Small Cap Value Report (16 Aug) - PGB, VLX, OPM, TNO, SUN, AVON

Good morning! It's a very quiet day for results, but there are a few trading statements that I'll take a look at.

Markets overall had a much-needed correction yesterday - the tone in small caps has become far too bullish, even slightly frenzied in some areas, and it's becoming very hard to find value now. Just look at the extraordinary bull run in the FTSE Small Cap Index XIT (FTSE:SMXX) below. Some of that rise is due to increased earnings, and also the marking up of prices to factor in economic recovery, but surely a more meaningful correction is only a matter of time? Hence why I'm selling things that look fully valued (I sold Pilat Media Global (LON:PGB) yesterday at 62p for example on a big spike up following positive contract announcements, and a magazine tip).

The opportunities now are probably going to come from sitting in cash, and picking up bargains when the next big market sell-off occurs. This sometimes hits small caps hard, providing good opportunities, e.g. yesterday Volex (LON:VLX) suddenly spiked down 10% on thin volume, and no news, as a clumsy seller hit the Bid hard - which you see a lot of these days, as Spread Betting companies close out over-geared clients, and don't really care what price they get.

Such spikes are one person's pain, but our opportunity. Hence why I think having some cash on the sidelines is vital right now, and it doesn't matter at all that you get no return on the cash in the meantime, as simply having it ready will provide a much bigger opportunity when the market suddenly throws a bargain in your direction. That's how I see it anyway.

Opportunities are also coming on an individual company level from profit warnings. I've not measured it, but the market seems to be forgiving good companies for profit warnings more quickly than in the past. Subjectively, it seemed to be at least six months for sentiment to recover on a company that disappointed, whereas now I've observed it can be as little as a fortnight, or more typically about two months. As long as it's a good company, that has just hit a temporary bump in the road, and not something that's in terminal decline, then these can be good opportunities. However, getting the timing right is so difficult.

 

 

 

 

 

1pm (LON:OPM) has issued another bullish trading statement. This is a small asset financing business, which is exploiting a lucrative niche left behind by the Banks, of financing equipment purchases for small businesses, e.g. equipment needed for hairdressing salons, cafes, etc. They have a sound business model, with low rates of default, since they secure personal guarantees from borrowers, and spread their risk over lots of relatively small customers. Margins are good, and it's a nice little business.

The shares have tripled in price this calendar year to date, and in my opinion are probably now up with events. Although for long term holders, I think this share is likely to do well, as it's now simply a matter of them doing more of the same - lending to the many businesses that need financing, and 1PM obtaining its own finance from various outside investors who are attracted by a better rate of return than a deposit account. At some point new entrants will eat away at this niche, but 1PM seem to be making hay whilst the sun shines.

It's a difficult one to value. To be prudent, one should really value the company at NTAV (net tangible asset value, i.e. the Balance Sheet total). However, with a profitable niche, you could also convincingly argue that it should be valued on a multiple of say 15 times next year's earnings. Trouble is, I can't see any estimate for next year's earnings, just for this year, which is for 0.019p per share. That looks a little pessimistic, given that they did 0.0178p for the y/e 31 May 2013, and are growing strongly, although there has been some dilution from a recent equity fundraising.

So if they say do 0.02p EPS this year, then at 0.285p the shares are rated at about 14.5 times this year's earnings, which is probably priced about right for the time being. Nice little business though, and I'm kicking myself for dithering too long, when it was flagged up to me by a friend at around 0.15p per share. Would have almost doubled my money by now if I'd taken the plunge. Never mind.

(Edit: I hear there has been a kerfuffle over the AGM today, in that shareholders were expecting it to start at 12:30, but it had been brought forward to 10am (but the time change had not been issued via an RNS). So there are some very unhappy shareholders travelling long distances today, I am told).

 

 

 

 

 

As I've repeatedly warned here, RSM Tenon (LON:TNO) seems likely to be a complete write-off. That was blindingly obvious from the accounts for a long time, but still the shares are trading. The company sets it out starkly this morning, saying:

 

... However, it is now likely that, as a consequence of the Company's high debt level, if an offer is made by Baker Tilly, minimal value, if any, will be attributed to the issued share capital of the Company.

 

The last hope for shareholders is that some sort of white knight crops up, but it's very unlikely indeed - because the bank debt considerably exceeds the probable value of the business. Hence nobody in their right mind would buy the business through acquiring the equity. Instead they would just do a deal with the Bank to take control of the parts of the business they want through acquiring the debt & then restructuring through an Administration probably. That of course leaves shareholders with nothing.

How utterly bizarre to see an accountants practice ending up in this state (not for the first time, Vantis ended in a similar way). I really do think there must be something badly wrong with accountancy qualifications, if they teach people only how to do the technical stuff, but not an ounce of basic commercial common sense, by the looks of it.

 

 

 

 

 

It's noteworthy how strongly gold producing stocks are recovering at the moment. Unfortunately, I got the idea right (buying Medusa Mining (LON:MML) and African Barrick Gold (LON:ABG) a few weeks ago), but fluffed the trade, as I lost my nerve when the price of Gold suddenly tumbled, and hence lost out of the big potential gains. Very annoying when you get an idea right, but in a moment of doubt, close the position (usually at the worst possible time).

Lesson learned from this: keep positions sizes smaller, and ride out short term fluctuations. In fairness, that's what I normally do, but in this case got cold feet because gold mining shares are really outside my area of expertise.

Second lesson learned from this: stick to my knitting! It's easier to ride out a bad patch if you've done your research properly, and hence are reasonably confident that you're going to be right in the long run. Whereas trades that are under-researched, and more of a punt than an investment, tend to go wrong more often because you don't have the conviction to hold through a rocky patch.

 

 

 

 

 

The market likes today's trading update from Surgical Innovations (LON:SUN) with the shares having risen 22% to 5.63p this morning at the time of writing (09:58). I last looked at this company on 19 Feb 2013, and thought it looked interesting, but felt they were fully priced at 7p per share.

Some big orders slipped past the 31 Dec 2012 year end date, as was explained at the time, which caused 2012 figures to miss target, but of course gave H1 this year a flying start. That reality seems to have been conveniently forgotten in announcing positive H1 results today! Funny that.

Revenues for H1 (to 30 Jun 2013) were £3.88m (up 28% on the prior year H1), and adjusted EBITDA was up 16% at £1.14m. Profit before tax more than tripled to £567k. As always with EBITDA figures, they need to be treated with suspicion. I don't mind excluding goodwill amortisation on acquisitions, but anything else is usually questionable.

This company has also, unusually, benefitted from a £5m Grant to build a new facility, so that's encouraging stuff, but had been previously announced. As a potential investment, a significant grant win would give me some confidence about the ability of management to raise money, and that they must have a fairly convincing proposition.

The key sentence is that the company, "continues to trade in line with market expectations for the full year". Stockopedia shows consensus forecasts of 0.4p EPS for this year and next, so that puts the shares on a PER of 14.4 times forecasts, based on the current mid price of 5.75p.

I don't really know whether it's good value or not, as this is a growth story - so one would need to really get under the bonnet, and ascertain the likely growth prospects for the products. I've not done that, so cannot really give a view on the valuation, other than to say it looks priced about right, maybe even a tad expensive, based on broker forecasts. The market cap of £23m after today's rise seems pretty steep for such a small company.

 

 

 

 

Avon Rubber (LON:AVON) has issued a statement saying that, "The group has continued to make good progress and expects to deliver full year results in line with market expectations".

The shares are on a forward PER of about 14, and pay an unexciting 1% dividend, so I can't see anything to get me interested there.

 

 

 

Gotta dash, as I'm off to London for a meeting.

Have a smashing weekend, and see you on Monday from 8 a.m. as usual.

Regards, Paul.

Of the companies mentioned today, Paul has a long position in VLX, and no short positions.

A Fund to which Paul provides research also has a long position in VLX, and no short positions)