An understandably quiet week on SCL this week as many of us were at Mello 2022. It was great to catch up with old friends, make some new ones and put some faces to names too. Much kudos to David Stredder for running such a successful event again, and in challenging circumstances (for both covid and market sentiment reasons).
Of the companies at Mello, Tandem had a good stand with lots of their products such as e-bikes. The new CEO was there, although he was only 2 days into the job. In general, they seemed confident in being able to overcome the current challenges and grow the business. I’m pretty sure all 500+ attendees must have asked why their previous CEO left so suddenly so they must have been fed up fielding that one. They managed to give nothing away. Although, they felt that Jim Shears was unlikely to sell his stake in the company soon, which was the main concern we had when we reviewed the announcement on SCL.
Sanderson Design were one of the most popular presentations. Although we are naturally a little wary of something that is already popular (where are new buyers going to come from?), the management team presented well and their strategy seems sound - strong design-led sales with increasing manufacturing efficiency. The modest rating presumably reflects the negative consumer discretionary environment. Design-led premium products can buck this trend though.
Sigmaroc also presented well. This is a roll-up of European quarries that have presented at Mello in the past. The attraction here is that these are long-life, regional monopoly type businesses where operational improvements can drive significant value enhancement. Their strong operating cash flow allows them to continue to acquire quarries. However, the presence of debt means that the rating here is perhaps less compelling than a headline P/E would initially suggest.
The Mello BASH remained one of the most popular sessions with investors pitching Christie Group, Luceco, Gulf Marine Services, Equals, FireAngel, PCI-PAL, Belvoir and Best of the Best over two days. Mark’s pitch, Luceco, was a hold from the panel and an avoid from the audience. So his record of Mello BASH strong “avoid”s remains unbroken!
RA International (RAI.L) - Final Results
We know things were not going well here with Force Majeure declared on a major contract and taking 5 months to produce audited results. However, these are in line with what Mark was expecting following recent trading updates:
The management commentary is surprisingly upbeat given the year they’ve had but we doubt that will carry much weight with the market at the moment.
We responded with agility and resilience to the major external challenges we faced in 2021 and delivered on significant projects for our clients, building our reputation as a trusted partner. Looking ahead, it remains difficult to forecast with real authority how the current year will play out but we are continuing to stabilise the business post the pandemic and its effects, and see the scope for a return to accelerated contract awards as and when a more normalised operating environment returns. In the meantime, we take great confidence in the strength of our offering, which is differentiated by our technical capability, proven ability to innovate and continue to perform under extraordinarily challenging circumstances, and by our attractive pricing, particularly where we self-perform.
Indeed, the market reaction has been negative. Presumably due to the large write-down of assets in Mozambique - although this is non-cash it means the company no longer trades at a discount to TBV. Plus perhaps the lack of any significant new contract wins:
Having had a previous strategy of pursuing more commercial contracts, they are increasingly looking to government contracts. Perhaps they are learning that when operating in places where things often go wrong, Western governments are often much kinder on terms.
Revenue on the higher-margin IFM contracts is holding up well. However, they have faced inflationary pressures:
Approximately half of the decrease attributed to IFM services relates to lower occupancy in our Somalia hotel facility, with the remainder being the effect of general inefficiencies and inflationary pressures.
In H2 2021 inflationary pressure was primarily seen on food and beverage imports and logistics costs, however in some locations we are seeing significant wage inflation as well. We have recently been successful in agreeing price increases on some IFM contracts, however, we anticipate continued margin pressure in 2022. We continue to work with our long-term suppliers, and plan to leverage our existing inventory holdings to mitigate inflationary effects where possible.
They should be able to mitigate these in time but it is clear that there is no easy and quick fix here.
This week they also announce the cancellation of their LTIP Options. It sounds like these options were never going to be in the money so they are going to reissue them at a lower price which is a bit of a joke. It is understandable that extremely OTM options don’t motivate staff, but the CEO & COO own 80% of the equity here and should require LTIP options to motivate them.
Zotefoams (ZTF.L) - AGM Trading Update
This company has sparked quite a lot of debate on SCL recently. On the surface, this is a very highly-rated company given its mediocre bottom-line performance over a number of years - for example, 2022 estimates are for EPS to be below what they delivered in 2016. However, the aggregate figures hide a declining core Polyolefin business and a growing HPP business. It is possible that a sum of parts valuation would show these to be good value.
This trading statement starts off well:
…we have experienced good demand in the first four months of 2022, resulting in Group revenue for the period being approximately 13% ahead of the comparative period.
This sales performance is driven by the core business:
Polyolefin Foams sales increased by 20%. Volumes have increased by 5%, with the majority of the sales uplift being driven by increased prices
This suggests that they have pricing power in this part of the business. However, if this is the case, it perhaps implies that they don’t have that pricing power in the HPP part of the business, since here they say:
High-Performance Products (HPP) sales increased by 6%:
• Footwear sales at similar levels to prior period, as expected at this point in the demand cycle
• Aviation sales improving strongly from a low base
• T-FIT® insulation products sales increased by 18%
We would imagine that the raw material cost increases would be similar between the business units and if volumes are at similar levels if sales are only up 6% in monetary terms this implies a reduction in margins.
Hence we are not surprised that they say:
…we anticipate Group revenue to be ahead of market expectations for the full year, with demand in line and higher prices recovering cost inflation.
But profit expectations are only in-line, having been helped by recent sterling weakness. Still, the outlook is cautious but positive:
We have delivered good sales growth in the first four months of the year and anticipate this sales momentum to continue, supported by the price increases and a strong order book with excellent visibility to the end of June. However, we do not anticipate the challenging macroeconomic environment to ease and remain mindful of some specific risks around COVID-19.
However, given that there are undoubtedly headwinds for the business in an inflationary environment, it doesn’t feel like the market to be paying a high multiple for a company in the hope that they can finally turn their sales growth into profit growth.
Hostmore (MORE.L) - Trading Update
This is a restaurant chain so bad that it doesn't even know what its own restaurants are called. At first, they were "T.G.I. Friday's", implying it was founded by a generously-initialled Mr Friday.
Originally they were founded as a hook-up bar, but they found the distracting decor also kept small children occupied while waiting for food and so extended the offering to family dining during the day. Neither drunk people nor children are the most discerning of customers and so the food at T.G.I. Friday's never needed to be any good, and they duly obliged.
In 2013 they rebranded to TGI Fridays. By this time, they were mostly family dining, plus groups of friends who can't agree on where to go. TGI Fridays remained a very silly name because even quasi-restaurants serving quasi-food to quasi-families already tend to be full on Fridays. Really you need a name that suggests they should go out on Monday-Thursday.
The answer was clear since most people were already just calling them "TGIs". So they rebranded to…."Fridays". The management seem as confused as the general public by this change and continued to refer to themselves as “TGIs” on investor calls and use their tgifridays.co.uk URL. And of course, what better name for the UK franchisee of the Fridays "brand" than a company called "Hostmore".
This week’s trading update for whatever they are called is for the 20 weeks ended 22nd May.
LFL revenue for the 20 weeks ending 22 May 2022 is c.6% lower than 2019, with dine-in sales remaining in line with the market benchmark data.
This is actually quite impressive, although the bigging up of management actions suggests the management may be a bit more pleased about a 6% decline than they should be:
Management actions, including pricing adjustments and hedging of utilities, limiting impact of lower volumes on margins.
As does this:
Successful new store openings in Dundee (Fridays and Go) in March and Chelmsford (Fridays) in May.
Since nobody can know if a restaurant opening is successful after only two months, let alone a few days. There also seems to be some vague doubt about their future openings:
Three further new sites now anticipated to open in financial year 2022 ("FY22").
"anticipated to open" makes it sound like they may (or may not) spontaneously open of their own accord completely outside of management control. What they probably mean is that there is some doubt on the timing, though and this may slip into FY23.
Continued cash flow generation, balance sheet strength and liquidity headroom provides a base to almost double the estate in the medium term.
The usual rule applies: when a management mention balance sheet strength it probably isn’t what we would call strong. They have net debt before IFRS16 and a large negative working capital. However, they are cash generative so this isn’t a cause for concern as long as they are able to keep trading.
Secondly, the market seems unconvinced that the current estate can be run profitably and make distributions to shareholders, so doubling down on many more “restaurants” seems unwise in the short term.
On current trading:
We believe this is primarily a result of consumer confidence weakening significantly since Russia's invasion of Ukraine on 24 February 2022 which is contributing to the current cost of living crisis.
If we assume they know what they are talking about for a moment, this would mean that a lot of the bad news is already embedded in consumer behaviour. Yes, there may (or may not) be a further jump in domestic energy prices coming in October, but at least half of that will be covered by government cash, wages are rising rapidly and most people could easily reduce energy consumption if they wanted to.
Our focus on quality, relevance and simplification continues to deliver a significant improvement in guest satisfaction scores.
Having previously been very wary of this as an investment due to the very poor reviews, here we have some quantifiable good news. Local TripAdvisor reviews have materially improved. Most reviews are 5* and they are being properly managed. Clearly, something has dramatically changed in the last few months - it might genuinely be the service, or it might be the solicitation/management of reviews, but either way it is very positive to shareholders. Even if they are literally just deleting bad reviews, that is an indication that they actually care about what people think whereas before it was very evident they didn't.
The strange thing is that at no point did the board give any indication they knew or cared that they appeared to supply terrible food with terrible service and got terrible reviews, yet behind the scenes they have fixed something, even if it is just the reviews.
The step-change in Google reviews is not quite as obvious, but here a number of customers seem to be marking them down due to being expensive. e.g.
Management are following up on every review though.
The challenging consumer environment means that we are taking a more prudent view on trading for the remainder of year, including the assumption that LFL dine-in volumes, as compared to FY19, may reduce by 8% for the rest of FY22.
Reducing by more than the 6% of the first 20 weeks is indeed required given the picture deteriorated during the period. -8% doesn't seem unreasonable.
However, improved customer satisfaction scores demonstrate the success of our investment in improving the quality of our customer offer and now provides a strong basis for appropriate pricing adjustments
Given that many people already consider them too expensive, this may be a stretch too far. We may have spotted their real price adjustment strategy here:
They clearly have to be careful of taking this too far and the reviews deteriorating again. However they achieve it, if successful, this suggests the equivalent of around -4% revenue impact after mitigation.
in line with broader sector announcements, to mitigate approximately half of the impact of the lower volumes now anticipated.
Brokers’ consensus has been dropping:
But the last update on Research Tree is from Edison in January, so we assume that they are in the consensus but stale. So the fall in forecasts off the back of this update probably needs to be doubled to get close to the true figure. That comes to 6.86p for FY 2022. This means the P/E is around 6.2x. Even with some net debt added in this looks cheap.
That’s it for this week. Have a great weekend!