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Small Cap Value Report (Tue 4 Apr 2017) – FUL, KWS
Good morning! It’s Paul here.
I’ve just about recovered from a fantastic weekend – in particular, participating in the UK Investor Show. I (perhaps foolishly!) agreed to be interviewed by Tom Winnifrith, in a “live bearcast”. We didn’t get off to a good start, as I had a brainstorm, and turned up at the wrong venue – a North London conference centre. Only to realise, with complete horror, that there was a room full of people, and a very angry Tom Winnifrith, waiting for me at the QE Centre, a couple of miles south of my actual location!
Anyway, I hopped on the tube, and arrived in time to be torn to shreds by Tom. Although I did manage to get some quite good points in, during the brief gaps when Tom paused his monologues to draw breath! Anyway, it was all a bit of fun, and I popped over (well, spent the next 2 hours in) the Westminster Arms, and had all sorts of interesting conversations with various readers of my articles here.
Then it was back over to the QE2 Centre, to do a main stage stint. If you had told me, when I was in the depths of despair, from 2008-2012, that in 2017 I would be on the main stage, interviewing Nigel Wray, I would have laughed at the implausibility of such a suggestion. Yet that’s what happened, and the initial stage fright immediately dissipated, and it was a thoroughly enjoyable half hour.
The trick is to prepare really thoroughly in the days beforehand, and practice exactly what you want to say, and how to say it. Also, I telephoned both Nigel Wray amp; Paul Mumford, and ran through all the questions with them, so had a good idea what they wanted to say.
So I think I’ve finally cracked how to do public speaking, which for most people (certainly including me) is something which seems very daunting. However, the only way to overcome those worries, is to tackle it head on, by getting up amp; doing it. That involves accepting that at first, you’ll be pretty rubbish at it, but that hopefully each subsequent time is an improvement.
Fulham Shore (LON:FUL)
Share price: 19p
No. shares: 571.4m
Market cap: £108.6m
(at the time of writing, I hold a long position in this share)
Trading update – for the year ended 26 Mar 2017.
This is a restaurant roll out, by experienced management. The main chain is called “Franco Manca”, and is a pizza restaurant, with some nice original touches – e.g. blast cooked sourdough pizzas, premium ingredients imported from Italy, “no logo” craft beers at low prices, wine bottles refilled with tap water amp; mint leaves put on every table when you sit down, etc.
The point being that Franco Manca does actually have some good points of difference, as opposed to being just another “me too” pizza/pasta chain. This is important, as there seems to be over-capacity emerging in the restaurant sector, with so many roll outs occurring. Inevitably that means weaker formats could fall by the wayside.
Fulham Shore also operates its smaller The Real Greek chain, and is experimenting with some interesting new ideas, e.g. street stalls. Both chains make fairly decent operating profit margins at store level, which is absolutely key to determining whether a roll out will work, or not.
As we saw with Tasty (LON:TAST) last week (in which I have a long position), those that make mistakes with poor menus amp; poor site selection, or just don’t offer good enough value for money, can start to go wrong – Tasty warned on profits a few days ago, which I reported on here.
So I was apprehensive about the next update from FUL – is a general slowdown occurring in the restaurant sector, or are Tasty’s problems self-inflicted? It seems to be the latter, because FUL has updated positively;
The Board expects that Fulham Shore will report full year results in line with market expectations for the financial year to 26 March 2017.
Other details include;
- The company is to invest £100k in a seasonal branch in Sicily – via a franchisee. I’ve got mixed feelings about this, but it’s not a huge amount of money.
- Rapid amp; ambitious roll out. 16 new sites opened in FY2017 – going from 29 to 45 sites in one year is a helluva challenge, but the company seems to have pulled it off.
- Pre-opening costs higher than anticipated, due to delays at one site, and 2 additional sites opening earlier, which had been intended for the new financial year. No big deal in my view.
- A further 15 new sites planned for the new financial year (ending 3/2018). Ambitious again, but the company seems to be able to cope with rapid expansion. It does increase risk though.
- Will these formats work outside London? As they are lower priced chains, I reckon they will. The company doesn’t indicate any problems with regional site openings to date.
- HSBC borrowing facility expanded from £6.5m to £15.0m, to finance rapid expansion – so this roll out is not entirely self-funding. They’re going faster, and increasing borrowings to do so.
Valuation – I’m struggling to get hold of the latest forecasts. It might be helpful if the company commissioned some research, to help investors better assess the prospects of the company. That might also help improve liquidity in this share, which is currently poor.
My opinion – I love good roll outs. The beauty is that bolting on each new site increases cashflow, thus creating a virtuous circle where expansion becomes self-funding. So providing nothing goes wrong, then investors can just sit back amp; watch the company grow considerably, with little to no further dilution.
When a format works, I also like the roll out to be done fairly aggressively, if management can handle that without making expensive mistakes on site selection. This seems to be one of the issues at Tasty (LON:TAST) for example.
I’m relaxed about FUL borrowing more from the bank, to part-finances rapid expansion, as long as trading remains robust. It would of course increase risk, if trading went badly wrong. Personally I don’t see how a chain serving nicely done, large pizzas, from £4.95 each, is likely to suffer in a recession. The opposite could actually happen, as people might trade down from more expensive offerings?
Another key requirement for roll outs is experienced, and capable management. FUL gets a tick in that box.
Overall, FUL has good formats, which work well at individual site level (strong individual site profitability/EBITDA). I’ve read commentary that EBITDA is nonsense. In this sector, actually EBITDA is critical, and it’s the most important measure for assessing performance. The reason being that it’s all about cashflow, not profits. I could explain more, but don’t have time now. Also it’s a pointless discussion. You either understand that roll outs are all about cashflow, or you don’t, and miss the point completely.
The ambition here is to get on with it, and build a national chain. That should see profits go through the roof over, say, the next 5 years. That’s why I hold this share.
These bank facilites will enable Fulham Shore to gradually accelerate its opening programme and push for a nationwide presence throughout the UK.
Of course, the downside risk is that rapid expansion could lead to mistakes, and things going wrong, as has recently happened at Tasty (LON:TAST) . So roll outs are not without risk. Personally though, my assessment now is that FUL is one of the best roll outs on the UK market, based on currently available facts amp; figures. Of course, if the facts amp; figures change, then I reserve the right to change my mind in future. Views on shares should never be fixed. They can amp; should change when the facts change.
Keywords Studios (LON:KWS)
Share price: 694p (up 1.6% today, at 11:24)
No. shares: 54.4m
Market cap: £377.5m
Final accounts – for the year ended 31 Dec 2016.
Results today look in line with an update given on 8 Feb 2017, which I reported on here. Actually adjusted profit before tax is slightly above, at E14.9m, when E14.8m was indicated earlier. Always nice to put a cherry on top, with a slight beat against a previous update!
This group is highly acquisitive, and describes itself as an - “international technical services provider to the global video games industry”
The pace of acquisitions is the first thing that stands out with this company. It did an astonishing 8 acquisitions in 2016. I cannot understand how management could possibly do so many acquisitions, at the same time as running the business? So that’s a bit of a worry. Although the bolt on acquisitions seem fairly small in total, just over E20m, as I noted in my previous report on this company. I wonder why the vendors are selling, if their businesses are doing so well?
Like-for-like (“LFL”) revenue growth from existing businesses looks excellent, at +24%.
Cross-selling – someone at the UK Investor Show was briefing me on this company, and reckoned that the acquisitions are good, because it increases cross-selling opportunities. That’s confirmed in the narrative today;
25% increase in clients using three or more services from 51 to 64
Current trading – looks fine;
Trading in the first two months of the year has been in line with the Board’s expectations
Debt - more debt for more acquisitions. Looks fine, providing profitability remains strong;
Terms agreed for a revolving credit facility of up to €35m with Barclays Bank, which will provide further headroom for selective acquisitions
Diluted EPS – is 10.87 Euro cents. It’s about £1 = E1.17 at the moment, so this translates to about 9.3p. Therefore at 694p per share, the PER is slightly under 75. Yikes!
Now of course, the statutory numbers are the most conservative version of profit, so we should also look at the adjusted EPS figures, to remove things like goodwill amortisation (which is fine by me, that’s just a rather annoying book entry).
Adjusted basic EPS is much higher, at 20.59 Euro cents, and is up 61%. So clearly the valuation of this company partly hinges on strong growth (although remember that a lot is coming from acquisitions, so that has a one-off benefit). Also it partly hinges on the big difference between statutory amp; adjusted EPS.
So investors really need to be certain that you’re comfortable with the adjustments to EPS, because they’re big adjustments.
These adjustments are;
(before share option charges, amortisation of intangible assets, costs of acquisition and integration, and foreign currency movements)
…acquisition and integration expenses of €1.3m (2015: €1.1m), share option charges of €0.7m (2015: €0.4m), amortisation of intangibles of €1.6m (2015: €0.9m), and foreign currency loss of €1.7m (2015: loss of €0.5m).
Balance sheet – Net assets total E100.6m. As you would expect from a highly acquisitive group, this is becoming top heavy, with intangible assets.
Goodwill amp; other intangible assets total E55.5m, so take that off (to look at the most conservative view of the balance sheet – always worth doing) we get NTAV of E45.1m.
The rest of the balance sheet look fine to me, I can’t see any particular funnies in there, or anything out-sized – debtors look about right for the size of business.
Cashflow – this is often more revealing than the Pamp;L statement, and generally I think we should place more emphasis on analysing cashflow.
I don’t see anything untoward here either. The net cash provided by operating activities, of E15.0m, is a huge increase on 2015′s E3.4m. Although favourable working capital movements in 2016 of E3.2m are the reverse of a E3.2m adverse movement in 2015. So a E6.4m working capital improvement in 2016 vs 2015, reduces the increase in operating cashflow from E11.6m, to E5.2m. Still good, but we mustn’t get carried away!
Pleasingly, there’s no sign of aggressive accounting treatments that I’ve seen – e.g. no aggressive capitalisation of costs.
Basically the company has generated a lot of cash, and topped that up with some bank loans, to buy more bolt on subsidiaries.
Dividends – just a token amount really, but that’s fine for a group with a growth strategy.
My opinion – I don’t really have any opinion on the company’s prospects or what the share price might do.
The main thing to point out, is that the stock is pretty expensive now, so the growth has to continue to justify that high rating. If you think that’s likely, then everything’s fine.
I was asked by a reader to run my slide rule over the accounts, which I’ve done, and it all looks clean to me – I don’t see anything fishy, or suspect in there at all. Personally I would probably reverse out the adjustment of share-based payments, as that’s remuneration, but it’s not a huge amount. There’s also some dilution from deferred consideration (in shares) for acquisitions, but that seems to have been accounted for in the diluted earnings numbers.
Overall – looks interesting, but quite pricey!
Right, I have to take the dogs out to the groomers now.
I’ll do some more writing later this afternoon, early evening. So pls revisit this page later, if you wish.
Regards, Paul.
Source: http://www.stockopedia.com/content/small-cap-value-report-tue-4-apr-2017-ful-kws-178950/
