Small Cap Value Report (12 Aug) - DLC, SIV, RNWH, AUK, PHD

12th Aug '13 by Paul Scott

7 comments 13852 reads

Good morning! Let's start with interim results from a company I've always liked, Delcam (LON:DLC 1610p). They are a British CAM (computer-aided manufacture) software company. For the six months to 30 Jun 2013, turnover rose 9% to £25.0m. Pre-tax profit rose 35% to £2.8m, , and basic EPS rose 18% to 30.8p. An unusually low tax charge in last year's first half is the reason that EPS rose less in percentage terms this year compared with the larger rise in pre-tax profit.

There seems to be an H2 bias to trading, and they emphasise that Q4 is important to their full year results. So given that H1 saw basic EPS grow from 26.2p to 30.8p, being a 4.6p increase, then it would be reasonable to assume the full year result is likely to be around 10p higher, on top of last year's vasic EPS of 58.2p, that means I reckon the full year 2013 should be around 68p per share. So broker consensus of 64.2p is looking a little pessimistic.

However, at 1610p the shares have already factored in a lot of future growth, and I make that 23.7 times the higher figure of 68p EPS which looks likely for this year. You would really need to be very confident that growth will continue to be strong to pay up that kind of multiple. I can't get anywhere near to that sort of multiple, and personally I would only pay about 15-16 times earnings at a stretch if I was convinced that nothing could go wrong. So whilst shareholders have done extremely well to date, they need to be clear that the company is now priced to perfection, so if anything does go wrong, the shares would probably halve overnight, because the more highly rated a company is, the bigger the percentage fall when something does go wrong.

The outlook is "very positive", and they confirm full year expectations. Also there is a very high R&D spend, which is always a good sign in my view. New products include software for controlling robots in manufacturing. Sounds intriguing.

The Balance Sheet is strong, with £11.2m in net cash, although most of that has come from up-front payments from customers. Investors differ in how to treat deferred income, but for me, it has to be offset against cash when calculating the enterprise value.

So my conclusion…

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marben100

12th Aug '13

News of a sensible sounding acquisition by Renew Holdings (LON:RNWH) of Lewis Civil Engineering.

Continues Renew's strategy of focussing on "specialist engineering", rather than construction where Renew originated. This strategy has already raised operating margins towards a 5% target (2.9% last year, up from not much more than 1% historically). According to the figures in the RNS, Lewis's operating margin is already at the 5% level.

Paying a reasonable multiple of 8x operating profit, in cash, funded from own resources + overdraft facilities.

I have held Renew for a long time and their management team has done an excellent job in moving to more profitable business lines. This has been reflected in strong profits growth in recent years and strong SP growth from the depths of the GFC. Despite the strong SP growth the shares remain on a mutiple of just 8x and yielding around 3%.. The business has very modest net debt, good cash conversion and a manageable historic pension scheme.

Having added to my holding in the depths of the GFC, I have topsliced on the way back up, mainly to control the risk in my position size as the value of my holding has grown. Neverheless, Renew's business performance has exceeded expectations, so far, so having made my last topslice a year ago, when the shares were at 87p, I am happy to retain the remainder which has re-grown into a decent sized holding of 2.3% of my SIPP portfolio.

Cheers,

Mark

Randval

Hello Paul
Stockopedia tell me that Renew have a negative Altman Z score of 0.25, in the distress zone.
I have approx 6% of my portfolio in Renew & it has done very well for me over a number of years.
My general strategy is LTBH but I wonder how the low Z score can be reconciled with what seem to be a good performance overall .
Perhaps I should just top-slice & pay the CGT

Any comment would be appreciated.

Regards,
Randval.

maillotàpoisrouges

Dear Paul
i read AVDFN news every morning which lists that days RNS's but i cant see a couple you refer to. Where do you look for RNSs and company results?
thanks

Randval,

When you see a metric with a troubling score (whilst the company looks OK), it is worth clicking on the metric to see the details. In Renew's case, there are two factors that trigger the low Z score.

First is the fact that Renew, in common with most firms in the sector, has negative working capital. Similar to the issue with deferred income in software firms, discussed recently, that's because Renew tends to take up-front payments for contracts. The key point is that the negative working capital is not due to large amounts of short-term bank debt. Hence, I personally do not see this as a significant bankruptcy risk (as long as one has confidence that management have reported prudently - cf $SID !).

The second factor is that that market cap. is small relative to the size of the firm's balance sheet. The significance of this is that if Renew did need to raise equity capital to reduce liabilities, potential dilution is large.

In Renew's case, neither of these factors trouble me signfiicantly.

Regards,

it_trader

I use and prefer to use http://www.investegate.co.uk/ for viewing RNS updates.

Hello marben100,

Thanks for the reply.
I can see I will have to put in the effort to learn about the Z score,negative working capital etc.
I will get a copy of the accounts & look at them carefully before doing anything as drastic as triggering CGT.

Regards,
Randval

Murakami

Further to Marben's very helpful response, here's some more background articles on the Altman Z-Score that may be useful:

As an aside, we are also working on a new, even more predictive default risk metric - the CHS Score - which should be available soon.

Small Cap Value Report (12 Aug) - DLC, SIV, RNWH, AUK, PHD

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Paul Scott

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