Cube Midcap Report (23 Jan 2020) – Shoppers return to #ASC #PAY #CRW
Good morning, it’s Roland here with today’s Midcap report.
There’s quite a lot of news from companies in our universe this morning. I see in-line trading updates from Hotel Chocolat (HOTC), Daily Mail and General Trust (DMGT – I hold), Computacenter (CCC) and PPHE Hotel Group (PPH).
These updates should be broadly reassuring for holders. But I’m going to focus my time this morning on updates from companies that are moving the market today:
- ASOS (ASC)
- Craneware (CRW)
- PayPoint (PAY)
- CMC Markets (CMCX)
This report should be finished by
1230. Finished at 1245.
- Share price: 3,200p (+6%)
- Market cap: £2.8bn
The ASOS share price rose by 10% in early trade this morning, but has since pulled back somewhat. The gains were triggered by a trading statement showing that sales at the online fashion retailer rose by 20% to £1,074.9m during the final four months of 2019. This is significantly ahead of forecasts I can see suggesting growth of 15%.
Sales growth was fairly even across all regions, as this table shows:
Previous years’ growing pains relating to warehousing and logistics appear to have been resolved. The company reports “robust operational performance through peak period at all our distribution centres”.
Customer visits rose by 23% year-on-year and the retailer added 1.4m new active customers during the period.
There was only one fly in the ointment!
Margins are still falling
It’s a strong result, but of course it’s easy to boost sales if you cut prices. Today’s update reports a 1.7% fall in gross margin over the period. This is said to relate to US duty and planned “investment in customer acquisition”. I guess this means marketing spend and/or discounting to attract new shoppers.
ASOS’s gross margin fell by 2.4% to 48.8% last year (y/e 31 August 2019). Today’s update suggests this decline has continued and that gross margin may now be just 47.1%. However, I’m not sure of the correct comparative figure, as ASOS has changed its reporting dates since last year, when it didn’t publish a comparable four-month update.
By way of contrast, earlier this month rival Boohoo (BOO) reported a gross margin of 53.5% for four months ending 31 December, a fall of just 0.7% on the prior year.
Despite better-than-expected sales growth, today’s update merely confirms the outlook for FY20 and does not include any upgraded guidance. My reading of this is that margins are not expected to improve significantly and might even weaken further.
This business has consistently been less profitable and less cash generative than rival Boohoo in recent years. ASOS’s operating margin dropped to just 1.3% last year. BOO achieved an equivalent figure of 6.9%.
I’d also note that in last year’s final results, ASOS did not provide any forward guidance on EBIT margin or sales growth. This was a change to previous years, when the firm had always provided clear numerical guidance. When companies suddenly start to exclude financial guidance they previously provided in their results, I tend to take a sceptical view.
Another concern for me is that I believe ASOS lacks brand equity compared to Boohoo, which has built up a valuable collection of recognised brands. I suspect ASOS is more likely to have to resort to discounting to stimulate growth.
It’s possible that I’m being too harsh on ASOS. But the earnings forecasts I can see price the stock at 55x FY20 forecast earnings, falling to a figure of 35x for FY21. Until we see evidence that margins are stabilising or improving, I think the share price is up with events. If I wanted to invest in this sector, I would wait for an opportunity to buy into Boohoo, instead.
- Share price: 2,130p (-9.4%)
- Market cap: £571m
Healthcare software group Craneware was a high-flying AIM stock that could do no wrong until last June, when the company issued a profit warning which it blamed on slowing sales. Today’s trading update trumpets a return to growth, but the market doesn’t seem convinced. The Craneware share price is down by about 8% as I write. So what can we learn from this update?
The story so far
Craneware’s software is used by US hospitals to help them keep track of billable items that can be charged to patients. Over the years, the company has invested a lot in R&D and developed significant expertise in this area. According to the Craneware website, it counts “almost a third of registered US hospitals” as customers.
Hospitals sign up to multi-year contracts and renewal rates are generally high, leading to high margins and good visibility. The shares have quadrupled in value over the last five years, even after the impact of last year’s profit warning. So far, so good.
However, in June 2019 Craneware warned that “the timing and quantity of sales closed in the second half of the year have been lower than anticipated”. This led to a modest cut to sales and EBITDA guidance for the year and a significant de-rating of the stock.
The delays were said to be caused by hospitals assessing Craneware’s new product launches before making renewal decisions. September’s results did not contain any further nasty surprises and the shares have been gradually drifting higher:
Good news: Today’s trading update starts well, reporting H1 FY20 sales 30% ahead of H1 FY19. This is said to be driven by an increase in the number of contracts signed as the backlog from H2 FY20 is gradually cleared.
Sales of the group’s new platform, Trisus are said to be “good” while the core Chargemaster product is said to have delivered “a strong performance”.
I think the strong performance in H1 is encouraging, as it suggests that sales delayed in H2 last year are now being secured. In other words, these sales haven’t been lost.
On the other hand, this rate of increase seems unlikely to be sustained, as the backlog will presumably be cleared at some point.
Not such good news: It seems that not all contracts are being renewed as hoped for. Craneware says that “customer renewals by dollar value” were 73% for the half-year period, below the historic norm of 85%-115%. This is said to be due to the “disproportionate impact” of the loss of single large customer during this period.
Revenue from Craneware’s multi-year contracts is recognised gradually, as the contract is delivered. Growth in H1 sales is not expected to translate into an increase in H1 revenue, which is expected to be at a similar level to last year ($35.8m).
Adjusted EBITDA for H1 is expected to be around 10% higher, at $11.6m.
I don’t think today’s update is a disaster. But it does highlight the risks and ongoing challenges faced by investors in this group.
A further point worth mentioning is that this company capitalises a lot of its software development costs. Last year, the firm capitalised $9.8m of development costs, but only amortised $2.9m. If the full development spend had been expensed, operating profit of $18m would have been $6.9m lower.
However, it’s worth noting that Craneware has historically benefited from excellent cash generation and generated a return on capital employed of around 30%, according to Stockopedia. If these characteristics can be maintained then I’d agree that this business deserves a premium valuation.
After today’s drop, the shares trade at a multiple of c.10 times sales and 32 times FY20 forecast earnings, I would suggest that the share price is probably up with events until we see more concrete evidence of a return to growth.
- Share price: 1,000p (-4%)
- Market cap: £688m
Please note that Roland has a long position in PAY.
Another company that’s disappointed the market today is payment processing firm PayPoint. This business provides a wide range of payment services to convenience retailers — its UK network includes c.28,000 stores. It also runs the Collect+ parcel drop-off/collection service.
Graham covered the group’s interim results in November. If you’re not familiar with Paypoint, then his piece is an excellent introduction to this highly profitable business.
Moving forwards, today’s quarterly trading statement covers the final three months of 2019. PayPoint provides a reasonable level of detail in its quarterly updates, but unfortunately the news today is mixed.
Here are the main points:
- Underlying net revenue +4.1% (£1.3m) to £32.7m
- Service fees +32.8% to £3.5m — the rollout of the firm’s flagship PayPoint One systems is generating fee growth as retailers switch to the new system
- Parcel volumes +12.6% to 7.6m, albeit “towards the lower end of our expectations”.
- Retail services excluding parcels are said to be in line with expectations
- Bill payment net revenue +2.2% – an increase in net revenue per transaction offset a 1.1% decline in transactions.
One key figure that’s missing from today’s update is the value of the revenue generated by bill payments. This is important because this service — which allows customers to pay bills in cash — generated nearly 40% of net revenue during H1.
An accelerated decline in bill payment transactions is the main risk for shareholders, in my view. Paying bills in cash appeals to unbanked customers. But even so it seems likely to become a legacy service, given the growth of mobile banking and other electronic money services. PayPoint’s failure to renew bill payment contract with British Gas last year has not helped in this regard, either.
The company is working hard to replace bill payment revenue with service fees from its retail services. Progress so far is good, but as today’s update makes clear, the firm remains heavily dependent on bill payments.
For me as a long-term shareholder, PayPoint’s attraction lies in its 100%+ return on capital employed, strong balance sheet and super cash generation. These factors currently support a forward dividend yield of around 8%. (Note that this payout seems likely to fall over the next couple of years, as a planned cash return programme is completed.)
On balance, I don’t think today’s update changes the investment thesis here. I remain happy to hold. If the share price falls much below 1,000p, I may consider adding to my holding.
Unfortunately I’ve run out of time to look at CMC Markets (CMCX).
Thanks for your company today, I look forward to seeing you next time!
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