceandPeople to strengthen our network of prime destinations and to offer brands and pop up retailers premium, high footfall spaces across the UK. We look forward to working closely with these venues to delivering activations that are aligned with their new strategies as they emerge from the Covid-19 pandemic."

.

---

Angling Direct (LON:ANG)

68.5p up 9% - mkt cap £53m

Trading Update - all 38 shops re-opening today.

Exceeding expectations;

As a result of this strong trading, and the enhanced visibility over our operations as stores reopen, the Board believes the Company is now likely to exceed current market expectations with a forecast pre IFRS 16 EBITDA outturn for FY21, of not less than £3.8m.

Many thanks to N+1 Singer, which has kindly made available an update note today on Research Tree, very helpful indeed. This shows a very large 223% upgrade to FY 01/2021 forecast PBT to £2.75m.

"Good progress" but no figures given, on efforts to improve gross margin, operational efficiencies, and improving working capital.

Pots of cash: £17.9m at end Nov 2020

My view - sounds impressive. It could be worth readers taking a fresh look at this one.

.

---

D4t4 Solutions (LON:D4T4)

230p (up 6%) - mkt cap £92m

(I hold)

Contract upgrades - adding £3.5m extra to this year's revenues.

"These contracts provide us with even greater clarity on our outlook for the year. As a result, we are confident in delivering a very strong finish to the year in line with Board expectations."

My view - this looks interesting. Shares are not cheap, and contracts are lumpy, but I feel there's something interesting happening here, in a highly relevant sector.

.

---

Empresaria (LON:EMR)

43p (up c.1%) - mkt cap £21m

A small, international staffing group.

Today's update for FY 12/2020 sounds quite good;

We anticipate that the Group's full year net fee income will be in the range of £52m to £55m and adjusted profit before tax is expected to be in the range of £4.4m to £4.9m.

Net debt comments are self-explanatory;

At 30 October adjusted net debt was £11.4m, the increase from 30 June primarily reflecting the repayment of certain tax liabilities which were deferred in the second quarter of 2020 and the impact of increased working capital requirements as net fee income has improved. We would expect net debt to continue to return towards pre-COVID levels as net fee income recovers. Headroom remains strong at £17.6m excluding invoice financing facilities (30 June 2020 £18.1m).

That's an important point re working capital. As businesses begin expanding again this year, from covid lows, then that puts pressure on working capital, as receivables rise. Therefore net debt goes up, when business recovers. We need to consider this when working out what shares are worth, particularly if you are fond of using enterprise value (quite a flawed concept, in my view).

My view - looks cheap, on a very low PER, but shares are hopelessly illiquid, and spread is wide. so probably not worth bothering with.

.

---

Tesco (LON:TSCO)

Tesco decides to repay business rates relief

I've got to mention this, as it seems to me a seismic announcement.

In short Tesco has decided, seemingly voluntarily, to repay the taxpayer all of the business rates relief it has received of £585m.

This is despite the covid pandemic costing Tesco £725m this year.

"Our colleagues have done an exceptional job in responding to the challenges of the pandemic. We have invested more than £725m in supporting our colleagues, putting safety first, more than doubling our online capacity to support the most vulnerable customers in our communities, and hiring thousands of additional colleagues at a time of need. While business rates relief was a critical support at a time of significant uncertainty, some of the potential risks we faced are now behind us.

Every decision we've taken through the crisis has been guided by our values and a commitment to playing our part. In that same spirit, giving this money back to the public is absolutely the right thing to do by our customers, colleagues and all of our stakeholders."

"The Board has agreed unanimously that we should repay the rates relief we have received. We are financially strong enough to be able to return this to the public, and we are conscious of our responsibilities to society. We firmly believe now that this is the right thing to do, and we hope this will enable additional support to those businesses and communities who need it."

.

My view - I'm absolutely staggered by this, and I think it's a wonderful thing to do.

Have businesses suddenly decided to become all fluffy & lovely? Taken at face value, this looks like Tesco is doing something pretty remarkable. I wonder if there will be an advertising blitz now to promote the message that Tesco is public spirited, and not just maximising profits these days?

I'd love to hear from readers, to find out what you think. EDIT: looks like you lot are more cynical than me! End of edit.

.

---

I'll leave it there for today, thanks for tuning in.

See you tomorrow!

Best wishes, Paul.