Small Cap Value Report (1 Sep 2016) - REDD, VTU, LAKE, SDY, AVS

Good morning!

So far, so good with my AirBnB accommodation in Corfu. I'm staying in a lovely, spotlessly clean & well appointed 2 bedroom townhouse, in a perfect location, just a few hundred yards from the old town centre, down a quiet side street (see picture below).

It's costing about £85 per night for the whole house, which would comfortably sleep 4 people. The facilities are vastly better than a hotel, as it's someone's house, therefore has everything one needs when away from home. Having tried AirBnB (admittedly for the first time), for me it's a total no-brainer - vastly better value than a hotel. For this reason, I won't be investing in any hotel shares in the future (not that it's a sector I normally consider anyway - too much capex & debt usually, so very vulnerable to economic downturns).

I see that Redde (LON:REDD) has yet again put out excellent results today. It's now risen out of the top end of market caps that I cover (I start to phase out small caps once they reach c.£300m, and REDD is about double that now.). You can't argue with the figures put out today - they're excellent.

Although I have nagging doubts about the risks inherent in REDD's business model - particularly its vulnerability to changes in Govt policy, legislation, etc. That type of business could potentially be severely damaged, or even snuffed out overnight, if the Govt announced dramatic changes to the rules governing insurance companies.

I don't like any business which is fundamentally an unnecessary intermediary. Other people may see things differently, which is fine - that's what makes a market. Personally, if I'm uneasy with any business model, then I don't invest. There are plenty more fish in the sea. Although REDD shareholders will be rightly feeling smug, as it's been an excellent investment in recent years, including a superb flow of increasing dividends - so the profits are undoubtedly real - but sustainable long-term? Who knows?

Brighton ShareSoc - 13 Sept

ShareSoc are determined to get a monthly meeting going in Brighton, and I'm also very keen. The main attraction is a company presentation by Palace Capital (LON:PCA) . Also, I'll be giving a presentation on small caps - basically a whizz through of the best stock ideas that I've come across in the last month.

If people would like to come along, can I ask you to please book now - because it's chicken & egg - if not enough people book early, then the event just gets cancelled. Also, there's no point in me investing time & energy to prepare a presentation, if not enough people come along.

I see that sterling has just jumped up (great news for me, as I'm long sterling vs dollar) on some unexpectedly strong PMI manufacturing data. PMI data is closely watched, as it has a very good correlation with GDP growth. Although of course its the services PMI which is the overwhelming bulk of UK GDP.

Manufacturing PMI has jumped from 48.3 (July) to 53.3 (August). This is well in excess of the expected August figure of 49. Above 50 indicates expansion, broadly speaking. The reason I went long of cable is because I think the referendum fall in sterling looked overdone, and that a lower exchange rate would naturally stimulate UK manufacturing - making it much more competitive.

So thinking logically, a recovery in UK manufacturing seems a fairly obvious thing to happen. Why on earth would manufacturers move production to Europe, given that cheaper sterling just made the UK far more competitive than it was pre-referendum? Any tariffs (unlikely to happen anyway, in my view) into Europe would be c. 3-4%, which has already been more than outweighed by cheaper sterling.

We need to keep a close eye on this, because it's boosted a lot of shares with overseas earnings, and UK exporters. Could that impact gradually unwind perhaps, if sterling keeps recovering? Also, beaten down shares in UK importers could stage a recovery if sterling gradually rises.

Vertu Motors (LON:VTU)

Share price: 49.25p (up 1.6% today)
No. shares: 397.3m
Market cap: £195.7m

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

Trading update (pre-close) - this relates to the 6m period to 31 Aug 2016, being H1 for this car dealership group, which has an unusual 28/29 Feb year end. The company last reported on trading quite recently, which I reported here on 20 Jul 2016.

Things are continuing to go well;

In line with the Group's AGM statement made on 20 July 2016, trading has been robust with profitability ahead of last year.

The Board expects that the Group's full year results will be in line with market expectations with record revenues and profits.

Vertu has been expanding by buying up other car dealerships, so the growth in revenue & profit is to be expected. Note that it raised £35m in Mar 2016, from a placing at 62.5p per share. So the current share price of 49.25p is an attractive discount of 21% to the most recent fundraising. I love buying into good companies at a discount to what the Institutions last paid!

As in the previous update, Vertu emphasises that most of its profits arise from aftersales and used car sales. Hence the softening in new car sales is probably not a big deal;

Aftersales and used cars, from which the Group derives the majority of its profitability, have continued to grow demonstrating the resilience of the business model.

SMMT data has shown UK private new retail vehicle registrations softening since April 2016 compared to the strong prior year comparative period and the Board expects this trend to continue.

September order take levels on new vehicles reflect continued growth in the fleet and commercial sector and a continuation of the softening in the private retail new car channel.

On macro factors, they remain upbeat;

The macro-economic environment of historically record low interest rates and record high levels of employment in the UK provide a favourable economic backdrop for the sector.

Weaker exchange rate levels for Sterling create uncertainty around future Manufacturer strategies towards new car pricing.

The exchange rate comments strikes me as a change in tone from Vertu's July update, sounding a bit more cautious this time.

Referendum comments (I'm calling it that now, as Brexit hasn't actually happened, and isn't likely to for several years in practice);

The result of the Referendum to leave the European Union has, to date, not impacted consumer confidence as adversely as some were initially predicting and the Group has not experienced any significant change in consumer behaviour.

The Board continues to pursue its strategic objective of creating a balanced, scaled automotive retail group comprising both volume and premium outlets.

My opinion - I continue to like this share a lot, due to its low PER of 7.3, a reasonable yield of 3%, and a strong balance sheet).

My sector view is that profits could hold up a lot better than the market currently seems to believe. So far, that seems to be borne out by trading updates from other companies in the sector too, as well as Vertu itself.

I see today's update as reassuring, but price-neutral, as it's mainly just reiterating what the company said on 20 July.

Lakehouse (LON:LAKE)

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

Nil-cost options granted to Chairman - I've got to have a whinge about this. LAKE has granted 2.3m nil cost options to its new Chairman, Robert Holt. Now I accept that he is a good choice for Chairman, and has extensive & relevant experience.

However, to my mind option grants are to reward out-performance, and lock in key staff/Directors. Therefore the strike price at which the person can exercise their options should be set as a bare minimum at the share price on the date of grant. The Director is then incentivised to drive up the share price as much as they can, and the value of the options increases based on what the share price does.

The share price is currently 39p. So awarding 2.3m nil-cost options is effectively handing the Chairman about £0.9m in free shares, paid for by us lot - the existing shareholders are diluted by any new shares issued.

The vesting date seems to be in early 2019, so this looks a scheme designed to lock in key Directors, and subject to performance criteria. I've not drilled down into the detail of that scheme.

Overall though, nil-cost options strike me as an appalling concept, and I'd like to see this type of scheme outlawed.

Speedy Hire (LON:SDY)

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

Response to Toscafund statements - Speedy has put out another rebuttal of Toscafund's criticisms.

As someone with an economic interest in Speedy shares (via a spread bet - so I can't vote), I'm undecided about this. Not knowing the individuals concerned, it's impossible for me to judge who is best to run the company.

On balance, I really dislike Toscafund's attempts to force Speedy to bid for HSS Hire (LON:HSS) - because HSS is a complete crock, burdened with excessive debt (which I reported on yesterday). The whole reason I bought Speedy was due to its strong balance sheet, and turnaround potential. So burdening it with a highly indebted competitor seems a very bad idea - although there could be benefits from combining the businesses, and stripping out duplicated costs.

Overall, from what I've seen before of Toscafund's very poor decision-making on small caps (they've bought some obvious rubbish in the past), I don't rate their stock-picking at all. So on that basis, I don't see why Speedy should be forced to do their bidding, just because they own 19% of the company.

Still, it doesn't matter what I think, because the outcome of the EGM on 9 Sept will be decided mainly by the institutional holders. It will be fascinating to see if Toscafund has been successful in convincing other big shareholders that change is needed.

Avesco (LON:AVS)

Stop press! A "comfortably ahead" trading update has just been issued.