Issue #4 : A wholesale business and Berlin property
Some small caps worth exploring
Dear Readers,
Outside of the US megacaps there is still a lot of good value to be found. Especially when you go into the oddball part of the markets which is exactly where we like to go.
For the 4th edition of Bargain Stocks Radar I would like to once again highlight a small selection of ‘under-the-radar’ companies that could be worthy of further investigation.
One is a boring compounder, the other two are bombed out net-nets. Let’s start with the boring compounder.
Kitwave
Kitwave is listed on London’s AIM stock exchange with the ticker KTW and has a current market cap of £254 million.
What I like about Kitwave is the business is reliable, predictable, and provides an essential service for its customers.
Founded in 1987 Kitwave is a wholesale business delivering impulse products, frozen, chilled and fresh foods, alcohol, groceries and tobacco to approximately 42,000, mainly independent, customers across the UK.Â
This diverse customer base includes independent convenience retailers, leisure outlets, vending machine operators, foodservice providers and other wholesalers, as well as leading national retailers. They have 32 depots around the UK ensuring speedy delivery across the island.Â
While operating margins for a business like this are low, around 4%, the growth has been excellent. Last year alone revenue grew by 20% to £602.2 million (fy22: £503.1 million). Profit before tax increased by 40% to £24.9 million.Â
Returns on capital employed over the past eight years have averaged around 20%. The company has debt of £58 million which is manageable.
Competitive Advantages
At first Kitwave may seem like a very plain low margin distribution business but dig a little deeper and you can see some competitive advantages.Â
They have carved out a nice business for themselves by focusing on supplying small shops such as newsagents who get ignored by the big distributors because their order value is too small.Â
Kitwave has focused on serving these smaller customers with the average order value being around £400 compared to Booker (a big distribution company in the UK) whose minimum order value is £1,000. Rather than competing with the big fish on price it has niched down to focus on providing a reliable service to the overlooked shops.Â
Customers place their orders through the Kitwave website. The bespoke built software at the backend calculates the precise cost to serve each customer depending on their location. This ensures target profit margins are achieved.
Another key part of the business is the distribution of frozen and chilled foods. Delivering these products requires managing a more complex cold chain operation with a refrigerated fleet. The extra investment needed to compete in this area creates a barrier to entry for many firms.Â
In fact some of the UK's largest wholesalers such as Booker and Bestway actually outsource their frozen delivery to Kitwave. A national contract was recently secured to supply ice cream to all Domino's Pizza UK outlets, after being recommended to Domino's by Ben & Jerry's manufacturer Unilever. Winning contracts from recommendations and word of mouth is testament to the quality of their operation.
Growth Opportunities
Growth so far has been achieved both organically and through acquisitions. Kitwave have done an excellent job of making bolt on acquisitions. The strategy is to acquire smaller complementary businesses, which are predominantly family-owned.
Management believe Kitwave is well placed to capture market share in the highly fragmented UK grocery and foodservice market. Currently KTW only has 2% market share, so there is plenty of room to grow. There is also room to expand internationally.
Management
Founder Paul Young retired last month but still owns 15% of the company. There is always a risk when someone so integral to the operation leaves. However he has been replaced by COO Ben Maxted who has been in his role since 2011 and is more than capable of running the show.Â
Valuation
KTW trades on a current PE of 12, which seems about the right valuation for a business of this nature. The dividend yield is currently 3.2% and has been increasing every year. There has been little dilution to the share count.
Conclusion
I’m a big fan of boring companies with simple business models, consistent and repetitive income streams, capable management, healthy balance sheets, and growth opportunities ahead. Kitwave ticks all those boxes.
I also like businesses that can increase the value of their business in real terms. The UK has seen about 30% inflation since 2021, any business that has not increased revenue or profits by the same amount is losing value in real terms. Kitwave can handle inflationary pressures better than most by passing price rises on to its customers.
In February management stated that trading so far this year has started satisfactorily and they expect a positive outcome for the year. The construction of a new 80,000 sq. ft. distribution centre to fully integrate the group’s south-west operations has commenced with completion planned for the autumn. I hold.
‘You are crazy, my child. You must go to Berlin.’
— Franz von Suppé, Austrian composer, 1800
If you’re a true contrarian investor you are probably sniffing around many of the bombed-out property companies.
One such company listed in London is Phoenix Spree Deutschland (PSDL) an investment company specialising in Berlin real estate.
Its portfolio consists of approximately 94 properties containing 2,477 residential units and 137 commercial units, with a total lettable area of around 186,500 square meters.
Despite the fall in valuations there is an increasing shortage of available rental property in Berlin which is driving growth in rents.
As a recent broker note from Edison Research points out…
…FY23 new lettings were at a record €13.7 per sqm, 5.9% above the FY22 average, and a 31% premium to passing rents. In-place rents (+4.1% like-for-like) of €10.4 per sqm continue to offer significant reversionary potential. The new rent table, which will be released in May 2024, will support further rental growth.
Despite this there seems to be no appetite from investors for this type of investment trust. I wouldn’t be surprised to see that at some point in the future shareholders vote no in a continuation vote.
If this happens the company may choose to sell off its assets, pay back the debt, and return the excess cash to shareholders. The company is trading at a -54% discount to supposed book value. A situation worth keeping an eye on.
Macau Property Opportunities Fund
Another property investment company that’s also languishing on the LSE is a £19 million microcap called Macau Property Opportunities Fund (MPO).
As the name suggest it’s a property fund dedicated to investing in Macau, the world’s largest gaming market and the sole city in China in which gaming has been legalised.
Its portfolio comprises prime residential property assets, such as The Waterside, The Fountainside and Penha Heights. The Fountainside is a residential development located in Macau’s prestigious Penha Hill district.
As of 31 December 2023 the three properties had a combined value of US$183.5 million, a decrease of 2.1% compared to the prior six-month period.
Gross borrowings stood at US$96.5 million, equating to a loan-to-value ratio of 51.2%. Adjusted NAV is US$81.7 million, which translates to US$1.32 (104 pence) per share, a decline of 10.5% over the period.
The current share price is 31.5 pence per share, lower than it was in 2009, and significantly below the supposed NAV.
As the Chairman Mark Huntley stated in the interim results for the six-month period ended 31 December 2023, published on 4th March…
‘The twin factors of a sluggish Chinese economy clearly experiencing major issues, including in its own real estate sector, coupled with higher interest rates, continue to affect investor appetite for high-end real estate and have also increased our on-going debt service costs.’
At the company's annual general meeting in December, shareholders agreed to a further extension of the Company's life until December 2024.
The sole objective now is to sell off the properties, but how long that will take is anyone’s guess.
This is what the Chairman had to say about trying to sell Penha Heights…
‘Although the number of inquiries and viewings has increased, it will nevertheless take time to identify a buyer for the property, given its value and unique status as one of very few large, detached houses in Macau.’
It sounds to me like they’re not getting the offers they feel the property is worth.
Penha Heights, a stunning villa situated prominently atop Penha Hill.
The investment manager of the fund Sniper Capital has bought shares every year since 2007 but stopped buying in December 2022. Starting from 0% ownership, they now own 19% of outstanding shares. I’ve not done the calculations to see at what price they are averaged in at, but they will be sitting on a loss at present valuation.
This has been an awful investment for any long term holders and is the definition of a value trap. However, it will be interesting to see how it plays out. Investors buying shares at this level may see a good return eventually, but this is definitely not investment advice.
What we’ve enjoyed consuming in the past few weeks…
Below are two very interesting articles worth reading.
Well that wraps up the 4th edition of Bargain Stocks Radar.
If you’re seeking more ideas make sure to subscribe to our sister publication Capital Employed →
What’s on your radar? If there’s any stocks you think we should be looking at do comment below.
Please note the information in this report is for informational purposes only and should not be seen as investment advice. Please do your own due diligence before investing in any company. Full disclosure: the writer owns shares in Kitwave Group.
Dis you see MPO April 16 update on the changes in anti-speculation rules in the Macau property market ? Major positive impact on the value of their properties.