Small Cap Value Report (21 Apr 2015) - SHOE, IGR, UTW

Good morning! Advance warning of my next charity project - I haven't done anything for a while, so have been looking around for ideas which don't involve physical exercise, and have stumbled across a fundraising thing for next week - raising money for extreme poverty, by living on £1 per day for all food & drink.

I'll set up a charity donations page over the weekend, and then will do the challenge next week, Mon-Fri, and will blog separately about how it goes. There won't be any cheating - like most things in life, it's only worth doing if you do it properly! I was vegetarian for 5 years when a student, so eating cheap, basic food is a lot easier (and healthier) than most people seem to think, so it will be an interesting challenge. And let's face it, I'm carrying more than enough in reserves to see me through a lean week!

Back to the markets, and I've been clobbered with another profit warning unfortunately.

Shoe Zone (LON:SHOE)

Share price: 185p (down 28%)
No. shares: 50.0m
Market Cap: £92.5m

(at the time of writing I hold shares in this company)

Profit warning - this is an unsatisfactory announcement, because it doesn't explain the severity of the profit miss, so investors are really in the dark until revised broker notes are issued. The following points are made;

Negatives

• Warm weather conditions - had a "material impact" on autumn/winter trading, reducing sales.
• Product mix - although sales volumes were up, average selling price was down.
• Revenue & profit for H1 (6m ending 4 Apr 2015) will be "behind the prior year"
• Full year results - "expected to be below market expectations"
• Dividend will be "adjusted accordingly" (i.e. reduced from current expectations)

Positives

• Gross margin - "remained robust"
• Stock position - "well managed, with no requirement for additional discounting"
• Net cash position "will remain strong"
• Core strategy of opening larger stores - "continue(s) to make good progress"
• Online sales growing strongly

Directorspeak - this sounds reasonably upbeat, but the company doesn't have enough track record yet as a listed entity to determine whether any reliance can be placed on such reassurances.

My opinion - I'm annoyed about this. It's not acceptable to warn on profits only 11 months after first listing on AIM. The whole point is that companies have to under-promise and over-deliver, building up a track record of doing what they said they would do.

OK, the weather was mild this winter, that will have had some impact. However, when I visited a ShoeZone store a few months ago, I was totally underwhelmed with the limited choice, and uninspiring product. Am wishing I'd sold my shares then, but the newsflow from the company seemed good.

Also, the company made the following outlook comment on 14 Jan 2015;

So when they made that statement, they were near the end of the autumn/winter season, and should have been fully aware of the impact of mild weather. Therefore I'm struggling to reconcile the reasons given today for the profit miss with the more upbeat statement made on 14 Jan 2015.

Given that today's statement does not quantify in any way what scale the profit miss will be, then it's impossible to make an accurate judgment on whether or not to buy the shares on this dip. I don't like leaping into the dark, so will hold fire for the time being on topping up.

It's just a question of waiting for the company to brief the analysts, and then see what revised forecasts the analysts come up with. The profit warning isn't disastrous, by the sounds of it, so I'm not worried about continuing to hold the shares. I like the format of discount shoe retailing from low rent stores, and the company has experienced management with plenty of skin in the game. It's financially strong, so there are no solvency issues.

I suspect that the real reason for the profit shortfall is that product ranges were not up to scratch this season, and therefore competitors like Primark took business away from ShoeZone. So they need to pull their socks up & get the product right for spring/summer, whatever the weather is like.

International Greetings (LON:IGR)

Share price: 96p (up 14% today)
No. shares: 57.9m
Market Cap: £55.6m

Trading update - it's two years since I last looked at this share, having dismissed it before as being a low margin business, with far too much debt.

However, I'm warming to it after crunching the numbers today, and an upbeat trading statement. As the name suggests, it's a distributor of gift products.

Here are the highlights from today's update;

Valuation - broker consensus is for 9.15p EPS for the year ended 31 Mar 2015, so at a guess it sounds as if they might come in c.10p EPS, given the "ahead of expectations" above. So at 96p per share, the PER looks reasonable at 9.6.

Net debt - this has been very high in the past, but now seems to be coming down to more reasonable levels. I've reviewed the last balance sheet, and actually it has more debt than I'm comfortable with, but I've seen far worse. So overall, it's not too bad, and I would consider a small investment here.

The main problem seems to have been inefficient working capital - i.e. the company was holding a lot of inventories, and debtors were too high, with these large current assets being mainly financed through debt facilities - not a good business model, as the company has to pay interest on bank debt, so it is effectively operating as a bank for its customers!

Note there is large seasonality in the debt levels: net debt was £89.9m at 30 Sep 2014, and £36.9m at 31 Mar 2014. So it looks as if March is a seasonal low for debt, and it also just happens to be the year end date!

My opinion - it may not be my idea of a perfect investment, but it's starting to look quite reasonable now. There could be scope for further increases in share price perhaps, as this is starting to look like a convincing turnaround. More detail is given in the update, and this all sounds pretty encouraging to me.

I had a quick rummage through the last Annual Report, and note that there is about £12m in freehold property, at cost, on the balance sheet. So that's worth factoring into the valuation. I like freeholds a lot.

I'm tempted to have a little dabble here.

Utilitywise (LON:UTW)

Share price: 219p (up 4% today)
No. shares: 74.7m
Market Cap: £163.6m

Interim results - the P&L numbers look very impressive - turnover up 42%, adjusted pre-tax profits up 49%. I've commented before on not being comfortable with their accounting policy of recognising revenues up-front, and then having a large debtor balance in long term assets.

The cashflow statement looks difficult to interpret too, since it was cashflow negative in H1 last year and this year, but strongly cashflow positive in H2 last year. So it seems to have a very strong seasonality there in cash collection.

Dividends - the company started paying divis in 2010, and these have been rising strongly, which is nearly always a good sign.

Outlook - the comments sound positive, but a slightly odd wording to the last sentence?

My opinion - if you accept the figures as they are presented, then this stock looks very good value, especially on next year's forecasts, where the PER drops to only 8.4, and the forecast divi yield rises to 3.8%.

I am slightly uneasy about it, but it's difficult to ignore those valuation metrics.

Acquisition - separately, an announcement is made about the acquisition of T-mac Technologies. The price looks very full to me - £10m initial consideration (plus an earn out) for a business that only did turnover of £3.6m, and EBITDA of £0.3m for the year ended 31 Mar 2015, seems an awful lot. Still, one assumes management know what they're doing, there must be good growth potential for it.

Right, got to dash, back to Hove & some last minute preparation for the Mello Workshop event in Peterborough, hope to see some of you there!

Regards, Paul.