Small Cap Value Report (8 Dec 2015) - ZYT, VLK, UTW, PLUS

Good morning!

In case you missed it, I did a report yesterday evening, the link is here.

There seem to be some tremendously volatile price movements going on at the moment. I see that Plus500 (LON:PLUS) has had a huge bounce, and amazingly it rose to higher than the 400p failed cash bid.

On the downside, I see that controversial company Utilitywise (LON:UTW) has really fallen out of bed, and fallen from 200p to 120p. Thank goodness I got cold feet a day or two after results, and ditched mine. It's tempting to catch the falling knife, but that's not worked out well recently, as I can attest, with £DX. having failed to bounce significantly since its disastrous profit warning.

So very much a time for caution. I'm going to review all my positions tonight, and chuck out anything that I don't have proper conviction over, apart from short term trades, which are a different kettle of fish.

Companies that are delivering good trading results are going to new highs though, so it seems to be becoming a highly polarised market, where the wobbly stuff is thrown away (good shorting opportunities should therefore abound), and the decent stuff keeps going up. So very tricky for us as investors to handle. Arguably we need to be reckless with good companies (running them to over-valuations, which is what's working best at the moment), and ruthless with bad companies, chucking them out even if they appear cheap.

Zytronic (LON:ZYT)

Share price: 397p (up 0.8% today)
No. shares: 15.3m
Market cap: £60.7m

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

Results y/e 30 Sep 2015 - excellent results today from this bespoke touch screen manufacturer. The share price is only up slightly today because the market had already factored in strong results, since the company put out a "materially ahead of market expectations" trading update on 15 Oct 2015, which I reported on here.

What's particularly interesting, is that you could have grabbed two thirds of the move from 300p to 397p by buying on the day of that trading update. It just shows, that often it's the early bird which catches the worms.

I've noticed this happening with some other shares too - i.e. the initial move up on the day of an out-perform trading update can very often be the precursor to a bigger move up. That makes sense really - private investors can swoop immediately, and grab the worms, whereas Institutions have to sit patiently and accumulate shares in the market over a long period. Also, Instis might take a little while to have meetings to get purchases discussed & agreed, whereas again PIs have the advantage in that we can buy on the opening bell for our own portfolios.

Key figures from the Zytronic results for y/e 30 Sep 2015 are;

• Sales up 13% to £21.3m (in line with the 15 Oct trading update)
• Gross margin particularly strong, rising from 36.6% to 41.9%
• Profit before tax up 39% to £4.5m
• Diluted EPS up 24.6% to 24.3p (giving a PER of 16.3)
• The year's divis are up 20% to 12.0p (giving a yield of 3.0%)
• Net cash on the balance sheet rose to £9.8m, or 64p per share, clearly material to the valuation.

Also, these are some of the cleanest figures you'll see - no adjustments, or other silliness, just real profits that turn into cash. This matters because it gives confidence in applying a multiple to earnings, to value the company conservatively. Whereas, with some other companies, you can end up over-valuing the shares, if you put a multiple onto artificially inflated earnings figures.

Note that the % rise in EPS is lower than the % rise in profits because the tax charge has normalised this year - last year it was unusually low, due to releasing previous year's over-provisions - itself a good sign, in that the accounting is clearly being done conservatively.

Cashflow - looks absolutely clean to me. Note that only £388k was capitalised into intangible assets, which is close to the amortisation charge of £336k, so there is only minimal overall effect on profits.

Balance sheet - absolutely lovely. As already mentioned, the company has £9.8m in cash. There is a mortgage of £1.3m, but I tend to ignore this, as it's property asset backed.

Note also that debtors, inventories, and trade creditors are all modest - demonstrating good financial controls.

Outlook - sounds fine to me;

The year has started positively with maintained momentum and a continued drive to develop product functionality and expand the global sales footprint. We continue the focus on increasing shareholder value and shall update shareholders on progress and material developments during the course of the coming year.

I'm not sure what the focus on shareholder value means? Perhaps we might get a special divi at some point?

Valuation - I think you can safely take off the 64p per share net cash, as effectively being surplus capital. That takes the EV to 333p. At that level the PER would be only 13.7, which strikes me as a bargain in the current market.

My opinion - this is one of my favourite Value/GARP companies. It has high quality scores, a bulletproof balance sheet, a decent & growing divi yield, is on a reasonable/cheap valuation, has excellent management, growing markets, the list of positives ticks nearly all the boxes for things I like to see at a company.

As we know, the downside risk is that gaps can appear in the order book, as visibility is limited. That's a risk that shareholders just have to live with. It also provides excellent occasional buying opportunities when the price does plummet on profit warnings, but that's pretty rare in fairness.

Stockopedia likes it too, the StockRank is 96.

I've only looked at the (now) historic figures above too. Broker forecast is quite modest, but the upside case is that the larger touch screens the company is concentrating on could become much more popular, leading to earnings rising more rapidly than brokers currently anticipate.

Overall then, I am very pleased with progress, and will continue to hold for the foreseeable future. The shares look excellent value, for a smaller growth company that is firing on all cylinders, in my view.

I've not gone through all the narrative yet, but being very happy with the numbers, I often park the more detailed reading until the weekend.

Vislink (LON:VLK)

Share price: 28.35p (down 2.2% today)
No. shares: 122.6m
Market cap: £34.8m

Trading update - there's quite a bit of information in this update, and it's open to interpretation. The way I read it, the company seems to be saying that it could struggle to close some sales deals by the 31 Dec year end. A range of £54-58m is given for anticipated turnover for calendar 2015.

That constitutes a profit warning in my book, as brokers consensus is currently for £60.3m turnover, and £6.05m profit - although Vislink is prone to accounting adjustments, so whether that profit figure can be relied upon is questionable.

The bank facility has been increased from £10m to £15m, which the company blames on working capital requirements which should unwind in 2016. A small bolt-on acquisition is at the "advanced discussions" stage.

Positive noises are made about new product launches, and cost savings made which will benefit 2016 and beyond.

My opinion - I think they've done a great job in disguising a profit warning as positive potential for next year!

For me this share is uninvestable under the current leadership, due to excessive board room greed, with ridiculous remuneration for the Chairman in particular, and the last straw being the ill-considered "Value Creation Plan", which has coincided with remarkable value destruction in the share price, as shareholders voted with their feet, and sold out.

It sounds as if the core business isn't trading very well either. Although people who want to look for positives can find plenty of upbeat messages in today's update.

The Chairman has a track record of repeated wheeler-dealing, almost an addiction to making acquisitions. The trouble with this, is that it strips the balance sheet bare - you end up with mounting intangibles (often of little to no real value), and rising bank debt.

I don't like this type of growth by acquisition financial engineering, as it usually goes badly wrong in the end. The contrast between Zytronic & Vislink couldn't be more stark - the former has solid, modestly remunerated management, who get on with the job & deliver excellent results, with real profits & cashflow. The latter are always doing deals, and trying to concoct artificial, but probably only temporary shareholder value, in order to trigger massive personal gain from convoluted bonus/options schemes.

It's very clear to me which one is attractive, and which one is best deflected with a bargepole.

That's probably all I'll have time for today, as hospital visiting beckons for this afternoon & evening.

I see that Ensor Holdings (LON:ESR) has dropped a lot on publication of interim results, so if I get a chance might circle back to that one.

Regards, Paul.