Small Cap Value Report (6 Sep 2016) - SOM, ITQ, KNOS, G4M

Good afternoon!

Clarification - Fundamental Asset Management

I seem to have accidentally caused some confusion, for which I apologise. Fundamental Asset Management has asked me to clarify that the only part of their business I was involved in was a minor portfolio service called the Small Cap Value Portfolio.

So the SCVP had nothing to do with FAM's core business of IHT portfolio management, which is of course continuing completely as normal! (and is an excellent, well-run, strongly performing service).

One reader apparently misunderstood, and thought that FAM was shutting down, which obviously it isn't! This has caused a few red faces, for which I profusely apologise.

This is my last report from Greece, as am flying back tomorrow morning. We had thunderstorms last night, and it's very overcast/rainy today, so I'll be spending most of the afternoon indoors writing this report. Therefore please refresh this page later, and you will find more sections added.

Talking of which, I added 3 new companies to yesterday's report last night - here is the link to recap on that. One section completely disappeared - on Carr's, but it wasn't very interesting, so I didn't bother rewriting it.

I've been learning a few phrases in Greek, so that I can at least say a few simple things to locals, in their own tongue. It's so worth it - they really appreciate visitors making the effort. Marina herself, at Marina's Tavern (my favourite place for dinner here in Corfu old town), beamed at me, and flamboyantly roared,  "You're Greek now!!" when I told her that dinner was "poli kala" (very good)

It's interesting how English is used here as the standard language when talking to tourists from all countries. This infuriates the French! A rather pouty French lady nearby asked the waiter how much, "C'est combien?". He replied in English, "Seven Euro". She frowned, and replied, "Sept?". She nearly exploded, when he replied, again in English, "Yes, SEVEN!". That amused me.

Although you can see the stresses of a 30% drop in GDP, high unemployment, and crushing tax increases, on the faces of most locals. Talking to another restaurant owner, he said that most people are struggling. There are a lot of anarchy symbols painted on walls around the town. It wouldn't surprise me if Greece descends into civil disorder at some point. We certainly haven't had the last Eurozone crisis, that's for sure.

Somero Enterprises Inc (LON:SOM)

Share price: 169p (up 2.1% today)
No. shares: 56.2m
Market cap: £95.0m

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

Interim results, 6m to 30 Jun 2016 - results look solid to me, and an in line outlook statement.

Key figures (remember these are just for the half year);

• Revenue up 12% to $39.7m
• Adjusted net income (after tax) up 22% to $7.3m
• Adjusted diluted EPS up 30% to 13 US cents, or 9.7p

I've checked out the adjustments, and they're fairly modest, and reasonable - the main one being reversal of the amortisation charge. This is fine, as intangibles look to be historic things on the balance sheet - only small, and nothing new is being capitalised - i.e. no development spending is being capitalised to boost profits.

Overall, the figures look fine to me, I can't see any funnies, or red flags.

Somero is still very heavily weighted towards the USA - 75% of total sales. Growth in China looks a bit disappointing, but that doesn't really matter as the USA is pulling like a train.

Outlook - lots of detail is given on individual regions, but the conclusion is positive;

After significantly strong trading in June to finish H1 2016, the solid activity levels from H1 2016 have carried over to July and August as we continue to see significant opportunities across our broad portfolio of markets.

 We are very pleased with our performance in the first half of 2016 and remain confident in delivering another year of solid, profitable growth for our shareholders in line with current market expectations.

That sounds fine to me.

Valuation - broker consensus is 25 US cents for EPS this year, or 18.7p.

So at 169p per share, the PER is only 9.0 for this year.

That seems a remarkably pessimistic valuation.

Balance sheet - this is in terrific shape, with a very strong working capital position - the current ratio is excellent, at 3.27 - for me, anything over 1.5 is strong.

There is $12.1m in cash sitting on the balance sheet, less a small mortgage of about $1m.

So the company is in a smashing position overall.

My opinion - this is a core long-term holding of mine, so today's results confirm my positive view of the company, and a very low valuation.

I think the market was traumatised by Somero lurching into losses in the GFC in 2008. But so did loads of companies. The entire banking system collapsed, for goodness sake. Personally I think it's extremely unlikely that such a severe downturn is likely next time we have a recession. Plus SOM is now in very much stronger financial shape than back then in 2008, so it should be able to withstand anything the economy can throw at it.

Essentially this share is a bet on the US economy. If you think it's going into recession, then SOM shares are probably best avoided. If you don't (and you turn out to be right), then this share could be a bargain.

Overall, I really like it. This company is the global specialist in a niche market, and given that concrete sets in about an hour, then support & service will always count for a great deal in this sector. Am tempted to buy more actually.

EDIT - I note that there has been some rather wobbly economic data out of the USA today, so I think this needs to be watched carefully. If the US does go into recession, then Somero may not look so cheap after all. 

Interquest (LON:ITQ)

Share price: 45.5p (down 21.4% today)
No. shares: 37.2m
Market cap: £16.9m

Interim results, 6m to 30 Jun 2016 - this small recruitment group describes itself as;

the specialist recruitment business operating in the 'new digital economy'

There was a savage market reaction to its "materially below market expectations" profit warning on 27 Jun 2016, probably not helped by it coinciding with all the initial fallout from the Brexit referendum result. This share had been slowly recovering somewhat, but have fallen back again today.

Key figures for H1 2016 vs H1 2015;

• Net Fee Income down 10% to £11.0m
• Adjusted profit before tax down 44% to £1.4m
• Diluted adjusted earnings per share down 46% to 3.0 pence
• Interim divi halved from 1.0p last time, to 0.5p this time.
• Net debt has risen £3.0m to £9.9m

The Chairman's comments indicate that changes have been made to improve performance, with new management, and restructuring of one problem division.

Outlook - it's not easy to find the outlook comments, as no sub-headings have been used.

However, generally positive noises are made about the future, including this;

On entering the second half of 2016 the business is well set for growth, and to capitalise on the opportunities in the Digital markets.

I can't find any references to performance against full year expectations, which have already been revised down.

Valuation - it's tricky to value, as there's not much in the way of guidance. I've not seen any recent broker research. Stockopedia has the broker consensus at 8.7p for this year, for a PER of 5.2. That looks very cheap but I'm not sure how reliable that EPS forecast is.

Balance sheet - as noted above, there's a fair bit of debt.

Debtors looks high, so it strikes me that Interquest's customers are using it as a bank, to assist their own cashflow!

My opinion - this share could perhaps be a recovery candidate, if management's actions to fix its problems work out. I would have thought IT recruitment is a fairly good space to operate in.

A few quickies, as time is running short now;

Kainos (LON:KNOS) - I've only looked at this software company once before, here on 31 May 2016. I was staggered at the huge organic growth it has achieved, but wondered whether this is sustainable.

Today's update sounds positive, and mentions new contract wins. It's mainly focussed on the public sector, and notes pressure on NHS budgets.

Overall though, management seem happy;

Kainos has a robust balance sheet with strong reserves, no debt and strong cash generation, as well as a growing level of recurring revenue. The Group expects results for the full year to be in line with market expectations.

My opinion - I like this company, and it ticks a lot of my boxes - net cash, good divi of nearly 4%, terrific track record of growth. Whether it can continue performing this well, given that a lot of sales are public sector, who knows?

Gear4Music Holdings (LON:G4M) - I was already aware of this company, and I have held a long position in it for some time.

Today's update looks terrific I think. Sales growth in H1 has accelerated to +73%, which is all organic growth too. European growth is even faster. The company also says that it's going to open 2 European distribution centres, to accelerate growth towards £100m p.a.

Also, note that H1 profit will be ahead of management expectations. Good stuff.

That's starting to look quite interesting. The downside is that its margins are low, so you could argue that it's a low margin box-shifter, a bit like AO World (LON:AO.)  There again, look at the valuation AO has achieved, despite not really making any decent profit. So if this can keep growing turnover very fast, then the share price could potentially follow suit.

There's a very interesting article here about why online retailers are not overvalued (in the author's opinion). I don't completely agree with the article, but it does at least explain why this type of share is being looked at so favourably by other investors.

I think this is a dramatically better proposition than cash burning horrors like Koovs (LON:KOOV) for example. It's very illiquid though, with 79% of the shares held by Directors & other >3% shareholders.