Small Cap Value Report (3 Jun 2015) - COG, SPRP, CFYN

Good morning!

I've had a good response to my new "SCVR Extra" videos on YouTube, so will keep doing those most days, around lunchtime, once I've finished the main written report.

The format is a 10-minute commentary on company announcements that I haven't had time to mention in the main report here. Also it gives me an opportunity to be a little bit more cutting than I would normally be about companies that I don't like, or have a short position on!

Cambridge Cognition Holdings (LON:COG)

Share price: 86p
No. shares: 17.0m
Market Cap: £14.6m

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

Investor Teach-In - I attended this event last night, organised by Walbrook PR, and just want to mention how excellent it was. It was well attended, and a really good opportunity to learn about the company, and there was plenty of time to ask questions. We even got to try out the product - tablet-based cognitive reasoning tests with a variety of uses, e.g. to detect early stage dementia, or to prove that drug trials do not impair cognitive functioning.

Sadly I failed the cognitive reasoning test by stage 4, although the scientist from COG made my excuses for me, in that the room was noisy, plus I was on my third beer by that point!

What's interesting about this company is that its academic and clinical trials divisions are already (modestly) profitable & cash generative. The cash generated by those activities are being used to finance a potentially much bigger opportunity in healthcare. The timescales are not immediate, 2-4 years was mentioned, but it's an interesting little company with nice barriers to entry - some patents, but mainly the value of 30-years cumulative data & proof.

It's a difficult company to value, but personally I like to have one or two more speculative shares in my portfolio, and this is potentially interesting in my view. What I particularly like is that the company confirmed they will not need to come back to the market for any more cash for working capital.

The presentation given by the company was well-prepared, and interesting.

I note that the largest shareholder, with 20.2% is Euroblue Investments - an investment vehicle of Nigel Wray (known as Britain's Buffett).

I hope more events like this will be arranged, as it's great to meet companies, and then discuss them with other investors afterwards. It's good to see that more and more companies and their advisers are recognising the importance of interacting with private investors, as well as Institutions. In my view, to create an efficient market in a share, there needs to be a reasonable free float, and an active private shareholder base. The benefits that flow from private investors getting involved are considerable - volume rises, the spread narrows, and this creates a liquid market which makes everyone happier. After all, what's the point in having a listing at all, if there's no liquidity in the shares (as is the case with plenty of small caps)?

Sprue Aegis (LON:SPRP)

Share price: 287p (up 2% today)
No. shares: 45.5m
Market Cap: £130.6m

AGM Statement - this update has confused me a little;

So clearly the company has traded very strongly in H1, but drops a bit of a bombshell by saying H2 will go backwards. Why? No explanation is given.

Valuation - Stockopedia shows broker consensus as 18.0p EPS for calendar 2015, and the company has today confirmed that they are in line. So at 287p the current year PER is 15.9.

The company has an excellent balance sheet - last reported to include net cash of £15.9m, nearly 35p per share, so you're really only paying 252p for the business itself, which equates to a PER of 14.0, which looks about right to me.

My opinion - this company has many attractive features, such as strong growth, great balance sheet with plenty of net cash, good quality scores, and a healthy (and growing) dividend yield. The StockRank is not as high as I expected, at 73.

I have two reservations with this company. Firstly, I don't like the royalty fee it pays to sell third party products - I prefer companies which fully own & control their own product ranges. Secondly, there is an element of one-off demand coming from France at the moment, due to legislation requiring households to fit smoke alarms. Therefore I wonder whether profits are unsustainably high at the moment? If so, then perhaps a lower PER might be appropriate?

On the positive side, bulls point out the new, wireless products being developed, which could drive new growth opportunities. Overall, I like it, but can't see a particularly compelling case to buy at the moment, with only perhaps 10-20% upside potential on the current share price, at a guess.

Caffyns (LON:CFYN)

Share price: 638p (up 1.8% today)
No. shares: 2.8m
Market Cap: £17.9m

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

Final results for y/e 31 Mar 2015 - this is a chain of car dealers in Southern England. It's a family-controlled business, with an unusual share structure, which gives the family control via excess voting rights - an old-fashioned and rather discredited structure. There again, if you don't like it, then don't buy the shares!

I'm a little disappointed that underlying EPS has only risen from 75.5p last year to 78.1p this year - I was expecting more, given how buoyant conditions are in the sector. Still, that puts the shares on a very reasonable PER of 8.2 which is probably the lowest of the listed car dealers. They're all good value though, as the stock market prices in the likelihood that conditions are likely to deteriorate at some point when interest rates rise, and/or the Euro strengthens.

Margins are very slim for car dealers, and Caffyns only makes a 1.2% margin at the profit before tax level - although that's fairly similar to most car dealers, which seem to be in the 1-2% range typically.

Dividends - a useful increase in total divis, from 18.0p to 20.25p, so that gives a yield of 3.2%.

Balance Sheet - this is the interesting bit. Caffyns owns the freeholds to most of its sites. So do some other car dealers, e.g. Cambria Automobiles (LON:CAMB) so it's not unique in this regard. However, and I'm not really sure why, Caffyns doesn't seem to revalue its freeholds in the accounts, but does give a note of the latest valuations in the narrative;

So the £24.5m net assets on the balance sheet swells to £33.0m once you include the property surplus. Yet the market cap is only £17.9m, so that's a deep discount to net assets. There's only £0.3m in intangibles included in net assets, so as it's not material, I've left it in.

You could argue that the company is not using its assets very productively, so a discount is justified perhaps. Although from my point of view, the more assets that I get for free, the better!

Note that the company has about £10.2m in net debt, so the interest charges make quite a big dent in operating profit - about a third of the £3.7m operating profit is absorbed by £1.2m finance charges.

There's a pension deficit to take into account too.

Director remuneration - the problem with a family-controlled business is that there is a tendency for long-serving staff and Directors to end up being paid rather well.

Looking at last year's annual report, the Directors certainly took a big chunk of the upside with some pretty eye-watering bonuses, considering that this is only a £17.9m market cap company;

You do start to wonder for whose benefit this company is run, when you see remuneration on that scale. As major shareholders, the family are really getting two substantial pieces of this cake - salary/bonuses, plus dividends.

My opinion - you do start to wonder with car dealerships, whether they are just busy fools - shifting a large volume of cars for the manufacturers, whilst making a negligible profit margin. That said, as long as there's a decent, and growing dividend, and a big pile of freehold property, as is the case with Caffyns, then risk/reward for investors isn't bad.

I think there could be some corporate activity in this sector at some point too. Caffyns shares have put on a bit of a spurt recently, which might be because a selling overhang has cleared. There was a bizarre RNS yesterday, where a former 7% shareholder notified the market of all but 1,500 shares having been sold in various tranches over the last five years.

I comment on the following stocks in today's SCVR Extra on YouTube:

Seeing Machines (LON:SEE)
Globo (LON:GBO)
Advanced Oncotherapy (LON:AVO)
RapidCloud International (LON:RCI)
easyHotel (LON:EZH)

Regards, Paul.

(of the companies mentioned today, Paul has long positions in COG, CFYN, SEE, AVO, and has no short positions. A fund management company with which Paul is associated may also hold positions in companies mentioned)