Small Cap Value Report (18 May 2016) - DX., HMLH, CAKE, CHH

18th May '16 by Paul Scott

34 comments 19425 reads

Good morning!

What an awful day yesterday! First all the problems with LAKE, which caused me a nasty financial loss first thing (but I'm pretty confident that's money I'll get back in due course). Then my article here corrupted, with the formatting going haywire. So a reverse midas touch day. Never mind.

DX (Group) (LON:DX.)

Share price: 20p (down 11.1% today)
No. shares: 200.5m
Market cap: £40.1m

Planning application refused - this logistics company is committed to a very expensive new sorting hub in the Midlands. As its finances have deteriorated, external (therefore more expensive) funding was arranged.

Today it announces that the local authority rejected its planning application last night. The company is now considering its options.

In my view, this might be a blessing in disguise. My view on this share has hardened recently. I think that the core, most profitable business, the DX Exchange could now be in terminal decline. With a fixed cost base, it has big operational gearing. Customers are increasingly emailing documents, instead of using couriers. I don't see any reason why that trend would stop, let alone reverse. That leaves DX Exchange high & dry potentially.

Other business is low margin, and highly competitive. So this is likely, over time, to become just another struggling, and possibly even loss-making courier/parcels company. As such, the shares have little to no attraction in my view. Taking on a hugely expensive new depot seemed like overkill anyway, so hopefully the company might now drop its plans to do so.

Good money can be made from catching falling knives, providing you only pick companies with a good business model, sound finances, which have encountered temporary & fixable problems. I initially (wrongly) thought that DX Group fell into that category. However, I have revised that view, and now believe that this company is in structural, possibly terminal decline.

Also, when you look at its balance sheet, the deferred income is likely to unwind as the DX Exchange declines (because customers pay cash for an up-front subscription). Therefore, I think there is an increasing likelihood of a cash crunch here in the next few years.

HML Holdings (LON:HMLH)

Share price: 32.3p (up 2.5% today)
No. shares: 38.9m
Market cap: £12.6m

Acquisition & trading update - another small acquisition has been made. This is the group's strategy, of rolling…

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tjl

18th May '16

Excellent post; just the sort of thing one hopes for on this site.

rhomboid1

Re Capital Drilling (LON:CAPD) , poor rig utilisation is the spare capacity required for the business to benefit from an upswing, it is cash generative and paying hefty dividends in spite of costs of unmobilised rigs.

Re Spread , yes it is often very wide but I bought in over 20 transactions and only paid full offer one iirc.

Cheers

Fugwit

For those who like a bit of TA with their fundamentals there was a decent doji last week from Patisserie Holdings (LON:CAKE) with a strong following candle so far this week on the weekly chart. It 'may' indicate a reversal of the recent pull back. Definetly do not wish to start a black arts conversation.....

Cisk

An excellent post wgadsby1 - always good when posters speak up of their real-life experiences of the shares discussed here - many thanks.

DX (Group) (LON:DX.) is not a business that I would in any way want to invest in (lost money in Business Post years ago so won't make that mistake again). Too much competition, heavy investment required, and no real 'moat' to stop others. Also the lack of business common sense of delivery companies continues to amaze me - I lost count of how many times delivery companies would try to deliver to a residential address during working hours - and would continue to do so 3 or 4 times, when most working people are at work! The amount it must cost them in failed deliveries must be substantial... doesn't apply to business parcels of course. Resolved this issue by using Doddle, a service that is well worth the cost.

Anyway thanks once again, always heartening to hear of real-world experiences.

bobo

Thanks for the input

raggedtp

Thanks for sharing relevant experience. I've held Connect for a while and thought Tuffnells a good purchase, so let's hope they can nudge their pricing up with you, just a little bit, not enough to send you elsewhere, but... :). Seriously, we'd love it if you re-posted at the end of the year to tell us all how the delivery world has changed, or not, for you.

Dearg Doom

DX (Group) (Lon:DX)

Decided to buy an initial holding early this morning and than foolishly or otherwise increased my holding again in the afternoon.

Reasons

I had been looking to buy DX group previously when I missed the opportunity the day the directors bought at around 17p around March 10th 2016. The price increased too quickly to jump in.
I do realise the business model is challenged but the parts that will remain will more than justify a higher share price
The interim dividend payment of 1p does show confidence in the future. Unfortunately, May 13th the date of ownership required for dividend payment is now gone.
The acquisition of Legal Post and First Post for £3.5 milllion on 10th May 2016 offers the prospect of £1.2m in profits going forward based on current operating profit of 600k and a further 600k of savings to come. £1.2 million profits at 8 times earnings = 10 million capitalisation value on this one part of the company alone. A few more acquisitions like this would be looked on favourably if earnings are sustainable.
The fall in traditional mail service will take a few more years yet, and any yearly cash flow fallout will be small and well spread out. Taking an average of the high debt for the group at mid year and low debt at end of year averages circa £7 million.
The deciding factor for me is that the purchase of the hub was subject to planning permission. I think this is the second time the planning permission has not gone through as originally planned. If planning permission ultimately does not go through than I believe the company is de-risked somewhat. £35 million was a lot of juice. Other cheaper alternatives may become available.

The market could have today acted in two ways. It reacted badly as if this hub was the saviour of the company. I think not! My best guess is that the share will return to 21-22p over next few days when the news is more fully analysed. So much bad news is already baked in the share price that a small tailwind of positive news will carry it slowly upwards.

Regards

gus 1065

That's a brave contrarian call on DX (Group) (LON:DX.) Dearg. although I acknowledge plenty of thought has gone into your investment decision. I bought in at the time of the first profit warning last Autumn at just under 24p and have yet to see the shares come back above this level.

Re reading the 29th Feb trading statement, there is quite a lot of bullish commentary about new sales being made so far in the first quarter and the company exiting from marginal/loss making contracts. Remains to be seen whether this is just management spin or green shoots that won't be prejudiced by the failure to get planning permission on the new hub. One thing to bear in mind is that the £35m hub was being funded by a developer, presumably on the back of a long term DX lease, so it wouldn't have put the full debt on the balance sheet (although it would have tied them in with a substantial lease). I would be interested to know who is bearing the planning costs etc., for the hub - DX or the developer as these must be mounting up.

I am inclined to give the management the benefit of the doubt pending the next reporting update but resisted any temptation to top up today. It will be interesting to see if either the management make further purchases and/or some of the big II's that bought in at the time of the IPO decide to cut their losses on this latest round of news.

Gus.

will89

Thank you for the replies, I'll make sure I update later, we're a very Christmas focused business so it's always interesting to see how the different couriers cope at that time of year. Shipping is such an integral part of our operation, the whole business is reliant on it, and the courier is representing our business to our customers. As an industry I think there is much room for improvement!

I'll endeavour to add a few 'real world' comments as and when it seems appropriate and non-confidential, as our customer base includes many of the retailers that Paul comments on.

With lots of the retailers it's always interesting to see the insights that our sales team have on the approach of the buying departments of different companies, some are much more efficient and organised than others, some with heads in the clouds and extremely 'creative' and some with very grounded, realistic objectives, or at least that's the gut feel you get when working on projects. It's often obvious whether or not this is a yardstick for the effectiveness of the underlying business, and it can be very apparent if there isn't much top-down guidance going on. The screams or cheers of the accounts/credit control department can also be a useful indicator. It can act as a useful counter to simply looking at the company results.

Don't get me started on Patisserie Holdings (LON:CAKE)... I think it'll be a letdown!

Tamarix

Re CAKE. I have held this for a while and am showing a loss. ADVFN is today saying it rose by 6%, but that the Spread is 17.7 %.
That doesn't look very investable.

Rusty2

That spread is incorrect, its less than 1%, in fact its about 1p. It went up 4.8% according to HL. Stockopedia agrees also, spread is 35bps.

smallcapman

will89,

You've chosen to start. Please do elaborate on why CAKE will be a letdown.

Scm

jonesj

I'm not sure the spreads quoted for some stocks on websites are reliable.
Digital look recently quoted a spread of 7.78% for Begbies (BEG).
I thought that was a bit greedy, considering the spread was about 1/3rd of the entire 52 week price range.
However, I purchased some at less than the Digital Look offer price. Then I immediately got a quote to sell a block (but did not sell).
The real spread was 3.81%. Still something I would like to see eliminated, but less than half the value shown on Digital Look.
Ideally, they need to allow people to post flexible orders and bypass the market makers.

Hi Gus,

Thank you for your fair comment.

Originally DX group intended to purchase and develop the site themselves for around 35 million. This figure would have been reduced somewhat by the sale of their nearby depot and some other property disposals.

The lease option was necessitated by need to control cash flow given the markets uncertainty around the firm's future profitability. The development by DX group would have meant a destructive share placing at 10p or less on top of newly created expensive loans to finance the hub. The new hub would have needed to add 7 million to profits to give an 20% return. It may ultimately have just kept the company competitive with low returns.

I reckon the lease option was management's only option and also a poor option given that any developer would need to make a good rental yield on the 35 million investment, plus the developer would get any future capital appreciation and the upward rent reviews. DX group for its part would be tied into a long term lease with no real upside potential or future cost advantage versus competitors.

My main concern as a new shareholder today is that none of DX group direct competitors made money. They seem to go bust with regularity. Here is an industrial sector with very poor returns on capital in an ever shrinking market for its services. it is possible that two or three years out only negative earnings can be earned by DX group in its present format.

This industry certainly looks like a set of lemmings bent on self destruction with price competition. DX group may indeed be a lemming candidate with too small a share of the overall market, DX group possibly does not have either scale, enough hubs, or management skills to flourish,

Some lemmings do survive however. Is DX group one of them? That's the question. My gut feeling is that today was not negative news, Today's sudden share price drop gave me that opportunity to buy close to the recent directors' purchase price.

Finally if DX group can walk away from the hub deal and take advantage of other opportunities, than shareholders at current price may be rewarded. Lots of stale bulls will provide stiff resistance to a major pick up in the share price in the absence of positive news flow.

Hi DD

You make a very compelling bear case given you are a shareholder!

Best of luck , you'll richly deserve your contrarian profits if & when they arrive

Kenncam

This type of debate plus Super Pauly Scott's articles are the very reason I read this site on a daily basis. A huge refreshing difference to the bs on bulletin boards. Thanks very much.

Paul Scott

Absolutely brilliant reader comments today, well done to all contributors!

As the huge thumbs up score shows, readers very much appreciate people with sector experience commenting on how they see various companies - which often shows companies in a very different light to the one that management try to project!

Let's have more of this stuff please! So if you know a sector well, from working in it, or having worked in it, then I'm particularly keen to hear your insights on any company that I write about.

It's very much a team effort here, and I love it when we have high quality reader comments, as we did today! So a collective pat on the back is in order :-)

Regards, Paul.

HRISC

19th May '16

Thanks Paul for the report on CAKE; I hold a long position and up 30%.

CAKE offers a compelling proposition: High footfall (the shop near me is always busy). A range of premium products which add margin. High volume transactions. Solid investment programme and development of new stores. Free cash flow. Good management team with sound track record.

Expensive but worth it imho and I will be buying more. Can't get enough CAKE!

smatthews1

Paul

After briefly looking over DX its not really for me as its simply to competitive, but its reassuring to see your have a more 'hardened' view on this one now, compared to your last review on it.

The hardest thing is to sit on the fence and give a very objective view even if it does look potential value.

Keep up the good posts

Sean

20th May '16

Thanks Sean,

DX. does indeed look value, but I'm increasingly concerned that it may be in structural decline.

Also, I can't remember such a dramatic % share price fall - it dropped about (maybe) 60% on the day, then continued falling, and has never really recovered. That tells me something is really seriously wrong.

I wrongly caught the knife, as it was falling, but I reckon it could be a 0p situation in the long run. That said, management have bought massive amounts of stock personally, which boosted the share price for a while.

I generally pay very little attention to management buys these days. Just look at that lunatic at Tungsten, who did something like a £2m CFD just to prop up a fake share price. It's surprising what Directors when hubris, spur of the moment, and when under pressure from brokers, PRs, and Instis. Believing their own BS - you'd be amazed how many actually begin to believe their own nonsense, after they've repeated it 20-30 times in one day, to Instis, let alone long term.

We've got to be careful. A lot of the people we're dealing with, in UK small caps, are smooth liars.

Regards, Paul.

Small Cap Value Report (18 May 2016) - DX., HMLH, CAKE, CHH

DX (Group) (LON:DX.)

HML Holdings (LON:HMLH)

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Paul Scott

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