Alaric Delmas: ScS Group PLC Analysis

STOCK: SCS:LN

ScS Executive Summary

ScS Group plc (Bloomberg ticker - SCS:LN Equity) is a £56m micro-cap U.K-based home furniture retailer trading 33% below its highs from 18 months ago. It trades at 1.5x book value and more importantly at 108% of net cash, all the while having no debt, minority shareholder-friendly distribution policies and burning little cash in the upcoming couple of years. The company’s valuation has tumbled from inflation then recession fears, as, apart from its status as a consumer staples company, it is a business that should be exposed to today’s biggest headwinds. Yet energy and wage inflation, higher interest rates, a mild recession and an uncertain supply chain should not be having a material impact on ScS’s valuation.

The company’s business model is actually resilient to most of these issues, as:

• The company has no debt and hasn’t relied on it for years
• It is located in a value-for-money segment, and has great relationships with its clients
• ScS’s business model uses negative net working capital and more importantly most of its products are made-to-order, allowing for great inventory management
• Energy accounts for a small percentage of total expenses
• Wage renegotiations have long been part of ScS’s business

(ScS Group profit margin)

Dividends and buybacks

ScS should provide at the very least a 4.9% return in terms of dividends and buybacks over the next 12 months, up to 10.3% if it abides by the more lenient end of its dividend restrictions and profits only halve from the previous year, while having capital appreciation upside of 32% for a share price of 282 GBX.

Buybacks and dividend returns seem highly likely thanks to its minority shareholder-friendly position, with the company hiking its final year dividend in November - which has already been paid out - despite market conditions, and aggressively buying back shares as recently as a couple of days ago. These could be distributed while the company sits on £71m in cash and no debt, all the while generating free cash flow or being near breakeven every upcoming year except for FY2023.

Catalysts for the DCF upside

Regarding catalysts for the DCF upside, these include:

• Half-year results in March. ScS should see a not-so-dramatic sales drop, while we have modeled a conservative 10% fall in sales. It could also present an increased cash position despite buybacks, as the company announced in October its cash position had increased even if it operates in a tough macro environment and aggressively buys back shares. Given the company’s net working capital model and its complexities to be seen below, free cash flow results should also surprise to the upside.
• Holiday season trading results. ScS gives frequent updates on like-for-like order intake growth, and given recent results and the company’s resilience, sales numbers could be much higher than expected.
• Shareholder activism. Some funds have significantly increased their positions in recent months, including an activist fund. They could push ScS to increase shareholder distribution.
• Macroeconomic changes. ScS does not need interest rates or inflation to collapse to see its valuation justified. However, a slight change in inflation rates and consumer confidence surveys could provide investors with optimism and rerate the company that has been unjustifiably thrown out along its peers.

Forecasts

Forecasts for the company’s results are purposely thoroughly pessimistic, as the analysis sought to bring as much margin of safety as possible.

ScS generates substantial cash and has near 30% ROIC and over 25% in ROE most years. It trades at a historically-high forward P/E ratio or nearly 27x and a poor FCF / market cap ratio, but these multiples are computed with a conservative view, are likely to be one-offs, and do not represent the potential for shareholder distribution nor the company’s pristine balance sheet position.

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