Small Cap Value Report (1 Aug 2014) - CDY, RGD

Good morning! There's was a 300 point sell-off in the Dow last night, so the UK market is expected to open down, but only down about 12 points on the FTSE 100. Small caps have been in a downtrend since the Spring, especially on AIM, so it's about time the major indices had a sell-off too.

As pointed out in a useful article on Investors Champion yesterday, the decline in larger cap AIM stocks has been considerable, which is surprising as you would normally expect the smaller & more speculative stocks to sell off the most in a downturn. The FTSE Intl-aim UK 50 Index (FTSE:AIM5) Index (the 50 largest AIM cos) is down a remarkable 25% from its peak on 24 Feb 2014.

Whereas the broader FTSE Intl-aim All Share Index (FTSE:AXX) has fallen from a peak of c.897 in early Mar 2014, to 769 today, so a 14.3% fall. So as I've mentioned before, if you invest in small caps and are having a hard time at the moment, then you're not the only one. Although it is interesting that the most damage has been done to the likes of ASOS, Quindell, Blinkx, Monitise, etc, stocks which clearly reached valuations that were far too high for their fundamentals. Also in 3 out of 4 cases of those examples, companies with questionable business models - which people may ignore in a momentum-driven bull run, but which hastens the downfall when the tide turns.

Dark blue (top)line is FTSE Small Caps Index
Beige (middle) line is AIM 50 Index (note the 25% decline since Mar 2014)
Light green (bottom) line is AIM All share Index

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Nevertheless, in my view there are now far more buying opportunities in smaller caps - indeed I'm finding new ideas almost every day, on the back of positive newsflow. I like this time of year because so many market participants are on a beach somewhere (I can't think of anything more boring!). So if a cheap company puts out a positive trading statement, there is sometimes little market reaction as nobody much sees it. That can give a nice opportunity to pick up a bargain that could deliver results once people are back at their desks in September onwards.

After all, we are all trying to exploit market imperfections - i.e. buy (or short) shares which are incorrectly priced. You are likely to find more such opportunities when the market is half asleep at holiday time. Hence why I never take any time off.

For the long term part of my portfolio, all the above is just background noise. As long as the economy is set to grow, which seems likely for the time being, then my long term positions just stay as they are, regardless of what the markets are doing in the short term. I'm not trying to time the market with my long term holds, but am backing companies where I think there is a significant mismatch between the company's underlying value looking forward a couple of years, and the current price. So even price movements of 25%+ don't concern me at all, providing nothing has changed with the company's fundamentals. Market sentiment and fundamental value have to be totally separated in the decision making process.

EDIT: That reminds me. Clem Chambers made a very interesting point in a recent interview. He said that the small cap indices give you a much clearer view of market trends, because there are no futures contracts available on the Indices. So they are not "mucked about with" by high frequency traders, options, etc, manipulating the market indices. Therefore what you see is what you get - so the trend in a small caps index tends to be much clearer and more consistent.

Casdon (LON:CDY)

Share price: 54.5p
No. shares: 5.524m
Market Cap: 3.0m

Bad news for shareholders here I'm afraid - the company has decided to de-List. So that means the shares will probably crash about 40-50%.

This is the big problem with micro caps, especially ones where they are controlled by a dominant shareholder or group of shareholders (the Cassidy family control over 50% of this company's shares). So with one other large shareholder, only about £1m of shares are in free float. So it cannot possibly make sense to maintain a listing.

The reasons given are pretty sensible;

• management time wasted on the Listing
• illiquidity in the shares
• cost of Listing
• no need to raise capital.

Also, having been Listed since 1989 they've given it a good go. So cannot be accused of being fly by night characters.

I've steered clear of this company after a phone call with their FD at some point in the last couple of years. I was interested in buying some shares, after a good set of results, but he was so hostile, and suspicious of me, that it was obvious the company was not at all external shareholder friendly. So (wisely as it turned out) I didn't buy any stock in it.

It's not a bad little company though, so if the shares really collapse, it might be a nice opportunity for people who are prepared to hold shares in a private company.

Results for y/e 30 Apr 2014 show a reduction in operating profit from £553k to £382k. EPS is down from 7.55p to 5.24p. There's a solid Balance Sheet, so if it gets down to a really silly low price, then it might be worth a look for people who are happy to hold a private company long term.

It is a good reminder though, when looking at micro caps, to ask yourself if it makes sense for the company to maintain a listing (which can cost £50-200k p.a. even for a very small company). So anything that doesn't make much profit, and has a very small free float with dominant shareholder(s), is at risk from them deciding to pull the plug on the Listing. Hence great care is needed with micro caps.

Real Good Food (LON:RGD)

I've been bearish on this stock for a long time. It's capital-intensive, has too much debt, and it's not clear that there is even a viable business there at all.

Results today for the year ended 31 Mar 2014 show a move down to around breakeven at the operating profit level, and then losses once the significant £1.6m finance costs are taken into account.

Balance Sheet - It's not too bad, at least there are positive net tangible assets of £10.1m, but the company is dependent on bank borrowings to support its working capital position. Whilst banks are generally supporting Listed companies, even basket cases, personally I wouldn't want to invest in any company which is unprofitable and dependent on the continued good mood of the bank manager. There's a small pension deficit too, which doesn't help.

Dispute - The main problem seems to be a pricing dispute with a key supplier, British Sugar. So that issue would need to be investigated thoroughly.

It just looks too messy to me, and needs to be seen as a special situation. Maybe the company will recover, who knows? It's not for me.

Sorry, have to dash to an investor lunch in London now, so have a smashing weekend & see you back here on Monday morning!

Regards, Paul.

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