Good morning! We look set for a fairly ugly start, with the FTSE 100 Futures down 66 points at 6,442. As I've been saying for a while now, in my opinion small & mid caps are in a very frothy bull market, with a lot of valuations seemingly carried upwards unendingly on momentum, but increasingly detached from sensible valuation metrics. Hence in my opinion this is a time to be top-slicing or exiting completely from anything whose valuation looks full, and sitting on some cash to await the bargains that will be thrown at us once this euphoric mood of Mr Market turns once again to despair. I don't know how big the correction will be, or when it will happen, but I reckon it's coming.
That said, there are always bargains to be found in the small caps space, they're just harder to find, and less obvious at the moment - but I'm particularly focussing on companies that are out-performing against broker forecasts - because brokers tend to be too pessimistic in an economic recovery, forgetting about operational gearing, which can see profits shoot up much faster than turnover. So situations where that is happening can end up being cheap once results are issued that beat expectations.
Zanaga Iron Ore (LON:ZIOC) is a special situation that I like a lot - their interim results are published today, and the narrative gives a decent summary of the current position. They are jointly developing a world-class (in both scale and low production cost) iron ore project in the Republic of Congo. In my view there could be further considerable upside on the current share price despite it having doubled recently. The big uncertainty is what level of dilution will be required to finance the project, using third party debt and equity. Glencore and ZIOC are jointly working on raising the financing, so I'm sure we'll get another update in due course, but so far so good. There is a cash pile of $35m as of 30 Jun 2013, and about half that is ear-marked for ZIOC's contribution to the 2014 development costs, so the cash backing behind the shares is diminishing, although the project viability has dramatically improved in recent months, with planned capex reduced from $7.4bn to the $2.5-3.0bn range, achieved by altering the plan to develop the project in stages.
I don't normally take an interest in this type of thing, but ZIOC just seems such a remarkable situation, that it was a gift at 11.5p when I bought in, and in my opinion (based on meeting the company twice) there could well be considerable upside from here. It's obviously speculative though, as we don't yet know what sort of deal will be done on financing, but it's likely to involve the Chinese, who are likely to look favourably on a project capable of supplying them with large amounts of iron ore at low cost - and with early production capable of commencing as early as 2015, with output ramping up in stages.
As always, please be sure to DYOR, particularly with more speculative shares like this.
Fragrance maker Treatt (LON:TET) has issued an in line with expectations trading update this morning, relating to its year ending 30 Sep 2013. They also describe the order book as "encouraging". I've been surprised at how the share price here just seemed to go up & up, although broker forecasts have also been steadily increasing, such that it is now priced on a not unreasonable 12.9 times broker consensus forecast EPS for 2013/14.
It's not of interest to me, as the re-rating has probably happened now, and I've missed the boat, but have been wrong in being too cautious about this share - I've reported the positive trading updates here before, on 28 Mar and 28 May, but I was too slow in realising that this presented a good opporutnity for the share price to rise, which it has by around 50%. Ah well, can't win 'em all. Plus in fairness, we've had lots of big winners here in the same period anyway.
Another bull market trait which is becoming increasingly striking to me, is how smaller cap share prices are responding to newspaper and magazine tips. It's difficult to be sure, as I've never measured it, but I don't recall share prices reacting this strongly to newspaper tips for a considerable number of years - I'm thinking back to the late 1990's, when the tech boom was in full swing.
This morning Fairpoint (LON:FRP) shares have quickly risen 5% to 131p, on the back of a tip in the Sunday papers. As a holder, it's difficult to know how to react. On the one hand, newspaper tips tend to draw in unsophisticated punters with a very short attention span (which makes me lean towards selling into the spike from their buying). On the other hand, some shares tipped in newspapers have risen strongly, and continued rising (e.g. Staffline, which I sold at 300p on the back of a strong rise after a newspaper tip, and it has since almost doubled in price from that point!). So it's a tough call. I suppose all we can do is look at the fundamentals, and make an informed judgment based on the information available.
Since FRP is still on a cheap PER (of about 8.5), and has an excellent dividend yield of almost 5%, then I am minded to sit tight on my small position there.
My aversion to pawnbrokers thankfully meant that I've avoided the value trap that Albemarle & Bond Holdings (LON:ABM) has turned out to be. They've issued a pretty disastrous-sounding trading statement this morning, indicating that a deeply discounted Rights Issue at 50p is necessary, to raise £35m. Worst still, there is no certainty that the Rights Issue will go ahead, and they are trying to get their major shareholder, EZCorp (which owns just under 30% of their shares) to underwrite the Issue.
This is a prime example of why to avoid any company with high levels of gearing, i.e. bank debt. If something goes wrong with trading, which it has in this case because of the fall in the gold price, so something that should have been fairly easy to predict, then the business is basically at the mercy of the bank manager. Just because the banks have been under political pressure to prop up zombie companies doesn't mean to say that they won't play hardball if they think shareholders can be pushed into getting the bank off the hook.
So ABM shareholders have woken up this morning to a near-50% drop in the share price, down to 67p at the time of writing. I wouldn't touch them with a bargepole, with that level of uncertainty over their financing. It's a very powerful reminder that Balance Sheets really do matter a lot, and that highly indebted companies are accidents waiting to happen, which is why I don't go near them.
Imposing strict rules on Balance Sheets has dramatically improved my investing performance in the last couple of years. Sure, you might miss the odd high risk multi-bagger when a company that was insolvent (e.g. Thomas Cook prior to its refinancing) manages to survive. However, screening out the 50-100% investment losses from your portfolio before they happen, which almost always come from either companies with high levels of debt, or blue sky story stocks (the majority of which end up worthless), really does gives things a terrific boost over time.
Interim results from Tanfield (LON:TAN) really are horrendous. They've managed to clock up an £8.5m loss in just six months, on turnover that has fallen again to £18.9m. The Balance Sheet is running out of fuel, with them drawing down on stock and debtors to stay afloat, as you would expect from a shrinking turnover business.
It seems to me that the recent deal to secure third party refinancing of the aerial platforms business was a very good one, and a lucky escape for shareholders. Whether there is any value in their electric vehicles business, who knows? All in all I can't see anything of interest here, and the £27m market cap looks far too high to me. I'm dropping update coverage of that one from this point.
Readers of my reports were amazingly generous in Jan & Feb of this year, when I did a booze-free January ("Dryathlon") for Cancer Research, which ended up being 2 months booze-free, and also my first ever Half Marathon, raising money for MacMillan, and the Sussex Beacon. Anyway, it's fundraising time again, so I'm running the London Royal Parks Half Marathon this coming Sunday, 6 Oct, to raise some dosh for the disability charity, Scope.
Anything you can spare for this excellent charity would be very much appreciated. I've set up a fundraising page here, where donations & Gift Aid can be made by debit/credit card, should you wish to support me in this project. Last time was certainly an interesting experience, especially as I couldn't actually feel my legs at all for the last 2 miles, but they somehow managed to keep working!!
Interim results from Universe (LON:UNG) look pretty good - operating profit was up 28% to £0.75m for the six months. A recent acquisition was only included for one month of this half year. The narrative sounds upbeat, talking of a positive reorganisation over the last couple of years. Their shares are up 15% this morning to 5.6p, which puts the market cap at about £12m. IF they achieve broker forecast of 0.74p EPS next year, then the shares would be on an undemanding PER of about 7.6.
I don't know the business well enough to be comfortable forming a view either way, but am flagging it here as something that might potentially be of interest to readers. They did a fundraising in 2012, although I note the funds were all used for an acquisition, and the Balance Sheet is now dominated by Goodwill. Write that off, and there's nothing left in terms of net tangible assets, so important to bear in mind the lack of asset backing - because that makes it all the more important that trading remains good. There is no dividend either, which combined with the small size and lack of asset backing probably rules it out for me.
I'll leave it there for today, as I have to prepare for a company meeting in London this afternoon.
See you from 8 a.m. tomorrow.
(of the companies mentioned today, Paul has long positions in ZIOC and FRP, and no short positions.
A Fund to which Paul provides research services also has a long position in ZIOC)