Small Cap Value Report (28 Apr 2016) - SPRP, WAND

28th Apr '16 by Paul Scott

17 comments 11858 reads

Good afternoon!

Not much to report on today, and I have to drive back down from Cheshire to the south coast this afternoon, so will just do a short report now, and then hopefully add some more comments once I get home this evening.

Sprue Aegis (LON:SPRP)

Share price: 137.5p
No. shares: 45.9m
Market cap: £63.1m

(at the time of writing, I hold a long position in this share)

ShareSoc meeting - as I mentioned in an earlier report this week, management of Sprue Aegis have been very open to discussing the company's problems with investors. This is very impressive. In my view investor confidence is more likely to return when management do their utmost to communicate openly with shareholders.

Also, I like the balance sheet at SPRP, stuffed with cash. So on that basis, and after talking it through with a friend, I've opened a smallish long position in the share. It's not a conviction buy for me, hence why the position is initially small. Also, I waited for the share price to stop falling, and start rising, which is quite a good idea usually.

It might take another lurch down, who knows. I understand there has been a big seller in the market, so it depends when they stop selling.

I didn't manage to get to the ShareSoc meeting last night, so if any readers attended, then please do add your thoughts in the comments section below - either in detail, or just your overall impression.

Potentially interesting, although I am worried about the long-term reputational damage from the failure of some sealed for life products.

WANdisco (LON:WAND)

Share price: 213p (up 18.4% today)
No. shares: 29.9m
Market cap: £63.7m

OEM sales partnership with IBM - this sounds an interesting announcement, and the kudos of the IBM name has given this share a bog boost today, up 18.4% to 213p.

The only financial information given is vague, saying:

WANdisco will receive a royalty on the Fusion component of IBM sales. Whilst we expect that revenues will begin to flow during the second half of this year, we will provide further guidance once product launches have taken place and initial customer uptake has been evaluated.

Joint development work, funded by IBM, will complete the integration of Fusion with the IBM platform over the coming months. The impact upon WANdisco's operating costs, net of IBM's…

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Rusty2

28th Apr '16

Paul I take it you have only recently bought Sprue Aegis (LON:SPRP) shares? Just a few thoughts. Re the battery problem, I can't see that going away soon as surely more and more come to light in the next few years and no I don't think you can just replace it and you can't stop it bleeping either. Claiming money back from manufacturer I suspect that is doubtful as Chinese. Not sure about other countries but in UK its the retailer who will be getting the hassle of returns, so they maybe relunctant to restock with Sprue products again.

GavSmith01

I'm not so sure. I am expecting the battery issue to blow over. Despite there being a couple of articles in the Daily Mail, I don't think this will remain in the general public's consciousness for the long term. Retailers will be off the hook, as most won't take returns after 90 days, and the issue only becomes apparent after a number of years. Most people will have chucked the receipt. And personally, if I had a bleeping alarm after 3 years, I'd probably just throw it in the bin and buy a new one. Maybe even from the same manufacturer - I probably wouldn't even check. It might even boost sales! It's such a low ticket item that I generally think most people won't bother claiming on the warranty.

Once this all settles down, Sprue are in a great position to capitalise on the legislation changes across an increasing number of European countries. Plus, at this level, especially with the cash balance, they look very vulnerable to Jarden (now part of Newell) coming back in for again. I am willing to give management the benefit of the doubt here.

Ramridge

I came to a similar conclusion yesterday and bought a medium size holding. On fundamentals, the share looks ridiculously cheap:
- cash £22.4m which is approx 37% of M Cap
- no long term debt
- a PE on todays sp = 5.6
- PE on a cash adjusted basis = 3.5

- CFO and FCF: very positive

So this is really a bet on management to be able to go into damage control and address any reputational and financial risk. If they have the nous to execute this successfully in the next few months, then the upside from that point is clearly big.

Well that's IMO and please DYOR

What about all the french sales in the last 2 years or is that a different battery? I don't think that is correct about retailers, your contract is with the retailer, its not a return, its faulty, the SOGA gives you at least 1 year warranty, in fact you can claim for upto 6 years. Yes I agree many will have chucked the receipt by 3 years.

timarr

Well as they've already taken the worst case costs, that all failing units need to be replaced, it doesn't matter in a financial sense if "more and more" do come to light. The investment issue is more about reputational risk and management competence: is this an unlucky (albeit large) one-off or is it the forewarning death rattle song of a gassed canary?

No small company ever got to be large without having things going wrong along the way, so this kind of issue is a habitual risk for a small cap investor. Where management are open about the issues I tend to give them the benefit of the doubt, but the strikes against Sprue are beginning to mount up. I wouldn't want to see any more missteps. But as it stands, the company is still going cheap, cheap ...

timarr

JohnCap

On the surface this looks like a good buy option but having looked at the financial statement in detail it seems that these problems have been known about for a long time, last year there was an substantial increase in warranty costs. I really would like some more clarity from the Board that they don't have a problem with all the alarms sold last year. Perhaps a disclosure of how they see the warranty pot being split over years numbers.

My thoughts are that the warranty cost may not cover the problem will this years increase be needed again next year and the year after?

I would also like an explanation on where the 2016 H1 loss is coming from surly the warranty issue are covered already?

All this though I think will be academic must be ripe for a take over if not perhaps time for new management the reports in the Mail over the last couple of days must have strained management staff relationship!

ridavies

Couldnt have put it better myself. Legacy issue are potentially huge, both actual and trust.
PS I wonder if the bigger US company who share the same facility in China have had the same problem. You would think that they would have, unless Sprue are talking about an entirely different product which they have designed themselves.

johnrosier

My thoughts on SPRP

I attended a question and answer session with the management last night.

The main points:

A lot of detail on the nature of the battery failure issue but importantly I was reassured that they have been conservative in their provisioning for future claims. Clearly they cannot guarantee 100% that they will not have to top up the warranty provision but I think they have built in a lot of slack.
It sounds like they handled the situation with customers well; they were pro-active in explaining the problem and feedback has been good.
Going forward, they will update at each results the returns they are experiencing under the warranty, against their expectations.
They do have some redress against the battery supplier but only for the cost of the battery and not the whole unit. The battery is typically 15% of the cost. The supplier, is clearly being cooperative as I guess it would like to receive future orders!
The downgrade to 2016 forecasts was principally due to its German distributor postponing its orders until the battery issue was sorted out. Sprue is now using a higher spec Panasonic battery in its alarms destined for Germany. It competitors in Germany use Panasonic batteries.
German certification will hopefully be given next week, 4th May and the products will then ship towards the end of June for sales in H2 2016 and beyond.
Germany should provide significant growth in the coming years driven by new legislation in Rhineland next year and Bavaria the following. After that we come to the 10-year anniversary of first sales in Germany, which should see a decent replacement cycle kicking in.
The company is confident about prospects but has taken a cautious and conservative view on provisions for the battery problem and sales in 2016, 2017 and 2018. The Executive Chairman Graham Whitworth; “there is only one profit warning”, “we need to deliver, deliver, deliver” and “we don’t want to over-promise”.
Brokers forecasts, which I believe they are happy with, are for earnings per share of 11.2p in 2017, rising to 12.9p in 2018 with a dividend of 8.0p in 2016, 9.0p in 2017 and 10.0p in 2018. These I think should all be seen in context of the preceding point about the company being conservative in its forecasts.
It’s worth noting that its own forecast for H2 2016 of £3.8m is above the H2 2015 result of £3.1m

Conclusion: I take my hat off to management for fronting up to shareholders, being open about the problem and I also rather liked the apology to shareholders in Tuesday’s results statement; you don’t often see that sort of thing. I guess the healthy attitude is fostered by the fact that our interests are aligned; management hold a lot of shares in the company, (Graham Whitworth, Exec Ch. 7.3%, and Nicholas Rutter, Managing Director, 6.5%) and will be desperately keen to see the share price recover. I think this is a one-off problem, it has been handled as best as could be and that future forecasts are conservative. It still has a leading market share in a growth market. On current forecasts the shares are valued at 11.8x 2017 earnings and a 2017 dividend yield of 6.8% and in 2018 a PE ratio of 10.2x and a dividend yield of 7.6%. The balance street is strong with current net cash of £13.2m. I’m happy that I added a couple of days ago, even though I was little quick out of the blocks, as although I’m sure the recovery will not be in a straight line, I would hope to see the shares back up towards 200p in the next year or so. Reassured Holder!

jonesj

Even when goods are out of guarantee, the consumer has the legal right to claim if the product does not last a reasonable amount of time. I believe the guidelines are 6 years for many electrical appliances.
For a sealed alarm with specific life, I expect the consumer could claim any time in that lifetime & if it went to court, win.
In practice, as above, I suspect most consumers would not bother doing that for a £20 alarm.

As an aside, for anyone buying a big ticket item like a fridge or TV, the way forward is obviously to (i) Reject buying the extended warranty. [Which is the most profitable part for the retailer & therefore the worst value for the consumer] and (ii) Pursue a claim through the small claims court if the product fails within 6 years. Of course, this will hardly ever be necessary given the reliability of some big ticket items.

Very interesting review and most helpful on the warranty issue. A couple of questions though.

Why are they only changing the battery in Germany does this leave exposure in France/UK?
How will the announced redundancies and mail article effect the long term morel with the work force? Will they have an issue with the high dividends the two directors have earned whilst cancelling staff bonus?

I must point out though that you are wrong that this is a one off they had a major battery issue some years back that was all over the press. One would have thought that the SMT would have learnt from those mistakes!!

On the whole I see this as a buy only because of the strong take over probability.........just my view current management keep making too many errors to have a battery issue once can be forgiven but twice......

Just one final thought for now they have an Exec Chair, CEO and MD seems a lot for a SME who is actually running the business?

Hi John -
Thanks for the write-up on your meeting with SPRP. Clearly you are satisfied that the management have the skills and competence to dig the company out of the present predicament.
Yesterday I took the decision to invest by taking a punt on this question. Today & following your note, it is less of a punt ( but still the key risk to my mind).

actsofvolition

29th Apr '16

I'm tempted at what seems like cheap levels but I'm hesitant due to the potential competition from the likes of Nest. At a ShareSoc meeting in October, the SPRP FD admitted that potential customers seem to prefer the Nest products at first sight but they don't currently offer good value for money. How long will that last though given Googles cash? Presuming an increasing move towards interconnected homes, phones, alarms etc., surely SPRP will not be able to compete with Google's already deeply embedded existence in our lives?

rfcg1

Any view on AIR - which reported year end results on Thur?

andrewjames

30th Apr '16

Just a couple of points to add to John Rosier's excellent report on the ShareSoc meeting last Wednesday evening.

We were told that the German distributor required that replacement Panasonic batteries were installed in all the sealed unit smoke alarms - and that it cancelled orders with the other cell where issues have arisen elsewhere, as reported. This was because German competitors use Panasonic batteries and so the view is that that market will require it - and will be willing to absorb the extra cost of this more expensive alternative, so no erosion of profit margin. I guess the proof of the pudding will be in the eating. I am not sure how their pricing compares with competitors in the German market, but the extra cost will presumably have some impact on demand levels. It appears that German consumers are considered more demanding than customers in other jurisdictions.

We were also told that they are aiming for a very rapid date to achieve certification in Germany - and then to have the alarms available for sale. Once certified, they say that they already have orders tied up for the remainder of 2016.

I share the view of others that they have seem to be managing this significant setback well, but I bet they are regretting giving the market an estimated operating profit for 2016 of £8.3million (in itself a mini profit warning) as recently as 10th March, when they issued an RNS on the revised supply terms with DTL. The timing is at best unfortunate.

smythw

3rd May '16

Regarding interconnected homes and SPRP, I don't have any real concerns. In general, most home appliances connected to wifi fix a problem that doesn't need fixing and open up additional avenues of attack to anyone intent on accessing otherwise secure networks.

I want my alarms to sit there and require no interaction. Just tell me when the battery is low(every few years), or when there is a fire etc. Anyone who wants to interact with their alarm via an app probably has too much time on their hands.

People should be a lot more suspicious of anything connected to the internet, that doesn't absolutely require it. Internet enabled TV with a camera and microphone in, wifi enabled baby monitors, "smart" wifi toaster? That last one made me chuckle when I heard about it; maybe they mean the toaster is smarter than the owner....

I think there will be a hell of a lot more bad press in the next few years about avoidable hacks and intrusions via these devices. People are already starting to become aware that their information is not safe even when stored in well managed data centres. Only a few weeks ago Troy Hunt(a security blogger) exposed flaws in Nissan's phone app to allow him to drain the battery of a Leaf he didn't own, which was half way around the world, by allowing him to turn on all the air con while it was parked up.

gus 1065

4th May '16

RNS from Sprue Aegis (LON:SPRP) this morning appearing to confirm that they have received (subject to paperwork) final approvals from European authorities for their latest products. Hopefully this starts to free up the recent sales delays into, inter alia, Germany.

http://www.investegate.co.uk/sprue-aegis-plc/rns/product-testing-completed/201605040700071197X/

Small Cap Value Report (28 Apr 2016) - SPRP, WAND

Sprue Aegis (LON:SPRP)

WANdisco (LON:WAND)

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Paul Scott

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