Small Cap Value Report (28 Aug 2014) - XAR, MLIN, KMK, OFF

28th Aug '14 by Paul Scott

21 comments 19337 reads

Good morning!

Xaar (LON:XAR)

Share price: 440p
No. shares: 76.4m
Market Cap: £336m

I dropped SCVR coverage of this innovative industrial printhead manufacturer last year, as the shares shot up, taking its market value into mid cap territory. However, after a series of profit warnings (another one today) it's coming back into range, indeed it's a stock that I already hold, having seen value at around 500-550p, based on its strong Balance Sheet with plenty of cash, and a PER that was in the low teens at the time.

The catalyst for my initial buys was the R&D Director spending £200k buying stock - which clearly indicates that he must feel confident about the new products due for launch over the next year, which seem to have potential to be game-changing (allowing inkjet printing directly onto any shape, such as bottles, without the need for a label). I am guessing that more Directors buys could be likely now interim results have been published today.

Averaging down - In my view this morning's initial 25%+ drop in share price was a considerable over-reaction, so in my opinion was a buying opportunity on the opening bell. People say that averaging down is a losing strategy, but personally I've found it can be a highly successful strategy, but only if you are certain that the difficulties triggering the profit warning are of a temporary & recoverable nature, and only if you're prepared to hold for a while, riding out any further price weakness. Averaging down on a stock that is fundamentally going to pot, or is a stale story stock, is of course a disastrous strategy, so great care is needed!

Interim results - As you can see from the headline "adjusted" figures below, taken from today's interims, both turnover & profits are down - the main reason for this is because of increased competition in their main market of printheads for ceramic tile manufacturers. Although this is a known factor, and a broker says this morning that the interim results were in line with expectations. 2013 should really be seen as a spectacular one-off year of growth, which is not sustainable;

Outlook - the long-term prospects sound good (and bear in mind that only something like 3% of potential industrial printing has made the move from analogue to digital, and that the technology is being…

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kevanp

28th Aug '14

Very tempted to switch from Molins (LON:MLIN) to Xaar (LON:XAR). They've both come out with reports today which have materially hit their prices, but Xaar seems to offer so much more potential.

Do you still hold Molins Paul? Do you have a view on their half-year figures?

Paul Scott

Hi kevanp,

I don't recall ever holding Molins (LON:MLIN), as the pension deficit has always put me off. Possibly I might have briefly held some, it rings a vague bell? Ah yes, I think I bought some after one set of results or trading statement a while ago, but only held for a few days, changed my mind when I researched it in more depth.

Also not convinced about upside from recent levels. Connection with tobacco industry puts me off also - as I'm the world's worst ex-smoker, and utterly despise everything about smoking & anything connected with it!!!

I'll review the numbers & report back here in about an hour.

Regards, Paul.

Great, thanks Paul.

Yeh, it was 26 Feb:

After skim-reading this morning's results for the year ended 31 Dec 2013, I've taken the plunge and bought a few at the open. Just a starter size position, as I generally like to start small, and then build a bigger position if and when my confidence grows after doing more in-depth research. Also that way you don't lose much money if it turns out not to be good, after doing more research. - See more at: http://www.stockopedia.com/content/small-cap-value…

I bought some, perhaps for sentimental reasons — never a good idea — because one summer vacation, while studying for an engineering degree many years ago, I spent several enjoyable weeks working for a precision engineering company in Portsmouth which made little gearboxes for Molin's cigarette making machines!

As for the morality of investing in 'unethical' companies — my reprehensible attitude is "where does one stop".

Best, Kevan

bicboy100

Paul,
Just taken a quick look at XAR. Not sure that today's fall is necessarily overdone. Based on your full year figure of 30p eps, they were forecast to hit 38.5p. So using a per of 14 * the shortfall 8.5p we get about 117p off the price. On top of that it has for this year and next, in effect gone ex growth. Now it may be a blip or it may not, but until we know I'd expect the price to reflect that a bit so 140p fall doesn't seem excessive, just about right, or very mildly overdone..
Anyway just bought a small position in anticipation of a small bounce to keep me interested in what is an interesting stock.

Lee

Hi Lee,

Yes that sort of calculation would make sense if Xaar (LON:XAR) was just a mature business, however it's not! Or rather it's a mature business (the ceramics printheads) combined with an exciting growth business (the new products for new sectors coming in the pipeline).

Therefore for me, I would probably ascribe about half the market cap to the old business, and the other half for the future potential from new products. That's probably why, for me, today's fall seems excessive. Other people might look at it differently though, that's what makes a market!

Regards, Paul.

Gostevie

Hi Paul,

Thank you as always for the morning report. An essential daily read as always for me.

Consider this - trade & other creditors (excluding bank debt) is £64.3m, versus £85.4m in six months Cost of Sales (from the P&L a/c). Assuming it's all UK turnover, then trade creditors will include VAT, so strip out 20% VAT in trade creditors, reduces ex-VAT trade creditors to £53.6m. So I make that 114 days credit they're taking from suppliers!

I was wondering if Paul or any other accountant reading this could explain the above to a non-accountant like me. Is it saying that money being owed by the company includes VAT, and that money being owed to the company doesn't include VAT? Or am I getting the wrong end of the stick completely? Probably the latter I suspect.

Many thanks,

Steve

Hi Steve,

To clarify, all figures in the P&L account EXCLUDE VAT.

Whereas Debtors & Creditors on the Balance Sheet INCLUDE VAT.

So to compare them, one has to adjust the VAT out of the trade debtors or trade creditor figures. But that's only if business is UK-only. It gets more complicated if there are sales overseas.

Regards, Paul.

cig

The "where does one stop" issue applies to price as well: the edge between poor and good value is fuzzy and hard to pinpoint exactly, so what about buying anything at any price? If not, whatever technique people use to find where to stop on price can be applied to ethical standards.

More generally, there are many issues in life where "where to stop" is not clear, but most cases are not edge cases. Whatever one's moral standards are, crooked businesses according to those standards are generally easy to recognise.

Personally I find ethics coincides with naked self-interest in investment: I just make a weak holder of crooked businesses, thus making me more prone to loss aversion and churn, hurting the bottom line directly. Moreover crooked businesses tend to be run by crooks (what a surprise!) who tend to abscond with one's funds more often than not.

Thank you Paul. That clarifies it perfectly. Much appreciated.

PhilipHanson

Hi Paul

Any comment on PPHE Hotel (LON:PPH) today, Paul? I know the last time you looked at this you were concerned about the amount of debt - any change in your opinion on this? Net debt has reduced slightly in the last six months, gearing on their measure reducing to 59.4% from 61.4%.

Personally I don't see this as a problem as I view PPHE Hotel (LON:PPH) as half REIT, half hotel service company anyway! Much of their debt is secured against freehold property, much of which (by value) is prime London property, the market value of which is surely somewhat higher than book value.

Just wondered if you had changed your view on the company?

Cheers

Cig, I think that 'unethical' and 'crooked' are two entirely different concepts. Crooks are, of course, unethical, but I was using the term unethical in the context of how some view different industries: tobacco, alcohol, gambling, defence, oil, banking, insurance, clothing manufacture, supermarkets — the list, if not exactly endless, is long.

I would guess that most quoted companies in these sectors are squeaky clean legal. There's nothing crooked about them. They just operate in businesses with which some people would prefer not to have any dealings.

Many thanks for your thoughts on Molins (LON:MLIN) Paul. Much as I had anticipated.

I shall now satisfy my confirmation bias (sadly, but surely, the most powerful psychological factor in investment decisions) by reading Paul Hill's note!

Best, Kevan

Fair point. It does overlap though to some level: one can follow the letter of the law and be dishonest in a common sense way. I do find that most businesses I wouldn't invest in on ethical grounds are dodgy enough that they tend to attract shady characters, but you're right that there are numerous exceptions (dodgy businesses run by decent people and conversely).

I was mainly questioning whether it's too hard to draw a line. People with a very sensitive definition may end up drawing that line so far away they don't invest in stocks at all or only in a small select subset. It's fine for them to do that, and fine for others to disagree with them. It is tricky to define an ethical position and set limits, but in my view still worth doing nonetheless.

DarwenLad

Paul, love your column as always, but as a non-numbers man feel that it might be worth keeping an eye on what is happening in Xaar’s boardroom when assessing the company’s future prospects.
A couple of pointers, Ian Dinwoodie, the CEO who has masterminded Xaar’s stellar performance over the past decade, announced a few months ago that he was quitting in 2015. During his time at the top Xaar’s adjusted eps has risen from 1.6p to 43.2p. Given that he is still only 53 fears that he was exiting at the top of Xaar’s growth curve will not have not been helped by his decision to sell 150,000 shares(nearly three quarters of his holding) at £8.34 a year ago. The transaction was described at the time as “part of a pension fund re-balancing exercise”. To be fair he did buy 20,000 shares at around £5.0 in June but his shareholding is still less than half what it was at the end of 2012.
Perhaps Xaar’s management is such a well-oiled machine that a change of CEO will make no difference to its future prospects. But given the rapid changes in technology and the increasingly competitive marketplace, Dinwoodie’s replacement could be critical to the company’s future success.
Meanwhile, Ramon Borrell, 50, Xaar’s long time R&D director, whose chunky share buys first sparked your interest in the company, has been shunted off the board, and replaced by Edmund Creutzmann, 59.
Borrell has been given the task of developing Xaar’s next generation Thin Film development (P4) technology “to market dominance”. This may be a sensible boardroom change, but Borrell, unlike Dinwoodie, had continued to build up his stake in Xaar, and now owns 221,721 shares – nearly three times as many as Dinwoodie.
I think it might be wise to add a modest “management” warning to the latest profit warning.

jonesj

I presume most of us believe we should be free to drink, therefore people should also be free to smoke, as long as no third party has to suffer passive smoking.
Therefore tobacco companies pass my ethical investing test.
None of them go around dishing out free packs in schools. Also it's a lot better having a proper tobacco industry than a criminal supply chain, as with certain other drugs.

29th Aug '14

my lungs are damaged from smoking, so every time my selfish neighbour stands outside his front door, that STENCH flows into my house. We are on a collision course. I just haven't yet decided how I will deal with this particular person. in my view normally you can negotiate and persuade, far better than dictating.
In fact, being nice and having a good laugh is always better than anything else.
p.

jeff - keep your cigarette smoke WELL away from me, then we can all be happy! ;-)

Ramridge

Re. XAR. Today's (29/8) piece in the Times by Tempus is interesting and rates this share as high-risk buy. It pretty much echos the general view of this board.

PhilHofGrowYourDough

It's true that there is no clearly defined right or wrong when making ethical decisions.

However, I think a common pattern is that individuals think of the ideal situation as a defence. For example, I used to play a lot of online cash poker. On one occasion a player at my table was rinsing a lot of money, hundreds of pounds. I was quite an aggressive player and I took quite a bit off money of this player. The player repeatedly reloaded the cash at the table and kept blowing it. Clearly they were not in the best space. Meanwhile, the sharks where queueing up to get onto the table to exploit this player. When I realised that this player was out of control I suggested that he/she take a break or just stop. My comment was met with consternation at the table. How dare I say that to that the player. One other player asked me to justify my comment that might kill the cash cow and I indicated that this player was out of control. The response was "How do I know that this isn't some well heeled banker who's just come home from a hard days work and is just blowing off some steam with a few hundred quid which to them would be a drop in the ocean"

And there you have it! Focus on the best possible scenario and deny the possibility of the alternative.

I now choose to put myself in the position of the salesperson. For example ...

Would I be comfortable profiting from selling cigarettes to an individual with lung cancer or BOPD or knowingly selling a product that caused these issues?

Would I be comfortable profiting from selling alcohol to individuals with alcohol issues, or alcopops to kids?

Would I be comfortable profiting from playing a croupier in a betting shop raking hundreds of pounds off addicted gamblers on roulette machines?

I've seen the misery of all of these experiences in my counselling room and in my experience I'd suggest each of them have impacts that go beyond the individual as addiction difficulties frequently cause big issues for the nuclear family and I'd suggest wider society. For example, a young father dieing of lung cancer causes misery for his family, denies his kids a father, puts an expense on the NHS and denies the society his earnings.

The top 5 killers in UK are:

Coronary Heart Disease (smoking is a contributory factor)
Respiratory Diseases, e.g. COPD (smoking is a contributory factor)
Stroke
Cancer (smoking is the primary contributory factor for lung cancer)
Liver Disease (alcohol intake is the primary contributory factor)

The question is "Does the company do enough to mitigate against these issues?"

Perhaps if they spent as much money on support and education as they do on advertising there might not be such an issue.

We all have to make choices we're comfortable with. I tend to use "Can I think about these scenarios and look myself in the mirror?"

Best of luck everyone

Phil

Just to be clear, I have NEVER smoked tobacco (& only once tried anything else). I don't permit smoking in my own house, our outside it in my garden.
However, any free society should allow people to do whatever they like, as long as it does not harm any third party. Providing tobacco taxation covers the healthcare costs, smoking in suitable locations seems to avoid harm to any other party.

Small Cap Value Report (28 Aug 2014) - XAR, MLIN, KMK, OFF

Xaar (LON:XAR)

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Paul Scott

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