Small Cap Value Report (5 May 2017) - RCN, CTO, FST

5th May '17 by Graham Neary

11 comments 11584 reads

Good morning!

Redcentric (LON:RCN)

Share price:89.75p (+3%)
No. shares: 148.9m
Market cap: £134m

For my previous (bearish) analysis of Redcentric, see the 23rd Dec SCVR at this link.

At the time, I had the impression the company had responded professionally to the discovery of accounting errors including the overstatement of historic profits and understatement of net debt.

But I still thought the episode raised such fundamental questions that I would have marked the shares down even lower than they were.

Today's trading statement for the year ending March 2017 says performance was in line with expectations, with "good sales momentum".

There was no evidence of theft in the accounting fiasco, and customers are apparently still happy, so it seems as if the effect of the errors was limited to giving shareholders a false impression of profitability.

Net debt reduces to £39.5 million from £42 million, and the banks have played ball:

Our lending banks have remained supportive over recent months and the Company is pleased to announce that amended debt facilities are now in place. Waivers in relation to historic covenant breaches have been secured such that the Company is fully compliant with its facilities.

My opinion

The shenanigans which took place here are a real shame, as it looks to have some quality services and a strong ability to win contracts (including a major NHS contract in January).

And it is probably my own fault, but I still can’t see how a market cap around the current level can be justified. Statutory PBT came in at just £0.3 million in H1, it’s under FCA investigation, the previous year was heavily loss-making after restatement, and the debt load is substantial (£39.5 million).

Even with the greatest of efforts and professionalism by staff and senior management in the current circumstances, I don’t see how a market cap of >£130 million makes any sense. An enterprise value of over £170 million, operating in the very competitive space of diversified IT services. Perhaps someone can help me to understand!

T Clarke (LON:CTO)

Share price:88p (+12%)
No. shares: 41.8m
Market cap: £37m

AGM Statement

Many new projects have been secured so far in 2017 by this building services contractor (mechanical and electrical contracting and similar services).

Interesting names on the list include Dyson, Thomson Reuters and Gloucester Royal…

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Ramridge

5th May '17

Hi Graham. re T Clarke (LON:CTO) I am puzzled by this share's low PE ratio of around 6-7. Sector median is 12. The company's financial history looks sound. No debt. Reasonable growth. Good dividend yield
So what is it that the market doesn't like about this share?
Thanks. Ram

Beginner

T Clarke (LON:CTO) has, as Graham says, very thin margins. This may be a deterrent. Also a couple of years back there were problems with contracts they inherited from a takeover. This could easily reoccur. There is also some inflexibility in the workforce, which is all directly employed: no agency staff here!
(I hold and am happy to do so. My nephew is a former employee. He cannot speak highly enough of the company).

rhomboid1

I believe this took it off many people's watch lists..

http://www.investegate.co.uk/clarke-t---plc--cto-/rns/re--investigation/201610311637559084N/

TClarke plc ('the Company') announces that it has uncovered financial irregularities within the accounting function of a wholly owned subsidiary, DG Robson Mechanical Services Limited ('DGR'). From initial investigations it would appear that funds in excess of £2.8 million have been misappropriated by an employee over a number of years. The Company has taken appropriate action, including the appointment of expert professional advisers to assist with our investigations and to recover the stolen funds.

Jack Owen

Re redcentric valuation - because it generated £6.8m of free cash flow in H1

laurie

T Clarke (LON:CTO) TClark--the position regarding the financial irregularities
From the full year report 28.03.17:

During the year ended 31st December 2016 the Group uncovered financial irregularities within the accounting function of a wholly owned subsidiary, DG Robson Mechanical Services Limited ('DGR'). GBP2.9m of cash was misappropriated over a number of years, of which GBP1.9m has been expensed in 2016 and GBP1.0m had been charged to the income statement in previous years within cost of sales and administrative expenses. The 2016 expense has been separately disclosed as a non-recurring item. Results prior to and including 2015 have not been restated as the impact cumulatively and in each year was not considered to be material, however, the 2015 results have been re-presented to show funds misappropriated in that year as non-recurring, in order to aid the comparison of underlying performance.

The Group engaged expert professional advisers to assist in the investigation and recovery of the stolen funds. The cost of the investigation to 31(st) December 2016 is GBP0.4m.

no position

muckshifter

6th May '17

I bought quite a few T Clarke (CTO) after careful consideration of the “investigation” RNS in 2016. Hopefully this won’t turn out to be a bad decision, but anyway my reasoning was as follows, fwiw.

T Clarke has been a familiar name to me for decades and although it was in an entirely different type of contracting to my own, my understanding of TCO was that it was a well respected London centric electrical contractor. I began to take a little more interest in their progress in 2015ish when Balfour Beatty had a huge string of massive profit warnings, many of which, related to their mechanical / electrical contracting, and also their major building projects in London – which between them lost something of the order of £50m. Obviously I felt that Balfour would probably have been competing directly with CTO on the electrical contracting, and also might even have been an exceptionally hard up / contractually tough client of CTO, fighting them for every penny, on some of their major building jobs. So, in that light, the poor years results from 2014 & 2015 looked explicable.

Then, I looked at the fraud situation, which had clearly exacerbated the bad results in preceding years to the tune of £2.8m at least. CTO had clearly had one big job which had gone seriously wrong and it had cost them perhaps a million or two, but they also had big legacy costs in defending, and eventually settling, a sub contractor claim against one of the subsidiaries they had bought. The claim related to work carried out by the subsidiary before it became part of CTO. Reading the annual reports provided information on these problems over a few years, but not enough to pinpoint the major project that went bad, or the subsidiary they had acquired which had a “skeleton in the cupboard”. The two large subsidiaries they acquired in 2010 are the likely source of the hidden “skeleton” imho, and of the two, the one which stands out as the most likely to have a historical contractual fight on its hands with a subcontractor would be DGR. In March 2016 Danny G Robson left the board to “pursue other interests”, rather abruptly. The “investigation” RNS in October 2016 related to misappropriation of £2.8m at the DGR subsidiary by an unamed person, who was being pursued for repayment. Danny G Robson had been paid £5m+ for his company, DGR, in 2010 including partial payment by 1.45m shares in CTO which he still held at departure. The opinion I reached about the fraud must be clear from the above, and obviously whoever took the £2.8m may well be forced to pay it back (or presumably go to jail).

More recently, I note that in the 2016 accounts, payments to Danny Robson ended after approximately six months. ie. about the a month before the “investigation” RNS, despite notes, iirc from accounts saying that directors were given 12 months notice.

If the company can put all that behind them in a situation where work is less competitive and more profitable (thank you BBY), with the possibility of recovering the £2.8m, it should bode well for CTO even though I’m not that comfortable with their London “centricity” during Brexit changes.
Regards.

Great post Muckshifter, top sleuthing,if you're correct in your analysis then a full recovery of the the £2.8m is plausible less costs, so a nice tailwind for CTO. I think that makes a major difference to the buy case, thanks for posting.

7th May '17

Hello rhomboid1,
The other thing I saw in the recently released 2016 accounts, which I felt was a further indication that perhaps my conclusions a few months earlier were not too far out, was this item changing the remuneration terms for the directors:
Introduction of recovery and withholding provisions – in line with best practice, the revised policy will enable the Committee to recover and/or withhold remuneration in certain exceptional negative circumstances such as a material misstatement, error and gross misconduct.

It was in the remuneration committee report and I had forgotten it!
Regards.

Trident

I read that the TClarke fraud has most been expensed through the p&l, and therefore the possible recovery is an upside, though the costs of pursuing of is another ongoing expense.

Unlike other frauds therefore this is unlikely to lead to a further write-off. Sounds like supplier invoices have been falsely generated over a period of time?

Graham Neary

8th May '17

Thanks so much for the fantastic, in-depth info on the CTO irregularities! Shows the value of looking into these things in proper detail.

18th Jul '17

Nice to see that Clarke announced yesterday that the first half of the missing £2.8m is due to be refunded by year end, and they continue to pursue the remainder. This sounds distinctly like crooked payment deals with subcontractors, which might make the second half of the missing cash much more difficult to reclaim - much depends on whether or not it was a single subbie and their current financial state.

Small Cap Value Report (5 May 2017) - RCN, CTO, FST

Redcentric (LON:RCN)

T Clarke (LON:CTO)

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Graham Neary

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