Small Cap Value Report (17 May 2016) - LAKE, ZYT - New Version (old One Corrupted)

17th May '16 by Paul Scott

30 comments 16538 reads

This is the new version of this report, created from a backup.

My apologies, but I had technical problems & the earlier report corrupted, so had to ditch it.

Regards, Paul.

Good morning!
A horrible start to the day for me, with another profit warning from LAKE.

Lakehouse (LON:LAKE)

Share price: 32p (down 33% today
No. shares: 157.5m
Market cap: £50.4m

(at the time of writing, I hold a long position in this share)

Interim results, 6m to 31 Mar 2016 (profit warning) - the FD has done a good job issuing the interims reasonably promptly, given the distractions of board room upheaval. Slater Investments, and the founder Steve Rawlings were successful in taking control of the Board. So there might be an element of "kitchen-sinking" in these numbers possibly? (although I don't see any obvious signs of that in the numbers).

I've spent all morning so far, ploughing through the numbers, and the extensive narrative. It seems to me that the downturn in performance has, as its root cause, Government policy. Forcing councils & housing associations to lower rent by 1% p.a. means that inevitably, they have deferred planned maintenance spending, which impacts LAKE. Also, reductions to subsidies for property insulation have also hurt LAKE.

Given the changes to the Board, mismanagement seems to have also been an issue. Furthermore, LAKE concentrated arguably too much on making acquisitions, which maybe caused management to neglect the core businesses?

So this share is very much a special situation, not for people who are easily upset.

H1 profitability has fallen sharply:

• Underlying EBITA down 42% to £5.1m for the 6 months. However, this is flattered by contribution of profits from acquisitions.
• Excluding acquisitions, underlying EBITA was down 80% to £1.7m

My view - we were expecting a poor H1 anyway, and whilst these figures are clearly poor, the group has remained profitable. Remember that the context here is a share price down about 70% from this time last year, so a lot of bad news is already in the price.

EBITA is a reasonable performance measure here, as it's basically operating profit (i,e, EBIT) with acquisition-related amortisation charges stripped out. That's fine. There are no significant exceptional items, so the figures above look clean to me.

Expectations have been revised down for the full year again, but the company doesn't say by how much! They could & should have given…

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JohnEustace

17th May '16

That's what I thought too. The clue being in the name, Special Dividend.

FREng

Si

Yes, of course. It's easy to feel schadenfreude when one escapes being hit by a profit warning.

I bought Lakehouse (LON:LAKE) on Feb 5th as a short-term trade because the fall looked overdone and I expected a bounce. My note says "fall overdone, if the broker is honest". I sold in March for a profit of £1200. But I'm not necessarily negative about the company - it's back on my watch list. I was just commenting on what felt like an inconsistency in Paul's (consistently excellent) analyses. I thought hard before posting it but Paul has said he welcome's contrary views as they provide a balance to one's own.

dscollard

what a tangled web we weave. This thread is a microcosm of what makes markets. Difference in opinions, timescales, expectations and convictions combined with myriad approaches.

One man's meat is another man's poison.

Some trade,some invest, some speculate and some gamble

Threepeat

I too had Lakehouse (LON:LAKE) a while before the profit warnings and boardroom antics. I watched all the acquisitions but still was unable to see where the forecast eps was going to come from. Consequently I sold for a miniscule loss.
Paul , it seems to me that you are trying very hard to convince first and foremost yourself that a good turnaround can be achieved. For my part I will continue to sit on the sidelines.

Thanks as ever for the tireless efforts to keep us informed

Steve

Paul Scott

Hi FREng,

I think you may be allowing your long position (and sunk costs) to cloud your normally acute criticisms of companies that have falling profits, debt, a weak balance sheet with -ve NTAV and yet choose to pay dividends rather than paying down debt. I think they are propping up the share price with your money!

I mentioned all the negatives in the article. Then I gave an overall opinion - which you are of course free to agree or disagree with.

There's no sign of debt being a problem at LAKE. The company has only used half its banking facility, and is still profitable, in the weaker seasonal half year of trading.

It's a judgement call, but overall I feel that the market doom & gloom towards this company has now been considerably overdone. In this particular case, I don't see a 1p divi as being a problem.

As I say, feel free to hold a different view, that's what makes a market!

I don't think my long position has clouded my judgement at all. Maybe it has, but I try very hard to not let that be the case. If you re-read the article, you will see that I'm actually very critical of the company, pointing out all the negatives, as well as the potential positives.

It's then just up to readers to form their own opinion.

Paul.

rhomboid1

Sorry Paul, gave you a thumb down not an up, fat fingers!

On Lakehouse I'm agnostic but if mgt were as bad at due diligence and acquisitions as they were at running the core business there could be all sorts of surprise items, having said that sentiment is so bad that survival should reap rewards.

One point is that the bank probably has enough warning flags here to cancel the facility any time. They haven't chosen to yet but if the 'new' mgt fail to hit cash flow/profit forecasts from here on in they'll get a justified kicking and withdrawn undrawn headroom.

Good luck

Modform

Paul, the problem with LAKE is the lack of corporate governance. So far the company has given 3 trading statements, followed twice by profit warning. It looks like to me at least that the company deliberately mislead the investors, to allow people in the know to sell on a high, and you see that by the continuous selling pressure after every trading statement and the drop in the share price.

This stock has moved from BARGPOLE AND REACCESS AFTER RESULTS, TO BARGPOLE AND AVOID in my spreadsheet.
Bottom fishing is not a part my investment strategy, particularly when a company has no corporate governance, but good luck to you and a lot pi who hold this from around 90p.

TheWatchmaker

Hi Paul,
Thanks for the LAKE write up. Hellish long RNS that I had about 20 minutes to make sense of before dashing off to work this morning. Most of which was spent searching for an indication of just what the boards revised expectations actually are - a search that proved to be in vain. I came to an adjusted EPS estimate/guess of 5.5 to 9 p for FY16 - bracketing your 7-8p. Have to admit I was rather surprised by the extent of the market sell off this morning as I was already expecting a downgrade and calculating on 8p rather than the broker 9.9p.
I'm hoping that the changes to the board will stabilise business and turn things around. The boards short track record of RNS communications has been woeful before today with numerous statements that appear designed to mislead investors as to the real status of business. Todays RNS gives hope for more openness in future - BUT they really should have elaborated on their guidance for FY16.
Geoff

Lion Tamer

Hi Paul

I've just listened to the Zytronic (LON:ZYT) audio on your site (many thanks!) I have one question on which you might be able to enlighten me. At about 18:15 when discussing the cash pile and replying to your question about a special distribution, Mark Cambridge says "we haven’t got that level of distributable reserves".

Well I can see the cash pile in the balance sheet (as "cash and short term deposits"), and in the cash flow statement. If the cash pile is not available, does that mean its been used for other undisclosed purposes such as to fund holidays (maybe Mark also likes the the Yas Viceroy:-)) or otherwise spirited away? I'm sure this is not the case! But it felt a little odd to say such a thing and not to elaborate for clarity.

Many thanks for your trusted, balanced and enthusiastic coverage of small value stocks, which are always very educational and frequently entertaining. I also value your interview recordings on your web site, a great resource.

(Disclosure: Long on both ZYT & LAKE, but only a conviction level in ZYT)

LT

Hi LT

http://www.icaew.com/technical/audit%20and%20assurance/~/media/6837da24c587470aa33732c58c1f6d14.ashx

Hope that clarifies

Santawani

Thank you so much Paul for the excellent interview with Mark Cambridge of Zytronic. I enjoyed your previous interview with him back in December and then, as now, really appreciate his ability to give the bigger picture, whether it is the balance between markets – there is always somewhere that is underperforming (at present China) but many other geographical areas are performing very well; whilst some of their industrial customers are struggling because of exposure to oil and gas but the gaming customers are providing good business.
I feel this company really benefits from strong management and the ability to know their markets and products, not to mention having a handle on the currency ramifications.
I was interested at Mark’s disappointment that the share price came off as I get the feeling that he thinks the falling revenue versus higher margins is a win win situation subject to all the usual disclaimers.
I note that in the hiatus of 2012/13 they were still able to keep paying the dividend – and also 2007 when there was a fall off in profit. Being products with short lead in times, I agree with you that this is a long-term-hold share and indeed I do!
Santa

Hi rhomboid1

Many thanks, a very fast and comprehensive answer. I am enlightened!

LT

AlanJenkins2

18th May '16

I beg your pardon ,Johns54 and John Eustace- I stand corrected ! If a company pays a 'special dividend' and refers to it only as such,it is effectively converting income into capital.That dividend is then treated as income by HMRC - which generally is a tax disaster ! However,sensible,helpful companies which are considerate of the welfare of their shareholders often give a capital repayment intead,,which is treated as a return of captal and not taxed as income.

aflash

Remind me not to read the comments! They do not move markets.

It is not the amount of money that Paul has invested in LAKE that is material, it is the amount of money that Slater and Rawlings have invested. The first has a reputation to live up to and the second is the founder. The company has made mistakes and Slater and Rawlings have intervened. Corporate governance has been adressed, if not necessarily fixed.

It is what comes next that is important, although the past gives some indication. Profits, if any, will soothe any further complaints about management. The problem is low margin contracts.

Those of you who criticise Paul's objectivity have themselves made a subjective judgement. So have I.

Ramridge

Re. Lakehouse (LON:LAKE) Does anyone know what the latest broker forecasts are?

PJ0077

Peel Hunt appear to be the sole broker who make guesstimates on LAKE.

Their new eps forecasts are: (forecast pre-yesterday) [forecast four months ago]

Dec 2016 7.9p (9.9p) [12.4p]
Dec 2017 8.7p (10.9p) [14.5p]

So these numbers have been reduced by c40% in the last four months.

The analyst Andrew Nussey retains a 'BUY' recommendation on LAKE.

He is also a buyer of Ashtead, Mears, Interserve, Lavendon, Costain, Kier, Northgate & VP.

Thanks PJ.
So the revised EPS for FY2016 is 7.9p. Yesterday's HY1 shows adj EPS of 2.4p. That means they have to earn at least 5.5p EPS in HY2.
Given recent history, competent management will set a target which is 99% certain of achieving.
I just hope they haven't set themselves up to fail again.

Declaration: no interest whatsoever and no intention to either.

simoan

FREng,

it wasn't so much schadenfreude I was referring to as confirmation bias that you made the right decision in selling.

I will freely admit I am rubbish at trading and so have no interest in trying to catch bounces, particularly in poor quality companies that I would not otherwise hold longer term. I have no skill at trading such situations but realise some people like Paul do. I would suspect that despite the occasional disaster Paul has done very well out of these situations over the years.

Personally, I can't see the attraction but I understand why flies are attracted to dog dirt! In their FY 2015 figures Lakehouse (LON:LAKE) made a pre-tax margin < 1%. That is all I need to know. It is a very low quality business.

All the best, Si

Hi PJ0077,
Thanks for sharing these updated forecasts.
It seems odd that Peel Hunt now have a target of 50p based on an EPS of 7.9p. All their previous targets appear to be on a 10x multiple. Would this indicate that they are really forecasting on 5p for this year?
I think it is very hard to forecast the future earnings for Lakehouse with any confidence.
Time will tell.
Cheers
Geoff

stocks321

19th May '16

Hi Paul,
I think you made a mistake: "Net cash has risen again to £99.5m". Zytronic's market cap is only £58.87m.
I believe net cash is £9.5M.

Small Cap Value Report (17 May 2016) - LAKE, ZYT - new version (old one corrupted)

Lakehouse (LON:LAKE)

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Paul Scott

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