Small Cap Value Report (22 Feb 2016) - Brexit, HOME, HDD, XPP
Good afternoon!
Up until today, I've been ignoring the Brexit issue - but as the politics seems to be hotting up (with Boris Johnson coming out in favour of Brexit today, and more senior Tories to follow no doubt), then it's worth thinking about the potential impact on our investments. That's an entirely different discussion from what is best for the country in the long run of course - where anyone who follows me on Twitter will already be in absolutely no doubt about my view on the matter!
The sharp fall in the pound today is actually rather helpful - making it more profitable for UK firms that export, but also of course meaning that imports get more expensive. A lot of companies blamed the strong pound for their profits being under pressure last year, so with that now reversing, it should now be providing a favourable tailwind for those companies.
I don't believe for one minute that the UK's trade with the rest of the EU would be very much affected if we do go through with Brexit. After all, we're a large net importer. So if the EU imposes a 5% tariff on all UK goods, and we do the same to them, then the UK will collect in far more tariff money than it pays out. That could then be recycled into an export subsidy administered through the VAT system, thus negating the impact of EU tariffs. Do we want to get into a trade war with the EU? Of course not, as it would just harm both sides.
So after an initial period where the EU tries to punish the UK for leaving, I believe that common sense, and self-interest on the part of EU exporters now finding it more difficult to access the UK market (or "treasure island", as the German car manufacturers call the UK) will return, and things will go back to pretty much how they were before - i.e. free trade.
Brexit really is not in any way a leap into the unknown. It's simply going back to being an independent, self-governing nation, like we have been for centuries, before 1975.
In any case, it's about getting back our democracy. If we have to give up say 3% of our GDP to become a self-governing, sovereign nation again, then frankly it's worth every penny.
You only have to look at Southern Europe to see that the EU is a disastrous experiment that has gone spectacularly wrong. It's corrupt, and undemocratic, and the sooner we're out, the better. Then we can do our own trade deals with the rest of the world, and really begin reconnecting properly with the English-speaking world, and powerhouse growth countries like India, setting our own agenda, not waiting in a side room whilst an unelected EU official that we've never heard of, thrashes out a deal that suits German exporters best.
Home Retail (LON:HOME)
I hope some readers managed to profit from the higher, competing bid for the Argos-Homebase (pending disposal) group. Steinhoff has indicated a potential 175p cash bid.
Personally I sold out gradually between 133-155p a little while ago, because my feeling was that risk:reward was no longer favourable, given that if the J Sainsbury (LON:SBRY) deal fell through, then the downside could easily be revisiting the sub-100p area.
I suppose the big question now is whether SBRY might try to sweeten their offer above 175p, or whether they will pull out? I don't see any recent statement from SBRY on the RNS, yet.
It just goes to show, the enormous value on HOME's balance sheet was tremendous hidden value, and it seemed obvious to me that, sooner or later, it would attract a bidder. Many people who looked at the share were not even aware that £800m of cash, and near-cash was sitting there in current assets - because they hadn't properly studied the balance sheet.
I feel that a failure to properly study the balance sheet is a glaring oversight in many investors. Just look at the tremendous upside on HOME which was lying there, dormant. It was a unique situation though - I've not seen any other retailer with so much hidden value in the balance sheet.
It's quiet for company results, but here goes with the ones that do look slightly of interest:
Hardide (LON:HDD)
Share price: 0.91p (down 4.2% today)
No. shares: 1,334.7m
Market cap: £12.1m
(at the time of writing, I hold a long position in this share)
AGM statement - this sounds rather negative to me;
"Hardide continues to make good progress in diversifying its customer base and thereby reducing reliance on a major customer and market sector. However, demand from the upstream oil & gas market is very subdued. The technical approval of the coating by Airbus, the recently-announced long-term supply contract for components for the revolutionary X-ray baggage scanner and other potentially high-value applications currently in test give the board confidence about the medium and long term prospects of the Company.
"The new US facility is fully operational and producing good quality coatings on customer parts for verification and life testing. Full-scale production is due to commence early in calendar Q2 2016. Additional employees have been hired to enable production levels of operation.
"The Board continues to monitor the oil & gas markets closely and is keeping the Company's cost base under tight control.
My opinion - when companies say that they are confident about the medium & long-term prospects, that is usually code for saying that things are going badly in the short term.
The comment about over-reliance on one customer, and the oil & gas sector, are also worrying. If I'd done my research properly, I would have found out about those points in advance, and not bought the shares.
However, this is a time to be humble, and admit my mistake here. I bought some shares in this company on impulse, after two positive-sounding announcements about new contract wins. I didn't do my research thoroughly enough, and hence missed the important potential negatives.
As a result, my impulse buy at 1.5p is now well underwater. What's worse still, is that I can't get out! The market makers are only offering firm prices on 50,000 shares at a time - that's only £455-worth! Anyone wanting to transact in larger size, will have to take a haircut. So my broker is currently ringing round, to see if any of the MMs want to buy some (or all) of my shares.
I have a horrible feeling that it will be a situation where I'll end up high & dry, unable to sell, and then the shares are likely to take a hit when results come out in May.
Ah, just had my broker on the phone, it's not quite as bad as I feared. Have had to take a haircut of just over 11% to get rid of them. So in my brief period of ownership, I had to over-pay to get in (as there were no sellers at the time), and now that things have deteriorated in terms of fundamentals, I've had to take an 11% haircut to get out! Given that the quoted spread is already wide, then this buy & sell transaction has been a bit of a disaster!
1.5p to get in, and 0.8p to get out. In just a few weeks of ownership. Dear oh dear, a very poor trade. This further reinforces my absolute revulsion for micro caps. Every time I cross the line into something this shockingly illiquid, it ends up being a disaster. So the lesson learned here is to do the research properly in the first place, and if it's an illiquid micro cap, the upside needs to be very much greater, to compensate for the difficulty in getting out.
Schoolboy errors. Putting it down in writing, for several thousand people to read, and tut at my stupidity, will hopefully make me think twice in future before making such a silly error again!
XP Power (LON:XPP)
Share price: 1521p (up 3.2% today)
No. shares: 19.0m
Market cap: £289.0m
Annual financial report - I am grateful to Colin, for pointing out in the comments section below that XPP has today announced its 2015 results. I missed it because the company really gave the wrong title to the RNS. Usually "Annual financial report" is only used to refer to the Annual Report being posted out, after the preliminary results have already been announced. For that reason I always ignore any announcement that is given this title.
XPP is an overseas company, but has a full UK listing. It has a long track record of being profitable, paying decent divis, so my usual reservations about overseas companies do not apply in this case.
The figures look alright, if unexciting. 9% revenue growth, to £109.7m. Adjusted profit before tax is up 6%, to £25.7m. Note the very strong profit margin, that's a 23.4% overall profit margin, which is superb.
Total dividends are 66p (up 8% on last year), so that's a decent 4.3% divi yield.
Balance sheet - looks good to me. Although inventories look rather high, at about 6-month's worth of cost of sales, so it could be carrying too much slow-moving stock perhaps?
Outlook - note the mention of macro headwinds, which a lot of companies are saying at the moment, which makes me nervous;
While we recognise a number of economic headwinds with the potential to impact our business in 2016 - notably slowing growth rates in China and North America - we consider that we remain well positioned in our marketplace. We have good momentum as our design pipeline continues to grow, order intake in the fourth quarter of 2015 was strong at £30.0 million and we entered 2016 with a healthy order book.
In addition, following the acquisition of EMCO, we are excited by the prospects for our new high voltage DC-DC module product line, which will provide additional revenues this year. The combination of these factors gives us confidence that we should see further revenue growth in 2016.
We remain confident in the long term prospects for our Company.
So I read the above as saying that there could be trouble ahead, but things are fine in the short term.
Valuation - I'm not entirely sure if I'm comparing apples with apples here, but it looks as if XPP results for 2015 came in slightly ahead of broker forecast, after a wobbly Q3, but a better Q4.
Forecast for 2016 is 106p EPS, so at 1521p/share that is a PER of 14.3. That seems a reasonable price, if forecasts are achieved. The worry is the macro outlook which may lead to 2016 actual results being lower than forecast? Time will tell.
My opinion - I don't know enough about the business to form a view on it really. So I think it's a case of having to really get into the research in more depth, and understand the products, markets, etc.
The modest growth is a bit of a concern, and my worry is that such juicy profit margins might attract competitive threats. Nice divis though, sound finances, so if you think the company can maintain its margins, then it could be good. Overall, I'm probably neutral on this one, and would rather sit on the sidelines until it becomes clearer what the macro outlook is going to be like.
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24 comments
As for lack of accountability, it's to an extent self-inflicted - says Cig
Then argues to stay!!!!
The perversity of the argument beggars belief - who on earth would want to stay within a group that ignores you?
If what people want is more sovereignty, it's not obvious that being out will be more helpful than in. Imagine you're a UK widget manufacturer worried at some misconceived EU product standards, now you can lobby your minister/MEP to make your point at EU level and possibly change them. After Brexit, you'll have no direct route to lobbying, and still have to build your product to EU standards anyway as it would be suicidal to make UK-only widgets. In an interconnected world, national sovereignty is a bit of an illusion anyway, especially for small and mid-sized nations.
As for lack of accountability, it's to an extent self-inflicted: the UK has been consistently sabotaging any attempt at building more federal institutions ever since joining (not the only culprit, but distinctly unhelpful). One could argue that pro-European Brits should vote for Brexit so that ever closer union can proceed with less hindrance.
As for the EU trying to "punish the UK for leaving" this is just silly. Nobody in the EU cares that much. It would just be a long process of disentanglement and negotiating one-by-one a bunch of bilateral rules that do more or less the same thing as existing EU rules when it becomes obvious that really reversing most of them would be silly (e.g. nobody will want to actually deport British pensioners settled in Spain or on the Cote d'Azur back to Blighty). It would just keep many lawyers and bureaucrats busy for a decade.
Hear hear to Brexit. We are finally beginning to see an improving debate after the monotonous pro status quo propaganda the Beeb has shamefully been pedalling. I fear that as a nation we may still chicken out and vote to stay in but at least having Boris on side the arguments should get out there.
In my view the EU has not yet seriously damaged the quality of life in the UK but the way it is constructed and its lack of accountability will inevitably do so as time goes on.
Re XP Power (LON:XPP) Not sure if this has come out clearly in comments so far, but this company is based in Singapore, so the more than usual caution should apply in looking at their accounts.
That said they have healthy FCF and are paying out decent dividends. No suspicious looking capitalisation either.
Not invested but on my watch list.
If anyone missed it, Woodford has produced a long report on the risks/outcomes of an EU exit / staying.
https://woodfordfunds.com/economic-impact-brexit-report/
Hi Cisk
I'm not invested , I'd rather leave my money on the bus, I'd probably stand more chance of getting it back..
HDD aiui coats critical components with a vapour deposited tungsten carbide 'plating' which is a non polluting process unlike Chromium plating with Chromium-6, which is in its death throes. September 21 2017 has been ordained by the European Commission as the sunset date for Cr(VI)-salts after which Cr(VI)-containing products can only be placed on the European market, if a substance- and application-specific authorization was granted to the company by the European Chemical Agency (ECHA). Last applications for authorisation must be submitted by March 21, 2016. That's why I'm hanging onto my small HDD holding, but wthdik
.
Ref XPP
I like this business, they seem to have a bit of a Niche in that their products seem to be increasingly of the type that are custom designed but based on the same theme and mission critical type items for the customer. This seems to give them a level of protection against cheaper non established rivals who probably can't get through the approval process to be able to be supply their products. This may be an over simplification in that they probably still do the bog standard stuff too but they seem to have enough added value to make them a go to company of sorts for what they do. The proof of the pudding is in the Margins they make and they are reasonably stable.
It is probably a good Niche area to be in offering your services particularly if they can eek out ongoing efficiency improvements by making the product better and using newer technologies - i like the fact that the R&D is (mostly??) straight via the profit and loss account so the profits look very real.
I have no worries with regard to stock - they make their own kit and two factories and the specific nature of the varied items they do probably means its sometimes necessary to start the process well in advance of customer delivery if only to ensure to they can always deliver on time.
Finally i like the fact this company has been chucking off good extra cashflow that can be put to real use to improve the long term business prospects. The extra cashflow needed for the Vietnam factory was primarily funded from profits not paid out as divis and the new acquisition will be paid for in under two years ($12 million dollars) from my calcs. So it wont be long before they have another £8-£10 mill burning a hole in their pockets (or ability to borrow that amount short term if needs be) ready for the next cunning plan that will keep the business driving forward. There must be any number of associated Niche areas they can gently expand into when the right opportunity comes along.
I guess though its all in the price at 15*PE but i would be happy to top up my current holding at around current prices were it not for the slightly cheaper looking alternatives that can suck me in - cheap aint always good though. Perhaps i am pimping this share up a bit as the profit growth hasn't exactly been Stellar for the last 5 years but they seem to be in a stronger better position each year since they last had a wobble back in 2012.
Paul, Apart from the wisdom of your analysis of accounts and balance sheets and the relevance or not of DB pension schemes and LTIP's for directors the real value of what you write is that agree or disagree, it comes from a position of Honesty, rare today in may walks of life but like rocking horse DO DA when talking about investments. I can remember well the ones I got right but tend to forget the ones and importantly the reasons for the ones I got wrong. I will now try to honestly revisit them! Many thanks
Hi Colin
I'd not looked at XP before as I'd mistakenly thought of them as an ADVFN punters stock like UKOG or Worhington or Rurelec!
Having looked at it I really like it , I particularly like how they've morphed into a bona fide manufacturer rather than just a distributor. The dividend yield/record , strong cash generation and modest debt . They also sound relatively bullish to me , in particular forecasting revenue growth for this year.
It's gone on my watch list awaiting fresh funds to purchase , thx for flagging it up!
Cheers
Hi Rhomboid.
Not sure if you've been keeping an eye on your other punters stocks but UK Oil & Gas Investments (LON:UKOG) is up by about 100% since the turn of the year!
Gus.
Hi Gus
Re UKOG
http://euanmearns.com/the-gatwick-gusher/
Great piece that sums matters up well
ps ...every dog has its day but some just have fleas
Thanks Rhomboid.
Good to read a piece on the subject without having to wade through the mindless profanities found on some of the blogs - TW springs to mind.
Not sure anyone really knows how much of what is down there is recoverable and at what cost. I agree this particular dog is unlikely to ever win Crufts but it might make a reasonable return, especially if there is value in some of its other prospects such as its IOW gas field.
In the meantime, I've top sliced so have a small, free residual holding so interesting to see what happens.
Gus.
You're brave investing in anything connected with Lenigas. Having seen the likes of him many times in my investing history, personally I'll give anything connected with that man a very wide berth.
Presumably, assuming Brexit, you'll be hoping that people in other EU countries don't decide to start boycotting the UK and UK goods, as you promised to do to Scotland if it was a yes to independence.
Even though, on balance, I probably favour Brexit, I'd be nervous about holding UK companies where a large number of sales went into the EU. The vote will probably be to remain though.
Thanks Paul. Steady and stable with modest growth suits me fine right now, in contrast to some of the other horror stories. There are indeed concerns about the sustainability of that growth, but I think they are overdone; as the report itself remarks, the diversity of sectors and geography means that declines in one are more often offset by the others. The investment in Vietnamese production facilities - to undercut the Chinese! - seems a smart move, and might explain the build-up of inventory while the line comes up to speed.
There are a number of videos on the company website where CEO and FD explain various aspects of the business. They come across as credible and competent, with clear communications. I was also interested to read in today's report that one of the core company values is perceived to be integrity and the videos exemplify that. It's a good defensive moat re competitors too - if they can fake that, they can fake anything!
Perhaps I'm in danger of believing the story. But it seems credible to me and the management appear trustworthy - a key message in your recent interview with David Stredder. XP Power (LON:XPP) is one of my largest holdings and I'm happy to hold.
Colin
Re Brexit. The best the bookies will give you is 2:1. Remain in the EU is 4:7. Unlike lucien2k I think it will be very difficult for the Brexit campaign - the British people will probably be scared into voting for the status quo - as in every referendum we have ever held. Even Boris expects to lose according to Westminster gossip, but he has his eye on another prize.
I don't know, turnout is very poor at European elections normally. 35.6% in the last one. That suggests it is hard to get people to care for the EU. How do you mobilise that other 65%?
The polls suggest that the 60+ age group are firmly in the leave camp. They are the most likely to be registered to vote and also turn out to vote. The 40+ group are also generally more in favour of leaving.
Last general election the turnout was 70-78% amongst that older group vs 43-54% in the younger vote. That could have a big effect on the results.
You make some interesting points about differential turnout, although turnouts on previous referendums have been rather higher than for European elections: 65% for the in/out referendum in 1975, and even 42% for the below the radar AV referendum. The Scottish referendum of course managed 84.5% Personally along with the bookies I think the odds are stacked against Brexit: the leader of every political party except for UKP will be on the other side. The uncertainty though may be bad for already fragile markets.
Microcaps are sometimes OK but more often than not a total pain.
Does help if you avoid the serial duffers though, such as HDD or MOS etc. If you see an interesting situation then look in past RNS or BB and you will perhaps avoid the 50% losses.
Having said that, I need to read and follow what I just wrote as I'm as guilty as anyone.
Paul
XP Power (LON:XPP) announced its full year results this morning, which look pretty solid to me. The language and message is commendably clear, as ever with XPP, and they seem to be making good progress; profit, EPS and dividend are all ahead of market expectations . The balance sheet looks good too (to me, but then I don't have your forensic capability!). I'd welcome your comments
Colin
It will be interesting to see how the opinion polls shake out over the next few months.
Personally I think they will be misleading, thinking back to the Greek referendum (https://en.wikipedia.org/wiki/Greek_bailout_referendum,_2015#After_the_referendum_announcement). They predicted almost a 50/50 split with a slight bias towards no. The end result was 61/39 in favour of no.
It is much harder to mobilise a vote for the status quo than a vote for action.
I think if there's a vote for brexit, we'll end up with another referendum within 6 months.
Reference HDD: Oh dear, Paul. If someone as knowledgeable in the mysteries of balance sheets as you can't get it right, what hope is there for the rest of us lesser mortals! Reading today's report makes me think I'd better change my on-line name to Bread Tomorrow, sell all my under-performing shares, and hide what's left of my cash under the mattress - if only to give the mice something to eat. It's an oil can half empty sort of day then?
Hi Paul,
RNS this morning from Kromek (LON:KMK) to announce that it's sorted out it's contract with DARPA, any thoughts?