Small Cap Value Report (21 Jan 2014) - FRP, TMMG, IQE, RST, OPTS, NFC, NET, UBI, PRW

21st Jan '14 by Paul Scott

19 comments 32124 reads

Good morning! When I first started investing, an old friend taught me that you have to ask one key question before relying on a PE multiple to value any company - "are earnings sustainable?". If the answer to that question is yes, then you have to try to accurately guess what sort of upward trend in earnings is the most likely to happen, and value the company accordingly. The faster, and more certain the earnings growth, then the higher the PER that can be justified, within reason.

The good news is that, at this stage of the economic cycle, most people (including brokers making forecasts) tend to under-estimate the effect of operational gearing, and hence companies tend to out-perform against forecasts in an economic recovery.

That means two things - that if you spot a good company with decent management on a reasonable rating, then you might well get a pleasant surprise on results day. The opposite also being true - that if you over-pay for a company that does not deliver strong profits growth, then you'll get a nasty shock on results day as the share price will open a lot lower. In a bull market investors often over-pay for growth stocks, and that is very much the case at present - I can foresee many of today's extremely expensive growth stocks leaving investors heavily out of pocket once reality dawns on people. Momentum doesn't carry on forever. However, the odd one will do very well.

So with the market for smaller caps generally quite expensive at the moment, there are going to be a lot of banana skins around this year, as those hefty PERs come down to earth with a bump for companies that fail to deliver strong earnings growth. So you have to be very, very sure that a company is indeed going to perform well, before paying an expensive earnings multiple for the shares.

Fairpoint (LON:FRP)

At the opposite end of the valuation spectrum is Fairpoint (LON:FRP) which is a debt management company, helping consumers recover from severe over-indebtedness. They seem to operate ethically, from what I can ascertain.

I listened in on a conference call with management last year, and asked a few questions, and they sounded competent.

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Ramridge

21st Jan '14

NRR. New River Retail. Price has dipped by 3.6% on news of a placing today. That makes a current dividend yield of 5.8% better still at around 6%. On this basis I have topped up my long term holding in my SIPP.

Gostevie

Hi Ramridge,

I too am a holder of Newriver Retail (LON:NRR) and happy to remain so. The placing seems to be at a reasonable discount, and given the track record of shrewd management I am confident that they will use the funds wisely to make further appropriate acquisitions.

Steve

bsharman

Hi. I would be interested to hear any thoughts people had on the CLIG (CIty of London Investment) presentation from the Mello meeting yesterday. Thanks

trufflehunter

hi paul,
views on NRR placing?

Reynart

I had a thoroughly good evening at Mello as the quality of conversation over diiner is always excellent, but was underwhelmed by both the CLIG and SND presentations.

The SND balance sheet looks lazy to me - cash raised from shareholders has led to dilutions in EPS and is being utilised to pay off pensioners. The chairman seemed over-defensive about his 5% organic growth. And his order book seemed to be lumpy and full of low value contracts. Better value elsewhere IMHO!

There were plenty of people in the audience who understood CLIG better than me, so will leave them to comment on their strategy. My only reaction was that the company will probably perform better when the CEO hangs up his boots and hands over to his able looking deputy - not convinced by 69 year old CEOs who claim to want to continue to 75!

carla77

Totally agree in regard to debt, the first thing I look at is debt, many companies seem oblivious to debt and use it to fund buy backs often when their share prices are high e.g. GSK's debt at Dec 2012 was 53% higher than the previous year, this is financial incompetence and Directors should be held to account.

gregpacey

Hi Paul, I'd be interested to hear your comments on the Next Fifteen Communications trading statement.

PFhunting

Like the new format, much better when referring back to them

JamesHolmes

Improvement, keep going!

Cuthbert C

re CLIG

I had the opposite reaction to Reynart. I liked Barry Oliff very much and was impressed by his obvious mastery of his subject and his refreshing candour and evident integrity. His understudy did not make such a strong impression, not necessarily his fault - he spoke less and was cast in a relatively subordinate role.

Conclusion I reached was that if Oliff were 40 years old and likely to run the business for another 25 years, I'd have filled my boots this morning. As it is, I worry that the business might be badly impacted by his imminent retirement.

I am still reading and pondering and have not yet bought in.

I would say to anyone interested, that one of the best assessments of CLIG I have found is on a somewhat obscure website/blog wertartcapital. I recommend reading it.

BahrainChris

Definitely an improvement.

Soundbuy

Ditto.

IQE. Is a PER of 13.7 right? Well it depends on which side of the fence you fall. The company is a world leader in compound semiconductors, the stuff that chip manufacturers use to make the chips for mobiles, tablets, wireless devices, etc. That market however is maturing so growth is expected to plateau soon. This wireless market accounts for 80% of their revenue. However the company also produces semiconductors for the photoelectronics market (around 20% of revenue). Growth of this segment is expected to be significant over the next few years.
If IQE go on to make major inroads in the photoelectronics market in the way they have for wireless then a PER of 13 or so is undemanding. A rating of over 20 may be more appropriate. The fundamentals of this business are right and there is a very experienced management on board. I have a small holding that I intend to top up.
Regards, Ram

monzo

Next Fifteen Communications (LON:NFC) director dealings just popped up.

"Mr Richard Eyre, Chairman of the Company, has today purchased 28,781 Ordinary Shares in London at a price of 86p per share."

"Tim Dyson, a director of the Company, has today received 150,000 Ordinary Shares at nil cost following the vesting of performance shares under the Next 15 Long-Term Incentive Plan awarded on 9 February 2010. Mr Dyson today sold 77,997 Ordinary Shares in London at a price of 86p per share."

davids_h

Re Fairpoint

"although in this case they are helping people resolve high levels of indebtedness, so are actually doing good."

Up to a point.

They charge a fee for their DMP services which is included in the monthly debt repayments. They obviously make their profits from this, but it inevitably cuts the amount by which customers reduce their overall indebtedness and increases the repayment time. There are plenty of professional free services available (e.g. StepChange, National Debtline, Payplan, Citizens Advice) offering DMPs etc that maximise the amounts repaid, and which also offer advice on other options e.g. Debt Relief Orders, Admin Orders etc.

I'm not sure there would ever be sufficient green flags on Stockopedia's page for me to invest.

Mark Simpson

I still think Restore (LON:RST) is overpriced given that it's only really grown by issuing a lot of shares for acquisitions and has struggled to generate any real FCF and looks expensive on almost all of the Stockopedia metrics. It's operating margins look high for a company with little competitive advantage in a declining industry and when a company grows by acquisition it can be hard to tell how the underlying business is really performing. As with Quindell (LON:QPP) I'm sure they will be fine as long as investors are happy to put extra cash in to fund the growth but may become unstuck if they can't access fresh funding or their high margins erode over time.

Danger (no position)

oldnotbold

My goodness Paul, you are a hard-working guy. Very impressive and thoughtful report today.

The list of companies today all seem to lack a 'moat' be it brand or intellectual property. A rising economic tide may carry them up, but then what? Only IQE seems to have a product that has real potential in next generation solar and wireless, but many hearts have been broken in those sectors.

The problem with companies like Mission Marketing is that the assets walk out the door every night (and marketing is hardly an industry known for loyalty or financial discipline). Difficult to know what the value proposition is with Mission?

melody9999

Danger - I beg to differ on RST. The half year 12 /9/13 states: Equity of GBP7.0m was raised during the period to fund three acquisitions whose net cash consideration was GBP9.4m including costs. For me, my investment in RST is based on Charles Skinner driving the business. He followed the same acquisitive strategy successfully at Brandon Hire. I'm happy to pay for some dilution if it results in higher operating margins and earnings appreciation. Been in since 80p and see no reason to sell after today's update.

Paul Scott

25th Jan '14

Hi Oldnotbold,

I take your point about trying to find a "moat" in companies that we invest in, very much a Buffett thing, which makes obvious sense.

Trouble is, businesses with a clear moat are usually very expensive, and competitive pressures can rapidly drain a moat, especially with smaller caps.

So personally I think the moat thing is great when you find it, but not usual in smaller caps. However, plenty of smaller companies do very well indeed from humdrum activities, but doing them well. So I think looking for really strong, entrepreneurial management, is more important in small caps than a specific moat. Cost control also very important, which is why I like businesses that operate in the Midlands/North/Scotland, as you tend to get a much lower cost base, and management who pay themselves relatively modest salaries, and don't have delusions of grandeur - they just get on with the job & work hard.

As regards Mission Marketing (LON:TMMG) the value proposition is pretty clear - it's on a low PER! Debt is now under control, and the economy is improving so their results should also improve on an operationally geared basis. I'm not saying it's the best business in the world, which it clearly isn't. But at this price, I think it's an attractive investment. It's all down to price. I'm not looking to hold it forever, just to hold for a re-rating, then move on.

Moats are more for very long term investments I think. So I would say that, e.g. Spaceandpeople (LON:SAL) has a moat - in that it totally dominates its sector, and doesn't really have any competition. Their one competitor recently went bust, as you need scale to make it work. New entrants can't get scale, so they fall by the wayside. So it probably has quite a strong moat. And is reasonably priced. So for me it's a hold forever type of share.

Regards, Paul.

Small Cap Value Report (21 Jan 2014) - FRP, TMMG, IQE, RST, OPTS, NFC, NET, UBI, PRW

Fairpoint (LON:FRP)

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Paul Scott

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