Small Cap Value Report (5 June 2017) - AVCT, SOM, DP Eurasia, DSG

Good morning!

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Avacta (LON:AVCT)

• Share price: 96.5p (unch.)
• No. of shares: 68.4 million
• Market Cap: £66 million

ShareSoc Growth Company Seminar

I'm glad to help to publicise a ShareSoc event. There is a very long Avacta comment thread here which is relevant to anyone watching  or holding this share.

It's on Wednesday 14th June in the City. Registration from 5pm.

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Somero Enterprises Inc (LON:SOM)

• Share price: 292.5p (-7%)
• No. of shares: 56.2 million
• Market cap: £164 million

AGM Statement

A detailed announcement from this US-based manufacturer of screeding equipment (tools which help to ensure that new concrete floors are perfectly flat, e.g. using lasers).

Trading so far this year is in line with market expectations:

The Company remains encouraged by the positive trading environment across our footprint, the growth opportunities visible in North America, Europe, Middle East, Latin America and our Rest of World territories, and the prospects for improvement in China for the remainder of 2017.  This constructive, positive environment, combined with continued solid margin performance, cost management, and healthy operating cash flow generation means the Company's trading to date is in-line with market expectations for the full year ending 31 December 2017.

There is no explicit mention of an "H2 weighting", but it sounds to me like there is an implication of same, as in the description above of an "improvement in China". Also from this earlier sentence in the statement:

In North America, while H1 trading in 2017 has been flat compared to the prior year due in part to poor weather across the US that has delayed numerous project starts and ongoing political uncertainty, we remain encouraged by healthy market fundamentals in the US that are reflected by the high-level of activity and extended project backlogs our customers continue to report.

The US is the core market for Somero and I think this very mixed set of circumstances may have spooked a few investors out of the stock today.

Some Stockopedia commenters have been discussing it on this thread, with a few existing holders top-slicing their position on this announcement.

I can see why they might do that: prior growth expectations are now potentially under threat. Somero's target has been to achieve $90 million in sales by 2018, which at prevailing margins and effective tax rates would result in PBT of $23 million and net income of $15.5 million.

The current market cap is c. $212 milllion in USD terms or $192 million excluding the year-end cash balance, about 35% of which is being paid out in August in the form of a special dividend (13.3 cents per share).

So if the targets were hit, the 2018 valuation doesn't look too bad. If the targets are missed, and results stay flat, then investors will have to satisfy themselves with net income in the region of $14 million.

The worry of course is that we see another cyclical downturn as occurred from 2009-2011.

On balance, I have a pretty favourable view of Somero. The company's competitive position in the US/Europe looks pretty strong, with only one smaller competitor I could find in the US, and with patents covering its newer generation of machines.

Trading into China looks more difficult given the difficulty of enforcing foreign patents (and Somero's penetration into China remains tiny - see here for the range of screeding equipment by Chinese manufacturers available on Alibaba).

So I wouldn't place any firm value on Chinese growth possibilities, but I could see this remaining a good US/Europe/Mid East/Lat Am story.

A pretty reasonable holding, in my book.

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DP Eurasia (New flotation)

Intention to float

Some readers share my interest in new flotations (though I don't invest in them, I like to see what's happening in the IPO market). So in that spirit I'll say a few words on DP Eurasia.

It has less in common with Domino's Pizza (LON:DOM), and more in common with DP Poland (LON:DPP), as the holder of the exclusive master franchise for Domino's in a particular geographic area. Whereas DP Poland has a single country, DP Eurasia has Turkey, Russia, Azerbaijan and Georgia.

DP Poland has been a serial loss-maker for many years (though hopefully not forever), and I cannot see any reference in this RNS to DP Eurasia's profitability beyond "adjusted EBITDA". So perhaps it is also loss-making on a statutory basis.

Like DP Poland, DP Eurasia has a mix of corporate-owned (37%) and franchised (63%) stores.

System sales (i.e. sales including those by franchisees) reached TRY 650 million in 2016, or about £140 million. It claims to be the largest pizza delivery company in Turkey with 51% of the market, and to be the fifth largest master franchisee with Domino's. It has 567 stores in total, and plans to open 70-90 per year. That's a lot bigger than DP Poland.

I'll look forward to more details about this. It's a far from proven investment thesis but perhaps these will turn out to be good, profitable enterprises some day. Obviously the macro-political risk should also be factored in, when venturing into riskier locations.

Admission is scheduled for 3 July 2017.

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Dillistone (LON:DSG)

• Share price: 71p (-16%)
• No. of shares: 19.7 million
• Market cap: £14 million

Trading and new product update

It's my first time looking at this small software company, focused on the recruitment sector.

It produced revenues of £10 million last year. Adjusted profit was almost flat at £1.4 million, but including one-off items it fell to £0.5 million. That's after capitalising £1 million of spending on intangibles.

Today's RNS is a profit warning, although you have to read down to the 11th paragraph before this is confirmed:

The Board currently expects that the second half of the year will deliver better results than the first half in terms of general trading.  However, the slow start to the year and the higher cost base mean that the results for the full year are expected to be significantly below market expectations.  In view of the proposed fund raising, the Board expects to reduce its dividend until the benefits of its investment in the New Product flow through to the Group's balance sheet.

A fund raising? There is talk in the statement of a "New Product" that "addresses a market need which, in the view of the Board, is global in nature and has the potential to be very significant for the Group".

It's very secretive about this product, but says that "fundraising for completion and launch of the product is now being explored". It is anticipated to be "highly cash generative" from 2019.

CEO comment:

"We've seen improvement in the order book since the beginning of the year and are confident that this will improve further in H2. 

"We are delighted by the early response to our New Product and excited by its potential.  The New Product is essentially a start up being developed within the auspices of an established business.  We believe that it has the potential to transform the nature of our business and to deliver significant shareholder value."

This is all very strange to me. Should listed companies be raising money and diluting shareholders for confidential projects which they can't tell anyone about?

This is effectively a mystery box with a secret prize inside, and shareholders can only find out what's inside it after they've bought the box!

It doesn't sound terribly investable to me. Though it has historically been decently profitable for its size, and paid dividends when it could afford to.