Small Cap Value Report (5 Feb 2016) - LAKE, OTB, DSG

Good morning!

Quiet today, as usual on a Friday, so I'll comment on a couple of news items from yesterday too, that I missed.

Lakehouse (LON:LAKE)

Share price: 40p (up 13.5% today)
No. shares: 157.5m
Market cap: £63.0m

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

Director buying - 4 Directors of Lakehouse conducted apparently orchestrated (as same quantity & price) buying of shares yesterday, at 35p. A total of £100k, or £25k each.

Personally, I'm not a fan of orchestrated Director buying, as it looks bad to my mind - with the main motivation presumably being to send a PR signal to the market. Anyway, it doesn't really matter what I think, because it's what works that matters, and today's announcement has certainly triggered a significant bounce in the share price after heavy recent falls. up 13.5% today, at the time of writing.

I reported on the company's shock profit warning in Monday's SCVR, here. At first my view was fairly scathing, as indeed was the market, crushing the shares by 54% at the time. However, as I updated Monday's article in the afternoon, to reflect a Peel Hunt note which suggested that the market reaction was overdone, and that it could be a buying opportunity. You might quip "well they would say that, wouldn't they!", since this was the broker that floated Lakehouse in the first place, and now has egg on its face, and probably some very unhappy clients.

Having said that, personally I really rate PH research - it's usually very good indeed, so worth sitting up & taking notice of.

Hence I did pick up a medium-sized position in Lakehouse earlier this week, and wonder if the Director buys announced today might support the share? It has done in the short term, but we'll have to wait and see if the sellers are done yet? I've been looking out for TR1 form announcements, to see what the major shareholders are doing (i.e. buying or selling), but so far there haven't been any. Therefore we can only really gauge market sentiment from the share price.

If PH are anywhere near right, that the company will do 9.9p EPS this year, then the shares probably won't stick around on a PER of 4 for very long. Personally I think there's scope for this share to rise to say 60-70p in the coming months, which would be a very nice return from 40p, providing existing big shareholders are happy to give management the benefit of the doubt.

The downside risk is that big shareholders now want out, and could drip-feed stock into the market thus depressing the share price for perhaps a long time? There's no one-size-fits-all rule after profit warnings - the subsequent price action depends entirely on the balance of buyers & sellers in the market, says he stating the obvious!

It's always very uncomfortable buying shares after a profit warning, but I ask myself one key question - are the problems transitory & fixable? I'm not entirely sure with Lakehouse, but am leaning towards that probably being the case. Therefore it's one I'm prepared to take a punt on. As always though, this is just my personal opinion, and includes an element of guesswork at this stage, as we're trying to predict an uncertain future.

On the Beach (LON:OTB)

Share price: 295p (down 3.4% today)
No. shares: 130.4m
Market cap: £384.7m

AGM Trading update - this online travel company has a 30 Sep year end, so today's update covers the first 4 months of the y/e 30 Sep 2016. Clearly it has disappointed the market a little, as the shares are down 6% today.

I did a review of the company's IPO here on 9 Dec 2015, concluding that the shares looked quite attractive at 180p. It's since shot up 64%, so am annoyed that I dithered too long, and didn't actually buy any.

Back to today's update. It gives some background, but the key figure is that UK revenue is up 26% year-on-year, so clearly that's good growth, and seems to be slightly above broker consensus turnover growth for the full year of 25.8%. There's a bit of international growth, but it's mainly a UK website at the moment.

As regards profitability, it's a tad annoying that the company refers to management expectations, when they could surely have not introduced doubt by referring to market expectations?

"On the Beach continues to efficiently execute its strategy. The Board believes that the Group is well positioned to continue generating attractive levels of growth and therefore remains confident in meeting management's full year expectations."

Valuation - broker consensus is for 12.4p EPS this year, which means the PER is 23.8, which is clearly rather expensive. However, brokers are forecasting a substantial increase in next year's EPS, to 18.1p, so providing the company executes well and meets that forecast, then the PER next year would drop to 16.3, a more palatable level.

My opinion - the company seems to be performing well, and the share price looks up with events in my view. Before being prepared to chase the share price any higher, personally I would want to see much more credible overseas expansion. So far, the company seems to only be dipping its toe into Scandinavian markets.

Looking at this chart, and thinking about the rather warm valuation, personally I would be banking some profits at this stage - as it's had a very nice re-rating in the last few months - probably justified, but can it continue at the same rate? I doubt it.

Dillistone (LON:DSG)

Share price: 73.5p
No. shares: 19.7m
Market cap: £14.5m

Trading update - this sounds quite solid;

We are pleased to confirm that pre-tax profits before acquisition related items are expected to be in line with market expectations.  The Group is expecting to report an increase in revenue approaching 10%, with both divisions delivering organic growth.  Product development has continued to be a priority throughout 2015 with a number of upgrades and new product launches successfully achieved and more expected in 2016.

The Group has enjoyed a promising start to the year with new business order levels in January up on those seen in the previous two years in both divisions.  In addition, the Group has a strong prospect pipeline. As a result, the Board is optimistic about making further progress in 2016.

However it is also mindful of wider economic influences and their potential to impact on the performance of the business.  The Group remains profitable and cash generative and continues to follow a progressive dividend policy, subject to the needs of the business.

My opinion - quite a nice business, and the dividend yield is particularly attractive.

However, the shares can be a bit of a lobster pot investment - easy to get into, but difficult to exit from. The spread can be prohibitive too, so it's easy to lose all of the first year's divi just on the bid/offer spread, which means that it's only worth buying for the dividend yield if you're happy to hold for years. Arguably it makes more sense to go for a large cap, if you want good divis, as at least there the cost of changing your mind is minimal.