Small Cap Value Report (18 Aug 2015) - CGS, HAT, APC, MNZS

18th Aug '15 by Paul Scott

26 comments 24221 reads

Good morning!

Trading volumes are extremely light again this morning - about a third of the companies I monitor haven't had any trades at all yet this morning (at 9:10 am). Thin markets mean more pricing anomalies occur, so I like this time of year!

I've had some excellent results recently, from reacting quickly to positive trading updates (e.g. accesso Technology (LON:ACSO) and MySale (LON:MYSL) ), as there is often a delayed response at this time of year, because so many people are away on holiday. Or, the share price may not move much initially, because the buying might be offset by a stale bull selling. All of which can create an opportunity to load up at a favourable price immediately after good news.

On that point, the key thing is to separate genuinely good news from spurious RNSs. Jam tomorrow companies are notorious for this - they put out repeated good news announcements, designed to push up the share price primarily (in advance of the next Placing), so investors develop an impression that everything is going brilliantly. Then the results come out, and they're diabolical!

So when I read RNSs, I always try to think how the news might affect the company's profitability. Above all else, the key phrase to look for, is "exceed market expectations", or similar. If that phrase is missing, then the news being announced is probably not material to trading, and should largely be ignored. Maybe a contract win has just replaced another contract lost? Isn't it funny the way companies only tend to announce the contract wins, but usually keep quiet about losing customers?! (unless it's a catastrophic loss, in which case they have to announce it).

Equally, the little graph on Stockopedia which shows changes to broker consensus EPS forecast over the last 12 months is invaluable. Most companies work quite closely with brokers, and will give them a lot more information than PIs have. So if you see earnings forecasts being guided down gradually, then it could mean something is going wrong, and is often a precursor to a profit warning.

An AIM CEO once told us at a presentation, that with small caps, the house broker forecasts are effectively the company's forecasts. Usually, the FD will have been through the numbers in detail with the analyst, and will have guided the…

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janebolacha

18th Aug '15

I once did a study on how poor people in towns in County Durham managed their finances and regular access to pawnbrokers was always seen as very fair and beneficial, rather than as an abuse. At that time, facilities such as what were called "clothing clubs" were often used on a rolling basis, that was something like the Provident Financial business which gave cheap loans to people in the form of a ticket that could only be exchanged for tokens and then spent at one particular store. There was then an informal trade in these tokens which could be sold at a steep discount for "real money". There were also "Christmas clubs" where people would put money aside for the end of the year, rather like the Park Group business. Was all of this unethical? No, it was simply recognising the reality of poor people surviving in life. The considerations are very different when one is poor. As Graham N says, much better this kind of known, understood and controllable facility than what is offered by exorbitant payday loan sharks. Imo, pawnbrokers and the like are to be encouraged.

Paul Scott

Hi Graham,

Thanks, interesting points, have a thumbs up!

I'm not saying that pawnbrokers should be closed down, and I accept your points, especially that they can help people avoid being evicted, etc, in extreme situations. It's more that I would not feel comfortable making a profit from that misery by investing in shares in a pawnbroker.

My experience of friends & acquaintances living in poverty (I have a surprisingly broad circle of friends, from multi-millionaires to people living on benefits) is that the mindset of many people on low incomes today, is to live from hand to mouth, day by day. So they will borrow from wherever they can, often maxing overdrafts (the banks DO lend to the poor, arguably far too much), borrow from friends/neighbours/relatives, absolutely anyone who will lend to them. Then each week is a constant juggling process of robbing Peter to pay Paul. Pawnbrokers can come into that mix once other sources have been exhausted. Their circle of friends will be almost all people who live the same way, so that normalises this dysfunctional behaviour.

I'm sorry to say it, but people who live like that are simply dysfunctional, and unable to manage their own affairs, often due to poor education. Very often income is frittered away on cigs/booze/drugs, which are prioritised over paying essentials like rent. So they lurch from one crisis to another, never learning from it. Not everyone on a low income is like this of course, but a helluva lot are.

(and I'm talking from my personal experience of what I've actually seen, and talked to people about, not from watching TV programmes - although TV confirms what I've already seen happening).

It doesn't seem to occur to people that breaking out of the cycle of borrowing, and becoming a (modest) saver for a rainy day, is the solution. Or rather, they know this, but don't have the self-discipline to actually do it. There's always a large flat screen TV at home though, and plenty of toys for the kids strewn all over the place, and general junk that's been bought in pound shops, etc.
So low income isn't the core problem, it's more that income is spent unwisely, and there is almost zero planning for the future done in probably a million or two households in this country - each day is just a challenge to face, and tomorrow will look after itself, seems to be the mentality amongst many of the poor these days.

All of this provides fertile ground for high cost lenders, such as pawnbrokers. It's such a pity. We somehow need to educate people, drum it into them (at school perhaps) about the importance of financial management. Most kids seem to leave school totally unaware of even the basics of how to run a household, so they just emulate what they think is normal from their own upbringing. Often parents don't seem to bother doing much parenting either, in terms of teaching kids how to sensibly manage their lives as an adult.

So massive cultural, and educational changes are needed to fix these problems.
In the meantime, H&T will probably have a nice, profitable business, for years to come.

Regards, Paul.

P.S. Before anyone jumps down my throat with a "Do you actually know how hard it is to live on Benefits?!" type of comment, the answer is yes. I've had 2 or 3 episodes in my life where I've been totally skint, and had to rely on Benefits whilst I sorted out a new job, home, etc, and it's very tough. However, it's do-able, and I managed on £19 a week Income Support for a few months in 1993, because I had to. And guess what the first thing I bought each fortnight was? A packet of cigs. So I do know from first hand experience how these things work.

Hi Delpher,

Re Seeing Machines (LON:SEE) - yes I saw the announcement today, which is interesting, but it doesn't give any financial information, or even an indication as to how it might affect the company's finances. For that reason, it's not something I would include in today's report.

I've been a shareholder in SEE for a couple of years now, and I think the company's products are proven, and have great potential, particularly if they crack the road transport markets, starting with coaches, trucks & high end cars.
Then the icing on the cake could be aviation, and consumer electronics. As you say, lots of potential, and a proven product.

The downside is mainly that the company has been quite cash hungry, and I was hoping for more tangible progress by now, so it's taking longer than I anticipated. There again, new products nearly always do.

Regards, Paul.

MGerard

Many thanks Paul

Lord of the Files

Company's been around since 1876, listed on AIM 2006.
Solid list of major investors.
(https://www.handt.co.uk/about-us/investor-relations/major-shareholders/)

Might well take up a few of these, not least for the IHT benefit.
Thanks to whoever asked you to take a look!

iwright7

Paul,

I do agree with you about careful scrutiny of the outlook statement and excitement when, "exceed market expectations" occurs. This phase almost always generates upward price momentum so that you could create a system where a new "exceed expectations" is the buy trigger. I believe there is academic acceptance that profit warnings are very rapidly factored into the SP, but that upgrades are much more slowly accepted, especially when the SP is near its 52 week high. accesso Technology (LON:ACSO) is a case in point. A case for buy high, sell higher. Ian

Graham Neary

Thanks for the reply, Paul.

Another way of looking at these things is that those of us who fund pawnbrokers are increasing capacity in the sector, thereby lowering the prices (interest rates) faced by those who use it. We're the real bleeding hearts, not those who refuse to invest ;-)

Camtab

I appreciated your thoughts on ROCE. I recall Lord Weinstock when in charge at GEC made a similar comment not long before he was forced out and GEC broken up (by the City Moguls). That worked out well didn't it!!

FREng

Paul

You last wrote about Digital Globe Services (LON:DGS) in the SCVR of 20 March, when you said that the problems that had led to the share price halving looked as though they might be temporary.

The share price has picked up recently, rising 10% in each of the last 2 days. There has been no news that I have seen.

I just thought you might like to know about the price jump! (and that, maybe, some other reader might have an idea about why the price is rising).

bobo

I know the people at Castings pretty well and they are very sensible specialists. I very much doubt they will buy anything though they could expand on their present site and they have the interest in their technology to keep developing. Just going to be dull and developing. If someone told me this was a company in Germany I would believe them. Watch that liquidity though.

ROCE is a key tool, it shows if the management can use their money correctly overtime. As someone else even more famous said, but I paraphrase, it means the company can be run by a numpty and still keep getting better

Ramridge

Hi Paul -
Re. ROCE. ROCE unfortunately doesn't tell you anything about the strength of the balance sheet. You need to look at other metrics for that. Take the case of Auto Trader (LON:AUTO) for FY2015:
- a very healthy ROCE of 28%
- however Total Assets < Total Liabilities
- huge Net Debt of £519m
- negative equity of £176m

So it's possible to have in the same sector, 2 companies with similar ROCE, one cash rich and the other saddled with huge net debt with negative equity.

Regards, Ram

Example:

Non-Current Assets £10m
Net Working Capital £12m of which operationally surplus cash is £4m
Net Income £2m

Capital Employed: Non-Current Assets £10m + Working Capital Requirement £8m = £18m
ROCE £2m / £18m = 11.1%

This is only one possible method of calculating ROCE but as Ramridge suggests, it is independent of the company's balance sheet strength vis-à-vis long-term liabilities.

Return on Equity does change (it increases) as a company takes on more leverage.

Return on Assets increases if a company returns excess, low-yielding cash to shareholders, or borrows to invest in assets with a greater return than the average return on its existing asset base.

Return on Invested Capital uses the sum of debt and equity finance in the denominator, and is therefore agnostic between different forms of funding and won't change in response to changes in leverage. It is similar to ROCE but it focuses on the company's funding rather than on its use of funding.

This post should thoroughly refute anybody who thinks that finance isn't exciting.

cig

19th Aug '15

Would have these people been worse off, on a consolidated lifetime basis, without access to these facilities? Did your study compare the lifetime consumption level of user and non-user households within the same income group? It's one thing to understand and have sympathy for what lead people to use this, and another thing to find out whether it's good for them.

Hi Ram & Graham,

Useful points, many thanks.

I need to be more precise in my comments, as I've tended to slip into commenting on ROCE & ROE interchangably, where as you both rightly point out, they're very different concepts wrt debt. Although my point that lots of freeholds will pull down ROCE, but make a share much more attractive & safer to hold (in my eyes anyway) still stands.

I'll sharpen up my use of these terms in future, so thanks for the refresher course!

Regards, Paul.

Whether more or less people get evicted/starving because of distressed lenders targeting the poor is a controversial question: to know the answer we need to subtract the bad cases (all these interest payments that did not buy food or pay rent, plus the additional distress debt spirals can cause, e.g. suicide, depression, domestic violence, etc) from the good ones. Is the net effect positive?

That was not the purpose of the study which included other elements, actually including doorstep lenders, the Wongas of their day, tolerated but operating illegally then but with almost certainly less implied licence to abuse than today's payday loans providers seem to ( legally ) have. We're now rather off-topic but if there is a social question (which you would perhaps term "a moral question") to be answered, it's perhaps not the one you seem to be leading on to, of whether "it's good for them" to have "access to these facilities" but whether the situation of poor people ought not to be seen as simply one more economic circumstance from which profit is to be extracted mercilessly with little effective legal or social regulation. That does seem to be the situation in UK today with regard to job insecurity, housing insecurity, the cost of higher education, etc, etc and I'd suggest that tackling the causes of poverty would be a more productive approach rather than talking about whether the solutions poor people devise to survive in life are "good for them". This is a debate the Victorians would have recognised and, in one of the World's richest countries, that is perhaps in itself a terrible failure, whatever your political persuasion may be.

I actually agree with your end point. I'm just not convinced that the benefit your study saw do exist in net terms, even within your own definition of good. Sometimes people devise solutions to their own problems that make the problems worse, and part of the solution involves trying to help them away from such self-harm (though not necessarily through an outright ban, as that can be counterproductive). By and large, I see distressed consumer finance as facilitating self-harm.

underscored

Thanks providing clarity Jane. For what it's worth, I am not sure you are off topic, the ethical aspects of investing are on many peoples minds.

timaru69

I think Paul hit the nail on the head. Schools don't teach (or didn't in my day) kids how to save, invest etc etc. In my mind this should be a core subject at school.

jonesj

It's not just the uneducated poor that borrow irresponsibly.
Just look at our previous Prime Minister. Then when he gets kicked out, he actually tries to get a job at the IMF. Now that would be putting the fox in charge of the hen house.

Small Cap Value Report (18 Aug 2015) - CGS, HAT, APC, MNZS

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Paul Scott

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