Small Cap Value Report (7 Jul 2016) - INL, BVS, SPD, MKS, PMP, HAT

Good morning!

Several readers flagged up that a quote from a French Govt Minister in yesterday's report was not current, but 3 years old. I've not had time to go back & check yet, but assume you're correct, so my apologies for not checking the source more carefully. That's the trouble when you rely too much on Twitter, I suppose, and are in a rush. The occasional cock-up will inevitably slip through the net, so again apologies, and thanks for flagging my mistake.

I'm avidly reading trading updates from large caps, as well as small caps right now, as it's essential to get an idea asap about how businesses in various sectors are being affected by the current economic uncertainty.

Housebuilders

As mentioned yesterday, the housing sector in particular interests me, because I think there could be some good buying opportunities there. I am firmly of the view that the residential housing market continues to have very favourable characteristics - shortage of supply over demand, very cheap mortgage financing, and considerable support from Govt schemes such as Help to Buy.

Thank you to the reader who flagged up comments yesterday from Inland Homes (LON:INL) which are reassuring, as it is one of the few companies which has said something specific about market conditions since the Referendum vote - as opposed to the cop out of too early to judge which is being trotted out by most companies;

"In the two weeks since the Referendum vote, we have continued to see the same level of appetite from potential purchasers for our homes, which are at the more affordable end of the housing spectrum and are supported by strong fundamentals such as the current low interest rates and the Help to Buy scheme. While we are vigilant to the wider market landscape, we will continue to seek opportunities that meet our strategic objectives

So that confirms my inkling that demand for affordable new housing should remain strong, and hence shares in housebuilders outside London could be a nice place to do some discount shopping right now.

I note that the same reader left a caustic post-script to his comment, saying that facts speak louder than opinions! Whilst that is of course true, I retort that nobody can invest in the current market without an opinion on where the economy is going. The facts will then subsequently either prove or disprove our opinions.

If you think the economy is going to hell in a hand cart, then you're probably already 100% in cash, and hoping to get back in at lower prices in the future. If, like me, you think a post-Brexit wobble is likely to be of fairly limited depth & duration, then you're probably happy to ride out the current weaker share prices, in most cases, and even buying good quality, over-sold cyclical stocks.

Bovis Homes (LON:BVS)

Reports today. Good figures for H1 are in line with expectations. The current trading comments are of more interest, and sound reassuring;

After a strong period of selling during the spring, sales rates have followed a normal seasonal reduction as we have moved into the summer period.  We continue to see a healthy level of interest on our active sites.

So clearly, potential house buyers do not as yet seem to have been scared off by Brexit & economic uncertainty. That might change of course, but it's encouraging to hear this, so soon after a big unexpected shock to the system.

Further outlook comments are given by Bovis today, and include the now oblilgatory "too early to assess" line;

The housing market fundamentals remain strong with high demand from home buyers, good availability of affordable mortgages, good land supply and cross party political support to build more homes in the UK.  Our geographic spread, targeted product range and agile management structure ensures we can be proactive in the market both demonstrating the appropriate degree of restraint in the short term but also well positioned to take further advantage of a fundamentally positive land market at the right time.

We have traded in line with our expectations for the first six months of the year.  At this time it is too early to assess the impact of the EU referendum on the UK housing market.  We have demonstrated good discipline in carefully managing investment and driving growth in revenue and profit.  This discipline will be maintained into the second half year as we target the delivery of sustainable build and sales rates from our sites.

We are confident that the Group's strategy of investing in land, in the south of England, where we can build our high quality traditional homes provides the ongoing opportunity to attract home buyers who can secure affordable mortgage finance to acquire a new home.

If the housing market stays upright, then it suggests to me that consumer confidence overall is probably holding up reasonably well. So if these reassuring comments become a trend, then I can foresee the seeds for a decent rally being sown. Bear in mind though that my natural bias is to see life as glass half full, so it's absolutely fine to disagree with me!

Retailers

There are a couple of interesting announcements from big retailers today, as follows;

Marks and Spencer (LON:MKS)

Q1 trading update for the 13 weeks to 2 Jul 2016. The LFL figures look awful in non-food, down 8.9%. Total UK LFL sales are down 4.3%, which looks poor. However, this seems to be due to a revised strategy to do less discounting. So there should be an improved gross margin. The key comment is;

Full year guidance remains unchanged.  We continue to manage the business for the challenging market environment.

Also, note that the summer sale has been pushed out into July, so this means that Q1 will inevitably have lower sales, but at higher margins.

Outlook/Brexit comments are as follows;

"As highlighted in May, consumer confidence weakened in the run up to the EU referendum. While it is too early to quantify the implications of Brexit, we are confident that our strategic priorities and the actions we are taking remain the right ones to deliver results for our customers and our business."

MKS share price is currently down 1.5% at 289p, so it looks as if the market has adjusted the share price to the right sort of level for now.

Sports Direct (SPD)

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

This one is up 14% to 318p, suggesting to me that perhaps shares in retailers have been over-sold?

Underlying EPS for the year to 24 Apr 2016 has slipped down 8.7% to 35.5p. Given the appalling & sustained press coverage of Sports Direct & its controversial boss, "Mad Mike" Ashley, this seems surprisingly good to me. The share is therefore on a PER of just 9.0.

That may sound cheap, but bear in mind that most retailers are facing three headwinds now;

• Probably reduced demand, as the UK economy is likely to slow in H2 this year.
• More expensive cost of goods, due to the devaluation of sterling (much product is imported from the Far East, and invoiced in US dollars) - this is bound to impact on gross margins, as not all the extra cost is likely to be passed on to customers.
• Higher wages cost from future Living Wage cumulative increases - although I'm increasingly coming round to thinking that the big planned increases will need to be moderated or deferred by Govt, given the softening economic backdrop.

It's important to remember that currency hedges for most retailers are likely to only defer the impact of higher cost prices into next year. SPD has already said that it has not adequately hedged, so will feel the impact sooner.

The balance sheet at SPD is strong, with significant investments in other listed sports companies & retailers. Mike Ashley is quoted today as saying that he currently has no plans to take it private.

A share buyback is being considered;

Further to the authority to repurchase shares granted by the Company's shareholders at its 2015 Annual General Meeting, and in light of current volatility in equity markets, the Company is announcing that it is considering commencing a share buyback, the purpose of which would be to reduce its share capital.

This should be supportive for the share price, but would of course further increase Ashley's dominant shareholding % (assuming he doesn't see any of his shares back to the company).

Overall, I like it at this price - it looks good value, whilst accepting that earnings are likely to be under pressure for the next year. It's a very entrepreneurial business, so is likely to be a long-term winner, whatever happens.

Portmeirion (LON:PMP)

Share price: 865p (down 21.3% today)
No. shares: 10.8m
Market cap: £93.4m

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

Trading update (profit warning) - a disappointing update today from this (largely) UK manufacturer of branded pottery, and associated products.

Total revenue for 2016 is expected to be ahead of 2015, notably because of the recent acquisition of the Wax Lyrical business. However, pre-tax profits are expected to be materially below the record level of £8.6 million reported for 2015.

Materially below usually means at least 10% below. Cantors has reduced its 2016 profit before tax forecast from £9.6m to £7.5m - so a significant drop, but not a disaster. The equivalent EPS forecast has dropped from 71.6p to 56p for calendar 2016.

What has caused this? Asian sales have been disappointing;

At the Annual General Meeting we reported an unexpected decrease in demand from Asian markets. In particular, sales to South Korea still show no signs of recovery and the performance of our distributor in India has continued to be extremely disappointing.

S.Korea is one of the big 3 markets for Portmeirion - in 2015 its sales were as follows;

• USA              32%
• UK                26%
• S. Korea      18%
• India, Taiwan & Thailand   14%
• Others         10%

Production is split roughly 50:50 between UK production, and overseas sourced (mainly China, if my memory serves me correctly).

There are also negative comments about the UK market. So British people are still buying houses, but not decorative pottery, it seems!

In addition we have seen negative effects on demand in the UK before and following the leave vote at the EU referendum.

However, its largest market is performing well;

However, the United States continues to perform well.

Forex - Portmeirion should be a significant beneficiary of the weaker pound, as a UK producer/exporter. It uses forward hedging contracts, so the benefit of this has not yet kicked in, but it remains a positive factor for the company, and should give the figures a boost next year.

The potential benefits of a weaker pound have yet to translate into firm overseas orders

Directorspeak - this is quite key, because management at PMP has a track record of telling it like it is. So I am encouraged by their comments saying that the bad news today is a temporary setback.

They're backing up that view with a useful increase in the interim divi. Although note that the interim divi is typically only about 21% of the full year divi - so there is still wiggle room to cut the final divi if things don't improve.

The Board does believe that this is a short term setback. Accordingly, it is our current intention to increase the 2016 interim dividend by approximately 14% in line with the increase in the final dividend for 2015 and with our previously stated policy. This will mean that dividend cover for 2016 will fall marginally below our historic guideline of two times; our longer term view is that we can accommodate a temporary reduction in cover.

That says to me that the Directors are reasonably confident about the future.

My opinion - it's obviously very disappointing, and embarrassing, to be hit with a profit warning within days of buying back into a stock, but there we go, these things happen from time to time.

The PER now works out at 15.4, based on a reduced share price of 865p, and 56p revised 2016 EPS forecast (from Cantors). How you view that depends on whether you accept management assurances that this year is a temporary setback, or whether you think we're at the thin end of the wedge for possibly further bad news.

My feeling is that 2017 will benefit from exchange rate movements - note that the annual report gives a sensitivity analysis on forex movements, but it's only concerned with the impact on balance sheet items - it doesn't include the profit boost from cheaper sterling.

Furthermore, 2017 should also benefit from a full year contribution from Wax Lyrical, which was acquired in May 2016.

The balance sheet is fine - a small amount of net debt, but nothing to worry about.

Personally I'm happy to remain in the stock, as the PER should drop next year, providing the current issues are indeed temporary. Also, I see this as exactly the kind of stock which could attract a premium-priced takeover bid from the US - after all the shares have just dropped heavily, and there's a favourable exchange rate movement too, making this a tempting morsel for a larger US group.

So a setback, but not a disaster.

Running out of time fast, so a few quickies before I go out for another investor lunch;

H & T (LON:HAT) - a reassuring update;

The Board expects full year profit before tax to be in line with market consensus expectations.

• Good growth in personal loans (new product)
• Pledge book also up
• Benefits from higher gold price

My opinion - forward PER of 14.8 looks a bit warm now, but people are no doubt keen on the counter-cyclical aspect of a pawnbrokers. Very good balance sheet.

Sorry, got to dash.

Regards, Paul.

(usual disclaimers apply - these reports are just my personal opinions only, not recommendations or advice. Pls DYOR)