Small Cap Value Report (29 Apr 2014) - WLF, UTW, WGB, LID, DSG, WINK, INCA, CTG

29th Apr '14 by Paul Scott

12 comments 22279 reads

Good morning!

Wolfson Microelectronics (LON:WLF)

This semiconductor maker has had a dismal few years, indeed it hasn't made a profit since 2008. I've been vaguely monitoring the shares for signs of a possible turnaround, as there can be exciting upside with this type of company if they develop new products that take off. Also it spends a remarkably high percentage of turnover on R&D, which can also be very positive.

Its Q1 results today look poor to me. However, of more importance is that an agreed cash takeover bid at 235p per share is also announced. So that's an instant 75% profit for shareholders, who have every right to be delighted at that outcome, given the poor performance of the company in recent years.

Utilitywise (LON:UTW)

It's moving out of my range now (I normally don't go much above £200m market cap, and this has reached nearly £243m at 335p per share), so this will probably be the last time I report on Utilitywise, the cost consultant for energy costs.

Very impressive interims are announced today, for the six months to 31 Jan 2014. Revenue is up 105% to £21m, and adjusted pre-tax profit is up 133% to £4.9m. Adjusted fully diluted EPS is 5.1p for the six months, so double that to annualise it (simplistically), and just over 10p per share. So a pretty racy PER of almost 33 times!

Although as you can see from the Stockopedia graphics on the right, the forecast PER drops to 19.6 allowing for future earnings growth (based on broker consensus forecasts). These graphics perfectly illustrate the high valuation, but strong earnings growth which has driven investors to give this share a high valuation.

Acquisitions have helped drive those numbers, but without acquisitions, like-for-like revenue still increased 65%, which is very impressive.

I'd be amazed if these profits are sustainable - it looks to me like a company that has found a sweet spot, but competitors will inevitably be drawn in by these bumper profit margins, one imagines. It might also be worth looking into their revenue recognition policy, as I note that there is a very unusual £11m…

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RicGains

29th Apr '14

Morning Paul,

I'm always wary of commenting when I'm speaking to an accountancy expert, but maybe I could just throw one bit of extra information out there about Utilitywise (LON:UTW).

My understanding with Utilitywise is they have a whopping book of "secured future revenue" that they can't recognise yet. The ink is on the paper, the contract is fully signed and ready to roll, it's in the bag - it's just that the client is still tied into their old contract and there is a date in the future when £UTW's comes online.

Typically, 70% of the "future secured revenue number" starts to come on stream inside the following half year, but even then, that leaves 30% for a later date.

As of 31st Jan, as far as I understand it - and do put me straight someone - £23.8m was just floating around ready to hit the top line at some point in the future. They can then build on this already "in the bag" revenue with all the other stuff they do and with clients who want to sign up straight away.

I have weak balance sheet knowledge - but maybe that has something to do with the "non current assets" you mention?

Personally, with all this unrecognised revenue, plus the expansion both geographically and in consultant headcount in the UK, I am comfortable with a high PE; as long as one of my favourite things, the PEG ratio, is looking healthy.

I know you were being "back of the envelope" - but with the "future unsecured revenue" figure swelling, I wonder if just doubling the EPS number for the full year would be unwise!

Best Wishes,

Richard

MichaelFBS

Hi Paul

"so this will probably be the last time I report on Utilitywise"

Maybe you will be (covering them that is) when the market gives them a small sensible rating!

Secondly Christie this is one of John Lee's core holdings and has been a stellar performer for me and today's jump has cheered me up no end after the disappointments of Sweett (LON:CSG) and Seeing Machines (LON:SEE) (on the latter I spoke to CEO today and am reassured and will try and pick up some more shares later today).

I now have to decide whether to follow Warren Buffets view on risk management (put a small number of eggs in one basket and watch it very carefully) or yours and reduce my holding to 15% of 10% from 20%.

By the way does your 15% limit apply to 15% of stocks + cash (that maybe allocated to stocks in the future so not rainy day money) or just value of stock investments.

Thanks as ever for a great blog.

Hutch_Pod

Hi guys - enjoyable discussion on UTW, many thanks.

The growth in non current assets (trade and other receivables) between is indeed comparable to the growth of future secured revenue between 31st Jan 14 and 31st July 13 (50% vs 43%), though less so between 31st Jan 14 and 31st Jan 13 (110% vs 180%). I might speculate this is down to a changing % of future secured revenue to be recognised, but that would be out and out guessing..

The cashflow is materially affected by the decrease in trade receivables at £205k compared to a a £2m increase in the comparative period or £7m in the full year.

The commentary on cashflow does say they have invested £2.3m of cash for operations around headcount growth, infrastructure and other investments which they expect to pay off in the second half - they do specifically mention how the cashflow "trend will improve in the second half as revenues and cashflow from this investment in talent and infrastructure follow and the effects of second half supplier tranche payments take effect."

The cashflow does seem healthy in this light.

Keep up the good work!

cheers

Paul Scott

Hi Richard,

Thanks for your comments. If an item appears within Debtors, then that suggests that the revenue & profit has already been recognised in the P&L, since the double entry would be: Credit: turnover (P&L), which drops through to profit, and Debit: Debtors.
Then when the customer pays, the Debtor disappears, and is replaced with cash in the bank.

The other possibility is that they might Debit Debtors, and Credit Deferred Income, both Balance Sheet items, which would have no P&L impact.

I'm not interested in buying any shares in Utilitywise (LON:UTW) at this high valuation, so won't be digging any deeper, but when I spot potential red flags (such as negative cashflow, and unusual Debtors) then I feel obliged to flag them up here, so that readers can then do their own Due Diligence on these potential issues.

Regards, Paul.

"I feel obliged to flag them up here, so that readers can then do their own Due Diligence on these potential issues."

And it's hugely appreciated - loved the risk management stuff on Thurs as well - thanks.

marben100

Worth mentioning Renew Holdings (LON:RNWH) acquisition announcement this morning. A model RNS, setting out all the key financial details for their purchase of Clarke Telecom:

£17m total cash consideration
£2.3m normalised operating profit (£3.5m reported) for FY October 2013
5% revenue growth for FY14 at same operating margin anticipated. So implies ~£2.4m operating profit & consideration a very reasonable multiple of ~7x this.
Clarke operating margin = 7%, so will improve overall Renew margin of 3.2%
Clarke operating profit will add ~20% to Renew's total operating profit. This should flow through to EPS.

I know Paul isn't keen on the negative working capital here (in common with the entire construction industry), but I am more sanguine, with the bank debt (even after debt taken on to fund this acqusition) remaining low. Another concern about this type of company is project risk: with relative thin (but improving!) margins will profits disappear if a project goes wrong? I asked the directors about this when I first invested, back in 2007. They were able to reassure me that individual projects were generally small & any significant ones were closely monitored by the experienced senior management team. They haven't let me down since that original investment! Moreover, they have successfully transformed the business by successfully executing their strategy of moving away from run-of-the-mill constructution to higher margin "specialist engineering". This acquisition represents another step along that road.

Interims are due on 20th May and I expect them to be strong, as the firm has been heavily involved in repair work from the weather damage this winter, including being the main contractor for the Dawlish rail repair, which they performed superbly on. A positive trading updatereflecting this, was issued last month.

Trading for the first half of the year has been strong and well ahead of the comparative position last year, in line with the Board's expectations. Performance is being driven by growth in all of our Engineering Services markets but particularly so in Infrastructure where our Rail business is continuing to experience record levels of activity. Specialist Building is performing in line with expectations.

The shares seem very reasonably priced to me,

WHI have raised their FYSep2015 EPS f/c from 19.0p to 21.8p.

Though my holding was already signfiicant, I added some more shares at 225p this morning, which, on a forward multiple of little over 10, seems like rather a good price to me, for a business that is growing strongly. WHI have raised their target price from 275p to 325p following today's news.

Cheers,

Mark

Thanks Paul, you are indeed right on the revenue point. I think this (from 2013 accounts ) explains it well. It seems logical and reasonable to me, but I do not know the broader industry practice and I would definitely defer to your view.

Revenue for the Group is measured at the fair value of the consideration received or receivable. The Group recognises revenue for services provided when the amount of revenue can be reliably measured and it is probable that future economic benefits will flow to the entity.
The Group provides services through negotiating rates with energy suppliers on behalf of business customers and generates revenues by way of commissions from
the energy suppliers. This type of revenue is recognised when the contract between the customer and the energy supplier becomes live. No further services regarding procurement are performed once the contract has gone live. Commissions are calculated based on expected energy use by the business customer at agreed commission rates with the energy suppliers. Where actual energy use by the business differs to that calculated at the date the contract goes live, an adjustment is made to revenue once the actual data is known.
The cash received profile relating to these revenues varies according to the contract terms in place with the energy supplier engaged and can be received before the date the contract goes live or spread over the term of the contract between the energy supplier and the end customer which can be for a period of up to three years. Accrued revenues relate to commissions earned, not yet invoiced or paid and are discounted at an appropriate rate.

30th Apr '14

Mutt say, that seems like a very aggressive accounting policy to me. Is it really sensible to account for future reveneus that are anticipated but not yet due? I'd much prefer to see these commissions booked when they have been invoiced & beome payable, not before..... but I guess Utilitywise's figures wouldn't look so good if they did that? ;0)

Most companies consider such "revenues" as a forward order book & quote that alongside actual sales, but do not actually include it in their accounts.

stpalm

as regards SEE, looks like they may go to 4p fairly quickly, what do you think? looks like support on the chart.

Hi - I had a look at the accounting standard, IAS 18 I think. It's been a long time since I've looked at an accounting standard :) so please forgive any slips.

"Revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably." http://www.ifrs.org/Documents/IAS18.pdf

And in relation to rendering of services, which the UTW accounts reference in relation to "No further services regarding procurement are performed once the contract has gone live"

"The recognition of revenue by reference to the stage of completion of a transaction is often referred to as the
percentage of completion method. Under this method, revenue is recognised in the accounting periods in
which the services are rendered. " http://www.ifrs.org/Documents/IAS18.pdf

Finally on cash,

"If the inflow of cash or cash equivalents is deferred, the fair value of the consideration receivable is less than the nominal amount of cash and cash equivalents to be received, and discounting is appropriate. This would occur, for instance, if the seller is providing interest-free credit to the buyer or is charging a below-market rate of interest. Interest must be imputed based on market rates. [IAS 18.11]

It does sounds like the accounting standard is quite explicit on revenue recognition rules, and that UTW have indeed followed this standard.

Comments welcome as it would be good to dig deeper if needed.

Sorry typo should have been Spaceandpeople (LON:SAL) I sold my small holding in Seeing Machines a while back at a small loss at 6.25p. I did not really understand the company and when paulypilot wrote

New order for "472k in sterling, since AUD$1 = £0.59) for Seeing Machines equipment to be fitted to 66 mining trucks. That works out at about £7,150 per truck" http://www.stockopedia.com/content/small-cap-value-report-11-nov-sal-see-tng-flyb-79024/#sthash.nodCtzcA.dpuf

I just wasn't sure it was for me .

Additional it is non UK/USA and at the moment I am trying to restrict my investingations to companies based in those countries occassionally straying into mainland Europe.

andrew2004

7th May '14

I note Woodford Investment Management has recently bought 6.5M shares in Utilitywise (LON:UTW). Interesting to see how Neil Woodford's new fund(s) perform with the spotlight fixed on him from the start....

Small Cap Value Report (29 Apr 2014) - WLF, UTW, WGB, LID, DSG, WINK, INCA, CTG

Wolfson Microelectronics (LON:WLF)

Utilitywise (LON:UTW)

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Paul Scott

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