Small Cap Value Report (31 Jul) - MIN, MEC, SOG, VCP, FOUR

Good morning. I'm running a little late today, apologies for any inconvenience.

Firstly, I've been looking at the interim results to 30 Apr 2013 from Minoan (LON:MIN 4.5p). This is a UK company which has been trying to develop a large holiday resort in Crete from what seems like the beginning of time. Obviously macro events have conspired against them in the last five years, so they bought a travel agency business to keep them busy whilst the Crete project was effectively on hold.

The market cap is only £7m at 4.5p per share, and it might be worth a further look, treating the shares as almost an option on possible long-term upside from the Crete project. Although they report a loss before tax of £900k for H1, on £19.8m turnover, the segmental analysis shows that the travel agency business is trading profitably (just), with a £117k profit on £19.8m turnover.

Costs of £604k were expensed on the Crete project, of which a third was paid in shares, and "corporate development" cost £416k. That last item sounds an awful lot for just six months, for such a small company, so the overheads might well be top heavy, that would need looking into.

I could see the share price being a high risk/ high reward type of situation, but it would need a lot more research to determine whether it's attractive or not. Just wanted to flag up the idea if any readers fancy doing some digging into it. I would also want to look carefully at the cash position, and solvency, as the Balance Sheet looks stretched to me.

 

 

 

 

Mecom (LON:MEC 39.75p) issues its interim results to 30 Jun 2013. This share is a similar situation to Trinity Mirror (LON:TNI 115.5p) which myself & many readers did extremely well on last year (we could do with another big winner this year, after disappointments from my largest two positions so far this year).

However, after going through the figures for Mecom again today, I think it's too high risk. Advertising revenues being down 20% year on year is just too steep a decline to be able to predict what the future holds, and they still have E95m of net debt.

There's a "going concern" note in the narrative, which is a big red flag, and there are some very worrying points made in that note, which for me make this far too high risk to consider as an investment. So I shall be dropping update cover on Mecom from now on, as it looks touch & go whether they will be able to maintain or renew their bank facilities. If I were the Bank, I'd want out, as their business is declining too fast to be sure that there is a workable business model here for the long-term.

The Board are covering themselves if the worst were to happen by saying this:

 

The Board is making full disclosure of the uncertainties set out above since the Directors have concluded that the circumstances where trading were to deteriorate further within the expected life of the current facility ... represent material uncertainties which may cast significant doubt upon the Group's ability to continue as a going concern.

 

Because of this, Mecom is very much a job for my bargepole.

 

 

 

 

My pet hate at the moment is software companies that steer you towards valuing the business on adjusted EBITDA. In many cases, this is a horribly misleading performance measure, greatly overstating the profitability of the business.

The culprit is development spending. Software companies have to keep innovating with their products, or they die. So development spending should be seen as a normal overhead. Yet accounting standards allow companies to capitalise some or all (subject to it meeting the required accounting criteria) of their development spending onto the Balance Sheet, and then amortise it over the expected period when the company is reaping the benefits of that development spending.

EBITDA by-passes that development spending AND the amortisation of it too! So it completely ignores what is sometimes a significant chunk of a company's overheads (mainly staff costs usually).

For this reason, I'm now ignoring adjusted EBITDA for software companies, and am only interested in adjusted profit (since that does include the amortisation of development spend, or at least it should do - always worth checking the figures yourself).

In fact I'm coming round to the view that it's best to just ignore the highlighted financial items at the top of results statements, and instead go straight to the P&L, and calculate your own EPS figure!

 

The software company that I'm looking at today is StatPro (LON:SOG 83p). This is a new company to me, with a market cap of £55m at 83p. The company name sounds like an oil company, which is I think why I've not looked at it before?

Their interim results to 30 Jun 2013 are published today. The most striking thing is that nearly all turnover is described as recurring, which is the key thing we look for in software companies, as it de-risks everything very nicely if you have a guaranteed income stream. Overheads can then be planned to generate a certain level of profit which is highly predictable. Hence a very low risk of profit warnings, so investors should be prepared to pay a higher price for that degree of downside protection, so I'm not expecting this company to be cheap.

Revenue for the six months is up 3% to £16.5m, and profit before tax is up 32% to £1.89m. The business looks mature, although they mention a new product called StatPro Revolution, which is showing strong growth from a low base, with revenue up 124% to £2.4m. I don't know if any of that growth is cannibalising sales from existing products, that would be worth finding out.

The Balance Sheet is weak, with £49.8m net assets, but of that £57.7m is intangibles. Strip those out, and you have a negative net assets position of £7.9m. I don't invest in companies with negative net tangible assets, so that rules out this one for me.

I also note that their cash position is not good - whilst they report £2.9m in cash, creditors includes a whopping £13.5m in deferred income - i.e. customers who have advance paid. So that £13.5m should be sitting in the bank, but it's not, it's been spent already.

Let's move on, this one's not for me.

 

 

 

 

Next, I've had a quick look at results for the year ended 30 Mar 2013 from Victoria (LON:VCP 237.5p). They're not good, as you would probably expect from a carpets manufacturer & distributor in the current economic climate. Turnover is down 8.1% to £70.9m, and they have sunk from a pre-exceptional operating profit of £2.7m to a loss of £0.4m this year. There are a fair chunk of exceptional restructuring costs, which mean the loss before tax is reported at £3.5m.

Surprisingly, they have kept paying a (slightly reduced) dividend, of 6p final, giving 8p total for the year, which provides a yield of 3.4%. In my view it was a mistake to declare this dividend, and they should have retained the cash in the business.

I say this because their financial position looks potentially wobbly with regard to the Bank debt. Victoria has £7.5m of net debt, and there is a going concern note in the narrative to today's results, which as mentioned earlier today, is a red flag for investors that you are entering into a high risk situation.

Overall though, the Balance Sheet looks quite strong, although most of the £38.5m net assets is tied up in fixed assets, as you would expect. I've had a quick look in their 2012 Annual Report, and fixed assets includes £10.8m in freehold property (note 13), which is stated at a 2004 valuation, so depending on where the land is, its current value is probably in that same ballpark?

I see from note 18 of the same Annual Report that the bank debt is secured agains the freehold property. That makes me a lot more relaxed about the debt position, as given that they have solid security, the Bank are likely to be accommodating about the business running at breakeven whilst they turn it around.

So really these shares are a bit of a punt on management being able to successfully turnaround the business back into sustainable profits & growth. Carpets don't strike me as an area that is particularly attractive for investors - capital intensive, and low margin, but who knows? Victoria seems to be a high-end brand, and could see a cyclical recovery in the UK. Although I note that most of their turnover, 61% is generated in Australia. So worth considering their macroeconomic position as well.

At the current market cap of about £16m, at 235p per share, with net debt on top (although arguably you could just offset net debt against the freehold property), I'm struggling to make these numbers stack up.

I like special situations & turnarounds, but the figures here are not compelling on valuation terms. If it was valued at below c.£10m then I'd regard risk/reward as favourable, but not at £16m market cap, so I'll pass on this one.

There was some kerfuffle here over control of the business I seem to recall. This is possibly reflected in the slightly caustic comment in the Chairman's report, which amused me:

 

The Board was fortunate in finding some really talented and committed people at Victoria and it has certainly made our job easier having some people that can be relied upon to deliver on their promises.

 

Using the word "some" twice in that sentence seems to be somewhat barbed!

 

 

 

Just a quick note to say the 4imprint (LON:FOUR 551p) have announced strong interims to 29 Jun 2013 today. Revenue up 14%, underlying EPS up a superb 54% to 13.2p.  The growth is organic, and profit is ahead of expectations. I missed the boat on this one unfortunately, it was high on my watch list late last year, but the big money has probably now been made on these shares, with the forward PER up in the mid to high teens.

 

One interesting snippet from 4Imprint's results, they mention that their pension deficit has fallen from £22.9m to £17.0m, in the first half of 2013. So we should see the same trend appear with pretty much all other final salary pension schemes, as bond yields have risen somewhat, that overall should reduce pension deficits. Worth bearing in mind when looking at other companies with pension deficits - it should now be a shrinking problem.

 

 

Sorry for the late running today, I shall sign off, and be with you again at the normal time from 8am tomorrow.

Regards, Paul.

(of the companies mentioned today, Paul has no long or short positions)