Small Cap Value Report (Weds 5 May 2021) - SNWS, CTO, MCB, CAMB

Good morning, it's Paul and Jack here with the SCVR for Wednesday.

New thread for BOO results - Boohoo (LON:BOO) (I hold) results are due out today shortly (I'm writing this at 06:35). Given that it's my largest, long-term personal shareholding, I'll obviously want to spend some time this morning going through the numbers in detail. Given that BOO is now way too large for the SCVRs at a market cap of £4.3bn (we usually stop when we get into the £400-500m range of market caps), then these days we discuss BOO on a separate thread, which is here. So please put any BOO related comments there, much appreciated.

Agenda -

Paul:

Smiths News (LON:SNWS) (I hold) - an interesting turnaround is underway here. Interim results are in line with expectations. Debt starting to reduce. Balance sheet still ugly, but within 2 years debt should be reduced to 1x EBITDA. Dividends to resume this year. A nice value share, in my opinion.

Tclarke (LON:CTO) - in line with expectations trading update for 2021 to date, plus a record order book. Very nice, but this is a stock that will always be on a low PER, as it's earning low margins, on large complex projects.

Jack:

Mcbride (LON:MCB) - rising input inflation and volatile revenue sees the private label manufacturer downgrade full-year guidance

Cambria Automobiles (LON:CAMB) - solid update from asset-backed car dealer. Government support has helped through lockdowns and Cambria could emerge as a winner in this sector

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Paul's Section

I've managed to tear myself away from BOO!

Smiths News (LON:SNWS)

(I hold)

39.2p (slightly up today) - mkt cap £95m

This is the UK’s largest distributor/wholesaler of newspapers & magazines.

I’ve gradually warmed to this share, as a decent recovery is gaining traction.

For background, I reported here on 3 March 2021, when it reported an in line with expectations H1 trading update.

Interim results - today are in line with expectations, as previously confirmed.

Key numbers:

• Revenues £551.6m in H1, so a significant sized business
• Adj EBITDA in H1 £20.5m, as expected
• Adj profit before tax £14.4m in H1
• Adj EPS of 4.6p
• Net bank debt of £70m, slightly below the £71m previously indicated - at 1.9x EBITDA this is now comfortably within covenants, and on a falling trajectory (down from £79.7m 6 months earlier).

The attraction of this share, is a value situation, where the market is slowly waking up to the fact that legacy issues have been resolved, and a resilient & cash generative business is emerging. Specifically;

Disposal of Tuffnells completed, which was previously dragging down the whole group

Bank facilities refinanced in autumn 2020, and are now secure, with scope to reduce the expensive 5.5-6.0% over LIBOR interest cost in due course, as risk is reducing, I hope

Pension scheme liabilities seem to have been extinguished in Feb 2021, so the cash outflows should now have stopped, and there could eventually even be a return of the surplus in due course, but that’s a bonus if it happens in my view.

Balance sheet is still weak, with NTAV negative at £(66.0)m - all of which is due to the £71m net bank debt. Debt reduction is a priority -

... targeted reduction of net debt to 1 X EBITDA on track by end of FY2023.

1 times EBITDA would be a perfectly manageable level of debt, which should be capable of being refinanced to a much lower rate of interest, boosting profit by several millions in reduced interest cost, I suggest. It’s an August year end, so this timescale is about 2 years + 3 months.

My opinion - so far so good. The business has proven itself remarkably resilient during covid, with upside to come from full re-opening. Set against that, obviously newspapers & magazines seem to be in long-term structural decline, but they’re still quite big business (over £1bn p.a. revenues for SNWS). Digging a bit deeper, it seems that cover prices have risen to offset about half the volume declines, and revenues for SNWS are based on cover price and volume combined. Hence its revenues seem resilient for the foreseeable future.

Cost-cutting has made up most of the shortfall, hence the resilience in earnings.

The StockRank of 89 is strong, and “Turnaround” style from Stockopedia means the computers have picked up on the convincing turnaround underway here.

This is not a share I want to hold forever, but I think it’s too cheap, and could recover to a PER of say 6-8, once it’s paying divis again (to resume in H2 the company confirms today), hardly a demanding multiple. On say 8-10 EPS, that might be a share price target of 48-80p, in a timescale of maybe 2 years, with divis being paid along the way. That’s quite attractive to value investors, compared with a current share price of 39p.

I think there’s also a wild card that SNWS might attract a bidder, keen to bolt on other goods & services onto its existing rapid overnight distribution network. The company’s own diversification failed in the past, hence the current strategy is all about getting back to basics, which is working well. But someone else might look at it and see an attractive way to buy in cheap, dependable cashflows, and acquire a well organised distribution network to use for other purposes. Supreme (LON:SUP) which I looked at yesterday, springs to mind, since it distributes small, high profit items such as vaping, batteries, to lots of retailers. If SNWS is calling on many of those retailers every day anyway, then taking some extra parcels might make sense? Maybe we should put management in touch with each other?!

Note also the pleasing, stair-step chart below, which does seem to suggest that buyers are outweighing sellers, and are sticking around for further price rises.

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Tclarke (LON:CTO)

131p (up 3% today, at 14:49) - mkt cap £57m

Trading Update

I lost interest in this company several years ago, because it's always on a low PER, due to operating in a low margin, competitive sector, carrying out large, complex major projects - where it's easy for things to go wrong, but without the margins to absorb mistakes.

That said, today's update sounds good -

The Group is pleased to report that trading in the first four months of the 2021 financial year has continued to be positive and is in line with expectations. The Board is particularly encouraged by the growth of the forward order book and importantly the number of significant opportunities that TClarke is well placed to secure across all of our market sectors, as we move forward with our strategy to grow revenues to £500m, whilst maintaining our underlying margins.

The forward order book reflects growth coming through and now stands at a new record level of £472m (2020: £382m). The growth in the order book has been driven by successful project wins in technologies (data centres) and infrastructure (healthcare), where we have been further developing our capabilities.

The business is well positioned to take advantage of further opportunities and we are confident that this positive momentum will continue across all of our markets and geographies and the Group has aligned its resources to match the anticipated growth in revenues.

In summary, TClarke has made an excellent start to the year and the Board looks to the future with continued confidence underpinned by excellent revenue visibility and we look forward to reporting on the progress that we make over the remainder of the year.

My opinion - that does sound encouraging, although such an upbeat tone doesn't strike me as consistent with just being in line with expectations. Maybe management is signalling that they think expectations might be raised later this year?

It's not the type of share that I would invest in, and I have never understood why this company arguably wastes so much money & effort on being stock market listed, when there's no logical reason for that.

There's a lot of infrastructure spending going on, and it sounds like CTO is enjoying good times, so maybe this share could be worth a closer look, if you invest in this sector? It's had a good run already though.

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Jack’s section

McBride (LON:MCB)

Share price: 93.6p (pre-open)

Shares in issue: 175,455,445

Market cap: £164.23m

It looks like a notable downgrade in FY expectations for Mcbride (LON:MCB) here.

This is a leading European manufacturer and supplier of private label and contract manufactured products for the household and professional cleaning/hygiene markets. It considers itself a ‘private label expert’ in these segments.

I would have assumed strong demand for its products over Covid, and in its half year update the group noted a ‘strong profit performance driven by increased demand for cleaning, dishwash and aerosol products outweighing weakness in laundry products, and a slight softening of certain raw material and packaging pricing’.

This was back in February, and the group has been busy buying back its shares since.

And, as with so many stocks now, we have seen quite a strong rerating over the past few months (around +50% or so):

Despite the rise, McBride retains strong Ranks across the board with a Q Rank of 83, a V Rank of 92, and an M Rank of 84 all making for a StockRank of 98.

The cash generation is there, too, although it looks lumpy so the group spends a fair amount of cash on maintaining operations.

Meanwhile revenue growth over time has been poor.

Private labelling can be a tough market and is less profitable than owning branded products. In this type of business model, power often lies with the customers - big supermarkets and the like - who are free to shop around for the most economical deal.

So, while the value is compelling, the business model makes me wary.

Trading update

The outlook appears to have changed due to a ‘further rapid, significant and sustained price escalation for many of our raw materials, particularly core chemicals and plastics’.

The group now anticipates more than double the rates of input price increases by June 2021 than was previously expected back in March. McBride does not ‘see these prices returning to more normalised levels in the near future.’

Revenue volatility continues to be a challenge. Demand for auto-dishwash products has remained strong but volumes in household cleaners have been normalising from the peaks seen in 2020.

Sales of laundry and personal care products have remained ‘very subdued’ and the Liquids and Aerosols businesses have reduced their demand outlook for the final quarter.

As a result, the group now expects second half constant currency revenues to be approximately 6% lower year on year.

Consequently the final quarter is expected to be significantly weaker than the first nine months of the financial year and full year EBITDA profits are now expected to be approximately 15% lower than the previous year.

Conclusion

Numerous operators have noted increasing price pressures now. For some, consumer demand has so far outweighed this inconvenient dynamic. Others will be finding it an issue.

At what point might general inflation become more of a central issue for reporting companies? This is a useful update to bear in mind for that reason. A note of caution in amongst the general euphoria and frothiness.

Volatile conditions are understandable, but McBride does not give any guidance for the next financial year due to this. I would imagine shareholders would have wanted more here.

The company must be modelling scenarios, negotiating forward contracts, gauging customer demand for the year ahead and all the rest of it, so even a very broad range of outcomes would be useful.

Instead, the company hopes to update on the outlook in its September 2021 preliminary results.

There’s no doubt McBride stacks up well on some fundamental indicators, hence the StockRank of 98. But there is a lot of debt on the balance sheet too, and a pension fund to take account of. Meanwhile profit margins are low and capex spend is high.

It looks like a tough business. Markets and consumer spending had been favourable for years pre-Covid and McBride apparently did not have the product portfolio or business model to take advantage. There’s a lack of meaningful revenue growth here.

I imagine most of the upside went to branded fast moving consumer goods makers like Unilever. They have much more scale and bargaining power with some pretty large and ruthless customers.

Given the vulnerability to input inflation, an apparent lack of demand for various product lines, and the absence of any meaningful guidance, it’s not a stock I would analyse in any more detail for now.

Perhaps in September, if the company can provide more detail then. But even then, as a private label manufacturer, does the company have the ability to pass on prices?

Cambria Automobiles (LON:CAMB)

Share price: 79.5p (+0.63%)

Shares in issue: 100,000,000

Market cap: £79.5m

It’s been a similar rerating at Cambria Automobiles (LON:CAMB) as it has been for McBride, with the shares up by 50% or more over the past half year.

More money is flowing into the reflation trade and cyclical value in general. Car dealers tick a few boxes in this regard.

The shares here are quite tightly held by private investors and, with about 70% of stock held by the Top 10 holders, the free float in reality is probably less than the 50% or so shown on the StockReport.

Liquidity is an issue. The spread is 513bps and it looks like you can reliably purchase about 3k shares, which equates to an investment of around £2,385.

Cambria has good asset backing but low operating margins (as do most car dealers). The returns on capital figure is good though, at 14.6%, and the net debt figure is low. Meanwhile, shares in issue have remained stable through lockdown so it looks like the company is being managed prudently for shareholders.

The group was established in 2006 and has built a balanced portfolio of high luxury, premium and volume car dealerships, comprising over 40 franchises representing major brands across the UK.

Local brand names include County Motor Works, Dees, Doves, Grange, Invicta, Motorparks and Pure Triumph.

Interim results

Highlights:

• Revenue -16% to £254.7m,
• Underlying PBT +55.5% to £9.8m,
• Underlying earnings per share +52.4% to 7.79p,
• Underlying net profit margin up from 2.07% to 3.83%,
• Balance sheet net assets up from £68.5m to £79.5m,
• Net debt down from £6m to £5.6m.

The disconnect between the revenue and profit % result is interesting. New vehicle sales are down 16.6%, used vehicle sales are down 30.8%, and aftersale revenue is down 12.7% but group profits are up (partially as a result of cost reduction measures).

During the period, the group utilised the Government's Coronavirus Job Retention Scheme (CJRS) and the Business Rates reliefs to support its staff and operations.

Cambria's showrooms were closed for 82 days due to Lockdown restrictions, with the majority closed for a further 16 days as they operated in Tier 4 restricted regions.

All showrooms are now open though and the group was able to operate a digital click and collect service through the disruption.

Following the re-opening of showrooms on 12 April, trading has begun positively ‘however it remains too early to draw any firm conclusions about the trading outlook at this stage’.

The group also notes a ‘global semiconductor shortage’ that is impacting the production of cars and vans.

Cambria continues to withhold guidance until there is more certainty over new vehicle supply and the post-lockdown economic environment.

Conclusion

This update looks good from Cambria, but it also becomes more interesting when coupled with the above comments on McBride.

Again we have a lack of guidance, but there are some bigger themes at play here in the form of post-lockdown global supply chain disruption, which is driving inflationary pressures in some quarters.

On a company-specific level, Cambria looks to be doing well with the hand it’s been dealt. Underlying profit is up, the aftersales business is strong, and the cost base has been reduced. One off government initiatives like the Covid Job Retention Scheme have contributed to profits.

In fact, during the period the group benefited to the tune of £2.45m. That’s about 25% of underlying PBT, so is significant and should be treated as a one off.

That aside, the company has navigated a dangerous period and there is light at the end of the tunnel, with a wall of consumer savings and people presumably itching to get out for day trips in the summer months and beyond.

The group's strategy is to acquire earnings enhancing operations and it has a medium-term target of creating a £1bn turnover business ‘producing attractive returns on capital’. Forecast 2021 revenue is for £718m so that leaves a quarter of a billion in revenue to aim for in the upcoming years.

Cambria looks to be well positioned with a clear growth strategy in a disrupted sector, and the update reads well, so worthy of further research.