Small Cap Report (7 May) - QPP, SNX, CAP, KBC

Tuesday, May 07 2013 by
13

Pre 8 a.m. comments

Good morning! It looks as if small cap Directors spent the weekend enjoying the sunshine, as there are very few results or trading announcements from them today.

Synectics (LON:SNX) announce a major contract win with Stagecoach. Although I'm wondering whether they have got the balance right in announcing frequent contract wins, when in this case £5m over three years doesn't sound material to their results?

 

Although it's now a mid-cap, I cannot hold back on commenting on results from Quindell Portfolio (LON:QPP).

On the surface they look amazing - turnover has risen from £13.7m to £137.6m. The profit margin looks incredibly high, as in not credible. However, the biggest red flag by far is that Debtors has risen from £31.7m to £202.3m! That's not a typo. The increase in Debtors is higher than the entire year's turnover! So that surely means that all the sales & profits booked for the year have not actually resulted in a single penny in cash being collected from those sales?

I'm almost blinded by the red flags jumping out at me from both the figures & the commentary. It reminds me very much of one of my worst investing mistakes a few years ago, Accident Exchange - which operated in the same area as Quindell, supplying replacement vehicles to people who have had accidents & then trying to reclaim the money from their insurance company.

They load up the pricing, which generates huge paper profits, and then haggle with insurance companies over payment, which results in a debtor book just getting longer & longer, before eventually there are huge discounted settlements, a large chunk of debtors is written off, the shares collapse, and a rescue refinancing is needed.

Quindell might be different, but the key figure to watch is debtors, and as I expected, this has ballooned to a clearly excessive level with QPP, so the big warning sign from similar companies in this sector whose shares eventually collapsed to virtually zero, is there - loud & clear.

I will never again invest in any company which cannot keep a tight control on its debtors. A large & growing debtor book is almost always a precursor to serious problems. That's the same reason I never invest in any Chinese companies, as they don't collect in the cash - because arguably the whole Chinese economy is a gigantic game of pass the parcel, but where everyone has been told that the music will never stop - so nobody worries about holding the parcel. The "parcel" being  bad debts of course, which are never recognised. Eventually the music will stop, and there will be the most almighty crash, we just don't know when.

 

Post 8 a.m. comments

Apparently Clean Air Power (LON:CAP) was tipped in a share newsletter over the weekend, which explains the flurry of buys and the price being up 13% this morning. As regulars might recall, this is my main blue sky/GARP pick. It's speculative, but the price seems pretty reasonable considering the potential growth from USA sales when they launch there is 2014. Their product allows HGV diesel engines to run mainly on natural gas, which of course is now very cheap in the USA.

My observation is that there seems to be a wave of new investors coming into the small companies investing space, and that generally new investors tend to go for story stocks, rather than value - because they want excitement & quick gains. In a bull market there can be rich pickings in this area, although eventually most companies disappoint. Hence why I've adjusted my investing focus a bit to look for more GARP opportunities, as well as value shares.

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It's worth bearing in mind too that value stocks did really badly in the late '90s tech boom. Of course that presented some spectacular bargains when the TMT frenzy was at its peak, but the point I'm making is that when the market is looking for growth stories, then value shares can just languish for a very long time, so they're not necessarily good things to be in during a bull market, unless they pay a good dividend.

 

Another share in my personal portfolio which has been tipped over the weekend, and has risen  this morning as a result, is KBC Advanced Technologies (LON:KBC). Simon Thompson of the Investors Chronicle has done a positive write-up about the company apparently. I find that shares being tipped in magazines, online, etc, can be a double-edged thing. On the one hand it's pleasant to see the price rise, but on the other hand you know that the buying will generally be from investors with a very short time horizon, and who probably haven't done much,  if any, research of their own.

So those same investors who are chasing up the price this morning, will be a steady trickle of sellers over the next few weeks. Unless the momentum builds, and you get a continued share price rise, in which case that attracts in momentum buyers - as we've seen in the last year with many shares, once upward momentum sets in, it fuels itself.

So for more value-orientated people like us, this creates a real quandary - do well sell into rallies, or sit tight in the hope that it's the beginning of a new upward trend? For me it all depends on valuation - if the share looks fully priced, then I sell.

 

This morning has seen bizarre goings-on with the share price of Emblaze (LON:BLZ). My broker mentioned it first thing - saying that a freak trade at 15p this morning had probably triggered stop losses, and hence the shares collapsed in price at the open. I dithered, and wanted to look at the accounts first, but missed the opportunity to buy when my broker suggested (at 30p). They're now 56p. Very strange company though, which appears to be a very small, loss-making Israeli outfit, sitting on a vast cash pile. So my initial reaction to the share price collapsing was to worry that someone might have run off with the cash?

Anyway, it convinces me more than ever that putting in automated stop loss orders for individual stocks is a mug's game, if you use a CFD or Spread Betting account. All it takes is a freak trade like that to stop everyone out, and crystallise a nasty loss. That's why I never use stop losses on individual stocks.

 

So a slightly different focus today, as there were not any results of interest, so hopefully we'll have a few more tomorrow?

Regards, Paul.

(of the companies mentioned today, Paul has long positions in CAP and KBC, and no short positions)


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Quindell PLC is a holding company. The Company is engaged in sale of software and consulting services, and the provision of technology enabled business process outsourcing services to brands operating in the sectors, which include Insurance, Finance, Health and Legal; Telecoms, Utilities, Retail and E-commerce, and Government and Public Sector. The Company operates in two segments: Software and Consulting and Technology Enabled Outsourcing. The Software and Consulting Division provides software, business and technology consulting services, administration and management services, white labelled solutions, e-commerce, membership services, Software as a service (SaaS) solutions and other services. The Outsourcing division provides technology enabled sales and service related outsourcing services. more »

Share Price (AIM)
161.25p
Change
-5.0  -3.0%
P/E (fwd)
2.2
Yield (fwd)
2.3
Mkt Cap (£m)
725.4

Synectics plc is an United Kingdom-based company which operates in control room surveillance markets. The Company’s markets include urban surveillance, offshore adverse area surveillance (oil, gas, chemical and mining), casinos, military, banking, retail, transport (buses and trains) and prisons. The Company is engaged in high security programs globally. It operates in the United Kingdom, the United States and the Far East. In North America, it is investing in routes to market for its next generation solutions in mobile, transportation, marine, oil and gas, retail and urban surveillance programs. It is selling EX explosion rated, marine and hazardous area surveillance products into the Far East shipyards and it is working with its partner to extend the portfolio to the range of Synectics products and services. more »

Share Price (AIM)
370p
Change
0.0  0.0%
P/E (fwd)
10.7
Yield (fwd)
2.4
Mkt Cap (£m)
65.8

Clean Air Power Limited is engaged in developing and marketing Dual-Fuel solutions to power heavy goods vehicles. In addition, the Company sells specialized components used in the automotive industry. The Company operates in two segments: Vehicle systems and Components segment. The Vehicle systems (Dual-Fuel) segment allows a standard diesel engine to operate on natural gas without any changes to the engine. The Components segment designs and delivers Hydraulic Valves and Natural Gas Injector Components for natural gas engines that enable automotive and truck manufactures’ to build low-emission gasoline, natural gas and diesel vehicles. The Company’s subsidiaries include Clean Air Power Limited, Clean Air Power Inc and Clean Air Power Pty Ltd. more »

Share Price (AIM)
2.63p
Change
-0.5  -16.0%
P/E (fwd)
5.7
Yield (fwd)
24.0
Mkt Cap (£m)
8.0



  Is Quindell fundamentally strong or weak? Find out More »


13 Comments on this Article show/hide all

ericb 7th May '13 1 of 13

I agree with your comments on SNX - its not even really a *new* contract win, just an extension of an old one.

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CantEatValue 7th May '13 2 of 13
1

"Of course that presented some spectacular bargains when the TMT frenzy was at its peak, but the point I'm making is that when the market is looking for growth stories, then value shares can just languish for a very long time, so they're not necessarily good things to be in during a bull market, unless they pay a good dividend."

True Paul, put probably only if you're a trader. If you're an investor the underlying businesses will be carrying on producing profits, throwing off cash and growing regardless of what the markets think of them. If anything it presents great opportunities for share buybacks at an attractive price and so increases the attractiveness of it as an investment option.

I don't think I'd be able to time getting in and out of market favourites du jour at the right time (can anyone?) so I think this practice is probably best avoided in favour of investing with a long term perspective.

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Paul Scott 7th May '13 3 of 13
2

In reply to CantEatValue, post #2

Hi,

Generally I agree with those points you make. However, it amazes me how even the most successful value investors can lose patience with a great company whose shares languish for a long time. Remember that there is an opportunity cost with every investment. So holding something where the shares are dormant, or in a slow gradual decline, whilst other things are going up, is very frustrating for even the most disciplined investors.

It's easier if the share is really deep value - e.g. Trinity Mirror (LON:TNI) last year. I got my timing wrong, by about a year, but as it got cheaper & cheaper I just bought more & more, confident that my research was correct. By the time it got to 25p I was almost all-in, with 60% of my portfolio in that one stock. It paid off of course, as my research was correct.

However, it's a lot harder to be so bold if a share is good, but not great value.

I don't see any problem at all with blending investing & trading, and that's something that feels natural to me. So I'll happily hold some shares for years (I've held Indigovision (LON:IND) continuously for 9 years now!), whilst will nip in & out of others in quite a short timescale (say a few weeks) if a good trading opportunity arises in a company whose accounts look sound to me.

I'm very wary of blue sky these days, and hardly ever touch it - because such a proportion of blue sky stories from years ago turned out to be commercial failures.

Quite a big topic that we could discuss widely. Just to emphasise though, my approach is still very much value & GARP. But in a bull market I'm prepared to be more flexible if the right opportunities arise.

Cheers, Paul.

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Marky 7th May '13 4 of 13
1


Re: Quindell debtors

If QPP was growing revenues purely organically then of course you would be correct, however it has made an array of acquisitions which have had the effect of increasing the balance sheet, including the level of debtors.

Some of these acquisitions occurred late in 2012, so for these QPP was taking on minimal 2012 revenues vs full debtor balance.

"So that surely means that all the sales & profits booked for the year have not actually resulted in a single penny in cash being collected from those sales?" No Paul, it doesn't. EBITDA to cash conversion was 74%, at a time of exceptional growth.

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it_trader 7th May '13 5 of 13
1

I think the issue with QPP currently it is all very much in the air and risky. Due to all the acquisitions throughout 2012 it is hard to give them the true credit for the increased EBITDA figures as well as all the blame for the increasing debtor figure.

I'm sure they are well on with sorting out the debtor problem now into 2013 and there wasn't probably much they could do about the 2012 figures. However they did use those debtor 'asset' figures as a way of 'valuing' their acquired companies so a very big issue for current share holders who saw their holdings diluted time and time again with the presumption they were earnings enhancing.

They need to collect that cash, or at least the majority of it.

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Paul Scott 7th May '13 6 of 13

In reply to Marky, post #4

Hi Marky,

Fair point, about multiple acquisitions meaning that the year-end Debtor is included in full on the Balance Sheet, but the P&L might only have a small impact from the acquisition, especially if it happened near the year-end.

So we need to know the run-rate of annualised turnover really. Stockopedia shows 2013 forecast turnover at £442m, so that implies that at £202m the year-end debtor is still very large, but not quite as horrendous as it originally appeared in the results.

Trouble is, large numbers of acquisitions in a short space of time, is itself a red flag, and rarely ends well. Aside from the problems of integrating multiple acquisitions, acquisitions can also obscure the underlying performance of a group. It's only when the acquisitions stop, and you see the underlying situation, that the fog clears.

I may be wrong on QPP, as my bad experience with Accident Exchange taught me that companies which try to exploit the insurance sector and book apparently huge profits, come unstuck in the end, when the insurers or Govt eventually wise up to the problem. It's like the huge numbers of fraudulent whiplash claims made in the UK - it's been going on for many years, but at some point that will be snuffed out too.

Regards, Paul.

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thekingsgambit 7th May '13 7 of 13

Hi Paul,

I was just wondering why Iofina (LON:IOF) doesn't show up on your daily screen as the year end results were released here.  Do you have a stockopedia screen you are using?

Thanks in advance

Stuart

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jraitt 7th May '13 8 of 13
1

In reply to thekingsgambit, post #7

Paul
Tiny point your heading is QED - should be QPP. Just for information.
John

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jraitt 7th May '13 9 of 13

In reply to Paul Scott, post #6

Paul,
I have only paid a very cursory interest in QPP so may be entirely wrong. Is not the difference between QPP and Accident Direct? also Helphire that QPP is employed by the insurers to handle the claim on behalf of the insurer whereas the others solicited the no fault victim of the accident to hire a replacement car from them. They were thus third party suppliers who seemed to rather abuse their position by loaning bigger cars, at very high prices for longer than necessary periods.
If QPP are, in fact, just subcontractors of insurers outsourcing their back office work providing a one-stop shop in claim handling then they would have proper contracts and payment terms. Working for the insurers is a very different business model
Have I misunderstood?
John

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SevenPillars 8th May '13 10 of 13
2

Quindell share price has now been hammered two days running. News today in The Times that the company has £13.3million of derivatives, CFDS, listed in the accounts as a wager on the share price to go up. The company seems to feel that the share price will be sorted out, in a positive way, once it moves to the main market.

Big moves one way or the other seem to be the order of the day with this company. So far, rapid growth by acquisition hasn't convinced those buying in the AIM market. Shorters seem to be having a better time of it lately.

There is quite a long article in the Investors Chronicle, The curious case of Quindell, that is worth a read by any holder. Most of the comments I've read around the web from those that hold it on fundamentals seem to suggest that the acquisitions they have made are all good, sound buys and will pay off long term. Others clearly doubt the strategy as too much to soon.

Also worth noting that CEO Robert Terry was previously at Innovation Group and did much the same thing there. Haven't checked the history of that company, but in the article below the share price was around 305p and today they stand at 25p 'ish (don't know of any share dilution, new issue, etc since then). So, Quindell's CEO has a reputation for the rapid acquisition approach.

http://www.telegraph.co.uk/finance/2729417/Innovation-shares-fall-as-acquisitions-fail-to-impress.html

 

 

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dangersimpson 8th May '13 11 of 13
1

If what the times is reporting is correct that alone would be a red flag to me - any company not incorporated as an investment company that uses shareholders funds to speculate on the price movements of their own shares shows, in my opinion, an attitude of management which is inconsistent with an aim of building a successful long-term business whether their speculations are ultimately profitable or not.

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SevenPillars 8th May '13 12 of 13

It's also reported that Evil Knievil, Simon Cawkwell is short of Quindell. According to Quindell CEO Robert Terry's twitter feed, EK has had a big short forcing down the price.

EK is probably looking to get back some of his ASOS losses.

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Paul Scott 10th May '13 13 of 13

In reply to jraitt, post #8

John,
Many thanks, I've corrected it now.
Regards, Paul.

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Paul trained as a chartered accountant with Price Waterhouse. He then spent 8 years as FD for a clothing retail chain. "Retired" in 2002 to become an independent investor & analyst. more »



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