Small Cap Value Report (2 Jun 2014) - ARL, TRB, DQE

Good morning!

 

 

 

Atlantis Resources (LON:ARL)

This company is on my watchlist, after an interesting presentation by the CEO at a Mello investor evening a few months ago. It's a tidal power (from submerged turbines) company building an offshore project in Scotland.

Results for the year ended 31 Dec 2013 have been issued this morning. I was initially confused by these results, as the company appears to be heavily loss-making, and to have negligible cash, and a lot of debt, so from these figures it doesn't look viable. However I've just realised the company only floated in Feb 2014, i.e. after the reporting date in these results, so it must have raised fresh cash at that time.

Sure enough the Admission to AIM announcement from 20 Feb 2014 indicates that £12m in new equity, and £8m in "non-dilutive funding" (presumably loans or grants?) was raised. It generated a $13.7m operating loss in 2013, on $6.2m of turnover. So it's not possible to value the company based on these accounts. Instead one would have to get more information about the capex needed to complete the tidal energy project, future operating cash burn, and then look at forecasts for what profit it is likely to generate in the future.

One to watch, but I've not got any idea how much it's worth. Tidal energy seems conceptually a good idea - in that, unlike wind turbines, the amount & timing of electricity generation is entirely reliable & predictable. The only thing that could change it, is if the moon suddenly deviated from its orbit around the earth, changing tidal patterns.

The share price began falling soon after it floated, but has since stabilised at a lower level.

 

 

 

 

Tribal (LON:TRB)

Tribal describes itself grandiosely as, "a leading provider of technology enabled management solutions to the international education, learning and training markets" - what on earth does that mean? I know they do the OFSTED inspections for schools. So I am awarding them a grade D- for ability to explain what the company actually does.

It announces an acquisition of an Australian company, for A$15.2m, which at the current exchange rate of £1 = A$1.81 converts to £8.4m, so small beer relative to Tribal's market cap of £165m (at 178p per share).

The company describes this acquisition as earnings accretive, which obviously it will be, since no new shares are being issued, and the company being acquired is profitable. It made A$2m of normalised operating profit on A$7.3m turnover in 2013, so a good % profit margin there. 

I was going to dismiss this deal as immaterial, but actually with forecast net profit of £11.8m this year, adding on another £1.1m of profit is almost a 10% hike in group profitability. So that is likely to drive forecast EPS up to about 14p by my calculations. Therefore the PER seems reasonable at 12.7, based on 178p per share.

Tribal shares have been under pressure lately, with the drop on 16 May coinciding with an IMS issued on that day which said that profits are expected to be more H2 weighted in 2014 - which introduces additional risk that a profit warning might possibly be on the cards later this year? Companies often hope to recoup a shortfall in H2, but such a pattern often turns out to be a deferred profit warning. So I would treat this one with caution, which the market seems to be doing of late;

 

 

 

 

 

 

 

DQ Entertainment (LON:DQE)

It's difficult to thnk of a better example of why I don't ever invest in Chinese or Indian companies, than this company. Its accounts are just ludicrous. It reports good profits every year, but negative cashflow, and the telltale signs are always to be found on the Balance Sheet - over-sized debit balances in fixed assets and current assets are the giveaways that things may not be as positive as the P&L suggests.

The point is that debits can either be put through the P&L as costs, or put onto the Balance Sheet as assets (which therefore boosts reported profit). However, if that asset has little to no value, then it shouldn't be on the Balance Sheet at all.

So capitalising costs onto the Balance Sheet is the time-honoured way to boost profit in the short term, but of course you can't keep doing it forever, as the whole thing will eventually implode once people realise that the Balance Sheet has been stuffed with costs that should have gone through the P&L.

Indian accounts are easy to interpret, as there are 99 Rupees to £1. So just divide all figures by 100, to get the corresponding sterling amount. So in this case turnover for the year ended 23 Mar 2014 was about £24m, and a healthy profit before tax of £4.6m is reported. After tax that is £4.3m.

Given that the market cap is only £ 10m at 17p, this company looks amazingly cheap, that's a PER of only 2.3, what a bargain! However, it falls apart completely when you look at the Balance Sheet, an extract of which is below. Note how Trade Receivables of £30.5m is more than the entire year's turnover! In fact debtor days works out at no less than 464 days!! That's just ridiculous. Normal debtor days is about 60 days, and 90 days would worry me, but 464 days is beyond madness in my opinion, you just can't take the figures seriously at that level.

 

Also note that about £ 10m has been capitalised into "intangible assets under construction", so presumably that is the costs of making films. That's fine providing that the films can then be sold for a profit. Although given that customers don't seem to like paying the company's invoices, then that has to be questioned.

 

 

The Stockopedia graphics show how cheap these shares appear on conventional measures.

However, I need to keep nagging Stockopedia to include some warning flags for companies with growing intangibles, and in particular excessive debtors - since it's the excessive debtors that is usually the giveaway of dubious profitability in my opinion.

The same issue of excessive debtors exists at two of my other least favourite companies - Globo (LON:GBO) and Quindell (LON:QPP) (incidentally, I closed my shorts on these, so am able to discuss them here now).

 

 

 

There are some serious warning signals in the narrative - the worst one by far being that they are now seeking additional financing. The plans for a maiden dividend have gone by the board;

 

The total outstanding Trade Receivables of the Company at 31 March 2014 was INR 2,599m, out of which INR 1,322m was outstanding for more than 180 days. The Company has confirmations from its customers of their dues to the Company. The monies are being received on a regular basis from most of the customers, though in small values, thus confirming their commitment to pay and honour their liabilities. 

The debtor position has inevitably put pressure on our cash flow and working capital which of course we are monitoring closely and our banks have been supportive.  However, whilst debtors are gradually repaying, it has not come at a rate we expected and so we have been exploring options for a longer term funding solution for the Company to crystalize the large and growing pipeline of orders as quickly as possible.  In this regard we are in active discussions with strategic / financial investors to refinance the business.

In view of our cash position, which as on 31^st March 2014 stood at negative INR 844m, and the pressure on working capital, the Board is reviewing the Company's dividend policy and whilst it is not recommending a dividend at this time it will seek to pay dividends to shareholders as soon as financially and commercially viable.

 

So not a happy situation, and entirely predictable that the wheels would come off here - the accounts have been screaming that for a long time, in the excessive debtors, and the capitalising of costs. I see that the shares are down 26% already this morning, unsurprisingly, as there's now a significant risk that the company could go bust.

I hope no readers here are in this stock - I've warned here about its weak accounts numerous times.

 

 

 

Other than that it's extremely quiet for results & trading statements today, so I shall sign off and have an early lunch. More results are expected tomorrow, so see you then.

Regards, Paul.

(of the companies mentioned today. Paul has no long or short positions)