Small Cap Value Report (1 Aug 2014) - CDY, RGD

1st Aug '14 by Paul Scott

9 comments 12698 reads

Good morning! There's was a 300 point sell-off in the Dow last night, so the UK market is expected to open down, but only down about 12 points on the FTSE 100. Small caps have been in a downtrend since the Spring, especially on AIM, so it's about time the major indices had a sell-off too.

As pointed out in a useful article on Investors Champion yesterday, the decline in larger cap AIM stocks has been considerable, which is surprising as you would normally expect the smaller & more speculative stocks to sell off the most in a downturn. The FTSE Intl-aim UK 50 Index (FTSE:AIM5) Index (the 50 largest AIM cos) is down a remarkable 25% from its peak on 24 Feb 2014.

Whereas the broader FTSE Intl-aim All Share Index (FTSE:AXX) has fallen from a peak of c.897 in early Mar 2014, to 769 today, so a 14.3% fall. So as I've mentioned before, if you invest in small caps and are having a hard time at the moment, then you're not the only one. Although it is interesting that the most damage has been done to the likes of ASOS, Quindell, Blinkx, Monitise, etc, stocks which clearly reached valuations that were far too high for their fundamentals. Also in 3 out of 4 cases of those examples, companies with questionable business models - which people may ignore in a momentum-driven bull run, but which hastens the downfall when the tide turns.

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Dark blue (top)line is FTSE Small Caps Index
Beige (middle) line is AIM 50 Index (note the 25% decline since Mar 2014)
Light green (bottom) line is AIM All share Index

Nevertheless, in my view there are now far more buying opportunities in smaller caps - indeed I'm finding new ideas almost every day, on the back of positive newsflow. I like this time of year because so many market participants are on a beach somewhere (I can't think of anything more boring!). So if a cheap company puts out a positive trading statement, there is sometimes little market reaction as nobody much sees it. That can give a nice opportunity to pick up a bargain that could deliver results once people are back at their desks in September…

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Hutch_Pod

1st Aug '14

Paul, I really appreciate your broader small caps comments above, as these more strategic thoughts play heavily on my mind, but I rarely see good assessments (unlike on the US indices, where they are pretty common eg on Seeking Alpha). Thanks! and also like the quote from Clem Chambers. Something i need to get my head round.

Cheers
HP

nicktudor

Morning Paul / all, thought it was also interesting in that interview that Clem Chambers referenced the SMX specifically dropping through 4400 as his bearish signal as its been trading in such a tight range (4400-4500'ish) for the last 6/7 months.
This morning the SMX dropped through 4400 and is currently sitting at 4375 !?

JakNife

Re RGD (of which I'm not a fan either but that's by the by), I recollect speaking to the finance director at a Mello event, probably about a year ago, where I asked him about their bank debt. He said that the main part of the debt was with HSBC and secured on their receivables.

From my own experience I know that HSBC have a receivables finance product which is referred to as an "asset-backed loan", it typically provides up to 85% of the balance of outstanding receivables. The advantage of such a product is that the loan can flex directly in line with working capital. Also, from the company's perspective, the covenants on the loan are balance-sheet based rather than linked to interest cover or EBITDA which the finance director certainly found more appealing.

As I flicked through the accounts I was surprised to see how the results of the different businesses were split out. Does anyone else think that it kind of reads like an advertisement for sale?

JakNife

Leven

AIM50 decline not surprising given ASOS (LON:ASC) and Quindell (LON:QPP) comprised almost 30% of the index (20.6% & 8.2%) on 24 Feb

MichaelFBS

Hi Paul

Your work work ethic is extraordinary. I do wish you would "take some time off" and write a book (or have it ghost written) about your time as a private investor since you left the ladies fashion retailer.

It is interesting that you say that you "never take any time off." I contrast that with Robbie "Naked Trader" Burns who, says, he has secured his future (property) and has closed out many of his positions and is taking the summer off.

Personally I like taking time out as it gives time to think and clear out the cobwebs and with iPhones and iPads one can still keep on top of what is going on.

Anyway thanks as ever for a great blog/column.

The Phoenix

Yep c'mon Paul time for a book from the rise and fall with Indigo to the comeback with Trinity Mirror.

cig

2nd Aug '14

The lack of derivatives on small cap indices also means they're hard to short, which means people with bearish views cannot express them easily, hence more volatility. (Compare and contrast with classic stock-level shorting...)

BrianGeee

The RGD debt is with PNC - perhaps you're confusing them with Silverdell, who's debt was with HSBC!
See http://www.investegate.co.uk/real-good-food-co--rgd-/rns/new-bank-facility/201212310700125058U/
Anyway, it is mainly secured in receivables, and as of end March was at 91% of outstanding, so almost certainly at its limit. Payables has shot up by 40% since last year, with no real increase in turnover, so they're clearly in a distressed situation. They probably want to raise equity finance, but can't with the uncertainty of the British Sugar dispute hanging over them.

Hi Brian,

I've got the name wrong, it was that facility structure but with PNC rather than HSBC. This is the bit that's the "receivables finance part", taken from the announcement that you linked to:

"The new facility which, represents a £10 million increase on the existing facility, will run until December 2017 comprising, as now, of a mixture of revolving credit facilities secured on trade debtors..."

Note 6 to yesterday's results show that the RCF part is £27.3m and the term loan is £7.2m. The trade & receivables are £34.3m so that's about a ratio of 79%. Some of those receivables are probably ineligible, (it's rare that all are eligible) so I can't tell if PNC work off of 85% or perhaps a lower advance rate..

Small Cap Value Report (1 Aug 2014) - CDY, RGD

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Paul Scott

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