Small Cap Value Report (2 Dec 2016) - TRCS, IND, TUNE

Good morning!

Firstly, I'm going to take circle back to 17 Nov, when results from Tracsis (LON:TRCS) came out. It's a tradition that I interview CEO John McArthur after full year results, but haven't got round to it yet.

Tracsis (LON:TRCS)

Share price: 517.5p
No. shares: 27.8m
Market cap: £143.9m

Audited results for year ended 31 Jul 2016 - the key figures look good to me, and a broker note says they're in line with expectations.

Key figures;

• Revenues up 29% to £32.6m (fuelled mainly by acquisitions)
• Adjusted PBT up 18% to £6.9m (note the excellent profit margin of 21.2%)
• Diluted, adjusted EPS up 22% to 22.37p (PER of 23.1)
• Net cash of £11.4m - however note that a fair bit of this will be needed for deferred consideration creditors of £6.1m - but I seem to recall John McArthur previously saying that these would be self-funding from cashflow generated before the payments need to be made

As a reader pointed out a fortnight ago, the profit growth has all come from acquisitions. The continuing operations adjusted EBITDA actually fell, from £6.2m to £6.0m.

Balance sheet - not as strong as it was, due to intangibles mounting up from acquisitions. Net assets are £28.7m, but take off intangibles of £26.1m, and NTAV drops to only £2.6m.

However, this is unavoidable at buy & build groups. The good thing about TRCS is that, to date, it's not used any bank debt. So if something did go wrong with trading, there's no risk of the sort of collapse that we've seen before at highly indebted buy & builds.

The number of shares in issue has not risen that much either - up from 20.2m in 2011, to 27.8m now. This is because most acquisitions have been funded from the strong cashflows of the existing businesses - a really good strategy that has worked very well to date.

Overseas order for RCM - this is the potential big excitement. After several years of testing the water, pilots, etc, a "significant" order has been received from the USA for its condition monitoring equipment, which has been a great success in the UK. Although this order is only $0.4m, it's a step in the right direction. The share price contains a premium for the potential of overseas expansion.

Acquisitions - sounds as if they are trading well. The group hasn't really put a foot wrong with its acquisition strategy, which again does justify a premium rating.

Dividends - very small, as the group is investing in expansion, mainly through acquisitions. That's a better use of the cashflow than paying divis, in my view.

My opinion - I like it, but given the lack of organic profit growth this year, I think the share price is possibly looking a bit full now. That said, you can justify this due to the really good track record on acquisitions, and the overseas growth potential. Also there are high margins, and recurring revenues to take into account, all of which support a warm rating.

Indigovision (LON:IND)

Share price: 154p (down 1.3% today)
No. shares: 7.6m
Market cap: £11.7m

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

Trading update - this Scottish digital CCTV company made a loss of $269k in H1, but announces today that it's going to recoup that, and more, in H2;

As anticipated, the second half of the year to date has seen higher revenue than in the first half and second half revenues are running ahead of the corresponding period in 2015, with camera volumes up 20% year on year largely offset by lower selling prices.

Price competition has had limited impact on IndigoVision's gross margin as a result of the change in hardware strategy made at the start of 2016.

Overheads remain well controlled and materially below last year.

As a result of these factors IndigoVision is trading profitably in the second half, after losses in the first half, and expects to report a profitable outcome for the year to 31 December 2016 as a whole.  This would represent a substantial improvement over the 2015 full year operating loss of $0.7m. 

Note the hefty price deflation which is ongoing, although the company seems to have managed to mostly maintain its gross margin, by the sounds of it, as production is outsourced.

Forex moves this year have benefited IND, as it's UK-based HQ will now be costing less in dollar reporting terms.

Variable cost base - as I've mentioned before, IND can scale its costs up & down fairly easily, to reflect sales activity.

Forecasts - the existing forecast for this year from N+1 Singers was pie in the sky, so everyone seems to have ignored it - hence little move in the share price today. Sensibly, but tardily, they've now revised down the forecast for this year to a more realistic $0.3m overall profit for the year.

Next year's forecast is now $1.5m, but as we know from experience, IND is impossible to forecast, as it relies on big contract wins to deliver good years.

Balance sheet - remains strong, and note that net cash was reported at $4.6m at 30 Jun 2016. Today the company says;

The working capital improvements previously reported have been maintained and the Group expects to finish the year with an improved net cash balance year-on-year (2015: net cash of $2.8m).

That sounds to me as if we're looking at the same ballpark as the $4.6m from Jun 2016.

My opinion - it's dirt cheap at £11.7m market cap, but understandably so, given that performance has been disappointing overall, in the last few years.

That said, the company's got a good product range, and is out there innovating, and competing. It's coping with price deflation, and has a solid balance sheet.

So overall, I'm going to stick with it (12 years now, and counting!)

Focusrite (LON:TUNE)

Share price: 204p
No. shares: 58.1m
Market cap: £118.5m

Results year ended 31 Aug 2016 - I really liked this company when last looking at it, here on 14 Mar 2016. I only have time for a very quick glance at the numbers issued recently (on 22 Nov 2016). Several readers have asked me to look at it.

A few quick comments;

• Good P&L, showing solid growth.
• Adjusted diluted EPS up 8.6% to 11.4p (PER of 17.9)
• Net cash of £5.6m, and a good balance sheet overall in my view
• Modest divi yield of about 1%
• Upbeat outlook comments, and narrative talks about new products, and expanding sales internationally
• Very good operating profit margin
• Excellent track record of organic growth

So there's lots to like here.

That said, I'm not sure the growth rate is strong enough to justify the rating going much higher - so is there much upside on the share right now? I don't know, more research would be needed on its products & markets.

Note that cashflow poor in the year just reported - all its cashflow was sucked into increased working capital, and capitalised development costs. That's hopefully just a one-off, as I think the profits are genuine here.

Ignore EBITDA, as it capitalises nearly £3m p.a. into intangibles, thus rendering EBITDA meaningless.

My opinion - this looks a smashing, high quality business. I would need to do a lot more research on the company before being prepared to pay a fairly hefty multiple for it though, after the recent jump in share price.

There again,the market is paying up for high quality growth companies right now.

Note that the outgoing CEO sold his c.1m shares recently, and then exercised options over a fresh batch of 619k almost free shares, which he currently holds. The key player is the major shareholder/founder.

I'll leave it there for today & the week.

Just to let you know, I've asked Ed for a week off, as am grabbing some winter sun, and feel completely burned out at the moment, so need a rest from report writing next week (for the first time in 4 years!).

There was talk of someone possibly covering for me, I'm not sure if anything has been arranged on that front.

Regards, Paul.