Small Cap Value Report (9 March 2020) - Oil apocalypse, OTMP, THAL, ORPH, VLG

Morning all.

I feel privileged to be reporting to you on this dramatic morning.

Some key developments:

• 133 people in Italy tragically lost their lives to the Coronavirus yesterday. Lombardy and other parts of Northern Italy are now under a travel ban.
• In better news, the number of new cases in China has reportedly collapsed.
• The number of UK cases rose from 209 to 278 on Sunday.

Financial movements:

• US Crude Oil is down 27% (not a typo) since Friday. Brent crude is down 26% at $33.50.
• The FTSE is currently set to open at around 6065, down 6.3% since Friday.
• The S&P is trading down 5% overnight.
• The FTSE MIB (Italian equity index) is down 8% overnight.
• US Government Bond Yields are hitting record lows, an indicator of bearish sentiment. 

The US 10-year yield fell to less than 0.5% (it was 1.5% a few weeks ago), and the 30-year yield fell to less than 1% (it was 2% a few weeks ago).

This morning's price action is likely to be dramatic, for obvious reasons, in the oil sector. Also worth watching are transports, hospitality and financials.

Sector indexes worth a watch:

• FTSE 350 Oil & Gas Index
• FTSE 350 Oil Equipment & Services Index

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What I'm doing

I'm fully invested, so I'm not doing anything.

Actually, there is one thing I'm doing. The FTSE trade which I opened two weeks ago is currently showing a large mark-to-market loss, so I'm making sure that there is enough collateral in my trading account to withstand these temporary losses.

I'm also thinking about what shares I might buy, when funds allow. I love looking at contrarian ideas so I'd like to study Carnival (LON:CCL) at some point, if I can find the time.

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What you should be doing

I only know what I'm doing, and can't speak for what anyone else should do!

In very general terms, I do strongly believe in having a plan. If you didn't already have a plan for what you might do in a bear market, then creating that plan now might not be the worst idea. 

Even if the plan is "do nothing", at least you'll have certainty!

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US Markets

Regarding the S&P, Dow and NASDAQ Indexes, it must be said these futures markets are all currently limit down, as they started to trade more than 5% lower than their previous close.

When indexes trade "limit down", no more trading is allowed until a certain amount of time has passed.

If you're interested, you can check the daily limit levels here. The 5% down limit for the nearest futures contract on the S&P, for example, is 2819. The nearest futures contract is "SPH0" - H is the code letter for March, and "0" represents "2020".

Since the 2819 level has been breached, there will be no more trading of these futures until this afternoon (UK time). When they reopen, there will be new down limits (which you can also see if you click the link).

The Dow and NASDAQ are in the same position. No more trading for now.

My first permanent job in the financial markets involved analysing futures, and I used to find it fascinating when things went "limit up" and "limit down". It usually took 30 seconds of puzzlement before I realised what had happened. And then the intraday chart which I'd been analysing would be ruined.

While I understand the rationale for having up limits and down limits, I do much prefer the anarchy of not having them. Today, for example, US index traders (if they are awake) are going to spend the next four hours nervously waiting for the markets to reopen, locked into their positions.

Up limits and down limits are supposed to help maintain orderly markets. But when people face getting locked into their positions, I wonder if that can ironically increase the levels of panic and herd behaviour?

It will be fascinating to see what kind of herd behaviour takes place in the US markets at 13:30 this afternoon.

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Oil Wars

I don't know much about this topic ("what's new?", I hear you say). Disagreement between the oil-producing nations is the immediate trigger for the sell-off we witnessed this morning.

According to Bloomberg, Saudi Arabia wanted OPEC to cut down on oil production in response to weak demand (because of Covid-19).

Russia refused to go along with this, and the cartel's existing agreement fell to pieces. Russia is said to be more comfortable with lower oil prices than Middle East producers, and wanted to give barely-profitable US shale producers a bloody nose.

The upshot is that instead of oil production going down, it's set to go up. 

In an act of retaliation against Russia, Saudi Arabia slashed its official oil price. We've got a full-on race to the bottom.

My view

Please bear in mind that I'm very far from being an expert when it comes to oil. Treat what follows as you would the ramblings from one of your local pub regulars.

That health warning out of the way, I must say that a falling oil price does not strike me as terrible news, if it is the result of increased production.

Indeed, if you were a casual reader of the news in recent years, you might on the contrary think that a rising oil price is a bad thing:

• "The recent rise in the price of oil has raised the likelihood of a recession, according to market forecasts." (2018)
• "Spiking oil prices have led to recessions in the past, and that’s why the stock market is on edge" (2019)
• "How an oil price surge could hurt the US economy" (2020)

Maybe the oil price is like the proverbial porridge in the Goldilocks story. It can't be too hot or too cold, or else there will be an economic disaster. For a healthy economy, maybe it needs to stay exactly where it is?

I do of course understand that oil producers such as Royal Dutch Shell (LON:RDSB) (down 14% today) and BP (LON:BP.) (down 19%) will find the new conditions less favourable, and that indexes with a heavy bias towards oil production (such as the FTSE) will reflect this.

On the other hand, a falling oil price also clearly has many positive economic side-effects. Virtually everything in the global economy becomes cheaper, when oil is cheaper. It's effectively a pay rise for everyone. The consumer is enriched, and companies are enriched (all except for oil producers and their suppliers).

Looking at things from another perspective, we can also take solace from the fact that the "Peak Oil" theory is still just a theory. Oil production reached an all-time high in 2018, and recent events suggest that highs will continue to be breached.

On the other hand, while I welcome a falling oil price caused by increased supply, I don't necessarily welcome a falling oil price from decreased demand. The Coronavirus is clearly hurting global demand.

As things stand, we have the twin forces of increased supply and reduced demand. It's bad news if you're Shell or BP. For the rest of us, do we really have any reason to panic?

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Large Cap View

You might recall that I provided a view on Tesla ($TSLA) for Stockopedia last week.

This week, I've looked at Alphabet ($GOOG), where I have a long position:

"Just Google It" - Alphabet is the most powerful collection of monopolies ever assembled

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I can't remember what this article was supposed to be about - small caps?

Small caps with announcements today:

• Onthemarket (LON:OTMP)
• Thalassa Holdings (LON:THAL)
• Open Orphan (LON:ORPH)
• Venture Life (LON:VLG)

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On the Market (OTMP)

• Share price: 69p (-1.4%)
• No. of shares: 70 million
• Market cap: £49 million

Directorate change and trading update

The CEO falls through the trap door and is replaced immediately by his CFO, until a permanent replacement can be found.

This is despite a positive trading update. Revenue for FY January 2020 is "slightly" above guidance  and adjusted EBITDA (for whatever little that's worth) is "better than anticipated".

The Chairman praises the outgoing CEO while also saying that a new leader is needed "to take OTM forward through the next phase of its corporate development". Much is left unsaid.

My view 

I've been consistently negative on this share (see the archives).

The CEO getting the boot for mysterious reasons is hardly going to change my view, and nor is a better-than-expected "adjusted EBITDA".

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Thalassa (THAL)

• Share price: 62.5p (unch.)
• No. of shares: 16.2 million
• Market cap: £10 million

Trading update

My thanks to @rhomboid1MF on Twitter for highlighting the RNS published today by this BVI-registered investment vehicle.

The Chairman complains that insiders got a very good deal at one of Thalassa's investees, and that Thalassa was "unable to acquire a significant stake".

Maybe the investee should feel relieved about that.

For the Thalassa Chairman knows every trick in the book, and has even invented one or two of his own.

In 2018, he concocted a scheme whereby each Thalassa shareholder received Preference Shares: one Preference Share for every Ordinary Share held. Each Preference Share carried 10 voting rights.

Sounds pointless, doesn't it?

After you read the Terms & Conditions, it all became clear. The Preference Shares could not be bought or sold, and were cancelled, along with their enormous voting rights, as soon as the Ordinary Shares associated with them changed hands. It meant that anyone who simply sat on their existing stake was likely to see their influence grow and grow.

It was the most imaginative scheme to influence company voting power that I've ever come across. Thankfully, it was abandoned after a short while.

In early 2019, Thalassa then used its 25.1% stake in Local Shopping REIT (LSR) to delay that company's liquidation, an outcome which LSR had been working towards for years and which most of its (non-Thalassa) shareholders supported. That 0.1% made all the difference.

See what I mean about its latest investee potentially feeling relieved?

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Open Orphan (ORPH)

• Share price: 5.9p (-0.8%)
• No. of shares: 533 million
• Market cap: £31 million

Coronavirus Challenge Study Model

Open Orphan is going to use its 24-bed quarantine clinic to examine viruses similar to Covid-19. These viruses only cause "a mild cold-like respiratory illness".

The goal is:

to obtain fast proof-of-concept data against this important family of viruses... to test the efficacy of both new novel and existing vaccines and anti-virals. This will allow the effective selection of the best candidates and the effective products to be fast-tracked for subsequent field testing against Covid-19.

Funding is planned to primarily come from "new Chinese pharmaceutical partner companies".

My view - I'm afraid I have no idea what this might be worth.

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Venture Life (VLG)

• Share price: 28.8p (+5%)
• No. of shares: 84 million
• Market cap: £24 million

Trading update

A rare bit of blue in the sea of red.

This "self-care" company, which owns UltraDEX, Dentyl and a range of other brands, announces "a strong start to 2020". Orders from China are exceeding expectations.

Furthermore, VLG's facility in Italy holds "ample stock for production and packaging and now has additional reserve stock".

Staff are turning up to work as per usual, and production and shipments are unaffected.

In short, everything is fine at VLG and the soothing words have helped to trigger some relief buying of the shares.

My view - this one may be worthy of more detailed research.

Checking the archives, I have maintained a positive view of VLG as a company, but thought the shares were fully valued at their previous level of 50p.

At 29p, with operations seemingly unaffacted by the virus, they are considerably more attractive.

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Calling it a day there. And what a day!

Good luck everyone.

Graham