Small Cap Value Report (Fri 18 Sept 2020) - EYE, PCIP, ABDP, TIDE

Good morning, it's Paul with the SCVR for Friday.

I'm running late today - one of my dogs just got diagnosed with cancer, so I'm a bit pre-occupied. It's one thing after another this year, isn't it? Estimated finish time is 2pm.

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Webinars earlier this week

I had some more thoughts on both Eagle Eye Solutions (LON:EYE) and Pci- Pal (LON:PCIP) which have both put out very interesting results webinars this week. Recordings are available, and well worth watching.

EYE is here, courtesy of our extremely busy friends Tamzin & Tim at PIWorld.

PCIP is here on InvestorMeetCompany. On this platform you have to make a list of companies you follow, to be notified of upcoming and recorded presentations.

Small Growth Companies

Subscriber IGotPoesJacket started an interesting discussion in the comments to yesterday's SCVR, talking about a strategy of buying into loss-making small caps, when they seem on the cusp of moving into profits from good growth. I was thinking about this last night. My biggest ever investment gain was on a Scottish CCTV company called IndigoVision, where I spotted that sales of its innovative product were beginning to take off (triple digit % growth from a low base). I worked out that on 60% gross margins, and with a largely fixed cost base, the operational gearing should result in the company rapidly moving into profit. That's exactly what happened, and the shares 30-bagged.

I've tried to find other similar situations since then, but without much success. There's the odd big winner, like Best Of The Best (LON:BOTB) for example, but most tend to disappoint. Why is that? It's usually because;

1) They struggle to maintain the revenue growth rate, and/or

2) Overheads constantly increase, thus moving profitability further & further into the future, like a mirage.

A good example of this is Cloudcall (LON:CALL) (I hold) which is delivering good revenue growth, but never achieves its profit targets, because costs keep rising. When I talk to management, there's always a sound commercial reason for the increased costs they are incurring, e.g. expansion into the USA (which has worked well), Australia (because multi-national potential customers want global coverage), adding more product features to maintain market relevance & leadership, etc.. As investors do we want companies to invest for growth, or to fall by the wayside? Growth is clearly the right route to take. Maybe companies shouldn't be listed on the stock market, with investors who think quite short term, and who focus on profits too early?

Will EYE & PCIP make it into profit?

EYE - a couple of points from the webinar did concern me. It takes 6 months from project signing to going live, which management seem to think is good, but strikes me as quite ponderous. I'd prefer an investment where new customers can sign up and go live almost instantly, but I suppose that's not possible when your customer is a large, complex organisation like a supermarket. Also, 27% of revenues are implementation fees, which are one-off in nature. Although later in the webinar they said this includes professional services income, some of which could be ongoing in nature. This makes me worry that EYE has to keep signing up new customers, just to stand still in terms of profits. Although the very low churn rate of less than 1%, and increased recurring revenues, is good news. Another slight worry was that the CEO talked about having to "invest" in the USA - i.e. increased operating cost, as this is the biggest market opportunity. To me, that says the company isn't likely to be generating big profits any time soon, because point 2 above is likely to happen - constantly rising costs, blunting the operational gearing of increased revenues.

PCIP - if you watch the presentation, it very clearly sets out revenue growth (based on contracts already signed going live), and specifically stated that operating costs (80% of which is staff costs) do not need to rise much further. One slide showed the increased contracted revenue, against mainly fixed costs, and this should result in a dramatic fall in losses in the new year. Therefore I think management has set out a reasonable explanation for why it should achieve profits next year. It's not just an aspiration, they've given the evidence for why it should happen. IF that fails to happen, then investors can justifiably read them the riot act in future. Of the 2 companies, it seems to me that PCIP is probably the better bet, given its low valuation, and more convincing operational gearing, and faster growth than EYE. Whereas EYE is more sexy looking because of the big name clients, vast number of transactions, etc, hence why I think it has caught investors imagination more so than PCIP.

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Ab Dynamics (LON:ABDP)

Share price: 1838p (down 4% today, at 12:23)
No. shares: 22.58m
Market cap: £415.0m

Trading Update

AB Dynamics plc (AIM: ABDP), the designer, manufacturer and supplier of advanced testing systems and simulation products to the global automotive and mobility sectors, provides a trading update in advance of the publication of its results for the year ended 31 August 2020.

This sounds reassuring;

The business is performing well against the challenging global trading backdrop caused by COVID-19. Our manufacturing facilities have been fully operational with no significant supply chain issues, ensuring the Group has been able to deliver against customer requirements. ...

It took quite a hit from covid by the looks of this next bit;

Reflecting the resilience of the business model and the Group's strong market positions, we expect to report revenue for the year ended 31 August 2020, in the range of £60m to £62m. This includes the effect of COVID-19 specific disruption to our international customers, which resulted in a reduction in activity levels in the second half with Group revenues for the period being down by approximately 20% against a very strong prior year comparator.

Orders are recovering, so it sounds like they're possibly still trading a bit behind pre-covid levels?

The Board anticipates this recovery towards pre-COVID levels will continue into the new year, provided there are no further significant market disruptions.... we remain confident of winning these deferred orders, albeit timing is likely to be dependent on further stabilisation of customer visibility.

That last bit sounds a little hesitant.

Gross margins are up on last year.

It has plenty of cash.

Balance sheet - I've checked the last report (as at 29 Feb 2020), and the balance sheet is absolutely bulletproof, with lots of surplus cash. Hence no solvency issues whatsoever, the company could easily survive many harsh winters!

Outlook comments sound upbeat - making good progress on strategic growth plan, and new product development. Also looking at acquisitions.

Dividends - it previously suspended the interim divi (unnecessary, given the balance sheet strength), but will resume divis. They're tiny, so not worth bothering with.

Share based payments - this is pleasing. The company announces a more prudent accounting policy, whereby it will stop adjusting out share payments (to staff/Directors) from adjusted profit. This is music to my ears, as I've been arguing for years that share based payments are staff remuneration, so are not valid adjustments to profit.

My opinion - this is a terrific growth company I think. The shares never look cheap though.

I'd like to see the full year figures before deciding whether it's fairly valued or not.