Small Cap Value Report (24 Sep 2014) - JDG, RGS, SSY, MMX

24th Sep '14 by Paul Scott

32 comments 27127 reads

Good morning!

Judges Scientific (LON:JDG)

Share price: 1297p
No. shares: 6.0m
Market Cap: £77.8m

These shares had been recovering from the shock profit warning in Jul 2014, but today they have lurched down again by 240p (15%) to 1297p this morning - roughly the previous low in July. So results must have disappointed, let's take a look.

Interim results - for the six months to 30 Jun 2014 are out today. The group's strategy is to grow through repeated acquisitions, buying private companies cheaply. This is kept rolling by having highly rated shares, thus the acquisitions are earnings enhancing, and only a relatively small number of shares need to be issued from time to time because the cashflow from the acquired companies, combined with a modest amount of bank debt, has funded most of the acquisitions. It's a clever business model, and has been executed brilliantly by CEO, David Cicurel.

The rating got far too high in the 2013/early 2014 bull market, and these shares have now almost halved since the peak.

The interim figures look OK to me, so I'm a little perplexed as to why the share price has dropped so sharply today. Adjusted EPS came in at 50.3p for the half year, up 22%. Although the growth seems to have all come from an acquisition, with no organic growth.

Outlook - the order book seems to be the reason investors are concerned;

Organic order intake during the six-month period decreased 4.8% compared to the first half of 2013; total order intake (including Scientifica) was 11% below the level required to meet the Group's sales budget without consuming its order book. The second quarter showed a moderate but insufficient improvement compared to the first. The order book at 30 June 2014 represented 7.8 weeks of sales, compared to 10.6 weeks at 30 June 2013.
Trading at the start of the second half has continued to be difficult. Weekly order intake in the third quarter has broadly mirrored the activity seen in the first half.

Broker forecasts - WH Ireland has trimmed its full year EPS forecast from 86.4p to 80.3p, but given that the group achieved 50.3p in H1, that seems a fairly pessimistic view for H2 (of only about 30p EPS). I suppose if you assume that is the new level of earnings, at about 30p EPS per half year, then that suggests a drop to only…

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MrContrarian

24th Sep '14

Tesco - better to wait for all the dirty washing to come out. Sainsburys looks the best segment - aspirational but not double expensive like Waitrose.
As Morrisons, Aldi & Tesco chase Aldi customers and also cut costs the stores will feel cheaper and people will wonder why they are going to ersatz Aldis but still paying more.

Cisk

I worked at the head office of a supplier to the major supermarkets some years ago. Tesco were renowned for being the worst of the lot to deal with, treated their suppliers like absolute dirt with the thinnest of margins - clearly not a sustainable relationship in the long run. And you had to get Tesco on the roster to get business in the others.

Finally the accounting irregularities are coming to light - taking longer and longer to pay suppliers whilst recognising 'incentive' payments up front. Personally I think this is the tip of the iceberg and there's more to be uncovered.

As for margins, UK supermarkets plc have been fleecing consumers for years and operating as an effective cartel - US retailers have a much lower margin, so I would expect margins here to move in that direction.

Retailing goes in cycles - out of town used to be better and convenience stores weren't trendy, Morrisons used to be lauded for being focused with no internet sales, no home delivery, no convenience stores - now it's the other way round.

I wouldn't buy shares in Tesco just because they are 'perceived' to be cheap - I think there are more fundamental issues here and wouldn't be surprised to see Tesco broken up and be a completely different company in 5 years time.

ExpectingValue

Cisk - why do you think UK supermarkets are fleecing consumers? Walmart, for instance - a company I would have thought was on the thinner margin end of the spectrum - earns 8% operating margins in the US.

Sainsbury's have sit just below 4% for a long time, Tesco were lauded for hitting 6, and MRW hover somewhere around 5. I can actually think of few industries where competition has been more effective at driving down prices for the consumer.

In fact, that they're all struggling to earn decent returns on their capital would suggest to me that consumers are doing rather well out of them..!

kbkb

In my view, the warning signs for Tesco were when they abandoned expanding abroad, as they have reached saturation point in the UK.
People are doing what Paul and others have said, in using Aldi/Lidl, and to some extent Waitrose and localised retailers again, which is also why there seems to be a general disillusionment with shopping at an aircraft hanger, not just the price, the experience.
A fellow poster mentioned that Tesco have a Bank, Insurance, Mobiles, and so on, yet I think tis has been a poor strategy, as people don't want to have everything under one roof, and it may be that the senior management at Tesco were so busy trying to get their fingers into every pie going, that they made the classic mistake that businesses make when in a 'death' spiral, which is to forget, and consequently neglect, their core business, and their core customers.
I have to say, we stopped buying anything fresh from Tesco many, many years ago, as the quality, in our experience, was not up to scratch.
The entire Tesco brand and shopping experience is far too complicated, with too many pointless and meaningless offers, and they need to up their game in order to stop the market share from falling further.
Based on a visit to one of their stores today, this seems a long way off.
The £250M "error" is astonishing, and who knows what else lurks in the murky depths.
A reputation can be destroyed quickly, and maybe Tesco has literally got too big for it's own good

EV, the mere fact that new incumbents can enter the market and charge less, to me indicates that we're being fleeced, wouldn't you agree?

Groceries generally in this country are very expensive (notwithstanding the fact that we have less home grown produce).

Also I suspect that the cartel aren't particularly focused on minimising managerial overheads, and of course, historically have spent a lot opening large out-of-town superstores and accumulating land banks.

Redrumtum

My household has totally ditched Tesco et al and we comfortably do all our shopping at Aldi and a brilliant local organic grocery store. Totally agree with your comment Paul about resenting Tesco's over-pricing, and the limited choice at Aldi is a blessing; I get my shopping done in half the time without the stress of too much choice.

I have been watching the share price decline with interest, but this thread is an timely reminder that there's probably plenty more pain to come.

Cisk,

Two things re: the new entrants. Firstly, they run a slightly different operating model - something closer to the pound stores, by way of example. They get cheap stock by the crate and essentially put it out like that. Ranges aren't particularly fixed, but are dependent on cheap availability. This reduces operating costs, at the expense of meaning that at your typical Aldi or Lidl, you probably can't go in and get X Y or Z brand consistently along with another particularly item.

I say this not to say it's better or worse - it's just different.

Secondly, they're both private companies with no public shareholders (hence less disclosure) and clearly longer time-frames. A quote from an article from someone who probably knows a lot more than I do:

"Aldi’s private status has been key to it establishing a presence in numerous markets, regardless of the number of loss-making years this might entail. In Denmark, appropriately enough, it reportedly took 10 years for Aldi to make a profit."

Source: http://www.retail-week.com/comment/comment-aldi-and-lidls-discounting-is-no-new-phenomenon/5062220.article

The accusation of them being slow to move with the times, stodgy and rather self-serving isn't one I can disagree with. I remember studying a module in economics that was more or less about the fact that most competitive markets - where everyone is screwing everyone else in a desperate attempt to get their head above the parapet - are the least innovative, since no-one really has much slack to think on a long-scale timeframe. Maybe that hurt them.

EV, yes they definitely have differing business models.

I think one area where most can improve is customer service - e.g.:
- we have to scan our own items (in many, certainly smaller format stores)
- bags are charged extra e.g. M&S - if they are so worried about the environmental aspect, then free paper bags maybe?
- little or no help packing shopping
- constantly changing the location of items
- products being out of stock (in these days of computerisation and modelling, this should be predictable) etc.

I think when any of the big supermarkets puts themselves in their customers's shoes then the shopping experience would improve - not sure whether profits would though...

And when they end silly practices like at WHSmith in airports - who wants your boarding pass even when the item you are buying is not VAT-free and then charge you for a bag, shopping will be more pleasurable!

I think enough ranting on my behalf ;-)

Cisk,

God knows I've been Tesco's cheerleader for long enough - I'm hardly an impartial and fair observer like I'd hope to be as an investor!

One thing I definitely can say with my consumer hat firmly on - leaving my investor one behind - is that competition can only be a good thing. It's been a 4 player game for a long time, and not much has happened. A kick up the backside does make the sector better for consumers as a whole, whether it's by way of innovation or because the incumbents actually realise they have to start not taking your custom for granted.

sbotting

Hi Paul,

Dragging the conversation back to Regenersis I listened to the presentation on the Preliminary results, it seems that they have not renewed some contracts in the UK that were proving to have very low margin in the UK in their depot business and as a result closed two factories, I assume this and the "currency headwinds" (such a great euphemism) resulted in a substantial reduction in turnover for the Western European Depot business.

Going forward they seemed keen to highlight their effort in maintaining // improving margins in the depot business and putting focus on the Advanced Solutions (Digital Care, In-Field Testing and newly acquired Blancco) which they think will go from being ~ 16% margin to over 20% margin.

It seems curious that the share price has been hit so hard. but their were a couple of large sells yesterday

Incidentally Matthew Peacock was Non-Exec Chairman of Fairpoint (£FRP) from 2008 - 2013 (according to his Linkedin page)

jonesj

Applying a few Peter Lynch principles, it was clear to me that Tesco were going to struggle at least 3 years ago.
I was going shopping and could only buy about 80% of what I needed, as they just weren't getting the stock onto the shelves. Just Like Sainsbury's 10 years earlier when they got into trouble.
Tesco also have slow demotivated staff who pass your groceries over the scanner at a snails pace. Lidl staff must work at double the pace, whilst Sainsburys and Asda staff are more motivated as well.

On the positive side, there must be cost reduction opportunities from expanding self scanning and scan as you shop.

MichaelFBS

Tesco: BlackRock Sold 408.6 Million Shares. So they watch the shares fall 56% losing a billion pounds from the peak 5 years ago. Seems a bit slow off the mark? I would rather take my chances picking my own shares than leave it to people like this to make me money. Though I assume they do?

Getting back on track, Paul do you have any further thoughts on Regenersis (LON:RGS) after the Webinar? Market seemed to like it as the stock recovered most of their loss on the day.

Thanks.

johnrosier

Surely the problem in the UK is the cost of property. To make a decent return UK supermarkets have to charge more and screw their suppliers. You go to Spain and marvel at the cheapness of your weekly shop but the store probably cost £1m rather than £20m!
That's why I also do not trust the NAV's of the UK retailers. Who is going to pay the historical prices quoted if in the new era of austerity it will be impossible to make sufficient returns..
Too early for Tesco these things always take a lot longer to sort out and goodness knows what the new CEO and FD will find out. In early 1990's ASDA was not a buy until it had its rescue rights issue.
SBRY probably the best of the bunch given it's market position but even so I just think the sector is one to avoid. We don't know how TESCO will respond but it could be dramatic with repercussions for the whole sector. More pain to come I think.

shipoffrogs

The make up of Tesco's board is a joke.

Until yesterday - there was one executive and nine non-executives.

And no-one with any retail background.

Paul Scott

Hi sbotting,

I also listened to the webinar from Regenersis (LON:RGS) today, and was sufficiently reassured that I also bought some shares in it. It seems to me, on my fairly limited research, that the share price fall looks overdone, so I've bought more for a bounce, than as a long-term holding.

Regards, Paul.

Susan Marmor

1st Oct '14

'ello sweetpea. You haven't done your research on MMX! I've had my doubts here as well but actually it's all rather clever. The profit derived from auctions will last another year or so.That gives them breathing space for new domains to ramp up and give them what is in effect an annuity income.

No question at the current MCap it's expensive but you have to think forward on this one. So far they have sold 65k domain names but we don't know the price....£20 upwards, a lot are premium. If we take an average of £30 per each then they have already booked £2m of revenue. Profit margin as yet not known. They are selling domains at the rate of a few hundred a day....like I say, you have to look forwards. You are right that we google but we still need to buy a domain for people to google.

They value their intangibles at £16m, not a lot when you think about possibble revenue/profit already in the bag. I would say it is fairlly obvious they will sell themselves to a bigger player in due course. How much would you pay for an annuity income?

So Dahlink....we don't really know how this will turn out and you are right to worry but you must start doing just a tiny bit of research else people might think you are a lazy git. Not me, I would never think that.

Love you.

S

djpreston

Just a quick comment on the whole Tesco/Aldi/Lidl thing

Its interesting to see how Aldi and Lidl seem to have this glowing reputation at the moment. It would be interesting to see how that stands up when their treatment of staff gets exposed and examined more widely.

On the subject fo their stores, the format is changing markedly. Yes, I have been a Lidl shopper for years (my wife is half German). The stores are being revamped and "tarted up" with greater range being introduced they even have fresh baked goods. What Ive also noticed though is that their prices have been rising sharply. With Tesco aggressively targetting the basics (cucumbers etc) at Lidl/Aldi prices as well as their reduction in on line delivery prices and the Fuel Save scheme, many people I know are startign to pop into Tesco more (or use their on line service) often rather than do a separate trip to a second supermarket.

On the subject of land - I wonder how much scope their is to release some of the land around the bigger stores and build flats/affordable housing.

They also have the biggest estate of local stores (having started that trend).

Overall, I think Tesco is looking very interesting at the moment. The only problem for me is the possibility of further accounting related fun to emerge first.

Thank Sue!

I was wondering where you'd got to.

Was expecting a far more heated reply - this is terribly civilised by our standards lol!

I take your point about recurring income - but it's only recurring if people renew their domains. A few years ago I registered a lot of fancy domain names, e.g. pilot.info more as an impulse buy than anything. I was approached once to sell on the domain, for peanuts, and apart from that, there was no interest in the domain at all. So I just let it lapse - why pour more money down the drain, when you don't need to?

My main point is that Google will find, and rank highly in searches, and busy website with decent content. The domain name is completely irrelevant. You could register bt8+rf3.co.uk as a domain and Google will find you if you put decent content on it & build an audience.

Seriously, domain names just don't matter any more. So to try to build a business around them seems very behind the curve to me.

Regards, Paul.

Domain names matter in so much as we need to have one. We will put them on our biz cards, our biz van, marketing literature, advertising etc. They are not going away and they need some thought.

Yes, correct, it's not year one that counts but year two and three etc.

See you in 6 months when we will have the first clue as to how much they are making per registration.

S

p.s. The extraordinary thing about his biz is that there's no guessing involved. We know the numbers and soon we'll know the profit margin.

http://ntldstats.com/backend/Minds-Machines-Ltd

Small Cap Value Report (24 Sep 2014) - JDG, RGS, SSY, MMX

Judges Scientific (LON:JDG)

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Paul Scott

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