Small Cap Report (18 Mar) - Cyprus bail-out, SAA, TRK, NGR, TNI, PEN

Pre 8 a.m. comments

The big news this morning is not from any company results (which are scarce today), but with the latest Eurozone bail-out, of Cyprus, which has really put the cat amongst the pigeons. For the first time, conditions have been imposed on a Eurozone Government which involve them directly plundering all bank accounts of Cyprus banks by up to 10%.

This seems a terrible mistake to me. The entire global banking system has always relied on one key fact - that depositors funds are sacrosanct. So by plundering everyone's bank accounts in Cyprus to fund the country's bail-out, the Eurozone have now made it rational for everyone to withdraw their entire savings from all Cyprus banks, at the earliest possible opportunity.

The initial plan did not even respect the Eurozone's own depositor guarantee for small depositors. They seem to be trying to back-track on that element now, but the damage to confidence is surely already done?

It's not just Cyprus either. This must surely trigger a fresh series of bank runs in the weaker Eurozone countries such as Greece, Spain, Portugal and maybe even Italy (where I understand a small, sub 1% bank account levy was done in the past, so they have form). Market Futures indicate that today will see a nasty sell-off, with the FTSE 100 due to open about 125 points down (almost 2%), the Euro has fallen 1.3% against the dollar (hardly a catastrophe though), and Gold is up 0.8% to $1605.

My Twitter timeline (which I use almost exclusively for financial news & views) was buzzing yesterday, when it's usually very quiet on a Sunday, so this has really rattled a lot of investors. As one commented, the market has been looking for a reason to sell off, and the Cyprus bail-out is probably it. I agree with that.

Personally I won't be selling any of my shares, because they are all long-term value small caps, so I don't respond to events like this. However, I have hedged myself by opening a new long in Gold at $1,605. It seems to me that there is a big risk now of bank runs in the Eurozone periphery, and people seeking the safety of physical assets (especially Gold), after this destabilising move to plunder the bank accounts in Cyprus. People don't believe politicians and officials assurances any more, so them saying it is a one-off is not believable. This sets a dangerous precedent.

 

M&C Saatchi (LON:SAA) has been on my watch list for a while, although I've never bought shares in it. Although as with most small to mid caps, the shares have done well over the last few years, having risen over 7-fold from their 27p low in Feb 2009.

With the shares at 219p, their reported EPS of 15.1p (up 6%) and full year dividend of 4.95p translate into a PER of 14.5 and a yield of 2.3%, neither of which interest me, because they look fully priced. You could argue that a cyclical group (being a high profile name in advertising) could command a premium price in a weak economy, to anticipate growth in an economic recovery, but personally I'm not happy to cough up a PER of 14.5 when it could have been had on a PER of under 10 just a few months ago. Some might say that is short-sighted, but I don't find it profitable to chase shares up, and pay a high price after a large rise has already happened. I'd rather buy when they're cheap, or not at all.

SAA also has some strange, and material financially, arrangement with a Put Option with a shareholder. It is shown on the face of the balance sheet as a liability of £20.5m (taking both elements in current and non-current liabilities). It seems to be related to minority shareholders in subsidiaries where SAA does not own 100%. That looks messy, and certainly puts me off investing.

 

Post 8 a.m. comments

Surprisingly, the UK market seems to be shrugging off the Cyprus issue so far, with the FTSE 100 already having recouped half of its initial losses, and is now only down 60 points at 6424.

There is very little volume in the small caps I follow on my monitor list, and the only significant moves seem to be in things like Ocado (LON:OCDO) and Thomas Cook (LON:TCG), which have had huge (in my view unjustified, and excessive) rises, so unsurprising that people would want to bank profits there.

I am wondering about revisiting Quintain Estates And Development (LON:QED) at 62p, on the basis that London property is likely to continue to be a safe haven for Eurozone investors, fearful of further issues developing there.

 

Torotrak (LON:TRK) announce an interesting deal, in which they will receive £6m in licensing fees from Allison Transmission Inc., for continued exclusivity (apart from 2 other licensees) to make and use Torotrak gearboxes in the commercial vehicle market. TRK also get a royalty on production, and Allison are taking a 5% stake in TRK at 30.255p a share, a premium of 20% to the market price. Sounds encouraging. It's taken them about 15 years to get anywhere with this product, but TRK do seem to be making some progress.

Historically, licensing revenues have tended to be blips in an otherwise steady stream of trading losses, so it remains to be seen if they have a viable business. It's not one for me, I've heard the story so many times over the last 15 years, and it never seems to deliver on the hype, so after a while you just become immune to it.

 

Shares in Nature (LON:NGR) have risen 9% to 35% on news of two orders for its "Compact Treatment Units". They seem to be for liquid waste treatment. No financial details are given, so I am not able to assess the importance of these contract wins. The shares don't look good enough value for me to investigate further, based on a forecast PER of about 16, and a dividend yield of only about 1.5%.

 

I note that shares in Trinity Mirror (LON:TNI) have taken a battering in the last week, since the phone hacking scandal has once again resurfaced, as regulars will recall that I've warned about in the past (indeed it was worries over this which led me to sell, with awful timing, at 64p last year).

They've come off from recent highs of 120p to 87p today. It's probably too late to sell, but they're too risky to buy at that price in my view. Phone hacking is an unquantified liability, which has not been accrued for, as far as we know. It is well documented that Mirror Group journalists were involved in phone hacking historically, although News International seemed to take the blame & the costs for an industry-wide problem. It was very much a stick with which to beat Rupert Murdoch, and a blind eye was turned to other newspapers doing the same thing, by many of the people who professed to be so appalled by the activities of the News of the World.

On the other hand, TNI is still generating fabulous cashflows, and recently reported just under 30p EPS. Whilst a declining business, it is likely to continue chucking out enough cash to repay most of its debt by 2014, and the pension deficit is under control. They also have freehold property which could be seen as an offsetting asset against the pension deficit - especially as the pension deficit is likely to shrink as long term interest rates rise.

Personally I might look again at TNI if it drops to around the 50-60p level on a serious outbreak of phone hacking panic, which may or may not happen. It's an issue that's not likely to go away for the time being though, just ebbs and  flows. I seem to recall there were some trials scheduled for June 2013 related to this? So the risk is that the Police might end up with evidence implicating TNI in many hacking cases, and that could end up being very expensive. The costs ran into £ hundreds of millions for News Corp, as reported in their 2012 Annual Report, which I was looking at yesterday.

So for the time being, I'm watching on the sidelines with this one.

 

I've looked through the other results for this morning, and can't find anything else of interest to me.

The top risers list today shows a spectacular 63% gain to 70p for shares in Pennant International (LON:PEN), on news of its largest ever contract win. Pity I missed this one, as the StockReport before the rise is just my type of thing - lots of green bars, indicating good value, with a forward PER of 8.8 and 4.6% dividend yield. Of course those are based on the share price before today's 63% rise, so it's academic for my purposes now.

 

This evening I'm off to the latest "Mello" investment dinner in Beckenham, organised as ever by my good friend David Stredder. I think this one is booked up, and should be well attended (about 70 investors) and the guest speaker is award winning small company fund manager, Gervais Williams. So it should be an interesting evening. I do urge readers to get involved in the Mello investor evenings, as they are really enjoyable, and everyone is very friendly, so not daunting at all, you'll soon make new contacts & friends. It would be particularly good to have more ladies attending, as these events tend to be overly male represented, and there must be ladies interesting in investing too, surely?

Click here for details of future Mello events, including the quarterly one held in central London at FinnCap's offices.

See you same time every weekday morning. Follow me on Twitter @paulypilot  if you wish to receive notifications of when articles are published here - I always send out a Tweet when my articles here are published, with the link. So that saves checking each day.

Regards, Paul.

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