Small Cap Value Report (14 Jun 2016) - NXR, DSG, TRI, CML, CYAN

Good morning!

EDIT: Forgot to mention, I've been nominated for an award for writing these reports! How exciting. Let's hope the judges didn't see last Thursday's, when I was plastered. It's the 2016 Small Caps Awards dinner this Thursday, and I'm on the shortlist of 3 for "Journalist of the Year". Here is the link, it's the 7th section down. So keep your fingers crossed for me!

Fairly busy for results today, so thought I'd better start a bit earlier to fit it all in.

As no doubt you've already seen, markets are really going wobbly at the moment, with all this uncertainty about Brexit. I enjoyed our reader discussion in the comments section here after yesterday's report. If only the politicians could have such a sensible & courteous discussion as we managed.

Taking everything into account, the only bit I'm really worried about is the impact on the financial sector. Although City veteran David Buick reckons there's nothing much to worry about on that front, in this video.

There's also a fascinating article from former Chancellor, Norman Lamont, in which he runs through some figures which suggest the UK would have a better trading arrangement outside the EU. His argument is that paying the 3-4% external tariffs to the EU would actually be cheaper than our present arrangement, which works out as the equivalent of a 7% tariff! Plus of course we would collect in a mint from taxing German cars ourselves with a 3-4% import duty. I wish there had been more commentators who had actually crunched the numbers properly. It's mainly just baseless assertions from both sides.

The betting odds have narrowed sharply to about a 40% chance of Brexit happening, and equity markets are floundering, I'm sure most of us are taking some pain in our portfolios right now.

There are lots of bargains appearing, especially in illiquid stocks. In normal circumstances I'd be snapping up those bargains, but given the Brexit uncertainty am sitting on my hands for now, probably like most other people. So I think we could see some even better bargains appear over the next fortnight from panic selling.

Volatility is part of investing in equities. I think it's important not to get shaken out of great companies at the wrong time & price, only to miss the rebound. Having said that, this is definitely not a time to be geared, in my view.

Anyway, on to what I'm supposed to do - looking at company results & trading updates. There are about 12 that I'd like to cover today, so will see how far we get.

Norcros (LON:NXR)

Share price: 177p (up 2.3% today)
No. shares: 61.0m
Market cap: £108.0m

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

Results, y/e 31 Mar 2016 - these are good results in my view, especially given how low the rating of this share is. Although, as with other shares, there's unlikely to be much buying until the Brexit vote is done & dusted.

Here are some key points I noted down whilst reading the results:

Profit marginally ahead of expectations

Revenue up 6.3% to £235.9m (driven by acquisitions)

Underlying profit before tax up 29.1% to £20.4m - clearly a good result. That's a lot of profit for a business with a market cap of £108m.

Underlying diluted EPS up 31.8% to 27.8p - so the PER is currently only 6.4. That seems considerably lower than it probably should be.

The one item I would query in the adjustments, is the £1.7m administrative cost of the pension fund (see table below). To my mind that needs to be left in as a cost, when valuing this share. Note that exceptional items were a credit this year - on a land deal.

(Norcros table)

So the PER would actually be a little higher than 6.4, if you reverse this pensions adjustment. The latest note from Numis reports actual EPS as 24.6p for FY2016, so it looks as if they've possibly made the same adjustment.

The PER on Numis's figures is 7.2 - still dirt cheap, as they have been pointing out for some time in their reports on Norcros. It's a significant discount to sector peers. It remains a bit of a mystery as to why the market takes such a negative view in valuing Norcros shares, when the company is actually performing rather well, and making excellent acquisitions too. There's a clear opportunity for a re-rating here, but continued patience may be required.

Numis has a forecast of 27.0p EPS for this year (FY2017), giving a forecast PER of 6.6

Net debt is £32.5m - which looks reasonable to me. It is only 1.2x EBITDA (commonly used by banks as a key measure). There's plenty of headroom on a total £100m bank facility.

Pension deficit is £73.5m on the last actuarial valuation, clearly a big issue. However, overpayments of £2.5m + CPI look reasonable, and can be comfortably afforded.

The pension deficit on the balance sheet is lower, at £55.7m - but still clearly a big issue that needs to be taken into account when valuing this share.

Total dividends of 6.6p this year (up 18% on last year, so a usefully progressive dividend policy). The yield is 3.7% - a good return whilst we wait for the shares to eventually re-rate.

Three acquisitions - Vado last year, Croydex & Abode this year - are trading well.

S.African operations have absorbed currency headwinds, even reporting increased profit in sterling terms - impressive stuff. £4.1m profit this time (£3.2m last time). The 5.6% operating margin (4.4% last time) is starting to look more reasonable, although still well below the UK margin of 10.6%.

Overall group margin of 9.0% (7.6% last time) looks quite good, and surely justifies a higher rating than a PER of just 6.4? (even allowing for the debt & pension deficit).

Outlook - a bit mixed, but OK overall, is my interpretation of this:

The Group has made good progress towards its strategic targets during the year. Whilst the outlook for the market in the UK is somewhat variable in the short term, with general uncertainty caused by the UK's EU referendum exacerbated by challenges in our DIY retail sector, improved RMI spend and increased housebuilding activity in the medium term should benefit the Group with good growth opportunities.

Our South African businesses have continued to perform strongly, and, despite recent political and economic concerns, the medium-term outlook in South Africa remains positive, providing opportunities for the Group to gain added momentum.

With our leading market positions, portfolio of strong brands, continued new product investment and self-help initiatives focused on market share gain, the Board remains confident that the Group should continue to make further progress for the year ending 31 March 2017.

Remember that Abode was acquired at the end of the year, so didn't kick in any significant P&L activity, however its full balance sheet is in the group accounts on 31 Mar 2016. So that has distorted working capital movements somewhat. The benefit will be felt in the P&L in this new year.

Similarly, Croydex will contribute a full year in 2016/17, as opposed to a part year in 2015/16. So we should see a further increase in EPS.

My opinion - this is a core value holding of mine. I'm really pleased with these numbers. Everything looks pretty good, and the valuation seems a clear anomaly. In my view there's a fairly easy 50% upside on this share, to be had at some point in the future if things continue in the same vein.

It's a bit of a dead money stock though - there never seems to be a catalyst to take it higher, and the pension deficit might well put off some potential acquirers.

There again, I'm perfectly happy to continue collecting in the nicely growing dividends, and just wait for the value to eventually be recognised by the market.

(Norcros share price graph)

The group is clearly in much better shape than it was 2 years ago, but the share price is slightly lower. That doesn't make sense, so I'm expecting this one to re-rate decently at some point. No idea when though!

EDIT: I'm seeing Norcros management at a lunch tomorrow. So if anything interesting crops up, I'll edit this article to keep you informed.

Dillistone (LON:DSG)

Share price: 80p (down 7% today)
No. shares: 19.7m
Market cap: £15.8m

AGM Trading update - this is not the easiest of statements to interpret, as the first 4 paragraphs sound very positive, talking about excellent new order wins, etc..

However, the 5th paragraph suggests that additional licences from existing clients are drying up (possibly due to Brexit):

"Despite our excellent performance in the market, the Group has noted a softening of the economic environment over recent weeks. While we continue to win new contracts, it is apparent that many recruitment firms are not currently hiring additional staff, resulting in a reduction in the normal flow of incoming licence orders from existing clients.  We would hope that with the Brexit vote imminent this will prove to be a short term phenomenon. 

It then goes on to say that full year expectations are unchanged, but might be more H2-weighted:

"Nevertheless, we are pleased to confirm that the Group currently remains confident of delivering growth in revenue and pre-tax profit and meeting expectations for the full year. We reiterate our belief that the second half of 2016 will be better than the first half. The first half of the year is likely to show revenue growth when compared to the same period in 2015, but a slightly lower level of pre-tax profit, reflecting increased costs and depreciation. However, it is expected to show improvement over the second half of 2015.

"In light of these points, the Board is optimistic for the future."

Lots to take in there. The only way to work it out is to refer back to H1 and H2 last year:

I've deduced the H2 figures by subtracting H1 figures from the full year figures.

Therefore what the company appears to be saying for H1 2016 is this:

• Revenue will be above £4.71m
• Profit before tax will be slightly below £566k
• Profit before tax will be above £506k

Why couldn't they have just spelt that out, which would have saved me some time!

My opinion - overall then, today's statement looks something & nothing. I bet it scared a few people out of the share though, probably for no good reason.

Looking at the valuation, I'd say it's probably about right.

Trifast (LON:TRI)

Share price: 135.25p (up 0.2% today)
No. shares: 116.8m
Market cap: £158.0m

Results y/e 31 Mar 2016 - this manufacturer of industrial fastenings put out a positive year end trading update, which I reported on here, on 19 Apr 2016. That said the y/e 31 Mar 2016 had ended well, towards the upper end of market expectations.

I've copied the financial highlights section below:

(Trifast table)

Underlying EPS up 15.1% to 9.99p is a good result.

The PER is about 13.5 - which looks sensible to me.

Net debt looks modest at £16.0m, I don't imagine that would cause any problems, unless demand fell off a cliff.

Dividends - 2.8p total for the year gives a fairly modest yield of 2.1%, but note that it's rising quite fast - a 33% increase on last year.

Outlook comments sound quite positive:

In FY 2016 we have seen another year of strong trading, making this our sixth year of continuous growth.

For us, Europe, Asia and the USA all remain key areas for growth both organically and non-organically. Our enquiry pipeline is strong, whilst our core organic strategy of focusing on our multinational OEMs looks set to continue to deliver growth. FY 2017 will be the first full year of trading from our latest acquisition, TR Kuhlmann, and we are already starting to see opportunities coming through as the result of us working together.

On the manufacturing side, the investments we are making to increase capacity and the focus we are putting on making better use of existing capacity, specifically in our Malaysian sites, should start to impact positively on results in the next year and beyond.

Our investment in the UK business, in to both senior sales resource and driving further operational efficiencies, is expected to continue to build on profitability in this region.

Looking ahead there are some macroeconomic factors that we cannot control, including the ongoing volatility in the foreign currency and raw material markets. However, building on the strong performance delivered last year and, with our geographical spread, balanced sector mix and our clear strategies for growth, the Board is optimistic for the current year and the Group's longer term prospects.

Balance sheet - looks fine to me, with a very healthy working capital position.

My opinion - it looks a good company, but I can't see any reason to rush out and buy the shares, with all the current uncertainty.

Brokers are only forecasting modest earnings growth, of about 4-5% p.a., in the next 3 years. So the group will need to do some more acquisitions to spice things up a bit, I suspect.

Overall, this share looks priced about right, in my view. I suppose the attraction to holding this share is that, given good performance in the last few years, it might out-perform against forecasts, giving further upside on the share price.

There's not much time left, so I'll just do some very brief comments on a few more companies:

CML Microsystems (LON:CML)

Share price: 365p (up 0.7% today)
No. shares: 16.2m
Market cap: £59.1m

Results y/e 31 Mar 2016 - a very interesting little company, which says that it: "designs, manufactures and markets mixed-signal and Radio Frequency (RF) semiconductors, primarily for global communication and solid state storage markets". I'm not at all familiar with that sector I'm afraid.

A few comments on today's results:

• Basic EPS up 8% to 18.03p
• PER of 20.2
• Good operating margin
• Low tax charge due to R&D tax credits
• Very strong balance sheet, includes £13.6m net cash
• Freehold property owned - 28 acre HQ site in Essex, with planned development work on surplus land - sounds material to the valuation
• R&D spend is huge, at 27% of turnover. £5.4m was capitalised onto balance sheet, which exceeded the amortisation charge, of £3.3m
• 3 biggest customers make up 33% of turnover - risk
• Positive outlook comments

My opinion - it's a special situation really, as you have the profitable business, but also considerable surplus assets on the balance sheet. Quite interesting, and possibly worth a closer look, in my view.

Cyan Holdings (LON:CYAN)

Share price: 0.195p (down 8.3% today)
No. shares: 7,111.3m before Placing.     14,114.1m after Placing
Market cap: £27.5m after Placing

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

Placing, subscription, and acquisition - Cyan has finally got away its fundraising, at a lower price of 0.18p per share. This is the one where Tom Winnifrith publicly revealed confidential, price sensitive information about the Placing (according to him at 0.21p), which of course was totally wrong. If anyone is in possession of price sensitive information, whether a journalist or not, they should keep quiet about it.

The result of which is that existing holders have now been diluted more heavily, as the company had to reduce the Placing price and do it at 0.18p. Thanks for that. We really need reform of this ridiculous system where shares continue to trade whilst discounted Placings are being negotiated.

My suggestion is that, if a Placing is being planned at a 5% or greater discount to the prevailing share price, then the shares should be suspended. Otherwise we simply have a false market.

Part of the funds are for acquiring a Swedish company called Connode Holding AB.

Management are putting up £304.5k into the fundraising, and unusually are also taking 1 year's worth of remuneration in shares. A nice touch. I like management putting (or being forced to, perhaps?!) some skin into the game, as part of a fundraising.

My opinion - the outlook for Cyan's smart meters business looks very interesting. Forget about its old activities, in micro chips, that's been abandoned. The £10m contract with Iran could lead to considerably more business. So I'm keeping an eye on this one, and hold a few personally already.

Mind you, I was taken aback by the level of cash burn in the recently published accounts. I vowed to stay away from this type of jam tomorrow share, as they can be very costly. Am already in the red, thanks to the shenanigans surrounding this Placing.

All done for today.

Apologies, but I had to remove all the pictures from today's article, as it all corrupted. Tried to rejig it and get them back in, but it corrupted again. Very frustrating. I believe we're getting a new user interface soon - it can't come too soon!

I have 2 company meetings tomorrow, so that report will be earlier & shorter than usual.

Regards, Paul.

(usual disclaimers apply)