Small Caps Live Weekly Summary

ARC GMS SDY VTU

US markets were weak this week. The reason given appears to be that investors don’t like September as it is historically one of the weakest months for stock market performance. It is a shame that the appearance of September is completely random and can’t be forecast by investors. Perhaps one day, AI will be advanced enough to help out.

In UK small caps, the week hasn’t been helped by material profit warnings from the likes of Michelmarsh Brick and Churchill China (the discussions on Discord were too brief to summarise here), and smaller ones from others such as Vertu.

Arcontech (ARC.L) - Final Results

Sales are up a bit, but EBITDA is flat as those increased staff costs start to come through:

Adjusted EBITDA £1,030,898 (2023: £1,044,522; 2022: £1,019,478)

The EPS figure isn’t particularly useful as a lot of the change in earnings is simply interest on the cash balance.

They are more positive than in the past about the progress on increasing client numbers, but may need additional staff to do so.

·      Overall engagement with the market much stronger than the previous two years

·      Sales team has been increased to identify growth opportunities with existing clients

·      Several PoC (Proof of Concept) with prospective clients have been started

·      Working with clients on additional planned developments to round out offering

They are very expensive unless you assume they do something with the cash balance. This continues to build to a pretty phenomenal level for such a small company:

Net cash of £7,160,177 (2023 £6,411,241), an increase of 11.7%

There’s about £1m of negative working capital that may give variable levels of cash during the year, but even netting that off, there’s about £6.2m of cash that is free to use, but they don’t seem any closer to having any idea what to do with it.

Their broker, Cavendish, sees declines in EPS to come, presumably due to higher costs. Their 2026 EPS forecast is still below 2022 levels. So even on an EV/EBIT level, this isn’t particularly cheap for a non-growth illiquid micro cap. There is probably nothing in the forecasts for new sales, though, so all eyes are down on whether the new sales headcount can deliver.

In terms of price action, there was little response until this was tipped in the Investors Chronicle, which caused a roughly 20% rise in the price. Given the cash balance, this is equivalent to a 40% rise in the valuation the market is ascribing to the operating business. So it seems that potential for growth has already been priced in, and then some. If they keep up their historical pattern of failing to sign any new clients, then it will be a long way down for the share price from here.

Gulf Marine Services (GMS.L) - Half-Year Report

Net debt is coming down quickly:

Net leverage ratio¹ on 30 June 2024 improved to 2.62:1 (31 December 2023: 3.05:1). Net bank debt¹ lowered by US$ 28.8 million to US$ 238.5 million (31 December 2023: US$ 267.3 million) as the Group continues its focus on deleveraging. In addition to its contractual obligations, the Group made an additional payment of US$ 5.0 million in debt reduction. Further measures were taken to minimise interest charges.

But the net profit shows where this is coming from:

Net profit for the period decreased by 15% to US$ 7.4 million compared to US$ 8.7 million reported in H1 2023. Despite the growth in revenue and reduction in finance costs, net profit reduced due to an increase in the fair value of warrant liabilities and an increase in general & administrative expenses (as explained above).

I.e. they have much lower capex than depreciation. In this period, depreciation was over ten times larger than cash spent on PP&E.

Shares initially dropped in response to these results. Some investors may have spotted that 0.68c EPS means that there is a lot to do in H2 to hit their 3.3c forecast. It may also be that the lack of dividends disappointed many. Individual investors tend to have an irrational love of a dividend payout. In reality, the company is better off getting their debt below 2xEBITDA, so they get a step down in interest rate.

The other love that individual investors love is a tip, and it is Simon Thompson in the Investors Chronicle to the rescue again, whose tip caused the shares to rebound on the day. This is another huge nail in the coffin of efficient markets at this level.

The rebound may not be for long, though. Seafox shareholders are going to receive a distribution of 15% of Gulf Marine shares around 15th September. Some may hold, but the typical spin-off behaviour will see the share price weak for a few months as lots of small sells go through. Perhaps this is better than Seafox placing them in a block, which could have seen the price go even lower. It may be worth considering in a few months’ time after the Seafox shareholders selling abates, particularly if the price gets hit severely.

Speedy Hire (SDY.L) - AGM Statement

They guide in line but continue to highlight 2nd half weighting. It sounds even more like a Q4 weighting:

Steps to mobilise the Group's new contract with Amey are in hand and it is anticipated that this will generate revenue in the final quarter of our financial year.

Also, "steps" being "in hand" is hardly the strongest statement of progress. Breaking it down further:

We are encouraged by the new government's plans, although at an early stage, to support residential housing market growth, and we look forward to long term infrastructure projects continuing to be supported.

This may be preparing the market for a profit warning if infrastructure projects are cut back. The government has already cancelled the Stonehenge tunnel, and there's talk of major cuts to the roadbuilding programme, both to save money and for ideological reasons. Any alternative investment will be timed later.

It really sounds like yet another miss is nailed on and it’s hard to believe that Speedy could have written this statement without realising it themselves. It is tempting to think that the market knows they will miss as well, but there is little sign of it in the recent price action:

Vertu Motors (VTU.L) - Trading Update

There is a further profits warning here:

Full year FY25 adjusted ¹ profit before tax expected to be broadly in-line with current market consensus. H1 profits will be lower than prior year levels as anticipated.  Performance in H2 is expected to improve over prior year levels due to a stronger used car market and enhanced used vehicle trade values.

However, we agree that they can expect a stronger H2, and that:

The current dislocation in the market presents opportunities for Vertu Motors to capitalise on

This part is particularly interesting:

BEV (Battery Electric Vehicle) adoption, which are now expected to account for 18.5% of the overall market in 2024 against a headline Government target of 22% (rising to 28% in 2025) with associated significant fines for Manufacturers for non-compliance.

Some OEMs have said they will not pay fines, and if they stick to this, it means we are getting within 1-2 months of a hard halt to legacy-fueled vehicle sales. Fortunately, they just have to store the cars for a few months (which is not unusual) and sell them next year, but surely we'll see some extended Christmas factory shutdowns.

Vertu confirm what Leo has long been saying about weaker new vehicle margins, mix and volumes, but again, what shareholders should be worrying about is aftersales, and they are fine. Opening three BYD dealerships after previously saying they would avoid new Chinese brands due to the lack of aftersales volumes. We suspect they felt they had no choice and they are initially loss-making despite higher new margins and being a source of trade-ins and a venue for used sales.

Broker Progressive say:

We have edged our FY25 forecasts back, primarily due to the softness of the retail new car market but also to reflect some further staff cost pressures, with adjusted PBT moving from £42.2m to £40.2m.

For investors, the bottom line is 8.2p EPS. This makes the shares simply nowhere near as cheap in the past on earnings, and forecasts assume stronger used values in H2 whereas in some past times they have not factored in strong used car dynamics that were already manifest.

One of the pluses for Vertu is the backing of freehold property. Being able to dispose of unwanted sites for alternative use and for at least book value is key to this asset backing. They have not reported any further progress today and elaborated on the delays in Scotland:

The Group previously disclosed that cash receipts of over £10m were anticipated in FY25 from surplus property disposals. The largest of these property disposals in Glasgow has been subject to renegotiation, due to the prospective implementation of rent control legislation in Scotland, such that £2.7m of the anticipated proceeds have now been deferred for approx. 2 years until completion of the build project.

If I understand correctly they are now partly financing the residential development without charging interest, either because other lenders pulled out or to disguise a 15%-20% effective cut in sale price that surely takes originally planned FY 2/2025 disposal prices below book, despite including a site that may have been cherry picked for its suitability for residential development.

Normally, we'd say a drop in EPS for a single year wouldn't justify a similar fall in the share price. However, here we've got an increased H2 weighting on logical but uncertain hopes, a trend of profit warnings, weaker than expected cash flow and doubts raised over true tangible asset values. But most importantly, this just isn't a business model with a normal life expectancy - various threats most notably to aftersales are looming ever closer. On the plus side, the update was timely and detailed, and the shares are cheap on asset value and not expensive on earnings. Also, their competitors appear to have been badly mismanaged and/or starved of capital after being taken over.

That’s it for this week. Have a great weekend!