Small Cap Value Report (1 Feb 2016) - LAKE, SAL, ISL

Good morning! I'm writing this on my laptop in a hotel room in Vienna, having decided to grab a cheap deal for a few days' change of scene, with friends. Things got off to a rather painful start when I had an allergic reaction to some radox shower gel, and ended up enduring the flight with my nether regions stinging very badly!

To make matters worse, I hardly got any sleep, due to one of my party turning out to be a human foghorn in the snoring department (a small group of us hired a family room, to save money). Never mind, it's all part of life's rich pageant I suppose!

Lakehouse (LON:LAKE)

Share price: 38.4p (down 54.3% today)
No. shares: 157.5m
Market cap: £60.5m

Profit warning - bad luck to any readers who got caught on this one. I reported on the company here on 10 Dec 2015, concluding that it looked an accident waiting to happen - a low margin group of contracting businesses, with little balance sheet strength, and growing by acquisition. The worst aspect was that it's a recent IPO (Mar 2015) and the original shareholders cashed out some of their chips in the IPO - it's rarely a good sign if the people who know a business best are cashing out.

Today's profit warning mentions several headwinds - e.g. that social landlords are being required to reduce rents by 1% p.a. for the next 4 years. That's the first I'd heard of this, which has led to a reduction in orders for Lakehouse, as you would expect. It would be interesting to find out when this lowering of rent requirement was being mooted - before or after the IPO?

Insulation, and smart meter contracts are also coming through at a lower level than expected. So all in all, a series of unfortunate headwinds, all of which were no doubt completely unforeseen at the time of the float in Mar 2015.

Quantifying it is rather difficult, as the company's last results had so many adjustments. Today it says;

In light of the above headwinds the Group now expects the financial outturn for the current year to fall short of its previous expectations and to see a reduction on last year's profit level.

Current year forecast is for 12.5p EPS, so the actual result (y/e 30 Sep 2016) is going to be below that, but we don't know how much below.

As regards falling short of last year's profit, well that's not very helpful, as it isn't clear from today's statement which profit figure they are referring to.  Last year saw adjusted EBITA of £22.2m, but after exceptionals, etc, the profit after tax was only £2.4m. So a very wide range there, and I feel clearer guidance is needed as to how far below the current year is likely to fall, and below which figure?

Valuation - I've really got nothing firm to go on, so will have to wait until updated broker notes have been published. There's nothing in my Inbox this morning as yet.

My opinion - the market is brutal towards new floats which warn on profits early on in their life as a listed company, and today's 54% share price fall reflects that. I think it also reflects the imprecision of today's announcement - if you're going to warn on profits, then at least give some proper numbers for investors to be able to quantify the extent of the problems. If incomplete, or vague information is given, as in this case, then investors just assume the worst.

Overall, I didn't like this business to start with, so now after a profit warning, it has even less appeal. So it's definitely not one I'm tempted to bottom fish. It usually takes quite a few months to re-establish credibility, after shattering it with a profit warning less than a year after floating. 

UPDATED FORECASTS - a broker note has come through, and suggests that this is a buying opportunity. The broker has reduced adj. EPS estimates for the current year to 9.9p, which puts the shares on a PER of about 4! That's very good value, if their estimate turns out to be correct, so I am considering a possible purchase - more research needed I think, and confirmation from another broker would be useful.

Forecast dividend is now 3.5p, which would give a yield of about 9% at the current share price of 39p. Net debt is forecast to be £17m, considerably higher than before, and just over a quarter of the market cap, so needs to be factored in.

I suppose the key question is whether this profit warning is a one-off, or if bad news is going to be trickled out, with further downgrades later this year? It's a tough call, but if trading firms up at around 9.9p EPS, then the shares would certainly go higher than the current price, since a PER of 4 won't be the permanent valuation if a steady trading level is established. So overall, worth a closer look I think.

The problem with recent IPOs warning on profits, is that any share price recovery is dependent on what the Instis who bought at the IPO do next. Many feel let down, and embarrassed that they participated in the IPO, and got it so badly wrong. So they have a tendency to throw out the baby with the bathwater - they overpaid in the IPO, and then sell out at the low after the profit warning - not very good business for their clients!

If however the Instis can be convinced that it's a temporary blip, and the market has over-reacted, then they might support the share price by buying after a profit warning. So I think it's very important to watch the TR1 RNSs in the (say) fortnight after a profit warning - if major holders are reporting selling, then the share price could remain depressed for a long time, as a selling overhang will need time to clear, and the share price could drop even lower to clear it.

If however TR1s show existing holders hoovering up cheap stock, then there's a better chance that the share price might recover well, and quite quickly, from the profit warning. So I've added it to my watchlist, and will monitor what TR1 statements are issued this, and next week.

Spaceandpeople (LON:SAL)

Share price: 64p (up 11.3% today)
No. shares: 19.5m
Market cap: £12.5m

(at the time of writing I have a long position in this share)

Trading update & contract win - profit for 2015 has come out a little below expectations, at £1.0m, however this is said to be due to a change in revenue recognition, which has deferred £150k of revenue into 2016. Broker consensus is for £1.09m, so it looks as if they would have come in a bit ahead of expectations if revenue recognition had remained the same.

The full year divi has been raised from 2.0p last year, to 2.2p this time, which is reassuring. Note that even after its annus horribilis in 2014, SAL still remained on the dividend list, so it has a good track record on that front, and it's pleasing to see the divis rising again.

Good growth is coming from the new Mobile Promotional Kiosks (MPKs), which are promotional kiosks which can be managed remotely, and are let for very short (one week) stints to various operators (e.g. charities, utility companies, and anyone who wants to promote a product or service face-to-face within a shopping centre). The branding is downloaded onto flat screens on the kiosks remotely, so they are set up with the correct branding for each client each week. These units have been well-received, and are generating much stronger margins than conventional units.

Another growth activity is the Network Rail contract. Another decent contract win is announced today, with British Land, that should be extended to 40 sites in due course. Plus there is a pilot scheme in France starting.

My opinion - we all know the history of this company, with all sorts of things going wrong in 2014, but things are getting back on track again by the looks of it. Also management have learned from their mistakes, and are now guiding expectations fairly modestly, so that unexpected costs or setbacks can be absorbed within market forecasts. That should mean the likelihood of another profit warning is quite low now.

I'm not concerned by a bit of revenue being deferred from 2015 into 2016, as the valuation is very modest now. So hopefully there should be scope for the 2016 figures to improve on 2015, with several growth catalysts underway.

The Directorspeak sounds upbeat;

 "2015 has been a transitional year for the business with a major contract being agreed with Network Rail for the first time, the successful launch of our MPK programme and the agreement with Immochan to launch a pilot scheme in France for the first time. The Company continues to progress and with the announcement of a new relationship with British Land we have had a positive start to 2016."

BROKER UPDATES - a couple of broker notes have come through, and sound positive. The Equity Development (company-commissioned) note this morning is here - an advantage of commissioned research is that it's easy to get hold of. All research is paid for somehow, so personally I don't have a problem with this type of info. We can always adjust their forecasts ourselves if we think they're being too optimistic, but it's useful to have someone else do the work for us - saves time - and there's always useful background info & additional colour in broker notes.

ED are forecasting an increase from £1.2m to £1.9m at the operating profit level, from 2015 to 2016, so that's quite a decent jump, reflecting new contracts already won, kicking in.

My feeling remains that SAL is on the mend nicely now, pays good divis, and therefore I'm happy to hold for another year - it's one of my long-term things, where I ride out any bumps in the road.

IS Solutions (LON:ISL)

Share price: 120p (up 27.7% today)
No. shares: 36.4m
Market cap: £43.7m

Trading update - on a much more positive note, this software company has put out a very bullish sounding update, with the key part saying;

The Board is confident that the business will deliver a strong performance for the year ending 31 March 2016 with both revenue ahead and profitability significantly ahead of current market expectations. Trading for the 2016/17 financial year is also expected to be significantly ahead of current market expectations.

So earnings estimates will be rising considerably for both 2015/16 and 2016/17.

The company's track record looks unexciting - it's bumped along, making between £0.6m to £1.0m p.a. between 2010-15, so clearly something has very much changed for the better more recently.

Mention is made of big contact wins;

In 2016, we continue to witness stronger demand resulting in sales for both the IS Solutions business and Celebrus now well ahead of management budget.  We are delighted to announce that the Company has secured a further two major projects with new and existing customers operating within the retail and financial services sectors.  It is anticipated that these will add contracted revenue of up to £2 million in the current financial year and in excess of £250,000 per annum of recurring revenue in subsequent years.  We have a number of other exciting opportunities in the pipeline with the potential to convert these in the first half of this calendar year.

The figures quoted suggest a large up-front licence fee, which of course is not recurring. Therefore investors perhaps need to be a little careful not to get too carried away with profit figures which receive a large, high margin boost from one-off licence sales.

We have to value businesses on sustainable future earnings, not on the basis of one-off boom years. That may not be the case here, but I'm just flagging up the potential risk, for people to double-check.

My opinion - a friend flagged up this as an interesting company a few months ago, but I didn't get round to doing any proper research on it, more's the pity!

I'm a little wary now of chasing a rapidly rising share price. However, it's always worth looking at companies that are winning big new contracts, and this company certainly seems to be on a roll. Have any readers looked at it in depth? I'd be interested in your views if you have.

The company name isn't looking too attractive in the current environment - maybe they could consider a re-branding?

The sun's just come out here in Vienna, so I'm going to down tools & do some sight-seeing!

See you tomorrow morning.

Regards, Paul.

(usual disclaimers apply - most important one being that these reports are my personal opinions only - never advice or recommendations)