Stockwatch: gold and two small-caps providing good news

Besides the yellow metal on the rise, our companies analyst looks at two interesting smaller companies.

The week has started with gold rallying to fresh record highs – at least in sterling terms – due to festering uncertainties over Covid-19, plus its typically inverse relation with the US dollar that is having a terrible month.

Dollar weakness itself derives from growing expectations that the US Federal Reserve will pump liquidity continuously in the hope of mitigating recession, hence the currency debasing effect. Silver is also benefiting as precious metals gather momentum as a perceived safe haven.  

Attempted bid for control at Petropavlovsk 

A rising attractiveness of gold producing assets is reflected in a proxy contest for board control at this Russian-based miner/processor Petropavlovsk (LSE:POG) listed in London, where I made a 'buy' case last March at 16p. The stock has more than doubled to test 40p, and is currently around 38p, where it is capitalised at £1.3 billion.

This reflects not only the value of gold assets but, crucially for Petropavlovsk, the long-term potential of its Pressure Oxidation hub – a game changer for the Russia industry which has substantial quantities of refractory ore with fine particles of gold that are resistant to standard extraction.

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A key plank of my 'buy' case was the stock effectively being a technology play able to run other producers’ ores through this facility, offsetting output variability from its own mines – a classic risk with miners. 

However, the benefits for shareholders look potentially in jeopardy if a 38% concert party of two Russian investors succeeds at a 10 August requisitioned general meeting.

This move has the feeling of a takeover attempt by proxy context – a game where control can be achieved simply because enough holders fail to vote, and the percentage of votes cast carries the day. I did stress “country risk” involved with Russia, although it can be averted simply if holders act against this. 

Any direct shareholder can visit the Petropavlovsk website and vote electronically up to 11am Friday 7 August. However, the deadline for the vast majority of private shareholders in nominee accounts will be earlier, making it essential to address the matter this week. I think the medium-term upside of gold production in the new era of higher prices, make Petropavlovsk worth fighting for as a 'hold' rather than ditching its stock. 

A promising omen from Headlam’s upturn in business 

Although only a modest £220 million FTSE small-cap, an update from Europe’s leading floor-coverings provider Headlam (LSE:HEAD) cites strong revenue recovery in June, and July UK revenue is actually ahead of 2019. That would appear to imply Europe (15% of 2019 revenue) has yet to achieve the same. Moreover, there is still a caution about limited visibility in the order book – but that is to be expected. 

The positive general upshot from this news is that some businesses are able not only to rebound, but also enjoy an aspect of pent-up demand following the lockdown months. This was sometimes entertained as the most optimistic outcome of emerging from Covid-19, where full production and consumption is re-gained, with a temporary exceptional boost also. In reality, the outcome is going to be very mixed, yet Headlam (LSE:HEAD) shows there can be silver linings.   

This is not a manufacturer but a network of companies in the supply trade both to the retail and commercial sectors. Conversion of operating profit to cash is excellent as shown in the table where free cash flow is often ahead of operating profit.

Yet its chart has not really joined re-ratings that we have seen elsewhere. After a 19 March low of 253p, there was a rebound to 360p in just a week, then a prolonged fall to 237p as of 16 July. So, while Headlam’s first half-year overview could be declared “good in parts”, the stock has been steeled for worse, hence it has firmed 11% to 285p.

A single figure PE and 7.5% yield? 

The table suggests median earnings per share (EPS) of around 35p in recent years, so if 30p is a conservative target in the new normal of coping with Covid-19, then the forward price/earnings (PE) is around 9.5x despite the current rise. If the 25p a share recent dividends are similarly de-rated (by way of benchmark expectation), then the prospective yield would be 7.5% - though it may take time to rebuild towards this.

The percentage of staff furloughed has also been in an 80% range since March, leaving something of a moral dilemma if this effectively results in government/taxpayer hand-outs supporting a return to shareholder payouts. But, intrinsically, you can conjure scope to resume eventually a worthwhile yield.  

Obviously, floor-coverings have not had a great history. Carpetright shares spent a long time on a seemingly cheap PE and attractive yield before finally collapsing to a 5p takeover last autumn. However, Carpetright did get over-indebted and into a protracted battle with, ironically, its founding family who left to set up rival Tapi Carpets.

There is also the Brexit trade issue to settle which could dampen recovery both for this company and the UK generally if no agreement can be found.  

Headlam is also writing down £20.9 million of goodwill. Yet the end-2019 balance sheet had already shown net tangible assets of 231p a share, disregarding £48.5 million of intangibles. A total of £44.6 million leases were the chief liability relative to £6.2 million long-term debt and negligible overdraft. However, debt had appeared to rise to about £40 million, as deduced from May’s AGM update, with revised covenant tests due end-June (on facilities that run to end-April 2023) and discussions to extend this arrangement to end-December 2020. 

For patient investors, I would still rate Headlam a 'buy', targeting a steady recovery to about 350p initially.  

Card Factory also surprises on the upside 

Similarly encouraging in terms of consumer recovery from the lockdown months is this FTSE small-cap retailer of greetings cards and gifts Card Factory (LSE:CARD). It has just declared like-for-like store sales down 21.6% in its first month of reopening, versus an anticipated 50% reduction. Obviously conservative targeting is involved, but average spend in stores is up nearly 25% too. 

Online like-for-like sales rose nearly 121% during the March to June period of store closures, and are up 69% for the current financial year to 19 July 2020.

The actual sales split is not quantified, but later in the update a capital markets briefing today from 2pm (accessible via a weblink in the RNS) will cite a 2025 revenue target of £635 million – said “of which circa 20% will be broadly split between online/multichannel and retail partnerships” relative to £452 million group revenue in the last financial year to end-January 2020.

Not the best clarity but you can see online sales growth presently enjoys the advantage of a low base. 

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Again, quite like Headlam, the stock is up pretty sharply on this better-than-expected news, from 41.5p to about 45p after 47p initially.

Capitalised at around £154 million, the stock is on around 20x consensus EPS of just 2.2p for the current financial year, improving to just 4.9x if hopes for 2021/22 EPS of 9.2p are fair.

The sense is also for a modest dividend - around 3.8p implies an 8%-plus yield, albeit highly speculative as yet. To date, the company has received £15.5 million government payouts to protect jobs in recent months.  

It also similarly avoids guidance, being “far too soon to determine whether initial trading reflects the release of pent-up demand following lockdown, or the point at which footfall and sales will settle to a sustainable level.” But this kind of statement is prudently skewed on the wary side, avoiding much risk of needing to warn in future. Meanwhile, the market senses an improving trend. 

A flawed story albeit trading potential   

Sceptics have wondered if Card Factory is due a decline after rolling out a concept to meet the growth hopes of a stock market listing, now facing a younger generation less inclined to send cards, and those who still do possibly seeking better quality. It has already struggled with higher costs, lower footfall and weak demand for gifts.  

Down in a 40p range, however, the stock at very least has “cigar butt” trading potential - the share is typically cast aside and has one puff left, but that puff is pure profit - if its numbers and narrative continue well enough in the short to medium term. It fell from over 150p in January after a 0.6% fall in sales was reported for the 11 months to December 2019 when “the Christmas trading period was challenging”. It is a tricky one to tuck away, but alert traders might consider a Buy.    

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.