Small Cap Value Report (20 Sep) - TFW, TAN

Good morning! The FTSE 100 futures are indicating an open down 15 points to 6,608 this morning. The divergence between the main index, and small caps is becoming remarkable though. Check out the chart below, which shows that small caps (the beige line) began an astonishing bull run in Nov 2012, and that if it had kept pace with small caps in the last year, then the FTSE 100 would by now have reached 8,400! So that's a 27% out-performance by small caps vs large caps in the last year (the chart actually shows two years, but they were closely correlated until about a year ago).

So I suppose you could look at this two ways. Are small caps likely to continue out-performing, or are we now due a correction? In my opinion things are getting so frothy, a correction is both likely, and necessary, hence I continue to carefully top slice one or two of my positions, just to be on the safe side.

In a recovering economy, I do think one can be a bit more aggressive on growth assumptions, and hence be prepared to pay a little more in slightly higher PERs, but personally I won't go higher than about 13 for good quality businesses (adjusting them to net cash/debt neutral).

 

Another sign of a bull market is that IPOs are back with a vengeance, and are going to a premium apparently, although I've not really looked at any. IPOs don't generally interest me, as they are usually over-priced, why else would founders sell or accept dilution? London estate agents, Foxtons, is the latest, with a valuation of £649m at 230p a share - will be interesting to see that probably going to a premium too. I was a Foxtons tenant a few years ago, and they don't have a good reputation - in my experience tenants find them pushy, and landlords say they sit on the rents for months before paying them over. I would also worry about the need for Govt to act on excessive admin fees.

 

 

 

One of my favourite companies is FW Thorpe (LON:TFW), a family-controlled maker of lighting equipment. Their results for the year ended 30 Jun 2013 are issued today, and I like the chatty, but no nonsense style of the narrative. Not a great year for them though. Turnover is down 0.4% to £55.3m, although it remains a high margin business, with operating profit of £10.8 (down 9.3%), so that's a very healthy margin of 19.5% - indicating strong pricing power.

EPS dropped 3.8% to 8.16p. Note that there was a 10 for 1 share split from 19 Aug 2013, so the share price dropped by 90% when that was done, as the number of shares increased 10-fold. Losses within two subsidiaries, which have been named & shamed, and various other one-off factors mean that profits should rise again this year in my opinion, so I can see an argument for valuing the company on say 9-10p forecast EPS (although I can't find any published broker forecasts).

So at 115p these shares don't look expensive. Particularly when you take into account the amazing Balance Sheet. In fact, it's such a strong Balance Sheet, I have to show it to you - see below. If that doesn't give you a warm glow, I don't know what will!

 

 

As you can see, Thorpe has net cash of £33.4m (being split into two lines, £20.1m shown as "Short term financial assets - deposits", and the balance of £13.2m as "Cash & cash equivalents"). That is 25% of the market cap, or 28.5p per share. Although one could argue that a company hoarding cash is not really doing a lot of good for shareholders - surely it would be better to put that cash pile to some use - i.e. value adding acquisitions, or just pay out the surplus element of the cash to shareholders as a special dividend.

With controlling family shareholdings, a share buyback would not be a good idea, as that will just make the shares even more illiquid, and there is already a punative bid/offer spread - they are currently priced at 112p Bid, 120p Offer, which is just ludicrous, and makes this uninvestable for me - pity, as I really like the business, Balance sheet, and management.

 

 

 

 

Tanfield (LON:TAN) has come up with an interesting solution to its ongoing woes - a staged disposal of their powered access division, involving a partner company refinancing it. Looks like quite a clever deal, with TAN having a Put Option to sell at an agreed price in future.

It will at least stop shareholders having to stump up more cash to fund the never-ending losses there. The market doesn't seem to like the deal though, perhaps because it's an admission of defeat, and takes away the upside? The shares are down 11% to 20p. I've never thought much of this company, and think they're on a hiding to nothing with their other division, an aging electric vehicles company.

 

 

 

I've not trawled up anything else of interest today, very quiet for news, as Fridays often are.

Even the laggards in my portfolio have started moving up strongly this week, so it really is a bull market! My stance remains - enjoy it whilst it lasts, but top slice or sell completely anything that is starting to look fully priced. There will be a pullback at some point, we just don't know when - and it's essential to have some dry powder to deploy on such a pullback, with some of the profits to date in the Bank.

As always, that's just one person's opinion, and readers may disagree - feel free to discuss in the comments below (there is a free registration option, but it's tucked away on the price plans page!).

Hope you enjoy the weekend, and see you back here at 8 a.m. on Monday.

Regards, Paul.

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