Small Cap Value Report (31 May 2016) - RNO, KNOS

31st May '16 by Paul Scott

40 comments 18253 reads

Good morning!

It's so difficult to get moving again after a Bank Holiday, isn't it? The extra day off just seems to make me relax to a point where I grind to a halt completely! After an enjoyable brunch with investor friends on Sunday, I ended up binge-watching my favourite comedies (Big Bang Theory & Goldbergs) all day yesterday. Not a productive use of time, but it did help me unwind a bit!

Not forgetting of course New Top Gear, with Chris Evans & Matt LeBlanc. I think they pulled it off, perhaps not surprising given that Evans is an experienced TV host, and a massive petrolhead. Although his inability to modulate his voice from its single setting of hysterical shouting, can become wearing. LeBlanc was the opposite end of the spectrum, being a bit soporific and wooden. But it's very early days, so give him time! I suppose as a fallback position, he could always slip into character and become Joey again! So there is life after Clarkson.

Looking at Brexit, I've heard from several businesspeople that the vote is stalling certain projects. In particular IPOs. The CEO of Porta Communications (LON:PTCM) noted in a recent video that his firms have 11 IPOs in the pipeline, all of which have been put on ice until the Brexit vote is done & dusted.

So this could be quite a nice opportunity to pick up some bargain shares, for companies which may be experiencing low activity now, but should catch up after the vote. The key thing is that business is simply being deferred, not cancelled.

As regards IPOs, the City seems to have finally woken up to the fact that investors want good quality companies to be floated, not more junk. Certainly the handful of IPOs that I've looked at so far this year have looked quite interesting companies, although pricey.

I prefer to wait for them to warn on profits, and investor sentiment get crushed, which happens in a lot of cases. You can then pick up the occasional bargain - e.g. Boohoo.Com (LON:BOO) has been fantastic for me in the last year and a bit. To my mind, it's all about spotting great companies, then just waiting for Mr Market to present me with a buying opportunity at the right price.

The latest potential fallen angel is, I think possibly,…

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ds1980

31st May '16

Not quite. 70-80% of money will be on stay which is why they're between 7/2 on and 5/1 on. Bookies wont lose on any outcome in a 2 horse race especially in the day of age we live in now with computers running the books. Odds shorten and lenghten due to liabilities. Most bookies are running at around 105-108%. The 5 - 8% being their margin, regardless of result.

DarwenLad

Wish I could share Paul's enthusiasm for Renold. It has to be congratulated for surviving as one of a dwindling band of traditional UK engineering companies which remains a world leader in its specialist field - chain. But it is a low margin commodity business and the market has little growth at the best of times. Chain accounts for three quarters of group revenues and it sounds like Renold has just about turned round this side of its business so that it can benefit from any global upturn when it eventually comes.

But Renold still has a long way to go in turning round its smaller torque transmission business which has traditionally been much more profitable than chain. It is not obvious why Renold retains this business but then, as a non-engineer, I may have overlooked some obvious synergies.

My final quibble, which you do address, is the weakness of the balance sheet. In its last financial year, Renold's net assets slipped from £11.6m to £10.5m, pension liabilities increased from £61.2m to £68.1m, and net debt rose from £19.5m to £23.5m.

These are big numbers for a company with a market cap of just £90m. Whilst Renold might be heading in the right direction, it is more than a decade since it last paid a dividend, and there seems no early prospect of a resumption. It could do with another rights issue, but it is hard to see Renold's big shareholders stumping up yet more cash until this stock can prove that it is going to resume dividend payments.

rgwarner

Ref: Kainos and Government Digital.
I interviewed with them recently for a contract role through them with government (ended up with another part of government through another company).
Essentially, in recent years there's been a shift with government IT away from massive contracts that don't deliver (NHS IT, anyone?) to engaging with smaller companies that do. The revamped gov.uk sites are part of this; the goal is to drive change by delivering value for both the user (taxpayer) and government. This makes a lot more sense for government: they pay less and get more value. So while this means the massive consultancies lose out, the smaller ones such as Kainos are well-placed to win business.
On the sustainability of this, there is a *lot* to get done in government and somebody needs to do it. So if Kainos can demonstrate value, there shouldn't be any reason that they don't continue to win repeat business going forward. Sure, the profits are good but they are still far, far, less than the mega-corps were taking and at a much smaller level - I don't know how many people Kainos have on government projects but imagine it's going to be weighted towards provision of software developers and the like rather than middle managers..

JohnEustace

Re Kainos (LON:KNOS), I see they score 4.6 out of 5.0 on Glassdoor which is very encouraging given their dependency on attracting and retaining skilled people. One ex-employee review which raised a negative got a detailed and thoughtful response from the MD which I thought was excellent.

rhomboid1

I've been following Renold for over 20 years, during that time its main achievement has been simply to survive. I have never bought shares as they always appeared to have to paddle hard to stand still, I also like my metal bashers to come with a divi, Castings (LON:CGS) or Hill & Smith Holdings (LON:HILS) or Goodwin (LON:GDWN) or Hayward Tyler (LON:HAYT) are all core holdings and demonstrate that we still have a viable world class engineering capability.

Going back to Renold (LON:RNO) I also got a twitch of bull from the RNS, eg. "management bandwidth " , plus why are they contemplating acquisitions before being capable of a sustainable dividend? I was also not impressed by the mention of the new HQ office, it's on a business park and nowhere near the 'mucky bit' which makes the money. A whiff of ivory tower & blue sky thinking .

Good luck Paul!

Paul Scott

Hi DerwenLad,

I agree with you on the weak balance sheet at Renold (LON:RNO).

However, your key point, that's it's a low margin, commodity business, doesn't stand up to scrutiny at all. The figures today show that it made an adjusted operating profit margin of 8.6% - that's actually a pretty respectable margin for an engineering company, or for any business actually. It's nowhere near what I would call low margin (an operating margin of say 3% or below).

It's the decent level of profitability, from turnaround actions, which is what interests me about Renold.

I wouldn't go as far as saying that I'm enthusiastic about it. I can see good potential upside on it, if the turnaround continues.

Reinstating divis is clearly on the cards now - that's mentioned in the commentary today. The company has clearly briefed brokers to start pencilling in small divis in the current (new) financial year. That's a good catalyst for the shares to re-rate, with a say 1-2 year view.

Rights Issue? It doesn't need to do one. The working capital position is fine. The pension deficit it huge, but that's a long-term liability, which I just view as a drain on cash for the next say 20-30 years. It's bad, but it're reflected in the valuation in my view.

I would sell Renold if its margins were going backwards, for sure. It's the rising margin that interests me most. Management say their target is 10%, so more to go for there.

Regards, Paul.

Ramridge

RE Kainos (LON:KNOS)
I bought Kanos at the IPO stage and sold the shares recently booking a healthy profit. Looking at my notes, the following may be of interest:
- Just over 88% of revenues are recurring
- Central Government accounts for around 50% of total revenues (70% of divisional revenues)
There was a wobble around September 2015 I think when they got negative press about a failing MOT project. However they recovered pretty quickly as I recollect.
Overall I like this company and may well go back in. At the moment it looks fair valued.

melody9999

Hi Paul - note your comment as copied below.:

"Whatever the polls say, my view is that Out voters are very highly motivated, hence more likely to turn up and actually vote on the day. On the other hand, there could be a silent majority, who turn up on the day to protect their perceived personal interests (of staying in the EU)".

Actually I think there could be a silent majority that turn up on the day and vote Out ....Why? because they are totally disenfranchised with the political system and will want to "stick two fingers" up to Cameron et al.

peterthegreat

My impression is that the Brexit vote is done and dusted as the betting odds for leaving are so long (decimal odds of 4) that this outcome is most unlikely. However, if anyone disagrees with me then here is an opportunity to quadruple your money. My personal belief is that it will be closer than the odds suggest but overturning these kind of odds would be remarkable as the odds at betting exchanges reflect the "wisdom of cowds effect". I find it puzzling why so many people on TV think the two camps are neck and neck.

MichaelFBS

Re Brexit. Just returned from Hay Book Festival where I listened to the Telegraph EU debate (http://www.telegraph.co.uk/news/2016/05/31/telegraph-eu-debate-at-hay-festival-2016-highlights/). The Brexit camp of Liam Fox, Roger Bootle and particularly Alison Pearson were absolutely cringe making in delivering their arguments and in their closet (or not so closet) xenophobia.

Sovereignty in this day and age is not an issue for me but if I had been wavering these three would definitely have swung me firmly into the remain camp.

Sorry Paul I have to strongly disagree with you on this one, it is all about the economy.

smatthews1

1st Jun '16

Regarding Renold, lets not forget revenue has dropped about £44m over the past 5 years, I would agree the management have done exceptionally well to maintain a decent profit margin up until now, which they have stated , and rightly so.

However I cant find statements to suggest what factors might change the outlook in the future demand, I think you would have to be very patient with this one.

Sean

Fangorn

Purple,

How is wanting to choose who comes to the UK on a skill basis in anyway Xenophobic?

If anything one could argue that discriminating against Non EU(predominantly non white) in favour of EU migrants(White) is where the Xenophobia comes in - if playing a pedants card is required!

We have more connections with Commonwealth as well so why turn such people away with needed skills in favour of some low skilled low wage Eastern European? Sensible?

Not quite sure how you felt those three speakers tickled your xenophobia radar myself. all looked pretty sensible. Given the scarcity of housing, schools places, overstretched NHS , congestion, and social cohesion issues, choosing who we let in, based on skills, rather than their membership of some European nation, sounds eminently sensible.

England is the most densely populated nation in Europe outside of principalities. More densely populated than Netherlands. Note I say England, and not United Kingdom. Plenty of room in UK I admit but nearly all migrants don't want to go to Wales or Scotland - hence the density per capita issue down in England.

ridavies

Regarding Kainos (LON:KNOS), thanks for the coverage Pail. Incidentallyt, I read somewhere - Small Company Sharwewatch - that a share overhang may be holding back the share price - still a big shareholding from the University of Belfast?

2nd Jun '16

Hi ridavies,

The Uni of Belfast sold about half their stake in the IPO.
So, there would only be an issue if they were now dribbling out stock into the market. That's not happening, as there would have to be an RNS.

I reckon there are probably lots of stale bulls - e.g. people who got over-excited on the SCSW tip - a similar thing happened with Tungsten a while back - shares went crazy, sucked in all the people who love a story & don't care about valuation [[hrrrmppph, no comment! We all make mistakes!]], then it takes a while to shake out all the stale bulls.

I could see KNOS zooming up again actually, if the news is positive. But the time for that should have been this week, and it didn't happen. So maybe there are more stale bulls than new buyers?

I don't know. All I report on, is stocks that looks potentially interesting. It's then up to readers to decide how DYOR goes, and how they want to finesse their buying or selling. I've no idea what to do.

Regards, Paul.

Thanks for that. A puzzling one but one I will keep faith with.
Regards rid

Hi Fanghorn

Maybe I am overly sensitive and while I'm pretty much 100% Anglo (I believe I am 1/16th Italian) and a very right of centre Tory, free marketeer and an entrepreneur for the last 25 years, I am married to a Singaporean, my brother in law is French, my sister in law is half polish and I run a business that would have to close if we Brexit (it would simply not be profitable). But sitting there in the tent where the audience seemed pretty evenly split but it is always hard to tell, I just felt uncomfortable with their statements and body language. There is nothing wrong in being able to choose but this was not the inference I got from their statements.

Bootle came closest to being rational and this has for me been the major problem with the campaign that each side have made ridiculous extreme claims.

But it wasn't just this, they simply weren't convincing about life after Brexit and while I would have voted out in 1975 (I couldn't as I was only 14) we are simply to embedded in Europe to exit now.

As I have said before contrary views are what makes a democracy but I for one will not enjoy waking up on 24th if we Brexit to a non viable business and country led by Boris, Gove, Lawson and I assume Farage.

Rusty2

Even if we remain things will change, maybe the Tories will lose MPs to UKIP, there will be another elelation then we will probably have a coalition government again. The EU will change, more countries, more laws we can't opt out of. Really there is a no win situation for the UK. I'm for voting out still, at least we will have more control over our own country.

@Purple,

Wow, that's quite some exposure to Europe - Intrigued that brother in law is French, Sister in Law half polish yet wife Singaporean. Or are these former two unrelated to where your life is from?

Life after Brexit - it's a tough one to quantify. It certainly hasn't gone down the route of the blatant dishonest scaremongering of IMF, OECD,Treasury and Co.

It's genuinely a tough decision - the economic argument hasnt been won either, despite protestation to the contrary by Remain.

It really boils down to whether you want UK to be an independent sovereign nation again or to inevitably get subsumed into a United State of Europe. There is no status quo and a remain vote on 23rd June will be taken as carte blanche to press ahead with the integration process.

Just what legislation has been held up who knows. By voting to remain we are leaping into the dark as well.

What I can tell you is that if we vote to Remain this is what will happen.

Our contribution will rise.
There'll be another Adhoc GDP demand,
Forced Migrant Quotas
We'll see Net migration soar as Europe implodes economically.

EU powergrab for control over elements of social security & taxation. eg EU wide Nat insurance/Min age, Minimum state pension

Greece will blow up - again. Costing us billions(despite our opt out!)

Italian banks blow up (followed by italy)
Spain blows up, preceeded by Portugal.
(Who's going to pay for these? Us of course.Question is how.)

Freedom of speech restrictions./erosion(see Germany & Erdogan as a aster of whats to come) Add to that the "talk" of ID cards to log into social Media. I joke not.

An EU Army - with British army, being only one of two viable ones currently, being subsumed into a structure we will have little say over when it comes to their deployment.

Imagine a Falklands problem - will EU Army fight for our sovereign control over those Islands when its clear they;ve stabbed us in the back in the past! Ditto Gibraltar.

This lack of democracy, and the exorbitant cos we have to pay to be part of a declining customs union is simply unacceptable imv. As is the disgraceful discrimination against Non EU migrants (predominantly non white, ex commonwealth with whom we have history) in favour of EU migration(many of whom we've been at war with over the centuries)

Personally don't see the issue with Gove myself - did wonders for schools.(If only he'd been given more time.) Doubt Boris will be next leader. All far better than dishonest Dave & chums, who wipe the floor with Corbyn and his front bench - oh boy)

xcity

Life after Brexit is hard to pin down largely because the decisions will be taken by the government of the day (will be Tory, led at least) and will depend on how they decide to negotiate. In practice, there will be 2 years before anything much changes and after that there's the choice between the EEA/Norway solution (little economic change, restricted control of immigration but more freedom in general and time to negotiate our own commercial treaties with other bodies), the WTO approach (much edgier) etc etc. I doubt that there will be a political consensus even within the Tory party or within the Leavers to take an extreme position unless the EU was pushing, so the mild Norway solution seems the most likely. And UKIP will continue to oppose immigration - and at least the decision would then be ours to take.

I believe life after remaining will bring significantly more change. Nothing then to hold back the EU Masters from increasing their central power and control. We will just have to put up with it because we will only have a voice and a perennially lonely vote. Economic stagnation as the Euro hangs around the neck of the European economies. Until the whole edifice collapses because of the tensions of trying to maintain the Euro and a single economy become impossible to maintain.

8th Jun '16

We will have to agree to disagree but just to clarify.

My sister is married to a Frenchman
My wife's mother is from Singapore (Father from Lancashire)
My wife's brother is married to somebody who is half polish.
My wife's sister is married to an Englishman and have adopted a Chinese baby.

My son is a quarter Chinese but looks blond and English so that's ok then.

So pick the bones out if that one!:-)

Small Cap Value Report (31 May 2016) - RNO, KNOS

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Paul Scott

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