Small Cap Value Report (13 Jun 2016) - FITB, WATR, EGS, TRD

Good afternoon!

It's a very slow day for company news today.

Brexit seems to be very much dominating things right now. The opinion polls are showing a late surge for the Out campaign. I've always assumed that the British people are most likely to do what always happens on big issues - if unsure, at the last minute people trot out and vote for the status quo (e.g. AV referendum, Scottish Independence, etc.).

For that reason, personally I've done very little to my portfolio, other than placing a bet on an Out vote succeeding, as a hedge, and also for fun. It's beginning to dawn on me that the amount I might win on that bet would be only a fraction of what might be needed to hedge fully against an Out vote.

My feeling is that an Out vote succeeding would be likely to trigger quite a big, panic spike down in UK listed company shares. I say spike down, because I suspect such a panic fall would be fairly short-lived. It's likely to dawn on investors that actually nothing much will change for a while. It's going to take many years to unpick all our arrangements with the EU, and nobody really knows what the end results will be.

Looking at it from a high level though, it's pretty obvious that trade will continue largely as normal. There might be some trade tariffs in both directions, but as a large net importer, that's actually a boost for the UK economy overall. Remember that UK tariffs on EU goods will help import substitution, so UK producers will become more competitive in their home market.

I imported some goods from Hong Kong last year, and the import tariff was small, and no impediment to my purchase decision whatsoever - either financially or administratively. The freight forwarder just emailed me an invoice, I paid it, and the goods were delivered. Easy peasy. Free trade & globalisation really isn't the panacea that some people seem to think - look at all the manufacturing jobs we've lost. So I don't think we should fear the imposition of tariffs by the EU against Britain. We should enthusiastically reciprocate, and you can bet that German manufacturers will soon be hammering down the doors of the EU to get those tariffs reversed.

Whilst personally I favour an Out vote, as the best thing for our country long term, I'm not under any illusions that an Out vote would almost certainly trigger an extended period of uncertainty, even semi-chaos. That's bound to unsettle equity markets pretty badly, for a time. However, that would also provide some smashing buying opportunities. Lots of things to think about anyway.

Fitbug Holdings (LON:FITB)

Share price: 0.55p (down 18.5% today)
No. shares: 281.5m
Market cap: £1.5m

Just a quick comment on results from this one. As always happens, the big ramp of this share a while ago has completely failed. The figures out today are horrendous. The company has an insolvent balance sheet, with £8.2m net liabilities. It is dominated by shareholder loans of about £9.3m.

Since there is no viable business, and the old activity is being abandoned, then it's quite obvious that the equity here is really worth nothing. So anyone with an ounce of sense would ditch the shares now, and salvage what you can.

The company is now trying something different, a B2B software product. Good luck with that.

Expect a debt for equity swap at some point, which is likely to hugely increase the number of shares in issue, thus eliminating what little value is left for small shareholders.

So, yet another story stock that dismally failed to deliver on all the hype. Readers here were warned about its terrible balance sheet, in 3 articles since Oct 2014.

Water Intelligence (LON:WATR)

Share price: 69p (up 16.9% today)
No. shares: 10.6m
Market cap: £7.3m

Results y/e 31 Dec 2015 - a very sloppy reporting cycle - there's no excuse for reporting 2015 figures in mid-June 2016. That said, the numbers are actually quite good.

Turnover up 22.4% to $8.8m (note that this company's main operations are in the USA, so it reports in US dollars)

Operating profit rose 54% to $1090k. Impressive.

Profit after tax is a lot lower though, due to finance costs, and (much higher rate than UK) USA corporation tax. So PAT was $581k (about £410k). So I make that a PER of 17.8, which seems quite high for such a small company. There again, if the strong profit growth is maintained, then it could end up looking cheap in a couple of years' time, perhaps?

Outlook comments talk about strategy, and note the last sentence, saying 2016 has started strongly:

As noted above, we have a significantly strengthened management team that is able to execute an ambitious growth strategy.  First, we continue to expand our sales footprint and our franchise business thus ensuring the growth of royalty income.   Second, we continue to unlock revenue and earnings through franchise reacquisitions.  Based on the positive results from our current selection criteria, we will look to make similar reacquisition choices during 2016 and 2017.  Some of the reacquisitions will be underperforming franchises so that we can achieve faster headline growth.  Some will be franchises with dependable revenue and earnings where we can illustrate a positive partnership approach and still achieve solid growth.  We are always mindful of the geography of potential opportunities so that we create regional infrastructure to support our franchisees and link our nationwide sales footprint for customers.  Third, since we have achieved success with our strategy, we plan to extend the model to the UK, Canada and Australia during 2016 to position Water Intelligence for future growth given the reality of a worldwide addressable market for solutions to mitigate water loss.

Given our 2015 achievements, we look forward to building a multinational growth-oriented company that unlocks shareholder value. We are off to a strong start in 2016.

I should mention what the company does. It detects & fixes water leaks - e.g. swimming pools. Some branches are company-owned, others operated by franchisees.

Balance sheet - looks alright to me. Not particularly strong, but not worryingly weak either.

Dividends - no, it doesn't pay divis.

My opinion - this company looks potentially interesting. I like the growth being achieved, and the upbeat commentary. Expansion into new countries does carry costs, and risks. The very small market cap, and overseas company being listed on AIM, does put me off somewhat. That said, it has been listed on AIM since 2005, and personally I don't have a problem with American companies, as their corporate governance is probably better than that in the UK.

Overall, I'd say the figures look quite interesting, and if you can live with the lack of liquidity in this share, then it might be worth doing some further research on the company. I'd want to better understand the growth potential, and sustainability of profits, before committing any money.

eg Solutions (LON:EGS)

Share price: 52p (down 4.6% today)
No. shares: 22.7m
Market cap: £11.8m

Board changes - this company is never far from controversy. The root cause of its problems seems to be the overpaid CEO, who has plundered this company for personal gain through ridiculously high remuneration over the years. Shareholders are then required to replace the looted cash through Placings, as the company has been incapable of generating consistent profits.

I set out the figures in my report here on 29 Oct 2015. It's a pity, because the company's software sounds interesting, and it has a good client base. However, the behaviour of the CEO makes this share uninvestable for me. 

Worse still, I understand that the company threatened legal action against one shareholder activist who complained about executive pay. That's really not the way to get private investors onside, as things like that quickly spread through the grapevine, leaving a very bad impression in the investor community.

Today's statement suggests another major board room bust up. 4 Directors, being the CFO, Chairman, and 2 NEDS have resigned! So that only leaves the CEO and one remaining NED. What a ridiculous state of affairs. A new Chairman is being lined up.

My opinion - I think the CEO of this company is completely out of control. Losing 4 Board members (with no explanation as to why) further reinforces my view.

An absolute bargepole stock, which has really become a joke stock now after this latest dysfunctional event.

The company warned on H1 profits recently, saying they hope to make up the shortfall in H2.

I'd be amazed if anyone is prepared to refinance this company again, once the current cash pile has been burned up.

EDIT: Equity Development points out that the incoming proposed new Chairman has excellent credentials:

Nigel Payne has a 30 year plus track record as a director of both listed and private companies and his quoted sector experience includes current roles as Chairman of AIM-listed Gateley (Holdings) plc and Stride Gaming plc, and director of Gama Aviation plc. He was previously CEO of Sportingbet plc, one of the world's largest internet gambling companies.

From a practical perspective the executive team i.e. EGS founder Elizabeth Gooch as CEO and outgoing CFO Jonathan Kay is still in place providing temporary continuity. The addition of a highly experienced listed company director would be positive and our inference (not confirmed in the RNS) is that Nigel Payne would rapidly seek to reinvigorate the focus on profitable sales growth.

I'm not sure what that last sentence really means. Why would 4 Directors all resign? Were they pushed, or did they jump? I think there are clearly questions that need to be answered here.

Triad (LON:TRD)

Share price: 32.7p (up 29.4% today)
No. shares: 15.1m
Market cap: £4.9m

Results, y/e 31 Mar 2016 - a reader has asked me to have a look at these figures.

I must say, I'm impressed. This share looks very good value for a company that has just reported very good profit growth. If profits are sustainable, then I could see this share gaining another 50-100%. It's too small & illiquid for me, and I don't really want to buy anything new at the moment.

Triad seems to be an IT consultancy, for both private & public sector clients. I'm not entirely clear what its activities are exactly.

Key points:

Turnover up 20.6% to £28.3m

Operating profit up a very impressive 112% to £980k. Quite a slim profit margin though, at 3.5% of turnover.

EPS is heavily boosted by a negative tax charge (as previous tax losses are brought back onto the balance sheet). So the jump in diluted EPS from 2.32p last time, to 7.72p this time, needs to be treated with caution.

Balance sheet - looks OK overall. Debtors has risen a lot, as you would expect from the increase in turnover. There's negligible debt, and overall it seems to have net cash of about £0.9m - pretty good.

Note the provisions for empty properties, which will be a cash outflow in due course.

They don't capitalise development spend, which is a positive thing in my eyes.

Outlook comments sound fairly good. Although presumably increasing headcount means increasing overheads? So maybe that might hit profits in the short term, possibly? 

Further to the progress achieved during the year we have started the new financial year with a strong order book and healthy pipeline of opportunities. Underpinning the Group's success will be our ability to develop new and existing accounts and deliver successful outcomes for our clients.

In order to capitalise on the opportunities being developed efforts to strengthen our business model continue. A key aspect is the need to increase the headcount across the business.

My opinion - overall this share looks strikingly cheap. Just £4.9m market cap, for a business that's just reported a profit of just under £1m.

The key question is whether that profit is sustainable, or whether this was just a one-off bumper year for some reason? So more digging is needed I think.

I've not found anything untoward in the figures - the accounts look clean to me, with real profit, and positive cashflow.

Overall, it's probably too small & illiquid for me, but it certainly looks worthy of more research for any readers who delve into the really tiny end of the market. It would be interesting to meet the Directors, and better understand the business model, and strategy.

That's me done for today. See you tomorrow!

Regards, Paul.

(usual disclaimers apply)