Small Cap Value Report (19 May 2014) - DRS, GCH, ZTF, TNG

19th May '14 by Paul Scott

13 comments 16768 reads

Good morning!

DRS Data and Research Services (LON:DRS)

Quite a nasty profit warning from this tiddler, which specialises in the area of electronic reading of exam papers, ballot papers, etc. In an IMS today it says;

Revenue for the first 4 months of 2014 is significantly down on the same period last year.

The trouble is that last year's H1 results were poor, with a £638 loss, as I reported here last August.

The outlook for the rest of this year sounds grim;

In addition it is now understood that a prospective large international census client will undertake their count manually. This means that there are currently no large scale census or election revenue opportunities in the current year.

So, as you would expect, they are now implementing cost cutting initiatives, and conclude that;

...the reduced level of revenue is likely to result in pre-tax profits being significantly below current market expectations.

It's at times like this that the Balance Sheet becomes the most important part of the accounts - i.e. if bad news happens to a company with a weak Balance Sheet, then it could go bust. However in this case I'm rather impressed with the last reported Bal Sheet. It shows a solid net cash position, and current assets were a very strong 278% of current liabilities. I'm prepared to disregard the long term liabilities of £1.8m, as that is mainly a mortgage on a freehold, so asset-backed.

The shares have been marked down 33% to 18.8p this morning, and that values the company at £5.7m, which looks potentially good value if they can turn it around. Trouble is, at this stage I don't know what the extent of trading losses (if they are now loss-making) in 2014 will be, nor whether they even have a viable business going forwards at all? More info is needed, but it's going on the more research list. I'd be particularly keen to see any updated broker notes on this company after today's warning.

Important warning on Chinese stocks

As regular readers here will know, I have been extremely bearish on ALL Chinese stocks Listed in the…

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kenobi

19th May '14

Hi Paul,
so would you think that shorting a basket of cherry picked chinese stocks would be a good strategy ??

K

Paul Scott

Hi K,

You read my mind, I've just been pondering that.
The trouble is, if you short a stock on a PER of 1-3, and it turns out to be genuine, then you'll be taken to the cleaners. So risk:reward isn't great on doing that short. You are likely to make a 50-100% gain on the short, but there's a chance you might make a negative 500-1000% return. Why take the risk?

For shorts, I prefer situations where the market cap is large (hence less chance of a massive spike up), and there are no doubts at all - i.e. it's just a ridiculous over-valuation, in a bubble, and when market sentiment breaks, then the price will collapse - so OCDO is a good recent example of that. Or Blur.

Shorting Chinese stocks, even if you could get a borrow, could be very risky. When there is low-hanging fruit available elsewhere (mainly recently floated story stocks on wacky valuations), I probably won't be risking any shorts on small Chinese AIM stocks.

Cheers, Paul.

Stegrego

I find myself actually agreeing with you with regards to Chinese stocks on AIM.
Having held a basket of them for several years when they were in fashion and managing to make a good profit, mainly due to West China Cement, I concur that they just cannot be trusted.

I think its the norm to lie in business in China and also to avoid paying bills where possible. Anthony Bolton appears to have reached the same conclusion recently.

Some interesting results out today which you may want to cast you eye over - Tangent Tangent Communications (LON:TNG) Gable Gable Holdings Inc (LON:GAH) and announcements from Mirada Mirada (LON:MIRA) & Somero Somero Enterprises Inc (LON:SOM)

Cheers

OsullivanB

Experience led me to the same conclusion about Chinese stocks a long time ago. The two that I have owned had two things in common: the story was constantly changing, and there was always an outflow to consultancy and other "soft" expenses, which reduced a decent profit to one which left little for the shareholders.

Mind you, de-listing to the advantage of the majority shareholder is not confined to Chinese stocks. To my fury (and loss) something very similar happened with WT Foods some years ago.

adam

re DRS. Have you removed your lower limit of m/cap for coverage?

ajrc00

I can accept that investing in Chinese companies from the UK has not been good for many (self included) but I am feeling uncomfortable about the sweeping statements, e.g. Anthony Bolton: "the Chinese are liars" referring to about one third of the planet. OK, they do business differently over there and Bolton couldn't adapt. Meanwhile we read almost daily in Paul's blog that statements from UK businesses are not always what they seem. Space and People come to mind, and what about the allegations in the papers that Glaxo SK were bribing health professionals in China to prescribe their drugs? Request: Please avoid national generalisations in print. Pumping up tribalism is not good for peace.

Hi Adam,

re DRS. Have you removed your lower limit of m/cap for coverage?

I'm flexible now on low market caps. The thing is, that I missed a lot of big multi-baggers last year by refusing to go below £ 10m mkt cap. So these days I will have a look at things below that level, but it depends how much news there is in my normal £10-200m mkt cap range. On a quietish day like today, then I might mention a tiddler, but on a busy day probably won't.

Also I tend to review the biggest % risers & fallers every day, so if there is a big mover, then it is more likely to be reported on here, esp profit warnings, or out-perform trading statements, which are useful to put down on record here so it's there in the archive.

Regards, Paul.

ajrc00,

Please avoid national generalisations in print. Pumping up tribalism is not good for peace.

This is a finance Blog, not a politics blog. So ways of doing business in particular countries are extremely important for investors to know about, and to act accordingly.

The fact is that you cannot rely on accounts from Chinese companies, and that misrepresenting the truth is so widespread that it is an obvious and huge risk for investing in that country. To suggest that such risks are quietly ignored for the sake of (short-term) harmony seems ridiculous to me.

The only way you get people into line when they are lying to you, is by saying something like, "I know you are lying, so please stop", plus, "I will check everything you do, and you will only get paid if you do exactly what you are supposed to do".

Then and only then can you have harmonious business relationships, as many companies do manage with the Chinese, Indians, etc.

As a pretty much unregulated market, with many gullible investors who don't do proper due diligence, AIM is a magnet for less than 100% honest companies, and as you correctly state that is certainly not confined to Chinese companies, in fact it's widespread. Although it's a lot easier to check things if it's a UK company.

Which is why my bargepole is deployed for virtually ALL overseas companies listed on AIM, not just Chinese ones. Today's article homed in on Chinese companies for the specific reason that 3 have already de-Listed this year, citing the same reasons. Therefore there is clearly a major risk that virtually all remaining Chinese AIM stocks will also de-List.

If I see a risk, that readers need to know about, I report my view on it, and readers can then make up their own mind.

valuemonster

http://www.zotefoams.com/downloads/library/478_Dove%20Packaging%20Mucell%20Technology.pdf

"Dove Body Wash bottles will contain at a minimum 15% less
plastic as a result of a newly developed packaging technology launched by Unilever today. Unilever
intends to widen the availability of this technology to be used more broadly across the industry"

Also, I would add that lying is totally widespread in the UK too! But it's a much more subtle form of lying, where a game is played so that people are never (or rarely) caught out blatantly lying. Instead our culture is for devious ways to warp the truth so that it still appears to be the truth, whilst actually is quite misleading.

Hence all the PR that goes on, which we have to unpick. That's our culture, but the figures in accounts are usually broadly accurate, and if you know where to look you can usually find the things that have been stretched (e.g. revenue recognition policies, inflated debtors, capitalised costs, etc).

Whereas in some other countries the business culture is far more extreme, so that falsifying figures, bribing officials, etc, are widespread. We have remarkably little bribery in the UK - it must go on, but we don't have to bribe any officials in day to day life to get anything done, the civil service is pretty straightforward here. What bribery & corruption there is, is pretty well hidden. That's not the case in many other countries.

Investors need to consider these factors, and discuss them. I don't think it is good to sweep these issues under the carpet, perhaps in an attempt to appear to be PC?

cig

Yes, you need to understand foreign practices when investing there, but you wouldn't want people to judge British business practices based exclusively on accounts of the behaviour of the Kray brothers. There's no valid reason for a normal Chinese company to list on AIM, and plenty of reasons not to, so of course those we get are mostly self-selecting crooks. Whatever bad (or good) practices and customs they have in the country at large, it surely differs considerably from the practices of that very peculiar lot.

Thanks for your 2 replies, Paul. I greatly value and enjoy your blog and your particular approach which has taught me a lot. Please continue to rip shreds off any company, Chinese or other, that is making misleading statements. The view I wanted to put forward is simply that the nationality of such companies usually adds little to the criticism and may, in time, foster stereotyping and social divisions. Take for example Asian Citrus Holdings (ACHL), a Chinese orange farmer, some of which I own. I bought because I was struck by the candid way they described their successes and failures, their stated lack of debt and the high divi yield. The shares have tanked following poor weather and poor harvests but nothing suspicious that I've noticed. Maybe I'm a sucker for a well-told story but this experience with a Chinese company seems strikingly different from your own. I'd be very interested if you have any views on them. Best regards, John

20th May '14

That sounds nice. Good luck with it.

P.

Small Cap Value Report (19 May 2014) - DRS, GCH, ZTF, TNG

DRS Data and Research Services (LON:DRS)

Important warning on Chinese stocks

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Paul Scott

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