Small Cap Value Report (28 Jan 2016) - SSY, AIR, QRT, FLYB, MTEC

Good morning!

A shortish report today, as I have to travel up to Oxford, for a brainstorming afternoon at Stockopedia's HQ. It's a pleasure working with the Stockopedia team, as they're not only super-intelligent, but also super-decent people. After one particularly bad experience in 2013, I now only work with people that I like and respect. Life's too short for anything else.

SCISYS (LON:SSY)

Share price: 73p (up 6.6%)
No. shares: 29.0m
Market cap: £21.2m

Trading update - this sounds encouraging to me, and it looks as if the company has moved on from the problems encountered in H1;

The Directors are encouraged by the performance of the Group during the second half of 2015 and believe that the underlying results will comfortably meet current market guidance.

Despite the continuing headwinds created by adverse foreign exchange movements, the Group's trading performance for the second half of the year indicates that the Board's previously-expressed confidence, that problems encountered in the first half were a temporary anomaly, was well founded.  As announced on 14 October 2015, the isolated contract that had been the cause of the problems was brought to a mutually satisfactory conclusion, ensuring that SCISYS could fully focus its efforts on its unaffected activities which represented the vast majority of the Group's projects.

It's good to see that the problem contract which gave rise to the profit warning in Jun 2015 has now been resolved. Although I would still like to know how this problem arose, and what internal controls have now been put in place to prevent a recurrence.

Outlook - this sounds reasonable;

The Directors remain confident that current market guidance for 2016 will be achieved.  Although we anticipate that the relative weakness of the euro will continue to have an impact on our financial performance in 2016, we have implemented currency hedging contracts to mitigate the risk and this is reflected in the guidance.

My opinion - It seems to me that a business model which is susceptible to major problems occurring without warning on a large contract, needs sorting out. Perhaps stronger internal review processes are needed before contracts can be signed? Perhaps a complete re-think of what contract terms are used is needed? If another accident is just waiting to happen, then I wouldn't want to repurchase the shares I used to hold in this group, even though it has some attractions, such as a forward PER of 11.

The shares are extremely illiquid, and I had considerable difficulty selling just a small amount of shares a while back, which combined with a wide spread, is a negative.

Overall the business looks stale - it's ex-growth, and profits are unpredictable. With a dividend yield of only 1.3%, it's difficult to see much attraction for shareholders. Although I do like the fact that the company has generally quite reliable recurring income streams, and is embedded into a lot of large organisations, providing mission-critical software.

What is needed is some growth excitement. It's no good just pottering along with turnover static, or falling. Most investors want to see growth, and that is needed if the PER is ever to rise from c.11 at the moment. This share has always been on a low PER, it was as low as 8 a while back. There needs to be a catalyst for growth, to increase the rating.

It's interesting how shares behave after profit warnings. If you'd managed to catch that spike down to c.40p on the profit warning last year, then you'd be laughing now - people are dismissive of catching falling knives, but in some situations it's the right thing to do.

Air Partner (LON:AIR)

Share price: 388p (up 5.6% today)
No. shares: 10.3m
Market cap: £40.0m

Trading update - this sounds positive, although note that profits should be up against last year, as 2 acquisitions were made;

Trading momentum in the second half of its financial year ended 31 January 2016 remained good, with a stronger than expected end to the period. As such, we expect underlying pre-tax profit to be not less than £4.2m which compares to £2.6m reported in the same period last year.

It's good to see a figure given for expected profit. All companies should do this, or give a range if they are uncertain of the exact figure. That takes the guesswork out of interpreting these update statements.

I've only got an underlying EPS forecast for 2015/16, not a profit before tax forecast. So given that the EPS forecast of 27.5p is almost identical to last year'a actual EPS, then assuming no distorting factors, one would expect 2015/16 EPS to be considerably higher, since PBT is up 61.5% against last year.

Another way to estimate it, is to take the £4.2m underlying PBT estimate given by the company in today's update, take off c.20% tax, and that gives earnings of £3.36m. Divide that by 10.3m shares, and it implies an EPS figure of 32.6p, well ahead of 27.5p forecast.

If my 32.6p EPS estimate is right, then the PER would be 11.9, which seems quite reasonable.

Note also that there is a very generous divi yield here - so a strong update today probably strengthens the case for maintaining a big payout.

It has a StockRank of 99 - another positive factor. So all in all, this share looks quite interesting.

Quarto Inc (LON:QRT)

Share price: 216p (up 3.8%)
No. shares: 19.7m
Market cap: £42.6m

Trading update - a positive-sounding update today from this illustrated books publisher;

A strong performance in the core publishing businesses sees Quarto well placed to exceed management expectations for the year.  Our recently established global sales and marketing structure has worked effectively to attain a market-leading presence in the adult colouring book category, particularly in North America.  Further, the Ivy Press acquisition has been successfully integrated into our business and has surpassed expectations in its first year.

This strong trading will enable Quarto to report earnings growth and debt reduction for the third year running.  Net debt on 31 December 2015 was $59.7m (31 December 2014: $66.0m) and we continue to maintain our focus on managing our working capital.  The reduction of the company's debt (over 25% since 2012) and further increase in earnings will allow progression in the company's Final Dividend, to be announced on 17 March 2016.

Interesting to note that the group has caught the fad for adult colouring books - apparently a stress-busting activity.

The forward PER of 5.48 looks attractive at first glance, at a very low 5.48, however the sting in the tail is the awful balance sheet - loaded up with way too much  debt still. It amazes me that the group's bank have been so relaxed about letting it have so much debt. Although the trajectory of bank debt is downwards, it would take many years to reduce it to a level where I would consider this share investable.

Still, if you like a low PER, and are happy to ignore the risk of high debt, then this share might appeal to you? Strong trading certainly helps anyway, so shareholders are in a better position today, knowing that the company is trading well, than they were yesterday.

Flybe (LON:FLYB)

Share price: 82.75p
No. shares: 216.7m
Market cap: 179.3m

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

Trading update - this is frustrating update, because it really doesn't give private investors the simple information we need - i.e. how is the company's profitability performing, compared with expectations? That's pretty much all we want to know, but is notable for its absence in today's statement - as is so often the case with updates from many companies. I think there needs to be some sort of rulebook introduced by the authorities about trading updates, giving specific requirements for what must be included in trading updates, and their frequency, etc.

Instead we get reams of stats, which is great for the analysts who have detailed models on the business, but private investors (and commentators like me, where I cover 500 companies - far too many to build forecast models for them individually!) are difficult for us to interpret.

Revenues per passenger are dropping, and load factor (utilisation of available seats) has dropped quite sharply, from 74.3% a year ago, to 68.9%. However, the benefit of cheaper fuel is also feeding through, as hedging (at higher prices) gradually works its way through.

The terrorist attack in Paris has had some impact on air travel, as you would expect, but that tends to be a temporary factor - denting confidence for a little while, then is gradually forgotten, as people regain the confidence to use air travel. Terrorist attacks never stop me going anywhere - after all, if you change your plans, then you're letting them achieve their objective. It's more dangerous crossing a road than flying anyway.

Cantors have helpfully crunched the numbers, and their morning note says that they are leaving forecasts unchanged for now, but there is an increased risk of a future downgrade.

My opinion - I'd like to see more broker notes, to better understand how the figures have been interpreted, but from what I can make out at this stage, this seems to be a slightly negative update today.

Matchtech (LON:MTEC)

Share price: 495p (up 1% today)
No. shares: 30.9m
Market cap: £153.0m

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

Trading update - This staffing group shows how it should be done - a simple one liner at the start of the update, tells me everything I need to know;

The Board currently anticipates profit for the full year to be in-line with its expectations.

There's then more detail given, but I don't see any need to report on that - profits are as expected, job done!

Outlook - sounds positive;

"Demand in the UK for skilled engineers remains robust and looking ahead we have identified a number of opportunities to roll out our Engineering recruitment services across our overseas locations. Investment in headcount is taking place in these areas and I remain confident that we will convert these exciting opportunities into significant growth over the next few years."

My opinion - the acquisition of Networkers seems to be going well. I cannot understand why the stock market repeatedly ignores positive updates, and progress from this group. It's possibly due to an overhang of sellers in the market, who knows?

As you can see from the usual graphics below, the valuation is modest, and this share has an attractive divi yield of 4.79% too. Directorspeak sounds encouraging, so all in all I like the look  of it, and am considering a top-up.

In my opinion the market price of this share simply looks wrong. I think the correct price would be in the 600-700p range, based on a more appropriate PER, bearing in mind the group's expansion and good performance/outlook.

Right, I'd better get my stakes on, can't keep the boss waiting!

Regards, Paul.

(usual disclaimers apply)