Small Cap Value Report (3 Nov 2016) - VCP, IGR, GBG

Thursday, Nov 03 2016 by

Good morning!

Exchange rates

I've been pondering this issue a lot lately. On balance, I'm beginning to wonder whether myself & other commentators might be over-reacting a little? Certainly prices of most things will rise, due to weaker sterling. However, I was reading an article yesterday saying that a lot of larger retailers have hedged their currency forward by a considerable amount - e.g. Debenhams is 1-2 years hedged apparently. So maybe inflation could be more gentle & gradual than I previously thought?

Also, if you look at the long term chart of sterling against the dollar, we saw a huge devaluation from mid 2008. Sterling dropped from about $2.00 to a low of around $1.40. That caused a surge in inflation for a while, before it came back down again. It's no wonder that the British manufacturing sector was hollowed out, with sterling having been overvalued for so long.

A burst of inflation could be seen as a good thing, as it will scrub off some of the national debt, and private sector debt.

I think smaller retailers will feel the pain most, as their larger competitors will be cushioned from the impact of higher prices through their currency hedging. Also the bigger companies have more leverage to resist price rises from suppliers.

Breaking news! The Government has apparently just lost a court case over invoking Article 50. This apparently could delay Brexit, which has given sterling a boost - it's bounced a little in recent days to about $1.24.

Victoria (LON:VCP)

I had a fascinating meeting yesterday with Geoff Wilding, the former investment banker who has been instrumental in Victoria Carpet's remarkable renaissance over the last 4 years. He gave me a masterclass in how to do a successful buy & build (he's done 6 of them, in various sectors, including Victoria, so is worth listening to).

His 4 key points were;

1) Don't buy turnaround situations. Target companies must already be well run, and profitable.

2) Retain existing management - lock them in with earn outs over 3-4 years, to keep them motivated & involved.

3) Buy companies which have modern factories & equipment - this minimises capex requirements in future.

4) Management have to be honest & trustworthy. If in any doubt, walk away.

He pointed out that many private companies have very inefficient balance sheets, as owners often focus on profitability, but not ROCE. So there…

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Victoria PLC is a designer, manufacturer and distributor of flooring products. The Company's principal activities are the manufacture, distribution and sale of floorcoverings. Its segments include UK and Australia. It manufactures wool and synthetic broadloom carpets, carpet tiles, underlay and flooring accessories. In addition, it markets and distributes a range of luxury vinyl tile (LVT) and hardwood flooring products produced by third-party manufacturers. Its product offering in the United Kingdom ranges from both crafted, woven Wilton carpets to Tufted carpets in a myriad of fashion colors and styles. Its stock range offerings cover saxonies, tonals, velvets, twists and natural loop pile styles for residential use. The Company supplies its products to the mid to high end residential market and contract sector both in the United Kingdom and overseas. Its subsidiary, Munster Carpets Limited, is engaged in the manufacture and distribution of floorcoverings for the contract market. more »

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IG Design Group plc, formerly International Greetings plc, is engaged in the design, manufacture and distribution of gift packaging and greetings; stationery and creative play products, and design-led giftware. The Company's geographic segments include UK and Asia; Europe; USA, and Australia. The Company sells its products in over 150,000 stores across approximately 80 countries. It also offers a portfolio of licensed and customer bespoke products suitable for sale through multi channel distribution. The Company's products include crackers, pens and pencils, stickers, single cards and gift wrap. The Company offers its products under the brands A Star, B Stationery, Papercraft and Pepperpot. Its subsidiaries include Artwrap Pty Ltd, International Greetings UK Ltd, International Greetings USA, Inc, International Greetings Asia Ltd, The Huizhou Gift International Greetings Company Limited, Hoomark BV, Anchor International BV and Hoomark S.p.z.o.o. more »

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GB Group plc (GBG) is a global specialist in identity data intelligence. Its segments include Identity Proofing division and Identity Solutions division. The Identity Proofing division provides Identification (ID) Verification, ID Employ and Comply services and ID Fraud and Risk Management Services. It also includes the operations of ID Scan Biometrics Ltd, a provider of software that automates on-boarding of customers and employees by simplifying the identity verification and data capture process. Its Identity Solutions Division provides ID Registration, ID Engage, and ID Trace and Investigate services. The Company helps organizations make decisions about the customers they serve and the people they employ. It provides various business solutions that are focused on informing decisions about customers or employees in areas, such as employing people, registering identities, verifying identities, fighting fraud and locating people. Its products include GBG ID3global and GBG Datacare. more »

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  Is LON:VCP fundamentally strong or weak? Find out More »

28 Comments on this Article show/hide all

JohnEustace 3rd Nov '16 9 of 28

In reply to post #156844

Well done, you found the one product that didn't go up. Macs are up, MacBooks are up, iPhones are up, and iPads are up.
Watches aren't selling very well so I expect there is some stock in the UK for them to sell through before they go up as well.

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dscollard 3rd Nov '16 10 of 28

In reply to post #156856

VAT doesn't cover the price differential , logically if our currency is worth 20% less then for dollar value to remain constant then GBP price must compensate (or Apple lose margin) - in terms of LFL The 6-core Mac Pro now costs £3,899, £600 more than its previous price of £3,299, while its US price hasn't budged.

Of course Hammond could drop VAT. in the Autumn statement....

| Link | Share 3rd Nov '16 11 of 28

Debenhams is 1-2 years hedged apparently. So maybe inflation could be more gentle & gradual than I previously thought

It is true that Debenhams are hedged for dollars at $1.50 for at least another year and possibly a little further, but if exchange rates do stay at these or similar levels, there is an increase to their "cost of goods sold" of c20% looming at some point (even if delayed by hedging) on the 35% of stock they source in dollars...a cost increase to them of c£80m.  Can they pass all of that on to customers and preserve their margin and profit....or will that prove extremely difficult in an area like clothing where Demand appears weak and any LFL growth anywhere appears hard to come by, and promotion and discounting is rife.  A business with c£100m PBT and c£280m of Debt, and a potential £80m cost increase looming.

If that were not bad enough, the next question is "where is the other 65% of goods sourced from, which is not paid in dollars?".   I am sure some will be in Euro's, and other foreign currencies where we have also seen a sizeable depreciation of sterling. 

If businesses can pass the exchange rate hits on to customers, then we will see significant inflation. To the extent they cannot, then we could see a very nasty squeeze on profits and share values, which could be fatal for some of the weaker players.  

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FREng 3rd Nov '16 12 of 28

In reply to post #156859

The BoE MPC today said:

"Largely as a result of the depreciation of sterling, CPI inflation is expected to be higher throughout the three-year forecast period than in the Committee’s August projections. In the central projection, inflation rises from its current level of 1% to around 2¾% in 2018, before falling back gradually over 2019 to reach 2½% in three years’ time. Inflation isjudged likely to return to close to the target over the following year."

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fanmail 3rd Nov '16 13 of 28

Re Victoria one of my investment memes is never to invest in companies which are managed by ex investment bankers, particularly if they grow by acquisition!! Perhaps VCP is the exception which proves the rule.

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IR35 3rd Nov '16 14 of 28

In reply to post #156862

I didn't single out the watch because it hadn't gone up. It just happens to be the one apple product I can remember the price of. My point really isn't whether they will go up or not. More that they charge different prices in different countries - and as you point out it depends on what they can sell things for. For example :

iPad Pro $549 or £549
iPhone 6S $549 or £499

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ap8889again 3rd Nov '16 15 of 28

Hi Paul,

The axe has finally fallen on the Motley Fool discussion boards, where your Paulypilots Pub was a real powerhouse of investment discussion.

Just wondering what your thoughts and feelings were at the UK Motley Fool's demise?

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PJ0077 3rd Nov '16 16 of 28

In reply to post #156877


How does the exception prove the rule? Wouldn’t it do just the opposite? Doesn’t it prove that the rule does not hold for all cases and is therefore not a rule at all?!

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JollyBiologist 3rd Nov '16 17 of 28

In reply to post #156886

It's "prove" in the sense of "test". So this is an exception that is testing whether the rule is valid or not.

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dgold 3rd Nov '16 18 of 28

Paul, Re Gattaca (LON:GATC) please try to throw light on where the company's revenues come from? The CFO's review says 32% of NFI is from abroad, yet in the segmental breakdown it syas that UK revenue is £587m out of £618m. How does this tally? In your last write-up in August you mentioned that 90% of turnover was from the UK. Maybe the answer lie in the note which says "Revenue and non-current assets are allocated to the geographic market based on the domicile of the respective subsidiary." BTW there doesn't seem to be a break-down of the geographical breakdown of profits, only revenue. Not sure if that matters. Thanks very much.

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tabhair 3rd Nov '16 19 of 28

In reply to post #156883

That is a real shame. Seems to me like there would be a gap in the market for an online shareholder discussion forum. I am surprised that the likes of ShareSoc don't have this. Has anyone got any suggestions on where people can discuss UK shares? stockopedia comments section is useful, but not really suited for a discussion forum.

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seadoc 3rd Nov '16 20 of 28


iii and lse are fairly active, I post on both but there are many more, never managed to log in to some of others, wrong inside leg measurement? and head to community and share chat

To post you need to be registered for a day or so but I could read from day 1.



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investimouse 3rd Nov '16 22 of 28

All Apple prices have gone up around the world. It has nothing to do with Brexit or currency devaluation. Check the prices in the Apple stores online in the US, Australia and NZ - all have gone up.

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ridavies 3rd Nov '16 23 of 28

Re your comments on IG Design (LON:IGR) Paul, the surge at the end of summer may have been down to some extent to Small Company Sharewatch's comments on promises to come for the SP. I guess when they said:
'IG Design looks like it will surprise on the upside as it spreads from giftwrap into new areas of, as the CEO put it to me, “everything but the cake”. Sticking my neck out I wouldn’t be surprised if the shares are closer to 300p than 200p in 18 months time'
that it would come so quickly, though only lasted for a little while before the fall you have identified. After the songs of praise in August, they duly added the share to their portfolio for Sept issue (ie bought in August for 220p). The US acquisition does seem to be a good deal, and of course their sales will be in $US there. However, the PE and PEG are pretty demanding, and consumers can always cut back on discretionary purchases like this, especially downtrading to a less expensive alternative.

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Fangorn 3rd Nov '16 24 of 28

"Also, if you look at the long term chart of sterling against the dollar, we saw a huge devaluation from mid 2008. Sterling dropped from about $2.00 to a low of around $1.40. That caused a surge in inflation for a while, before it came back down again. It's no wonder that the British manufacturing sector was hollowed out, with sterling having been overvalued for so long.

A burst of inflation could be seen as a good thing, as it will scrub off some of the national debt, and private sector debt."

Spot on Paul. So many Remoaners failed to acknowledge that Sterling was massively overvaslued in the first instance over last few years.

Inflation is indeed going to be used to erode our stratospheric National debt around £1.7trillion on balance sheet. It continues to grow because we're apparently rich so can afford reckless spending/generosity.

All the while the "Illusion of wealth" gets stronger & stronger. Just like the China credit bubble,and at some point they will burst..and Govt bond markets will spiral downwards.

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Kevin_T 4th Nov '16 25 of 28

On the subject of big companies hedging, which includes Next, Sports Direct etc so the prices rises would be gentle and over the next couple of years, I can't believe that UNILEVER would not have done similar. Yet it was the first big one to very quickly raising prices within a few months of currency depreciation. Unilever's competitor like Proctor & Gamble, and lots of others (including holiday companies) don't seem to have jacked up prices across the board. I can't help wondering whether we are taken for a ride by Unilever!

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Sniggolb 4th Nov '16 26 of 28

I am amazed anyone listens to forecasters because they get everything hopelessly wrong. Who would have forecasted Trump or Corbyn or that the euro would cause massive unemployment and we would prosper out of the Eurozone? Or that Brexit would win or that Cameron would be toast? No one has a clue.

Why listen to any of these asses other than Paul who is often right

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WDWombat 4th Nov '16 27 of 28

I have just bought some IGR - a first half position - so clearly do not agree with the comments on this one. I have the company on about x14 for the year to march 2018 with around 15% growth in reported eps for this year and next. My main concern is the exposure of its UK sales (around 30% of the total) to the feeble sterling price. It imports a fair share from its own operation in China, I believe on a dollar pricing basis, but against this sales in the US (approx 40%) will be boosted by the purchase of Lang this year. Net debt fell from £25mn to £15m in the year to March 2016, operating cash flow was better by 8% and reported 'real' eps grew by 23% to 12p. The current boss took over an ailing company in 2008 and has it set, ,I hope and believe, to do great things.

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BEN12358 29th Nov '16 28 of 28

re GBG, 287k share options at an exercise price of 2.5p, with a fair value of 300.5p. To me, this is like giving founders' profits to hired execs. Maybe I mis-understood?

Also, share option costs are excluded from the operating profit headline figures. What usefulness then are the headline figures.

It's a shame - otherwise I would consider buying this company's shares.

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 Are LON:VCP's fundamentals sound as an investment? Find out More »

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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