Small Cap Value Report (19 Nov 2015) - PLND

Good morning!

Poundland (LON:PLND)

Share price: 224p
No. shares: 268.7m
Market cap: £601.9m

Interim results to 27 Sep 2015 - It's not a small cap, but there are some interesting nuggets in these interim results. Its shares are down 19.5% to 224p at the time of writing, giving a market cap of £603m. Do remember that, in common with most financial websites, Stockopedia data is updated overnight, not in real time. So the market cap of £748.6m shown for Poundland is as of last night's close. Clearly it's essential to manually adjust that figure, so I just took off 19.5% to arrive at the current market cap of £602m. It's sobering to think that £146m of shareholder value just vanished on publication of interim results.

Poundland joins the long list of recent IPOs (Mar 2014 in this case) where shareholders have been disappointed. Furthermore, a Placing at 280p was done less than 2 months ago, to finance the acquisition of 99p Stores Ltd - which looks to have been a cracking deal, based on the figures given in today's announcement - a 3-4 year payback is not to be sniffed at.

Although the Institutions who backed the Placing must be livid, at a profit warning following so soon after, leaving them 20% underwater from the Placing price.

J P Morgan Cazenove, and Shore Capital were the bookrunner and co-lead manager.

LFL sales fell by 2.8% in the 6 months to 27 Sep 2015. That's no good, because retailers are seeing cost pressures - so they have to drive sales & margins up, just to stand still. In particular, the Living Wage is going to be a serious problem for many companies in retail, hospitality, healthcare, etc, as not only will the minimum wage for over 21s rise from £7.20 ph to £9.00 ph by 2020, people above this level will be seeking to maintain differentials. Thus a domino effect of rising wages is likely - bad for profits, but good for aggregate demand in the economy (although much is being offset by the Govt reducing so-called Tax Credits).

The company refers to "highly volatile trading conditions so far in the 3rd quarter", and that the 6-weeks leading up to Christmas are a very important busy period, as with many/most retailers.

Note the mitigation comments here, which have read-across to other low wage employers. Thinking about how, and to what extent, employers will be able to improve productivity is a key investing theme over the next few years.

The National Living Wage

New National Living Wage ('NLW') legislation requires employers to pay £9.00 per hour by 2020 with the first stage increase effective April 2016, when it rises to £7.20 per hour. Naturally, this impacts on our cost base.

Although Poundland is not a minimum wage employer, we need to maintain pay differentials when new rates are introduced. Without mitigation, the increase in wages attributable to the new NLW is estimated at £4.3 million in the 2017 financial year.

We are mitigating this additional cost. We have accelerated investment in the current year in productivity including the trial of hybrid self-scanning checkouts, new sales based ordering systems, shelf ready packaging, the installation of LED lighting and other operational measures.  We will spend an additional £2.0 million this year in these areas, as we seek to fully mitigate the additional costs of the NLW.

To put the above into context, Poundland made a £44.4m underlying operating profit last year, so £4.3m of additional costs (before mitigation) in 2017 is not going to break the bank. Although there will be further, significant additional costs in each subsequent year. So the impact could get quite nasty by 2020.

It's certainly worth thinking about not only the companies that will suffer additional costs from NLW, but also which companies will benefit from supplying the equipment needed to raise productivity, and lower costs.

All in all, a key area to get our collective heads around. There's also the cost of the Govt's newish pension scheme too, to further increase wages cost. I'll certainly be treading carefully when weighing up new positions in companies with a lot of low paid employees.

Johnston Press (LON:JPR)

Share price: 47.4p (down 10.6% today)
No. shares: 105.9m
Market cap: £50.2m

Trading update - covering the 17 weeks to 31 Oct 2015. The key part says;

The Board expects underlying profit and net debt for the full year to be in line with expectations. We have retained our focus on cost savings, delivering strong cashflows and debt reduction.

Underlying total revenues for the 17 week period to 31 October fell 8.8% year on year, having fallen 7.6% in the second quarter.

Underlying digital revenues were up 8.4%, whilst Publishing revenues fell 10.8%, with print advertising revenues down 14.7%.

My opinion - I'm kicking myself for not having shorted this share, as I've been saying consistently, for several years here, that the equity was probably worth nothing. The reason is that the company still has a large burden of debt, plus a pension deficit, and just servicing these debts is consuming so much cashflow, that there is unlikely to be enough to fully cover liabilities. Especially given that the core newspaper business is dying.

Therefore management are really just managing the decline, and clutching at straws (the way I see it) for digital initiatives. The 14.7% decline in print advertising, which I have bolded above, is a key number to me. In my opinion, this shows that we're probably now getting into the end game, where even local advertising moves online.

Small businesses I talk to, have mostly worked out that business improves for them, the more they spend on Google ad words. The next big area is engaging with customers on Facebook & Twitter. Whether there is much ad revenue left for local papers, who knows? It's clearly in steep decline, and the newspapers are now in a vicious circle, where the more they cut costs, the worse the product becomes, giving customers less reason to buy it. Customers are literally dying out - how many people under 40 buy a local paper these days?

I suspect JPR could be quite near a tipping point where revenues just go into freefall, costs can't be cut any further, and it's game over. Note how the previously key categories of ad revenues, - employment and property, fell by 22.4% and 20.8% respectively. That's a structural move of ad revenues away from newspapers, and it won't be coming back. It's gone online - to Rightmove, Zoopla, and Onthemarket.com .

The most recent balance sheet is a car crash - NTAV is £313.3m negative! So actually thinking about it, the shares might well still be a good short? Although shorting is dangerous, as you can get caught out with a sudden spike in price, or someone may come along and bid for it. With so much debt though, and a now rapidly declining core business, I very much doubt it.

The bondholders will end up calling the shots here I reckon, unless management can get another equity fundraising away. So it remains a complete bargepole stock for me, indeed it's been on my Bargepole List since Aug 2014, and is down 77% since then. It amazes me how long it takes sometimes for really very obvious bargepole stocks to unravel.

Note that the StockRank is rather low, at 44. It's only that high because the Value score is very high at 97 - although of course this stock is a value trap, as it's technically insolvent, doesn't pay divis, etc, so the PER is meaningless.

I keep telling Ed that the Value ranking needs to be changed, to take into account the balance sheet, as it's utterly bonkers in my view to have a stock which is technically insolvent (and very likely to become actually insolvent in the not too distant future) scoring 97 on a Value ranking system. Value is all about balance sheet strength - that's absolutely core to value investing - that box has to be ticked before you can move on to consider low PER, divi yield, etc. Or alternatively, you can just manually screen out weak balance sheets, as I do - after all, it's quick and easy to do.

Just to stress, in all other respects, I absolutely love the StockRank system, but this balance sheet issue is very important to think about, as otherwise you can end up being sucked into value traps. Although that's my job really, so I'll warn you of the risks whenever I find a company that is high risk.