Again, there is a limited amount of news this week. Here is some of what we discussed.
Argentex (AGFX.L) - Board Change & Trading Update
Having lost their founder-CEO last week, Argentex lost their CFO this week:
…announces the resignation of Jo Stent, Chief Financial Officer from the Board of the Company with immediate effect. She has agreed to work her notice period whilst a suitable replacement is identified.
It seems that the relationship here hasn’t completely broken down because:
She has agreed to work her notice period whilst a suitable replacement is identified.
However, we expect the immediate effect means she is off the board and doesn’t want the legal responsibilities of the board position. Unlike Adams, she is actually thanked by the Chairman.
Then, a few days later, we get the news that:
Argentex expects to report revenue and operating profit for the year ending 31 December 2023 at approximately the same levels as for the twelve months ended 31 December 2022, which are below current market forecasts.
Perhaps unsurprising, given that they have just lost most of their board. However, if this is the reason for these board members leaving, then surely they should have told shareholders over a week ago with the first announcement. It seems doubtful to expect that this Friday was the first the board has heard about the weak trading. If the CFO knew but was not communicating with the board, why is she being asked to work her notice? Perhaps the Chairman also needs to fall on his sword here.
The share price fell on the news that the CFO was leaving, with many reading between the lines. However, it actually bounced on the profits warning. Perhaps investors feared much worse. Given the coalition of chaos that appears to have been running the show here, we wouldn’t rule out further resignations or warnings.
With Argentex describing business conditions as “challenging”, we can also see why competitor Equals seems so desperate to sell themselves that they announced a bidder last week, who promptly RNSed that Equals approached them and didn’t want to bid!
Luceco (LUCE.L) - Q3 Trading Update & Investment
Forget what other companies say about resilience. This is what resilient performance in difficult markets actually looks like. Sales are up 8.3%, the operating net margin is up around 1% and free cash flow from releasing working capital brings net debt below their target range at the end of Q3. Also, there is a positive outlook for Q4, although partly due to weaker comparables.
The full-year guidance is unchanged, but this gives a lot of confidence that the management here knows how to run this business well. The market didn’t like the update, though, with the shares down around 10%. Normally, at this point, we would expect that a closet broker downgrade had been deployed. However, Liberum say:
We hold EPS estimates for 2023 and 2024, having upgraded them twice already this year.
We can only guess that a few were hoping for a third upgrade.
The next day, the company announced an investment:
Luceco has subscribed for 35,078,000 new ordinary shares in eEnergy at a price of 5p per share, representing a total investment of £1,753,900 for approximately 9% of the enlarged issued share capital of eEnergy. Luceco will have the right to nominate a board member.
With a forward P/E of 400, according to Stockopedia, we are not sure eEnergy would be our first choice for investing in, especially since they are paying 5p versus a share price of 4p prior to this announcement. It is on a historical P/E of 19 and doubling revenue this year, so forward P/E is perhaps not a great measure. The announcement from eEnergy perhaps reveals more of the real reason:
The subscription proceeds will be used for general working capital purposes, including settlement of certain trading balances due to Luceco.
Following the Investment, eEnergy will maintain Luceco's share of applicable lighting spend at current levels, subject to competitive pricing and stock being made available.
It sounds like they were overdue paying Luceco, and they said, “We’ll take payment in shares.” How to turn a credit provision into an asset! It looks like there may be scope for Luceco to do well out of this in the short term, as Energy say:
During the first half of 2023, the Board received a number of unsolicited approaches expressing interest in acquiring the Energy Management division (the "Division")... cash offers which valued the Division in excess of £30 million.
eEnergy intends to invest this capital back into the business, but at least that means buying more Luceco products. Hopefully for cash this time!
Still, the amount “invested” is small beer for Luceco, which remains a very well-run business on a modest rating.
Warpaint London (W7L.L) - Trading Update
An H1-H2 analysis indicated a positive trading update was virtually inevitable for Warpaint, and here it is:
The Company is pleased to report that the strong trading has continued, with significant growth in all geographic areas, and consequently the results for the year ending 31 December 2023 are now expected to be ahead of market expectations.
Broker Shore retained a £14.5m PBT forecast at the time of the H1 results, so £16m+ is just over the 10% materiality threshold that mandates an announcement. Stockopedia's consensus forecast trend often merely captures delays to broker updates rather than a true trend, but not here, with a single broker and spaced-out jumps:
This not only suggests strong trading but conservative rather than extrapolatory forecasting. For example, they might only be counting revenue where they have a 99%+ probability of recognising rather than doing a weighted probability thing.
We think this sentence is the key part of the trading statement:
Group sales for the year ending 31 December 2023 are now expected to be at least £85 million (2022: £64.1 million), with the key pre-Christmas sales period for the Group still ongoing.
In summary, there is a lot of evidence that forecasts still don't include significant amounts of pre-Christmas sales that they hope and expect to make and that the final results will almost certainly be for yet another beat. A repeat of today's 4% ahead on revenue and 10% ahead on profits would be our best guess.
The trouble is that even if we assume a future beat of this magnitude, the implied FY2023 17.3p EPS would need to be repeated 18 times just to get your money back. This seems a lot for a producer of unpredictable fashion-driven consumer discretionary products, even in normal market conditions. Growth is forecast for next year, but the future is a foreign country.
The Works (WRKS.L) - Trading Update
This is a profits warning, with EBITDA expectations down from £10m to £6m. The blame is put on:
In the nine weeks since our previous update, consumer demand has softened further and, combined with unseasonable weather conditions, this has caused reduced footfall.(1) We have seen a slowdown in the rate of store LFL sales growth as a result, particularly in October although, conversely, the online LFL has improved.
Which they have responded to with more promotional activity. Of course, a 40% drop in EBITDA means that EPS drops by much more. The broker upgrade that happened in September now looks unwise:
In light of this, that the share price hasn’t dropped below the level before this upgrade seems bonkers.
They say:
The Group had net bank borrowings of £2.5m at the Period end, reflecting the build of stock prior to the peak trading season, and the corresponding low point in cash levels. There was £17.5m of headroom within our £20.0m bank facility.
This doesn’t sound too bad until you realise that lease liabilities are over £30m more than lease assets. Any further downturn in trading could easily put them under.
Zotefoams (ZTF.L) - Trading Update & Board Change
The Group has good visibility of confirmed orders for the remainder of the year and expects to deliver revenue for 2023 at a similar level to 2022, albeit with an improved product mix.
…it expects adjusted profit before tax to be in line with current market expectations. Current Zotefoams-compiled consensus expectations for adjusted profit before income tax and separately disclosed items, for the year ending 31 December 2022, is £12.5m.
This looks like a warning on revenue as Stockopedia says the consensus is £134m versus £127m the prior year, and Singer have cut from the forecast £132.7m in September to £127.5m now. They were saved by product mix, or perhaps inflation peaking and savings not yet being passed through to customers.
£12.5m PBT also means the H1-H2 split is £7.4m-£5.1m, so they look to be going backwards. There is Q4 weighting highlighted in the Singer note. This is not evident in the RNS beyond them saying Q3 was weak but implying there was better momentum in October that they hope will continue:
The Board is confident in the Group's ability to carry positive momentum through the remainder of the year.
Singers say:
A strong final quarter is expected and good underlying growth in profitability in the combined foam business.... Our net debt forecast rises by £4.5m to £32m to reflect the phasing of sales into Q4 and a build in inventory ahead of Q1 FY24.
So, they look at risk of a last-minute EPS miss. The key point, however, is that even if they manage to hit these forecasts, £12.5m PBT is £9.3m Net Income, giving a return on equity of 8.2%. (Assuming similar equity to the Half-Year). So, this is yet another year of returns below their cost of equity.
We also get news that the CEO is retiring after 23 years at the helm. The Chair says:
David has made an enormous contribution to Zotefoams.
Given that the company has not generated a return above their cost of capital for almost all of his tenure, David has certainly not made an enormous contribution to shareholder value. Indeed, he appears to have consistently destroyed it.
The kindest interpretation is that he was taking care of other stakeholders, such as employees, by not shutting down the unproductive parts of their business. Another reality may be that the productive and unproductive parts simply can't be separated, and they are hoping the loss-making "growth" parts eventually deliver sufficient returns to make the other parts worth keeping going. However, if this is happening anytime soon, why would the CEO leave now?
If the second option is true and the businesses can't be separated, then this tears a hole in the argument that we should value this business as a sum of parts. Which is pretty much the only bull case.
Perhaps we are being a little harsh on the retiring CEO here. After all, Warren Buffett famously said:
When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.
The CEO may well have been a brilliant manager who sadly ended up running a business with terrible economics.
That’s it for this week. Have a great weekend!