Small Cap Value Report (6 Aug) - WGB, PRV, SRT, CTO, ZTF

Good morning! Luxury interior furnishings group Walker Greenbank (LON:WGB 137p) issues a half year trading update today. The update says that "the Board remains confident of the outlook for the full year". A jump in earnings per share (EPS) from 6.89p last year to 9.59p this year (ending 31 Jan 2014) is forecast by brokers. So at 137p the shares are not as cheap as they were, on a current year PER of 14.3. That looks about right to me, so I'm not interested in buying back into this one at that price.

Readers here were alerted to the opportunity when these shares were on a forward PER of just 8, on 13 Nov 2012. The shares were just 72p at the time, so that's a 90% rise in just under 9 months. An excellent performance, but how much more is left in the tank after that kind of rise? As with lots of shares right now, I think the big gains have been had, and it's perhaps time to wait on the sidelines for better opportunities that will inevitably arise from time to time?

 

 

 

 

Porvair (LON:PRV 251p) has announced a contract extension, but gives no financial details. The cynic in me wonders whether this is a PR exercise after a sharp & sudden correction in its share price (see chart below)?

I like this company, but just couldn't get above 200p for a sensible valuation, and even that was putting it on a fairly racy earnings multiple. So the continued momentum from Mar 2013 onwards from 200p up to almost 300p per share really did look as if the share had run ahead of itself on momentum alone.

The trouble is, as we have recently seen here, when valuation detaches from reality, the correction can be big & very quick, as everybody rushes for the exit at the same time. Broker consensus is for 11.6p EPS this year to 30 Nov 2013, and 13.3p next year. A sensible rating for this type of company is about 15-16 times in my view, so that gives a share price range of 174-213p. Hence even though it has fallen to 251p, I think that still looks expensive. If you think it is likely to exceed broker forecasts, then maybe the share price does stack up?

I think it's more a case of momentum traders getting caught out & Stops being triggered at the Spread Bet companies, as we saw with Iofina recently. As I've warned before, it's really not a good idea to use Spread Bets for shares on racy ratings, as once those Stop Losses are triggered, it can generate wave after wave of forced selling.

 

I think we'll probably see more of this type of sudden plunge in highly rated shares over the quiet summer months. Personally, I never invest in highly rated shares, but if I did, then I'd be looking carefully at cutting positions which have done well in the last year, or at the very least closing any leveraged positions, and just holding the physical shares. Or sitting it out in cash, and buying the dips, which is probably the best strategy.

After all, if a share is already on a PER of say 25, what are the chances of it going up another 20-30% in the short term? Pretty slim, I would say. But the chance of it suddenly dropping 20-30% are quite high. So risk/reward looks awful for that type of share in my opinion. I'd rather be in cash & maybe even have a limit order in at 20% below the current price, to catch anything that spikes down? (although you'd have to watch out for a profit warning RNS, and make sure you cancel the limit order quickly if they do warn on profit).

 

 

 

 

It sounds as if things are going well at Software Radio Technology (LON:SRT 36p). They have issued an RNS about a $0.67m order received, and there's a comment from the CEO which sounds upbeat:

 

General core demand for AIS continues to grow annually and this is reflected in the increasing frequency with which we receive orders from existing customers.  From time to time these orders are of a substantial individual value as in this case.

Our supply chain strategy of holding a mixture of long lead time components, modules and finished stock enables us to react quickly to such orders and meet our customers' requirements.

 

The market cap of £41m is already pricing in good news, but at least shareholders will be relieved to have continued positive newsflow.

 

 

 

 

Next, I've had a quick look at interim results to 30 Jun 2013 from T Clarke (LON:CTO 55p). It's a building services group. The results are not impressive at all. Big tunover, but no profit to speak of, so what's the point? The pre-tax profit margin is only 0.7% (up slightly from 0.5% for H1 in 2012).

They have consistently paid dividends, but it has been rebased downwards twice in recent years, from 13p in 2008 and 2009, to 8.5p in 2012, then 3p in 2011 and 2012. Given that profits are such a tiny sliver of big turnover, I don't think the dividend can be relied upon, despite the apparently attractive 5.2% yield.

Big turnover, wafer thin margin companies always scare me, as they are only potentially one big bad debt away from insolvency. In this case, whilst there is net cash of £7.8m, it doesn't look genuinely surplus cash to me, taking the Balance Sheet as a whole. Indeed, stripping out intangibles, the Balance Sheet only has £800k in net tangible assets. That includes an £11m pension deficit.

The only reason I can see for wanting to buy these shares (the market cap is about £23m at 55p per share) would be in anticipation of them being able to achieve better profit margins in a recovering economy. Certainly if you look back to the pre-crash figures, turnover was similar, but profits were £5-9m per annum. The problem is, how do you increase margins? Once customers have realised they can get things cheaper, they don't like paying more again, unless there is a shortage of potential suppliers - and it's difficult to see that happening any time soon.

So overall this one gets a thumbs down from me. It might show an improving performance as the economy recovers, but the risks are too great for my liking.

 

 

 

 

I last looked at Zotefoams (LON:ZTF 206p) on 8 Jul 2013, when they issued an H1 profits warning, and was surprised the shares held up as well as they did at the time. Sure enough, the H1 figures published today are not good. Turnover fell 6.4% versus the comparable half year in 2012, and pre-tax profit is down from £3.5m to £2.5m. That's still a good operating profit margin though, so they obviously have some pricing power.

Diluted EPS has fallen from 7.0p to 5.0p for the six months. They did 11.6p diluted EPS for the full year in calendar 2012, and are saying that despite H1 being poor, they expect to match this for the full year 2013.

So an uphill journey to get to 11.6p, no growth, and a share price currently at 206p, for a PER of 17.8 looks extremely generous to me. I'd only be interested if the share price dropped to about 120p.

They do have a solid Balance Sheet, and have a solid dividend yield of about 2.5%, but even so that earnings multiple really does price in quite a bit of recovery that looks some way off. Risk/reward doesn't look good at all to me.

 

 

 

Right, that's it for today. I'm certainly seeing more activity in AIM stocks this week, so the ISA inclusion rule change seems to have given things a nice boost, long may it continue.

Regards, Paul.

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