Small Caps Live Weekly Summary

QRT HEIQ VTU CAPD SHOE LOOP

An understandably quiet week this week with a Bank Holiday on Monday and perhaps the last of the summer sun. Weak US markets haven’t helped sentiment, and it has been a week of further selling in small cap shares. Retailers & hospitality have been particularly badly hit as they face the twin shock of higher energy costs (with no price cap) and lower demand from consumers. As always, weak markets and illiquidity drive down the good with the bad. This really is a stockpicker’s market.

Mark continued his Screening for Value article series on Stockopedia, looking at When to Buy a Value Stock.

Small Caps

Quarto (QRT.L) - Half Year Results

These look decent results:

With net debt now down to $5.6m, from $10.5m at year-end. Considering this was over $60m 2016-2019, this is good news (although some of the reduction was due to a placing). The company looks much more financially strong than in the past.

The historical P/E is 7, and EV/EBITDA is just 1.74, according to Stockopedia. EPS has more than doubled since last year too, so despite no forecasts, this looks good. especially as H1 is the weaker half.

However, there is a sting in the tail:

Outlook:

As we move into H2 this financial year, we expect to see a turbulent second half of the year, with the cost-of-living crisis impacting both the US and UK trade sales. We are also seeing a sharper fall in online sales than expected, impacted not only by the increased cost of living, but as the consumer returns to purchase books from the traditional book stores. Business to business sales is continuing to hold firm, with particular growth through the custom channel. However, we expect this channel to become increasingly more challenging.

Sales and costs are impacted:

Whilst the volatility in freight has reduced, costs remain at the high levels of last year, along with pressure on print prices. We continue to try to mitigate these costs and have actively increased our use of local print suppliers as well as review our inventory policy, to ensure we print at the most efficient quantities. We expect this pressure on print and freight to continue for the foreseeable future.

So, the best we can say is that H2 is highly uncertain. They are taking actions to focus on their core business:

We have taken the decision to close our Distribution Service, where we provide Sales & Logistic services for third party customers, which will start to impact our sales from July 2022. We have also decided to sell Smart Lab, our Toy imprint, in order to focus on our core publishing business.

Although reducing scale by exiting low margin distribution only works if you can take out the corresponding costs too. Smartlab is valued at $2.3m in the accounts, and they expect a sale in September, so it will be interesting to see what they get for it in the current market. They say they have received a non-binding offer, so you assume it must be in that ballpark.

The problem is that there are no forecasts in the market. The company seems cheap, given the progress on reducing costs and paying down debt, but we really have no way of valuing it at the moment. The market doesn't like the uncertainty either; hence the SP was down 10% on these results. Director CK Lau owns over 45% and has been buying in the market together with other directors (the takeover code doesn’t apply here as a foreign-domiciled company.) Perhaps if they keep buying, this is a sign that the outlook isn’t too bad. A controlling shareholder is a risk too. Although directors have treated external shareholders fairly in the past.

Heiq (HEIQ.L) - Trading Statement

Heiq is the optimistic covid float that subsequently slashed forecasts last year:

This half’s revenue performance doesn’t sound bad:

HeiQ is pleased to report that the Company is expecting to report revenue of over US$30m for H1 2022, an increase of more than 17% compared to the six months ended 30 June 2021 ("H1 2021") (US$25.8m)

However, they did a couple of acquisitions at the end of H1 last year, and no LFL is given, so we really don’t have any idea if it is good or bad. 21H2 revenue was $32.1m, so 22H1 is down on that, which perhaps isn’t great. Although, margin increases are to be welcomed:

The Company expects to report gross profit margins for H1 2022 of 46.7%, an improvement from the levels seen in the second half of the 2021 financial year (43.7%).

These are way down from where Cenkos were forecasting up until last year. Also, 21H2 costs were over $17m, so if 22H1 is similar, then they could be looking at a loss for H1, depending on how much they can book of other income (presumably license fees.) We will find out on the 13th September when they issue their results.

The market seems unconvinced with the share price down slightly despite their usual bullishness about their own prospects:

HeiQ is pleased to report significant progress regarding the development of its potential blockbuster technologies:

· HeiQ successfully launched HeiQ AeoniQ, a high performance, climate positive, cellulose yarn designed as a sustainable substitute for the US$135 billion Polyester and Nylon market.

· Received investment from HUGO BOSS which provides an implied valuation of US$200 million for the platform...

They've actually been paid by (or have at least billed) HUGO BOSS $9m which is material to the company. But this looks to already be in the numbers as, overall, they say in-line for the full year:

HeiQ has demonstrated a resilient trading performance during H1 2022 and the Directors remain optimistic that the Company will trade in-line with market guidance for the full financial year, although, like all companies, the Company is not immune from the impact of unforeseen global economic events and raw material spikes.

Which means a 29x forward P/E. This seems much too high for a company whose bullish talk rarely appears in their financial numbers.

Vertu Motors (VTU.L) - CEO Interview

Looks like we were wrong to expect a trading statement this week from Vertu. However, we did get an interesting interview on Radio 5 with CEO Robert Forrester:

Interesting comments on Vertu’s “record order books” with no sign of customers cancelling orders so far due to cost of living concerns. The weakness of the pound vs the dollar has little impact, they are more exposed to the Euro, which has been fairly flat versus the pound. Well worth a full listen for anyone interested in the sector.

Capital Limited (CAPD.L) - CEO Appointment

Capital has been running with founder Jamie Boyton as Executive Chairman and no CEO, since the previous one retired in 2017. This week they have decided to appoint a new one. The reasons given are:

These changes represent further steps in reshaping and strengthening the Company's leadership team while also adhering to the Company's commitment to the highest levels of corporate governance. Jamie Boyton, currently Executive Chairman, will oversee a handover period with Mr Stokes over the ensuing six month period.

Having a combined Chairman & CEO role is frowned upon in some corporate governance circles, although we have never doubted the company’s commitment to doing the right thing. So it may be that larger shareholders have demanded this appointment.

Expanding a management team comes with increased overhead costs, but perhaps also frees Boyton to focus on what he does best: capital allocation. We think there is a strong argument for capital to be directed to share buybacks at this time. The share price is below where a buyback was conducted earlier in the year, but since then, the 2023 EPS forecast in dollars has risen 17%, and Sterling has depreciated by 11% against the dollar. This makes any buybacks about 30% better value than they were earlier in the year.

In terms of the candidate, Peter Stokes, he appears to have had a strong career across mining & logistics. We can see him managing the operations well and leaving the investment & business development side to Boyton. Probably a win-win for both of them.

Shoezone (SHOE.L) - Trading Update

We're getting one of these a month now.

June:

the Company now expects adjusted profit before tax for FY 2022, to be not less than £8.5m.

July:

the Company now expects adjusted profit before tax for FY 2022 to be not less than £9.5m.

Now in August:

the Company now expects adjusted profit before tax for the financial year ending 2 October 2022 to be not less than £10.5m.

It seems unlikely this is due to pent-up consumer demand for shoes in general, but perhaps the recent weather and recovery in demand for foreign holidays play well with their strengths in cheaper, more casual styles. They have previously cited tailwinds from lower rents and supply chain management in particular. We suspect their larger retail park stores have helped them access new markets and go upmarket in customer perceptions.

The share price responded well to the update but then sold off again in the retail gloom. One of the issues we have is that brokers don’t seem to think this performance is sustainable into 2023:

Which makes them look very expensive in the retail sector at 13x 2023E Earnings. No one buys Shoezone at a 13x P/E, so investors are clearly pricing in a beat for next year too. As are the management, who announced a fairly aggressive £3.5m share buyback which has been well received by the market.

The management are excellent here, but we would be surprised if they don’t face inflationary headwinds, particularly around labour costs. For example, they are currently advertising a London-based Store Manager for £21.5k! So a lot of unknowns. Investors who think the growth can continue and they can do closer to 20p EPS in 2023, rather than the 11p forecast, will still see a lot of value here. Those who are more circumspect may want to use the extra volume generated by the buyback to take profits.

LoopUp (LOOP.L) - Contract Win & Trading Update

When we last looked at LoopUp we didn’t hold out much hope for a positive outcome for shareholders. With the debt they were carrying, the risk was that no one would be willing to sign any new long term contracts with them. In view of this, the following is very good news for them:

Meetings: New material contract win expected to generate c.£10 million of revenue and c.£5 million of net cash in the 12 months from October 2022 to September 2023

That's quite a margin for their legacy in-house could-have-been competitor to Zoom. Elsewhere they say:

Cloud Telephony: 133% increase in customer wins and 252% increase in individual contract wins during the second year post service launch

Which perhaps would be expected after a new product launch. They then go on to say that this part is the strategic future of the business and give some numbers, such as:

Minimum Annual Recurring Revenue (ARR) of £1.2 million and minimum Total Contract Value (TCV) of £4.3 million, based on minimum contracted levels;

Expected ARR of c.£2.4 million and expected TCV of c.£7.8 million, based on expected rollout levels, where LoopUp has relatively strong visibility of customer intent based on conversations, planning and pricing;

The trouble is that they appear to be effectively acting as an aggregator/reseller here, so the margins are not clear. And these installations can take time. There's revenue, there's ARR (based on the last month's trading, assuming no attrition over the next 11 months), and there's "expected ARR", as quoted here.

But for those still holding out for the dream of a high-margin tech video conferencing business, it will be the first part of the announcement that will interest them. At first sight, it is the most interesting for investors, too, with "£5m net cash" inflow for a business that looked close to collapse. But based on the commentary, it seems they are simply taking on the customers of a competitor that is also giving up in the face of competition from Teams, Zoom etc. This has been arranged in a way that is supportive from a cash perspective:

There is no initial or fixed consideration payable to PGi Connect for the transfer of its customers to LoopUp. Instead, the Group has agreed to pay PGi Connect a share of revenue invoiced and received from successfully transferred customers for a period of three years.

Attrition rates in the transfer are likely to be high, but both parties are well motivated to keep them down. In the short term, i.e. H2 of their accounting year, but the first half of the first year of the transfer agreement, the cash impact is less clear due to the profile of the ramp-up and investment in a smooth transfer process and possibly adding features that would be missed:

marginally lower profitability after some additional required investment associated with the PGi Connect customer transfer project

At first sight, the financial situation remains pretty desperate:

The Group expects revenues of approximately £6.6 million for the six month period ended 30 June 2022 😄, at a gross margin of approximately 67% 😄, and an EBITDA loss of approximately £1.5 million 😟. Net debt was approximately £8.0 million at 30 June 2022 😱, prior to the receipt of an R&D tax credit of c.£1.9 million that the Group expects to receive🤞 within the next 60 days.

[Emojis may not have been in the original statement!]

The obvious time for the H1 trading statement would have been at the AGM, which was bang on the 30th June period end, but this was enveloped in chaos as the audit for the previous year wasn't remotely ready in time and resolutions related to the annual report had to be withdrawn. But still, a trading update 2 months after the period end is pretty poor going. Here's the likely reason for the delay to that Annual Report in the auditor's words:

These events or conditions indicate that a material uncertainty exists that may cast doubt on the Group’s and Parent Company’s ability to continue as a going concern.

But of course, they judged that they were good for the next 12 months, otherwise we wouldn't be here. Since the cash outlook may have deteriorated since then, it is worth looking at how much headroom they have in the short term.

At the balance sheet date, the Group had outstanding borrowings of £7.9m, including £6.9m under a facility agreement with Bank of Ireland ... holiday on planned principal repayments through to June 2023.

Therefore we understand the maximum amount of the facility agreement to be £6.9m. They have an undrawn revolving credit facility of £1.5m, but also have £1.0m debt acquired in SyncRTC acquisition. This implies they have only just dipped into the RCF by £100k and have £1.4m left.

With only £100k burnt in H1, the main concern is the 2023 repayments. This week’s news is universally good over that time period. They do now seem to have a route to cash and accounting profitability in FY 2023, although it is unclear how sustainable this would be. Assuming the rest of the business breaks even (pessimistic) and they continue a £5m run-rate from the PGi Connect deal (optimistic), and we assign them a PE of 5 (about right), then we have a valuation of £25m. That's well above the current EV and, due to the debt, implies a multi-bagger on the equity if they hold out on the inevitable equity raise until the last moment. Still, there is plenty that could go wrong between now and then.

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