Small Cap Value Report (Thu 3 Nov 2022) - CER, HWDN, SBRY, IGR, BT., TIFS, UPGS, KITW, GATC

3rd Nov '22 by Paul Scott

63 comments 7121 reads

Good morning from Paul & Graham! Today's report is now finished.

Podcasts - I've managed to iron out the problem with my podcasts not working on Google Podcast service. That's now fixed, and they download automatically now. I had to install an SSL certificate. Amazingly, even though I have no idea what an SSL is, I managed to somehow install one last night!

Agenda

Paul's Section:

Cerillion (LON:CER) [no section below] - another interesting CEO interview, which I recorded yesterday afternoon. The audio is here, and on podcast. I tried to get to the bottom of why the company's performance (revenues & profits) have exploded upwards in the last couple of years, with some key factors emerging. Just for Stockopedia subscribers (please don't copy it elsewhere!) I've also typed up the interview in a separate post here. I think it's fair to say that CER shares are not a bargain, on a forward PER of 32, but I think that valuation can be justified, given the outstanding profit growth, and a big market opportunity to continue growing. So it's a gone on my watchlist of things to buy on the next market downturn.

Mid caps that I happened to look at briefly this morning, so might as well comment here. Both seem to be trading well, so what about this recession that’s supposed to be starting? No sign of it so far, with either of these 2 companies. Maybe consumers are cutting back in some areas, but not others? Or is the impact of a slowdown yet to be felt? Who knows.

Howden Joinery (LON:HWDN) - trading well, and expects PBT this year to be “marginally ahead” of broker consensus.

J Sainsbury (LON:SBRY) - also says current trading is good, and leaves profit guidance for this year unchanged.

BT (LON:BT.A) Interim results - I had a very quick skim, a few key points - valuation now looking interesting, with the PER and divi yield both around 6. Lots of gross debt, so need to check interest charges (how much is fixed or variable?) Divi yield is slightly higher than the 2028 bond yield (with a running yield of 5.7%). Trend (long-term) is revenues falling. Heavy capex. Cost-cutting to maintain margins. Note pension deficit has gone up - blaming rising gilt yields (presumably that means the fall in asset values has…

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3rd Nov '22

This is bang on Boon. I looked at their new full fibre offering with an intention to proceed until they declared a rise next year of rpi plus 3.9%. When asked about it they replied that is what all the companies do. It isn't and I walked over to one of their competitors. Really silly of them in my view. As I said "I have no problem with RPI everyone can see what is happening but 3.9% on top is just plain greedy."

Helvellyn

MVNO , FTTP ??

TFF Google :-))

Boon

MVNO= mobile virtual network operator

FTTP = fibre to the premise

Paul Scott

Exactly. It's so quick for me to look at the headlines & outlook comments, that it's not either or (small caps or mid caps), it's both.

RDHOWARTH

Are BT necessarily a loser when customers switch to an MVNO?

Tommy H

I have been trying to boost the cash balance in my Vanguard account by buying the obvious dips, not timing the bottom but buying on big down days, or several down days and selling into the bounce.

Obviously a far more simplistic method, but slowly offsetting some of the losses, and looking at the monthly report, 5:2 up since the tax year started!

Tommy

Martin_576

Another huge effort by Paul and Graham today - many thanks

Equity Development

Strong progress for the key brands Beldray and Salter plus significant advances in supermarkets and online coincided with increased margins across-the-board and an improvement in UP Global Sourcing Holdings (LON:UPGS) net debt/EBITDA position in FY2022. Moreover, the company anticipates that the market’s profit expectations for FY2023 will be met.

Strong sales growth in supermarkets and international sales were confirmed by today’s data which reported increases of 38% (25% excluding Salter) and 22% respectively. Online sales were a significant beneficiary of the Salter acquisition and increased by 23%.

The current share price fails to capture three salient growth drivers (namely brands, distribution and international) of the business. We believe the company’s ability to cope with external headwinds has been proven repeatedly, alongside its well-executed financial resilience. Hence, we base our 250p fair value / share assumption on an FY2023 EV/sales ratio of 1.5x and 12x EV/EBITDA.

Full note https://www.equitydevelopment....

Investor Presentation on the 9th at 11.30 https://www.equitydevelopment....

BnB

Gattaca (LON:GATC)

Is it too small, or just not good enough (probably both!)

Certainly the latter but, far from being too small, it's almost certainly too large. To borrow a phrase, in recruitment only three things matter - focus, Focus and FOCUS. The much vaunted but cumbersome SThree (LON:STEM)'s margins are only half what the top boutiques achieve.

There's not really any dilution or insolvency risk, so you get any turnaround upside in for free.

While you watch any remaining human capital bleed out of a losing team until there is nothing left but a balance sheet rapidly draining into the hands of an incompetent legacy management and and inexperienced replacement cohort.

I've gone into more detail in the past on this so I won't rehash as users can search through past discussions. Sure, there's rebound potential but there's almost/just as much at RWA or STEM, which both look dirt cheap, as you've rightly acknowledged many times. I really would advise investors (as opposed to traders) to avoid.

A_Private_Investor

Hi BnB, I've read your previous posts on recruiters with your recommending SThree and Robert Walters. Both are on attractive valuations, look good companies etc based on the figures. I get what separates SThree from the pack - a focus on STEM and hiring in for a temporary appointment which would appeal both to a lot of tech people and companies with a project to deliver - but what separates Robert Walters from the pack ? Or put another way, when the downturn almost inevitably comes, are there any factors which would allow them to outperform other recruiters?

Completely understand if you don't respond, but would be very appreciative if you did !

In my podcast with UP Global Sourcing Holdings (LON:UPGS) today, their MD Andy Gossage indicated that the savings from drastically reduced freight costs, are offsetting dollar strength. So he doesn't see any need to raise selling prices in 2023. Very interesting! The audio is just published, on my website here. Well worth a listen!

Cuddlesticks

Brilliant, thank you.

What separates Robert Walters from the pack ?

Or put another way, when the downturn almost inevitably comes, are there any factors which would allow them to outperform other recruiters?

When I highlight the virtues of RWA and STEM, it is only in contrast to other listed recruiters (Page, Adecco, Hays etc), but not in comparison with the quality end of the wider market. All will underperform quality boutiques, and in all market conditions, owing to weaker margins, inflexible incentives, slacker cost controls and a relative lack of focus.

Nevertheless RWA's virtues include a long trading history and excellent reputation, strong client relationships, and good sector concentration in attractive niches. It has a less attractive business mix than STEM, being 70/30 perm/contract, rather than the other way round. And that, along with the broader sector mix, has me favouring STEM. Contract is a bit like SAAS: your revenues are booked well (often years) into the future; perm has you staring into space all the time and wondering where the next deal comes from.

However, I rate RWA's management extremely highly. Roger W himself is a top man and shareholders' money is in excellent hands. More than anything I would suggest that this is RWA's strongest suit. Roger has been there and done it over 40 years: dotcom crash, GFC, pandemic - he's steered a good ship through all those storms.

I could add that RWA is more exposed to Asia, where the rate of growth of professional appointments is greater than in Europe or the USA.

eParo

Announcement by National World (LON:NWOR) late in the day for a possible offer for Reach (LON:RCH):

The Board of National World plc ("National World" or the "Company") notes the recent press speculation regarding a potential transaction involving Reach plc ("Reach"). National World confirms that it is at the early stages of exploring a possible offer for the entire issued and to be issued share capital of Reach ("Possible Offer"). National World has not yet approached the Board of Directors of Reach with regard to the Possible Offer.

RCH is 6x bigger than NWOR. How will they fund it? Will it flush out others?

Possible cash offer? Seriously? https://www.reuters.com/market...

For Mobile - yes, BT loses out if someone leaves. Unless the MVNO is using EE (owned by BT). However, those MVNOs get bulk, regulated rates on the data and line usage. So the replacement income is not the same.

For Broadband - yes, but still get something most of the time. The vast majority of broadband currently is on Openreach, which is owned by BT. However, using (very simplified examples), a BT customer that has been with BT for many years might now be paying like £50pm for broadband (because that was the cost back then, plus all the yearly increases). If they swap to the best of market price now (Shell Energy) at £14pm, yes - some of that £14 will go to BT. But it will still be less than the margin they used to get on the £50 customer.

So really, the whole BT business model, because they are #1 in customer numbers for Broadband (and also for Mobile I think) - is to prevent their existing customer base from churning. As customers call up to leave, they retain them by putting them on better pricing. But that means that their recurring revenue is shrinking over time, even if they manage to retain every customer. And new customers they bring in, are at a much lower revenue than the existing base.

That's why the key business model driver for these Telcos over the last few years has been how much cost can they cut - they need to do it faster than the deflationary impacts of (1) data trending to £0 cost and (2) churn of their existing base.

Inflation has definitely changed the picture; but even with my former Telco experience, I'm not quite sure how this will impact BT, Vodafone, etc. Quite complicated as you look into existing back books, customer switching behaviour, debt levels, debt cost, capex requirements, competitor landscape, etc.

TheFloatingInvestor

Excellent analysis BnB, clearly an expert in this field, and appreciate you views!

Sorry Dicktrade FTTP.

Albertos

When the deals start to get ludicrous its a harbinger of the long awaited crash.

Thank you that is interesting although both consumer and open reach looked ok to me today. I think there are always examples where pricing of any offer can look way off or just doesn’t work for some people. When I have looked at it bundles tend to be much more competitive … and when I have considered switches myself the gains hardly seemed worth the hassle in the end. But I also agree that for others that’s not the case and they switch. As you say it’s complex but I believe the build out will put them in a stronger position and I’m happy collecting the divi in the meantime. The brokers seem to agree with you however … but in this sector they look at one no FCF and if it slips they jump up and down.

4th Nov '22

Me too! Thanks for taking the time to respond.

Small Cap Value Report (Thu 3 Nov 2022) - CER, HWDN, SBRY, IGR, BT., TIFS, UPGS, KITW, GATC

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Paul Scott

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