Small Cap Value Report (Tue 4 Jul 2017) - QRT, XLM, STAF, VLTY, JSG

4th Jul '17 by Paul Scott

31 comments 14902 reads

Good morning! It's Paul here.

Quarto Inc (LON:QRT)

Share price: 176.6p (down 25.6% today)
No. shares: 19.7m
Market cap: £34.8m

Trading update (profit warning) - bad luck to shareholders here. This company is mainly an illustrated book publisher.

It says today that guidance given to the market has turned out to be too high. However, this explanation simply doesn't make sense to me;

Prior to entering the closed period, the Group has been reviewing guidance as given to the market. This process has revealed that the guidance currently in the market uses a publishing-only baseline for 2016 that does not reflect the benefit of $2.1m relating to the reduction in the amortisation of capitalised pre-publication costs - as explained in the FY2016 Results announcement on 31 March 2017 and in the Group's Annual Report. As a result, the baseline guidance for 2017 and beyond has been set too high.

Surely if the company didn't include the benefit of a $2.1m lower amortisation charge in its guidance, then the profit guidance would be too low, not too high? So the above paragraph doesn't make sense to me at all. Maybe I'm just being slow? (I am only half way through my first coffee of the day).

EDIT: a note from Liberum today explains it much better. They say that the baseline for forecasts was set too high, due to a one-off benefit in the prior year baseline figures.

Whatever the explanation given, the upshot is that profit guidance in the market is currently too high. So it's a profit warning. QRT joins RBG in a category of companies whose finance departments don't seem to be very good at forecasting.

As well as this apparent forecasting error, underlying trading conditions seem to be soft, causing under-performance in the year to date;

The Interim results will reflect the ongoing soft retail environment in the Group's domestic markets, resulting in a lower-than expected trading performance in the year to date - as well as a more pronounced second-half weighting, natural in a pure-play publishing business.

The Group expects its strong publishing programme, combined with the continuing resilience of its publishing portfolio and enduring backlist, to perform significantly better in the second half.

Investors should bear in mind that QRT normally has an extreme seasonal weighting…

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ricky65

4th Jul '17

Quarto Inc (LON:QRT) reminds me of Utilitywise (LON:UTW) in that they both had negative trending charts (both below 50 and 100 SMA) before their profit warnings. Consequently, can it be just "bad luck" when a profit warning appears? There often appears to be a forewarning.

Rusty2

But I'm sure there are many that go below the 100 MA and don't issue a profit warning, Purplebricks (LON:PURP), Rentokil Initial (LON:RTO), Tristel (LON:TSTL), Microgen (LON:MCGN), H & T (LON:HAT) and £G4M are ones that I know of, in fact it would have been a good buying opportunity.

Splode

Veltyco (LON:VLTY) seems to have had various names and businesses as its SP dived and the company (then called Velox3) was suspended from AIM twice in 2014 and 2015. Trading was resumed a year ago still as an online trading business but it then acquired Sheltyco Enterprises Group which was involved in the “promotion of third party online gaming, lottery and binary option operators”. Velox3 changed its name to Veltyco Group, and moved from the Netherlands to the Isle of Man. So the new business as VLTY is still only a year old.

Since then Veltyco (LON:VLTY) seems to have done well and the house broker gives it excellent forecasts. But Stocko rates it as a Momentum Trap with very low Q and V ratings and a total StockRank of only 34 although the analysis is presumably based largely on the previous business? Stocko shows a PE of 11 and PEG of 0.3 but the other Price ratios are poor.

I think this may be better than a punt but it’s not for me yet. The SP is up 8% today after the AGM statement.

tabhair

Looking at Quarto for the first time, has anyone got any thoughts on how to value it? If you use free cash flow, the numbers look crazy cheap because pre-publication costs (which get amortised to virtually nothing in the next year) are essentially an extra capital expenditure that isn't included as such. Would it be too simplistic to say a fairer measure of real free cash flow would be to subtract the entire pre-publication cost from free cash flow?

seadoc

herbie,

"But I'm sure there are many that go below the 100 MA and don't issue a profit warning,"

Is that not the all dogs have 4 legs but not all 4 legged creatures are dogs argument?

"in fact it would have been a good buying opportunity"

Held Tristel (LON:TSTL) from early 2012 it halved and is now a 10 bagger. It has been below 200 MA on many occasions, all of which would have been buying opportunities. I am applying same to accesso Technology (LON:ACSO) but I am still holding the cash ready as I think it has a bit more to retrace.

And to ricky:

I chart 20d 50d and 200d moving averages. I know crossing one of these is "significant" but if all three come together in a micro/small cap "something" is going to happen to sp, often in relation to warning/takeover/revision forecast. The chart of 600 (LON:SIXH) reporting today shows this perfectly but I suspect some news was "leaked" hence rise yesterday and to a lesser extent on Friday.

Regards, Seadoc

Funderstruck

They are Very 'Left' !!!!!!

mojomogoz

Agreed Seadoc

My preferred time to buy is when people have hated and are disinterested. I like stale hate. Hate is so backwards looking. I prefer to sell when enthusiasm his high (though it is always uncomfortable and in general I find the procrastination involved in thinking the extra enthusiasm might be justified useful).

Not everything works out like above but it makes my karma best when it does.

Quarto I owned and sold 2-3 months ago as did my fundamental work more deeply and the issues that arose were obvious (and there's more to come)

Pre-publication cost should pay back with some added extra over 2-3 years. Quarto Inc (LON:QRT) 's own figures say that they make back 1.5x what they spend in 1st year of publication with the current 'front book' (new titles). This is a great improvement. The issue is that that means the back book isn't making as much money as it should or once did suggesting some tired assets somewhere.

There's been a lot of work that I think is good by the CEO in recent years tidying up publishing and there's a chance that 2017 sees that work pay off and the back book generated from work in the last few years starts paying off much more (eg children titles). That is the upside surprise that means I will have been wrong to sell a few months ago. That would lead to pure free cash flow that can pay down the debt

More analysis on QRT here:
http://www.stockopedia.com/content/quarto-financial-noose-chokes-good-operational-advances-in-publishing-188339/

TerryHancock

Not entirely, Quarto invest in new titles for the co-edition segment with the assurance that it has pre sold to co-edition partners that cover the cost, the problem is that as other commentators have noted is that this process only generates material cash and profit if the books have a subsequent life as back list. The anecdotal evidence is that the company has got better at initial sales margins but has been less successful with extended shelf life. A slightly off beat analogy might be they have been getting better at constructing (book) properties but increasingly less successful at extracting ongoing rents from that investment, not a sustainable trend when your balance sheet is under stress.

PS The potentially stale assets hint that a goodwill write down could be in the pipe from somewhere. That has no cash impact but it will trouble sentiment and perception

Paul Scott

Hi doublelutz,

Re XLMedia (LON:XLM) - you said;

I am sorry Paul, when you are happy where the income comes from I think it will be too late!

That's fine. The nice thing about small caps, is that we have so many to choose from (over 600 in my investing universe), that it really doesn't matter if we miss some winners - there are plenty of other winners to be found.

In my experience, if I feel uncomfortable about any share, then it's best not to buy it. The reason being that I'm far too likely to sell on any dip in share price, if it was an uncomfortable buy originally. Therefore it's almost setting myself up for a fall, by over-riding my doubts about a company.

Good luck to all holders of XLM, as I said in the main report, the figures look very good. But it's not for me.

Regards, Paul.

Hi herbie. You are correct, most stocks that go below their 100 SMA don't issue a profit warning.

It's not just dropping below the 100 (or any other) SMA. It's also whether the SMA is an a downtrend or not; I don't want to hold any stock in a long term downtrend. It's not just about profit warnings, it's the market telling me something is wrong. Apart from Tristel (LON:TSTL), all those stocks you mentioned wouldn't have concerned me when they dipped below their 100 SMA. Here's my analysis of all those stocks you mentioned:

Tristel (LON:TSTL) - This is a clear example of where my strategy wouldn't have worked. I would have got out during the drop below the 100 and 200 on high volume in Feb 2016. I see it retraced from 150p to 88p. I wouldn't have had the bravery to hold through a entrancement like that! I see the share price has more than doubled since then.
Purplebricks (LON:PURP).- Since the all time high breakout in January it's not dropped below the 100. It's bounced off the 50 SMA multiple times.
Rentokil Initial (LON:RTO) - to my eyes its been in a solid uptrend since early 2015. You're right that it dropped below the 100 a couple of times but never dropped below the 200 which has been in a clear upward trend.
Microgen (LON:MCGN) - Looking back to early 2016 when the current run started, there's a couple of sideways consolidations where it dipped below the 100, but the 100 has not been itself in a downtrend.
H & T (LON:HAT) - Yes it dropped below the 100 but never the 200 which has been in a clear uptrend. I count 5 bounces off the 200 since beginning of 2016!
£G4M - Again dipped below the 100 for a short period but the 100 was not in a downtrend, 150 and 200 were (and still are) in an uptrend.

Hi seadoc.

Personally I use 50, 100, 150, 200 simple moving averages. I want to see all of them in an upwards trend ideally.

Regards

Ricky

bestace

Hi Paul,

In your previous comments of XLMedia (LON:XLM) here and on Twitter, you raised the prospect of meeting the management in person. It sounds like you're not pursuing this anymore, or did they turn out to be "too busy"?

I bought a small position in January and would have topped up given the strong uptrend, but like you I had some lingering concerns about the sustainability of the business model that have stopped me from doing so. That was despite having watched the webcast that Maddox highlights in post #6, which I would recommend to anyone trying to understand their technology and business model.

davidallen77

Paul any thoughts on sbry ts today not putting separate like for like sales for sbry and Argos red flag?

dfs12

Hi,
With regard J Sainsbury (LON:SBRY) ... I don't think this is a red flag offence as they announced that this was intended shortly after the acquisition. I listened to webcast this morning and the major takeaway was that J Sainsbury (LON:SBRY) is transforming into a real internet player. Much of their business is now online or internet driven and they are executing pretty well.

Hi bestace,

No, I haven't got round to following up the idea of meeting mgt of XL Media.
It's a time issue mainly (I do loads of other things, with private companies, as well as writing these reports, and managing my family portfolios). So I've had to park any projects or possible meetings that don't really rank as a high priority. When things are this busy, I tend to just meet management where I'm seriously considering making an investment, or have an existing investment. XLM doesn't fall into that category right now. There are lots of other more interesting things I'm researching at the moment, in my area of expertise - which online marketing isn't!

Regards, Paul.

+lavinit

The reason I suggested that you write off the publishing costs straight away is that if you look at the average depreciation charges that the company has taken for the last 5 years, those charges seem to have a very tight correlation to the pre-publication costs themselves.

Depreciation $27.8M (5 year average)
Pre-publishing costs $28.6M (5 year average)

I know this not not exactly a like for like comparison as there are other assets on the balance sheet that Quarto will be depreciating. But given the anaemic revenue growth of the recent past (revenue is almost exactly the same it was 5 years ago), then from an accounting perspective, it makes perfect sense that Quarto are depreciating virtually all of the pre-publishing costs within a year as it seems to me they add at best minimal value after year one. I think Lavinit actually summed it up quite well in his blog, this is a company that is running to standstill.

Getting back to the over all picture, what's especially worrying here is that the company is clearly wobbling. I think it's crazy that the company increased debt last year AND increased the dividend. Perhaps it's a case that they are confident of the year to come, but it would make much more sense to pay out a higher dividend after shareholders actually see the profits.

Net Debt
2016 61.8
2015 59.5
2014 66
2013 71
2012 80.9

2016 was not a good year for Quarto, and it looks like 2017 might not be much better given this trading update. When you have the leverage that Quarto have and you're in a sector like book publishing that is under pressure, then this is clearly the sort of thing that could spiral out of control very quickly. Perhaps I am wrong, but when I look at the future of this company I think "there be dragons here".

Oh, and just for good measure, I haven't even gotten onto the $4m of compensation that management and directors received for 2016. GAAP net income for last year was negative $5.7m, making a mockery out of the $21.7m adjusted earnings that management headlined the annual report with.

iwright7

5th Jul '17

Re XLMedia (LON:XLM)

I have just been through the XLMedia (LON:XLM) metrics again and there is almost nothing not to like. Growth, Momentum, Quality and Value are all cheap. The return numbers alone put XLM in the Top 5% of listed companies. Of course there is the digital gambling lead in aspect, but if you can get over companies making money from fools, which to my mind is no worse than the Bookie companies, it’s a pretty compelling proposition.

So what’s really holding the XLM PER back? - It has to be doubt over Israeli accounting "accuracy" - Can a company on a PER <12 really have a ROIC of 33%; well yes in this sector I am pretty sure it can.

Worth the investment of a £150 Easyjet flight to Tel Aviv to do local due diligence, before deciding to seriously invest or not? I just wish had a little more time. I hold a small position, but as ever please DYOR. Ian

MichaelFBS

Hi Paul

I bet all that keeps you busy but have you parked the book idea or is that due out soon?

Thanks.

Michael

Small Cap Value Report (Tue 4 Jul 2017) - QRT, XLM, STAF, VLTY, JSG

Quarto Inc (LON:QRT)

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Paul Scott

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