Small Cap Value Report (Fri 1 Nov 2019) - LOOK, CAR, XSG

Good morning, it's Paul here with Friday's SCVR.

I'm writing this from a gently swaying yacht, moored in a marina on the outskirts of Valletta, Malta, which I've rented for 3 days via AirBnB. It sounds very grand, but is only costing 100 Euros per day, I'll post a picture or two later on Friday. It's amazing the quirky things you can find on AirBnB. The great thing about shares analysis & investing, is that all you need is a laptop and wifi, and you can work literally anywhere on earth.

Estimated time of completion - it's Friday, and I'm sort-of on holiday, so let's see how we get on. I should have something decent up by 1pm, but reserve the right to add more sections in the afternoon if anything interesting crops up on the RNS. Update at 09:28 - not much to report on today, so this should definitely be done by 1pm. Update at 13:03 - today's report is now finished.

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Lookers (LON:LOOK)

Share price: 42.7p (down 14% today, at 09:30)
No. shares: 389.2m
Market cap: £166.2m

Trading Update & Board Changes

Lookers plc, ("Lookers" or "the Group"), one of the leading UK motor retail and aftersales service groups, issues its trading update for the period ended 30 September 2019 ("Q3" or "the Period").

Note that the company has a 31 Dec year end, so this is Q3, not a full year.

Trading has deteriorated further;

As reported in the Group's interim results statement trading during the six months ended 30 June 2019 ("H1" or "first half") was challenging. This was driven by ongoing weakness in consumer confidence in the light of political and economic uncertainty, pressure on used car margins and retail cost inflation. The Board expected these conditions to continue to impact the Group during the second half, but trading, particularly over recent weeks since mid-September, has been much more challenging than expected.

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Car dealers have 3 profit generators - new cars, used cars, and after-sales (servicing & warranty/recalls)

New cars - OK up to mid-Sept. "Much weaker than expected" in 2nd half of Sept (a key month for profits). Also experienced margin pressure. Total profits £7m below last year, for Q3.

Used cars - Sounds OK. LFL unit sales accelerated slightly to +2.6% y-on-y, from +2.0% in H1. Gross margins improved on H1, not quantified, so probably only a slight improvement.

After-sales - Also OK. LFL gross profit +2.9% on last year.

The problems therefore seem to be a recent sharp downturn, affecting new cars only.

Closures - 13 out of 15 sites earmarked for closure, will be closed by end 2019. This will eliminate £3m p.a. in trading losses, and more importantly generate £28m cash from sale of freeholds at above book value.

FCA investigation - this worries me a lot, and has ruled out the whole sector for me, as possible investments. If this is the next mis-selling scandal, then it could drag on for years and cost a fortune, as did PPI for the banks.

Balance sheet - figures are given to remind investors that the company owns a big freehold property portfolio, and doesn't have a lot of net debt. Although on closer inspection, there's a ton of non-bank debt, to fund the inventories. Taking off intangibles, the NTAV is not particularly strong for the size of business, at £154.6m. That's close to the market cap, so overall it's satisfactory.

My opinion - with earnings forecasts coming down again, on poor recent trading, it's looking as if the tough new car market is likely to continue for some time. There's over-supply, that's the fundamental problem. Excuses about Brexit don't cut the mustard for me - that's a catch-all reason everyone is using for a market which boomed, was over-supplied with cheap deals, and now we're experiencing the hangover.

IT's the FCA investigation into mis-selling that worries me the most, and with that being potentially a large & unquantifiable multi-year liability, why take the risk of investing in this sector at all? Accordingly, it's a no-go area for me.

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Carclo (LON:CAR)

Share price: suspended since 1 Aug 2019 at c.11p
No. shares: 73.4m
Market cap: £8.1m

Final results

These are late, hence why the share is suspended.

There's not much point in me doing detailed analysis here, because we cannot buy or sell the shares, since they're suspended.

It doesn't look as if the shares are coming back from suspension, even though the late accounts have now been filed.

This is a financially distressed situation, where the outcomes look roughly like this;

Worst case - The whole group goes bust, and the good bits are sold off by an Administrator to recoup bank lending first, then other creditors, so almost certainly a complete wipe-out for shareholders.

Upside case - WiPac (the problem division) gets sold off, enabling the (nicely profitable) remainder of the group to potentially recover, and reduce its bank debt over time, maybe combined with an equity placing.

My opinion - at a guess, I reckon the odds are about 50:50 for the above possibilities.

Fingers crossed for shareholders that they recoup something from this. Bank facilities have been extended to 31 Jan 2021, and the pension fund trustees are being supportive. It looks a situation where everybody's interests are for the businesses to continue trading, and be supported. Although I think the risk is that shareholders are now largely irrelevant - it's the bank and pension scheme that are calling the shots on what happens next. Bear in mind it has £21m in property assets, so deals could potentially be done with those assets.

I wish everyone involved well, and hope that a solution is found. It's easy to forget, when analysing accounts, that people's livelihoods are involved, and that it's a shattering experience for many people (employees, suppliers, and shareholders) when businesses fail.

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Xeros Technology (LON:XSG)

Share price: 1.0p (down 20% today, at 12:18)
No. shares: 257.0m + 505m placing shares (at 1.0p issue price) = 762m
Market cap: £7.6m

Placing at 1p

This blue sky share has been a complete disaster. The thing is, it was obvious right from the start that this was likely to be a disaster, due to the massive cash burn, and failure to achieve anything commercially significant. Also, it had Woodford as a big supporter, throwing good money after bad, in an almost criminal irresponsibility with other people's money. If people want to do reckless punts with their own money (e.g. me!) then fine. But doing reckless punts with someone else's money is beyond the pale, in my view. Woodford fully deserves all the criticism he gets, and more.

My archive of 6 bearish articles here, from 2014 onwards, about Xeros is actually quite interesting to re-read. It shows the journey that so many blue sky shares (almost all of them, actually) take. From initial excitement and high valuation, then come a series of rampy RNSs, to prop up the excitement. Eventually the cash runs out, there's nothing of commercial value to sustain things, and the death spiral downwards of more fundraisings, and lower share price, reaches its inevitable conclusion when the company folds, or is sold off for peanuts. It's worth re-reading those articles, as they contain some good points, of general application to blue sky shares.

Despite all of the above, I do sometimes buy some blue sky shares myself. Well, everyone likes a good story, and the hope of a 10 or 20 bagger. Very occasionally, a bombed out blue sky shares does actually begin to succeed, and that can be a very lucrative proposition. Look at how I made £5m from Indigovision, when I spotted that it was starting to succeed. I bought 8% of the company c.2004 for not very much, and it 30-bagged. If only I'd sold out at the top. Never mind, it was fun while it lasted! Lessons learned in investment are sometimes very expensive, unfortunately.

Thinking in a contrarian way, maybe the Woodford angle has created a buying opportunity here? After all, to new shareholders looking at buying now at 1p, it doesn't matter a jot that previous investors have lost nearly all their money. Previous shareholders have paid for all the development work, and now we can pick it up for virtually nothing. This could be an (admittedly very high risk) opportunity perhaps?

Reading through the most recent accounts, and the placing RNS, I see that the company is now sensibly changing its business model from a very high cash burn one, to a purely licensing model. That makes a lot of sense to me. It seems to have some licensing deals in place, with washing machine manufacturers in India & China, big markets.

I haven't included the 200m share open offer in my figures above, as I doubt there would be much take-up of that, given that the market price has come down to that level anyway. The take up in open offers tends to be highest when there is a decent discount on offer, compared with the prevailing share price.

Plus there is the Woodford overhang in the market, although we're talking peanuts now, in £m terms.

This small fundraising should keep the lights on until end 2020, they reckon. Then breakeven in 2021. That's the best case scenario presumably, and is not very attractive.

I'd want to see more detailed figures, about what the licensing deals are. How much is to be paid per machine, and how many machines are likely to be sold? Without that info, it's impossible to assess the chances of success.

My opinion - this fundraising doesn't fix the funding issue for long enough to tempt me to have a punt on this.

IF the 1p refinancing were to complete, and the share price then falls to say 0.5p or below, then I might have a fun money punt on this.

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I was going to write a post script on GOAL, but actually there's no point. The BBC has beaten me to it, so here is their article. It seems to have been a long-running fraud. Let's hope something actually happens to the perpetrators. Otherwise white collar crime is likely to continue to blossom in the UK, if people are seen to get away with it.

For fun, here is a quick guided tour of my AirBnB yacht in Malta;

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Have a lovely weekend!

Best wishes, Paul.