Small Caps Live Weekly Summary

Popularity Problems HEIQ CRL MGP VANL BSE BKS CARD QUIZ CAPD MYX

There was no Large Caps Live this week, but we are well and truly into results season now so there was plenty of small cap news to keep us occupied.

Mark did a book review of a great book called ‘Dead Companies Walking’ at this week’s Mello Monday investor event. Leo also presented the company SCS as part of the ‘BASH’. He included a unique data set that he had gathered from the company’s Trustpilot reviews. This is a unique analytical edge that other small cap investors are highly unlikely to possess, so would be well worth your time checking out if you didn’t see it on Monday.

Small cap markets have been a little weak recently and the weakest of hands sell first and therefore sell-offs tend to disproportionately affect the popular stocks. Therefore, we thought it is worth starting with a cautionary tale of the problem with popularity.

As an example, let's look at the 1-month performance of some stocks that one of the most popular small cap commentators, Richard Crow (Cockney Rebel), has been tweeting about over the last month or so:

So, as you can see, investors who followed Richard into the stocks will have faced a 15% loss on the month, on average. Of course, this isn't to say that this was Richard's performance, he may well have sold out many of these (indeed someone of his portfolio size may actually cause the falls not just be victim to them), and many will have been long term winners, far exceeding the recent drops. But this highlights the risk of being in illiquid, popular stocks.

Richard also may well be able to stomach a 15%+ monthly loss in relatively benign market conditions (this still isn't a major sell-off) but for many newer investors, and even if it happened to us, it would be decidedly uncomfortable.

The moral of the story is not to blindly follow anyone in or out of a stock, and if you are relying on the research of others, even us on here, you should expect higher volatility since, by nature, this will attract inflows on the way up and outflows on the way down, exaggerating the otherwise normal market fluctuations.

Small Caps Live Wednesday 29th September

HEIQ (HEIQ.L) – H1 Results

This was one of the biggest fallers on Tuesday, down about 25% on these results:

· Revenue of US$25.8m, decreased compared to an exceptionally strong pandemic related 1HY 2020 (US$ 30.1m), and up +27% compared to 2HY 2020 (US$20.3m) reflecting consumer driven demand for innovative functionality from brands.

· Adjusted EBITDA of US$4.8m, lower than 1HY 2020 (US$12.0m) and up 147% on the prior half year period 2HY 2020 (US$1.9m)

· Operating costs of US$10.6m, up 48% (1HY 2020: US$7.2m) reflecting the investments across sales channels, digitization, branding, regulatory and innovation in line with our communicated strategy for future growth

This is very much looking like a well-timed IPO, listing on the exceptional demand for hygiene-related products in early 2020. It doubled shortly after IPO as it was touted as a growth stock in a tech industry.

The very high rating meant that investors were assuming that it would beat forecasts. However, the outlook suggests otherwise:

Macro-economic issues such as supply chain instability, together with freight and raw material costs, increasing by up to 500% and 300% respectively over 1HY 2020, have had a significant impact on our supply; lockdowns in some key regions for our industry, particularly South Asia, resulted in delay and loss of sales due to forced shutdown of manufacturing facilities. The market for facemasks and personal protection equipment (PPE) is under extreme price pressures caused by low-cost suppliers flooding the market in Q1 2021 and there being large amounts of excess stock from the previous year.

Indeed, the accompanying note from the house broker Cenkos slashes the EPS forecasts:

Down 70% for 2021 & 63% for FY22. So, in light of this, a 25% fall looks far too light. This really should be down 60%+ on the earnings outlook and then a further reduction since it should logically lose its growth rating.

Valuation-wise, an 80-90% fall wouldn’t have seemed out of place. However, stocks rarely re-rate so quickly - investors are slow to update models, have fallen in love with their stocks and anchor on higher prices. So anyone who holds and hasn't sold yet has still been given a gift to get out at a price that still seems wildly overvalued.

Creightons (CRL.L) - Acquisition

Hot on the heels of what looked like an expensive acquisition of Emma Hardie, Creightons announce an acquisition that more closely matches their existing business:

Creightons, manufacturers of personal care, beauty, and fragrance products, announces that it has acquired the entire share capital of Brodie and Stone Holdings Limited and its subsidiary, Brodie and Stone International Limited.

Brodie and Stone sells products under the T Zone, Natural World and Janina brands, primarily to retailers in the UK market.

Although we thought they were more looking for brands with existing online sales presence, and these appear to be weak in this area.

Here’s the financial details:

The gross assets applicable to the Transaction as derived from the most recently available accounts of BSH and BSI to 31 December 2020 were £2.2 million and the turnover was £5.8million, with profits before tax of £0.5million, as adjusted

The consideration for the transaction is approximately £4.8 million comprising £3.7 million in cash and the issue of 1,000,000 ordinary shares.

So, looks immediately earnings enhancing. It makes sense for Creightons to do as many of these sorts of transactions for as big a proportion of shares that they can get away with, given their new high rating.

Both manufacturing and management synergies will drive a higher return in the brands.

Branded T-Zone products are found in Superdrug and Tesco, but looks like they may have agreements with retailers not to sell online. Natural World is apparently Tesco only.

Janina sounds like it might be a more unique name, but it is a relatively common female name. It is a toothpaste apparently: https://www.janina.com/. Again, looks like a condition of being on Boots.com is that the product is an exclusive.

So they look like moderate-poor quality brands with limited development possibilities and strategic value. But they are not terrible and do look like a reasonable fit with existing brands. At less than 1x sales they are not expensive and there are likely to be very considerable cost synergies.

They say:

These brands are placed well in the Company's core market position and therefore, enhance the current brand portfolio by strengthening the coverage and category presence with key mainstream retailers in the UK market, in the core performing categories of both skincare and haircare.

Agreed - retailers being Superdrug and Tesco (plus Boots online)

There are also significant opportunities for extending distribution, particularly in international markets

Mostly agreed - brands names may be too generic in some countries.

The brands provide good vehicles through which product innovation can be harnessed and delivered quickly to the consumer.

Not sure the brands are great but Creightons so seem to do pretty well managing low-end brands by using operational excellence. Perhaps it is the manufacturing volumes and customer agreements that are more valuable than the brands? The target company was doing well to generate almost £6m of revenue from 6 employees, so clearly, manufacturing was outsourced and will be brought into Creightons.

Both manufacturing and management synergies will drive a higher return in the brands.

In general, we much prefer this acquisition to the rejected takeover of Innovaderma. Better value, better cultural fit, easier acquisition. Clearly, if they continue acquiring at the current pace and manage to integrate well then they will easily meet their medium-term growth objectives. But it is unclear how many brands of this size are available at reasonable prices, and acquisitions/integrations are always risky. And these sorts of deals are also a lot easier when your shares are at all-time highs.

Medica (MGP.L) - H1 Results

UK NightHawk revenue increased by 39.1% from £10.2m to £14.3m compared to H1 2020 which was initially impacted by the pandemic. Compared to H2 2020, revenue also increased by 12.6%.

Whereas:

UK Elective revenue decreased 8.5% YoY from £6.7m to £6.2m due to the comparative period which included a strong Q1 2020, before the impact of Covid-19. However, compared to H2 2020, Elective revenue increased 8.8%.

Really what we want to know here is the terminal LFL revenue run-rate for both these operations compared to 30th June 2019:

CEO / CFO Outlook

In my experience, extrapolating the short-term outlook is often a better guide to the future than the medium-term outlook. This is because short-term outlooks are based on things that are actually happening on the ground, where as the medium term is based on educated guesses.

Elective reporting activity in the UK is now close to pre-pandemic levels (when compared against average reporting activity in January and February 2020 combined).

Although we would have liked these results issued two months ago.

Following an extremely busy summer period, we expect Elective activity to continue to build month-on-month throughout the remainder of the year aided by the continued NHS efforts to tackle the significant Elective backlog.

This assumes that there is no further material impact of Covid-19 on the ability of the NHS to manage Elective activity. While there's been a lot of unpredictable irrationality, they seem to be starting to get their act in order over COVID and so these impacts should be relatively predictable from data on COVID and winter flu cases. Nighthawk continues to see month on month growth with significant opportunities to continue to expand services with existing clients and to win new contracts.

So it looks like Medica is in at least as good a shape as pre-COVID - Jan / Feb 2020. The share price was then 156p, after a peak of 165p. So current share price of 168p (up 3% today and below the recent high of 170.5p) seems reasonable on that basis.

Liberum have updated with EPS forecasts of 7.7 and 9.3p for the next two years. This is a forward earnings yield of around 5%, which is a level where you’d say that such growth expectations are priced in, and then some. Liberum also include a financial model that has not yet been updated for FY 2020 results issued in May! Forecasts have been significantly upgraded since then, but still show an EPS of 15p in 2025, which is hardly ground-breaking. They also make claims that a semi-mythical DCF model shows a fair value of 245p. The discount rate and terminal P/E used are not disclosed.

What has certainly proven to be a myth is the idea that Medica's business is defensive against external shocks, and this must affect the valuation.

Van Elle (VANL.L) - AGM Statement

Van Elle had bucked the trend for share price weakness in September and rose in the following brief trading statement:

The Group's positive start to FY2022 has continued since the date of its final results announcement on 17 August 2021, with strong revenues being achieved across most divisions. The medium-term outlook for Rail remains positive, with increased tendering opportunities and a steady increase in contract activity.

This is good news because rail is the highest margin part of their business.

The Group has continued to experience the effects of industry-wide supply chain challenges and short term employee availability but, despite this, has continued to trade profitably.

So not unexpected that they face some issues, but trading profitably is a pretty low bar to step over given how strong the construction sector is.

The balance sheet provides significant headroom for growth and the Board continues to expect a return to profitability for the full year, in line with market expectations.

The balance sheet is one of the attractions with the shares on just 1.3x Tangible Book Value. However, a lot of this is fixed assets and working capital. And they had to do a placing last year to repair the short term balance sheet.

The problem is these assets have been relatively unproductive over the last few years and an in-line trading statement here does little to change that reality given the forecasts:

The forward P/E is c.27 with a Net Profit of £2.3m. £2.3m on a book value of £44m (at last balance sheet date) is a ROIC of just 5.2%. Even if they hit the brokers forecast for 2023 without expanding their balance sheet this is only 8.9% ROIC.

So, although a strong recovery is forecast, this remains a relatively poor quality business on an unusually high earnings multiple.

Base Resources (BSE.L) – Updated DFS

Mark presented Base Resources at the recent Stockopedia StockSlam event.

The essence of his Stockslam was that Base are a genuine ESG company - doing the right thing, generating profits for shareholders but also significantly enhancing the lives of people in the countries and areas they operate in.

Beyond their positive impact for local stakeholders, Base are so profitable in Kenya at the moment, that if they don’t end up developing the Toliara mine in Madagascar (this is on hold while they negotiate fiscal terms), then you largely get your money back via dividends. However, if they do progress Toliara then you will see the shares multi-bag, in time, through the sheer amount of free cash flow this project will generate.

How high the shares can go depends on the economics of that Toliara mine. So, in light of this, they gave Mark a nice Birthday present on Monday:

DFS2 Enhances Scale and Economics of the Toliara Project

By optimising the DFS, they increase the production rate after the first few years and therefore significantly enhance the economics of the project. Given the location, we think the NPV12 is a more realistic figure for shareholders to use than the NPV10. The NPV12 increases from $461m to $733m. This increase is despite updated figures for costs to match recent global cost inflation for steel, energy etc.

This figure needs to be discounted to reflect that this NPV is from the point of Final Investment Decision and that the project may not go ahead. However, the current market cap is around $240m and Mark estimates a DCF valuation of about 18p per share, even if Toliara is cancelled.

The chance that Toliara goes ahead isn’t 100%, but it isn’t zero either, which is the current valuation the market is currently putting on this project.

Beeks Financial Cloud (BKS.L) - Results and Trading Update

Unusual for a company to separate out these announcements on the same day, guess they wanted to create extra impact, and this has never been a company that is shy to blow their own trumpet.

The Group has continued to successfully deliver against its strategic objectives, achieving record sales in excess of $5 million of total contract value through July, August and September, ahead of Board expectations. Consequently, the Group's annualised committed monthly recurring revenue has increased to £15.0m (30 June 2021: £13.8m) and the Group will recognise an additional £1.3m of revenue from non-recurring product related bookings during the year from signings to date.

They did a £5m placing in April at 115p which we’d flagged as a risk due to their very poor balance sheet, poor cash flow and new contracts. Despite the raise, the balance sheet looks weak, with a current ratio of just 1.04 at 30th June.

The share price then really took off from early August on a trading update.

Prior to this week’s update, the market forecasts were for a fall in EPS for the current year (depending on how you choose to do the adjustments to the EPS) partially due to the dilution. So this doesn’t exactly seem to be a difficult bar to overcome. Or one that should cause the share price to double to a P/E over 40 even when looking out to 2023 estimates:

Even if we trust the 2023 estimates, and assume they can get away without further dilution, this puts them on a forward earnings yield of around 2% and a free cash flow yield of much less. This seems an extraordinarily high rating for a capex heavy company that is forecast not to grow EPS much this year and with a weak balance sheet.

Card Factory (CARD.L) – Interim results

This is an interesting company to follow since it hasn’t recovered anywhere near its pre-pandemic highs:

But then again, trading hasn’t returned to previous highs and there is concern over the high street footfall. Wayne looked at this in a recent Large Caps Live and thought that this concern may be to do with how these things are measured and the real high street outlook may be better than we expect.

Card Factory say that footfall is down significantly but the transaction size has increased to offset this:

High street footfall remains below pre-pandemic levels, impacting transaction volumes with Springboard reporting footfall for HY22 (from April 2021) being down 27.4% on a LFL basis compared to HY20. Average basket value has increased by 27.8% to substantially offset the decline in transaction volumes. This is due primarily to consumers spending more across fewer shopping trips.

So people are going out less often but spending more, buying 4 cards instead of 3.

It has always been run with high debt since its cashflows supported this...until the pandemic. But despite being loss-making, the EBITDA is still pretty good:

These are to 31st July so without key Christmas trading. If we get a normal Christmas then EBITDA could be £60m+? Market Cap is £190m. Online is still a small %age of sales so this is a high street play.

The debt is a potential issue though:

Completion of successful re-financing

As previously announced on 21 May 2021, Card Factory completed a £225m refinancing during the period. The facilities are structured to incentivise an early reduction of overall debt, with fees of up to £5m payable if pre-payments are not made in line with specified dates by 30 November 2021 through until 30 July 2022. The Company is permitted to facilitate these repayments through the issue of new equity or by using funding from subordinated debt sources. The Company continues to evaluate the options available to the Group and will update further as appropriate.

Perhaps the threat of a rights issue or placing has been hanging over the share price. But fees of £5m are not exactly the end of the world for a company with such EBITDA and little committed capex. Would they really do a large placing at a discount just to save a bit of debt cost?

Net debt is £96.5m excl lease liabilities. So adds about 50% to the EV vs market cap. So still potentially cheap. The long term target this week is £600m revenue by 2026. Which is double where they are today. Presumably, that will require more stores, but they should get cheap leases for these.

Lot's of moving parts but perhaps one to model, and look out for if they raise money or do a subordinated debt issue. That could be a good entry point?

Quiz (QUIZ.L) – Preliminary Results

The results themselves are obviously terrible given how much of the time they were closed and trying to sell going-out wear to people who were not going out.

Recently, the share price has bounced strongly as investors have looked through the current results to the hope of a return to normal. And there does seem to be signs of this:

Gradual improvement in sales since the removal of restrictions on large scale social events with performance approaching pre pandemic levels on a like for like basis

As a result, the Board is pleased that the Group has achieved sales of £30.6 million since the Period end (the five months to 31 August 2021), representing a £17.4 million increase on the revenues generated in the period from 1 April to 31 August 2021.

The problem is that ‘normal’ for Quiz is bad. This is a company that was struggling prior to the pandemic. And like-for -like involves removing pretty much all of the concessions since the host companies such as Debenhams went bust.

Cash is down to £1.5m at 30th June but increased to £3.8m at 28th September. Presumably, a lot of this movement is working capital flows, though. They are at least expected to be Operating Cash Flow positive:

With the recovery in revenues experienced to date the Group anticipates generating a positive cash flow from operating activities in the year ended 31 March 2022.

Unlike many physical retail companies for whom operation cash flow would exclude lease payments under IFRS16, the deals they did with landlords after the pre-pack admin makes the leases an operating cost:

The payment of lease liabilities amounted to £1.1 million (FY 2020: £6.7 million) reflecting lease charges now primarily being dependent on revenues generated which results in charges payable being treated as an operating rather than financing activity.

So this is good, although potentially a lot of this could be working capital flows.

As usual, the thorn in the side is valuation. Prior to this week’s fall, they had a market cap of £30m. Back in 2019, we may have said this level represents good value, but that was when they had c.£10m of cash and c.£20m of Net Working Capital. So the business was largely covered by liquid assets.

But they have burnt through the majority of that cash and, due to lower trading, the NWC is only around £6m. And they have a lot fewer stores due to the closure of all the Debenhams concessions. So the equivalent value today is c£10m.

The gap, then, is the expectation that the business will be sustainably profitable going forward. And in this case, it may well be a triumph of hope over reality. Investors have put this into the "surely must recover" pile, forgetting that that recovery is into a financially weaker, barely profitable trading company with a much-reduced store base, and a poor online operation.

Small Caps Live Friday 1st October

Capital Ltd (CAPD.L) – Investment Update

This has been a bright spot in an otherwise difficult market today, as the share price responded to the following update:

Capital reports its investment portfolio position within the interim and full year results. However, returns through Q3 2021 have been significant relative to the size of the portfolio announced in June. These returns are largely attributable to the performance of two key portfolio holdings and have driven an increase in the total investments value of approximately $23.2 million, taking the period end portfolio value to $54.2 million from $31.0 million at 30 June 2021.

We marvel at the market inefficiency here. It is relatively easy to find what Capital own and mark it to market yourself. Mark has a google sheet that does this with live pricing, and although it may be missing a few $m of minor holdings vs the precise figure they gave in the RNS, it largely tracks what is going on, instantly.

One of the worries when you analyse a company and make that research known, as we have on Capital, is that you are reducing the market inefficiency and if the company beats it is largely expected and doesn’t move the price. In light of today’s reaction to what we assumed was a known known, it seems that SCL is not as popular as we imagined ; - )

The other debate between shareholders is how much discount should you apply to these holdings given that they can be illiquid and are often part of a business development strategy so may not be easily sold. A figure of 25% has been put forward by some, but I think this sounds a little high, for the following reasons:

1. They say none of their contracts requires the equity holdings to be maintained. The original holdings are from drill-for-equity deals but they have done none of these deals recently. Now they tend to invest when they see greatest reward/risk. These investments do help maintain business relationships, for example by supporting fundraises which may have some lockups, but keeping all of the holdings, forever, is not needed for future contracts.

2. They have proven quite astute with their on-market trades by waiting for liquidity to sell rather than selling into weakness.

3. Funds get in trouble when they are forced sellers in illiquid instruments. This is what killed off the Woodford fund empire. However, Capital have never been forced sellers in the past. Indeed, this is a Buffett-style investment structure. It is like a closed-end fund without the right of redemption and no management or performance fee. And it is the fees that often leads to closed-end funds trading at a discount.

4. The vast majority of the unlisted equity is in Allied Gold and if that lists as planned then I’m expecting an uplift in value & greater liquidity for that, not a discount. In H1 they had an unlisted holding IPO and they were able to largely exit it at favourable prices thanks to the new liquidity.

In light of this, perhaps a typical closed-end fund discount of say 10% is much more reasonable than 25%, and maybes even less given the potential upside from an Allied Gold IPO.

Following this announcement, Tamesis Partners have increased their Price Target to 140p, effectively just adding on the change in listed investments valuation. They don't seem to apply any discount, but then they are generally paid to put forward the bull case.

There are a couple of places that Tamesis may be being too conservative though: their 2022E EBITDA looks able to be beaten given the higher GM's we've seen recently, and all the new rigs arriving.

The other one is the valuation of MSALABS. From what we can tell, all the brokers apply an EBITDA multiple to the whole business to generate their Price Targets. Which considering MSALABS generates only a small amount of EBITDA effectively values this part of the business close to zero. As most equity investors know, it is often better to use sales multiples for fast-growing businesses that generate little profit due to their investment into growth. Given the 100% revenue growth of MSALABS, a sales multiple is more applicable. Mark has gone for 5x TTM Sales and gets a valuation closer to 160p.

Berenberg and Peel Hunt also appear to have very similar Price Targets that are much lower than Tamesis, based on around $70m 2022E EBITDA and effectively close to zero valuation for MSALABS. Perhaps their EBITDA models for 2022 are better than Mark’s and $70m is more realistic. After all, it is dangerous to make predictions, especially about the future. However, not updating Price Targets for the increase in listed investments does look like a potential gap for both Peel Hunt & Berenberg, and attributing almost no value to MSALABS in the Peel Hunt, Berenberg and Tamesis notes seems out of place.

So despite the potential popularity of Capital amongst private investors, the brokers still look behind the curve here and upgrades could be on their way.

Mycelx (MYX.L) - HY Results

Mark didn’t get a chance to look at this on Wednesday so thought he’d cycle back to it today. Mycelx has been about the only share that has been close to a net net in recent months once you’d pro-forma the accounts for a recent property sale. Of course, this is a microcap and comes with all the usual warnings of illiquidity, etc. You just don’t get net nets in the FTSE 100!

When you buy companies this cheaply, if they return to sustainable profitability the returns can be exceptional. Sometimes, you don’t even need profitability just reduced losses. Xaar, trough to peak, went from a net net to a 15 bagger simply on reduced losses and investor sentiment. (Although a bit of sense seems to have returned to the price lately.)

So latest Mycelx results are key to continue to assess the potential here:

• Revenue of $4.2 million (2020 H1: $3.6 million)

• Gross profit margin of 45.6% (2020 H1: 45.3%)

• EBITDA of $1.2 million (2020 H1: negative $1.9 million), normalized EBITDA excluding sale of building negative $1.3 million

• Net profit of $435,000 (2020 H1: $2.8 million net loss)

A return to profitability in a cheap stock, that looks interesting, right? Until you realise that they have included the property sales in those figures:

Normalized EBITDA excluding the sale of building in Duluth, Georgia was negative $1.3 million….

The Company recorded a profit before tax of $599,000 for the first half of 2021, compared to loss before tax of $2.6 million for the first half of 2020. The increase in net profit was due to the $2.5 million gain the Company recognised on the sale of its building.

So really a $1.9m loss. That looks very cheeky to us and already puts a bad light on the results.

So what about the balance sheet? Well, the losses continue to erode the assets but are offset by the gain on the property sale. At 37p/share on google finance, then this is rated at 1.26x Net Net, and 0.7xTBV where the majority is liquid assets and they have already shown their property valuations are potentially conservative.

And they do have interesting technology. Effectively they treat wastewater from oil & gas, hence why performance has been weak with no one investing in oil and gas since the pandemic. Could this be about to change with the current gas prices & oil price strength? We have seen some contract wins:

In the Middle East, we were awarded two contract extensions during the period with customers in the Kingdom of Saudi Arabia. The combined value of these awards to MYCELX was $2.4 million. These projects confirm the commercial attractiveness, performance, and acceptance of our offering as the preferred method to improve process water for reuse and compliant discharge. In Nigeria, we successfully delivered the equipment for our third sale in-country. Our technology has gained significant recognition for reliable treatment of produced water for safe discharge in these regions.

And this has the potential to be big if legislation makes removal of these chemicals mandatory:

First, PFAS remediation technology opens opportunities for MYCELX in groundwater remediation projects. In the US, we progressed our offering in the PFAS market with the goal of securing pilot trials in Q4 2021 which will leverage the success we have experienced in the PFAS market in Australia.

And is obviously less exposure to the O&G capital cycle.

A mix of capital & consumables sales is also something that you like to see as an investor.

We also saw revenue from equipment sales and leases increase 58% to $1.9 million in the first half of 2021 (2020 H1: $1.2 million). Revenue from consumable filtration media and service was fairly consistent at $2.3 million (2020 H1: $2.4 million). Whilst the equipment sales are one off by nature, there is longevity to the media sales and on-going lease and service revenues.

The big question is can they generate sufficient scale again to overcome their SG&A costs and generate FCF. The other potential elephant is that fund manager Artemis have been persistent sellers here, and took the price to the low-20's last year.

They still had 6% in March 2021 and haven't RNSed any further position. So the price may be weak for some time yet if they continue to sell. Given the illiquidity, this could also easily be hit by keen sellers in any market downturn.

Despite some fairly big concerns, if Mark could buy it as a net net, somewhere below 30p/share, he would probably take the risk. After all, good things tend to happen to those who are disciplined enough to buy net nets when they go on sale.

That’s it for today, have a great weekend all!