Small Cap Value Report (3 Aug 2016) - NXT, CTO, PDG, FTC, GRG, ZTF, DIA, WAND

Wednesday, Aug 03 2016 by

Good morning!

Next (LON:NXT)

Always of interest (for wider read-across on consumer spending generally) are the trading updates for High Street bellweather, Next (LON:NXT) . Its update today is perhaps surprisingly solid. Q2 sales showed an improving trend on Q1. Although not specifically stated, you can deduce from the figures today that LFL sales are still negative.

Its comments on Brexit are particularly interesting;

With only a few weeks since the EU referendum it would be unwise to draw any firm conclusions of the effect the decision to leave the EU will have on UK consumer demand, particularly as the week after the referendum was an unusually strong week the previous year.   So far, we can see no clear evidence of any appreciable effect on consumer behaviour, apart from the first few days after the vote.

So this confirms my view that Brexit has had little to no impact on consumer behaviour. Obviously, more poorly performing companies are going to blame their poor results on Brexit, and/or the weather! Remember how Bonmarche Holdings (LON:BON) blamed the weather for its terrible performance in Q2? Funny that it hasn't affected Next, despite them having the same weather. So BON are looking rather a bit daft for those weather comments.

Next also makes some very interesting comments about the devaluation of sterling, as this is a key issue for clothing retailers. Most import the bulk of their product from the Far East, and it's usually invoiced in US dollars. Therefore the recent plunge in sterling will increase the cost of imported goods - meaning that selling prices in the UK are likely to rise in 2017.

On this issue, Next today says;

  • Currency is hedged for all of this year (y/e 31 Jan 2017), so no impact.
  • Imports expected to be 9% more expensive next year.
  • Mitigating factors mean this can be squeezed down to c.5% higher cost prices next year.

Outlook - Q3 is expected to be tough, due to very strong comparatives from last year (+6%). However, Q4 could be stronger, due to exceptionally mild weather last autumn, which depressed sales of warmer winter clothing ranges.

Profit guidance (why can't all companies do this, it's so helpful?) has been narrowed from the previous range of £748-852m, to £775-845m. Note that the main movement in the range comes from a £27m increase

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NEXT plc is a United Kingdom-based retailer offering clothing, footwear, accessories and home products. The Company's segments include NEXT Retail, a chain of over 500 stores in the United Kingdom and Eire; NEXT Directory, an online and catalogue shopping business with over four million active customers and international Websites serving approximately 70 countries; NEXT International Retail, with approximately 200 mainly franchised stores; NEXT Sourcing, which designs and sources NEXT branded products; Lipsy, which designs and sells Lipsy branded younger women's fashion products, and Property Management, which holds properties and property leases which are sub-let to other segments and external parties. Lipsy also sells directly through its own stores and Website, to wholesale customers and to franchise partners. The Company's franchise partners operate approximately 180 stores in over 30 countries. more »

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TClarke plc is a United Kingdom-based building services company, which delivers electrical, mechanical, and information and communications technology (ICT) services. The Company provides electrical and mechanical contracting and related services to the construction industry and end users. Its geographical segments include London and South East, Central and South West, the North and Scotland. The Company's businesses include Intelligent Buildings Green Technologies, Facilities Management, Transport, Mission Critical, Manufacturing Services, Residential & Hotels, M&E Contracting and Design & Build. The Company within its M&E contracting business has capabilities in sectors, including commercial offices, retail, education, healthcare, financial services and media. Its Manufacturing Services business includes in-house precision prefabrication and engineering services. Its projects include Beckley Court, Chiswick Park, Kettering Hospital, Project Nova, Mitie Care Home and Rathbone Square. more »

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Pendragon PLC is an automotive online retailer. The Company's principal market activities are the retailing of used and new vehicles and the service and repair of vehicles (aftersales). Its segments are Stratstone, which consists of its vehicles, truck and commercial vans brand, including the sale of new and used motor cars, motorbikes, trucks and vans, together with associated aftersales activities; Evans Halshaw, which consists of its volume brand, including the sale of new and used motor vehicles and commercial vans; US Motor Group, which consists of its retail operations in California in the United States, including the sale of new and used motor cars; Pinewood, which consists of its activities as a dealer management systems provider; Leasing, which consists of its contract hire and leasing activities; Quickco, which consists of its wholesale parts distribution businesses, and Central, which represents its head office function and includes all central activities. more »

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24 Comments on this Article show/hide all

Brackendale 3rd Aug '16 5 of 24

Paul, I think your question as tp whether PE12 is good level for a company that seems low or ex-growth (in this case NXT) is a fascinating subject, and would be very interested in hearing other people's views. In general, what do people think about investing in low/ ex growth companies?

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JohnEustace 3rd Aug '16 6 of 24

In reply to post #145449

Yes, an interesting topic at the moment. With little or no income available from the usual safe assets should equities be valued differently? The likes of Fundsmith have done better than they "should have" because people are buying into perceived safe dividends. Do we accept interest rates being on the floor for the foreseeable future and adjust the historic PE's we are prepared to pay for equities? Is it different this time? I think it could be but it's a risky game - be ready to be trampled in the rush to the exit at the first hint of rates heading higher, assuming we live that long.
I had a bet with a colleague in 2009 that the next rate rise would be up - six years later I may be about to lose that bet.
I remember a comment from Jim Slater when hardly anything qualified for his Zulu screen that he would relax his price limits but not the quality or growth criteria.

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PJ0077 3rd Aug '16 7 of 24

In reply to post #145449


The Gordon growth model simplifies Equity valuation to three factors : 

  • dividends (D)
  • growth rate (g) & 
  • discount rate (r)

i.e. P = D / ( r - g )

This can be transformed with basic algebra (*) into : P/E = (1 - (g/ROIC))  /  ( r - g )

So for a company capable of sustaining ROIC of 20% but capable of growing only at 2% per annum, then a p/e of 12x is clearly incorporating a discount rate in excess of 9%, which appears excessive.

(*) need to assume g = ROIC * ( 1 - payout ratio )

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bobo 3rd Aug '16 8 of 24

I see one of the P2P portals is proud they bailed out WAND this time..... crazy

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tads 3rd Aug '16 9 of 24

I think that the results from Greggs bodes very well for Crawshaws.

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Brackendale 3rd Aug '16 10 of 24

In reply to post #145461

PJ007 Thanks very much indeed for taking the time to put that together. I have been looking for a way to relate ROIC to PE for ages and missed this, so I am delighted with this, thanks! You made my day (I must be quite a sad individual!)

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gsbmba99 3rd Aug '16 11 of 24

I think the outlook for Greggs (LON:GRG) is quite promising though you probably have to look beyond 2017 to see it.

1. After nearly three years, they are reaching the end of the refurbishment of their entire store estate. The remaining stores should be upgraded to the Food on the Go format by the end of the year.
2. The net company owned store count has grown for the first time in 3 years in 1H16 which hopefully signals that revenue will grow faster than just LFL in coming years.
3. There are 108 re-sites to come in the second half (about 6% of store count). These are generally low or negative contribution locations. Since these are occurring in 2H16 we should see a better full year profit contribution from the re-sites next year.
4. The five year plan to transform manufacturing and distribution is now underway. At the end of the 5 year £100m (gross) investment plan, Greggs will have the manufacturing and distribution in place to support store expansion "well into the 2,000s" which I interpret as about 2,500 compared to about 1,700 today ie 50% expansion potential relative to today's store count. In future, it's possible that LFL plus store count increase could grow sales at say, 6-8% per year.
5. I like the company's positioning relative to competitors as they are a vertically integrated, low cost, low price provider. Greggs sells coffee and a savoury for £2 where you might struggle to get just a coffee.
6. Coffee sales (I think it was the 1H15 update last year) were stated to be £1m per week and growing at 10% per annum. Breakfast continues to be the biggest growth area. I like the fact that a significant portion of the LFL growth is coming from coffee which tends to be high margin.
7. The capex in the past three years (store refurb) and the next 5 years (manufacturing and distribution) is abnormally high. All of the capex is internally funded. Despite the unusually high funding commitments, they found a spare £20m for a 20p special dividend last year. I would hope that special dividends could become a more regular feature (maybe every other year) in another year or two when peak capex subsides.
8. The company has a good long-term track record of value creation and dividend growth. Morningstar says the 10Y total return CAGR is 13.0%. If correct, 1.13^10 is 239%.

I am a holder.

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rbf 3rd Aug '16 12 of 24

I remain keen on the motor dealing sector too and PDG results seem pretty ok.......BUT I completely agree with andrea341 that MMH and CAMB look even better bets. MMH interims out 16 August and CAM should issue a Trading Update in early September.

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RMundy 3rd Aug '16 13 of 24

Thanks Paul.
I couldn't agree more regarding NXT. Such a great company and even if the scope for significant growth isn't there, it's formidable cash generation means there's always those special dividends. And touching on your post the other day about the importance of quality Management, Lord Wolfson has to be one of the best examples across UK plc. 12x seems a bargain for a 20% margin cash machine, growing topline at 5-7% pa and returning excess cash to shareholders on a regular basis.

Website: Research Tree
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andrea34l 3rd Aug '16 14 of 24

What do you think of OPG Paul? Results out recently looked pretty good I thought, pretty low P/E but good growth, operating in high-growth area (India) not exposed to Brexit obviously! AIM... but doesn't seem jam-tomorrow.

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JohnEustace 3rd Aug '16 15 of 24

In reply to post #145479

Interesting article on this topic by Chris Dillow in the IC today showing that even intelligent people do not approach this topic rationally.
We have an "anchored" yield number that we want to achieve and will take on more risk as necessary to get it.

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janebolacha 3rd Aug '16 16 of 24

A view contrary to the analyst crowd wisdom on the likely Bank of England rate decision tomorrow:

"Opinion: Bank of England should worry about a Brexit boom, not a Brexit bust"

It's a view that may well have merit, whatever Govenor Carney and the MPC decide tomorrow.

( I love his judgement on Carney's performance to date, " An East German Trabant was more likely to get you to your destination on time." )

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JohnEustace 3rd Aug '16 17 of 24

In reply to post #145530

I can't see that a rate cut from these levels would do any good - in fact I think it would be net a bad thing from the impact on bank margins and the prospect of negative interest rates on bank deposits.

To be fair to Mr. Carney he has been saying for some time that monetary policy has reached the limits of what it can achieve and that the focus must be on fiscal policy - it was just that Osborne wasn't listening.

Add in the loosening of bank capital ratios post the referendum and the devaluation and I agree that it all adds up to a strong stimulus even before the Autumn Statement.

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janebolacha 3rd Aug '16 18 of 24

John, I agree completely.

Sensible and targeted fiscal measures aimed at areas of need, such as housebuilding, hospitals, infrastructure and local and regional transport would be far more sensible than yet another round of monetary easing, seemingly ever more ineffective as rates near zero.

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Paul Scott 3rd Aug '16 19 of 24

In reply to post #145536


I agree. 0.5% interest rates are already at a level where it's giving as much stimulus as it can.

So to my mind, a knee-jerk reduction to say 0.25% is both pointless, and likely to trigger a negative reaction - it says that the central bank is in panic, not in control, and thinks that things are far more seriously bad than most of us reckon.

Govts & their offshoots need to sometimes DO & TALK LESS! Just let businesses adapt, and get on with things. The trouble is, we don't have enough business people in positions of power in the public and political sectors, that's a big problem.

Regards, Paul.

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cig 4th Aug '16 20 of 24

In reply to post #145533

Why would lower base rates impact bank margin? Banks earn a spread, which is not directly linked to nominal rates.

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janebolacha 4th Aug '16 21 of 24

Cig, you might be interested in these comments by Bill Gross on the unsustainability of continuing to rely on the now very obviously clapped-out and ideoologically-driven monetary easing route to economic salvation:

In the July comment, he draws an analogy with the "Monopoly" board game. It seems whimsical but contains a lot of common sense.


"All right. So how is this relevant to today’s finance-based economy? Hasn’t the Fed printed $4 trillion of new money and the same with the BOJ and ECB? Haven’t they effectively increased the $200 “pass go” amount by more than enough to keep the game going? Not really. Because in today’s modern day economy, central banks are really the “community chest”, not the banker. They have lots and lots of money available but only if the private system – the economy’s real bankers – decide to use it and expand “credit”. If banks don’t lend, either because of risk to them or an unwillingness of corporations and individuals to borrow money, then credit growth doesn’t increase. The system still generates $200 per player per round trip roll of the dice, but it’s not enough to keep real GDP at the same pace and to prevent some companies/households from going bankrupt."

His monthly comments often debunk financial commentatorati shibboleths.
Well worth the read, imo.

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JohnEustace 4th Aug '16 22 of 24

In reply to post #145572

This is from the BIS
This paper investigates how monetary policy affects bank profitability. We use data for 109 large international banks headquartered in 14 major advanced economies for the period 1995–2012. Overall, we find a positive relationship between the level of short-term rates and the slope of the yield curve (the “interest rate structure”, for short), on the one hand, and bank profitability – return on assets – on the other. This suggests that the positive impact of the interest rate structure on net interest income dominates the negative one on loan loss provisions and on non-interest income. We also find that the effect is stronger when the interest rate level is lower and the slope less steep, ie that non-linearities are present. All this suggests that, over time, unusually low interest rates and an unusually flat term structure erode bank profitability.

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Trident 5th Aug '16 23 of 24

Apparently and the USA have previously toyed with Bonuses/Tax refunds to taxpayers as a more direct form of QE. The criticism of this would no doubt be that this increases consumer spending rather than 'investment' by the banks which QE is meant to encourage (but which arguably it doesn't achieve very efficiently).

I have no doubt that lower interest rates will encourage some money to go into equities. There is apparently already a movement of savers to withdraw funds - presumably to either put under the bed, buy gold, purchase equities, or take a holiday.

The potential problem with Tax refunds is that part of the Govt's policy has been to take a class of workers out of the tax band up to £10k of earnings, so it will not benefit them, unless they could think up some other mechanism.

Personally I think we have had a blip in the various factors leading up to Brexit. The real issue is likely to be later when the Govt realises it can't reliably keep the economy going, and significantly reduce immigration in the short term.

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dangersimpson 8th Aug '16 24 of 24


I’m still fairly bearish on Dialight (LON:DIA) despite undoubted progress from the new management.

Although they are quick to champion the £4m underlying operating profit & £13.4m cash flow there is reason to think that both figures are optimistically presented:

Underlying operating profit:
  • They capitalised development costs of £1.8m vs £1.5m 15H1 & £1.0m 15H2. While this is a perfectly valid accounting treatment rising capitalised development cost is a red flag. Particularly when this capitalised development has failed to generate any revenue growth.
  • How exceptional are their ‘exceptionals’ when they occur each year? Since 2013 exceptionals have totalled £25.8m. Given the difference between their current provisions and stated UK site closure costs 2016H2 will further increase this total.


  • Without exceptionals and capitalised development costs stripped out Dailight have failed to generate any real cumulative return over the last few years:57a895e925772DIA_PAT.png
Net cash from operating activities:
  • We know that they will close down their UK factory in September and it will cost them £13m. They have increased their provisions by £5.3m but there is not only the cash cost of that provision but also a large un-provisioned exceptional cash cost that will be borne by the company pretty soon.
  • £0.7m was a tax refund – not sure I’d classify this as cash from operations as they do.
  • £1.3m was a one off legal settlement.
  • Depreciation of PPE = capex excl. capitalised development cost so is likely to be just maintenance capex.
  • The majority of the cash flow came from working capital improvements. With the gap between DSO & DSR now at an all time low this is at best a one-off improvement:


So add in the c.£13m H2 cash outflow and net debt at year end will be c.£6m and you have an enterprise value of  at least £210m. This seems to me to be pricing a lot of hope for a company that has not generated any meaningful return over the last few years and still has significant cash costs & risks of restructuring to come in the short term.

The cyncic in me thinks they were desperate to get some good numbers in before all the costs hit the cash flow statement & balance sheet in H2 and have squeezed everything to the max to get them.

Book: Excellent Investing: How to Build a Winning Portfolio
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About Paul Scott

Paul Scott

I trained as an accountant with a Top 5 firm, but that was so boring that I spent too much time in the 1990s being a disco bunny, and busting moves on the dancefloor, and chilling out with mates back at either my house or theirs, and having a lot of fun!Then spent 8 years as FD for a ladieswear retail chain called "Pilot", leaving on great terms in 2002 - having been a key player in growing the business 10 fold. If the truth be told, I partied pretty hard at the weekends too, so bank reconciliations on Monday mornings were more luck than judgement!! But they were always correct.I got bored with that and decided to become a professional small caps investor in 2002. I made millions, but got too cocky, and lost the lot in 2008, due to excessive gearing. A miserable, wilderness period occurred from 2008-2012.Since then, the sun has begun to shine again! I am now utterly briliant again, and immerse myself in small caps, and am a walking encyclopedia on the subject. I love writing a daily report for on most weekday mornings, constantly researching daily results & trading updates for small caps. Cheese! more »


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