Small Cap Value Report (2 Sep 2016) - AVS, ECK, CHT, AVAP

Good morning!

There's not much news today, so I'll go back to an announcement from yesterday, and have a closer look.

Avesco (LON:AVS)

Share price: 261p (up 1.0% today)
No. shares: 19.1m
Market cap: £49.9m

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

Trading update - this was announced yesterday at 12:46pm. Why??? It's crazy to put out a trading update during market hours, as that creates a false market in the shares. Someone might see that the price has gone up, and decide to sell, not realising that there's been a price-sensitive announcement. Professionals can usually read, interpret, and react to trading updates much more quickly than amateurs, which gives an unfair advantage. Thus In my view it should be obligatory to announce price-sensitive news at 7am, to give everyone an equal chance to digest the news, before the market opens.

The trading update said;

Avesco Group plc (the "Group"), the provider of services to the corporate presentation, entertainment and broadcast markets, is pleased to report that trading over the summer months has been strong, particularly in its Creative Technology ("CT") division.

In the US, CT continues to grow revenue, while CT London had a very successful Olympics in Brazil providing equipment and services to many of the ceremonies and events in and around Rio de Janeiro.  CT London will be providing further equipment and services during the Paralympics.

Consequently the directors anticipate that results for the year to 30 September 2016 will be comfortably ahead of their previous expectations.

So now we're into the usual silly game of having to guess what they actually mean by "comfortably ahead". Why can't they just give some numbers?

A reader called PJ007 posted a useful comment yesterday, giving his interpretation of what specific words in trading updates mean. He's even copyrighted it! I think this looks very sensible, so it's worthy of repeating here;

"Materially better" than expectations : +10% to +15% beat
"Comfortably ahead" of expectations : +2% to +10% beat
"In line" with expectations : 0 to +2% beat
"Broadly in line" with expectations : 0 to -5% miss
Anything worse than this and a Boardroom shuffle is pending. Hope this helps!© PJ0077    2016

I urge companies & advisers to stop playing this game, and instead just give us facts & figures in trading updates. That is best practice, and should be done by all. Using vague words, then briefing the analysts on the actual figures, is a ridiculous way to do things, and needs to be replaced with proper transparency. Companies need to push back at their broker/NOMAD, if they say you can't give forecasts to the market. Yes you can! Plenty of companies do so, and it's very much best practice to do so.

Companies should also always state in trading updates what market expectations actually are - put a figure on it, as this eliminates any chance for error, or misunderstanding.

Finncap has put out a positive note this morning, but doesn't refer to any forecasts.

The existing broker consensus for this year (ending 30 Sep 2016) is shown as 22.1p. So I imagine that something nearer to 24-25p is on the cards. The company is trading well, but also benefiting from the translation of US earnings into sterling.

My opinion - this has been one of my favourite companies for several years now, and it's doing well, and paying good & rising divis too. The balance sheet is fantastic - as practically all debt was cleared from the proceeds of a freehold sale.

Even after the recent rise in share price, the PER is only around 10-11, which for an ungeared, niche hire business, looks attractive to me. I like the niche in which Avesco operates - providing large scale audio/visual displays, and clever software to create spectacular visual effects. This seems to be a good growth area.

I think there is additional value, in that CT USA on a standalone basis could be worth substantially more than the entire market cap. So hopefully an eventual sale/breakup could crystallise shareholder value.

In the meantime I'm happy to continue collecting in the divis.

Note also the high StockRank of 99, and the prevalence of green on the StockReport - indicating good scores for both value and quality. What's not to like? From my point of view, this is close to the perfect stock - overlooked, cheap, with a bulletproof balance sheet, and trading well too.

The Chairman is getting on a bit too, so at some point he's likely to want to sell, which could be a nice catalyst for shareholder value.

UPDATE: here is the link for an updated note from Edison (commissioned research), which confirms my view that Avesco is still significantly undervalued. Edison reckons its rating is substantially lower than sector peers. Well worth a read.

Eckoh (LON:ECK)

Share price: 35.4p (down 28% today)
No. shares: 239.4m
Market cap: £84.7m

Trading update - oh dear, this must be a profit warning, as the shares are down close to the obligatory 30% for a standard type of profit warning.

There seem to be 2 issues. A non-core division in the US has incurred cost over-runs on fixed price contracts, resulting in a £700k loss. This problem has been dealt with though, with the planned closure of this division. Therefore this looks a one-off loss, and hence can largely be ignored by investors.

The bigger issue seems to be that client contracts are moving rapidly from up-front licence fees, to a SaaS based model - i.e. recurring revenues over a 3-5 year term. SaaS is a much better structure, because it smooths out revenues & hence makes profit much more predictable, than the alternative of large, lumpy revenues. However, there is pain to be endured in the transition from licence to SaaS revenues.

This is the key part of today's profit warning;

...As a result of the transition to SaaS pricing and the cost over-runs at PSS's professional services division outlined above, it is expected that the Company's pre-tax profits for the year to 31 March 2017 will be below market  expectations and is expected to be in line with the performance last year, after absorbing the costs of the discontinued division.

The medium and longer term outlook for the Company remains positive, with the transition to a recurring revenue model and decisive action at the PSS professional services division resulting in an improvement in the certainty and the quality of its earnings.

Actually, that doesn't sound too bad to me. It's not a disaster. The company made a £4.1m adjusted operating profit last year. So if we add back the one-off loss of £0.7m, that seems to suggest the underlying profit is likely to be about £4.8m this year.

The trouble is that this share was very expensive to begin with. Even after the substantial fall today, the market cap still looks very high to me, at £84.7m. What's the correct price? Who knows, but personally I wouldn't be interested on a PER of over say 15. Yet the PER looks to be well into the 20s.

I'll keep an eye out for revised broker notes, to get a clearer idea of what the PER is. There is a lot to be said for a business with predictable, recurring revenues, so if the price comes off some more, it might start to look attractive later, perhaps? To sustain a high PER though, companies cannot put a foot wrong.

Constellation Healthcare Technologies Inc (LON:CHT)

Share price: 149p (up 4.6% today)
No. shares: 88.4m
Market cap: £131.7m

Interim results to 30 Jun 2016 - this share is a new one to me, so these are just some initial notes. It's a US-based healthcare group. I'm really struggling to understand what services they actually provide. It seems to be some kind of outsourcing for medical practices, focussed on billing. The website has pictures of attractive women sitting in front of computers, smiling.

The shares floated in the UK in Dec 2014. An obvious question is why a US-based company decided to float in the UK? It might just be that the company was able to achieve a higher valuation in the UK than the US. That was why Somero Enterprises Inc (LON:SOM) listed in the UK. Generally I don't usually touch overseas companies that list on AIM, because there's often something wrong with the company. However, US companies are usually OK in my view.

Dividends - this company doesn't pay divis, which is a big turn-off for me. Particularly because this company makes a big deal of being cash generative. If so, why isn't it paying divis? Although this might be because it's retaining cash for acquisitions.

Profits/growth - the headline figures certainly look impressive;

H1 revenue up 78% to $57m. Although note that a large acquisition drove most of this, although there was 22% organic growth in its main division (called RCM - revenue cycle management).

Operating profit up 92% to $14.5m - wow that's impressive - both the growth, but also the high profit margin of 25.4%.

Taxation - as readers note below in the comments section, the tax charge is very high. However, corporation tax in the USA is higher than the UK. So it's essential to value this share on post-tax profits (earnings).

Balance sheet - debtors has more than doubled to $22.5m, but that figure is not excessive when compared with $57m revenue for the 6 months.

The only red flag I see in the balance sheet is that the company simultaneously holds $21.9m cash, and $12.3m in debt. That seems illogical, and wasteful in terms of interest costs, so needs checking out.

Ah, I've just worked out what's happened. The company reported after the interim period end, here on 20 Jul 2016, that it had repaid all its debt, which will save $1.4m in interest payments.

So the red flag disappears.

Outlook - this doesn't really say anything specific:

The U.S. healthcare system remains complex and is likely to continue to evolve to cater for the ever changing demographic as well as the newly insured, while containing costs at each level.

CHT is well placed to take advantage of this new paradigm. The next few years remain exciting for our business as we build a truly scaled healthcare technology platform.

However, the CEO comments contain this in line with expectations comment;

At this point in time we feel very confident having delivered above  expectations for the first half of 2016, that we will meet the markets guidance on revenue as well as profits for the full year 2016.

Valuation - earnings of 22 US cents are forecast for 2016 & 2017. So converting into sterling at £1 = $1.332, equates to EPS of 16.5p. At 149p per share, the PER is 9.0. This seems a very modest rating for a growing company with net cash on the balance sheet.

It's the sort of rating which suggests that the market isn't convinced these figures are real, or sustainable.

My opinion - there's something here that the market doesn't like, because the rating should be a good bit higher. Maybe it's the shareholding structure, with the CEO owning 47.4%?

If the figures are real, and sustainable, then this share looks a bargain. Personally I'm not keen on outsourcing companies, especially overseas ones that don't pay dividends. So for me, it's a no. However, the figures do look attractive.

Avation (LON:AVAP) - a good update today from this aircraft leasing company. Top marks to them for giving figures, rather than vague words!

The Company expects that the pre-tax profits will be above market expectations for the period.

The unaudited lease revenues for the year are anticipated to be about 25% higher than for 2015, increasing to about US $71 million.

Financial year 2016 second half profits are expected to be materially increased when compared with the first half of the year.

For the year ending 30 June 2016 Pre Tax Profit is expected to be approximately US 18 million and associated earnings per share are anticipated to be about 32 cents per share.

The increased profits are primarily due increased trading profits from the disposal of aircraft.