Small Cap Value Report (Tue 18 Dec 2018) - Overdrafts/High-Cost Credit, ANG, SDI, TOOP

Good morning!

Paul has added new sections to yesterday’s report, so that’s worth checking out first thing.

Mourinho has been sacked - quite upsetting for me, as I bought some José-related memorabilia during my recent trip to Old Trafford, which I planned to give as Christmas presents.

On the other hand, maybe we can see some attractive football from the old club again, at some point in future.

Today I am looking at:

• FCA proposals on overdrafts/HCC
• Angling Direct (LON:ANG)
• Scientific Digital Imaging (LON:SDI)
• Toople (LON:TOOP)

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Financial Conduct Authority

FCA Proposals on Overdrafts and other High-Cost Credit Products

This FCA work has been rumbling away in the background for a while.

Indeed, I reckon that the regulatory mood in relation to credit products has been affecting the valuation at H & T (LON:HAT) (in which I have a long position). This share currently trades at less than 8x forward earnings according to Stockopedia. But it won't be affected by today's proposals.

Where the proposals will have a massive impact is on overdrafts.

Several years ago, I was a very regular user of my overdraft - and deliberately so. The rate being charged wasn't particularly high, so it was worth it.

That all changed when the bank introduced flat daily fees - fixed fees up to £1,000, £2,000 and £3,000.

This was trumpeted as an improvement, as it made the overdraft fee easier to calculate, according to my bank (I didn't agree, because it meant that a complicated calculation was needed to figure out the implied APR).

Perhaps due to pressure from the powers that be, the bank also cut some of the heavy charges that applied to customers who went over their borrowing limits and who requested payments which could not be made.

The abolition of those charges meant that higher charges needed to be made to customers for their ordinary use of overdrafts.

Put it all together and the implied interest rate on my facility had become exorbitant. It was no longer economic for me to use it, and I have only rarely done so since.

Proposals

There are several proposals announced today. This is one of the more interesting ones:

• Ensuring the price for each overdraft will be a simple, single interest rate - no fixed daily or monthly charges;

Will this make bank overdrafts an attractive form of credit again? It all depends on the interest rate. I'll be very curious to see what interest rate my bank will apply if or when this new rule comes into force. 

Also:

• Mandating that arranged overdraft prices must be advertised in a standard way, including an APR to help customers compare them against other products;

This is really just going back to common sense, back to the way overdrafts used to be advertised.

What will probably happen is that some customers wont be able to estimate the amount they will be charged using an APR, and then there will be pressure to go back to fixed daily charges again!

Also:

• Tackling the highest costs in the market by stopping firms from charging higher prices when customers use an unarranged overdraft;
• Issuing new guidance to reiterate that refused payment fees should reasonably correspond to the costs of refusing payments, and explain the costs that may be included;

My guess is that the new interest rate on my overdraft will be quite a lot higher than the one I had before.

My reasoning is that under the old regime, it was the customers who had big charges against them for an unarranged overdraft and unpaid transaction fees who made the whole system really profitable for the bank.

Without big fees from unarranged overdrafts and unpaid transactions, the arranged overdraft fees will, I suspect, have to be higher than they were before. So I doubt that I'll have any reason to become a frequent user of my overdraft again.

What about you, do you use an overdraft or would you use it if it was less expensive?

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Angling Direct (LON:ANG)

• Share price: 82p (unch.)
• No. of shares: 65 million
• Market cap: £53 million

Trading Update

This is the last fishy stock left after Fishing Republic (LON:FISH) went into administration. It has 24 stores (vs. 14 owned by Fishing Republic).

Forecasts for the current financial year have been edging downwards, and Angling Direct is now expected to make a small loss:

These are the only two growth metrics worth focusing on, in my view, and they are strong:

• store LFL sales +7%
• e-commerce sales +24%

(Total sales is uninteresting because you're not comparing like with like, and international sales growth is uninteresting for now because it's still coming from a really low base - although 96% growth does encourage.)

Outlook

Momentum has continued into the Christmas trading period. The Board is confident of meeting full year expectations.

My view

The company appears to be performing well (in line with expectations) and I can't fault management.

The bigger question for investors, it seems, is whether fishing tackle is an attractive investment niche in the first place!

Angling Direct's gross margin at c. 33% says to me that there isn't a great deal of value-add, and the high fixed costs associated with its physical stores - which are expanding - have resulted in extremely low operating margins in recent years.

We were reminded yesterday by ASOS (LON:ASC) that a low operating margin can be a major source of risk, as a small deterioration in trading can have a disproportionately negative effect on profitability.

There is also the very high number of SKUs to be reckoned with in this niche. Angling Direct claims to sell 21,500 different products. It's not easy to run an efficient balance sheet with such complicated inventory (though to be fair, Angling Direct seems to be much better at it than Fishing Republic was).

So for these reasons, I'm not tempted to get involved with this share, even if the company is growing and performing very well in the circumstances.

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Scientific Digital Imaging (LON:SDI)

• Share price: 36.2p (+5%)
• No. of shares: 90 million
• Market cap: £32 million

Interim Results

This is an acquisitive group I covered in some detail back in January and then again in July. I usually compare it with Judges Scientific (LON:JDG), another group of scientific businesses whose strategy is to grow via acquisition.

Summary of today's results:

• organic revenue growth is still good at 11%. Total revenue growth 23%.
• pre-tax profit +42% to £1.2 million
• current trading comfortably in line with expectations

When you have a collection of many businesses thrown together like this, it's difficult to study them all on a fundamental basis. So in my view, it's more reasonable to study the group's overall track record and management's big-picture strategy. So far, SDI management have done well.

An important checklist item for me is that a PLC's share count is not rising too fast (without a really good reason!)

In September, SDI made a small acquisition using its existing cash resources. I'll be curious to see if future acquisitions can be made without resorting to more share issuance.

Today's announcement is promising in that regard:

The Group has adequate working capital reserves and bank facilities that can be used, with its steady cashflow, to acquire new companies with complementary technologies and SDI expects to announce further expansion of the Group with the addition of at least another new company by the end of the financial year.

According to today's financial statements, the company has £2.3 million of cash and up to £3.6 million in unused bank facilities. As the company say, that should be sufficient (plus operational cash flows) to fund the next acquisitions.

Outlook

Very confident:

Going forward, all our businesses are in good health and are prepared to trade profitably through any potential turbulence, while also developing new opportunities

My view

Everything looks to be going according to plan at SDI.

Last time I analysed it, I came to the conclusion that management were doing a good job, based on some ROCE calculations. Today's results show that the good news continues.

Overall, I like this share and I don't think it's too expensive, either. It appears to deserve a high StockRank:

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Toople (LON:TOOP)

• Share price: 0.277p (-5%)
• No. of shares: 954 million
• Market cap: £3 million

Final Results

Toople PLC (LSE: TOOP), a provider of bespoke telecom services to UK SMEs, today announces is final audited results for the year ended 30 September 2018.

This company provides broadband, mobile phones, etc. to small businesses. It recently raised a few million pounds, with which it expects to "deliver cash generation".

Key points:

• Revenue is up 17% to £1.5 million for the year. £250k of contracted revenue was achieved in November.
• "Strong current trading including record month in October 2018 followed by another record month in November and a healthy new business pipeline."

RED FLAG - No financial statements in the RNS

The RNS, very unusually, doesn't include a copy of the financial statements themselves. It stops at the end of the CEO review. So we have to go searching elsewhere to find out how big the loss was!

Having visited Toople.com, I can report that the pre-tax loss for the year was £1.4 million. I suspected it was going to be worse, if the company didn't want to put it on the RNS!

My view

Appears to be growing well in the short-term, so hopefully it can reduce the losses and cash burn this year.

On the other hand, I don't see much evidence that the company owns any valuable intellectual property. My default assumption is that it's a standard IT services provider. It is therefore puzzling to me that stock market investors would want to fund it, rather than its own directors!

Stockopedia classifies it as a Sucker Stock, and I can only agree, based on what I've seen so far.

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That's it for today, cheers!

Graham