Small Cap Value Report (16 Dec 2015) - BON, TUNG

Good morning!

The UK small caps market feels very strange to me at the moment. It seems to be over-reacting to both good, and bad news. So companies which disappoint seem to be punished with a big, often excessive, and prolonged sell-off, whilst companies which report good news seem to keep going up, far beyond what seems a normal, or reasonable upside reaction.

So the market seems to be getting very polarised - growth companies now  seem terrifically expensive to me (so inevitably some will crash in price if anything goes wrong), whilst companies where there is any temporary bad news are being sold off really aggressively - I'm starting to see some really interesting bargains appearing, if you're prepared to look through temporary bad news.

There are also completely spurious spikes down occurring in a lot of smaller companies at the moment, which is really perplexing, but probably due to lack of liquidity, and a high number of market participants using trend-following strategies.

Utilitywise (LON:UTW) was a good recent example of extreme volatility - the price rose from c.180p to c.200p on recent results, but then turned round a few days later, and plummeted from c.200p to c.120p. Then it bounced on a positive AGM statement this week to 171p today. Utterly bizarre stuff - it's presumably down to short term traders stampeding in & out of stocks as a group.

This makes a mockery of any sort of charting analysis of course, as it's increasingly looking as if the traders who are moving prices don't know anything about the company concerned, or how it's actually performing. This is encouraging in a way, as it means that share price falls are not necessarily a cause for concern, but could actually be good buying opportunities. Therefore I'm focussing my attention now on using spurious spikes down to buy companies that I like.

Often the right thing to do is the complete opposite of what your emotions are telling you to do, so it's important to overcome the fear associated with buying when things look bad - but crucially, only for fundamentally sound companies, not speculative ones.

Mild weather

Which brings me on to the exceptionally mild weather. I can't remember the autumn & early winter ever (in my lifetime) being this mild, it's still almost T-shirt weather, 9 days before Christmas. That will undoubtedly be causing chaos for fashion retailers, because heavy winter clothing such as woollens and coats just won't be selling in anything like normal quantities.

Even if a cold snap does happen, it's too late now, and space requirements mean that a lot of the higher priced winter garments will now have to be sold at half price to shift them in time to make space for the new spring ranges, which arrive in stores in early to mid January.

So I feel it's now inevitable that many fashion retailers are likely to put out profit warnings. In this market, that's likely to be punished hard, which again is ridiculous really, because one bad season caused by extreme weather does not mean that the company is actually worth less at all, it's just a blip.

It will be interesting to see how Boohoo.Com (LON:BOO) (my favourite share) copes with these market conditions. It had a poor autumn/winter season last year, due to heavy discounting by the High Street, so is up against nice soft comparatives that should be easy to beat. Also, its "test & repeat" model means that it pre-commits far less to stock, but instead repeat orders things that are selling well. So, if that works well, then BOO could be a beneficiary of this year's bizarre weather, by hopefully having lower quantities of winter garments than its competition. Time will tell.

When you buy a company's shares, you're buying its earnings in perpetuity, not just for the current year. This year's poor figures will be next year's easy comparatives, so I'm expecting lots of bargains to be had in January, both in stores, and also on the stock market. Long term shareholders will just look through this one bad season, whereas short term traders will be trying to game the ups & downs.

The other thing to consider, is that if people spend less on clothes this winter, then they'll probably be spending that money on something else. So non-clothing retailers might see improved conditions, as might restaurants/bars, and other discretionary spending. With higher wages, and lower petrol, the consumer should overall have more money in their pockets this year than last, so it's likely to be spent somewhere.

Bonmarche Holdings (LON:BON)

Share price: 208p (down 30%)
No. shares: 50.0m
Market cap: £104.0m

Profit warning & CEO departure - as you can see, the market has slammed these shares down 30% today, which looks unjustified on what seems a fairly mild profit warning (and with a very clear external cause, with the mild weather), so I suspect it might be more about the departure of what seems to be a good CEO, Beth Butterwick, and also the rather irrational nature of the stock market at the moment - with indiscriminate selling on any bad news.

On trading for the current year (ending 28 Mar 2016) the company says;

In the Company's Interim Results report published on 23 November, the Board stated that, provided trading conditions normalised for the remainder of the financial year, its expectations for the full year would remain unchanged.

Trading conditions during December, particularly since "Black Friday" on 27 November, have been very challenging, and have not normalised. The Board's view is that these trading conditions are likely to continue for the remainder of the winter season and it has therefore revised its profit expectations for the current financial year. Given the ongoing volatility of trading conditions, the Board considers it likely that the PBT will be within the range of £10.5m to £12.0m.

The Company will issue its post-Christmas trading update on 15 January 2016.

The company did £12.4m PBT last year, so given the extreme weather over the important peak month of December this year, then a drop to the £10.5m-£12.0m range strikes me as being fairly reasonable. Certainly not a disaster by any means. This does not justify a 30% fall in share price, in my view, I would have expected a say 10-15% fall in share price, so this might be a buying opportunity potentially?

Departure of CEO - the key question on everyone's mind when a CEO leaves, is were they sacked or not? We have a ridiculous culture in this country whereby companies often feel obliged to lie about the circumstances surrounding the departure of Directors. So instead of telling the truth, announcements are usually written in coded form, which has to be deciphered in order to arrive at the truth. However, this creates uncertainty, and can lead to people jumping to the wrong conclusions.

In this case, as it is clearly stated that Beth Butterwick is leaving to become CEO of another fashion retailer, Karen Millen, and is staying on until a replacement is found, then it looks to me as if she's leaving Bon Marche of her own accord. So that's probably rather negative for the shares, and could explain why the shares have moved down such a lot. If institutions liked her, and she did lead the IPO, so presumably they do, then they could be trying to sell now.

My opinion - the shares are looking good value now, as by my calculations the company might deliver about 17-18p EPS this year, and maybe 20p next year. So at 208p, the shares look decent enough value. Especially considering that it has a strong balance sheet, and pays reasonable divis.

There again, an apparently well-regarded CEO leaving is bad news, and could unsettle existing holders into wanting to sell. Therefore I fear the price might continue to fall. So I think it's safest to just put this share on my watch list, rather than dive in straight away.

How about this for a brutal chart?!

Tungsten (LON:TUNG)

Share price: 39p (down 5% today)
No. shares: 125.4m
Market cap: £48.9m

Interim results & sale of Tungsten bank - the links on the left click through to the two announcements today from Tungsten.

Results - as expected, these are attrocious. Turnover has risen from £10.2m to £13.1m for H1, and the EBITDA loss improved somewhat, but is still awful, from -£13.2m in H1 last year, to -£9.5m in H1 of this year.

Note that it capitalised £489k into intangibles in H1, which is not material overall.

The balance sheet at 31 Oct 2015 is shown with a comparison against only 6 months earlier (30 Apr 2015), with cash having reduced from £32.6m to £15.9m in the last six months, an astonishingly high rate of cash burn. Clearly at that rate of burn, then the company would probably be out of cash by the summer of 2016.

EDIT: The company has been in touch, and asked me to clarify that there is additional cash in Tungsten Bank. I actually did mention this fact further down in this article (which I have bolded below), but just to be sure everyone gets it, and to be completely transparent, I am more than happy to publish the company's clarification note, sent to me by email today, as follows;

"As per the results announcement, Tungsten’s actual cash position was £39.7m, not £15.9m as stated. Understand that this confusion might have come because the bank cash on the balance sheet has moved to another line for assets for sale. As such, the ‘high rate of cash burn’ comment isn’t necessarily fair.There was an injection from shareholders of approx. 17m , so in the first 6 months of this financial year the burn rate is approximately 1.1m a month."

Disposal of bank - Tungsten Bank has not actually been sold yet, but the company has reached agreement to sell it for £30m in cash, which represents a relatively small premium over the assets held by the bank (which I seem to recall were mainly cash & bonds) of £25.4m. Regulatory approval could take 6-12 months.

My opinion - clearly Tungsten has been a complete disaster, with its original business model having almost completely failed. However, that has been reflected with the catastrophic fall in market cap, so I would be prepared to look at this again if a viable business model can be created out of the wreckage of the original shoot for the stars idea.

Sale of the bank should give the company a decent pot of cash to continue operating for some time to come, and if they are able to steadily reduce the cash burn, then who knows, it might have a future?

The only way to value this company would be to really get stuck into the detail of the management accounts, and prepare a proper forecast. I don't think investors have anywhere near enough information to create such a forecast, so it's essentially impossible for us to value - buying the shares now would just be a complete punt.

Outlook - these comments are interesting, but the trouble is, having failed so miserably in the past, I wouldn't put any credibility on comments from management, whether old or new. Jumping from a huge loss to breakeven, in a relatively short space of time, sounds like pie in the sky to me.

The new leadership team has moved decisively to realign the strategy to focus on improving the operational and financial performance of the business to achieve profitable growth. The steps it has taken, including the exclusivity agreement it has entered to divest Tungsten Bank, as well as ongoing targeted growth and efficiency initiatives, give the Board confidence Tungsten is on track to achieve break-even on an EBITDA basis by the end of FY17 and a positive EBITDA for the six-months ending 31 October 2017.

In FY16, the Board expects Tungsten to generate revenue of at least £27.5m and an EBITDA loss of no more than £19m. Excluding one-off items, an EBITDA loss of no more than £15m is expected.

With the proposed sale of Tungsten Bank and other initiatives underway, the Board is confident that Tungsten will have the cash resources required to meet the leadership team's break-even target. As at the end of FY16, the Group's cash position is expected to be at least £8m excluding the cash in Tungsten Bank, or no less than £33m including cash currently held in the Bank. The Board intends to access the liquidity in Tungsten Bank prior to completion of its sale, if required.

Some quite interesting comments in there - the most important being that the company can access the cash in its own bank for operational cash burn if necessary, so even if the sale of the bank doesn't happen quickly, then there should be enough cash to continue.

Overall, I think it's one to start watching again. Yes the performance to date has been dire. Yes Edi Truell has trashed his own reputation by being so ridiculously bullish about the prospects for the company, and ramping the shares to high heaven in the past.

However, the company appears to have enough cash to keep going for quite some time, if you include the cash in its own bank, so they have a second chance to see if they can make it work. For now, it's a total punt, so not for me, but if better figures start to come through in future, then it might be worth revisiting, potentially? The company hasn't yet demonstrated that it has a viable business model though, that's the big problem.