Small Cap Value Report (19 Aug 2016) - C21

Good morning!

It's extremely quiet for results again today - CEOs and FDs are probably lying on beaches, or their yachts, at the moment.

So I'll circle back to some remarkably good economic data & surveys out yesterday. This is reinforcing my conviction that Brexit has only had a small, and temporary impact. As I've mentioned before, you have to take a view on the macro picture, otherwise you really can't invest with any particular logic - unless your strategy is to buy & hold forever.

The devaluation of sterling is very positive for any UK company which makes things, and sells them abroad, or sells them in the UK against competition from imports. The UK just got a lot more competitive, thanks to sterling's devaluation. That's the whole point of floating exchange rates - that struggling countries adjust & become competitive again through devaluation of their currency. This is the gigantic flaw in the Eurozone - there's no mechanism for such adjustments to happen, other than deep recessions to crush wages & asset prices lower.

The problem with a devaluing currency, is that it drives up inflation, because imported goods & raw materials become more expensive. So I do think we need to prepare for higher inflation next year, and that could prove difficult. Mind you, sterling has recovered c.2-3% from its low, on the more positive UK economic outlook.

The Office for National Statistics published a report yesterday on July retail sales. It makes very interesting reading. Sales volumes were up a remarkable 5.9% in Jul 2016 compared with Jul 2015. Although this is flattered by price inflation being negative at -2.0%. So putting those two together, the overall value of retail sales rose by 3.6%, which is probably the most meaningful figure.

EDIT: I forgot to mention, the online sales growth is remarkable - it's up 16.7% for Jul 2016 vs. Jul 2015. Now, I would treat that with caution, as am not sure how they're measuring it. However, there's no denying that online is being enthusiastically embraced by Brits. Therefore, I am very focused on good online businesses, with a decent profit margin (e.g. Boohoo.Com (LON:BOO) ) - as opposed to low margin stuff-shifters, like Ocado (LON:OCDO) , AO World (LON:AO.) , and arguably ASOS (LON:ASC) .

Also, remember that a lot of conventional retailers also have very successful online activities. There could be some great bargains there, for the ones who make the transition well, and can get out of their shop leases.

These figures are for the immediate aftermath of the Brexit surprise, when any panic would logically be at its height. So it seems the British consumer has shrugged her/his shoulders and said "so what?!" It's very much business as usual for the consumer. This is backed up by numerous company updates we've seen in recent weeks. Good weather this July, following on from bad weather in June, will have definitely helped sales of clothing & footwear.

The GfK consumer confidence survey showed a dramatic drop in July. I seem to recall there was another survey published yesterday which suggested a rebound in confidence, but I can't find a link.

So it seems the immediate threat from Brexit has receded, and apparently we won't now be going into a recession after all. This is why share prices have been recovering so well recently. Well, that and ultra-low interest rates tending to push money into equities, where investors can at least earn a return - and a very nice return indeed, for those of us who held our nerve through Brexit. There must be cash on the sidelines coming back into the market now too.

So all very positive. Mind you, there is a longer term worry, that inward investment into the UK might stall. I've seen one or two articles where companies are threatening to move production to E.Europe. Although some of that was likely to happen anyway I think.

Right, on to what little company news there is today.

£C21

This c.£2m market cap tiddler has put out another profit warning.

I gave up on this share a couple of years ago, as it was becoming increasingly obvious that it's going nowhere - it's too small, and reliant on large, lumpy contracts.

Today's update talks of a "significant loss" for 2016, and it's cutting costs in response.

There was £1.2m in net cash at 30 Jun 2016, but I wonder how much of that will be left, after continued operating losses & redundancy costs?

Micro caps like this usually go wrong. I rarely delve down this low in market caps, as they're so difficult to trade (you often can't sell when you want to), and companies of this size nearly always disappoint. Occasionally you do get a multibagger though, but I don't think this one will be it.

Work (LON:WORK)

My attention has been drawn to the narrative with the late results from this struggling micro cap. It raises two important issues - lack of support from banks towards SMEs, and large customers exploiting their small suppliers with late payments.

A couple of excerpts to whet your appetite;

Throughout the course of 2015, we were without doubt struggling to survive and I must thank our people for their commitment and endeavours in achieving the outcome that we did.

However, our difficult trading conditions were exacerbated by some truly appalling corporate behaviour in the UK.   During 2014, we had concluded that our former bankers would not be the source of any short-term working capital on acceptable terms. We therefore entered into a confidential invoice discounting arrangement with another provider. However, in practice, the numerous conditions attached to these facilities, despite our client base containing many of the largest companies in the UK, meant that the facility was restricted to 18 per cent of our overall debtor book. This pressure on cash flow prevented us from shrinking our cost base to match our revenues.

This situation was aggravated by more of our working capital being tied up with UK clients which either required us to negotiate labyrinthine procurement and authorisation procedures or to accept ever longer payment terms. This culminated in a situation at the end of October when the amounts overdue (i.e. more than 60 days) from two UK clients amounted to three times our UK payroll.

As an SME with large UK corporate clients, we were quite simply exploited - a situation which we did not experience in the United States or Hong Kong. The positive cash flow from these overseas offices in reality prevented the Group from having to declare insolvency.

I am afraid that I also have to reflect that our former bankers did little to support us despite a relationship going back many years. Their constant change in personnel, interpretation of facility limits to the narrowest extent possible and, on two occasions, failure to respond to requests to the point where we were forced to elevate our request to senior management within the bank is a sad reflection on the state of a once reliable business partner. The reality is that they did nothing to help us and in practice nearly caused our demise.

Fairly blunt stuff. Mind you, banks are not risk lenders, so when clients get into trouble, they just want out. I experienced this in the 1990s, when Lloyds Bank almost destroyed Pilot, the business where I was Head of Finance. We once averted Administration by seconds, in a meeting when the regional office was about to make us insolvent.

I realised I had to do something, so I just blurted out, "We can pay you off in full, in a fortnight, from cashflows. I'll lock up the chequebooks". That completely changed the tone of the meeting, and we survived to fight another day.

I did indeed pay off the bank in 2 weeks, but the swine then bounced my payroll - saying there were inadequate cleared funds. Even though they knew we had enough funds, once uncleared cheques from customers were included, which were typically £10 each, and all had the guarantee number on the back (so none would bounce).

So I had to pay everyone (about 500 people) by individual CHAPS payments, on payday itself, all hand-written by me & my accounts team, and faxed one by one to the bank. Chaos - but we saved the business, and our CEO found a new financial backer to refinance things shortly afterwards.

Anyway, I should stop there, as this is all stuff that's going to be in my book! 

So the issues of banks failing to support SMEs, and large corporates exploiting SMEs for cashflow, seem to very much still be big problems. This hampers the UK's growth, so I hope Mrs May turns her attention to this area.

Sadly, there's nothing else of interest to me today, so will wrap it up.

Regards, Paul.

(usual disclaimers apply)