Small Cap Value Report (27 Feb 2014) - ZYT, DGB, COST

27th Feb '14 by Paul Scott

19 comments 22139 reads

Good morning!

Zytronic (ZYT)

This is a British maker of bespoke touch screens for large electronic devices (think vending machines, gaming machines, ATMs, etc). The company has this morning issued an AGM trading update, which reads very well, saying;

The board is pleased to announce that current trading is considerably ahead of the comparable period and revenues and margins, led by an improving trend in touch sensor orders and sales, are at levels similar to the performance of the second half of last year, which is in line with management expectations.

So to interpret this, I take the following steps;

1. Confirm the period dates that they are talking about - it's a 30 September year end, therefore this statement refers to the bulk of their H1 period, which is the six months to 31 Mar 2014. So as of today's date we are five months into that period.

2. Check what the company's performance was like in the comparable (i.e. H1) period last year - so checking the interim results from last year, the company performed poorly, with revenue down 20% to £8.5m, and profit down 64% to £0.8m. EPS was only 4.1p (prior year 11.1p). Therefore an improvement against those weak figures is to be expected!

3. As revenues & margins are at similar levels to H2 last year, then we need to work out what that was, by looking at last year's final results, then deducting the H1 results, to arrive at just the H2 results.

4. Consider any complicating factors - in this case they refer only to revenue & margins, so it's ambiguous as to whether that means gross margin, or operating margin, or both (note "margins")?. It would have been better if they had also mentioned profitability directly, since an increase or reduction in overheads would also have an impact.

Overall then, I've had a to make a few assumptions, but by my reckoning H2 last year was £1.1m profit, and 7.0p basic EPS (because H1 LY was 4.1p basic EPS, and FY LY was 11.1p EPS). So annualise the current run rate of 7.0p EPS, and we're at 14.0p EPS for this year probably (assuming no change in trading in H2).

However, also note that at the full year the company discloses…

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27th Feb '14

Hi Paul
I would be very interested in any comments you have on the dilution/fund raising at Costain (LON:COST) . You have commented on the company before, and it was Costain (LON:COST) that snapped up your previous holding in May Gurney.

Edward Croft

re. Shorting - I defer to the great James Montier:

James Montier: Short sellers are everyone’s favorite scapegoats. They make money when things go ‘wrong’. Of course, what the authorities forget is that simply because a short seller sells a stock, doesn’t mean it goes down – if only it were that easy we’d all be short sellers. As David Einhorn observed, I’m not critical because I’m short, I’m short because I’m critical.

In my experience, short sellers are amongst the most fundamental investors you’ll come across. They understand the ins and outs of a business better than just about everyone else. They are highly skilled at figuring out poor economics when they see if. They act as acting police, helping to uncover fraud – something that the regulators used to do (a very long time ago).

My own work on short selling has focused on a number of areas. In general, shorts tend to come into a couple of categories: bad businesses (i.e. poor economics), bad accounting (obvious), bad management (the guys at the top haven’t got a clue). In addition I often look for several traits, such as expensive, unrealistic growth expectations, too much debt, and poor capital discipline (i.e. needless and tangential M&A).

He created the C-Score (cooking the books score) to find companies worth shorting. We have it in the screener and also a tool here: http://www.stockopedia.com/apps/montier/

Crusty

Just like to point out that Kier (KIE) finally snapped up May Gurney, and they have issued stonking results today though the market seems to have expected more.

Antipathy to shorting stems from the associated jiggery pokery: borrowing shares from people who don't own them (ie institutions) and manipulating prices. However, if it's all open to the market and uncovers crooks what's not to like?

mrmodha

My issue with shorting is nothing to do with the perceived ethics of it, it is more to do with how difficult it is to actually carry out the instruction i.e. a single broker for more than just a handful of shares, unless I am missing something somewhere...

ValuableGrowth

MrModha,

Spreadbetting makes shorting a very simple process to execute (you don't need to borrow stock, you just bet on the price moving down), but it is still very diffcult to execute it profitably IMHO.

SevenPillars

I'm not against shorting for the reasons already highlighted, however, I do sometimes find the actions of shorters hard to fathom. For example, I've been following for some time IQE, an AIM company that has been heavily shorted by BlackRock for the best part of a year. One look at the chart will show how successful they have been although most of the news from the company hasn't really been bad and its fundamentals are nowhere near as stretched as many in the IT sector. I'm intrigued to know what their reasons are other than the possibility of competitors stepping into their market, which let's face it is something that could in theory happen to thousands of market quoted companies, especially the smaller ones. Does anyone here know why IQE has been so heavily shorted for so long?

cig

Spread betting based shorting only works if the spread betting firm has matching clients with long positions, or can itself borrow on the market (hedging your short bet with a classic short) or otherwise can find someone (be it their internal book) willing to take the matching position. If you try to short something where they don't, or in too large a size, they will simply reject your order or close your position. And they charge dearly for all this. So spread betting doesn't quite solve the capacity and cost problems of shorting.

jraitt

If I buy shares through online broker - Barclays, Halifax etc - and these are held in a nominee account can these shares be loaned out to shorters for a profit to the holders of the nominee account? Do they?
They would be collecting money to drive my shares down and cause me a loss. Institutions do it although I don't understand why - surely the fee they get does not match the loss in value expected, or why do it?
Don't mind the theory but the mechanics look dodgy.

lightweight1

Paul,

I think your analysis are very insightful and extremely helpful to the private investor, however I am disappointed when commentators talk about positive announcements from stocks they hold and when that company then issues a disappointing statement the commentators reaction is nonexistent.

One stock that you have held/still hold? Is Seeing machines which this morning I thought posted awful result. They have shown a loss, only have growth of 17% which for a company with a market cap of 56 million is awful. There are no signs of growth into other markets such as mobile or healthcare. They are in fact reviewing their strategy into these areas which is a red flag to saying its not working, the only positive is that they have cash. I am a holder of this stock and currently reviewing my position. I just find it disappointing that commentators love to tell us about the positive movements in stocks they hold but never the bad, promoting the idea that they are masters of the universe.

Your broker would have to tell you if they loaned your shares. I don't think any of the usual UK retail brokerages does this.

There's no adverse impact in theory for the long: before you sell you have to recall the short (you can't sell the stock while it's on loan because you don't have it!), which means the short guy will need to buy back the share on the open market to give it back to you, cancelling out the (theoretical) price effect their earlier sale had, and in the meantime you pocketed the lending fee.

pyemckay

I was surprised at the drop in Costain (COST) shares this morning but looking back over previous news there was a possible clue for the astute investor.

on feb 12 there was news of a contract win of £900m to electrify some of the railway infrastructure within its JV of alstom,babcock and costain.
this a large contract that requires a lot of machinery, manpower and money even within the comfort of a joint venture.
This demonstrates the issues that companies with working capital deficiencies face when they win big contracts.

p.

RichardK

I am not happy with Costain fund raising and open offer. I hold it in an ISA with no spare cash so can only take up the open offer if I sell something else or it falls after I can top up the ISA on 6th April. Otherwise I lose the premium on the new shares. I have not had time to check when the offer might be. can anyone enlighten me?
A rights issue would have been more digestible as I could have at least sold the rights and got the premium that way.

Richard

Regarding Costain (LON:COST), thank you Paul and apologies to Crusty, who is quite right. Their price is currently up and down like the proverbial bride's lingerie. It is not your usual sort of pick Paul, but I can see some profit here if prices get to the 260s again. They have good repeat business and a very strong reputation for qualty work. The fact that they failed to get May Gurney is perhaps indicative that if they do really want to expand and play with the big boys they need to undertake this fundraising. They failed too quickly to match Keir's bidding.

Regarding shorting and spread betting in general I do not do it because I do not understand it. Good luck to those who do, and who succeed in it. I think mixing morality, ethics and investing in this context is as dubious as yesterday's attempts at defining ethical investment. I just cannot think of a single sector which does not cause some kind of harm somewhere (since the failure of the International Bunnie Stroking Conglomerate). We would also all perhaps do well to remember that big money will always push little money around.

Back on shorting, if anyone fancies a simple gamble pick a brindle dog, or a horse with a sheepskin noseband and pricked ears in the paddock.(Tried and tested formulae, never fail, max stake £2 a place!).

kevanp

Re brindle dogs and sheepskin-nosebanded horses: sounds like a good theory. Do you have any quantitative data to back this up?

28th Feb '14

Sort of. My father picked a brindle dog, and if no brindle the form dog, unless it was grey, in every published race for about a decade. He never actually backed them, but kept a tally of what would have happened if he had. The result each year was a small profit, as far as I remember. In later years when he was less mobile, he took to the televised horses. Pricked ears in the paddock, but not dancing, then followed by the noseband, and if more than one candidate to be settled by reverse form. Over about a season and a half he again showed a very small profit (so he claimed!). (Flat racing only mind, as "everyone knows National Hunt is a lottery"!!!!) He never actually put money on either as he reckoned the weight of his "heavy money" would make them fall over. I had better say DYOR!!!! [1410, Sunny Donny, Polstar, a place]

Well I meant it as a joke, but you actually can back it up!! That's brilliant! I shall put the theory to the test when I next go to Glorious Goodwood — the only race meeting I ever attend.

Back to the serious stuff…

maffs0

Hi Paul,
any thoughts on Seeing Machines' results. I know you were quite on this before. I hold but wasn't impressed by the results overall.
M.

Paul Scott

2nd Mar '14

Hi maffs0,

Seeing Machines (LON:SEE) is a growth stock, so the financial results are not as important as the future prospects.
The key things are that they have a real product, already selling (to the mining sector). Also it now has plenty of cash, so can accelerate new business opportunities, the obvious ones being coaches, trucks, aviation, and also mobile devices, and tracking eyes in retail/advertising. The possibilities really are pretty endless with this product.

So I think for that reason it's worth holding despite a valuation that looks warm in the short term. It's not blue sky remember, it's a real product already selling.

High risk, but potentially high reward.

Cheers, Paul.

Hi lightweight1,

I was sorry to read your comment.

As the share price reaction has shown, the results from Seeing Machines (LON:SEE) were as expected, and if you want me to hold your hand instead of doing your own research, then you're reading the wrong column.

I didn't comment on SEE results simply because there was nothing in them that was unexpected at all, hence price sensitive.

If you want tips, and gushing bullish comments, go elsewhere please, that's not my game here.

I continue to hold SEE as a long term position, and see nothing in the results to change my view. In fact, FinnCap have become more bullish in their update. Speak to them if you want their view.

DO YOUR OWN RESEARCH. Do not rely on me to do your work for you! Nor invent motives that are untrue.

Regards, Paul.

Small Cap Value Report (27 Feb 2014) - ZYT, DGB, COST

Zytronic (ZYT)

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Paul Scott

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