Small Cap Value Report (Fri 26 Oct 2018) - CRAW, PDG, VTU

Good morning! It's Paul here - sorry, I forgot to put up a placeholder last night.

It's Budget day today. EDIT: No it's not, apologies, it's on Monday! I misread something.

Let's hope Philip Hammond doesn't try to steal any of our money! There's an interesting article on the BBC's website, entitled "What do young people want the government to spend more on?". Isn't that revealing? The assumption being that government spending should always go up, with total disregard for where the money is actually going to come from!

It doesn't seem to occur to the BBC or young people, that perhaps the government should spend existing resources more efficiently, and borrow less, so that we don't have to spend a fortune on debt interest in future.

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Crawshaw (LON:CRAW)

Share price: 1.88p (down 22% today)
No. shares: 113.0m
Market cap: £2.1m

Statement re media speculation

This chain of butchers/fast food, today says;

The Board of Crawshaw Group plc notes the recent media speculation regarding a potential financial restructuring and equity fundraising.

As announced in the Company's interim results on 26 September 2018, the Board have completed their review of the business and is implementing its change programme to restore growth and profitability, which includes reviewing its structure and investment in traditional high street locations.

The Board confirms that it is considering a number of remedial actions to address the key issues it has identified, which may include raising additional funding through an equity capital raising.

No decision has yet been made by the Board on these matters and the Company will update the market in due course.

I'm fuming about this, as it's a good example of how appalling the system here is, at raising money via placings. When a company is doing a fundraising, the shares should be suspended. I understand that is a requirement in some places abroad. Otherwise it's a false market. People are buying the shares in the market, oblivious to the reality that the company is trying to raise fresh equity, at a discount to the prevailing share price. In distressed situations like this, the discount can often be very large. Therefore, private shareholders are lambs to the slaughter, and are buying shares at an artificial price. This is scandalous!

We really should all write to our MPs, and generally lobby, to have the system changed, as it's grotesquely unfair right now. I think there could even be a legal case, for people who buy shares in the market, before a placing. They're being ripped off! Information leaks out, and some unscrupulous people do break the rules, and trade when inside. This is against the law of course, and can result in imprisonment, but very few cases seem to be detected, when we all know the practice is widespread. It's obvious from share prices which mysteriously move downwards before a discounted placing is announced.

From time to time, I'm taken inside by brokers, to ask if I would like to participate in a placing. It's a bit of a mixed blessing. I'm coming round to the view that placings only filter down to pond life like me, if the boys in the City aren't interested in putting their own money in! If it's a good company, then usually I don't hear about the placing, and it's a done deal by the time the RNS comes out. A thoroughly corrupt system! Brokers like to do as little work as possible when conducting a placing, and often look after their mates in the best deals.

When I am made inside on anything, I scrupulously keep quiet about it, not breathing a word to anyone. I certainly would never report on a placing underway here in these reports. That's not virtue signalling, it's just obeying the rules. I don't agree with the rules, but I have never & will never gossip, or write, about any fundraising. Also of course one is prohibited from dealing in any share, once you're made inside.

I recall one disastrous fundraising by Cloudcall (LON:CALL) where I was made inside, and had to watch in dismay as the share price drifted down - word had obviously leaked out and someone was selling. The placing was eventually done at about a 40-50% discount. If I hadn't been inside, then I would have sold my shares. As it was, I couldn't.

A good signal that a fundraising might be on the cards, is when a company with a weak balance sheet, loss-making, and/or some other problems, changes its broker. This announcement on 4 Oct 2018 disclosed that Peel Hunt had resigned, and had been replaced by WH Ireland. Clearly Peel Hunt didn't fancy trying to do a difficult, and small (hence not much in fees) fundraising, for a company whose business model has failed.

Long-time readers might remember that I was very sceptical about Crawshaws, when it was in the process of being a massive multi-bagger. It didn't seem credible to me, that a butcher & purveyor of horrible, stodgy hot junk food, could be a highly profitable retail roll-out. Price competition from supermarkets is intense, margins are low, so it just didn't make sense that a small, independent chain of butchers could be highly profitable.

What I think might have happened, is that the company had a purple patch, where it managed to source meat very cheaply, due to cancelled orders from supermarkets which had over-ordered. So a glut of cheap meat provided Crawshaws with a temporary run of strong profits.

One of my favourite friends in the City, Tony Brewer, gave me the best & simplest advice when i was starting out in investing, about 20 years ago. I used to meet him for epic lunches, at Fino's in Mount Street, a wonderful family-run basement Italian restaurant & bar. Our best ever lunch finished at about 2am the following day, by which time we were in a casino in Berkeley Street. It took me about a week to recover.

Tony's golden rule was to always ask, "Are profits sustainable?". It's surprising how often they're not. Big profits attracts competition, sooner or later. So conventional wisdom that a high profit margin is a good thing, may not always be correct. There also has to be a very large "moat", to protect companies that make big profits. If there isn't a moat, then someone else is likely to come along and steal your lunch! A good recent example of this was Safestyle UK (LON:SFE) - where employees went off to set up in competition, teaming up with Pat Butcher along the way to help with advertising.

We can pore over the numbers all we like, but a key investing skill is basic common sense. Does this look reasonable? What is the moat? How sustainable are profits? What competition is there? How well is a company executing?

Another lesson to be learned from Crawshaws is the importance of entrepreneurial management. In my experience, big company management rarely do well at smaller companies. That's because they need to be hands on, flexible, and quick-witted at small companies. Whereas big company management are used to being in a large team, where most of the work is delegated. I often suspect that some big company Directors are pretty useless. The good work is often done by an army of excellent middle management.

The chap that Crawshaws recruited from Aldi was very obviously useless - despite appearing clever and impressive when giving talks. He broke the business, basically. His biggest error was to imagine that gross margins could be increased. That was incredibly stupid, as it showed that he didn't understand the basic fact that Crawshaws is a discounter. People shop there because it's cheaper than the supermarkets. Once that ceased to be the case, then there was no point in shopping at Crawshaws, and sales/profits fell.

I suspect (and have always maintained this) that Crawshaws might succeed whilst very small, but once it became larger, it must have cropped up on the radar of the supermarkets, who can discount in specific stores to snuff out the competition.

Other problems include declining footfall in the secondary towns where Crawshaws is situated. Apparently, a lot of Midlands & Northern towns are like ghost towns these days. 

There's also a strange deal with 2 Sisters Food Group, which invested in Crawshaws, and supplies it with meat. I'm not a fan of incestuous deals like that.

I'd be surprised if Crawshaws is successful in raising fresh funding. It's far too small to be a listed company now. So I suspect it's likely to either go bust, and/or de-list. So a bargepole jobbie, in my view. the business model failed, time to move on.

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Pendragon (LON:PDG)

Share price: 26.5p (flat today, at 12:00)
No. shares: 1,402.8m
Market cap: £371.7m

Interim management statement

This Interim Management Statement for Pendragon PLC, the leading automotive online retailer in the UK, covers the period from 1 July 2018 to 25 October 2018.  Unless otherwise stated, figures quoted in this statement are for the three months ended 30 September 2018.

Underlying profit before tax is only £1.1m in Q3 (the year end is 31 Dec 2018). There's clearly seasonality affecting this, as the full year forecast looks more healthy;

We anticipate that our full year underlying profit before tax will be approximately £50m.

The new car market is in turmoil at the moment, due to new WLTP emissions regulations. There's an interesting article about it here. German car manufacturers seem to have been particularly hard hit. So the problem of reduced sales is due to restricted vehicle supply. It's got nothing to do with demand, nor Brexit!

This is a known issue, therefore, Pendragon's falling sales reported today, is not a surprise.

• Group revenue is down 7.4% on as LFL basis in Q3
• Used revenue is also down a similar amount, 6.3% LFL. I suppose fewer new car sales results in fewer trade-ins.
• The stand-out number is used car gross profit, which is up 13.7% LFL. That's impressive. Margins on used cars hit 6.9%, up from 5.7% - it's not clear whether the comparative is year-on-year, or quarter-on-quarter. But it's very good, anyway!

Management comments - nothing is said about performance vs market expectations.

We are encouraged by the improving used performance across the Group in quarter 3 of this year and this will be a key growth area for the business in 2019.

Valuation - a broker note out today shows 2018 forecast EPS at 2.8p, which is lower than the consensus figure shown on Stockopedia, of 3.09p

Using the newer 2.8p forecast, that puts the PER at 9.5, which looks about the right price to me. Car dealers usually tend to hover around a PER of 10.

My opinion - I don't want to own shares in car dealers right now. The Brexit uncertainty is weighing on the sector, plus supply difficulties relating to WLTP regulations.

I'd be staggered if there are any tariffs in either direction on cars, post Brexit. Both sides want free trade, so what's the most likely outcome? Free trade! However, it's possible that temporary supply problems might be encountered, depending on what arrangements are agreed.

This could leave car dealers very vulnerable, if supply bottlenecks get worse. They have a lot of fixed costs, so supply constraints would hurt.

The other way of looking at it, is that temporary, fixable problems could be creating a buying opportunity. PDG doesn't look particularly cheap, but shares in Vertu Motors (LON:VTU) have really fallen out of bed recently, down from c.50p to only 35p. Funnily enough, that's my favourite pick in the sector, so I'm sorely tempted to start buying that one.

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I have to down tools for now, due to a lunch appointment with mum! There's very little other news of interest to me today, but I'll circle back and have a look at the reader comments later today.