Small Cap Value Report (22 Jun 2016) - DEB, HRN, MIRA, IDH

Good morning!

Debenhams (LON:DEB) has put out an updated today. Not a small cap, but as regulars know, I keep a close eye on the retailing sector, as it's my sector specialism. It performed very well over the key Xmas season, but has now slipped back - reporting LFL sales down slightly, at -0.2% for the last 15 weeks. Sales are however still up over the last 41 weeks, at +0.7%.

The big problem retailers have, is that costs are relentlessly rising, in particular the cumulative impact of several years' rises in Living Wage will hurt. I suspect that the Government might be forced into deferring the increase in Living Wage at some point between now and 2020. It's just going to hurt businesses too much, especially in the retail, hospitality, and care sectors.

Note that Debenhams reports strong growth in online - up 9.1% over the last 41 weeks. So people are still spending, but a greater proportion is going online.

Costs are rising at just over 2% p.a., so that's the problem - if sales are not rising by a similar, or greater amount, then profit is likely to fall.

Overall though, the update says profit is in line with expectations. Note that Debenhams still has quite a lot of debt, c.£280m.

DEB is not one I currently hold, as I chucked it out in a regular portfolio pruning, a few weeks ago. Today's update doesn't motivate me to buy back in. Although the interesting thing to note with DEB is the scale of their internet sales - it's one of the UK's largest internet retailers actually.

Hornby (LON:HRN)

Share price: 31.8p (up 1.4% today)
No. shares: 55.0m before fundraising + 29.6m new shares = 84.6m
Market cap: £26.9m after fundraising

Results & fundraising - it's good to see that Hornby has managed to secure the equity funding it needed. The discount of 15% isn't anywhere near as bad as I feared. A placing has been agreed at 27p per share.

I'm delighted to see that the company and its broker have also included an open offer for existing shareholders to participate on the same terms. This is absolutely the right thing to do, so that the important issue of pre-emption rights is at least respected in part. So well done to the company & its advisers for structuring the deal in this way.

An open offer is only necessary where the placing shares are being issued at a discount of more than about 5%, in my view.

I won't go through the numbers or the turnaround plan any further, as it's not a share which interests me. Management have a tough job to get this company back on track (geddit?!). The remedial action being taken seems sensible - scaling down the size of the business, reducing costs, etc. It's also got a big overhang of inventories. New bank facilities have been agreed.

It lives to fight another day, but personally I would need a lot of convincing to want to buy into this share, which has been a serial disappointer in the past.

A few snippets now, as I'm meeting an investor for lunch shortly.

Mirada (LON:MIRA) - a bullish sounding announcement today of the commercial roll out of its software with a customer in Mexico. There have been several false dawns with this company in the past, so a degree of scepticism is probably sensible. Note that this relates to a contract win from over 2 years ago - May 2014. This share might be worth a fresh look, possibly?

Directorspeak is upbeat:

Jose Luis Vazquez, CEO of Mirada plc, commented: "Today's full commercial rollout is a defining moment in the history of Mirada. This is our largest commercial rollout by a significant margin and one of the largest in our industry in Latin America. As well as leading to an expected significant amount of subscriber-based licence fee revenues going forward, the commercial launch of our solution provides an excellent reference case for Mirada.

Immunodiagnostic Systems Holdings (LON:IDH)

Share price: 134p (up 3.4% today)
No. shares: 29.4m
Market cap: £39.4m

Results y/e 31 Mar 2016 -  it's been a while since I looked at this company. It makes medical diagnostic equipment. The shares have really collapsed, now at only 134p. They peaked at c.1200p in 2011.

Results for y/e 31 Mar 2016 look poor - profit has dropped 89% to only £466k. That's before an exceptional item of £37.3m - equivalent to almost the entire market cap!

However, what looks potentially interesting is the balance sheet - particularly the cash pile, which is £25.2m. That's about 86p per share, or 64% of the market cap! Providing management don't do anything stupid with the cash pile (e.g. blow it on a bad acquisition), then that should put a floor under the share price.

So I approached this with an open mind, as a possibly interesting special situation. However, reading the narrative, it comes across as a struggling company, that seems to be in structural decline. Its legacy products are seeing sharply falling demand, and its new automated products don't seem to be selling well either.

Moreover, the narrative has a rather weak, almost pitiful tone to it. It rambles on about how the company needs to change its culture, to be more commercial, etc. Alarm bells were ringing in my head. Is this a company staffed by clever, but commercially clueless academics? It sounds like it might be.

The danger is that if sales continue plummeting, then operational gearing in reverse could cause large losses to develop. Costs are being cut, but perhaps not fast enough?

The company says it has new products in the pipeline which have been delayed. 

Outlook comments strike me as being wishful thinking, rather than anything I could hang my hat on. See what you think:

FY 2016 was a year of transition: we continued to suffer from the downward momentum in the underlying business, but laid the foundations for a recovery - though these are not yet visible in the numbers.

During FY 2017 we will continue to make many changes in the organisation. We also expect that during the year you will see a slowdown in the downward momentum as the first actions undertaken become effective.

I remain confident that IDS has a good future: the automated part of the IDS business is a razor/razorblade-type business with recurring revenues at a very predictable rate. In nearly 40 years of business life I have come across several of these businesses - and they have always been businesses with outstanding profitability and returns to shareholders. At IDS this core strength of the business model is currently superseded by operational problems. But with the team that is emerging I am sure that IDS is a raw diamond waiting to be polished.

My opinion - oh I forgot to mention, the divi has been cut, but at least it's still paying out something (for now).

At some point, this share might make a nice turnaround, who knows? My main worry is that the multi-year downward slide in profitability suggests that this could be a business in terminal decline perhaps? I try to avoid structurally declining companies. IDH seems to be a small player in a market where the competition is eating their lunch. It doesn't sound like a dynamic, entrepreneurial company at all.

On balance then, I've decided not to get involved here. It's going on the watch list though. I would rather wait to see some more firm evidence that a turnaround is actually happening, rather than jumping in now. The big cash pile does make it quite tempting though. Also, the company has had considerable success in the past - so who knows, maybe it could get back on track at some stage?

All done for today.

Tomorrow is referendum day, at long last. I think most people are pretty bored with the whole thing now, and just want it resolved.

My feeling is that, whilst the Brexit case is very appealing, I feel that the multi-year disruption, even chaos, which will probably follow is a price that is too high to pay. It would be an incredibly long process to unpick a large chunk of the UK's laws, which have built up over more than 40 years.

Personally I think immigration is overwhelmingly positive. A pleasant Polish man has just washed my car, and over the last few weeks in London I've been served food by overwhelmingly pleasant & hard-working Eastern Europeans. These people are not a burden on the NHS (as they're young & fit), and they're a great asset to the UK, we're lucky to have them here, working hard. However, the numbers are too high, and we need a huge affordable house-building programme to commence, so people on low wages can afford to live decently.

So overall I think the EU is an awful organisation, and the single currency in particular has been a catastrophe. That said, is the cost & disruption of leaving it really worth it? It's finely balanced, but overall I think probably not. So I very reluctantly voted Remain, I'm afraid.

Although I feel that the EU is very much "on probation" now. So if things don't improve over the next few years then we should be looking to exit at a later date.

Best wishes, Paul.

(usual disclaimers apply)