A short trading week this week, and many of us will have wished it was shorter. These periods of market weakness are often harder to deal with since drops in responses to wars or pandemics are easy to understand. However, the current weakness seems to be more about capital flowing out of the markets, either through fund redemptions or direct sales by investors. Often these sales are in response to an economic backdrop that has significantly worsened for many companies. However, when the tide goes out, it goes out for everyone. Finding those companies that are unaffected economically but whose price falls is the key to finding real bargains. In general, we prefer cash-generative, conservatively financed businesses and at the moment many of these are ready buyers of their own shares via buybacks. However, this doesn’t make this market any less painful for us in the short term.
As a Bank Holiday special, WayneJ took a deep dive into bank capital requirements. It was beyond the Editor’s powers of summary so those interested should check out the full thread here.
Mello - Get Your Tickets
Don’t let the current state of markets put anyone off attending the upcoming Mello event on 25-26th May. As well as companies presenting, there will be plenty of educational content to learn from and time to spend in the bar for those who prefer.
Organiser, David Stredder, often has Mello discount codes on his Twitter so check it out for the latest deals.
Small Caps
Vianet (VNET.L) - Trading Update
This trading update was actually last week but didn’t make the email cut-off.
Leo reviewed the 2021 results here, and the AGM statement here. He commented that it all looked “jam tomorrow” and that they potentially needed to raise equity. So far he has been wrong on that and in fact, a buyback is technically underway. However, with a total size of £200k, the motives for this are questionable. Leo then found the October trading update a little evasive.
This week's trading update spends a disproportionate amount of time explaining what the company does, using buzzwords such as "IOT" and "cloud". Apparently what they offer is "unparalleled". They then talk about market developments:
The positive momentum experienced by the Smart Zones [pubs] division in Q2 as COVID-19 restrictions eased has continued through H2 [to 31st March]
Of course, we know full well when the pubs were open and when they are closed. There is some discretionary spend around the edges, but basically, when the pubs were open they were being charged and when they were closed they were not.
In the Smart Machines division, two material contract wins, the gradual re-opening of city centres and the continued demand for cashless vending solutions have resulted in new sales and an increase of over 20% in total connected devices. This has further contributed towards our strong H2 performance.
We can't find any figures on connected devices or whether they fell in H1 - trading here was badly hit by the closure of offices and city centres. The first number investors can use appears more than two thirds the way down the statement:
We are pleased to confirm the strong recovery in the Group's revenues through H2, with full year turnover expected to be up 55% to almost £13.0m (FY 2021: £8.4m and FY 2020: £16.3m).
But this is a 2021 comparative, which is largely irrelevant. In fact, they are down 20% versus FY 2020, though the impact from covid was of course far higher. Pre-covid they had 92% recurring revenues. These subsequently turned out not to be recurring at all, but nonetheless, the obvious metric to give us now is what the last month's recurring revenue was. Failing that, the best we can do is calculate H2 which at £6.7m revenue was down 15% from 20H2.
Clearly, recovery is taking much longer here than in other businesses. They comment on the full year:
This is a welcome result given that hospitality restrictions ran longer into the year than anticipated and whilst ongoing city centre economic recovery remains muted.
Vianet is really two businesses which, while both affected by covid, have different dynamics. It is therefore unfortunate that they feel unable to break down revenue.
On the balance sheet they say:
Whilst cash generation continues to improve, the Board is mindful that the well-publicised deterioration of semi-conductor supply globally will result in component premiums through FY2023. In these circumstances the Board believes it is prudent to preserve cash to invest in stock to underpin new sales and drive continued growth in quality recurring income. We therefore expect to delay reinstating a dividend until we have clear line of sight on a return to more normal semi-conductor supply.
They may be blaming temporary external factors for a more fundamental problem here. This is what house broker Cenkos has to say:
While we are yet to initiate a forecast for the new fiscal year, the current trajectory suggests the Group could achieve pre-pandemic run rate profitability within 6-12 months.
That is an exceptionally slow recovery, far slower than I would have imagined. Clearly significant amounts of pre-covid ARR have been permanently lost as well as momentum having been lost. Some more detail about the breakdown is given in the Cenkos note:
Recovery at Smart Zones. SmartZone sites are now almost all open and billing is at 100% of normalised levels.
Presumably, that means this is as good as it gets (without further sales) rather than being 100% of pre-covid, and this doesn’t sound good:
Now the pub industry has stabilised, we believe there are new sales opportunities which have been on hold over the past two years. Closing these sales will help replace revenue lost from a smaller than normal number of net site disposals made by customers during the COVID-19 period
We previously pointed out that long-term trends in pub closures could have actually temporarily slowed during covid and the recovery. We could be due for some catch up now. And this picture is entirely different to pre-covid when upselling was providing potential growth. Running the numbers, H2 Smart Zones looks to be around £4.0m of sales compared to £5.4m in 2020. Recovery looks like it will be to under £10m annualised sometime over the next 12 months.
On the balance sheet, Cenkos say:
Reducing debt. We believe that strong operational cash flow through FY22E will have further reduced debt (forecast £2.3m at year end) with the Vendman loan due for full repayment in April as a post balance sheet event.
FY 2022 Estimated debt is £3.6m (first year of CBIL paid off, assumes no overdraft drawn), with cash of £1.3m. The Vendman loan is for £0.7m, bringing cash down to £0.6m, assuming the overdraft is not renewed.
The repayment schedule for the CBILS loan is likely to be that £1.1m needs to be repaid in FY 2023. That brings cash down to (£0.5m), assuming no operating cash flow after investment and changes in working capital. In Leo’s opinion, a renewed overdraft of £1.5m would be too tight to cover this. Accordingly, he believes an equity raise is imminent.
Leo’s model shows just 4p EPS for FY 2023 and from then on it will be difficult for Smart Machines growth to compensate for likely losses at the larger Smart Zones for a few years. Also, the directors were massively overpaid last year, with pay rises despite covid. So even if they scrape by without an equity raise, they still look overvalued.
Card Factory (CARD.L) - Final Results
The share price is up over 10% on Tuesday, presumably since these beat EPS expectations, with 2.4p reported vs 2.02p forecast according to Stockopedia.
However, the balance sheet is terrible here, with a current ratio of 0.53. Retailers often trade below 1, but this is particularly low. They have recently re-financed their debt so this is not an immediate worry, however, these accounts are for 31st Jan which will be a low point in their net debt. So their balance sheet is likely to be even worse for most of the year.
On top of this, their inventories and receivables are down despite a big increase in trading. You could consider this is due to operational improvement but given inflationary pressures then it is surprising to see this down which means working capital is likely to need to rise from here, further sucking in cash.
No dividend is forecast for the foreseeable future - and the reality is they can't afford one. The CBILS loans is also acting as a stopper until at least 2024 on this.
The outlook is fairly positive:
While taking into consideration the inflationary headwinds mentioned above as well as the levels of trading seen in the new financial year, the Board's expectations for revenue and profit for FY23 remain unchanged.
And hitting EPS forecasts of 6.66p would mean it is on a P/E of sub-10. This may appear cheap on the surface, and attract the more superficial investor, but once you adjust for debt and working capital this comes out to be just a 6.5% forward earnings yield. Meaning that there is much better value in the current market elsewhere, and with much lower balance sheet risk too.
Luceco (LUCE.L) - Q1 Trading Statement
This is a profit warning:
Last year's unusually buoyant markets disrupted the normal function of global supply chains, leading to some customers ordering more product than it now appears they needed to meet demand. We expect that the reversal of this position this year will lead to a £15m shortfall in 2022 revenue compared to our previous expectations. The shortfall in 2022 Adjusted Operating Profit will be approximately £10m due to the lower revenues being in the Group's higher margin Wiring Accessories category.
£15m off the market consensus revenue would put them a little bit up on last year:
But £10m off operating profit would be around a 30% miss on EPS. The good news is they feel that they will be able to fully pass through cost increases:
Our estimate of the annual impact of input cost inflation remains at £25m, which will be fully offset by selling price increases. We will receive the full benefit of these increases in Q2 2022.
We are targeting Adjusted Gross Margin of 37% during H2 2022, representing the full pass through of input cost inflation. We are confident that the margin will improve thereafter as elevated input costs recede and our sales mix of Wiring Accessories normalises after destocking.
Significant cost inflation could dampen demand for their products but it is still better to retain gross margin. This is starting to look reasonable value despite the big miss on EPS.
Joules (JOUL.L) - Board, Strategic and Trading Update
Yet another profit warning from Joules:
However, as has been well-documented, market conditions have become more challenging during and following the Easter period as consumer confidence has been impacted by the rising cost of living. Joules has not been immune to these sector-wide pressures, which have led the Group's profit performance to fall below management's expectations…
Last time Garden Trading was a rare highlight. It is now struggling:
Consumer demand for home and garden categories has been subdued, particularly online, with Garden Trading performing significantly below expectations over its peak sales period in March and April.
And the CEO finally falls on his sword:
The Group announces that, after three years with Joules, Nick Jones, Chief Executive Officer, will step down from the role during the first half of the Group's next financial year.
Liquidity is said to be in-line but looks tight to us:
As at 1st May 2022, net debt was approximately £22m with liquidity headroom of £11m, in line with expectations.
Which means this remains a gambling chip, not an investment.
Smiths News (SNWS.L) - Half Year Results
These read well. The revenue decline is slight, which is the best you can hope for in the industry:
Although in their presentation, management highlighted that some of this is due to weak comparators:
Going forward, this will be more like a 5% annual decline. This will mean cost-cutting remains the key driver of shareholder value in the short term. Management have made a commitment to £15m cost savings over the next few years. Clearly, they can’t continue to cut costs forever but are not near the end of the road yet. They are looking for new complementary revenue streams to compensate but definitely won’t do anything daft as the company did with purchasing Tuffnells under the previous management.
This makes the company a reasonable income play for those willing to risk the “melting ice cube” nature of the current business.
Kinovo (KINO.L) - Year End Trading Update
The company has been moving from a high-risk construction contract business to recurring revenues and high margin specialist work in Regulation, Regeneration and Renewables with an emphasis on social housing.
They announced the disposal of their last non-core business in January. When we covered this, we pointed out there were quite a few loose ends in the sale and asked:
So apart from questions over whether performance conditions will be met, the questions that arise are:
a) When will any possible contract liability be transferred, and
b) How stable are MCG Global? [purchasers]
From today's statement:
Under the terms of the Disposal agreement with the purchasers, the Company agreed to provide a working capital facility to support DCB in completing active projects. The Directors assumed at the time of entering into the Disposal agreement the overall net outflow of cash to support DCB would be minimal, with the initial working capital support necessary to optimise the potential deferred consideration.
This is even worse when we see the details:
The Company has been notified that DCB has experienced delays in completing active projects and has not secured new project work to the levels anticipated at the time of the Disposal and has therefore had to provide unanticipated working capital support to date of £3.7 million, and the Directors expect this to increase in the short term, absent any additional investment into DCB.
Which is what tends to happen when the purchaser has no skin in the game!
This additional support was provided due to a lack of new business receipts, ongoing challenges and delays in the period. As part of our obligation under the terms of the Disposal, the Company provided parent company guarantees which run through to practical completion on each of the construction projects that were in existence at the time of the Disposal. It was, however, anticipated that the purchaser would make all reasonable endeavours to transfer these parent company guarantees post-disposal.
So this now has the potential to take the parent company down. Putting this bit about the company potentially being insolvent at the end of the trading statement seems a bit off. Looking at early comments on Twitter, it appears to have fooled some people. But with the price down over 40% it didn't fool the market makers or investors as a whole. With a market cap now only around £14m potentially there could be a lot of dilation if a share issue is required to fix this. However:
The Company as at 30 April 2022, had net cash of £0.4 million (30 September 2021: £1.7m net debt), which includes the impact of the working capital support [so far] to DCB.
If you do the maths given they have provided £3.7m for DCB, that's some incredible cash flow from the rest of the business. It is almost enough to cover the £1m/month that DCB are burning.
The problem seems to be they are on the hook for liabilities of an entity they no longer control. The company would have been much better off putting this subsidiary into administration. Clearly, this is a failure of financial control and the CFO should be replaced at the earliest practical opportunity.
It is worrying that shareholders are only finding out about the scope of these problems now, making this particularly high-risk. If they can stem the cash outflow to DCB this will look very cheap, but is only for the very brave given the potential downside.
Goldplat (GDP.L) - 3rd Quarter Operating Results
The two recovery operations continued a strong combined operating performance from the previous quarter and achieved a combined operating profit for the quarter of £2,286,000 which represented a 96% increase against Q3 in the previous period (Q3, 31 March 2021 - £1,165,000).
Good increase on last year, but since there isn't a lot of seasonality here then this isn't the greatest comparator. 22Q3 here is similar to 22Q2, which is still a decent result.
Sadly, Ghana has broken its track record of increasing quarterly operating profit that it has held for at least the last three years. This is due to some political instability in client countries:
The results for Ghana were supported by an increasingly diverse client base in West Africa and South America who provided a wider range of materials, although volumes were reduced due to political unrest in some of the jurisdictions in which we operate.
The good news is that South Africa continues to perform well:
The strong operational profits for South Africa during the quarter were supported by good production through our circuits, specifically gravity concentrators, and increased gross profits realised on the sales of material processed during the previous quarters. We are also seeing profits being supported by services in and production of platinum group metals ("PGM's").
House Broker WHI Ireland have put out a summary note, but they haven't updated their model yet, saying:
WHI View: Goldplat remains a very interesting gold recovery business in our opinion and is capable of treating all sorts of wastes produced as a result of mining. It makes money from other people’s waste and, as results show, is doing very well and increasing profitability. It has £2.0m in cash and £5.0m tied up in product either in transit or at smelters/refineries, so is well covered and was more than enough to complete its £0.4m share buyback programme put in place to return value to shareholders – shares bought are being cancelled. We still see fair value at 10.6p but will look to revisit our valuation in light of the increase in profits being generated by the company and the reduction in the number of shares.
By Mark’s calculation, if Goldplat generates zero operating profit in Q4 then they will report around 1.7p EPS for the full year, which makes the WH Ireland forecast EPS of 1.5p look seriously out-of-date. Underlying EPS (excluding any non-cash FX reporting) of somewhere around 2.5-2.6p would seem more realistic if Q4 performs similarly to Q3.
The other good news is that progress finally seems to be being made on re-processing the old Tailings facility. First, they need to build a new tailings facility:
The review of our water use license has been completed and we are awaiting the drafting and issue of the license from Department of Water and Sanitation. The license, once received, will provide us the basis on which a new tailings storage facility (New TSF) will be developed adjacent to our existing tailings storage facility (Existing TSF) at a cost of circa £ 350,000. The intention is for our deposition to be transferred from the Existing TSF to the New TSF, with the New TSF to be used for storage and the Existing TSF to be used for processing.
They now seem committed to processing by a third party via a pipeline:
We have received the environmental approval required for the installation of the pipeline to a nearby third-party processing facility, although the required water use license submission is still in progress. The nearby third-party processing facility has the potential to provide the necessary deposition capacity to process the Existing TSF.
Recovery, cost of processing and profit share are all unclear at this point, but 82koz of gold is worth $153m so even 1-2% of that as profit would be material to Goldplat. Still, good to see some progress on licenses and permitting after such slow progress here over the years.
The second piece of news this week is that Chairman Matthew Robinson is stepping down at the next AGM. Mark was never that impressed with Robinson. He seemed a nice chap but there didn’t appear to be a lot of passion for Goldplat's business, and his shareholding seemed more out of a sense of duty rather than a belief in the economics of the business.
It is not clear if such a small market cap business will really be able to attract a high-calibre candidate. Ex-CEO Gerard Kisbey-Green is now a non-exec and originally had been earmarked to be Chairman before stepping up to the CEO role, and then falling on his sword after investing too much into mining in Kenya, so he could be a good but controversial candidate. He is an Executive Director at Caracal Gold, which is where the Kenyan mine ended up, so may have his hands full at the moment.
That’s it for this week - thankfully! Enjoy your weekend!