Interactive Investor

Stockwatch: how rich is this AIM firm’s future?

This small-cap stock appears to have a corner of the market cracked.

13th April 2021 19:48

Edmond Jackson from interactive investor

This small-cap stock appears to have a corner of the market cracked.

A genuinely strong, full-year trading update has just landed from Cake Box Holdings (LSE:CBOX), a £102 million AIM-listed franchiser of egg-free cake shops. It has seen its shares attain a 261p all-time high – up from about 120p a year ago. At this level, its price-to-earnings (PE) ratio multiple is just over 31x earnings per share of 8.6p, assuming £8.6 million net profit on £19.7 million revenue. This is a consensus expectation the company says it is due to meet.

A novel-concept small cap enjoying strong current growth 

After 16% overall revenue growth, despite serial lockdowns, and given a rapidly increasing estate of franchised outlets, the recent hope has been for a 30%+ rise in earnings per share (EPS) over 11.5p in the current financial year to March 2022.

That assumes £24.4 million revenue, £4.8 million net profit and EPS of 11.8p. In that case, the PE multiple would ease near 23x with a price/sales ratio of 4.4x.

It may seem pricey for a novel-concept small cap, although there are not many about. In the short to medium-term, a smaller company in a purple patch of growth could mean EPS soars 37% this year, hence its PEG rating is a modest 0.6 – where value is generally understood to exist sub-1.0. 

The key question is whether a big wider market can evolve or if the extent of people interested in egg-free cake is limited.

It can mean drier sponge, hence online customer reviews polarise. Yet this company has established a good track record since founding in 2008 and flotation a decade later: its model is relatively simple and cash generative, based on franchising outlets and providing ingredients. 

After listing June 2018 at 108p, I drew attention as a ‘buy’ that September at 163p. Along with a rationale of a British weakness for cake, the popular fixation with TV shows about baking suggests it is hard to limit our interest in this topic.

‘Free from’ products are also an established growth niche. Also, many of the Hindu population are averse to eggs. Around 2% of children and 0.3% of adults are allergic to them.

Like-for-like revenue growth of nearly 15% 

This highlight in the update is selective – dodging the first lockdown that stunned many people into torpor – but does help give an underlying sense. For the 40 weeks from 1 June 2020 to 7 March 2021, like-for-like sales in franchise stores grew by 14.7%.  

Growth of 16% is proclaimed for the full financial year, given revenue benefited from “a very strong opening programme in the second half” including Gloucester, Epsom, Newport, Ipswich and Hove. Twenty-four store openings have taken the estate to 157 at the period end, i.e. a circa 18% increase in retail capacity.  

The pipeline constitutes a potential 52 new franchise stores and five kiosks via a national supermarket chain. Further initiatives include the launch of an own-brand delivery platform to complement existing click-and-collect, as well as third-party delivery offerings.  

Online sales leapt 84% last year, although are not quantified, so would probably have been from a small base. 

New bakery and distribution centre just opened 

A third such plant in Coventry expands capability from Enfield and Bradford. Possibly a central England hub makes sense – at what could be a still-early stage of roll-out – and/or there is a relatively strong contingent, say, of Hindu people in the Midlands, to justify this.  

As of end-March, there were 157 Cake Box outlets relative to an aim at flotation to establish some 250 globally – so the business is well-advanced already, to this aim, considering its expansion plan. It would seem quite a logistics challenge and cost, to roll out the concept abroad, but let us see what evolves.   

The Cake Box range is said also refreshed by egg-free custard, packaged loaf cakes and further gluten-free and vegan products. Celebration cakes – for example birthdays, in a £20 to £40 range – would appear a key means to exact margin, where the table of recent years shows an easing at the operating level from over 26% to 20%, but is still very good. It also helps explain high returns on equity and capital employed, substantially over 30% (see table). 

Gooey cake is obnoxious to me, so I cannot provide my own view. But on for example, 49% of 138 reviews cite the cakes as ‘excellent’ and 39% as ‘bad’ with 4-5% on ‘great/average/poor’.

Criticism focuses on dense/dry sponge with an excess of cream, which I would think is to be expected if removing egg from the ingredients, which then requires relatively more cream so as to be palatable.

Such reviews can bias towards negative though, as people are more likely to vent any complaint than praise, and inevitably a few cakes/deliveries will not be perfect. Cake Box’s financial revenue trend is the ultimate test, and it looks good. 

My concern is this ‘free from’ niche potentially checks sales growth in three to five years unless the company diversifies, say, into regular sponge-based cake so as to ensure appeal to traditional palates. You would think this possible unless the two Indian founders want the company to promote a strict religious diet.  

I am unaware of any rival egg-free producer though, so as niches go Cake Box looks to have this one well sewn-up. 

Cake Box Holdings - financial summary
Year end 31 Mar

  2016 2017 2018 2019 2020
Turnover (£ million) 5.6 8.7 12.8 16.9 18.7
Operating profit (£m) 1.2 2 3.4 4.4 3.8
Operating margin (%) 21.7 22.9 26.3 26.3 20.3
Net profit (£m) 1.1 1.6 2.8 3.0 3.1
Reported earnings/share (p) 2.7 4.1 6.9 7.5 7.7
Normalised earnings/share (p) 2.7 4.1 6.9 8.7 7.7
PE ratio (x)         33.9
Operating cashflow/share (p) 5.4 1.5 8.0 7.9 8.3
Capital expenditure/share (p) 1.4 1.0 1.3 5.3 3.1
Free cashflow/share (p) 4.0 0.5 6.7 2.5 5.2
Dividend per share (p)       3.6 4.8
Covered by earnings (x)       2.1 1.6
Return on capital employed (%) 58.7 46.2 54.0 43.8 33.2
Return on equity (%) 526 116 78.4 53.2 38.8
Cash (£m) 0.2 0.5 2.5 3.1 3.7
Net debt (£m) 1.5 2 -0.9 -0.9 -2.1
Net assets (£m) 0.4 2.4 4.7 6.6 9.5
Net assets per share (p) 1.0 6.0 11.7 16.6 23.7

Source: historic company REFS and company accounts

Financial year-end cash up 70% on March 2020 

Another case of low-base arithmetic aiding per cent growth, it ended the year at £3.6 million. November’s interim cash flow statement had shown net cash from operations up less than 8% near £2 million although within this, pre-tax profit eased 4% given a difficult first quarter. 

No final dividend was declared at last June’s 2020 prelims, after a 1.6p interim payout. But in September this was substituted with a 3.2p special dividend, paid last October, as performance rebounded. This implied earnings cover of 1.6x, hence an appropriate initiative.  

Around £156,000 of government money received under the Job Retention Scheme was repaid, reflecting good ethics. 

AXA Investment Managers trim stake from 8% to 5% 

This was early last March, the rising chart shows, and was easily absorbed. Otherwise, there has been no material selling into the stock’s rise. I imagine AXA knows the only time you can sell a material stake in a small cap is when demand exists, so this is prudent risk management. 

For fresh money, the medium-term prospect looks attractive, barring any general reversal in risk appetite towards small caps. This does however assume the company meets and sustains earnings expectations. Otherwise, net assets per share (there is no goodwill/intangibles) were 24.3p last September and if a circa 6p dividend expectation is met then the yield is 2.2%.  

At 261p therefore, the risk/reward profile is less enticing, if reflecting how risk assets generally have been bid up – potentially compromising longer-term returns. Momentum traders can consider buying any dips as the next two years still look promising for Cake Box. The test is yet ahead as to wider demand for egg-free cake. Hold

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

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