A time to forget

Revolution Bars Group runs 66 venues and employs 3,000 people throughout the UK. Its growth story is an admirable one. Two friends decided to open a bar just outside of Manchester in 1991, and it has grown into a successful chain of bars today and a bar-goers staple!

Penny stocks are those that trade for less than £1. As I write, shares in Revolution are trading for 22p. This time last year, shares were trading at similar levels, for 23p. The share price has meandered up and down throughout the past 12 months but my interest is in the longer term with Revolution. Shares are still below pre-crash levels.

Why I am considering RBG for my portfolio

1. The pandemic led to large-scale closures of many leisure venues including bars, pubs, clubs, and restaurants. This decimated firms like Revolution. The pent-up demand and leisure spending that the UK is now experiencing will benefit Revolution. I feel like there is a newfound appreciation for a night out after the past 18 months. Leisure spending has been growing at twice the rate of retail spending in recent times. This bodes well for Revolution in my opinion.
2. Last week, Revolution announced its preliminary results for the 53 weeks ended 3 July 2021. It also noted Q1 2022 progress too, which was encouraging. Overall, the signs solidify my belief that pent-up demand and leisure spending will boost Revolution and it could surpass pre-Covid levels. Its 2021 results weren’t great but this was to be expected. It took steps to conserve cash and has a robust balance sheet. More importantly for me, the first 14 weeks of 2022 revenue exceeds the total achieved in the whole of 2021! When the update was released, revenue for 2022 to date stood at 137% of 2021 levels. 
3. Revolution also had a decent track record of performance prior to the pandemic. I am aware that past performance is not a guarantee of the future but I review it nevertheless for penny stocks and established stocks alike. I can see that revenue was increasing year on year between 2017 and 2019 before the pandemic struck. If Revolution can steer clear of further roadblocks linked to the pandemic and macroeconomic pressures, I believe this type of year-on-year growth  could occur once more.

Penny stocks carry risks too

There are risks with Revolution too, of course. Firstly, if further restrictions were to force closures, Revolution’s trading and performance would be severely affected once more. Furthermore, macroeconomic issues such as rising inflation and costs as well as the supply chain crisis could affect operations. This in turn could affect performance and its bottom line too.

I like to look for contrarian penny stocks that others may be avoiding. As a Foolish investor, I invest for the long term, which means I am not averse to some short-term pain. With that in mind, I would invest £500 in Revolution at current levels. I believe over time it could return to profitability and growth and be a good small-cap addition to my portfolio.

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As a long-term investor, however, Revolution Bars is a share that’s still drawing my attention. The business operates dozens of premium bars across the country. It’s therefore well placed to exploit the trend of consumers spending ever-higher proportions of their income on going out. Leisure spending in Britain has been growing at twice the rate of retail in recent times.

Most recent trading data from Revolution Bars has illustrated the robustness of this trend too. Between 19 July and 2 October the business saw sales jump 17% compared with the same period two years earlier.

A rare beauty

I also like Rainbow Rare Earths (LSE: RBW). Demand for rare earth metals has rocketed over the past decade as the manufacture of mobile phones, computers and other consumer electronics has boomed. Elements like neodymium and praseodymium (commonly known as NdPr) are essential components in making such hi-tech devices run. Some analysts think that demand growth will move up several notches too as the green technology revolution kicks off.

Take the boffins at investment firm CITIC, for example. They’re predicting that “downstream demand for rare earths is expected to continue to improve” as sales of low-emission cars, wind turbines and special energy-saving air conditioners rise. At the same time CITIC thinks supply from China, the world’s largest supplier of rare earths, will fall as local lawmakers clamp down on unregulated production.

All this bodes well for NdPr prices for the first part of the decade, and by extension profits at Rainbow Rare Earth. Through its Gakara project in Burundi the company is sitting on one of the richest rare earths resources on the planet. Mining is a notoriously difficult business and setbacks can deal a significant blow to profits. However, I think predictions of soaring demand still make this penny stock very attractive today.

A penny stock for 2022 and beyond?

I think Futura Medical could be on the cusp of delivering explosive revenues growth. In a potentially game-changing year, the business — which has high hopes for its MED3000 erectile dysfunction gel — has received the green light to begin trials in the US. And it now has the critical ‘CE’ marking in European markets, as well as having signed key licensing agreements spanning the globe.

Futura has a battle on its hands to take on Pfizer’s market giant Viagra. But the fast-acting nature of its product could still make it a winner in a rapidly-growing market. That’s providing trials of MED3000 yield positive results in 2022. It’s estimated that global impotence rates will have doubled between 1995 and 2025.

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That said, I’m aware this sector faces some significant challenges. As such, the companies below might not be suitable for all investors. 

Still, I’m comfortable with the risks involved. That’s why I’d buy all three. 

Penny stocks for my portfolio

I think the first company on my list is a must-buy hospitality business. The Fulham Shore (LSE: FUL) has defied the gloom in its sector over the past 12 months.

At the beginning of the pandemic, management swiftly switched the business to a takeaway model. This helped it navigate the uncertainty and primed the group for growth when the economy reopened.

According to its latest trading update, between 17 August and 5 September, sales across all group restaurants increased 27% compared to 2019 levels. 

This growth is fuelling the group’s expansion plans. Since March, it’s already opened two new restaurants, has a further two in development, and 15 in the pipeline. This growth potential is the main reason why I’d buy Fulham Shore for my portfolio of penny stocks today. 

Some risks the firm may face as we advance include higher labour and food costs and the possibility of further lockdowns. These could weigh on profit margins, and high prices could put consumers off. 

Eating and drinking

The other two hospitality stocks I’d buy for my portfolio of penny stocks are Marston’s (LSE: MARS) and Revolution Bars (LSE: RBG). 

Like Fulham Shore, both have reported a strong rebound in trading since the economy reopened.

However, unlike their peer, neither of these companies were able to rely on a takeaway service to keep the lights on throughout the repeated lockdowns of the past 18 months. 

As a result, neither are in the same advantageous position as Fulham, but they’re still making a comeback. 

In its latest trading update, Revolution reported that trading has improved to 86% of 2019 levels. Despite this growth, the company still expects to report a loss in its current financial year. Meanwhile, sales between 12 April and 24 July across Marston’s estate totalled 90% of 2019 levels. 

Clearly, both of these companies have their work cut out to return to growth. They also face an uphill struggle to reduce the debt they’ve accrued throughout the pandemic.

However, I think both companies have the potential to return to growth in the near future. That’s why I’d buy both for my portfolio of penny stocks. 

Both firms also face similar risks to Fulham. Rising wages and food costs could eat into profit margins, and another coronavirus wave could dent consumer confidence, which may lead to a significant sales slowdown.

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However, I am comfortable buying and holding smaller businesses, and with that in mind, here are three penny stocks I would buy as recovery plays for my portfolio today. 

Penny stocks to buy for growth 

At the top of the pile is The Fulham Shore (LSE: FUL). Despite the disruption of the pandemic, this restaurant operator has been able to navigate the challenging environment quite successfully. Revenues decreased 41% for the year ended 28 March 2021, and the group reported an operating loss of £4.8m for the year. 

However, now all of its restaurants are back open again, management is plotting an expansion. It has identified 10 new locations, which it plans to open in the next financial year, with a further 150 additional sites on the cards. 

With management planning this sort of growth, I think the stock could be an excellent growth investment to add to my portfolio. 

Despite the opportunity here, I will be paying close attention to the company’s growth plans. Many restaurant owners have collapsed in the past due to over-expansion. The Fulham Shore is not going to be immune to this risk.

Reopening trade

As well as The Fulham Shore, I would also buy Revolution Bars (LSE: RBG) for my portfolio of penny stocks. With a market capitalisation of just £52m, this business is smaller than most and possibly riskier. Nevertheless, I believe it has substantial recovery potential. 

According to management’s latest trading update, the company is now trading ahead of expectations after the reopening. Trading between 17 May and 1 July was 86% of 2019 levels, which tells me the firm is heading in the right direction. 

It also implies consumers have been eager to return to its offering, which will be necessary for the recovery. 

Having said all of the above, Revolution Bars has been struggling with sluggish growth for some time. Before the pandemic, it had just undergone a significant restructuring. There is no guarantee it will be able to avoid ending up in the same position in the years ahead, especially after the events of the past 18 months. 

Delivery growth

DX (LSE: DX) provides a wide range of delivery services across the UK. Its services have been in demand over the past year.

Management expects the company to book a significant increase in profit before tax this year, as well as a considerable increase (37%) in the level of cash on its balance sheet. According to projections, it will end the financial year to 3 July with net cash of £16.8m. 

According to the company, the high demand for freight services means the group’s freight business will deliver substantial growth. It does not look as if the need for these services will let up anytime soon as the UK deals with its lorry driver shortage. 

With these tailwinds behind the enterprise, I would buy it for my portfolio of penny stocks. However, I will be keeping a close eye on DX’s growth. The delivery market is highly competitive, and if the firm fails to keep up with the competition, its growth could come grinding to a halt. 

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This is a strategy I plan to follow, but it might not be suitable for all investors. Penny shares can be incredibly volatile, and these smaller businesses lack the checks and balances in place at larger companies. Therefore, the risks of investing are significantly higher. 

Still, I am comfortable with the risks involved. That is why I have been considering buying the small-cap stocks highlighted below for my portfolio in August. 

Penny shares on offer

The first company is pub operator Marston’s (LSE: MARS). This enterprise has been on my radar for some time because I think the business is a well-managed operation that has always appeared to be undervalued by the market. 

And I think now could be the perfect time to buy the stock as it benefits from the reopening. According to City analysts’ projections, which are based on the company’s own forecasts, losses are projected to decline from £360m in 2020 to £65m this year. Marston’s could be profitable in 2022, analysts suggest, with income of £57m pencilled in for the year. 

Based on these projections, analysts believe the stock is trading at a forward P/E of 10.2. I think this looks attractive considering the company’s growth potential. 

That said, the business does carry a lot of debt, which could hold back its recovery if interest rates rise substantially in the years ahead. 

Debt reduction 

I would also buy Revolution Bars Group (LSE: RBG) for my portfolio of penny shares for the same reasons. As the economy reopens, I think the bar operator will see a substantial recovery in sales and earnings.

The company is projecting an earnings before interest, tax, depreciation and amortisation loss before lease adjustments of £12.5m this year. If the reopening continues as planned, analysts think the group will break even in 2022 and return to growth in 2023. 

Revolution has also taken advantage of the current market environment to raise money from investors. This has enabled it to substantially reduce borrowings to just £5m. A stronger balance sheet should help support the group’s recovery.

But while I am optimistic about the company’s prospects, I am wary that it was struggling to earn a profit even before the pandemic. This implies Revolution may struggle to return to profit even after the crisis has receded. 

Outperforming

I would also buy City Pub (LSE: CPC) for my portfolio of penny shares. While not technically a penny stock, its market capitalisation of just £123m gives it similar qualities. 

This premium pubs operator, which owns locations across the country, primarily in cities, is forecast to lose money for the next two years.

However, with the group’s latest trading update reporting that sales since reopening are running at 90% of 2019 levels, I think there is a chance the stock could outperform expectations. 

One challenge this company could face is the home working revolution. If workers are allowed to work from home forever, city centre activity may never return to pre-crisis levels. This would hurt City Pub’s growth prospects.

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Can the concept endure?

So, I wonder whether Revolution Bars Group has the legs to make a decent long-term investment. Today’s report doesn’t soothe my doubts. Although sales rose 8.7% compared to the equivalent period last year, the increase is down to the opening of six new sites. Like-for-like sales actually declined by 0.6%, which suggests a less vibrant outcome than the headline figure would lead us to believe. In fact, adjusted earnings per share tumbled 11% and the directors put a brave face on things by holding the final dividend flat.

What really worries me is the long list of justifications for the poor performance such as “the uncertainty following corporate activity, management change, extremes of weather and the FIFA World Cup.” Ok, the company was subject to a takeover offer that fell through and key management including the CEO quit, but if the customers were packing the bars through the period, I reckon sales and profits would have been more robust, whatever was going on in the back rooms.

I’m wary that fickle customers may already be growing tired of the firm’s concept, so, despite my bullish article earlier in the year, I’ve changed my mind. I can no longer see the point of taking the risk of buying shares in Revolution Bars Group and would much rather go for a proven winner like mid-cap pub operator JD Wetherspoon (LSE: JD).

Piling them in

The Wetherspoon concept has far wider appeal and more or less operates at the other end of the scale from the ‘premium’ approach taken by Revolution Bars. In fact, Wetherspoon bases its business model on selling ‘cheap’, and I think a value proposition like that is far more suitable for a long-term investment horizon because the concept is unlikely to out of fashion.

One of the things I like about the firm’s annual reports is the way the firm lists its annual performance right from the beginning of operations in a similar way that Warren Buffett does with his firm Berkshire Hathaway. It makes interesting reading. In 1984 the firm turned over £818,000 for a pre-tax loss of £7,000, and in 2018 it saw revenue of almost £1.7bn and made a pre-tax profit of more than £107m.

Since the firm came to the stock market, shareholders have been rewarded with multi-bagging gains, and I think there’s more to come in the years ahead. Wetherspoon strikes me as a decent bet for long-term growth and I think the stock is well worth your research time right now.

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Despite this disappointment, I believe this out-of-favour chain of trendy bars could still be a compelling buy for value investors. Here, I’ll examine the issues and give my verdict on this stock.

I’ll also consider a 7%-yield consumer stock that could be worth a closer look.

More excuses – what’s gone wrong?

In a trading update this morning, Revolution Bars complained of “challenging and volatile trading conditions” during the half-year to 9 June. Although new openings lifted total sales by 7.3%, like-for-like sales were 1.7% lower. This suggests that sales at some older bars are falling.

Unusually, the company managed to blame both cold weather and hot weather for lower levels of “late-night week-end trading”. But sites with outdoor seating areas are said to have performed well during the recent hot weather. So the problem may be that customers chose pubs with beer gardens instead of stuffy indoor venues.

Management also believe that the “prolonged absence of a CEO” and the distraction caused by last year’s two failed takeover bids have also contributed to the poor performance.

The good news is that Rev Bar’s aptly-named new chief executive, Rob Pitcher, is due to start work on 25 June. And the company is already moving ahead with other operational improvements. A new staff scheduling system has been rolled out and improvements are planned to marketing and to the group’s underperforming food business.

New profit guidance

Adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to be below market expectations and in line with last year’s figure of £15.1m.

What does this mean for the stock’s valuation? Well, last year’s adjusted EBITDA translated into adjusted earnings of 14.2p per share. The last-seen share price of 139p puts the stock on a forecast P/E of about 10 for the year ending 1 July.

The group has very little debt, so I’d imagine that the forecast dividend will be left unchanged, at 5.2p. This gives the stock a prospective yield of around 3.8%, which is reasonably high for a small-cap growth stock.

What could go wrong?

It’s always important to consider what could go wrong when buying a stock. In this case I can see several potential problems.

The first is that this profit warning may not be the firm’s last. Like-for-like sales only rose by 0.4% during the first half of the year and by 1.5% last year. These figures suggest to me that when you consider the effect of inflation, LFL sales volumes were flat at best last year and may already have been falling during the first half of the current year.

Although food sales should offer potential for growth, a number of casual dining chains are suffering from over-expansion at the moment. Pubs chains offering food have admitted that conditions are very competitive. Can Revolution Bars really outperform in such an environment?

The group’s decision to continue rolling out new bars has meant that although underlying cash flow is quite good, the company has needed to borrow cash to afford both capital expenditure and dividend payments. Arguably this means the dividend is being funded with borrowed cash. Given that net debt was just £4.5m at the end of the first half, I’m not too concerned about this yet. But I would be concerned if net debt continues to rise.

Buy, sell or hold?

Revolution Bars’ rollout has been promising, but hasn’t quite delivered on expectations. However, the firm is taking steps to correct problems and address areas where it’s underperforming.

Incoming chief executive Pitcher has 25 years’ experience in the hospitality sector. His previous role was as a divisional director at pub group Mitchells & Butlers, where he was responsible for food-led brands Toby Carvery, Harvester and Stonehouse.

Revolution’s bars focus on premium drinks, so are heavily dependent on consumer spending remaining strong. A recession could hit the group hard. But if the economy remains stable, my view is that this company does offer a potential buying opportunity.

After all, it wasn’t long ago that Revolution received a cash bid worth 203p per share. With the shares trading at around 140p, I’d rate the stock as a speculative turnaround buy.

A retailer with a 7% yield

Another stock that’s performed well during this long period of cheap credit and low unemployment is furnishings and floorings retailer ScS Group (LSE: SCS). Even more than Revolution Bars, this is an extremely cyclical business. Sales could collapse if cheap credit dries up or if the economy goes into recession.

For now, trading remains fairly good. Revenue rose by 4.9% to £333m last year while earnings rose by about 8% to 23.5p per share. Analysts expect the firm to report revenue growth of about 5% and earnings growth of around 2% for the current year, which ends on 29 July. On 21 March, management confirmed that trading for the year to date was in-line with expectations.

The company ended last year with net cash of £40m and no debt. Although some of this cash represents advance payments from customers, the group’s net cash position suggests to me that it could survive a downturn in sales more easily than rival DFS Furniture, which has substantial borrowings.

The group’s strong cash generation and lack of debt also means it’s able to pay generous dividends. This year’s forecast payout of 15.9p per share represents a forward dividend yield of 7%.

One to buy?

Like Revolution Bars, I believe ScS should continue to do well if the UK economy remains stable. I don’t have a strong view on the outlook for the economy, but I’d rate this stock as one of the more attractive options in this sector.

If you’re looking for a high-yield income stock with some growth potential, ScS could be worth considering.

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The company has reported that sales for the 26-week period to December 30 were £73.8m compared to last year’s £66.7m with like-for-like sales up 0.4% although this “was distorted by the absence of New Year’s Eve, one of the most significant trading days in the current period.” After extending the trading period by one week, to include New Years, like-for-like sales grew 1.9% year-on-year.

The firm is currently spending heavily to expand its offering across the country and including the costs of opening new premises, it reported an operating loss of £3.7m for the period. Stripping out these exceptional costs, adjusted operating profit for the 27-week period including New Year’s Eve rose 9.1% to £6m.

Commenting on these figures, CEO Keith Edelman said: “I am delighted with our sales performance in the second quarter…New openings are performing particularly strongly, and site refurbishments are delivering healthy returns.“

Investing for growth 

I’m excited about its prospects as it continues to expand. Over Christmas, the firm opened three new Revolution bars in Solihull, Inverness and Putney with “each surpassing their initial sales targets,” something investors have come to expect from the group. Two new sites are slated to open before the end of this financial year in March, and management is targeting the opening of six more venues in the next fiscal period. 

Off the back of this expansion programme, analysts are expecting the firm to grow earnings per share by 10.5% this year and 10% for 2019, which implies that the shares are trading at a relatively attractive 10.1 times forward earnings. As well is this earnings growth, the stock currently supports a dividend yield of 3.1%, with the payout covered nearly three times by earnings per share and supported by a debt-free balance sheet. 

All of the above indicates to me that Revolution is an undervalued dividend stock that’s worthy of a place in your portfolio.

Market-beating income

Another pub group I believes offers value today is Greene King (LSE: GNK). the shares are both cheaper and support a higher dividend yield than those of Revolution, but this is offset by a weaker balance sheet. 

Specifically, the shares trade at a forward P/E of 8.2 and yield 6.4%, although the company has £2bn of debt and a gearing ratio of 100%. Greene King’s growth outlook is also more downbeat with analysts expecting the firm’s earnings to hardly grow at all over the next two years.

Still, despite the lack of growth and high level of debt compared to Revolution, I believe it is a great income and value stock. The market-beating dividend yield is covered twice by earnings per share leaving plenty of room to both pay down debt and distribute funds to investors (even on a cash flow basis the payout is covered twice).

The group is looking to shave £40m to £45m off its cost base this year and is renewing its customer offering to try to drive sales growth, including reducing prices and increasing staff, which means earnings growth will be slower, but this investment should pay off over several years. 

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The firm provides information technology infrastructure services in the UK, Germany, France and Belgium and business has been stable and growing. I first noticed Computacenter around 2011 and saw that it was producing consistent annual gains in earnings and a steady increase in revenues most years. Over the last four years alone the dividend has gone up 45% and the share price has risen 60%.

Ahead of expectations again

In today’s pre-close trading update for the trading year to 31 December, the directors said they anticipate that adjusted pre-tax results for the year will be ahead of their most-recent expectations. They pointed out that they upgraded their expectations “a number of times” throughout 2017, which means it’s even more impressive that the firm’s performance is beating predictions now.

Revenue in constant currency for the year increased 12% compared to the previous year with all trading regions and all of the firm’s sectors rising. There’s strong evidence that Computacenter is generating decent profits from this turnover with the net cash figure of just over £191m, which is more than 30% higher than a year ago. However, because extended credit terms with one of the company’s major suppliers will end and revert to standard credit terms, the net cash position will shrink by just over £27m going forward.

The directors expect the positive momentum to continue during 2018 but said that a number of one-off costs and investments will likely “hold back the enhancement of profitability.”  However, 2019 looks set to be a good year for advances in earnings. I would see any weakness in the share price or any period of sideways movement that may result from this news as a good opportunity to invest in Computacenter.

Hitting the spot with customers

If you are looking for something a little more adventurous, you may be interested in today’s trading update from Revolution Bars Group (LSE: RBG), which resides in the FTSE Fledgling index and has a market capitalisation of just over £86m. The big attraction of smaller firms is that the shares can move quickly and that little companies can grow into larger companies if things go well. Balancing that attraction is the higher risk that tends to come with smaller firms.

Revolution Bars operates 72 premium bars in the UK, branded Revolution and Revolucion de Cuba. For the 26 weeks to 30 December, which includes the important Christmas and New Year trading period, sales were almost 11% higher and like-for-like growth in revenue over the key Christmas trading period came in almost 6% higher than a year ago.

The directors said this is the fifth consecutive year that the firm has enjoyed record sales in the festive period, which I reckon suggests the firm’s offering clicks with customers. Meanwhile, it has a good record of raising its dividend every year and I think it would be well worth your time researching the investment opportunity.

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Takeover battle raging 

Revolution is currently in the middle of a takeover battle between Stonegate Pub Company Limited, which is offering 203p per share in cash for the firm, and the Deltic Group Limited, which is proposing an all-share merger. 

Today Deltic revealed its latest offer for Revolution. The proposal provides for a combination under which existing Revolution shareholders would own 65% of the group, and Deltic owners would hold 35% of the enlarged group. According to the buyer, the combined group should benefit from approximately £6.8m of currently identified pre-tax cost synergies and approximately £0.9m of pre-tax financing synergies. What’s more, the group is “expected to be highly cash generative and financed conservatively, ” and there is to be “no change to Revolution’s existing dividend policy.“

Unlike the Stonegate offer, which provides a quick cash exit for investors, the Deltic merger could create more value over the long term. Certainly, for income investors, this might be the better option as it would allow shareholders to benefit from the merger synergies and the growth of the enlarged group. 

At the time of writing, shares in Revolution are trading at a forward P/E of 14.5. If shareholders vote to merge with Deltic, this valuation could quickly become out of date as synergies push up earnings and cash distributions to investors. 

That said, if the company chooses the Stonegate route, investors buying today could find themselves out of pocket as the offer is 3p below the current share price. 

Emerging market cash cow 

If Revolution is not for you, Symphony International Holdings (LSE: SIHL) might be a better buy. Symphony is essentially a private equity investor. The firm is a leading investor in consumer-related businesses, primarily in the healthcare, hospitality and lifestyle sectors in the Asia-Pacific region. This unique strategy has produced some exciting results for investors over the past five years. 

Last year the company paid out $40m to investors via way of a dividend, equal to around 5.7% of its net asset value. This year, distributions are on track to be even more significant. At the end of last month, Symphony declared a $60.3m distribution equal to $0.10 per share, taking the total dividend paid in 2017 to approximately $82.3m or $0.14 per share for a yield of 17% (Symphony’s shares trade in London but are quoted in US dollars). 

And as well as the company’s high double-digit dividend yield, the shares also trade at a discount of approximately 33% to net asset value of $1.20 per share.

So overall, Symphony is cheap, and the company is returning vast amounts of cash to investors. However, I should point out that as the shares are traded in dollars, investors are exposed to foreign exchange risks, and for this reason, the discount to NAV may never close. Still, for risk-tolerant investors, this looks to be an exciting dirt-cheap dividend king. 

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