Small Cap Value Report (7 Jul 2015) - CHH, SOM, GBO, CMS, CNCT, SOLI, MCB

7th Jul '15 by Paul Scott

29 comments 27759 reads

Good morning!

A couple of things to note. Firstly, the market crash in China is continuing apace - I'm not sure which Index is the main one, but currently the China 300 Index is at 3,660, which is down c.32% from the peak less than a month ago. It doesn't seem to be having any impact on our markets though, thankfully.

The second striking thing was the big drop in the price of oil yesterday. Looking at the chart of US Light Crude, it was trading in a range of $58-62 in May-Jun 2015, but suddenly lurched down to $53.18 over the last week. I don't know why, just the forces of supply and demand I suppose. It's making me wonder whether I should defer any further attempts at bargain hunting in the oil, and oil services sectors?

Right, quite a few interesting trading updates this morning, so let's get cracking!

Churchill China (LON:CHH)

Share price: 554p (price unchanged today)
No. shares: 11.0m
Market cap: £60.9m

Trading update - today's update is reassuring:

Valuation - I last looked at this company at 595p per share in Jan 2015, and concluded that it was rather too pricey. It's drifted down about 7% in share price since then, combined with broker estimates having edged up, so a double positive there.

The fwd PER is now 16.2, and the dividend yield is 3.2%.

Combined with a strong balance sheet, I think the shares look fairly priced.

My opinion - I like this company, its sound finances, and the valuation has come down from a touch expensive, to reasonable now, in my view.

There seem to be new restaurants and cafes popping up all over the place (in the South anyway), so I expect CHH will continue to enjoy buoyant trading for some time to come. Although it's important to remember that demand is cyclical, so profits are likely to drop when the next recession comes along.

I wonder if they are likely to be impacted by the strength of sterling? I've just checked the last Annual Report (page 57), and 60% of turnover is UK, with Europe being the next largest region, at 23%, N.America 8%, and RoW 9%. No mention is made about currency in today's update, so presumably the company must have either hedged, or absorbed the impact itself.

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Rusty2

7th Jul '15

Yes many people in China trade on the stock market but they seem to treat like gambling. It seems with the rise in market in the last year, it has sucked in a lot of new traders. Don't they say when everyone is talking about a share its time to sell.

mrwhits

hi jraitt,

I think Paul was short ASC.L so wont comment here, try his twitter feed for possible feedback.

regards

jamesdougal

Paul, any thoughts on the SUS disposal today?

rmillaree

Hello Herbie

Ref the senior secured loan notes - that's a whole new "War Chest" of cash(via debt) for possible acquisitions - the consensus on ADV.. was that it was probably the best route of raising the additional War Chest that Costis felt was needed again for future expansion.

The Danger here is that they will spend this all on businesses that has good potential but haven't proven themselves profit wise - so there may be diluting the cheap p/e somewhat - but as its all done via borrowings it shouldn't really be dilutive in that no extra shares need to be issues.

Presumably it should be taken as a positive in that they were able to go down this route at all, as presumably there are some reasonable (non foolproof) checks that go on before the notes are agreed and the appropriate credit rating issued. Bods lending cash are much more likely to ask questions than those buying shares in a company i would guess ????

The ultimate would be a largeish proven US company with Blue Chip clients where the there is cross selling opportunities - the more the company morphs into a US based business the more likely it it that they can list fully in US and have a stock price similar to what would be expected from a similar business that had always been US listed.

So bad news is that its more costs, more risks , more unknowns - less clarity - but the potential is also much higher in that they may be able to increase earnings by 30-50%+ simply by using the warchest - taking on net debt and not diluting shareholders.

Glaws2

Herbie - the revenues from the MoJ contract are yet to kick in - extract from the August 2014 RNS - "The contract is not expected to have a significant impact in the current financial year as most deliveries are expected to take place in financial years ending 31 March 2016 and 2017. The final deliveries will fall in the first half of financial year ending 31 March 2018."

Ramridge

Peter -
I can attest that Paul's forensic share analysis and red flagging has saved me from my own stupidity a number of times and in the process saved me a bundle. More power to his elbow.

Thanks I understand that but do you know if they have managed to issue any? Its seems to be for US acquisitions, which is maybe not the best time to do this, due to current high market values? It does seem strange to keep raising money when you have money already.

I see thanks, that is interesting news, so there is more revenue/profits to come.

Yes I believe that is so, so he can't comment on here. Had a quick look at the trading statement, looks ok but the slowdown continues, down from 40% sales growth in 2013 to about 16% now, some due to currency. I think the problem is the valuation, PE is about 74, PEG is 4.1

Boohoo in comparison looks much better value, PE 23 and PEG 1.05. Operating margin about 2x ASC's. BOO last trading sales were up 35%.

I should declare I sold out of ASOS (LON:ASC) and hold Boohoo.Com (LON:BOO) long. Believe Paul is short in ASC and long in BOO.

fifthcolumn

Paul,

Re: Globo and many others......Keep shouting from the rooftops! I'm one who appreciates your unbalanced but in depth personal view.

Paul Scott

Hi fifthcolumn,

You're not the first person to describe me as unbalanced lol!

Cheers, Paul.

Roger Lawson

Those who attended the Globo AGM, or read my report on it (available from the ShareSoc Members Network), will know why Globo is running with high levels of debt, and even trying to increase it. They are taking a very aggressive approach to capturing the US mid-market for their GO-Enterprise product - spending cash to increase their sales and marketing efforts and investing in R&D in effect. Now that might be a risky strategy, and some might not like it, but it is very much the strategy that many California based software companies would take. You either grab a major share of the market while it is still in its early phases (and compete head-on with your competitors in terms of investment in R&D), or you get left as a tertiary or worse player. They are using debt rather than equity to fund this expansion because their equity is so lowly rated (for a number of reasons) that it makes more sense to use debt. That was the explanation given. The strategy is perfectly understandable and makes sense in many ways to me but the bean counters won't like it no doubt. You can decide for yourselves whether you want to bet on the strategy working and whether you like debt in companies.

Roger,

Thanks for that explanation, but I think it rather misses the point.

I can understand why a company might want to borrow to expand, in the way you explain. However, that's not the issue with Globo. The issue is rather that they already held large cash reserves, but then inexplicably took out large (and apparently unnecessary) bank loans too.

I can't remember ever seeing any other company do this, because it's completely illogical, and involves wasting millions of pounds in unnecessary interest payments - because they are earning next to nothing on their credit balances, whilst paying E4m in interest on their unnecessary borrowings.

That is the specific point that I was querying, and to date I've not heard any credible explanation for why the company has gone down this bizarre route. It therefore remains a major red flag unless & until a logical explanation can be provided.

Regards, Paul.

Sometimes one takes on debt even when it is not immediately needed. From my experience of the funding tactics of many US software companies, they often way over-capitalise themselves in their growth phases and debt is of course now relatively cheap. But it was also obvious from the AGM that they are taking on more debt to finance some very specific acquisitions that they have already lined up. Read the report!
Incidentally a lot of the information re their exposure to Greece in the announcement today was also given in the AGM. It is always good to attend AGMs as you will learn things others do not know until later.

It still sounds very far-fetched to me Roger, but you're the expert at analysing software companies, so you keep telling us!

In my experience companies line up financing facilities, then draw them down when an acquisition is done. To draw the money down, start paying interest on it, then not use it, is clearly not logical, nor in shareholders' interests, due to all the wasted interest payments.

P.

There is more than one way to do it and it depends on the circumstances. You are jumping to conclusions about the future while having even less knowledge of the company than me. It was not practical to delve further into their future plans for obvious reasons.

rhomboid1

Good Evening Roger

You're right many companies do put in place debt finance to support potential acquisitions even if they are holding sizeable cash balances.

However they pay a facility fee only and drawdown the funds when a deal is done. Only then is interest payable.

I'd be fascinated if you can find an example to the contrary.

Only some of the debt is likely to be used for acquisitions - that was made clear in my report. And I suggest we all wait and see what actually transpires in due course.

Roger

The whole point of discussing these topics is to try and get ahead of events!

As to your report I don't see a way of accessing it without joining sharesoc , do you have a link?

Anyhow an example or two of something similar would speak volumes!

8th Jul '15

You do have to be a member of ShareSoc to read our AGM reports. We don't generally publish them and they are copyright material. But membership is only £45 per year.

Small Cap Value Report (7 Jul 2015) - CHH, SOM, GBO, CMS, CNCT, SOLI, MCB

Churchill China (LON:CHH)

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Paul Scott

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Small Cap Value Report (7 Jul 2015) - CHH, SOM, GBO, CMS, CNCT, SOLI, MCB

Churchill China (LON:CHH)

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Paul Scott

29 comments

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