Small Cap Value Report (Fri 31 Mar 2017) - PEB, SEPU, DX., HAYT, AVG

31st Mar '17 by Paul Scott

16 comments 12339 reads

Good morning, it's Paul here.

Just a brief report today, as I have to prepare for tomorrow's UK Investor Show.

Graham is travelling over to the UK today, as he's appearing in the bears panel discussion tomorrow at UKIS. Should be an interesting, and quite fun day! I usually run into lots of SCVR readers on the day too, so am looking forward to putting some names to faces, and catching up with long-standing friends.

Ed & the team are having a well-deserved break this year, so there won't be a Stockopedia stand at the show. So I'll be flying the Stockopedia flag, and hopefully won't say anything inappropriate! (that comes later, at the Westminster Arms!)

Pebble Beach Systems (LON:PEB)

Share price: 4.77p (down 6.9% today)
No. shares: 124.6m
Market cap: £5.9m

Final results - for the year ended 31 Dec 2016.

These are pretty shocking numbers. The original core business (which has now been sold) is split out as discontinued operations. Business there just seems to have fallen off a cliff;

Revenues down from £46.9m in 2015, to £31.7m in 2016
Despite cost-cutting, the adjusted profit fell from £3.3m in 2015, to a loss of £7.8m in 2016

NB. the figures above are just for the discontinued part of the business. I'm highlighting them because it's a reminder that demand for products at any company can just dry up. It's not clear what exactly went wrong here, but for whatever reason, some customers clearly just stopped buying its products. Maybe competition overtook Vislink, with better & cheaper products?

Technology generally seems to be moving ahead so quickly, that this is an ever-present risk with any company making technology-driven products. The product life cycle seems to be getting shorter, and cheaper competition from e.g. China seems to often move in, and destroy existing businesses such as Vislink.

Therefore, as investors, we have to be very careful not to buy companies which are subject to such forces, and can move from being highly profitable one year, to being dead in the water just a couple of years later. I'm increasingly wary of investing in any companies like this, with technology products which quickly become obsolete. They have to run to stand still very often.

This point is also important for broker notes. They usually just assume a continuation of business, with x% uplift each year for revenues. Yet in some cases,…

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Aislabie

31st Mar '17

The SEPU question is whether or not the Hytera cash offer of $92million will get over the line, as clearly the authorities are a bit concerned about their high security radios coming from a Chinese company.
If the deal does collapse then the share price could get very soggy.

cholertonandrew

Best wishes for the show tomorrow. Have watched a couple of your chats on IG and you always come across extremely well.

Cloudcall webinar was good - all very encouraging I thought.

Regards
Andrew

MrX001

Any view of QRT? Results look poor to me and having the FD leave at the same time seems to be another red flag.

Brilliant Leader

Friday Typo - I hope it all works out ok with the worm

ricky65

Crikey, looks like the damage John Hawkins did at Vislink is still ongoing. Just goes to show how the effects of bad management can linger after they've been given the boot.

Paul Scott

Hi MrX001,

I've not really got time to report on Quarto Inc (LON:QRT) today.
I did a quick skim of the results, and a couple of negatives were;

- net debt had risen a bit to $61.9m, which is too high for me to consider buying the shares
- FD resigning the day before results announced seems a considerable worry. That does tend to suggest some sort of falling out.
- outlook comments refer to difficult market background in 2017.

Also, I wonder how much the company benefited from the fad of adult colouring books?

I'm in 2 minds about this share. There are some interesting aspects to it, but overall I have enough doubts to prevent me buying any shares.

Regards, Paul.

seadoc

Avingtrans (LON:AVG) is a bit of an engineering dealer. Many years ago it built up and sold off a magnesium alloy arm, aviation and my local (Rochester) manufacturer of sporty wheels. Recently (10 years) it has been buying specialist Stainless Avionics companies, sold the lot and gave half the cash back to shareholders saying it retained nuclear and medical and was looking for opportunities to build. I guess £:HAYT has a foot in each camp but note 60% of nuclear power stations in US have their pumps. Looks a good fit.

Regards,

Seadoc

jonesj

I agree completely with your comments about the risks of investing in technology companies. Unless there are some excellent patents, they will face a lot of competition from the far east.

Thanks for the update Paul. Similar thoughts to myself, although wasn't sure if this just part of corrective action to get the company in order. In the end I don't like FD's leaving, do sometimes find it amusing with the reasons they come out with for leaving - have found through experience though that very rarely does it forecast good news.

sharw

The a/cs published today are to 31/12/16 and Hawkins was not given the boot until 14/2/17 but nevertheless his damage continues to hang over the company.

mojomogoz

Quarto Inc (LON:QRT) is always complicated and that is a problem. So much change and not a little opaqueness in terms of how the company translates its operating activities into a financially digestible package. I think there is quite a lot of work for them to do there.

However, a gunslinger negative view is in danger of throwing the baby out with the bath water in this case. Some quick thoughts before I have really done any proper work on current results:

1) The debt is high relative to capitalisation but the underlying cash flows are very robust and seem predictable and durable. Part of the optical problem here is that mkt cap should be higher...the share is in all probability undervalued relative to durable earnings. Without much optimism it should be up to 1.5-2x current....and with a more positive dynamic (message/debt reduction/growth/etc) there is a case for >3x from here. There is an negative endogeneity to its current share price/mkt cap position at the moment that circles around 'its a tiny company with a large debt relative to mkt cap' that stops a decent multiple being put on it.

2) The company has cleaned up its operations over the years with the last 6+ months seeing the final push into a pure publishing business and dumping less profitable or core activities

3) There has been a considerable pick up in intellectual property investment in recent years. This hits front end earnings but should see unhindered free cash flow come out the tailpipe assuming that newer publications have the same 'backlist' tendencies of older publications.

4) Adjust for disposals and negative impact from them the underlying earnings potential looks like it has really improved. There looks to be high forward earnings surprise potential to me.

I don't think the company helps itself with its financial communications and there is an element of too many different tunes over the years which can give the impression that they don't understand their own business to outsiders. As the business is not well explained to investors in terms of how activities turn into cash-flow contemporaneous negative factors (which always occur for everyone) will have disproportionate negative impact (the FD news plus debt covenant related issue in current results will likely see continued negative momentum in share price).

I do wonder whether the FD has left as he bit off more than he could chew. Quarto is a relatively complex FD role - there's a lot of work to do to keep on top of the job and tidy up some inherited mess (both in an accounting sense and in the internal financial mgt and reporting of the company).... AND a lot to do to communicate well to investors.

Every time I dig a little I feel this is a very undervalue share but I never quite understand QRT and that leaves me thinking I may have it wrong. In that is perhaps the story of why its not valued more highly.

paduardo

Just to add to Pauls and others comments on investing in technology companies. As more of the network / infrastructure migrate into the cloud the switching costs when changing providers are decreasing which, in my view, further increases the risk.

1st Apr '17

Hi lavinit,

I'm not sure the underlying cashflows at Quarto Inc (LON:QRT) are good at all. It depends how you quantify underlying cashflows.

The key figures are the pre-publication costs. To me, those are just costs. I don't like the way they go through the balance sheet, and appear to make cashflows look massive, when they're not.

Regards, Paul.

FREng

11th Apr '17

Sepura (LON:SEPU) UK review announced today. Still, with the Chinese building nuclear reactors in the UK and supplying technology into critical infrastructure, this could still get approval.

Are the bidders allowed to just buy the shares in the market at the current depressed price, or is that against the takeover code?

I have no position.

smatthews1

Hi Paul

"From one disaster, to another. The common theme with PEB and SEPU is that reckless, incompetent management destroyed shareholder value by gearing up too much for acquisitions"

Regarding acquisitions do you have a general rule about avoiding situations like this? this is an area I am trying to focus on at the minute, as it can become quite a minefield whether an acquisition can actually be beneficial. As sometimes it may seem a company is under pressure to please shareholders by using any cash resources they have available to grow other than pay dividends.

I am not particularly interested in DX (Group) (LON:DX.) but the cost synergies with John Menzies makes sense.

However i would personally rather see any company expand their own business rather than buy up others as it gives me a sense they have no room left to grow.

Would be interested in others thoughts on this as well.

Thanks, Sean

24th May '17

Hi Paul

Excuse long delay. I need to look into how I get a notification when I get sent a message like this.

You are right and I've changed my mind on Quarto following further analysis and think that this is a stock to avoid. I will post up why. I see an equity issuance coming and current expectations on earnings and cash are likely to be high by considerable margin (see notes from brokers Liberum and Stockdale).

I am just in the process of posting up my new view on Stockpedia

Best wishes
Paul

Small Cap Value Report (Fri 31 Mar 2017) - PEB, SEPU, DX., HAYT, AVG

Pebble Beach Systems (LON:PEB)

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Paul Scott

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