Small Cap Value Report (29 Jul) - CRE, XPP, SNCL, PTCM, ZATT

Good morning! The futures are indicating a modestly upwards open for the FTSE 100, up 15 at 6,569. Howewer if you look at the small caps index (see 3-year chart below), it's absolutely gone bananas in the last year, so my overriding sense is that this is a time to be extremely careful, and not over-pay for things just because they keep going up. I think there are many small to mid caps on very stretched valuations now, and personally I will not budge on my value criteria. Many over-bought shares just look like accidents waiting to happen, in my opinion. Hence why I think it makes sense to be sitting on some cash right now, as you cannot buy the dips unless you have some cash to hand. It doesn't really matter that you don't earn a return on cash, that's not the point. It's all about protecting capital.

 

 

 

Creston (LON:CRE 105p) is a share that I've spoken mainly positively about before, and it issues an IMS this morning, covering trading in their Q1 from Apr-Jun 2013. It starts off with a negative (which tends to set the tone), saying that revenue is 5% lower than last year, "as expected". If it was expected to have a soft Q1, then it seems odd that they didn't say so in the last outlook statement issued on 12 Jun. So this might cause slight jitters amongst investors today?

However, there might be enough positive news in the IMS to counter-act that. In particular I like this comment, which is a further pointer towards an economic recovery (my bolding): 

 

Don Elgie, Group Chief Executive of Creston plc, said, "The IPA Bellwether Report on client sentiment towards increased marketing spend is the most encouraging for six years. At Creston we are seeing this being borne out by high levels of new business activity and while opportunities must always be converted, the level of pitching we are seeing is the highest I can remember. Based on our historic pitch to win ratio, we are confident that this will lead to further underlying growth in our client base."

 

Overall then it sounds like Creston have had a fairly slow start to the year, but expect to make it up, and they summarise by saying that new business wins will enable them to meet expectations for the full year. That sounds OK, but I don't think I'll be chasing the shares up any higher than where they are, at 105p.

That said, at 12.1p consensus forecast EPS, the PER still looks fairly good value at 8.7, and there's a fairly good 3.7% dividend yield too.

 

 

 

 

XP Power (LON:XPP 1339p) issues its interim results to 30 Jun 2013. I've only looked at this company once before, here on 9 Jul 2013, and liked what I saw - a high quality business generating excellent profit margins, and paying a healthy dividend.

Turnover is up 5.3%, which is in line with their 9 Jul statement which indicated that results would be in line, and turnover up 5%. Diluted EPS came out at 41.8p for the six months, and it looks like there is a slight H2 weighting to trading, so 89.4p full year broker consensus looks achievable. That puts the shares on a PER of 15 at 1339 at the time of writing this.

Although it's a quality business, delivering a tremendous 21.6% operating profit margin, there's not a lot of growth in evidence, so it's difficult to justify a PER any higher than 15. So overall, I like the business, but the shares don't seem to have enough margin of safety (if any) for me at the current price.

The outlook doesn't sound great either - they refer to their markets "remaining subdued".

 

 

 

 

Profit warning of the day comes from William Sinclair Holdings (LON:SNCL 127p), their shares are down 15% to 127p at the time of writing, which reverses a similar sized gain in the last month.

Sinclair are a horticultural products group (e.g. compost, etc). Checking back into our archive here, my most recent comments from 10 Jun 2013 on this company proved correct, when I commented:

 

It's come up here before, as a potential buying opportunity (due to the coldest Spring weather for 50 years), but after looking at their interims this morning, I cannot get excited about William Sinclair Holdings (LON:SNCL) . It just looks too messy, with a lot of debt, a very capital intensive business (being a producer of horticultural products), and a pension deficit. Plus they are developing a large flagship production plant at Ellesmere Port, which involves duplicated overheads for several years. Just too messy, and it doesn't look particularly cheap at the moment either given poor current trading.

 

 The profit warning today is based on Q3 (Apr-Jun) sales being below forecast, with "little scope to achieve any further sales recovery in the final quarter" (Jul-Sep).

They also report processing problems at the new flagship site in Ellesmere Port, which will impact profit. The wording sounds worrying, as it conveys a sense that management do not seem to be fully in control of the business, referring to hiring a consultant engineer who has advised them to slow down production.

So the summary is that they are "unlikely to meet current market expectations", which doesn't sound horrendous, so the 15% fall in share price is probably about right. I'm taking this one off my watch list now, as it's too accident prone, and I don't like the Balance Sheet.

 

 

 

 

Porta Communications (LON:PTCM 8.6p) is an interesting one that's cropped up on my radar before. I noted the positive trading update on 14 Jan 2013, but didn't feel it contained enough information to value the company. Then on 9 May 2013 I was unimpressed with their 2012 results.

Porta is a marketing group, being built through start-ups, which doesn't strike me as necessarily a great business model, since it involves up-front losses.

They say today that H1 (six months to 30 Jun) turnover will match that for the whole of 2012, which was £8.4m. They expect further "substantial growth" in H2. They say that H1 will be loss-making, and H2 should produce enough profit to make the year as a whole breakeven. That seems to be well below broker consensus, which is showing as a £1m profit on Stockopedia. It's surprising then that the shares have risen today, given that this is really a profits warning, although perhaps it's couched in a sufficiently cunning way that people haven't noticed!

The shares are really just a punt on future profitability, which I have no idea how to assess without getting into the detail of each business. Really to invest in this type of situation you would need sight of the management accounts & internal forecasts, but that would make you an Insider, and hence unable to deal.

It might have great potential, but I don't invest based on hope that a business might make a profit in the future, when that cannot be quantified by me. Personally I think this is a good sector to look at now, being exposed to economic recovery, but to my mind established players offer more safety to investors, rather than a start-up.

 

 

 

 

 

Breaking News - I see that Zattikka (LON:ZATT shares suspended) has gone bust. This should not have come as a surprise to any readers of this column, as I published a strongly worded warning about these shares on 10 Jul 2013, as follows:

  

There was a hideous profits warning last night from computer games company Zattikka (LON:ZATT). It is clear that the company is in serious trouble, and is now "evaluating all strategic options", and is dependent on the continued support of creditors. Hence the 41% share price fall today to 16p if anything looks like an under-reaction. If I held these shares, I'd be dumping them as fast as possible today, because surely a deeply discounted Placing is on the cards now, or even insolvency if nobody is prepared to support it.

 

Zattikka only Listed in April 2012, at 100p. So to get into serious trouble in just 15 months after Listing is a very poor show. It once again calls into question the quality of companies listing on AIM. Nobody benefits from speculative, early stage companies getting a Listing & then blowing the cash raised in just over a year, it just brings the whole market into disrepute.

 

 

Shareholders are not likely to receive anything, as the statement today makes clear, the key sentence being:

the Group is considering its options in the context of insolvency proceedings

 

Yet again, the lesson learned is to scrutinise Balance Sheets, and make sure a company has a solvent financial position, relative to its trading & cashflows. If it doesn't then the shares are an accident waiting to happen. Nobody with a rigorous approach towards researching the figures should have been anywhere near this share.

It's these 100% losses that make such a big dent in a portfolio's performance, yet actually they are terribly easy to avoid - just don't buy any share based on hype/hope, but instead just stick to profitable, cash generative companies with solid Balance Sheets.

Or if you do go for something more racy, then make sure they have enough cash on the Balance Sheet to last at least 2-3 years at the anticipated cash burn rate.

 

 

OK, gotta dash, am heading into London to meet a small cap company management. Will report back if it is interesting!

See you same time tomorrow.

Regards, Paul.

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