Small Cap Value Report (8 August 2016) - UTW, QRT, TCM, YOU

8th Aug '16 by Paul Scott

35 comments 20063 reads

Good morning!

In case you missed it, I belatedly wrote a report on Saturday, for Thursday last week, which was a duvet day. Here is the link - it covers results from Portmeirion, Brammer, Johnston Press, and Zamano.

I'm having a quiet week in Hove (rather than charging round London to meetings, lunches & socials), so there shouldn't be any duvet days this week. Boring companies reporting today, so let's have a longer preamble.

Consumer spending data

There's an interesting article here showing data which suggests UK consumer spending is holding up better than might have been expected in July, thanks perhaps to warmer weather. Of particular note is that spending in hotels, restaurants & bars was up 9% against last year - a huge rise.

It does feel as if people want to have more experiences, rather than buy more stuff. Have we reached peak stuff? I certainly have - my flat in Hove certainly needs a massive de-clutter - car boot sale at the weekend maybe?! In the 1980s I had my own market stall at weekends, selling secondhand books & bric-a-brac when a teenager, so it's a trip down memory lane doing a boot sale every now & then!

With disposable income data looking positive, and interest rates at a record low, this just doesn't feel to me like the right set of circumstances for a recession - despite all the doom & gloom from forecasters & commentators. Also, the worrying data from manufacturers could improve once the benefit of weaker sterling feeds through.

Brexit uncertainty

An interesting comment last week came from the CEO of Vertu Motors (LON:VTU) (in which I hold a long position). He made the point that business leaders & managers will generally have been Remain supporters. So they have a preconceived belief that Brexit will cause a recession. Therefore, they are now acting on that preconception, by being more cautious. Yet evidence is mounting that Brexit (so far) has caused very little economic impact. So there is scope perhaps for the negativity to unwind, as businesses realise that life is continuing as normal. An interesting idea.

So my overall view remains that we're probably in for a bit of a soft patch, but not a deep or prolonged recession. The market seems to be signalling the same view, given the recent strong recovery from the Brexit plunge in…

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actsofvolition

8th Aug '16

re Telit(TCM)

I've often wondered why companies pay a dividend while they have existing debt or have even taken on fresh debt(usually to fund an acquisition) during the same period. It seemed to be common sense to pay off the debt with the surplus cash first, or am I missing something? Telit isn't the only one that ive seen doing this.

My understanding is that "dividend recapitalisation", to draw out value for the shareholder now and load up the company with, hopefully, repayable debt, can have its uses from a Private equity standpoint, but this doesn't seem like something the directors of a public company should be doing.

Am i getting things mixed up? Are there case(s) where this makes sense? Perhaps where the credibility in maintaining/paying a dividend outweighs the prudence in paying off the debt?

andrea34

Thanks Paul, and wise warning having read it; the actual (rather than adjusted eps) was putting me off a bit :-/

Orangetree

There might be consolidation in the sector, but it all depends on AIM IPOs activity, fundraising activity and AIM companies paying for research.

If all the above is low, then revenue would fall. And this contribute to falling share prices leading to consolidation to stay competitive and more importantly solvent!

Didn't know Neil Woodford holds 27.1% of Utilitywise, he must be losing his Midas touch!

dscollard

agreed on Brexit hasn't happened: we've had a vote and a change in sentiment but BAU except for sentiment and the odd under-performing company whinging and blaming Brexit.

I am increasingly of the view that the market is bullish on the change of government and a shift away from austerity towards a pseudo Keynsian expansionary policy

Caney doesn't operate in a vacuum despite the protestations on the independence of the BoE: the turnaround on monetary policy probably isnt based solely on one PMI report and is unlikely to be without political pressure. That Hammond has already hinted on a shift in fiscal policy may well be auguring some easing on VAT and the like come the autumn.

Once could conclude that Brexit is meaningless for now (mainly because it still is) , the real forces are a shift in the government's economic policy

bobo

general over view
I'm sticking with little shares, with small spreads, genuine cashflow (as much in dollars as possible) and a genuine story as to why they will make more money next year than last year.

Working with P2P has refocused me on cash flow as being critical, can the company demonstrate a track record of making cash and will it make cash in the future. If so it is worth putting in the collect basket, as long as it is good value.

mojomogoz

Hi Paul
I hold a position in QRT and could be interested in submitting questions. Will you be able to provide either audio playback of call or transcript? I ask as I asked to attend the last QRT analyst meeting and was declined entry. I think this is generally wrong and had a bit of bust up with IR people. They offered me meeting with Marcus Leaver which I did not take up - my interest was what they say and what other people asked given the rather extreme financial positioning of this company. I did not tell them that I am a CFA (Charted Financial Analyst) charter holder as I did not feel that was relevant to whether I should be able to attend a public meeting that obviously generates public information.
Best wishes
Paul

dfs12

With regards ipo and fundraising activities there seems have been a steady flow this year compared to last. Just this morning there was an rns on a new aim listing Loopup to be handled by panmure.

rmillaree

Ref dividends

"but this doesn't seem like something the directors of a public company should be doing. "

This happens the world over with small and big business, whether it is sensible or not is a tricky situation - HMV and probably Game Group probably went to the wall (bust) due to the fact they carried on paying divis when any man and their dog could see this wasn't sensible.

However give me a cash Neutral company that is making loads of dosh in cashflow terms, takes on debt to bump the earnings up - and i am happy to see that company continuing to pay the divi whilst it still has debt - as long as they are sensible about things.

It does though all Boil back down to have decent overall coverage - whether that be bullet proof profits flowing through to cash or excellent Tangible Assets elsewhere.

I guess if we can get our divi now with financing being cheap and i can invest that cash somewhere else i should be gaining - but there is a loss to the company with extra financing costs meaning future divi could have been higher.

If nothing else a decent maintained divi probably takes the temptation away from the average Megalomaniac type Bod in charge getting to carried away and taking on more debt that they can service. At least if a chunky dividend is present its an easy way to improve future cashflow by cancelling it when times are bad. WIth no dividend what do you cut first when you suddenly need to improve cashflow?

FREng

I'm nervous about inflation, because equities don't necessarily protect against inflation if the economy isn't growing.

The combination of the fall in sterling and the likely loosening of fiscal policy seems likely to stimulate inflation (indeed the BoE has said that they expect CPI to exceed their 2% target). Historically it has always proved harder to reduce inflation than to increase it and although a reduction in VAT would reduce CPI, the effect would drop out of the annual figures after 12 months.

I have bought quite a lot of £NG1Q a bond that pays 1.25% (ncreased by RPI inflation and redeems in October 2021 at £100 again increased by the RPI inflation value in Februar 2021, 8 months before redemption. The base value of RPI against which all increases are measured was 231.3 (DYOR) and the latest RPI (June 2016) was 263.1.

263.1/231.3 = 1.137, so that's the current multiplier for the bond value (£113.7) and coupon (1.42%).

It feels to me to be a reasonable place to put spare cash at present (and the market seems to agree, for the time being at least).

I also hold ISHARES ? IND-LINKED GILTS UCITS ETF (LON:INXG) which is an ETF for IL bonds.

Paul Scott

Hi lavinit,

Re my audio interview with Quarto Inc (LON:QRT) CEO tomorrow - I solicit questions from private investors - so pls feel welcome to submit a question (use a pseudonym if you wish) using the form on this page;
http://qualitysmallcaps.co.uk/ceo-or-fd-interviews/please-submit-your-questions-for-quarto-qrt/

Private investors are often excluded from analyst meetings, by brokers who are interpreting FCA rules about professional investors, etc.

Which is why I like doing CEO interviews, where PIs can submit the questions - it's a nice conduit between the company & private investors. Trouble is, there's not much interest in terms of questions, so it's sometimes like pushing something heavy uphill!

Regards, Paul.

Hi Paul, I will try look over my notes and then post here if I have anything up to date.
Best wishes
Paul

Actually - I will do it on link you provide

truegent

Hi Paul,

I must say that I disagree with your comments regarding YouGov (LON:YOU). Reported EPS has for the last 5 years been either bang on FCF/S or below - meaning they have actually made more FCF than they reported as profits.

For the last 5 years, earnings per share compared to Free cash flow per share (i have included the purchase of intangibles in the calculation of FCF) :

2011 -> 0.3 - 2.55
2012 -> 0.35 - 0.34
2013 -> 2.14 - 2.51
2014 -> 0.44 - 2.9
2015 -> 3.21 - 3.78

so as you can see 2012, 2013 and 2015 pretty much spot on ! and then in 2011 and 2014 then actually made more FCF than they reported net profit.

what is also interesting is that whilst they ammortize a lot of intangibles each year (in the P&L statement), they then purchase more intangibles (in the cash flow statement) so they pretty much balance out.

p/e is currently pretty high at 40x but 2016 forecast puts forward p/e of 25x which is still high but balance sheet has no debt so ive seen worse.

so i think you're being a bit harsh !

Jeremy Caton

I think Quarto,in which I have been a shareholder for many years, have always justified their apparently very highly geared balance sheet by pointing out that they have huge value in their back catalogue which is not valued in their balance sheet.Many of their tittles are continually rehashed.The company has many interesting books,not all are "The Works" Type pot boilers.The well known Alfred Wainwright Lake District Walking Guides are now in their stable for example.(Frances Lincoln Publishing division).
I must admit I have always found their accounts difficult to understand, which I am sure has nothing to do with their CFO for many years until he recently retired being called Mick Mousley!However the fact that the shares have increased from about a pound & the constant steam of divis has helped any concerns over the years.
The fact that the company is based in Delaware & subject to US Tax rules is also slightly annoying for UK investors.

janebolacha

Paul,

Following on from your opening remarks today, here are a couple of reports to indicate that, firstly, inward tourism to UK appears to be rising very sharply with the weaker pound sterling, and, secondly that credit card spending within UK seems to be recovering fairly well from the period of Brexit uncertainty:

http://english.aawsat.com/2016/08/article55356025/uk-tourism-boosted-brexit-weakens-pound

(an unusual source, I know! - But note the figures for flight bookings to UK from Hong Kong and from North America).

http://uk.reuters.com/article/uk-britain-economy-consumer-spending-idUKKCN10J0LV

(perhaps one of the earliest reports of "real spending", as opposed to surveys, in the UK retail and consumer economy).

Encouraging, perhaps, for companies involved in retail, leisure and hospitality in UK.

Hi truegent,

Thanks for your figures re YouGov (LON:YOU)

I'll take a closer look when the next set of figures come out, but in the past I was very unhappy with their capitalising policy.

Also there's a yawning gap between basic EPS and adjusted EPS, as I recall. Not sure how that sits with your idea that cashflow is strong.

Anyway, let's discuss in more detail when the next numbers are out. I'll make a mental note to cover them in a future report here.

Regards, Paul.

gsbmba99

In theory, taking on debt can enhance returns for equity holders. It depends, obviously, on the profile of the business and the level of debt it can sustain.

If you are looking for a case study of a company that has successfully used debt to enhance shareholder returns, you could look at Micro Focus International (LON:MCRO). From memory, they did one or more returns of capital by levering up with debt. They've also successfully used debt funding for value creating acquisitions.

9th Aug '16

agreed: suspect there will be an overshoot on inflation: there was probably no need for the BoE to take action until more data was available. I have NS&I index linked certificates maturing at the end of the month: I reckon I will reinvest and take the RPI + base only because I am interested in the variability of the RPI component and see this rising not falling (and I don't want to be bothered with more cash ATM). Not sure we will get to stagflation but then who knows in this crazy world: fundamentals got washed away in the QE floods a long time ago

Wimbledonsprinter

On TCM, this is a stock which I hold despite being in agreement with nearly all your poimts. The accounting treatment is very aggressive and almost exclusively focuses on "adjusted" numbers. But you can back out "real" underlying numbers and the management is forecasting a very strong H2 and seem optimistic about 2017 and beyond. There is a promised focus on improving FCF, hence the commencement of a dividend payment this year. If you model out double digit revenue growth(mostly organic) plus the c8% forecast margin improvement the FCF suddenly becomes very substantial and the shares look still very cheap. - and to me this is still cheap enough to warrant owning the shares as a punt. My main concern in the H1 numbers is the increase in Working Capital, which was not properly addressed on the conference call.

Small Cap Value Report (8 August 2016) - UTW, QRT, TCM, YOU

Consumer spending data

Brexit uncertainty

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Paul Scott

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