Small Cap Value Report (15 Sep 2016) - NXT, CRAW, FRP, IND

15th Sep '16 by Paul Scott

52 comments 25304 reads

Good morning!

There are some interesting announcements from large retailers today. It's worth checking these, to see how overall market conditions are faring.

Next (LON:NXT)

Share price: 5040p (down 3.3% today)
No. shares: 147.3m
Market cap: £7,423.9m

Every time I look at results from Next (LON:NXT) it reminds me just what a high quality business this is. The profit margin is spectacular. What this means, is that even when trading deteriorates, the business remains very strongly profitable. This is an important point to grasp, because at the opposite end of the spectrum people often buy poor quality retailers because they are on a low PER. However, profits can quickly turn into losses for low margin, poor quality retailers, in a downturn. Whereas a super-high margin business like Next can sail through a downturn with the bulk of its profits intact, because its operating margin is so high at around 20%. Even if it were to drop to 16%, you would still have a very profitable company.

Next describes current trading as "challenging and volatile". It is adding lots of new space, and with such good ROCE and short payback times, this makes a lot of sense. Continued share buybacks drive up EPS, even when profit is flat, or slightly down.

There are a number of headwinds though;

Struggling to recruit new customers for its credit offering.
As with all retailers, the cumulative impact of Living Wage is likely to hurt.
Rapidly growing online competition is relentlessly chipping away at the market share of traditional retailers.
Weaker sterling means cost prices rising next year.

For these reasons I'm reluctant to buy shares in Next, although on a PER of about 10-11, it's very tempting. The trouble is, it's difficult to see much future upside on profits. So as a mature business whose profits may have arguably peaked, perhaps the price is right?

Generally, I'm keeping away from opening any new positions in conventional retailers. I think online is gathering momentum at such a rate, that it's starting to seriously disrupt the sector. Companies like Boohoo.Com (LON:BOO) can dramatically undercut the High Street on pricing. A younger generation is increasingly happy buying frequently & cheaply online, which presents massive problems for conventional retailers.

Crawshaw (LON:CRAW)

Share price: 44.5p (down 39.5% today)
No. shares: 78.9m

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stevebreith

15th Sep '16

Since when has Next been a " small cap ", trading at 5040 per share and turnover of 7.5 billion. surely there has to be other companies worthy of your scrutiny.

Paul Scott

Steve,

I find Next (LON:NXT) is a useful bellwether for the retailing sector generally - since it's by far the best operator, in my opinion. Also its trading updates are amazingly detailed, and include lots of useful guidance which has read-across for other retailers (e.g. its comments about exchange rates recently have been useful).

You may have noticed that at the beginning of each report, I often comment on something macro-related, and occasionally something interesting from large caps. Then the rest of the report is on small caps.

Basically, if something is topical & interesting, then I'll write something about it. If that doesn't meet with your approval, then you can just move on to the next section.

Paul.

MichaelFBS

Thanks John for your thoughts on Crawshaw (LON:CRAW) and of course yours as well Paul. I bought these with a 3 to 5 year (or even longer view) and I am going to stick firm and indeed have topped up twice today. Once at the open (order placed over night) at 48p and once this afternoon at 44.45p.

It takes time to build a business and mistakes get learned from along the way. As you say it depends on the roll out and whether that continues.

Additionally Rose has skin in the game (a 7% holding) so he will not want to see it fail. It would be nice to see Noel Collett do some buying at this level as he appears to have no interest at the moment.

AnonymousUser37607

Why would you invest in something that requires you to forecast out to 2024 in order to justify potential returns - this is a small, niche butchers chain. Valuation always looked stretched here and still looks the case now

Hi Purpleski,

I've found that it is usually a mistake to immediately average down on an existing holding after a profit warning. Although we always deny it, the psychological factors driving such a decision tend to be;

- anchoring to the previous share price, and not allowing for the fact that things have changed for the worse, and

- a subconscious desire to support the share price, and willing other people to do the same (groupthink on bulletin boards, where people strenuously support the company despite the bad news).

Having said that, as a non-holder of Crawshaw (LON:CRAW) at the beginning of the day, I gradually warmed to the idea of picking up a few by the end of the day. If the LFL drop is indeed 5%, as rumoured, then that's fixable. It doesn't necessarily mean that the wheels have come off.

The mistake they made in today's RNS is to imply that the High Street new store openings are not very viable any more. I don't think they meant to say that, but the emphasis on factory outlet centres gave that impression.

So I suspect that management will be busy on the phones & in meetings, reassuring big shareholders that everything is going to be fine. If the big shareholders buy that explanation, and the next set of numbers aren't too bad, then I could see sentiment gradually recover for this share over the autumn.

Regards, Paul.

Re Crawshaw (LON:CRAW) yes I personally would buy my meat from a independent butcher and can't remember when I last bought meat from a supermarket, I don't trust where it comes from. My town here in Herefordshire (Bromyard pop 7,500 and not a wealthy demographic by any means) supports 4 butchers plus the Co-op selling meat.

For all the butchers it is not just the meat but the added value products (pies etc) that people go for and if you are going for a good quality pie you might as well buy your meat as well. I speak BTW as a vegetarian but I buy for my son and wife!!!

johnrosier

After a day like today I can see your point!

However, I don't think you need to look out to 2024 to justify buying it. That was just an illustration of what it could be worth then. It might of course be worth less or if the potential store opening programme is extended past 200 odd stores then more.

Clearly it has hit a bump on the road and hopefully only a bump. I have confidence in the management which was why I was happy to add today. Obviously I would rather have gone in to today with a smaller holding but I didn't!

tic_tac_toe

"yes I personally would buy my meat from a independent butcher and can't remember when I last bought meat from a supermarket, I don't trust where it comes from."

I think supermarkets probably have the most traceable supply chain, imo..

Hi Paul

Thanks you so much for taking the time to reply personally about Crawshaw (LON:CRAW) . Your points are really helpful and I will add them to my investing checklist. You have made these points before and they are very valid and I was aware of them when I made the purchase this afternoon which I may regret. But felt with a fall like this I could only do one of two things exit or top up. I felt doing nothing was not an option (this was something I cottoned on to after reading The Art of Execution).

Your first point I agree with entirely and I am probably guilty of that here but the second one I am not sure applies in my case.

I shall watch the share very carefully over the next few months but am prepared to give the stock plenty of time. Now 2.9% of portfolio so I think the exposure is manageable.

Thanks as always for the great reports, I lean as much from them now as I did when I first started reading them.

Not for me but all the best with it.

I would question though how much faith can an investor have now in the CEO; as a public company CEO he is quite inexperienced. He may have done great at Lidl as part of a well oiled machine but Crawshaw is a far different proposition. The extract below from today's RNS would seem to indicate that part of the problems are to a certain extent self-inflicted e.g. Crawshaw (I presume the CEO decided this strategy) was actively positioning itself at higher price points - clearly this did not work and I don't accept Brexit as an excuse as the UK retail sector has been cut throat for years now so consumers seeking out good/best value in their shopping habits is an established trend.

"Over the last year or so we have actively sought to rationalise range, reduce the number of price-led promotions and drive higher margin lines, and the strategy has worked well. However, with our customers now being even more price focussed post Brexit, and with the supermarkets very recently launching some aggressive meat promotions, we are reacting to ensure we maintain the value-led approach that has proved successful in the past. This includes introducing more local choice and lower price point packs. "

Clearly they took their eye off the ball but I think will rectify the situation. Luckily in the shower term the comparatives going into the autumn/winter are much easier. They have flexed the gross margin too far and I think lost some of its value proposition. I think like-for-likes will recover, the obvious question is at what cost to margin.

With an experienced Chairman in Richard Rose and with the recent appointment of Ken McMeikan as a Non-Executive Director they have a strong and experienced Board, which I'm sure will give wise counsel.

McMeikan is currently Group CEO of the Brakes Group, a position he has held since 2013. Prior to this, Ken was Group CEO of Greggs Plc, the UK's leading bakery food-on-the-go retailer, a position he held from 2008-2013. Additionally, Ken has a combined 18 years of senior retail experience with both Tesco and Sainsbury's.

PJ0077

Hey johnrosier..

Forgive me, but I disagree with the weight that you put on the management of this company.

Experience is no guarantee of success, surely?!

We can all think of great managers e.g. Luke Johnson.

Yet the Board of Crawshaws and their 'experience' will not determine the eventual outcome for this company. The management may tweak the outcome, but ultimately the industry will be the arbiter:

For example:

Roy Hodgson had huge experience as an international football manager.. but was blown away this Summer by superior managers
The Board of Lehman Bros in 2008 had huge experience.. yet were subsumed by their industry's problems

There are 1,001 reasons to continue to hold a stake in this company.. but management is not one of them.

melody9999

16th Sep '16

CRAW - the fact that they have such an experienced management team but yet release an RNS which does not give any numbers is a massive red flag as far as I am concerned.

If you don't know the facts, then your investment surely just becomes a gamble?

Raldridge

Wow. Good luck in life

back2value

Crawshaw is a textbook example of what happens to a share price when a stretched valuation meets bad news. It's been smashed.

Upon seeing the price fall I immediately thought to myself this may be a buying opportunity, but when I saw the total absence of figures and the stream of excuses in the RNS, I immediately thought "no way". Paul, I think you have let them off pretty lightly here - that's a shockingly poor bit of corporate communications which might well have made the impact of bad news worse. For me, it inspires no confidence in the management whatsoever. Anyway, best of luck to holders and buyers, but I am staying away from this one.

B2V

dprminvestment

I've held CRAW ever since I saw them at Mello a few years back. After this profit warning I decided to sell the lot. I think they have a results announcement out soon if you go by the timings of last year's RNSs and I don't want to take the chance of the shares tanking further.

sbotting

19th Sep '16

Regards Fairpoint (LON:FRP) they do seem pretty cheap but there legal services firm Simpson Millar has received *terrible* reviews online:
http://www.solicitor.info/solicitors/simpson-millar-llp/1645/1
and
http://www.mumsnet.com/Talk/property/1576553-Which-ONLINE-conveyancing-solicitors-have-you-used
(look at adda1 's review )
all since the acquisition by Fairpoint Group

I hold some of them (at a loss now) and was thinking about doubling down, but this makes me wonder how sustainable their business is.

Any people with legal expertise care to comment, Paul what are your thoughts about the relevance of online reviews as a signal for investment decisions?

Sam Koroma

22nd Sep '16

I find the article illuminating, critical and well-balanced.

Carcosa

14th Oct '16

Fairpoint (LON:FRP) Press coverage states that a previous source of concern over group earnings may have gone away. seems the government have shelved a reform around minor motor accident injuries, specifically the operation of whiplash claims.

http://www.telegraph.co.uk/business/2016/10/13/delays-to-whiplash-reforms-costing-drivers-3m-a-day-insurers-cla/

TangoDoc

2nd Dec '16

I hold FRP and am in for the long haul. I too am pleased they are less exposed to the "whiplash" business. I make the assumption that there is no sign that we are becoming a less litigious nation, nor any indication that civil law is likely to become less complicated over time. In addition, I can imagine that the implications of Brexit, hard or soft, will inevitably call for far more legal assistance for some years to come, including, sadly, assistance with debt. I also note that, within days of putting her South London house on the market, my daughter has shown six prospective buyers round. Looking simplistically at the graph and with Article 50 invocation looming, I may well add to my holding.

Small Cap Value Report (15 Sep 2016) - NXT, CRAW, FRP, IND

Next (LON:NXT)

Crawshaw (LON:CRAW)

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Paul Scott

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