Small Cap Report (30 Jan) - ZZZ, TRCS, HRN, GBG, SPE, RNWH

Regular readers of my Blog might recall that I did a write up on Snoozebox Holdings (LON:ZZZ) last summer. The concept intrigued me (they convert standard shipping containers into comfortable temporary hotels, or staff accommodation), although the valuation became pretty stretched, and I sold my small personal shareholding later last year.

I'm thinking about buying back in, after a decent trading statement today. Results for calendar 2012 are expected to be announced in early April, with revenues ahead of, and profit in line with expectations.

So what are expectations? The only forecasts I can find suggest a small loss for 2012, but a £2m profit for 2013 (which translates into 3p EPS for 2013). So the share price of 69p looks very warm, on a PER of 23 times 2013 anticipated EPS, but the market looks ahead and prices in growth, so good growth companies are rarely cheap.

There is encouraging contract news in the trading statement today, which makes it clear that the concept is taking off, so it's really just a roll-out now. The temporary nature of most installations is a bit of a worry, so there might yet be bumps in the road in future, if e.g. they have a period of under-utilisation of the units. The longer-term installations are what really matter, as that generates consistent cashflow, without the costs of repeatedly erecting & dismantling a Snoozebox mobile hotel. Thorpe Park is a good example of where it's working, plus numerous other sites, such as Silverstone.

So it's a great concept, that seems to be working. Roll-out potential could be huge (especially if they achieve global growth), but the valuation does concern me, as a fair bit of growth is already factored in.

 

Tracsis (LON:TRCS) is a very interesting little company. I was one of around 85 investors who met the CEO, John McArthur at a recent investor forum arranged by Equity Development - clicking on this link takes you to the page on their website where the presentation slides from the companies at the meeting can be viewed - the other two companies presenting were Regenersis and VP Group.

Tracsis specialise in scheduling software which pretty much the whole UK rail industry uses to plan which trains & crews go where, making significant cost savings by better utilising their resources. TRCS also supplies hardware which monitors the performance of critical components such as points, overhead wires, etc, and is able to accurately predict when repairs are needed before the component fails, with obvious safety, reliability & efficiency benefits.

I was impressed with the CEO, but find the valuation of the company pretty aggressive at around 4 times sales. Although bear in mind that about one fifth of the market cap is net cash, which provides some comfort. It's also impressive the way the cash has built up, without burning a hole in their pockets. As he quipped at the meeting, with a Scottish CEO and a Finance Director from Yorkshire, they don't over-pay for their acquisitions! Bulls might see it as similar to Judges Scientific, in that it uses cashflow from existing businesses to buy cheap acquisitions, with shrewd management selecting the right acquisition targets, at the right price.

The trading update from Tracsis today is solid. It's perhaps stretching it a bit when they describe sales as "buoyant", at only "in excess of £4m". Both adjusted EBITDA and profit before tax are ahead of last year, and in line with expectations. Shareholders have become used to TRCS exceeding expectations in the past, so I'm not sure whether today's statement is strong enough to take the shares any higher for the moment? A £40m market cap doesn't leave any scope for uncertainty. Although we are in a bull market, so who knows?

Tracsis indicate that they intend announcing an interim dividend in due course, and the acquisition pipeline sounds interesting. Overall, I like the company, but don't feel I can stretch to paying this valuation of 165p, as nagging doubts about the sustainability of profit always creep into my mind with Tracsis. They had a stellar year last year, but there's no guarantee that will continue.

 

Toy train company Hornby (LON:HRN) warned on profits in September last year, although it's interesting to note that after 2 months trading sideways, the shares have been in an up-trend since. I've noticed this pattern with a number of shares lately, so it's starting to raise the prospect of selectively buying after profits warnings. Whereas in the past few years, profits warnings tended to be followed by repeated further waves downwards. This seems another sign of a more optimistic market, which is why I try to observe such trends, and adjust my investing strategy accordingly. It's getting easier to hit the buy button in these more forgiving markets.

Their problems seem to have stemmed from their failure to properly manage the supply chain, and over-reliance on one Chinese supplier who messed up production. Today's Interim Management Statement (IMS) looks reassuring, with the key points being that underlying profits for year-ending 31 March 2013 are in line with market expectations, and that net debt has come down sharply to £3.0m at 31 December 2012.

Demand sounds subdued still, and given that I cannot find any market forecasts for the current year, it's not possible for me to value the company sensibly on current trading. Forecasts for 2013/14 are for 3.5p EPS, so a share price of 79p doesn't look cheap, a PER of almost 23. So the market is clearly pricing in further recovery beyond that, and an EPS figure of around 8p was where the company was performing prior to its supply chain issues. Even that is a PER of 10, which seems fully valued to me, so recovery is already priced in, therefore Hornby shares don't interest me.

 

A brief trading update from GB (LON:GBG) confirms that results for year-ending 31 March 2013 should be in line with market expectations. 4.4p EPS is the market consensus, so at 89p a share that puts it on a hefty PER of just over 20 times. For my purposes the shares seem fully valued, hence are of no interest to me. They do have net cash too, of £5.8m which compares with a market cap of just under £100m, so a nice buffer, but not enough to be material to the valuation.

 

Thinking about the markets overall, we've had a tremendous start to the year, and some investors I talk to are getting nervous, thinking a correction must come at some point. I agree, and believe it's essential not to overpay for anything - just because the shares keep going up, doesn't mean they are good value! Markets can & do get valuations wrong, often for extended timescales. Those of us who remember the technology boom & bust in the late 90's and early Noughties, just laugh when anyone mentions the Efficient Market Hypothesis. Investing fashions and a herd instinct actually mean that markets can wildly mis-price shares, which provides opportunities for patient value investors, especially in smaller caps where anomalies are more prevalent.

There are a lot of market participants using momentum investing strategies, and I think that's dangerous because it tends to take share prices above (sometimes way above) a sensible valuation, which then increases the risk of a sharp correction. In my opinion it is usually sensible to top-slice shares which have gone up a lot, to lock in some profits, and free up cash to buy on the dips, and of course to buy things which have not yet moved up.

 

Software company Sopheon (LON:SPE) might be worth a look. Their trading update today sounds positive, with revenues for calendar 2012 set to exceed market expectations of £12m (up from £10.3m in 2011), and EBITDA also ahead of £1.6m expectations. However, be careful of software companies quoting EBITDA, as they have a tendency to capitalise development costs, and therefore EBITDA gives an inflated impression of their performance (since development costs are just a normal part of their ongoing business). So that would be the first thing I'd check in their accounts when they are announced on 21 March.

 

I've generally been sceptical about Renew Holdings (LON:RNWH) in the past, but am warming to this share. Q1 trading (they have a 30 September year end) is described as "satisfactory" in their AGM Statement this morning. The Group order book is "strong" at £340m (up from £289m at the same time last year). Net debt has reduced to £4.0m (down from £6.75m). Pretty good stuff.

It's a very low margin business though, being a principal contractor in construction & infrastructure projects. So a sector that is susceptible to contracts going wrong, and there being no fat in the price to absorb the shock, which is why I try to avoid this sector. That said, Renew appear to manage the risks well, and have consistently paid a 3p p.a. dividend throughout the last 5 year downturn, which is impressive.

The shares look good value to me on a forecast PER of 6.9 times this year's earnings, and it's always easier to invest when you have a bang up-to-date positive trading statement, as we do today.

 

OK, that's it for today. See you at the same time, every weekday. I usually try to publish these reports by about 10am, but always before noon in the worst case scenario.

Regards, Paul.

(of the shares mentioned today, Paul does not hold any short or long positions in any of them)