Small Cap Value Report (1 Dec 2015) - BRY, ISG

Good morning.

This morning's bombshell is a 51% crash in the share price of software company Brady (LON:BRY) . For whatever reason, the company issued a trading update at 5:47pm yesterday. Since the market closes at 4:30pm, and even allowing for 5 minutes after that for the closure process to occur, there seems little point in issuing an update after that. People just assume that it's being slipped out after hours, in the hope that the damage might be limited. The normal time to issue updates is at 7:00am.

This is why it's important to use an email service to send you every RNS from companies you hold or follow, as otherwise it's easy to miss ones that are put out at silly times, like this one:

Brady (LON:BRY)

Share price: 37p (down 52%)
No. shares: 83.0m
Market cap: £30.7m

Trading update - this is a software company, selling trading & risk management software to commodity and energy markets. Given the sector in which it operates, it was really only a matter of time before it issued a profit warning. That's not just hindsight, but it was pretty much the conclusion I came to, when reporting on their lousy interims, and unrealistically upbeat outlook here on 7 Sep 2015. It's yet another example of a company saying everything is fine, we'll recoup the shortfall in H2, and then failing to do so.

Here is the detail of last night's statement;

In our September update, we reported a healthy sales pipeline that more than covered the sales needed to complete the full year in line with market expectations.  Whilst some of those opportunities have been converted into contract wins, including 5 cloud deals, we have seen a prolongation of the time required to convert the pipeline into the sales that we anticipated. Whilst most of the opportunities that were there in September are still good prospects, they will not be converted into sales in this financial year.   As a result, revenues and EBITDA for the financial year ended 31 December 2015 will be materially below market expectations.

 The Group's balance sheet remains healthy with cash in excess of £4 million and no debt. The Board has initiated a cost reduction exercise of £1.7million to improve profitability in 2016 over 2015.

My first reaction is that the business model looks bad. Software companies should have a SaaS model, which largely guarantees revenues, and hence makes profit warnings very unlikely. It looks as if Brady is still reliant on contract wins, and hence profits are unpredictable. I don't like that.

Secondly, it looks as if management have been far too optimistic, saying that they would still hit forecasts, after posting lousy interim figures. So expectations look to have been poorly managed, and people have lost money today as a result. That's not good, so if I were a shareholder, I'd be livid, and asking tough questions of management.

Thirdly, EBITDA is a meaningless figure for software companies, because they capitalise operating costs onto the balance sheet. It's always best to ignore all the flannel in results statements, and just go straight to the P&L and cashflow statements, and in this case it actually made a loss of £434k in H1. Calendar 2014 and 2013 were only profitable to the tune of about £1m apiece after exceptionals. So it doesn't look a very good business to me.

I wonder whether the dividend is sustainable?

The last balance sheet looks OK, but as usual with this type of business, it relies on customers paying up-front (reflected in deferred income).

Overall, if you like the company, then the shares are currently being offered on half price sale at the moment, so it could be a bargain, who knows? I can't put my finger on it, but the figures here have just never excited me, so I'll pass on this one.

ISG (LON:ISG)

Share price: 150p (down 27% today)
No. shares: 49.2m
Market cap: £73.8m

Profit warning - I'm feeling dizzy from the amount of spin in today's update from this low margin, accident-prone building contractor. It's dressed up as if everything is going great, oh and by the way we're going to miss forecasts by £5m, never mind!

Whoever wrote this deserves a slap. I just find it so misleading. It builds up your hopes, then dashes them. If bad news is the inevitable outcome, I'd rather just hear is straight, not have it dressed up, lipstick applied, and rolled in glitter like this:

The Board is pleased to announce that since the start of the financial year the Group has seen good trading conditions for the majority of our businesses with a particularly strong performance by our UK Fit Out and Engineering Services division.  Trading in UK Construction however has been disappointing.  We anticipate the results for the full year being in line with the Board's expectations for all divisions except UK Construction.  The Board also expects a greater second half weighting to this year's results.

We continue to work on the recovery plan for UK Construction.  Despite the many positive steps we have taken, we have continued to experience disappointing project outcomes on some older contracts.  In addition, with margin and risk control remaining our priority rather than volume and some customers delaying the start on site of their projects, volumes this year will be below our expectations with profit deferred to later periods.  As a consequence, this division will be loss making this year and will impact the Group results by up to £5m.  The Board is resolute in its ambition to refocus this division on core sectors, regions and skills.