Small Cap Value Report (Mon 24 Jan 2022) - RBG, SAA, GMS, DLAR, CNS

24th Jan '22 by Paul Scott

123 comments 12575 reads

Good morning, it's Paul & Jack here with the SCVR for Monday. Today's report is now finished.

Agenda -

Paul's Section:

Revolution Bars (LON:RBG) (I hold) a short video I made over the weekend, mystery shopping the reopened, refurbished Bournemouth site. I was impressed. 19 refurbs underway (28% of the estate) should drive strong sales & profit performance this year, in my opinion. Hence I think the ducks are now lined up for a much improved performance in 2022, whilst remembering there are cost headwinds too.

M&c Saatchi (LON:SAA) - Vin Murria looks to be flogging a dead horse here, with her ill-judged takeover attempt. There's a 40p cash element added, but the bottom line is she hasn't got the firepower to buy SAA, so should back off.

EDIT: SAA has now issued an interesting update, worth reading if you hold, basically saying there's no merit in the deal, so the independent Directors have unanimously rejected it.

Gulf Marine Services (LON:GMS) (I hold) - an in line update. This is an interesting situation - very high debt, but the strong and predictable cashflows from medium-term contracts, being renewed at rising daily rates, gives a predictable path to debt reduction. The benefit of that could flow through to equity holders over the next few years. Guidance for 2022 is positive, and specific numbers provided.

Jack's Section:

De La Rue (LON:DLAR) - profit warning, with a c20% downgrade in FY operating profit from £45m-£47m to £36m-£40m. Seems like quite a change from interims reported in late November of last year. The turnaround is set back by a year and there’s a question mark over the profit growth profile going forwards, with ongoing substantial pension contributions to consider. FY results out on 25 May, so it could be worth waiting until then for more detail and commentary.

Corero Network Security (LON:CNS) - EBITDA to be ‘materially ahead’ of expectations, with a maiden profit before tax in sight. There has been a lot of equity dilution in the past and that makes me wary, but the direction of travel appears positive. Its ‘Highly Speculative’ riskrating is well-earned.

Here is mine & Jack's weekly SCVR summary on 29 minute audio. We rattle through almost all the companies…

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Cal H

24th Jan '22

HMRC are still charging interest on payments after the normal 31st January deadline unfortunately. You just aren't charged the late submission penalty of £100.

ken mitchell

Barnaby

Just to say that it’s best to be very wary of anyone who thinks they know where markets are heading, except sometimes very short term. Time and again markets do the opposite of what we expect and they can climb “a wall of worry’” or fall heavily when least expected to.

e.g look the huge and fast rally from April 2020 when covid news was dire, much of the economy here and elsewhere shut down, and fears of another Great Depression ahead. Then many “market experts” were predicting a long and savage bear market. Instead it turned out to be a great once in a decade buying opportunity.

These days, with computers a factor in this, markets can turn on a sixpence, even on the same day.

E.g one day last week the Dow Jones index swung from 400 points up to 600 down by the end of the day.

Note too that more than half the shares in the US Nasdaq index are regularly hitting new 12 month lows, and many of those have now fallen over 50%. It’s the sometimes hugely overvalued shares like Tesla (PE300) that have hidden the much bleaker picture underneath that has been going on for a while now.

Key thing when we’re worried and markets are having a bad run is to sell anything we know we’ve got wrong, and also to have more in cash than usual (though arguably 100% in cash is extreme!) to take advantage in falling markets of the opportunity to buy quality bargains at a discount and to top up existing holdings we’re still confident about.

yiannos1

The UK market has never been close to the liquidity of its US counterpart , and will never be. What you are saying is nothing new and will be the same in the future.

NikT

Hello,

Wanted to get some insight into your reasoning behind Thg (LON:THG) over Boohoo (LON:BOO) (I hold). You mention Boohoo (LON:BOO) has a large amount of short positioning against it, which it does: Marshall Wace (2.7%), WorldQuant (0.53%), and AKO Capital (0.98%), and I'm sure there are others below the 0.5% reporting line. However, so does Thg (LON:THG): AHL Partners (0.61%), QUBE Research & Technologies (0.55%).

While both are arguably in deep Value/Contrarian territory. I do have a stronger conviction in Boohoo (LON:BOO) due to brand strength (as much as that exists in the retail space), and management experience compared to £THG.

Kind Regards,

Nik

Lefty99

I will definitely swap you, I am negative 10% and it is rapidly getting worse.

Boon

My personal view when it comes to shorts, and this could be a purely arbitrary thing that has no scientific basis... is that I don't touch any shares with more than 3% short outstanding, or have 4 or more investors reported above 0.5%.

That's my line. Boohoo (LON:BOO) meets the 3%, and until recently, also had 4 investors reporting >0.5%.

Brand strength - I would disagree. Thg (LON:THG) have some top eCommerce brands in the beauty space (Cult Beauty, Lookfantastic, Perricone, Myprotein, etc). Whereas Boohoo strategy is now buying up cheap/failed brands, ones that have been flogged to death to the point they go into administration to be picked up cheaply. I have yet to see Boohoo reinvigorate any of those brands. Look at Debenhams - IMO they are just milking whatever legacy brand equity there is left there, not building it back up. I'm not saying I think Boohoo has terrible brand strength - they still have Boohoo and PLT - but I think THG is on par or better.

Supply Chain, Inflation - this is where I see THG having the edge. Higher end premium products, ones with more margin. They'll weather the cost and supply chain inflation better than Boohoo (LON:BOO) will with its cheap-as-chips clothing. While Boohoo (LON:BOO) have now belatedly started investing in logistics, warehouses, back-end tech.... THG have been doing it for years, which leads me onto...

Ingenuity - a lot of criticism have been levelled here at this bit of the business. But this diversifies THG away from just an eCommerce company (which is 100% Boohoo), and into a B2B, SaaS/LaaS part of the business too. Fundamentally, eCommerce has gotten so competitive nowadays, that if you were setting up a new company, it would take too much capex investment to create a world-class, 5-star rated logistics, distribution, warehousing operation. Sure, 10 years ago you could sell CDs out of a garage (which is how THG started). But you'd get 1 star reviews now if you did that, AND lose money because its not efficient. It is like Cloud Hosting. Every website, including Stocko, now outsources their hosting to a cloud provider like AWS, Microsoft, etc. Sure, you could still stand up your own server in your garage, but the website would load so slow, and cost you more. Ingenuity is building that entire tech, logistics stack for mid-sized eCommerce businesses out there. Of which there is a huge market size. Think every single brand that wants to do D2C. I'd argue that the opportunity for them is greater than Ocado's opportunity in online groceries; as in Ocado's case, most markets have 2-3 dominant grocery players who have the money (and market share) to think about building their own online grocery operation.

(I now hold, as of this afternoon, shares in Thg (LON:THG) )

FederalReverse

This is a very important point. Personally I think this is getting worse all the time, mainly due to passive funds and indexing. Private pensions are almost universally directed to passive funds favouring sovereign bonds and mainly US equities, because of the huge US weighting. While indexing takes a greater and greater hold over the long run it seems to me there will be fewer and fewer discretionary traders of mid to small cap UK co's.

Might be good for UK stockpickers finding bargains, but I think in general this is very unhealthy for markets. I think the general lack of discretionary players has contributed to the extreme volatility during sell-offs in the last few years. You get glacial levels of volatility on the market march up and very fast plunges like we're seeing right now and in March 2020.

abtan

Hi Boon

Thanks for sharing your thoughts.

That's really interesting on Thg (LON:THG) . I must admit to only having glanced at it in the past as I was put off by its (to me) high valuation.

The ingenuity product sounds interesting, though I can't work out what the USP is. It seems to be a combination of Amazon's FBA service and the services offered by a company like Shopify/Channel Advisor - see here:
https://www.channeladvisor.com...

There are quite a few companies like Channel Advisor, many of which are listed, so perhaps I am missing the opportunity with Ingenuity.

I don't hold $SHOP, $ECOM or Thg (LON:THG) .

---

To pick up the point on Boohoo buying old brands that don't add much to the business, that may well be the case with Debenhams, though I'd like to highlight that Asos (LON:ASC) seems to be flourishing with the old Topshop brands, especially in the USA.

From the last trading update Topshop sales have grown 200% YOY, albeit from a low base.

I do hold £ASOS and am looking to make it a much larger portion of my portfolio (though not because of the Topshop brands).

Thanks again.

Hi again Boon

That is a ridiculously good YTD performance. I am 30% cash too, but my portfolio is still down 8% for the year.

Nice to see Spectra Systems (LON:SPSY) is on your top up list. I topped this one up last week - the first purchase of the year.

I've been slowly topping up a few other holdings today (including Asos (LON:ASC) ) but still retain a decent sized cash position.

Fingers crossed with the deployment timing!

Paul Scott

Sorry, typo but too late to edit. I meant March 2020 of course, not March 2000! Apologies.

Thanks for your insight. I will have to take a closer look into the Ingenuity aspect of THG's business.

I've not had direct experience of Thg (LON:THG) Ingenuity myself, so really am basing it off on investor presentations and my understanding of the service digging around their website for marketing materials.

But what I gather is that it is complete turnkey solution for brands. You can literally outsource the entire eCommerce operation to Ingenuity. Website, digital marketing, customer service, warehousing, fulfilment. And globally, not just in one market. You could be Primark, with no online capabilities, and within X months have fully functioning eCommerce operation without building headcount, spending CAPEX.

Amazon FBA only does the warehousing and shipping. Not the website, marketing, customer service. And definitely not packing items into fancy branded boxes (I believe it still arrives with Amazon tape on the box!)

Shopify only does the online website, order processing, payments. But not warehousing and fulfilment, and limited marketing. Plus, you still need to manage the website yourself, code it, update content, creatives, customer service, etc.

Channel Advisor is just an inventory management software, so it hoovers up all the orders from your various sales channels (amazon, website, ebay, etc) and sends them to warehouse. Does not give you an eCommerce website, nor manage the warehousing and fulfilment or customer service.

The question is how many brands want a fully outsourced solution (or maybe partial? I think Ingenuity can be bought in modules), since "digital" is meant to be the future. On the other hand, if Ingenuity does it well, and does it cheaper, then brands will happily outsource.

Trying to think of an illustrative example. Sodexho is the first that comes to mind. Companies can completely outsource their catering requirements to this company, who then does everything - make food, maintain canteen premises, manage payment, regulations, do marketing (website/email with menus). Complete turnkey solution. As Sodexho has the same playbook, systems, equipment for all company canteens, they are uniquely positioned. Some offices will still run their own catering, if they're big enough or too small, but many small offices outsource to Sodexho.

I can't remember the exact figure that was part of the Thg (LON:THG) scandal. The one where Softbank invested some money into Ingenuity for a future potential option to get a bigger shareholding. But that deal valued Ingenuity at like $6bn.

Now, I take Softbank valuations with a grain of salt. But they're not complete nutters. So that was what made me dig into Ingenuity. To see if there was actually some substance in it. And I liked what I saw, in terms of their ambition and vision. However, execution is important, and we haven't seen proper ££ figures yet for Ingenuity I believe.

Ah, I didn't end up pulling the trigger today on topping up with Spectra Systems (LON:SPSY)

The De La Rue (LON:DLAR) update spooked me. Can Spectra really escape the same shortages and cost inflation?

SPSY usually overdeliver in terms of EPS compared to broker forecasts. So maybe they'll still hit FY21 and FY22 forecasts even with headwinds, as the forecasts are conservative. Hmm.

Will mull it overnight and maybe decide tomorrow.

Thg (LON:THG) (no position)

Thanks Boon

I understand what you're saying; having everything organised under one roof certainly sounds appealing.

I guess what I don't really understand is that it will take many many years for Thg (LON:THG) to build a completely independent worldwide warehousing/delivery system and in the meantime several companies are already doing this.

In the UK £NEXT comes to mind, and more globally Asos (LON:ASC) , which has spent hundreds of millions of pounds over the last 3-4 years setting up a next day delivery service in the USA, and still plan to spend another couple of hundred million pounds this year alone automating their warehouses further.

Asos have also started taking orders for retailers such as Adidas and Rebok, which are then fulfilled by these 3rd parties directly.

For a bigger, better known beast in the USA, Shopify also offer fulfilment services, alongside online store creation:

https://www.shopify.com/plus/s...
https://www.shopify.com/plus/s...

I'm certainly not saying that Thg (LON:THG) won't be able to achieve success with Ingenuity, but I get the impression that they've just started a race that began a while ago. Or maybe I'm simply missing what's so special about it.

I'll try and keep an eye on it, as I'm genuinely intrigued, though like you, I am wary of any Softbank investments, especially after the WeWork debacle.

Cheers

Spectra Systems (LON:SPSY) (I hold)

I don't really follow De La Rue (LON:DLAR) , so I can't really comment on their trading update.

I do know that from today's Spectra Systems (LON:SPSY) update there was specific mention of an additional $700k in revenue above forecasts for the year.

Presumably if the forecasts had changed, one would hope that the company would have told us at the same time!

As for margins, I'm not really sure how these might be impacted.

Company revenues are quite small (c.$17m pa at the moment for the entire company) relative to some of the customers they deal with (eg Dr Pepper, Major National Banks, State Lotteries, etc...) so I imagine that if there are raw material costs to pass through, the end customer won't really have an issue with them.

It's also worth adding that:

many contracts are long term, presumably with raw cost increases built into them;
there are fixed licensing elements to the revenue stream ($1.7m pa) that add some certainty to the annual numbers.

Of course, nothing is guaranteed, but I've found that this company has been quite good at communicating with their shareholders.

Fingers crossed nothing has changed yet.

GloucesterBob

If I have any money left in March will try to set something up, we can drown our sorrows if nothing else.

timarr

25th Jan '22

There's not a great deal of detail in the De La Rue update but my guess is that the cost inflation primarily relates to their banknote production. Spectra, on the other hand, don't do any banknote production, they produce the security features that go into the notes such as security threads and inks (and therefore may be a source of the cost inflation, rather than the victims).

I wouldn't take this as gospel - it's quite hard to figure out everything that Spectra do, and De La Rue weren't exactly forthcoming - but I didn't immediately start panicking and sell my Spectra shares.

You're right that there are some other players globally that could offer what THG is trying to do with Ingenuity. Like ASOS. Even Amazon, if they really wanted to pull together a complete turnkey solution for brands.

That's a fair point, as far as I know Spectra don't have run production facilities for banknotes.

Small Cap Value Report (Mon 24 Jan 2022) - RBG, SAA, GMS, DLAR, CNS

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Paul Scott

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