Small Cap Value Report (30 Sep 2014) - ZZZ, ZIOC, BEG, BAR

Good morning! Clothing retailers are in focus today, as Next (LON:NXT) has announced that unseasonably mild weather is hurting sales of autumn/winter clothing ranges at the moment. This will be affecting all clothing retailers - I recall in my days as an FD in this sector, every year I hoped for a cold snap in September, as it would give sales a strong boost as people bought jumpers & particularly coats (higher priced, so have a good impact on performance overall). So the opposite effect is happening at the moment - slower sales due to mild weather. It all averages out in the long run, so personally I see dips due to unfavourable weather as potential buying opportunities.

On the flipside of that, I suppose DIY and garden centres do better in mild autumn weather, which could explain why Kingfisher (LON:KGF) shares have been creeping up lately. Incidentally, I read the last Annual Report for Kingfisher the other weekend, and was tremendously impressed with the strength of its Balance Sheet, stuffed with a 10-figure sum of freehold property, and yet still with net cash on top. So I bought some shares in it, as it's also a nice play on a recovery in the French economy, which is going to happen sooner or later, we just don't know when. Reasonably priced, and a 3.5% divi yield too, plus share buybacks.

Snoozebox Holdings (LON:ZZZ)

Share price: 7.0p
No. shares: 211.8m
Market Cap: £14.8m

There are three announcements from Snoozebox this morning. This company has carved out a heavily loss-making (!) niche as a provider of temporary hotel accommodation - a great idea, to convert standard metal shipping containers into small but comfortable hotel rooms. The original business model failed, because the units were far too complicated and costly to set up & dismantle, thus negating the benefit from room rates charged to customers.

However, new management took over, and the business model has been re-worked. So the version 2 units are self-contained (no need for a separate utilities service unit), and can be quickly & simply fixed up or taken down, just in one day. So having learned from the mistakes of the v1s, the v2s are actually a viable proposition. On the basis of this, I took part in the 10p Placing a few months ago, which on reflection probably wasn't one of my better decisions. However, after this morning's announcements I'm starting to feel a lot more optimistic. Principally because of this;

Lease finance - until now Snoozebox has relied upon repeat equity funding rounds, each at much lower prices, and causing more & more dilution, as losses mounted. Furthermore, the last 10p for £ 10m funding round was a struggle to get away (they tried for more originally, but investors were not prepared to invest) - and being cynical, when Placings filter down to the likes of me, then you can be pretty sure it's been turned away by bigger hitters!

So I've always hoped that they could secure some asset financing - after all, the Snoozebox units are long-life assets, which could easily be sold on in the event of debt default. Sure enough, a deal has been done, announced today, to raise up to £15.6m of lease funding.

This is highly significant, because it means that as of today, Snoozebox are no longer reliant on holders exercising the 10p Warrants that were attached to the 10p Placing. So those Warrants can expire in Dec 2014 without it harming the company's expansion plans for 2015.

It is not stated what the terms of this debt financing are, so I hope they are reasonable.

Interim results - to 30 Jun 2014 are also announced today. The way I'm looking at these, is that they're largely irrelevant - as they relate to the old v1 units. This share is all about the viability of the v2 units coming into service in 2015. Certainly those of us who put fresh money into the company in the last Placing did so entirely on the much more favourable economics of the new v2 units to be built using the Placing proceeds.

So all that matters with these results is that the losses are minimised until next year's launch of the v2s (I keep thinking about Hitler when writing about v1 and v2s). On that score, the company gets a tick - the pre-exceptional EBITDA loss for H1 this year is reported as £1.6m, vs. £3.6m in the equivalent period last year. Although I am somewhat taken aback by the dramatic drop in turnover - which was only £731k in H1 this year, down from £4.3m last year. However, in this particular case, turnover is less important than cost-cutting and preserving cash, which they've done.

Balance Sheet - this is sound, with the £ 10m Placing proceeds still intact, net cash was a whisker over £11m at 30 Jun 2014. That cash is mostly being spent on a batch of v2 units under construction, I believe. More units can now be built using the lease financing. So there should be a much better proposition for 2015 and beyond, hopefully.

Outlook - a fair bit of detail is given, and I am intrigued by the international sales potential, once they have hopefully got the new v2 units working on a commercially viable basis next year;

...The Company is experiencing high levels of rebooking, with over 50% of rooms booked for key events in 2015 that are on sale.  The event programme includes a hotel deployment during the Rugby World Cup next year

Snoozebox continues to see strong international demand. The Company successfully deployed at the World Equestrian Games in France and reached preliminary agreement for a Snoozebox Fanzone Village for the 2018 World Cup in Russia earlier this year. The Company continues to experience clear demand from the US, South America and Middle East and active discussions are ongoing for events including the 2016 Rio Olympic Games and 2022 World Cup in Qatar.

I believe the progress made in the underlying operating model in the first half of the year, combined with the launch of the Next Generation Portable Hotel in the second half provides a platform on which to transform the performance of the business in 2015 and to scale the business in 2016.

My opinion - Sentiment is very negative towards this company, which I like because it can mean the shares are cheap - but only when combined with specific reasons to believe that a turnaround is underway. I've drilled into the business model in some detail, and believe that the new v2 units will be a viable business, combined with the now much lower central overheads.

New management previously put some of their own money in too, which is confidence boosting.

This share is far too speculative for most people, but for me the lease financing deal is a game-changer, and I reckon this stock has potential to surprise on the upside in 2015. It may not, after all it's been a serial disappointer in the past, we'll just have to wait and see!

General Point - trading updates & Placings

As you can see from the Snoozebox chart above, on 20 Feb 2014 its shares more than doubled. I remember that day well, because the trading update RNS flashed up on my screen during the day, I quickly read it, noted that it seemed amazingly positive, so I then rang my broker with an instruction to buy as many ZZZ shares as he could get, below about 8p. I filled my boots, and the price shot up to peak at around 18p the following day, so I was thrilled to bits, having made a terrific profit. Like a fool, I didn't sell, as greed had set in by this stage.

However, the share price then inexplicably began falling. This is odd I thought. Maybe some profit-taking, before the price roars up again? Sadly not, as a few weeks later in Apr 2014, the company announced a discounted Placing at 10p. The Placing just about got away, but the price swiftly dropped below 10p (maybe Panmures had to pull in some favours to get buyers, who swiftly dumped the stock afterwards?) and we're now down at 7p.

Now I did bank some gains at the higher levels, although of course once I was taken Inside on the Placing then I was barred from dealing in the open market at all.

What are the lessons to be learned from this?

1. I should have banked at least half of the spectacular original gains, instead of holding on for a bit more.

2. That companies which need cash will use positive trading updates to get the share price up, in order to facilitate the next Placing.

I don't normally buy into shares with cash requirements - my Balance Sheet testing is such that I reject companies with inadequate cash reserves normally, but this was more a short term trade on the positive trading update, not a long-term investment. It's turned into a long-term investment since mind you, as I genuinely see good upside next year, and I don't mind waiting & absorbing losses in the short term.

Another key lesson;

3. Trading updates which contain lots of good news, but very few hard figures on profitability, are largely flannel! They might sound good, but you often subsequently find out that profits are disappointing, despite supposed good news on contract wins, sales increases, etc.

4. The key sentence to look out for in a trading update is "profits are ahead of market expectations". If it doesn't say that, or something very similar, then it's probably flannel designed to get the share price up! Which may well be followed by a discounted Placing.

5. Private investors are the cannon fodder that are used to lap up stories, get excited, buy the shares, create a favourable up-trend in the share price, so that Institutions then feel comfortable buying discounted shares through a Placing. So we need to be aware of this, and push back!

Zanaga Iron Ore (LON:ZIOC)

Share price: 13.625p
No. shares: 278.8m
Market Cap: £38.0m

Zanaga is one of my extremely rare sorties into the resources sector - which is not a sector I usually follow. The company has a JV with mining giant Glencore, over a huge iron ore project in the smaller, more politically stable of the two Congos, the Republic of Congo, also known as Congo-Brazzaville.

I've been excited about this project, and have delved into it in a lot of detail, meeting the company 3 or 4 times. However, I've also been tracking the price of iron ore, and it's fallen to five year lows of only around $80 recently. This project should still stack up at that level, but it's eating into the margin of safety for investors, and potential financiers of the necessary capex. So for that reason, as mentioned in the comments section of yesterday's report, I have cut back my position size to reflect the increased risk from the lower iron ore price. We discussed this in the comments sections of yesterday's report - which I urge anyone interested to read, as there were some excellent responses from readers.

From what I can make of it, and bear in mind this is not my sector, the company seems to be stating a Proved Ore Reserve statement for the first time. As expected, this demonstrates that there are vast amounts of high quality iron ore to be extracted, which has never been in any doubt. It's more the economics of the project at lower iron ore prices that is the burning issue.

As discussed yesterday, the key question is whether this project is actively progressed, or just mothballed. That depends on whether Glencore are prepared to look through the current weak iron ore price. They might well do, as it will take several years to develop Zanaga to production, and by that time Glencore are already on record as believing that iron ore prices will be rising again.

On the other hand, Glencore seem to be capex-averse, so we really have no way of knowing whether they will want to progress this project or not. The plan was to use debt financing for most of the capex anyway. We'll just have to wait and see what happens.

Today's announcement has firmed up the price by 8%, which is pleasing, but follows a period of quite sharp share price declines, reflecting the fall in the price of iron ore, unsurprisingly. Zanaga have always stated that there is a lot of high-cost iron ore being extracted, especially in China, so the lower iron ore price will be putting severe pressure on other producers. Therefore supply could tighten up again after a while, as high cost producers potentially go bust.

Begbies Traynor (LON:BEG) - today's AGM statement looks like it's warming up for a mild profit warning;

...As last year, the financial outturn for the full year will be heavily dependent on trading in our traditionally busier second half. However insolvency market conditions remain challenging, which may impact on performance for the full year...

Lower revenue is noted for the year to date (May-Aug 2014);

Market conditions remain challenging, with the Government insolvency statistics worse than expected. An 8% decline was reported in the number of corporate insolvency appointments to 8,948 in the first half of calendar year 2014 compared to 9,727 in the same period of 2013*. This reduction in market activity has led to lower year on year revenue which has been partially mitigated by the contributions from recent acquisitions.

Begbies shares are down about 7.5% today, to 48p.

My opinion - I'm less keen on this share than I was, as they've had a good run in the last year, so I was happy to bank the profit & move on some time ago. The valuation looks about right to me, taking everything into account. There's a good dividend yield. Also note that Stockopedia gives this a 99 score in the StockRank - surprising that it's so high, but it is, so there we go!

Sorry, go to dash now - lunch appointment.

Regards, Paul.

(of the companies mentioned today, Paul has long positions in KGF, ZZZ, and ZIOC, and no short positions)

Eclectic Bar (LON:BAR)  - Just a quick late one, to get my notes into the system. This company floated on AIM on 28 Nov 2013, at 160p per share. £15.0m was raised, but this was mainly used to buy out a shareholder called Avanti Capital, and to repay their shareholder loan. So the company retained only £1.8m of the net funds raised. I'm very wary of companies floated by PE/VC - they normally ensure that they get the better side of the deal. So why take the other side?

Results published today for the 52 weeks ended 29 Jun 2014 have not impressed me. Continuing operations had a turnover of £23.0m, and traded at just below breakeven for a £106k operating loss. Our attention is drawn to £1.1m in "highlighted items", being things like the IPO costs (fair enough), but also pre-opening costs for new sites, bonuses for management, etc.

So highlighted items rewind us to a £1.1m underlying trading profit, still not great for a £23m turnover business. The narrative tries to draw us to EBITDA - sorry, no way. Capex is continuous in the bars sector, because the customers trash the joints pretty quickly. Therefore in my view the market cap of £24.5m (at 190p per share) looks quite high.

Balance Sheet backing is fairly light - net tangible assets are only £4.5m.

The problem I have with bars, is that the young customer base generally can't afford to pay bar prices for drinks. They will just pre-load before visiting a venue, and buy a few drinks once inside. Why pay £3-4 a pint, when you can get a perfectly serviceable chilled can of lager from a supermarket for under a pound? It doesn't make sense for people who are struggling to earn more than minimum wage, or relying on parents for income.

So this one doesn't appeal to me at all. Bars & small nightclubs are better off being lifestyle businesses, owner-managed. I don't think there is scope for investment gains from owning emerging chains in this area. Luminar was a disaster a few years ago, as we discussed recently here. The cycle will just continue - new groups are formed, take on too much debt for expensive refits, then go bust in the next Recession. Repeats every few years.