Small Cap Value Report (10 Mar 2016) - SPRP, RST

Good morning!

I was rather late in completing yesterday's report, but in the evening I reviewed results/trading updates from 4 more companies, so 8 companies in total. Yesterday's full report is here.

I'm out all afternoon & evening today at a shares conference & dinner, so today's report is shorter & earlier than usual, and there won't be any late updates.

Sprue Aegis (LON:SPRP)

Share price: 264p (down 9.7%)
No. shares: 45.9m
Market cap: £ 121.2m

Update on supply terms - Sprue has agreed to revised terms with its main supplier, full details are given. Helpfully, the company also quantifies the P&L impact. I wish more companies would be as transparent as this, by giving an estimate of profit for the current year, even if it's a wide range;

Retrospectively with effect from 1 January 2016, Sprue has agreed to amend supply terms with DTL, as a result of which the Board now expects that the Company's operating profit for the year ending 31 December 2016 will be approximately £8.3 million, slightly below market expectations. 

Stockopedia is already showing reduced broker estimates for 2016, since a decline in last year's bumper sales to France is not expected. So a consensus of £ 8.06m profit is currently showing. That's in the same ballpark as the £ 8.3m operating profit from the company today, so the financial impact seems modest.

The detail given of changes to contract terms look perfectly reasonable to me - adjustments have been made to prices, based on increased wage costs in China, exchange rate movements, etc.

However, what concerns me is how dependent Sprue seems to be on Jarden;

Sprue (AIM: SPRP), one of Europe's leading home safety products suppliers, today issues an update on the supply terms with DTL, owned by Jarden Corporation ("Jarden"), the supplier of all of Sprue's own branded smoke alarms and accessories, which also supplies the smoke and carbon monoxide alarms and accessories of BRK Brands Europe Limited ("BRK"), also owned by Jarden, and a substantial shareholder in the Company.

BRK owns 23.6% of Sprue, so their interests are aligned with shareholders in terms of the share price. But there's a massive conflict of interest here, since they will also want to make as much profit as possible on product sales, on which Sprue seems to be highly dependent.

This is not a new issue, I recall discussing this with shareholders in Sprue a few years ago.

My opinion - wherever possible, I like all supply arrangements to be completely arms length. Being so dependent on one supplier, who is also a major shareholder, is fraught with risk I think.

Combine this with the declining earnings, due to a peak last year in legislation-driven sales in France, and the shares lack appeal to me.

On the plus side, there's a decent cash pile, and good dividends. So this might be a nice share to revisit at some point in the future perhaps, once earnings have stopped falling?

Today's announcement has understandably knocked 10% off the share price, as whilst not financially that significant, it reinforces the unhealthy relationship with its major shareholder/supplier.

Restore (LON:RST)

Share price: 321.5p (up 0.8% today)
No. shares: 96.0m
Market cap: £ 308.6m

Results y/e 31 Dec 2015 - where to start with this one? It's almost impossible to review meaningfully, because the group made 6 acquisitions in 2014, and another 6 (and 1 disposal) in 2015. So the growth has mainly come from acquisitions, therefore it would be a mistake to value it as a growth company.

Moreover, the balance sheet is becoming increasingly overweight with intangibles (now up to £ 118.6m) related to acquisitions, which accounting standards seem to now require be split between goodwill, and some arbitrary value put on customer relationships.

Net debt rose to £ 60.6m at year end, but a separate announcement today details the imminent sale of the Irish part of the business bought from Wincanton late last year, raising £ 27.8m. So that will bring group net debt down to about £ 32.8, which seems reasonable to me.

Valuation - when a group is this acquisitive, there are so many moving parts that analysis of the historic numbers is largely meaningless.

The only way we can really value it, is relying on broker forecasts for future earnings, and as we know, these are often considerably different to what results companies actually deliver, so it's a rather shaky basis to value a company on.

That said, a lot of Restore's revenues are recurring, on long term contracts, so there's probably quite good visibility here.

One broker has this morning reduced its 2016 EPS forecast from 17.9p to 16.9p, due to the Irish disposal. So that puts the shares on a PER of 19.0 times - a very full rating in my opinion, especially given that there is still debt of about 10% of the market cap. So the cash/debt neutral PER would be about 21.

My opinion - groups which grow aggressively by acquisition usually end in tears. This one seems to be going rather well, so maybe it will be the exception that proves the rule?!

Overall, I think the market is putting too high a rating on this share. It's not a growth company, it's buying in growth with acquisitions. So that does not justify a PER of 21 in my view (adjusted for debt), or a PER of 19 including debt.

To me, this share looks about 20-30% over-valued.

Sorry, run out of time for today, so I have to leave it there.

Regards, Paul.

(usual disclaimers apply - mainly, not advice/recommendations, these are just my personal opinions only, which are sometimes right, sometimes wrong! DYOR)