Small Cap Report (11 Mar) - HYDG, PUR, BRY, ESCH

Pre 8 a.m. comments

I'm having a quick scan of the 31 Dec 2012 final results for Hydrogen (LON:HYDG) first this morning, as it's a company which has come up on my radar as looking reasonably-priced before. Hydrogen is a mainly UK recruitment group They have some overseas operations too, but 81% is UK, so clearly 2012 will have seen challenging conditions.

It looks as if a lacklustre year was expected, as Stockopedia shows normalised EPS of 10.3p in 2011, forecast to fall to 8.6p in 2012. The actual number is 9.56p for diluted EPS (which seems the right comparative number, as prior year was 10.24p), so that looks like about a penny above expectations for the 2012 results.

At 95p this puts the shares on a PER of 10, which looks about right for a business that is in a competitive sector, and is not showing any profit growth. The question is how much should we be anticipating earnings growth from a recovering economy? That's really up to each investor to decide, but personally I'm not prepared to pay a significant premium, given that there are so many uncertainties about an economic recovery that is at best tentative.

The main attraction with Hydrogen is the dividend, and with the final dividend being raised slightly to 3p, plus the 1.5p interim dividend, that gives a yield of 4.7%, which is pretty good.

Their balance sheet looks sound, with net debt having risen from £1.4m to £2.8m, mainly due to higher working capital. Overall the balance sheet is fine, with £31m in current assets, less £20.9m in current liabilities, giving a healthy surplus of net current assets of £10.1m, and only £127k in long term liabilities.

In the context of a £22m market cap, making £3.4m operating profit in 2012, those balance sheet numbers look pretty solid to me. So it's a fairly safe investment, which looks OK value to me, although I'm not exactly jumping around with excitement at a PER of 10. There's probably fairly limited upside on that in the short term, but it looks a sound company which I will keep on my watch list, and buy if it dips to 80p or less in a market downturn.

 

The PER drops to 9.26 on current year forecast EPS, and the dividend yield rises to 5.0%, so maybe I'm judging it too harshly? The outlook statement says 2013 has so far been in line with expectations.

This is the "Growth & Value" box on the Stockopedia StockReport, which is an excellent quick visual way to get a snapshot of whether a share has good valuation characteristics.

In a nutshell, the more green it looks, the better! The bar charts show where Hydrogen ranks in both its sector, and the market as a whole. It's pretty green, meaning it's worthy of a deeper look, with the most green attributes being dividend yield and price to sales (although since some recruitment companies include the employees wages within turnover, then Price to Sales is a bit of a red herring in this sector).

 

A friend has been telling me to look at Pure Wafer (LON:PUR) recently, saying it's generating good cashflows, and that the shares might be cheap. Their results this morning seem to indicate he might be onto something, as Pure Wafer (which does some sort of silicon wafer recycling) reports a move into profit (just!), but more importantly net cashflow generated of $2.8m for the 6 months to 31 Dec 2012. There is a large depreciation charge, which is historic, and of course non-cash, so the attraction is that it's now throwing off free cashflow.

Following a Placing, net debt has fallen dramatically from $15.1m to $3.4m, so this look pretty interesting. The market cap is only £13.7m at 5.25p, so looks like worthy of more research, although one must remember to convert figures reports in dollars into sterling. It's a turnaround situation that I quite like the look of. IF they can continue improving margins, then they could have a nice business there, and providing no significant replacement capex is needed, which I'm told it isn't.

 

I've had a quick look through year ended 31 Dec 2012 results for Brady (LON:BRY) but can't get excited about the valuation, which looks a bit pricey to me. They are showing growth, but it's all come from acquisitions. Adjusted EPS of 5.94p puts them on a PER of 15.5, which wouldn't interest me unless there was very good organic growth, which doesn't seem to be the case here. They provide software to the commodity & energy markets. It has an unexciting dividend yield too, so not really my sort of thing. I like value (i.e. low PER, high dividend yield, and strong balance sheets), preferably combined with good growth as well. Characteristics which are becoming very hard to find, given recent very strong markets.

 

Escher Group (LON:ESCH) provides postal service software around the world, and has delivered strikingly good results today, for the year ended 31 Dec 2012. They report in US dollars. Turnover is up 66% to $23m, and net debt has fallen sharply from $8.3m to $2.2m, which seems to have been driven primarily by a $6.4m Placing in Apr 2012. Operating profit rose a very impressive 97% to $4.9m.

You have to wonder whether the stock market will give a premium rating to a software company in a structurally declining area such as the postal industry, althouth that depends whether the software can be used by courier firms too, or just conventional postal services? I've not looked into their activites to find out, but results showing this level of growth have certainly sparked my interest.

EPS translates from 16.5 US cents to about 11p per share. That means at 256p, they look expensive against 2012 earnings. Although Stockopedia shows 2013 EPS forecast at 47 US cents, which translates to about 31p EPS, so a share price of 256p puts them on a 2013 PER of only 8.3, which looks good value for a company that has doubled its earnings.

It all depends whether you think the 2013 earnings estimate is achievable of course, and whether it's sustainable, or due to one-off factors, which can be a risk with software companies that have lumpy licensing revenues. Earnings growth like that is unusual, and pretty exciting, so this one certainly deserves a closer look. Remember I only ever skim the figures in these morning reports, to highlight potential opportunities for further research by readers. However, on the face of it, Escher looks very interesting & worth a closer look.

 

Given that two companies I've looked at this morning report in US dollars, it's striking just how much sterling has depreciated against the dollar recently. It seemed almost fixed a £1 = $1.60 for quite some time, but a rapid move has taken that to £1 = $1.49 this morning. This is good if you hold shares that report in dollars, as earnings translate into a higher sterling amount. But it's bad if you own shares in a UK company which imports a lot of goods priced in dollars (which most consumer goods are). It also means higher inflation in the UK, with consumer disposable incomes put under pressure.

With such a fairly significant & rapid move in exchange rates, I'm just flagging it up to readers, that you need to stop & think how exchange rate changes will impact the companies whose shares you hold. If in doubt, why not ring them up, and ask the CEO or FD what the impact will be? Most small companies tell me that hardly any shareholders ring them up to discuss the accounts, so if you do, I find that you nearly always get straight through to one of the Directors. Or after leaving a couple of messages, they usually call you back. It's essential to have your questions prepared in advance though, as usually Directors are not interested in waffle, but will answer specific questions, providing you're a shareholder, and you're not asking for anything which might be considered price-sensitive.

OK, that's it for today. Thanks for reading & please feel welcome to comment in the comments section below. See you same time every weekday.

Regards, Paul.

(of the companies mentioned today, Paul has no long or short positions)