Small Cap Value Report (25 Aug 2016) - STV, PVCS

Good morning!

Our internet has gone down this morning unfortunately. However, I have found an ingenious solution - by positioning myself at the perimeter of our plot, I can pick up the WiFi of a nearby small hotel. They gave me the password when we were there having a couple of ice cold glasses of Mythos the other day.

As an aside, I am reliably informed by one family member that there are no Pokemon on Paxos. Although she did find some in Corfu old town.

STV Group (LON:STV)

Share price: 376p (up 2.5% today)
No. shares: 39.5m
Market cap: £148.5m

Interim results, 6m to 30 Jun 2016 - the financial highlights look good - a few snippets;

Revenue up 5% to £56.2m for the 6 months

Pre-exceptionals operating profit up 28% to £11.0m - so a very good operating profit margin of 19.6%

Net debt significantly down 17%, to £29.1m. At 1x EBITDA, this looks reasonable.

Digital revenues are mentioned a lot in the narrative, but at £3.5m this is only a small part of the business.

The company claims to have a strong balance sheet - which is an amber flag for me, because very often companies which claim to have a strong balance sheet, don't! That reminds me of Mrs Thatcher's quip that,

Power is like being a lady - if you have to tell people you are, you aren't.

I think the same is true of strong balance sheets. The figures do the talking. In this case, STV has negative NAV of -£26.7m, clearly not a strong balance sheet. Although its working capital position looks fine, with a current ratio of 3.1, which is excellent actually.

The problem is a huge jump in the pension deficit, from £7.8m last year, to £53.9m this year - which seems to have mainly been driven by mortality assumptions being extended by several years. A swing that large indicates a pension fund problem that seems onerous. Note that the 2016 deficit recovery payment was £7.8m, which takes quite a large bite out of profits.

Actuarial deficits can be considerably more than the accounting deficit. With interest rates reaching new lows recently, pension deficits are only likely to get worse. So who knows what the overpayments needed in future might be?

My opinion - overall, I think the pension deficit is enough to scare me off.

Also I've never properly researched this sector, so am not au fait with the business models, and in particular how the arrangements for revenue sharing with ITV works.

The forward divi yield of c.3.6% is reasonable, although I suspect payments into the pension fund could curtail growth in future divis.

My other worry with this sector is how the internet will disrupt it? Will conventional TV companies still exist in a few years' time? Who knows?

PV Crystalox Solar (LON:PVCS)

Share price: 13.5p (up 12.5% today)
No. shares: 160.3m
Market cap: £21.6m

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

Interim results, 6m to 30 Jun 2016 - this is an interesting special situation, which a friend flagged up to me about a year ago. The company manufactures solar panels for inclusion in various products.

The whole sector has been in turmoil for a while now, due to Chinese manufacturers dumping (i.e. selling at below cost price). That has undermined European producers, and companies like PVCS are faced with the very real prospect of simply having to shut down.

H1 of 2016 was a period of respite, as prices recovered, with PVCS reporting a profit. However the narrative makes it clear that plummeting prices since have returned conditions to crisis.

Therefore, I would value PVCS's ongoing business as worth nothing - possible even a liability, depending on closure costs.

Why the shares look interesting though, is as an asset situation - net cash of E24.8m (or £21.2m) is almost the entire market cap. Cash has risen considerably, due to de-stocking.

The wild card however is a claim against a customer which has failed to purchase contractually agreed quantities of product. The contract was agreed between PVCS & a major customer when solar panels were considerably more expensive than they are now. So, understandably, the client doesn't want to buy product at what is now an unfavourable price. However, from PVCS's point of view, the customer is contractually obliged to buy at the agreed price & quantities.

Today's update says;

Despite extensive negotiations it has not been possible to reach a mutually acceptable agreement and a request for arbitration was filed in March 2015 with the International Court of Arbitration of the International Chamber of Commerce.

The evidentiary hearing of the arbitral tribunal had been scheduled to take place in Frankfurt in July 2016 but following a request by our customer the tribunal agreed to postpone the hearing until November 2016.

The judgment of the arbitral tribunal is now expected in early 2017 and while the outcome is uncertain, the value of any award if our claim is upheld could be a multiple of the Group's market capitalisation.

I've bolded & underlined the last sentence, as it's so key.

My opinion - it sounds to me as if the customer is playing for time, so this arbitration could drag on & on. Therefore I think this is only a special situation for investors who are prepared to be patient.

It looks to me like a very interesting risk:reward situation - where the net cash underpins the market cap, but the potential arbitration award is a massive kicker, in for free. I imagine that the customer is likely to have to pay up - the principle of contract law, is that once you sign a deal, then it's binding. You can't renege on a contract just because market conditions have changed, and it's no longer favourable for you.

I'd like to know who the disputed customer is, and what their financial position is like - can they afford to pay, if PVCS wins the arbitration claim? I seem to recall it's a major company, but if any readers happen to know the identity of the problem customer, then please let me know in the comments section below.

Therefore, one imagines there could be a good prospect of PVCS benefiting from a nice windfall, which would in all likelihood be paid to shareholders.

I've tried to add to my existing long position this morning, but it's proving very difficult to trade. I only managed to get any shares by pushing up the price unfortunately.

That's all I have time for today. See you tomorrow - a key one will be Lavendon (LON:LVD), which is one of my larger holdings, and seems very good value to me.

Regards, Paul.

(usual disclaimers apply)