Another very quiet week for us on SCL. The first retail shares started to report with both Next and Greggs giving us insight into consumer sentiment. Next beat expectations after strong Christmas trading, helped by colder weather driving outerwear sales. However, the outlook was pretty cautious, so we were surprised the market liked these as much as they did. Greggs was in line. Both are decent businesses, but as large caps with 13 and 20 P/Es, respectively, we are unlikely to have any competitive advantage analysing these vs other commentators or the market.
Tips
In general, the markets in 2023 seem a little more positive, suggesting that small cap investors are starting to cautiously redeploy the capital that was scared out of the market by a very tricky 2022. The effect is not uniform, though, and as usual for this time of year, tips play quite a big part in where investors feel most comfortable investing. You have to feel sorry for the tip writer, though. You’ve got to suspect that the “Midas” column had to be hastily rewritten after one of their picks, Harland and Wolff, had a massive profit warning just before publication, as we reported on in last week’s summary email.
Since then, Mark also looked at the Harland and Wolff balance sheet, which turned out to be shockingly bad. The Current Ratio was just 0.57 on 30th June, and with ongoing losses is likely to have deteriorated further. They also had negative net tangible assets, which again will be eroded by the massive losses this year. In light of this, tipping this in a national newspaper seems pretty irresponsible. While it's certainly possible the company will survive and even thrive, this is a very risky stock that could easily be a zero or dilute existing shareholders to nothing. The average tabloid newspaper reader is unlikely to have the skills to assess the risk of this objectively.
While we are often very critical of tip journalism, we were pleasantly surprised by this article. And not just because it covers a company, Capital Limited, that we think is undervalued. It’s a surprisingly balanced and thorough view on the company, including the risks as well as the upside potential.
Small Caps
Heiq (HEIQ.L) - Trading Update and Acquisition
There has always been a bit of a smell about Heiq, which looked a lot like an optimistic covid float that never lived up to the hype. When we last looked at the company in August 2022, they were expecting to be in line with expectations, and we said:
…which means a 29x forward P/E. Seems much too high for a company whose bullish talk rarely appears in their financial numbers.
It seems we were right to doubt their bullish talk since this week, they say:
Whilst trading during the third quarter of FY 2022 remained reasonable, worsening macroeconomic conditions into Q4 have resulted in a significant deterioration in consumer demand which, in turn, impacted the Group's sales during the period.
Caused by:
HeiQ's customer base had up to 70% less demand in Q4.
Oh dear! Remember, this is probably the seasonally strongest quarter, so has a disproportionate effect. They blame the idea that:
Brands have become more hesitant to invest in innovations at this particular time.
The trouble is it is difficult to disentangle how much hesitancy is down to customers deciding these "innovations" have no benefits and how much is overstocking/low demand. Here are some of the examples Heiq select and so presumably are more credible than most:
HeiQ AeoniQ, the world's first cellulosic climate positive fibre...
HeiQ Synbio probiotic cleaners...
HeiQ GrapheneX membrane to leading players in the production of batteries and handheld mobile devices...
HeiQ ECOS silver nanowires, conferring infrared reflection for transparent insulation of building windows and stealth technology for defence
HeiQ BRAP, biodegradable meta material derived from bovine waste
So, what's the damage?
As a consequence, the Company expects a loss before tax of between US$ 2.5m and US$ 3.5m
The Company also expects trading for FY 2023 to be below market guidance, with anticipated sales and gross margins maintained at FY 2022 levels.
So how to get out of this hole? An acquisition, clearly:
…has signed an agreement to acquire the entire issued share capital of Tarn-Pure Holdings Ltd ("Tarn-Pure"). Tarn-Pure is a UK-based intellectual property company holding critical EU and UK regulatory registrations to sell elemental copper and elemental silver for use in disinfecting hygiene applications.
This appears to be about consolidation in a mature (at best) market.
Their house broker Cenkos takes (yet another) knife to forecasts, with 2023E EPS dropping a further 90%.
In light of this, the 50% fall in the share price on the day looks like an under-reaction.
The CEO has tried to shore up sentiment, spending £150k on shares at 28p. So a not an insignificant amount. However, connected parties to Mr Centonze sold around £2.9m worth of shares in the IPO, so he still appears to be quids in.
Given the lack of earnings, then the only way to value this is on tangible assets. NTAV is around 22p. However, realistically you’d want to buy at a big discount to this to cover the poor track record since listing and the fact that those assets may never be particularly productive. So Mr Centonze may yet regret this week’s purchases.
Dignity (DTY.L) - Takeover Offer
Unlike Dignity’s clients, the era of takeovers is not dead:
The Proposal is 525 pence in cash per Dignity share, which is a 23.4% premium to Dignity's closing price of 425.5p as of 3 January 2023, which was the last trading day before the release of this announcement, and a 32.4% premium to Dignity's closing price of 396.5p as of 11 November 2022, which was the last trading day before preliminary agreement was reached between the parties on price.
This is another one where the premium looks a little light, but this is another one that has bounced with the market while the discussions have been ongoing. In addition, there appeared to be a genuine insolvency risk with the loan covenants if they didn’t fix the capital structure. Given this and the existing holdings of the offeror, this looks like a done deal.
That’s all for this week. We are expecting a busier week next week.