Small Cap Value Report (17 Jul) - QPP, NRR, CLL, HSM, KBC, UBI

17th Jul '13 by Paul Scott

21 comments 20132 reads

Good morning. There's a trading statement from Quindell Portfolio (LON:QPP) which, as usual, sounds highly positive. They report 1.1p adjusted EPS in H1 (the six months ending 30 Jun 2013), which if you believe the numbers means annualised EPS of 2.2p, so at 11.25p the shares appear to be very cheap, on a PER of 5.1.

Clearly at that price, a lot of the market does not believe the numbers, and nor do I. The history of this sector (insurance outsourcing) is of companies reporting rapid growth, fabulous profitability, and a debtor book getting bigger & bigger, and eventually large chunks of it being written off an uncollectable. So the profits were a mirage. Some people believe Quindell is different. It might well be, who knows? But there are enough similarities there to make me treat it with a bargepole.

I note that of the remarkable £43.5m profit before tax they report for H1, only £2.3m has carried across to operating cashflow! The bulls will say this is because they are growing so fast. Bears will say it's the same old story - big profits, but no cashflow. The bulk of their revenues come from very low margin credit car hire, and the profit is supposed to come from IT contracts.

The vital number that is missing from this morning's statement is what the debtors figure is. Why haven't they reported on that? What are debtor days? Are they static, or have they grown again? I would put money on debtors having grown a lot, hence why they haven't reported the figure.

I will only believe the bull story here & admit I'm wrong if & when debtors stabilise & the cash comes rolling in. That is not happening yet. They have exited their ill-conceived "Equity Swap" which was presented as if it were a Placing in Dec 2012, when it wasn't. They have repeated that it's not material, but that's not the point - the issue is that they misled the market as to the true nature of the fund-raising. To my mind that's the biggest red flag of them all.

It sounds like the shares have been given to vendors for deferred consideration, which avoids having to sell them in the open market. The trouble is, there is a wall of sellers…

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bobdouglas

17th Jul '13

Good to see Newriver Retail using recent fundraising in such an efficient manner. Certainly if there were any doubts about the placing, then this purchase should be a confidence booster. As an aside personally I like the investment they are putting in the north east namely Wallsend and now Middlesborough - long may it continue.

steamy001

Good morning Paul Quindell Portfolio (LON:QPP) expected an Out flow of cash between £15 to £20 million, they actually reported £2.3m Inflow of cash, this is a very significant improvement over what they guided.

Extract for clarity, I fail to see what is wrong with this, the cash can only have come from Debtor or am I wrong?

"...Adjusted operating cash flow for the half year significantly ahead of expectations and guidance with £2.3 million inflow compared to guidance of £15-20 million outflow during significant growth in H1 ... - See more at: http://www.stockopedia.com/content/quindell-a-great-british-innovator-and-job-creator-now-with-fy13-forecasts-73640/#sthash.1Sx6i5QV.dpuf

Ramridge

Hi Paul
I have also been a fan of NRR and topped up this morning in my SIPP on a 'buy and forget' basis. The div is fantastic.
Just one thing that is nagging me. Looking at their march 2013 annual report, they report debt interest as just over 60% of operating profits. I don't fully understand the REITS sector, but this seems to me pretty high leverage. Wouldn't take much to wipe out net profit. Would appreciate your views.
Regards, Ram

Paul Scott

Hi Ram,

From the presentation by Newriver Retail (LON:NRR), I recall that they had every risk buttoned up. So interest rate risk is covered by caps, etc. Therefore the business model is pretty solid, they just buy assets yielding 9%, and borrow money at 4%. I think their LTV is something like 50%, so together with the interest rate caps, etc, means that there really shouldn't be a problem when interest rates do rise.

Rents of course are fixed on standard leases, with 5-year upward-only rent reviews, on typically 15 year leases. Their voids are low, and the tenants are value orientated retailers, so tend to do well in economic downturns.
They've really thought about everything, and structured the company accordingly. Superb management, absolutely superb. Down to earth too, not the usual gravel-voiced BS merchants that you find in the property sector!

I completely agree that New River is just a buy & forget share. Not racy enough for most, but sitting back and getting a 7.5% yield at low risk, and knowing that management are working hard to increase the asset values over the long term, is a good place to be for a long term portfolio like a SIPP. The yield should be inflation protected too, in the long term, making it even more attractive. Being a REIT, they must distribute at least 90% of profits as dividends, which is an excellent structure in my view.

These guys set the company up & are buying assets at the perfect point in the cycle, when the spread between primary & secondary property rental yields is at an all-time high, and they are choosing the assets wisely - with the right type of tenants, and with development potential too.

Cheers, Paul.

Hi Steamy,

Point taken that Quindell may be ahead of what was planned on cash inflow (when they were expecting an outflow), but as we have seen with other companies in this sector in the past, rapid growth can hide a multitude of sins. It's only when the growth stops, you realise that they're not generating any cash, but have reported huge profits and then have a huge debtor book.

This time it may be different, but I'm not prepared to take that risk. The PER of 5 says that a lot of people are similarly cautious!

Regards, Paul.

Fantastic. Many thanks. Ram

bsharman

Hi Paul. Hope you are well and working from the garden in this fantastic weather! I am very interested in Avation (AVAP) which manages and leases aircraft. It has a fleet of 23 aircraft and seems to be valued quite cheaply - PER of 6 and PEG of 0.29. I was first drawn to this company because Mark Slater has a holding. I would be interested to hear your thoughts on this one. THANKS!

Hi Paul
I was just reminded of the danger of investing in highly acquisitive companies with the conclusion of the final SFO court case against Torex Retail. Two of the exec directors had pleaded guilty of cooking the books. The third pleaded not guilty and was a few weeks back found guilty. All three are doing porridge. Shareholders lost all, but the banks managed to get back their capital. For two years before a senior manager became whistleblower, the execs went into a buying binge. To my recollection, no share analyst seriously questioned this strategy or their accounts. I too burnt my fingers losing 25% of my investment, which is my built-in stop loss.
For the avoidance of any doubt, I am not drawing any parallels with Quindell except for the highly acquisitive strategy and the dangers this entails. Just to balance my comments, I am sure people can find other examples where companies have gone on to become bigger and better companies.
Regards, Ram

rmillaree

Re QPP

I guess if you set your expectations low then its fairly easy to beat them.

I think they went from £16 mill net cash (31/12/12) to £14 mill net debt - so the actual cash position looks to be much worse than the operation cashflow which broadly neutral - albeit £35 mill worse than achieved in 2012.

Any they also expect margins to reduce by possibly 10% in the future - that isn't exactly going to aid cash collection.

And there is the continual increase in shares issued that means they need to be generating ever increasing profits simply to stabilise EPS.

Cisk

Ramridge - I too had shares in Torex (I held XN Checkout when it was taken over by Torex).

There's a nice summary of the sentences here: http://www.complianceweek.com/sfo-wins-conviction-in-torex-retail-false-accounting-case/article/300463/

Personally I'm glad the SFO is getting tougher on Directors doing this type of fraud - and, like you (and Paul), I'm very dubious of any companies growing through acquisions of other companies (as opposed to buying products etc) - there's just too much scope for adjustments etc. Also, combining this with software companies, many of whom have dodgy amortisation / goodwill policies and revenue recognition - lends me to avoid companies like Quindell.

Paul, what do you think are the best type of screens on Stockopedia to avoid companies like these? Or indeed take a short position?

dosh

Re: NewRiver
Would not the wafer thin dividend cover cause some concerns regarding the sustainability of the dividend?

Bonitabeach

Hello Paul,

Re: New River Retail

I have no experience of working in a retail business and only a little in property. However, my instincts still tell me that E-Bay and/or Amazon would make much better investments for a long-term pension fund than New River Retail. I would not want the progress of my investment to be dependant upon the growth of disposable income in Wallsend and err... Middlesborough.

Regards.

Bonitabeach

Interesting to note the success of the MetroCentre in Gateshead near Newcastle upon Tyne which has more than 340 shops occupying 2,930,000 square feet of retail floor space, making it the largest shopping and leisure centre in the UK.

One advantage that we have up here in the Grimm North is that everything is alot more reasonable price wise (can still get a pint in my local Thursday night and Sat afternoon for £2.00) so less spent on buying a house and a pint of beer (or 57) and takeaway at the end of the night and less (nowt) put into a pension at the end of the week = more money to spend in the local shopping mall on a nice new bit of tat - although if the Wallsend Mall is the town centre one it was very run down last time i went past so will mainly be restricted to locals - but being in the town centre it will always be right location to ensure they have enough customers passing by to make it worthwhile for someone to open summit there - better in town centre than in the middle of nowhere if the quality is a little less than on offer elsewhere.

Hi dosn,

No, the dividend cover on NRR is not a concern, because it's a property REIT, so in order to maintain its tax-free status, it HAS to distribute 90% of profit in dividends. Therefore the normal rules on dividend cover don't apply, as it will always be just about covered by earnings. But this means you'll get higher divis as the earnings grow (over the very long term, I'm not expecting any increase in rents in the short term).

Cheers, Paul.

Hi Bonitabeach,

Well it's that prevailing mood which is why NRR is able to buy properties on such attractive rental yields!

It's true that internet sales have made a dent in traditional retailing, but only in certain product areas. The internet has not made any impact on value retailers (e.g. Primark don't have a transactional website, despite being one of the UK's largest clothing retailers), and things like pound shops satisfy a need in some people on low incomes to just buy stuff, e.g. cheap toys for their kids, household basics, etc. That business will never go online.

Shopping Centres are morphing from purely shopping locations into meeting places as a leisure activity, and the food/drink offering is becoming far more important. As are cinemas, etc. Ladieswear is still very dominant, as people want to try things on. Many retailers are moving to a click & collect model, so shops become a hybrid between a traditional shop, and a collection/returns office. Much easier to try it on in the shop, and reject it if it doesn't fit, than having to drag yourself to the Post Office to return it by mail.

NRR are doing things like installing free WiFi in their centres, and installing Amazing collection lockers, to drive footfall. Coffee outlets as meeting places are very popular now, and so they're building a unit for Costa in one centre, having surveyed local people as to what they want.

I wouldn't normally touch a bog standard retailing property company right now, but having met them I've understood that New River are taking a really innovative approach to it, which works. The amount of activity they have going on to maximise the value of their centres is breath-taking, pages & pages of activity was explained on the slides they showed us. They are building a new store for Morrisons for example in surplus space outside one centre, and the build cost is £7m, it's pre-let, and the capital value once it's built will be £30m! This means that you will see NAV rise over the next few years.
Another example, they combined two large units in another centre they bought, and then let it to Primark, who of course generate massive footfall.

You need to get into the detail with New River before it starts to make sense.

Cheers, Paul.

laurie89

I think you are too harsh on QPP. At this price they can make the odd mistake

shipoffrogs

Paul

why don't the normal rules on dividend cover not apply on a REIT ?

I'd never go near one again because of the forced lack of dividend cover. A lesson I learnt the expensive way after a near total wipe out on the Mapely REIT a few years ago.

REITS live in the real world of cash flow just like other companies.

18th Jul '13

Paul, thank you for the response, I did not realise the dividends issue regarding REITs.
many thanks

Beginner

Hello Millaree

Just to let you know the Forum is being tarted up as we speak. The old Co-Op is becoming a new library, and a new extension will be built on part of the car park. The structure allows these renovations to be done quickly and cheaply. The anchor tenant will be the local council. This is a VERY smart move. I missed the boat here!

Small Cap Value Report (17 Jul) - QPP, NRR, CLL, HSM, KBC, UBI

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Paul Scott

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