Small Cap Value Report (Wed 19 Apr 2017) - Election/forex, LRM, ALT

Good morning!

As we all know, political events can have a big influence on markets. So it was interesting to watch what happened yesterday, after Mrs May announced that she's holding a snap general election on 8 June.

This triggered a big move upwards in sterling, which currently stands at just over $1.28. I'm flagging this point because a surprisingly large number of shares have been boosted by weak sterling. Dollar earnings make up the bulk of the FTSE 100, for example - hence its plunge yesterday. However, plenty of smaller caps also have seen their sterling earnings boosted considerably by forex.

Therefore, I am currently reviewing my portfolio, and considering whether to bank profits on shares which have received a large boost from forex in the last year.

Looking at the sterling:dollar chart below (courtesy of IG), you can note the big moves as follows:

June 2016 - a sudden devaluation of sterling from the Brexit vote

Oct 2016 - another sharp plunge in sterling, although I can't remember any specific reason for that at the time

Oct 2016 - Apr 2017 - sideways range, around £1 = $1.25

Now - who knows, but sterling is looking stronger, in the short term anyway

Importers have been struggling with weak sterling, as it's increased the cost of imported goods. Hedging arrangements only defer the pain. So weak sterling has been one of the woes hurting shares in UK retailers.

IF that pressure is now alleviating, then this could perhaps be a good time to reconsider whether it's time to snap up some bargains in the retailing sector? As mentioned previously, the only conventional retailer that interests me at the moment is Next (LON:NXT) - whose shares seem bizarrely cheap to me at around £42.

I think there could be a better outlook for Next than its extremely gloomy outlook of a few weeks ago suggested.

Going back to the election, markets seem to be anticipating Mrs May winning a bigger majority than her current, wafer thin majority of 17 (per the TV news last night). A bigger majority should make Brexit negotiations (and implementation) easier, so I think the market is probably right to cheer this move.

Anyway, it's a good time to monitor sterling, and to consider how your shares may be affected. Looking at the chart above, by Oct 2017, the year-on-year movements in sterling could actually start to be a headwind for many of the companies which have enjoyed a big tailwind in recent times.

The danger is that some investors may have got carried away with forex-related earnings growth, and over-priced shares with very strong earnings growth. We could therefore see some share price corrections later this year, when people realise that the forex gains were a one-off, and could now even begin reversing.

Lombard Risk Management (LON:LRM)

Share price: 11.7p (up 9.7% today)
No. shares: 400.6m
Market cap: £46.9m

Trading update - for the year ended 31 Mar 2017.

I last reported on this banking software company here in Oct 2016, noting that things seemed to be improving.

The information today is presented as if it's positive, but I'm not so sure.

The Company is pleased to announce that it expects to report revenues for the year, ahead of current market forecasts, in the region of £34.0m to £34.4m, primarily driven by strong revenue growth in the Company's Risk Management and Trading Software division.

Stockopedia shows market consensus as revenues of £31.9m, so this looks a reasonable beat at the top line level.

The Company expects to report a year-end net cash balance of £7.0m and

adjusted EBITDA in the region of £2.4m to £2.8m, significantly better than market expectations.

The net cash figure looks OK, and dispels any short term worries about needing another fundraising.

However, EBITDA is completely meaningless at this company, because it is so aggressive in capitalising development spending. EBITDA can be a useful measure in some sectors, where it can be a proxy for cashflow, but that is certainly not the case here.

The year-end cash balance was higher than expected due to a strong focus on debt collection and improved working capital management.

Capitalised Research and Development is expected to be in the region of £7.5m.

As you can see there's a mammoth amount of development spend capitalised, of £7.5m, so the underlying cashflow is clearly still very negative. It looks like the cash figure may have been flattered by short term movements. So I'm getting worried about whether that £7.0m cash figure can actually be relied upon?

The company did say at the interims that H2 would be a period of heavy investment in new product development.

My opinion - I did have a dabble in this share around 8p. However, a Simon Thompson article triggered a sudden spike up to 12p in mid March, so I was very happy to bank a lucky 50% gain. Why look a gift horse in the mouth?

I remain fairly sceptical about this company. Whilst there are some signs of improvement, in terms of revenues, and contract wins, it's still a long way from being a viable business in terms of profitability.

Indeed, on a recent video, the CEO made a comment which seemed to suggest he also had some doubts over whether there was a viable business here. That was one of the reaosns I was happy to sell up.

Overall, there are some promising signs, but this company still has a lot to prove. It's track record has been very poor, and it's been hungry for cash in the past, with numerous fundraisings. That said, there does seem to be a good market opportunity, with its software apparently in demand, due to regulatory pressures.

A lot of its customer contracts are surprisingly small - that was another key point which came out of the CEO interview. I think the jury is still out, on whether this will become a viable business or not. That's not good enough, to tempt me back in.

Altitude (LON:ALT)

Share price: 76p (up 27% today)
No. shares: 46.4m
Market cap: £35.3m

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

New supply agreements - this share is a bit too speculative for me, but a friend persuaded me to buy some recently. Graham wrote a section on it here on 14 Feb 2017.

The company has a small existing business, but the excitement (and valuation) mainly rests on hopes for its new activities in America. The story is that the boss at Altitude has experience in the promotional goods sector, having been in a senior role previously at 4imprint (LON:FOUR) .

Altitude's big idea is that it provides a software platform for a large number of promotional goods suppliers. This enables them to make personalised websites for their customers, instead of printed booklets. So customers can see products, with their own branding already applied, via 3D visualisation software online. They then place orders, and Altitude receives a cut of the gross profit from the manufacturer.

It seems too early to be sure whether this is going to work or not. So in that sense, this share still looks jam tomorrow to me. Hence why I'm only a nervous holder at the moment, until some tangible proof emerges that the business model is actually working.

This bit, in today's announcement sounds good;

The first of the new agreements is with Market Brands LLC ("Market Brands"), based in Buffalo, New York State, USA.  Under the agreement, Market Brands has undertaken to recruit 100 new sales staff who will target the creation of tens of thousands of branded web stores for small businesses throughout the USA.  The stores will be powered by Altitude technology and fulfilled through Aprinta.  Altitude will be remunerated through a percentage of the sales value of every order in line with the Group strategy.

My opinion - it's very unusual for me to even consider jam tomorrow shares, as they nearly always go wrong. So I've no idea whether this one will be any different, or not. My friend reckons he's checked it out thoroughly, and he's got a good track record, so I'm hoping for the best, whilst expecting the worst.

If I do get sucked into a jam tomorrow share, I always try to size the position so that a disastrous outcome isn't too financially damaging. The other key thing is to unceremoniously dump the shares once it becomes clear that things are not working out as planned. The really big losses are incurred by people who fall in love with a story stock, and cling on to the bitter end.

Mind you, occasionally a jam tomorrow share does actually work, although I'm struggling to think of any examples.