Small Cap Value Report (27 Jul 2015) - DIA, MYSL, XPP, FEVR

27th Jul '15 by Paul Scott

15 comments 19286 reads

Good morning/afternoon!

I'm running a bit late today, so please refresh this page, as I'm adding to the article throughout the afternoon. I've been dog-sitting for friends in London over the weekend, and there have been a few accidents, so I'm now expert at carpet cleaning!

Dialight (LON:DIA)

Share price: 488p (down 11% today)
No. shares: 32.5m
Market cap: £158.6m

Interim results to 30 Jun 2015 - this industrial LED lighting company warned on profits on 10 Jun 2015 - which I reported on here. In that update the company said 2015 profits would be significantly below market expectations, but didn't quantify how much. I concluded at the time that Dialight seemed "a can of worms, with possibly more bad news to come out", which looks to have been a sensible conclusion.

Results today look bad. Key points:

Turnover for H1 rose 14% to £86m
Underlying operating profit collapsed - down 74% to only £1.7m
Underlying EPS only 5.4p
Interim dividend has been passed
Moved from net cash into net debt, of £8.0m

Balance Sheet - overall this is still strong, but the main item which has consumed cash, and caused the move into net debt, seems to be a big increase in inventories, up £12m compared with a year ago, but up £4.1m in the last 6 months.

Significantly rising inventories is a red flag, so would need looking into, as it could be a precursor to a write-off of obsolete stock at the year end perhaps?

A useful check is to see what the stock turn is like. In this case, cost of sales from the P&L for the 6 months was £61.1m, so I would expect there to be no more than say 2 months' sales in stock, so about £20m, and hopefully less. However in this case, stock is much higher, at £36.5m. So that is certainly a concern.

Given that there is a new CEO conducting a strategic review (results to be announced in Oct 2015), then there has to be a heightened risk of him doing a "kitchen sink" job, and make a big provision against slow moving stock perhaps?

The net debt positions doesn't look to be a problem - the company says it has headroom on its banking covenants, and in any case I imagine the bank would be fairly relaxed, given the overall balance sheet strength, so I'm not worried over net debt,…

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Monty9

27th Jul '15

In 2009 I looked at IQE and DIA as a play on the promising LED lighting market. In the end I kicked myself for having plumped for IQE, as I felt it had a strong design and technology moat and in addition a big opportunity to provide more complex chips to the exploding smart phone market. More fool me as DIA subsequently ten bagged and IQE five. I still hold IQE so its really a 2.5 bagger for me so far.
However now the world is different and I fear the competition will hurt DIA now, at a time they are struggling with internal in-efficiencies. I think it highly likely there will be a kitchen sink exercise. Given the tough market for small caps I could see the PE reducing to as low as 5 when the full year results are published. Like you I have no interest until the full year numbers except possibly as a small short.
On the latter point I find it emotionally hard to short as I instinctively want to support companies I have invested time and money in, however the lunatic global fiscal position could play havoc with equity valuations and I feel one should start getting some protection in the portfolio, perhaps ftse index short bets would be easier if not to expensive.
Apologies - the above is all rather rambling and unstructured but hopefully of some interest.

Timhancock

Ha! Re. Fevertree Drinks (LON:FEVR), maybe that 'perhaps rather narcissistic/vain type of person' will no longer be a friend if & when they read that post, Paul!

Hydrus

Good, balanced report on FEVR Paul. I'm very much in the bull camp as the chance to own an extremely fast growing global market leading consumer brand doesn't come along very often. I agree with your comments about the broker estimates being way too cautious.

apad

FEVR
Coming from a slightly different direction I also estimated a forward PER of 33. Abcam, I estimate as a middling PER of 31. There is a type of share that has a very wide 'moat' which justifies these types of PERs.
I remember doubling my money on ARM in about a year and thinking they were too highly valued, despite knowing that it was the legion of software folks skilled in their programming that were the game changer when combined with their low-power consumption. I'm not making that mistake again.
Nicely balanced article.
apad

jonesj

Domestic LED lighting seems to be a rapidly evolving technology. The domestic bulbs have gone from quite poor light output to fully competitive with halogen in not much more than 5 years.

So I presume it's the same in the industrial sector which Dialight occupy.
Now anyone investing in a rapidly evolving technology needs to pick the right company and get out at the right time. Think of Nokia & Blackberry v Apple & Samsung.

Whether or not this analysis is correct, I would certainly want to understand the marketplace in more detail before taking a punt on this. A quick look at google shows there are other LED industrial lighting manufacturers. Trying to work out which ones have a technical advantage in one for the "too difficult" pile.

BrianGeee

CREE has been the market leader in high powered LEDs (and most SiC electronics) for some time now, but an increasing number of competitors seem to be emerging http://www.bloomberg.com/news/articles/2015-01-12/cree-sees-how-many-suits-it-takes-to-block-rival-led-lightbulbs.
They're probably a good company to follow if you want to learn more about the LED lighting space generally.

Paul Scott

28th Jul '15

Thanks Brian,

One of the lessons I have learned from my (many, and sizeable) investing mistakes, is that getting your information mainly from the company you have invested in, is usually a mistake - because they tell you a sanitised, optimistic view.

These days I'm interested in the interim and final results statements and narrative, but spend a lot of my time digging around for views about the company and its products from third parties.

For most sectors, I conclude that I just don't know enough about the sector to make an informed decision. So best to stick to what you know & understand.

Regards, Paul,

Ramridge

Hi Paul -
I agree with your view and would add Trading Updates and IMS s as requiring close reading. Read carefully and with good judgement, they are generally good predictors of where a company is likely to be at the next reporting date.

janebolacha

Paul, for me it's just as important to identify and monitor specific sources of information on companies in which one is invested, sources which might include trade publications or independent market analysis or all kinds of other specific information, sources that could provide very specific and timely indications of progress, setbacks or developments and that could put one ahead of most other investors, besides announcements and results from the company itself, and comment by other investors and investment publications. The reason I stress the former is that it's invaluable in providing what I'd call an "owner's perspective" on how a particular company is doing, something I find necessary to complement (and sometimes very much oppose!) the "investor's perspective" that is built up from sources such as Stockopedia and your SCVR, often mainly based on historical figures. Imo, both perspectives are needed in order to make good investment decisions but to cover stocks adequately in this way, one needs to deliberately limit the number of stocks held, I'd say to between 10 and 15, which is a useful exercise in itself as one effectively forces prospective investments to compete for investment money.

cig

Dialight (LON:DIA) don't make the actual leds, they just box them up, so you're not exposed to bad (good) technology as they can pass through advances from their suppliers. Of course, it means it is a relatively low margin commodity business.

There will also be circuits to power the LEDs. They don't just run on 230v.
So I suppose there's some skill in the design and integration of those circuits, but this would also be the type of thing any bright electronics engineer could work out.
Therefore I agree it could still work out as a low margin commodity business.
With no room for the kind of operational issues reported.

I follow the same philosophy, but a shallower version, that is I get the "owner's perspective" -- which I would call stakeholder's perspective, I'm also interested in what clients and employees think -- from googling or side channels of company data or secondary sources. This is easy (a few hours of work to research one company/idea) but imprecise, so it is a good match for a very diversified portfolio (which dilutes the inevitable errors). There's only so much research one can do from behind one's desk... It may be one of those things where 20% of the work gets you 80% of the result.

The point I'm making here is that people should not be turned away from taking a broader views because they think they can't do it in sufficient depth.

Cig, yes, I'm also interested in what clients and employees think. For the latter, a site such as Glassdoor can often tell you a lot. Even Google Alerts sometimes dredges up useful information from unexpected sources. Major suppliers should also be covered as well as developments in other or related markets that could well impact on the company concerned or be followed in its particular markets (this is, imo, something very often overlooked). For me, time is very much a limiting factor, as it is for many, but I find that once the work of identifying sources of info is done thoroughly, then I'm more than halfway there in getting ahead of the game.

You don't want the electronics engineer to be too bright, because they'll home cook the power conditioning circuitry, because it's fun, instead of using off-the-shelf led power ICs, of which there's a rich ecosystem.

Still integrating parts into end products is a perfectly valid business to be in, but as you say they must not cock up manufacturing. There's possibly an investor perception gap as well: some investors may see or have seen them as blue sky, and misprice them accordingly. And they have commodity industry exposure, which may be tough for some time. Overall may be a better short than long at the moment.

Santawani

Paul, I did buy some DIA in February, but due to the possible problems you flagged up in your April report I managed to get out unscathed. I am very grateful to you for keeping us on the straight and narrow!
Also, your covering of XPP is appreciated and avidly read. I bought some a while back round about the 1,000 mark and have done well probably more from luck than judgement. Their divi comes in handy and the good StockRank helps give us confidence.
As always thanks for your input.

Small Cap Value Report (27 Jul 2015) - DIA, MYSL, XPP, FEVR

Dialight (LON:DIA)

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Paul Scott

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