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One small cap I’d buy and one I’d sell in May

With consumer spending growing at its slowest rate in more than three years in the first three months of 2017, separating promising businesses from those in decline isn’t easy. That said, here are two companies that appear to have very different prospects.  

Tempting treat

With its instantly memorable ticker code, Patisserie Holdings (LSE: CAKE) has been consistently growing profits over the last few years. With interim results due on 17 May, investors will be hoping that Brexit hasn’t undone this positive trend.

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Even if management chooses to be understandably cautious over the £330m cap’s outlook, there are many other reasons to consider its shares. Patisserie has a solid balance sheet and very healthy cashflow. Returns on capital over the last five years have, with one exception, always been over 20%. Moreover, in a thoroughly crowded market in which companies struggle to differentiate themselves, Patisserie’s decadent cakes offer customers something a little more luxurious for their money.

While its share price graph over the last 12 months is at odds with its relaxed dining experience (with notable dips following the seismic political events of June and November), its stock has rebounded 28% since the start of December. Now changing hands for 330p, this leaves it trading on 21 times forward earnings. Even with its promising growth strategy, that’s not particularly cheap.

Nevertheless, when compared to another high street small-cap, Patisserie gets my vote.

Take care

Personally, I wouldn’t go anywhere near Mothercare (LSE: MTC) before or after full-year results (also due on 17 May). That’s despite management boasting of business being “solid” in the last quarter.

In its April update, the retailer reported a 4.5% rise in UK like-for-like sales in the 11 weeks to 25 March, much of this being driven by a 13.6% rise in online revenue. International sales climbed 15.4%.

Scratch the surface however, and these results aren’t so impressive. With trading in the Middle East remaining challenging, total group sales in Q4 declined by a hugely disappointing 12.2%. That’s despite decent progress being made in markets such as China, Russia and Indonesia. Moreover, overseas revenue actually declined 1.7% once the benefits of a weaker pound were stripped away. 

But it’s not just ropey overseas performance that makes me bearish on the £214m cap’s shares. In contrast to Patisserie, there isn’t much to distinguish the company from its peers. What can you buy from Mothercare that you can’t get cheaper from a certain US internet titan? Why would customers care if 70% of the stores have been refurbished if they can avoid the hassle of shopping with young children by ordering goods from home?

Like Debenhams, Mothercare’s substantial estate (152 stores in the UK alone) means that it faces considerable fixed costs that its more nimble competitors can avoid. Indeed, the fact that 41% of its UK business comes from its online operation suggests that Mothercare’s bricks and mortar estate is fast becoming a burden that’s only likely to get bigger over time. 

In 2010, shares in the Watford-based company were trading around the £5 mark. Over the last seven years, they’ve lost 75% of their value. With a substantial debt pile relative to net profits, horrific cash flow and no dividends since 2012, even a valuation of 13 times 2017 earnings isn’t enough to change my opinion on the stock.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended Patisserie Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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