Small Cap Value Report (29 Sep 2016) - PTSG, CRAW, ASY, FTC

Good morning!

My day started with a telephone call from the CEO & CFO of Premier Technical Services (LON:PTSG) (at the time of writing, I hold a long position in this share). I think they were a little put out by my report on Monday, flagging my concerns over high debtor days, and adjustments to the accounts. My approach is to just tell it how I see it, so if something concerns me, I'll say so - even if it's a stock I hold personally. Anyway, we ran through explanations of these points, which I'll update on below.

First though, let's have a look at the interim results from butchers & hot food chain Crawshaws, which has spectacularly fallen from grace in recent weeks.

Crawshaw (LON:CRAW)

Share price: 33p (down 7.0% today)
No. shares: 78.9m
Market cap: £26.0m

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

Interim results to 31 Jun 2016 - I last reported on this small chain of butchers here on 15 Sep 2016. The event being a bungled profit warning, which failed to quantify how much sales had fallen by. It also seemed to cast doubt on the store roll out programme. The share price has crashed from 80p to only 33p, a drop of 59%.

So the big question here is whether the company has just shuddered from a bump in the road during its expansion, or whether the wheels have come off, and it's plunged into a ditch, upside down?

Sales trend - this is rather alarming. The progression has been (for like-for-like ("LFL")) sales, as follows;

• Q1 down 0.8%
• Q2 down 7.8%
• Q3 (first 7 weeks) down 15.8%

So what's gone wrong? It seems to boil down to Crawshaws trying to be a bit too clever by pushing up its gross margins. Customers have rebelled against this, and clearly taken their custom elsewhere. The excuses about weather, and football, are clearly nonsense.

What are they doing to fix things? Basically, lowering prices back down to where they used to be, when customers were happy to buy from Crawshaws. Also giving store managers more flexibility to tailor products & prices to what best suits their particular customers. That means giving up some margin though, and this is reflected in a full year profit warning today. It's a "materially lower" outlook for the full year - not good, but largely priced in by the market already.

The interim dividend has been passed. It's not a material amount, but it does inevitably raise concerns about cashflow, cash, and what the future holds.

Cash is down to £4m, but there is also a further £4m of revolving credit facility available. The balance sheet overall looks fine to me - there are no issues here with solvency.

Profitability - not disastrous by any means. A £418k operating loss was incurred in H1, which is massaged up to adjusted EBITDA of positive £1.1m (slightly down on £1.2m prior year H1 comparative). This measure is pushing credibility somewhat, since it strips out pre-opening costs, and salaries (presumably of the store opening team). Bear in mind also that new stores will tend to make lower profits to begin with, as they start to build up a new customer base.

New stores - 9 were opened in H1, with 1 more so far in H2, taking them to 49 stores in total. On a crude measure of market cap divided by store numbers, this gives a current valuation of £530k per store. That is starting to look more sensible than the previous £1m+ level.

Only 2 more stores (both factory outlets) are planned in H2, so the conventional store roll out has basically been put on hold for now, whilst management focus on restoring sales growth. That makes sense to me - get the format right, then roll it out, not the other way around.

Peel Hunt mentions an important point in a note today, that even though performance has dropped, new store openings are still achieving a payback period of 2.5 years. That's actually quite good, and suggests to me that this is a format that is still worth rolling out further. The West Bromwich "factory outlet" store has been the stand-out performer, with a payback time of an outstanding 1.1 years.

For me, these payback figures are the crucial number, which have convinced me to give Crawshaws the benefit of the doubt, and hence I've picked up a few tranches of stock in the 30p's.

If management can stabilise LFLs, or move them back into growth, then I reckon investors would probably start to get excited about roll out potential again, and re-rate the share back upwards. IF the upside case plays out, then I could see this share potentially doubling from here. There's no guarantee that the upside case will play out of course. Also, I note some institutional selling, so it looks as if confidence in management has gone, for some. So it could be a long haul to regain the city's confidence maybe?

Forex - some investors were worried that, as a meat importer, Crawshaws would be hurt by the recent depreciation of sterling. So it's encouraging to hear the company say today that it has "largely mitigated" this, with "flexible sourcing". Presumably that means replacing more expensive imports with UK production? Or squeezing suppliers to take some of the pain?

My opinion - the Q3 LFL sales figure of -15.8% is alarming. However, if management action to regain its competitive edge on price is effective, then we could perhaps see this share start to turn a corner later this year.

The worry is that supermarkets may be squeezing independents like Crawshaws?

The jury is out on this one. Personally, I'm happy to have a dabble on this share at the current level, given that management are experienced people in this sector, so know what needs to be done to regain their competitive edge. Time will tell whether they succeed or not.

Worst case scenario, I think is that the company might bump along around breakeven. I don't see any need to raise fresh cash from investors, to fund the existing business. It probably will need to raise more money for the next stage of the store roll out. However, that's only going to happen if performance is back on track.

So an interesting punt at this level, in my view, if you think management are likely to regain their poise.

Premier Technical Services (LON:PTSG)

Share price: 68p (down 1.4% today)
No. shares: 88.1m
Market cap: £59.9m

Call with management - the CEO & CFO wanted to speak to me, to explain/discuss the queries I raised in this Monday's report here. I'm always happy to run through discussion points, so was happy to talk through the figures & issues with them.

So taking my points in the same order as from Monday's report;

1) Adjusting items. 

Management point out that the largest adjustment to profit is the £649k charge for "contingent payments in relation to acquisitions". They made the following points about this charge;

• One-off in nature
• Based on stretch performance targets, i.e. the vendor of the business acquired gets paid more, if it generates a higher than anticipated profit - hence, self-funding.
• Accounting standards (IFRS3) require this capital payment to be put through the P&L, as an adjusting item.
• Can be paid in cash or shares, at the discretion of PTSG.

These sound perfectly valid points to me, so I'm happy that the adjustments to profit look generally OK. Share options charges are quite high though, and this is really just additional remuneration, so I tend to reverse adjustments for share-based payments to Directors & senior staff.

2) High debtor days.

We ran through the figures, and the way the company works it out, the figure for the recent H1 2016 results drops out at 110 days. This is based on using a £15.1m starting figure for trade debtors (the total is £17.1m, but that includes £2.0m of prepayments). Strip out the VAT and we get to £12.6m trade debtors (exc VAT), which compares with turnover of £18.5m. So I make that 124 days.

To arrive at 110 debtor days, the company makes further adjustments for a £0.9m large cradle installation, which was paid 6 weeks late, but funds received in July 2016. So this is treated as a one-off.

The company also works backwards from the period end date (add back approach), so this shortens debtor days a bit, because more was invoiced near the end of the period.

So the company reckons that its measure of 110 debtor days is an improving trend over 125 days at the last year end, and 138 days a year prior to that.

I take on board all the above, however I retorted that 110 days is still very slow payment, and that my original assertion that debtor days is very high is still correct!

The company replied that bottom line is that customers force 90-120 day payment terms on suppliers, and this is a general thing in the sector. The key point is that there are no bad debts. So PTSG always gets paid, but slow payment by its customers is a "necessary evil".

The bank covenants are constructed around 120 days payment terms being the norm.

My opinion - I was absolutely right to flag up that PTSG has unusually slow customer payments, because it does. However, management are adamant that this is not a sign of trouble, but is normal for their sector, and that the underlying trend is improving. The key thing is that they're not experiencing bad debts.

I'm not really comfortable with 120 day payment terms, when 60 days is the more usual standard level for UK companies - maybe not in this sector though? Although I'm grateful to management for giving me a thorough explanation of how they see things.

A few snippets to round off with;

Andrews Sykes (LON:ASY) - a long term favourite company of mine. Interim numbers today look good, so it's definitely worth a look I think.

• Lovely dividend yield.
• Forex gains flatter figures today.
•  Note the strong balance sheet with net cash of about 10% of the market cap.
• Strange ownership structure, with a very small free float - maybe it's on AIM so the family get IHT relief? Just a guess. 

Anyway, I like this company a lot - it's been a fantastic cash machine for shareholders for years now.

Filtronic (LON:FTC) - an excellent update today. Q1 trading has been really strong, with £11.7m sales giving a £1.0m operating profit. However, this is based on one product, to one customer, as explained in the rest of the announcement. It's too unpredictable for me, and has been a serial disappointer in the past. So a great deal of caution is needed before getting too excited about one decent quarter's trading.

Right, that's all for today.

Regards, Paul.

(usual disclaimers apply)