Small Cap Value Report (16 Feb 2015) - DX., QFI, TUNG, ALLG

Good afternoon!

A late reminder, it's the Mello Beckenham tonight, and I've got a couple more investor events to mention tomorrow.

DX (Group) (LON:DX.)

Share price: 95p
No. shares: 200.5m
Market Cap: £190.5m

Interim results - are out today, covering the six months to 31 Dec 2014.

This company may not be on many investors' radar, as it floated about a year ago, went to a decent premium to the 100p Placing price, but has since drifted downwards to now stand slightly below the IPO price. As with quite a lot of smaller caps recently, the chart appears to now be forming a base, and edging upwards. So it looks potentially interesting, in terms of timing, maybe?

The group's activities are a parcels/logistics group, but for niche items - e.g. time-sensitive, high value, oddly shaped items, etc.

Trading - the company says it traded in line with expectations in H1, and notes that there is a bias towards H2 with its typical trading. Both turnover and adjusted operating profit are slightly down, therefore it looks like a mature business.

I note that the group has an unusually strong operating profit margin, given that it operates in a competitive sector, suggesting that it has some competitive advantages. The £10.7m adjusted operating profit is a healthy 7.3% of turnover. That's very good for a freight/logistics company.

Balance Sheet - this is dominated by goodwill, so stripping that out, the NTAV is negative, by £11.6m. However, there is surprisingly little debt, with net debt reported at only £12.1m, which is modest compared with the level of profits. On closer inspection, it appears that the company has a favourable cashflow model, whereby customers pay up-front - this is revealed by the £22.5m deferred income shown in creditors.

Overall, I wouldn't describe this as a strong balance sheet, but given the company's decent cashflows, it's not worryingly weak either.

Outlook - nothing specific on trading is said, just a general update on their plans to integrate & develop various parts of the group.

My opinion - I particularly like the dividend yield here, and the business has an excellent operating margin considering the sector it operates in. However, the company's comments about email substitution have rattled me a bit, see below (I haven't got the hang of the highlighter tool yet, so apologies for the wobbliness!);

So my concern is that the core business, which is probably the most profitable bit, is in long term decline. I spoke to a solicitor friend about this, who confirmed that they are using the DX service less than they used to, as more documents are now handled electronically.

Therefore it's a question of weighing up a fat dividend yield now, against the likelihood of core earnings probably declining in future. Although they might be able to offset that with acquisitions? Overall, my view is lukewarm now - it's difficult to imagine how these shares will attract a higher rating, given the declining core business.

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Quadrise Fuels International (LON:QFI)

Share price: 14.2p
No. shares: 809.6m
Market Cap: £115.0m

Business update - this is a blue sky company which has developed a method of refining a particular type of oil, which is cheaper and better than how it's done at the moment. Something like that anyway!

The shares went to a fantastically high market cap a while ago, and one or two of my shrewdest contacts liked the company, so I always sit up and take notice when smart & successful investors begin to congregate around a particular share.

The price was way too high for me at the time, but I've kept it on my watch list, and note that the price has now dropped by about two thirds from the peak. Although at £115m, the market cap is still very expensive for an unproven, zero turnover company.

Today's update is difficult for me to interpret, not knowing anything about the sector or the company. However, the core points today seem to be that;

1. Quadrise's innovative process is still viable, even at lower oil prices.

2. However (as you would expect), oil companies are reluctant to agree to new capex.

3. There are therefore likely to be unknown delays.

4. The company says it has enough cash in the bank (so hopefully no Placing).

My opinion - it all sounds too uncertain to me, and the market cap seems very high still. Although the key thing for any company related to oil, is having enough cash in the bank. That equals survival, when a higher oil price is likely to pertain.

At some point then, this stock could possibly make quite a good punt? Although for me I'd probably only want to have a flutter with fun money only, at about 5p per share, or below, which would still be about a £40m market cap incidentally.

Blue sky stocks nearly always take far longer & cost more than planned to commercialise, if they commercialise at all. Bulls of this stock argue that it is more credible than most, due to big name partners who have expressed interest in the company's technology. Maybe I'll just wait for the shares to bottom out over several months? It's almost got back down to where it started from - see two year chart below.

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Tungsten (LON:TUNG)

Share price: 212.5p
No. shares: 103.5m
Market Cap: £220.0m

Contract win - it's reassuring to see the announcement today that Tungsten has won a major new client, in Royal Caribbean cruise line, for its e-invoicing software.

We've discussed this company at length before, and I must admit to having gone a bit wobbly over it in recent weeks, as it became clear that things were taking longer, and costing more than planned.

That said, the core idea of creating a huge captive supplier base, and then offering it seamless invoice discounting, is a brilliant idea. Although on reflection the market cap probably got ahead of itself in mid to late 2014, as often happens with exciting concept stocks.

I'd like to see management firm up on the economics of things, rather than more of the flamboyant, but arguably over-promotional presentations of the past. It's all very well wowing investors with talk about hundreds of billions, and trillions, of invoice flow, but I think people are more interested in knowing how much profit will be extracted from the invoice flow.

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All Leisure (LON:ALLG)

I've had a quick skim through this small cruise ship operator, and the numbers look bad to me. The balance sheet in particular looks very thin, and hence the financial position strikes me as precarious.

The company says it should benefit from lower fuel prices in 2016, but is partially hedged until then, at higher prices. I don't think it's fair to criticise companies which forward hedged their fuel at higher prices - the hedge achieved what it was meant to achieve - i.e. certainty of price. Hedges are not intended to be gambling on the future price, they are to protect against unexpected spikes up in price.

There always seems to be some geopolitical disaster for this company. If a new war zone erupts somewhere, you can virtually guarantee that this company will be operating a cruise ship there, and will lose millions in bookings. This time it was Crimea. Previously it was Egypt. Then there have been repeated mechanical breakdowns, of their elderly ships.

The divis stopped a couple of years ago I note, and it's difficult to come up with any rationale at all for wanting to buy shares in this company. It looks high risk, and low reward, rather the opposite of what we're meant to be seeking out.

I don't know what the end game is likely to be for this company, but I suspect it won't be good.

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Apologies for today's report being late, will be at the usual time tomorrow!

Regards, Paul.

(of the companies mentioned, Paul has a long position in TUNG, and no short positions. A fund management company with which Paul is associated may also hold positions in companies mentioned)