Small Cap Value Report (25 Jan 2016) - TRAK, POS, HAL, RBN

Good morning!

Trakm8 Holdings (LON:TRAK)

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

Final call for questions (using this form only please) for my latest CEO interview, which I will be recording this afternoon, with the Executive Chairman of TrakM8. A very topical one this, as there was a (frankly rather half-baked, and backward-looking) bear raid on the share last week.

I believe that decent companies should have a right to reply to criticism, as demonstrated with my Brady (LON:BRY) interview, who wanted to respond to my sharply worded comments about them.

TRAK were asked if they would like to answer investor questions, through an interview with me, and they agreed. So I'm really looking forward to conducting what should be a fascinating interview later today.

(Incidentally, I refer sometimes to a company in the plural, because whilst strictly speaking it may be a separate legal entity, hence singular, in the real world a company is actually a group of people, speaking and acting as a group. Therefore the more natural reference, for me is to use the plural when referring to a company. Pedants, may I suggest taking some calming medication, or yoga, as I'm not going to change my writing style on this point!).

Remember that the format for my interviews is always the same - questions come overwhelmingly from investors, and I am happy to ask any question, regardless of how difficult - sourcing the questions from investors is great actually, as it means I can ask things that would otherwise be too impertinent! So it's a terrific format, that works well for everyone. I'll be focusing a lot more of my time on this in the future.

Just because I like the company, and hold shares in it, doesn't mean I'll hold back on asking them the tough questions that need to be asked. I'm a great believer in considering both the bull and the bear case for every share. Only then can you come to an intelligent overall view, which is more likely to be correct.

The way I see thing, the bears have come up with one or two relatively minor points, and blown them way out of proportion in a hysterical manner, clearly designed to induce investor panic. That worked for a couple of hours last week, but has already fizzled out. These questions are worth asking, but they demonstrate a complete lack of understanding about the bigger picture - the company's activities, and its rapidly growing recurring revenue base. I've not seen anything that even dents the bull case for the shares, which is based on out-performance against broker forecasts (twice upgraded in 2015).

Overall my current view is that the bears are wrong, but let's see how the company responds to investor questions today. I reserve the right to change my mind, if the answers given today are unsatisfactory.

Not a great start to the week - a profit warning:

Plexus Holdings (LON:POS)

Share price: 69p (down 43.8%)
No. shares: 89.4m
Market cap: £61.7m

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

Profit warning - broker forecasts for this year (ending 30 Jun 2016) has already been slashed from 9.1p EPS in Aug 2015, to only 1.3p in Nov 2015, to reflect the downturn in the oil & gas sector - Plexus supplies a high performance, patented wellhead sealing system.

I had hoped this would be sufficient to allow for the downturn in the sector, but unfortunately that has proven incorrect. As today's update spells out (in the usual long-winded way), trading has deteriorated far more than anticipated, with the key sentence saying;

...the Company's financial results for the year to 30 June 2016, which are subject to external audit, will be very significantly below market expectations. 

Oh dear. It's not a surprise that things are bad, but the extent of the downturn has caught the market on the hop, hence the shares being down nearly 44% today. The trouble is, there is not sufficient liquidity in the share to achieve price discovery, so anything could happen.

I would imagine that most shareholders will not be able to sell, even if they want to, and that's the big problem with small caps - this illiquidity can create an overhang in the shares that can last for a very long time, since people who want to sell, cannot sell.

Personally, my view is that the damage is probably done now, and as with a lot of oil related shares, it's a question of looking through the current low price of oil, and a return to profits once oil has returned to a level where exploration activity resumes. Plexus has been strongly profitable in the past, and clearly has excellent, patented technology. However, with the oil price this low, all bets are off for the time being.

Quantifying things, there's little doubt now that Plexus will be loss-making in the short-term. Revenue, guidance is given today;

The Board therefore anticipates that revenues for H1 FY16 will be below £7 million, and revenues for H2 FY16 are expected to be approximately 20 per cent below those for H1 FY16. 

So I make that roughly £12m revenue for the current year perhaps? That looks a disaster - current market forecast is for £23.9m revenue. With operational gearing, it seems to me that the company is heading for a substantial loss on the P&L this year.

Balance sheet - the first thing to check, when a company reports a severe downturn in profits, is whether it has the financial strength to survive. In this case, I think Plexus looks reasonably OK for the moment. It outlines the cash conservation steps being taken;

As a result of the disappointing financial performance, Plexus is currently taking significant cash conservation steps in terms of reduced capex, opex and personnel expenditure, which the Board believes will stabilise the Company during this difficult oil market cycle. 

The problem with cost-cutting is that it often comes with an up-front costs (redundancy payments, contract termination charges, etc). It also reduces a company's ability to benefit from improving market conditions when they arise.

The company does have some bank debt, gross debt of £6.3m at 30 Jun 2015, and with £3.3m of cash at the same date, net debt was £3.0m - not a big worry, providing the bank manager is in a co-operative mood.

The current ratio is 4.77 - very strong, being a surplus of £13.6m of current assets over current liabilities. As turnover has fallen considerably, a large part of debtors should turn into cash, so the company has a liquidity cushion there. Trading losses will however erode its balance sheet, over time.

Outlook - the company at least sees things starting to stabilise;

 ...it is anticipated that sales will stabilise going into the 2017 financial year prior to what the Directors and other commentators expect to be a strong recovery in relation to exploration drilling activity when the oil price recovers to sustainable levels.

My opinion - this is a very bad profit warning, with substantial losses now looking on the cards for 2015/16 FY. I'm really annoyed with myself over this one. It was obvious that the company was going to be struggling. Indeed, I was only wondering last week whether to play it safe and sell some (or all). Inertia meant nothing happened, and now there's a nasty loss staring at me on the screen.

I'm not going to average down here, as it's usually a mistake to start buying on the initial bounce after a profit warning, as the buyers causing the initial bounce are usually in denial, guilty of "anchoring" to the old share price, and often haven't done their sums properly in terms of being aware of the severity of the profit downturn. We've all done it! So I suspect another lurch down in share price could be on the cards here, who knows?

If any Institutions start selling in the market, then who knows where the price might end up? I'll give it a week or two, to see where the price settles, look at revised broker forecasts, and consider my options then.

There's no doubt that Plexus has terrific technology, with great profit potential in a buoyant oil market. So, in time, I see excellent potential here. In the shorter term though, things look absolutely awful, so it's a question of weighing up those two factors.

UPDATE: As expected, the latest broker forecasts are really grim. Cenkos has more than halved its current year forecast turnover from £26.1m to £12.1m (similar to the figure I estimated above). They have reduced PBT from £2.4m in the current year, to a loss of £6.7m - absolutely dire, as I flagged above.

I'd be amazed if the current price of 72p holds. I think this could be heading down to 50p, or even below. But it depends on whether there are buyers, happy to hoover up shares for the long haul, or if they decide to wait for the price to go lower first. It also depends on whether existing holders are prepared to tough it out for the long-term, or give up and move on. The only way Institutions could buy in size, is mopping up shares in a falling market. It's a brave buy at this point.

So, a good company long term, but a disaster in the short term.

Halosource Inc (LON:HAL)

Share price: 3.88p (down 32.6% today)
No. shares: 220.3m
Market cap: £8.5m

Profit warning - oh dear, this is a car crash. I put this share on my Bargepole List as recently as 20-Nov-2015, after a poor trading update. In my SCVR of 20 Nov 2015 I flagged that the company was running out of cash, due to poor trading, and heavy cash burn. Things have unravelled fast since then, with the shares down 84% in just the last 2 months.

Today's update is even worse, with 2015 turnover down 22.4% vs 2014. The company needed to grow rapidly, to curtail losses, so this is a disaster.

Net cash is down to only $4.6m, down $9.2m in a year, so at the current burn rate it looks as if there's only enough fuel in the tank to last another 5 months from now. So the company only has 2 options - either slash costs, and/or do another fundraising.

Outlook - makes it clear that a fundraising is on the cards;

We have implemented a number of structural changes during 2015 which we expect to continue to improve gross margins in both the Recreational and Environmental Water businesses while we continue to explore strategic opportunities to strengthen our balance sheet and improve cash reserves."

My opinion - based on past performance, I would be amazed if anyone is sufficiently bonkers to put more money into this company. At the very least, existing equity is likely to be virtually wiped out.

Robinson (LON:RBN)

Share price: 184p (down 6.8% today)
No. shares: 16.4m
Market cap: £30.2m

Trading update - for calendar 2015. A very clear, concise update, covering the main points that investors need.

Revenues are anticipated to be £29.1m for the year, which represents a 3.7% increase on last year. Two factors have significantly affected the reported revenues: firstly lower resin prices, which are passed on to our customers, have resulted in lower product prices and secondly, the stronger sterling value in relation to the Polish zloty has reduced the reported value of Polish sales (currently 38% of Group sales).  The two together amount to a revenue reduction of £2.4m whereas underlying Group volumes actually increased by 12% compared to the prior year.

Broker consensus is for revenues of £31.9, so this is a £2.8m shortfall at the top line, for the reasons given above.

The directors anticipate trading profits for 2015 will be in line with market expectations, including a stronger financial performance at Madrox and as a consequence the earn-out payable to the vendors in 2016 will be increased.

A good result on profits, in line with expectations, which is pleasing considering revenues fell short. Profit is more important than revenues of course, so a thumbs up here.

Why are the shares down today then? It's probably down to the "challenging year ahead" phrase used in the outlook comments;

The general economic conditions suggest a challenging year ahead with particular pressure on the major brands and the UK grocery sector.  Nevertheless, with new business being added in the first quarter, the directors expect to deliver revenue and earnings growth.

My opinion - quite a nice company, but operating in a cut-throat sector. So limited upside probably, as there seems little chance of the fwd PER growing much from the current level of about 13 times 2015 EPS.

There is potential upside from freehold property on the balance sheet, being worth potentially more than book value, so that could be a nice kicker at some point.

Overall, this share looks priced about right to me at the current level.