Small Cap Value Report (10 Feb 2016) - HRN, WAND, RNO

10th Feb '16 by Paul Scott

19 comments 17743 reads

Good morning!

There are 3 profit warnings I want to comment on today. Is this a sign of a worsening economy? Not really, as all 3 are companies with existing or previous problems, so for the time being anyway I'm still fairly sanguine on the outlook for the UK economy (not sure about overseas though).

So let's take a look, in order of magnitude of today's share price falls.

Hornby (LON:HRN)

Share price: 39.6p (down 51.1% today)
No. shares: 55.0m
Market cap: £21.8m

Just a bit of catch-up first;

I reported here on 18 Jun 2015 about Hornby's £15m equity fundraising at 95p, and how amazed I was that it had been possible to raise fresh funding in what was effectively a rescue refinancing, to get the bank off the hook. Sure enough, the investors who backed that 95p fundraising are looking unwise now, and indeed looked unwise at the time too.

In my report of 12 Aug 2015 I noted the non-specific but generally positive-sounding trading update, and the move from the main listing, to AIM (a sensible move for a company of this size, in my view), concluding that the shares (at 107.7p) were too high, given that the turnaround was not cemented yet. Risk:reward was all wrong at that price - with shareholders being asked to pay up-front for what was then only a tentative turnaround.

Interim results on 8 Dec 2015 look pretty awful, I didn't report on them at the time, but am just looking at them now. It was clear from the interim numbers that the turnaround plan was not working, and once again Hornby slipped into losses - £3.4m for H1, and that's before adjustments, exceptionals, etc. Once again however, management peppered the narrative with optimistic noises about the outlook.

Profit warning - here we are today, and it's clear the wheels are coming off. Clearly a serious profit warning, to have triggered a fall in share price of over 50% today, on top of the drift downwards in price since Aug 2015.

UK sales performance seems to have fallen off a cliff in Jan 2016, which looks very strange to me;

In the UK the Group saw a strong sales performance in the key November and December period as sales opportunities were maximised in the run up to Christmas. Like for like sales in this period…

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Patrick Dier

10th Feb '16

Hi Paul,
Thoughts on the Animalcare (LON:ANCR) half year out today?

kalkanite

Hi Paul

As an aside, I think companies that make a great song & dance about having a turnaround plan, and give it a silly name, as if it were some kind of separate entity, often seem to come unstuck. When actually, turning a business around is all about starting to manage it well, instead of badly.

A great comment, this is so often the case that management are actually talking about doing the fundamental day to day operational management. It's generally a red flag as it means they haven't got a clue what they are doing.

FCCN discussed their turn around plans a few years ago, it was basic operations that they should have already been doing and here we are a few years on and they still can't get it right. Would be a good investment if Stephen Marks was to retire.

Brackendale

Hornby - excellent analysis Paul. I remember looking at it a few years ago when the story was that demand was flying but a supply problem with a factory in Asia had temporarily meant they could not meet that demand. With some apparently good brands it looked like a good proposition to be a turnaround. But this is now the second management team that has struggled with it. A good case study and another one that reinforces my view that when management comes in and starts talking "values" and "passion" it's not just meaningless but downright dangerous! Only ray of hope for the poor investors perhaps that the brands might make an attractive target at a low price? Scraping the barrel..

Gostevie

Hello Paul,

Have to say your report on Hornby (LON:HRN) is the very best piece of analytical financial writing that I have seen in a very long time indeed, Really superb stuff! Thankfully I have never held shares in the company. What a mess.

Still like their trains though...

Steve

Fegger

The explanation for falling off the cliff may be that they were having troubles but managed to revive by a good push to Christmas . I think a lot of sets would be sold to adults who may not buy at other times of the year. From my perspective few kids ask for train sets now so the lack of demand is really showing now in January.

As others have said an excellent piece of analysis and essential reading!

Mark Carter

I don't see how WANdisco (LON:WAND) can both cut costs and grow at the same time. If they are cutting costs, then they are retrenching, which kills it as a growth stock, which is what it is purports to be.

This one will eventually fail. It's just a question of time.

dscollard

enjoyed that analysis, made me chuckle.

To quote Buffet, tho I am not sure brilliance can be applied to rubber chicken eaters who are more endeared with their PowerPointware than the day-to-day:

When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact

BahrainChris

Have you ever thought of simply shorting everything on your bargepole list?

colinhow

@BahrainChris - I certainly have!

Paul Scott

Hi BahrainChris,

I try to avoid shorting small caps, as it's too dangerous.

I've seen some crazy things happen over the years - e.g. something called CPP looked certain to go bust, and the shares went to 1p. Then they spiked up to 31p. Apparently some well-known shorters lost their shirts on this, as they had to buy back at any price.

Or say if WAND suddenly did announce a huge contract win, and the shares 5-bagged overnight. It's possible. Unlikely yes, but I wouldn't ever want to take that risk.

So I keep my shorts to mainly US large caps, and just ride the waves down, then close. Then re-short them again when they're rebounded upwards a bit, and when the market looks ready to tumble again. At least you can sleep at night with shorts on large caps. You can't if you're short small caps, and there was a story recently of a US punter who ended up $340k in debt when a small short position in a biotech went disastrously wrong.

Also, the really tiny stocks, you often cannot short them, the SB cos won't do them if they can't get a borrow. Or they might let you open a short against one of their client's existing long positions, but the trouble is then, your short is closed out when that punter decides to close their long. That completely ruins risk:reward for me, if I'm not in control of when I can close the position.

Shorting is a real minefield, and for most people best left well alone. I only do it with great caution, and only on large caps usually.

Regards, Paul.

Here's my take on Hornby (LON:HRN): it has had a ROCE of 2.5% over the last 5 years, which is abysmal. It has debt, and trades above book. It has lost money, in aggregate, over the last 5 years.

Despite a long and illustrious history, the company is basically a has-been. It's for traders, not investors.

Google Trends shows that interest has been waning over the last decade. It reminds me of Stanley Gibbons (LON:SGI).

I won't be investing.

jonesj

I wouldn't be sure about Renold getting even replacement business when the chains wear out. It is necessary to understand the competition, which means it lands on the "too difficult" pile for me.

If we look at another commodity -roller bearings, each bearing manufacturer will offer a catalogue of standard bearing sizes, which even have the same number printed on the side. If your FAG 6204 bearing wears out, you can replace it with an NSK 6204, or the same bearing from umpteen other manufacturers, in Europe, Japan & China.

I don't know how the chain business is, but the first Renold chain catalogue I found on their website has Renold numbers in the first column and ISO numbers in the second column. I presume any ISO chain with the same number will fit, but am not going to investigate any further, as this investment is not for me.

AnonymousUser192020

Yes, nice write up on Renold.
One detail - the 7 December RNS said they've derisked 50% of their liability for UK pensions in payment. Typically a DB scheme will have a similar liability again for its deferred pensioners, which are harder to derisk through buy-ins. The pensions disclosures to the accounts should show the breakdown of liability.

I thought Renold is a long established brand with a well diversified client base. I'm wondering if the decline in revenue is a precursor to stress in the engineering sector? Or is there growing competition from Germany and Japan?

AnonymousUser39114

Re Tangent Comms it looks as though Maven Venture Capital have purchased 1.87% of the share capital today. Presumably this indicates they may be helping finance the share buy-back, lending the company money as well?

cig

11th Feb '16

May not be enough to make it investable (yet), but it doesn't trade above book does it? (Market cap 16m, book 42m)

My bad. You are correct. I must have been looking at the wrong ticker at the time.

Jack Owen

In the right hands Hornby has some valuable brand names, known internationally. Where it goes from here is up to the institutional investors, which own most of the company 75% and Barclays. May need to sell off some of its brands and liquidate its slow moving stock to generate cash to keep Barclays happy. Situation reminds of Lego when it got itself in a mess. We can live in hope it will survive, as an independent, but really needs to be part of a bigger company

Funderstruck

Re Renold;
Their product is used in mining particularly coal, which is where I believe it built it's reputation in the UK where that business is no longer; possibly exports to Poland, but Price?? Other mining is on hold now until demand for resources picks up. Looks very long term.

12th Feb '16

Hi Jack Owen,

Yes, fair points ( post 17). I agree that Hornby does have some iconic brands, and in the right management hands, there could be value there.

I would look at it with an open mind, once it has resolved its financing needs. The shareholder list is quite heavily concentrated too, so they probably won't want an embarrassing disaster on their hands. Therefore it's possible that a rescue deal may be agreed.

I wrote the above article when the shares were 39p. They are now, a couple of days later, only 24.5p, so risk:reward has improved in terms of considering it investable. I'll wait to see what the major shareholders/bank decide to do. Then look at it fresh once that news is out.

Regards, Paul.

Small Cap Value Report (10 Feb 2016) - HRN, WAND, RNO

Hornby (LON:HRN)

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Paul Scott

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