Since its inception last autumn, our smart small-cap series has focused on companies that are, well, smart. We’ve featured a contractor that is helping to build a “vertical city” in the Saudi Arabian desert; a youth publisher that is raking in billions of views; and an engineering firm searching for new ways to extinguish lithium battery fires. This month’s choice, however, is “reassuringly boring”, according to Indriatti van Hien, deputy fund manager at the Henderson Smaller Companies Investment Trust.
Or rather – it should be.
Restore (RST) makes most of its money from box storage. It collects documents from organisations across the UK and stows them away in everything from modern industrial units to aircraft hangars and former stone mines. In total, it has 22mn boxes across 100 facilities and serves over 80 per cent of the FTSE 100. If this all sounds a bit low-tech, the company also has a digital arm which scans paper records and converts them into a computerised format. Ultimately, though, the work isn’t cutting edge – but it's stable, recurrent and generates a lot of cash.
“On the face of it, this is a really dull business which has got high market shares in each of its core markets,” says van Hien. Why, then, does she describe it as her “wildcard”?
Restore’s share price offers a clue. The company has lost about 60 per cent of its value since August last year, following two profit warnings in as many months. Restore’s chief financial officer jumped ship before the second downgrade and the chief executive left immediately after, amid anger from investors. So much for being a steady Eddie.
Thinking outside the box
A key problem has been Restore’s diversification strategy, says van Hien. More than 10 years ago, the company set up a shredding division which – with the help of some further acquisitions – now accounts for 13 per cent of sales.
“On paper, it makes sense,” she says. “The person you're selling your box storage to at a company will be the same person that procures the shredding. But that business has been somewhat of a disaster, not only because it was hit by the pandemic, but because a lot of the margin depends on the pulp paper price.”
Restore sells its shredded material to UK and European paper mills, on top of charging clients contracted service fees. This is all well and good when paper prices are strong, but it’s an erratic market and any fall in price immediately hits the bottom line. “It introduced volatility into the profit and loss (P&L) [statement] and nobody likes volatility,” says van Hien.
Shareholders are painfully aware of this. In its half-year results, Restore reported a £32.5mn impairment relating to the historic acquisition of Datashred, which dragged it into a statutory loss before tax of £25.9mn. A “significant reduction” in recycled paper prices is also expected to hit profits in the second half. “We will be pushing for them to sell the shred business. It detracts from the value of the underlying business,” says van Hien.
Shredding is not the only problem, however. Under the leadership of Charles Bligh, who took over as chief executive in 2019, Restore began bulking up its technology division, which recycles and decommissions IT assets such as laptops and servers. In 2021 it splashed out £86.3mn on company-wide acquisitions and more than doubled the size of the tech business.
Activity levels were initially high as organisations refreshed their IT equipment during the pandemic. However, van Hien argues the purchases were made “at the worst time – literally bought at the peak”. Since then, we have entered a cyclical downturn, with fewer quality IT assets coming up for resale.
This prompted management to conduct a recent impairment review. It came back clear, but the company warned that an increase in the discount rate, or a failure to achieve the profit growth forecast for 2027, could eventually result in an impairment.
'Easiest turnaround on the planet'?
So that’s the bad news.
It’s important to note, however, that many of Restore’s woes relate to mismanagement. The board has repeatedly over-promised and under-delivered in recent years, and some investors have complained that former chief executive Charles Bligh was more concerned with empire building than rolling up his sleeves. “You can't run this business sitting in Belgravia,” says van Hien.
Following the changing of the guard, Restore could be on the brink of a turnaround. Van Hien is convinced that the company is “deeply undervalued” and that investors are distracted by its “unnecessarily complex” business lines. Another in the City described Restore as the “easiest turnaround on the planet”.
With a forward price/earnings ratio of 8.9 times, compared with a five-year average of 15.3 times, the shares certainly look tempting. Cash generation has remained high throughout the tumult, and Restore is successfully upping prices to offset inflationary pressures, while simultaneously cutting costs by closing less efficient sites.
Elsewhere, the shredding division – while still unpopular – is finding contracts to sell paper forward to improve visibility, and a big chunk of company debt is now fixed, which should also limit the number of unwelcome surprises on the P&L.
Meanwhile, growth is still strong in the core records management division: total storage revenue was up 11 per cent in the first half of 2023, while long term contracts and recurring income was up 3 per cent.
It is somewhat counterintuitive, though, that Restore’s strength lies not in diversification but in old-fashioned storage – particularly as offices are increasingly paper-less. Is there a chance that growth will soon stagnate, if not reverse?
“It has definitely always been thought of as a risk for the box business,” says van Hien. “However, if you destroy a box, you pay to destroy that box. And if you decide to store something online, the price of that is the equivalent of 16 years worth of storing your box. There's a hedge there.”
There are also some hidden growth opportunities – particularly around public services. Restore already helps with summer exam scanning and stores over 22mn files for the NHS, but van Hien notes that the health service is still “storing boxes in really inefficient places”.
More generally, if companies keep cutting back office space, affordable storage is likely to be in high demand, and Restore is devising specialised solutions for the likes of BBC Heritage and life sciences companies.
In limbo
The big question now is who will implement the necessary changes and optimise the opportunities. Jamie Hopkins, who used to be senior independent director, took over as interim chief executive last month, and Mike Killick, former finance head at chocolate maker Thorntons, has been appointed interim CFO. The board is still searching for permanent successors, however.
“While they don't have a permanent CFO or CEO, it is concerning,” says van Hien. “And everybody needs to see a few more quarters of forecasts not continuing to move down.” So far, however, the signs are encouraging: shares have been ticking up since Restore published its half-year results, fuelled by sheer relief that the pages didn’t contain another downgrade.
There is also the small problem of an expensive IT project that remains in progress. It’s hard not to be reminded of education company and fellow small cap RM (RM.), which saw net debt quadruple last year due to a “challenging” IT revamp.
Van Hien is ultimately unfazed, however. “It needs to get a new management team and we need to know that they are going to go back to basics. But the risk reward looks very high here.”
