Small Cap Value Report (Weds 7 July 2021) - TLY, KINO, ACSO, SOM, WIN, QTX, REDD

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

Timing - today's report is now finished

Disclaimer -

A friendly reminder that we don’t recommend any stocks. We aim to cover notable trading updates & results of the day and offer our opinions on them as possible candidates for further research if they pique your interest. We tend to stick to companies that have news out on the day, and market caps up to about £700m. We avoid the smallest, blue sky type companies, and a few specialist sectors (e.g. resources, pharma/biotech).

A central assumption is that readers then DYOR (do your own research) and discuss in the comments below. The comments, incidentally, sometimes add just as much value as the articles. We welcome all rational views, whether bull or bear!

It's helpful if you include the company name or ticker within reader comments, otherwise some readers may not be aware of what company you are commenting on.

Agenda -

Paul's Section:

Totally (LON:TLY) - results from yesterday. Only trading around breakeven at PBT (I see EBITDA as a red herring, due to high depreciation & amortisation charges). Growth potential, but for me the £77m market cap looks high enough, or too high for where things currently are.

Somero Enterprises Inc (LON:SOM) (I hold) - what a lovely company! High quality, cash generative, and we're treated to another strong trading update today. Broker forecasts go up c.14%. Still looks good value to me.

Quartix Technologies (LON:QTX) - an in line with expectations update for H1, and confirms full year guidance. Impressive growth in fleet numbers, and overseas expansion going well. Valuation is too rich for me personally, but I like the business and management.

Redde Northgate (LON:REDD) - as it's not a small cap any more, I've commented on its results today in the comments section below this article, so please see that area if you're interested in this company.

Jack's Section:

Kinovo (LON:KINO) - notes from a follow up Q&A session with company management following yesterday's results, which saw the share price fall c7%.

Accesso Technology (LON:ACSO) - revenue expectations for FY21 have been upgraded again, this time to more than $100m. Trading sounds encouraging but not much to go on yet in terms of concrete figures.

Wincanton (LON:WIN) - strong momentum also in evidence across the logistics sector. Wincanton looks well placed to benefit but the share price is already comfortably above pre-Covid highs.

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Paul's Section

Totally (LON:TLY)

38.7p (down 9% yesterday) - mkt cap £77m

Preliminary results

Totally plc (AIM: TLY), a leading provider of a range of healthcare services across the UK and Ireland, is pleased to announce its preliminary results for the 12-month period ended 31 March 2021.

Title -

Record Revenue and EBITDA

Key points -

Impacted in various ways by the pandemic

Revenues up 7% to £113.7m, 93% of which is called “Urgent care”, which I think is mainly operating the NHS 111 phone line.

Low margin - gross margin of 18.3%

EBITDA of £5.0m, up 25% on LY (H1: £2.3m, H2: £2.7m)

Profit before tax only £0.1m (LY: £(3.4)m loss) - why such a big shortfall between £5.0m EBITDA and almost breakeven at PBT? (large depreciation £2.0m, & amortisation £2.8m charges)

Dividends of 0.25p interim, 0.25p final = 0.5p for the year (yield of 1.3% - low, but in a pandemic year when many companies suspended divis)

Presentation due on InvestorMeetCompany platform at 14:00 on 14 July 2021. There are 2 previous webinar recordings available to watch, I’m listening to the interim results presentation in the background whilst typing this (who says men can’t multi-task!)

No exceptional charges this year (LY: £2.0m)

NHS is a “reliable payer”, so cashflow is good - confirmed in the figures, as receivables look low relative to revenues, and cash of £14.8m is healthy..

Balance sheet - fixed assets are only £1.1m, so how come depreciation charge is £2.0m, seems too high? I suspect this may be due to IFRS 16, where some rent payments end up in depreciation & finance charges (ridiculous).

NAV is £34.0m

Intangible assets are £37.5m, deduct that, and we get £(3.5)m negative NTAV - not great, but given that it’s a capital-light business model, and receivables are low, the balance sheet seems perfectly adequate.

Cashflow statement - cash rose by £5.87m, but this is mostly due to £2.71m +£2.04m = £4.75m favourable working capital movements (receivables, and trade payables).

In my view, the business itself is not generating much free cashflow, once you strip out favourable working capital movements (since they can easily reverse in future years). Payments to HMRC were de

My opinion - I can’t get excited about this. Providing these services to the NHS involves a lot of work, and the margins are low. It’s only trading at around breakeven at the PBT level (EBITDA of £5.0m is a red herring in my view, as it ignores a lot of real world costs).

Therefore the £77m market cap looks too high, based on where the business actually is right now. Investors must be applying a premium valuation in the hope & expectation that profitability can rise significantly in future. Maybe that's justified, as management do talk about expansion.

There’s also the question of how much additional profits could be made as covid hopefully recedes?

I think this share is all about backing management to grow & develop the business. Subjectively, I imagine that management talk the right sort of language to reassure & connect with health professionals - their background is steeped in the NHS, a good thing. That’s probably why contracts tend to renew, and there’s an opportunity to gradually win more business from weaker competitors, perhaps.

I can see why investors might want to back this management team, but the numbers just don’t stack up for me personally, at £77m market cap. As always, I've no idea what the share price is likely to do, because that's driven by sentiment, we just look at the fundamentals in these reports.

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Somero Enterprises Inc (LON:SOM)

(I hold)

435p - £250m mkt cap

Trading Update

Somero® is pleased to provide an update on trading for the current financial year, ending 31 December 2021 ("FY 2021") following the end of its first half ended 30 June 2021 ("H1 2021").

Raising guidance due to stronger than anticipated trading in the US to end H1… and with this momentum carrying over to begin H2 2021, it now expects to exceed previous guidance for FY 2021 established in the 6 May 2021

Old guidance -

The Company's previous FY 2021 guidance indicated revenues were expected to approximate US$ 100.0m, adjusted EBITDA would approximate US$ 31.0m and net cash would improve consequentially from the original US$ 27.4m target established in our 10 March 2021 final FY 2020 results statement.

New guidance -

The Board now expects FY 2021 annual revenues will approximate US$ 110.0m, adjusted EBITDA will approximate US$ 35.0m, and year end net cash is expected to exceed US$ 33.0m.

That’s a 10% upgrade to full year revenues, and 13% increase in EBITDA guidance.

Or, $10m additional revenues, and $4.0m additional EBITDA. That makes sense, given that the gross margin was 55% last year, so today’s upward guidance allows for $1.5m higher overheads (i.e. $5.5m additional gross profit, resulting in $4.0m additional EBITDA).

Other points -

• Strong trading in May & June 2021 in its main market of the US.
• Higher momentum is carrying over into the start of H2
• Customer workloads at high levels, extending into 2022 (backlogs from covid) & healthy construction market (non-residential sector)
• eCommerce requirement for new warehousing is mentioned as a driver for growth
• Other regions trading in line with expectations
• New products contributing meaningfully to growth as expected
• Pipeline of new products to expand addressable market
• Dairy date 8 Sept 2021 for interim results to 30 June

Valuation - Finncap has issued an update. Price target going up to 590p.

Profit forecasts go up 13.6% this year and next year:

FY 12/2021: 45.4c = 32.9p (at £1 = $1.38), a PER of 14.3 (based on 470p current share price)

FY 12/2022: 48.7c = 35.3p, a PER of 13.3

My opinion - Somero looks good value to me, for such a high quality, cash generative business. It pays out cash in divis, and retains a strong balance sheet. This share seems woefully under-appreciated by the market, and always has been. I think it could sensibly re-rate to a PER of 20+ in the current market, so there’s good upside if I’m right about that.

Obviously we have to take into account that it’s a cyclical business, so how you view it depends on where you think we are in the economic cycle? My view FWIW is that it’s looking increasingly as if we’re in the early stages of an economic boom - which tend to last several years before things overheat & crash.

Personally I’m sitting tight with no plans to sell, or trim my existing holding in SOM. Obviously it’s up to you what you decide to do with your own money, e.g. some people like to bank profits when things rise a lot, or top slice some of them. For me though, the compelling value means I’m sitting tight for the foreseeable future. A takeover bid wouldn’t surprise me, as a bidder could pay the customary c.30% bid premium, and still buy it at a reasonable price, load it up with debt, and pay off the debt from the cashflows. Looks an obvious candidate for private equity in my view.

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Quartix Technologies (LON:QTX)

489p (flat today, at 11:27) - mkt cap £237m

Trading Update

Quartix Technologies plc, a leading supplier of subscription-based vehicle tracking systems, software and services in the UK, announces that it will publish interim results for the six-month period ending 30 June 2021 (the "Period") on Wednesday 28 July 2021. They will be posted on the Company's website that morning, together with accompanying presentations.

Quartix has traded well in H1

Strong growth in new fleet telematics installations

FY 12/2021 guidance -

In line to achieve consensus market expectations for the year

1 The Board believes that consensus market expectations for 2021 prior to this announcement, were as follows: Revenue: £25.6m; Adjusted EBITDA £5.1m; Underlying Free Cash Flow2: £4.0m.

H1 guidance -

The Board expects to report revenue of £12.5m, adjusted EBITDA of approximately £2.7m and underlying free cash flow2 of approximately £1.3m for the Period. The Company's cash balance was £4.2m at 30 June 2021.

Supply chain issues - this is self explanatory, and doesn’t sound concerning to me -

Although the sourcing of electronic components has been challenging during the first half, the Group has been able to secure its production supplies and remains confident of doing so through the rest of 2021. This has, however, been at the expense of higher costs in some cases and of needing to purchase larger quantities where components are available. This has had an impact on free cashflow in the Period and could have a moderate impact on free cashflow for the year as a whole if contingency stock levels need to be increased, but the additional costs are not expected to have a material impact on the Company's expected financial performance for the year.

Other points -

• Strong growth in new installations - 31% ahead of H1 2020, and 13% ahead of H1 2019 - good to see both comparatives
• Fleet subscription base is up 8% in the last 6 months, to 188,155 vehicles
• Insurance telematics - forget about this, it’s been winding down and is not significant

Current trading -

All major territories are now operating at above pre-pandemic levels with the exception of the UK, where record orders in H1 2019 were driven by a significant number of larger contract wins and distribution orders. This will be an area of focus for the Company's sales teams as contact restrictions are lifted.

New installations in international markets exceeded those in the UK for the first time, and performance in the Group's new territories and France were particularly encouraging.

Further investment initiatives are already underway which are expected to contribute to continued growth in the second half.

My opinion - every time I report on Quartix, I bellyache about the valuation being high, which it is. Based on current forecasts, the PER is now in the 50s, for this year and next year.

Is it a speculative frenzy then? No, I don’t think so. High valuations are often just a sign that the market believes in strong growth to come, and that forecasts are likely to be beaten.

The international growth is going well, and again that could be a reason why the valuation is so high.

Quality metrics are excellent, and often it can make sense to pay up for quality in the long run -

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The founder + family trust sold 7.2m shares at 401p in Jan 2021 (grossing £28.8m), but retain a very substantial remaining 10.66m shares.

Overall, for me, I like the business and management, but can’t get my head around the valuation.

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Jack’s section

Kinovo (LON:KINO)

Kinovo management discussion

I spoke with Kinovo management about their results yesterday, which caused the share price to fall c7%. First CEO David Bullen rattled off some points and then there was a more unstructured Q&A chat.

Notes are a little rushed - it’s hard to listen to, ask questions, and type up notes on a one-on-one video call to C-suite!

Key takeaways:

• This is a resilient performance given Covid disruption; £60m revenue is a good result
• H1 everyone was in the same boat; lockdown
• H2 was more complex with variable government tiering and new Covid variants; didn't re-furlough beyond initial wave; access rates to sites were an issue in H2
• In March 2020 the share price dropped down to 8p, so the company has proven its ability to navigate these tough conditions
• Net debt reduction and strong cash generation. Less than 1x leverage. Focus on WC efficiencies & investments during the year. However the cash conversion of 156% is likely unsustainable (see below)
• Divi subject to AGM - 1) nod to historic investors, 2) put a flag in the sand re. historic issues
• Rebranding & repositioning is important as it closes the legacy off & provides clarity on direction
• Underpinning that is recurring rev. £170m over three years, which doesn't include any frameworks like fusion 21, electrical, SSE for new build
• Will continue to focus on local auth housing associations, compliance and sustainability, long term contracts, recurring revenue, strong cash generation

Questions:

What is your competitive strengths that keep others at bay? Closest competitors?

End-to-end services help to strengthen the market position. The three Rs of recycling, renewables, and regeneration leave it well placed for organic growth (it’s a huge market).

Regarding its divisions of Mechanical, Electrical, Building Services, and Construction: there’s often a dividing line between mechanical + electrical and construction. Construction will be small scale but important as new builds will have to comply with sustainability initiatives, eg. no new gas boilers from 2025.

Kinovo’s businesses complement each other in terms of crossover work.

Huge market opportunity from existing and prospective clients.

Market shake up / disruption?

There was no supplier support or client support and limited government support for Kinovo.

Shake up has yet to come as there has been a lot of government support for others. That should unwind as support withdraws and some of it must be repaid. Also some inflationary elements (as companies in other industries have reported) so more to come.

Covid has become a positive and it’s possible that struggling competitors could be a tailwind down the line.

What is your target margin on a long term view? Gross and operating.

Run rates - gross margin dipped down during the year (covid related) down from 25% to 21%. Around half of this was down to volume and half down to less productivity and efficiency due to H2 site access issues.

They would hope for a sustainable gross margin of around 25% and an operating margin mid-single digits (north of 5%) on an adjusted basis depending on the exact nature of the contracts they ultimately win. Still low margin, so the company must be well managed at all times.

Where are you investing capital?

Historically Bilby had a buy and build focus with less attention on organic growth. This focus has been reversed under the new management, who believes there is great opportunity to grow organically.

It is building an end to end type service delivery in terms of what it offers. Build on core strengths: mechanical, building services, electrical and construction, but increase the breadth and depth across these areas. For example, Kinovo can become more involved in fire and security elements in electrical.

Compliance is non-discretionary spend. They can bring more of this house

Have ‘broken the back’ in terms of fixing the core of the business - the rebrand and repositioning, streamlining, reduction in net debt. Now it’s about depth & bredth of front end specialisation

They are not averse to acquisitions; will be very strategic to accelerate the above areas.

Why dividend over buybacks & strengthening balance sheet? Do you want any debt?

Positive progressive divi policy - older investors want income but the group will be conservative as it wants to reinvest into the business; have now got the backbone of the group, any further investment will be self-financing

Bullen doesn’t mind debt - but he wants good debt not bad debt, ie. debt taken on from a position of strength to finance growth and fund selective acquisitions, rather than an historic debt burden weighing on profitability.

By end of year the group, Kinovo should be near enough net debt free.

How much of an impact did Covid have? Why was electrical services down so much?

Struggled to access properties in H2 due to changing restrictions. This impacted electrical. Legal and regulatory work has been deferred and moved right.

Pent up demand is concrete, as a lot of the business is regulatory and compliance, which buildings will still have to do. It’s non-discretionary.

Closure of Purdy office etc. Quantify annualised cost savings

Fundraise in November, Covid in March, down to 8p and since recovered. Placing was well timed in retrospect.

Savings this year of c£1m+ but it won't all be to profit. The group is restructuring its cost base so that it can invest internally for growth.

Kinovo has moved very rapidly from survival to stability to growth in a time frame of just two years.

£4.6m cash inflow - is this a sustainable level of cash inflows? Or Covid benefits and expect moderation?

Not sustainable as a cash conversion percentage (156% this year). Internally they want high 80s; will continue to invest in the business; there is a positive one off element here.

They have invested in HR, IT, payrolls, and are offering opportunities for internal progression and personal development; improved clarity of strategic outlook. 90% of business is ensconced in ESG.

Standalone sustainability report will come out later in the year.

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Accesso Technology (LON:ACSO)

Share price: 590p (pre-open)

Shares in issue: 41,245,456

Market cap: £243.4m

Accesso generates revenue from ticketing, mobile and eCommerce technologies and virtual queuing solutions for the leisure, entertainment and cultural markets. As with other leisure companies, the shares have rerated strongly amid the successful vaccine roll out and, in this instance, are now above pre-Covid levels.

It’s worth noting that the company appeared to run into problems before the outbreak though. Accesso also has a net debt position, whereas most other high quality software companies tend to be net cash, in order to bolster their often light balance sheets.

Trading statement

Year-to-date revenues in 2021 significantly ahead of expectations… As a result, in the absence of major new impacts from the pandemic, the Board now expects full year revenue for 2021 to be in excess of $100m.

The current consensus appears to be for around $90.5m of revenue. In the group’s AGM statement, it said that stated guidance was $83.5m so its trajectory is now well ahead of that.

Since its AGM trading statement on 18 May 2021, Accesso has continued to benefit from pent-up customer demand and the accelerating trend towards online commerce. Its virtual queueing solutions have seen demand ‘well beyond historic levels’.

Accesso has also seen a significant uptick in demand from potential customers who are looking to introduce technology upgrades as part of their pandemic recovery initiatives.

To capture this long-term revenue opportunity, the Group is currently deploying additional resources across technology implementation, product development and customer support. While these investments will have a limited impact on Cash EBITDA in 2021, their full annualised effect will be felt in the 2022 financial year.

That’s interesting. It sounds like this is more than just pent up demand, but more of an entrenched shift in the positions of its customers. It’s good to hear the company talk about investing for the long term opportunity rather than a temporary boost that will revert.

Steve Brown, accesso CEO, said:

We are pleased by the robust results we are seeing as the leisure sector reopens. We're working hard to capture strong pent-up demand alongside ensuring significantly higher utilisation across our solution set. As our end markets emerge from the pandemic, we will continue to respond with adjustments to our business in order to capture the long-term value associated with this uptick in demand for our technology.

Conclusion

This company has not always been profitable, so understanding more about what went wrong in FY19 would be the next port of call. Presumably 2020 was largely down to lockdowns.

There have been some reasonably significant director buys recently.

I’ve never encountered Accesso’s services myself, but making physical queue lines a thing of the past sounds good to me.

Apart from that, there isn’t much detail here to go on. Yes revenue is up, but what about profits and cash generation? Presumably both are good.

I’m neutral for now until the next set of more detailed results but clearly there’s good trading momentum here and the fact that customers are looking to introduce technology upgrades does suggest that there could be further good news ahead.

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Wincanton (LON:WIN)

Share price: 440p (-6.4%)

Shares in issue: 124,543,670

Market cap: £548m

It’s a great time to be in logistics right now when you consider the amount of companies currently reporting issues, and Wincanton is well placed as a leading supply chain partner for UK business.

This is a very brief update today, so won’t spend too long on it.

AGM update

The Board confirms that the strong revenue performance recorded in the second half of the prior year has continued into the first quarter of this financial year, with sustained growth and an attractive pipeline of opportunities in each of the Group's four sectors. Wincanton continues to make operational and strategic progress and it is trading in line with expectations. Profits are up significantly on the same period last year.

Ikea has awarded two contract extensions to operate its customer distribution centres in Kent and Essex.

The group does note ‘sector-wide pressures related to the availability of drivers’ however.

Broker forecasts have been consistently nudged up but remain below pre-Covid forecasts. Meanwhile, the share price is comfortably ahead of pre-Covid levels.

Conclusion

It’s a very short update, but one that helps to confirm the positive tailwinds in this part of the market. Wincanton looks to have done some good work in its efulfilment capabilities, which have helped it to win those Ikea contract extensions.

Wage inflation would have to be fairly significant in order to outstrip the current buoyant trading. The net debt figure looks a concern at first, but around two thirds of it are capital lease obligations.

There’s a pension fund here to be aware of, with a recovery plan that sees Wincanton pay £18.2m pa from 2021 through to 2024 moving up with inflation, then £21.3m pa from 2024 through to 2027. It’s a big drain on cash flows, but if things go the right way then a recovering pension scheme can actually be great news for equity. That's very risky though, and not something management or shareholders have control over.

That aside, the question is whether or not the current environment is a transient logjam that will shake itself out or is symptomatic of a more sustainable increase in logistical demand going forward. The strides made in efulfilment look like a solid way to take more share in future.

The company also appears to have rerated from a multiple signalling distress to one that has broadly recovered and has growth prospects. On balance, it does sound like good news is to come but the valuation appears to have some of this priced in for now.