Small Caps Live Weekly Summary
CCT MACF ULTP
Nice weather always leads to fewer discussions, plus we are beyond the peak results season for UK companies. The nice weather generally leads to a cheerier investor disposition, too, and the strength of many small caps seems to reflect this. The news continues to be mixed, however. Here is what we looked at this week:
Character (CCT.L) - Half Year Results
This starts off well:
The Board is comfortable that the Group is on course to meet its targets
Here's the crux of it:
The Group reported profit before tax and highlighted items of £2.1m (HY 2023: £0.5m; FY 2023: £5.2m), the increase in profit being mainly due to reduced selling and distribution costs. This primarily related to the logistics costs associated with the Group's Scandinavian business being lower, as inventory was significantly reduced from last year, and increased influencer sales in our UK domestic market producing a lower advertising to sales ratio.
We see no reason why these lower costs shouldn't continue - inventory remained lower at the end of the period, and surely influencers are permanently replacing targeting children watching advertising-supported terrestrial TV.
In the past, we’ve not liked the company due to:
Overvaluation
Lack of brand ownership
Dealing in disposable plastic tat
Excessive management pay
EPS forecasts now 26.1p so this is no longer obviously overvalued. And on the lack of brand ownership:
The industry buzz around some of our new releases, such as Terror Fried, and new additions to our established lines, like Goo Jit Zu, is very encouraging too.
A recovery seems to be well underway, but not yet reflected in the long-term share price:
It now looks more likely that it could return to the 40p+ EPS of previous boom times. You could argue that for most points in the above graph, it "should" have been priced 20% lower, but at the very least, this now looks cheap compared to historic valuations.
One thing we'd caution about is that the cash inflow from inventory sales is not repeatable and history suggests it may reverse at some point. Plus, some of our list of concerns with the company remain. Just overvaluation isn’t the most obvious one anymore.
Macfarlane (MACF.L) - AGM Trading Update
Macfarlane have always been fairly conservative in their forecasting. However, this still isn’t a great update:
As anticipated, the start of 2024 has been challenging with first quarter sales and profits below the same period in 2023.
Here’s the key detail:
Sales in the first quarter were 9.5% lower than the same period in 2023 with continued weak customer demand and price deflation with the profit impact being partially offset by strong gross margins and the benefit of acquisitions.
This sort of revenue drop looks really poor given that it isn’t even a like-for-like figure and will have been aided by the acquisitions they made last year, but this is a distributor, so revenue varies with product price. We suspect the word “partially” does the damage here, as ideally, you want to make hay when your product price falls, and you are slightly slower to adjust pricing. However, not all is lost:
We expect some improvement in trading conditions in the second half of 2024 and we have a clear plan of management actions to enable the Group to continue its progress.
A 2nd half-weighting adds to the risk here, but they remain confident of meeting expectations. Broker, Shore keep their forecasts and they appear to be above consensus, or at least their way of making adjustments is!
However, a P/E of around 11 is surely about right, if not generous, for a company not forecast to grow beyond inflation from 2022-2026 and with a 3% dividend. The bullish will point to that conservatism, and that historically they have compounded EPS more rapidly than this. However, with an H2-weighting, the risk is that they miss this year. Or only hitting expectations via making an acquisition, which seems to be what they are hinting at (and excluding the costs of acquisition?).
Looking at the share price graph, the recent rise appears to be largely speculation, or perhaps more generously, investor cash returning to the small cap market and buying into momentum.
However, this is one case where the optimism appears to be misplaced, as it doesn't seem to have been backed by broker consensus:
This is perhaps a warning to those of us tempted to get excited by the current turn in sentiment towards selected UK equities - for such rises to be sustainable, they have to be backed by fundamentals, eventually.
Ultimate Products (ULTP.L) - Q3 Trading Update
When we looked at these less than a month ago, we said:
…given the usual seasonality, doing similar EPS in H2 as H1 looks a bit of a stretch. They must be really confident in pulling something out of the bag to say these will only be marginally lower this year. Management here are not the type to overpromise. Let’s just hope they deliver.
From the share price reaction, it looked like the market was looking forward to FY 2025, and any miss for FY 2024 would be small, given generally conservative forecasting.
However, this week they say:
In the Group's interim results, it reported total revenue down 4% with Adjusted EBITDA broadly flat on the prior year. Since that time, trading has been impacted by a slowdown in near-term sales from landed stocks (call off, regular stock and online sales), typically at higher gross margin, reflecting the broader slowdown seen in retail sales to consumers. This has resulted in revenue being down 7% year-on-year for Q3. The Directors believe it is sensible to assume that these trading conditions will continue throughout Q4. Therefore, the Directors expect FY24 revenues to be at least £156m, with gross margin being in line with last year, and Adjusted EBITDA to be in a range of £17.5-18.5m.
This is a classic reason why the market dislikes H2 weightings. So, in revenue terms, the miss is small - £167m to £157m. However, that relates to a very material reduction in EPS from 15.7p to 12.7p. While there was some signposting, it is now evident that they should have nudged forecasts down earlier - we certainly didn’t expect a company of this calibre to be issuing 19% profit warnings in one go. It seems bad form to go from being upbeat in a presentation less than a month ago to a profits warning this week. And not on a Friday, when investors are winding down for the week. Not a good start for Andy Gossage in his new role as CEO.
Here's the reason for the miss:
trading has been impacted by a slowdown in near-term sales from landed stocks (call off, regular stock and online sales), typically at higher gross margin, reflecting the broader slowdown seen in retail sales to consumers.
But much of the revenue miss is really just because the unusual H2 weighting didn't materialise, with the lack of progress on margin just exasperating this. They continue to be optimistic for FY 7/2025:
we are continuing to see the gradual resumption of normal ordering patterns from our retailer customers as the overstocking issues brought about by the pandemic subside. The increase in forward ordering by retailers has primarily been benefitting our forward order book for FY25, and as a result we are already seeing significant growth over the FY24 order book.
Yet FY 2025 forecasts have also been cut—revenue down from £175m to £167m and EPS down from 17.1p to 15.3p. The trajectory for cash and dividends has also materially worsened. They have form for issuing a profits warning, guiding brokers down by too much and then beating these figures. Last time, this gambit worked, and the rating actually increased, so they may well be playing similar games here, and things aren’t as bad as they seem.
However, balancing this is that it almost always pays to sell on the first profits warning. While the idea that these always occur in threes is not necessarily correct, the share price is usually weak for some time, regardless of future warnings or not. As such, it seems no rush to consider investing for any recovery.
That’s it for this week. Have a great sunny weekend!