Small Cap Value Report (Fri 20 Oct 2017) - REC, ESG, BOOT

19th Oct '17 by Graham Neary

51 comments 17006 reads

Good morning!

Graham here.

It's been suggested that we insert a standard disclaimer/information notice for new readers, so here goes:

Please note that these reports are just our opinions, and do not constitute investment advice.

We are particularly open to suggestions to cover stocks with market cap of less than £500 million. We cover a range of industries but tend not to cover oil, mining or other natural resources, REITs, investment vehicles, and the like.

Best wishes,

Graham

Record (LON:REC)

Share price: 45p (-5%)
No. of shares: 199.1 million
Market cap: £90 million

Second Quarter Trading Update

This is a currency asset manager which I last covered in April.

AUME (assets under management equivalent) started the year at $56.6 billion, and are now at $61.2 billion, after another quarterly increase.

As you can see, the vast majority of the AUM is in hedging products. This is either a cheap passive hedge or in a momentum-oriented "dynamic" hedge which tries to maximise the client's exposure to currencies which are strengthening.

Despite the increased size of the business, the flows were disappointing. There was a net withdrawal by clients of $1 billion, offset by market/exchange rate gains of $2.2 billion.

This is noteworthy:

For UK-based clients, Dynamic Hedging achieved cost-effective protection of currency gains from sterling's depreciation in the six months following the EU referendum. However, persistent weakness in sterling meant negative returns and cash flows were unavoidable. As a result Record's remaining UK-based Dynamic Hedging clients converted their mandates to Passive Hedging or terminated during the period.

If I understand that correctly, it sounds like Sterling holders eventually capitulated in terms of trying to use the more sophisticated Dynamic Hedging product, and instead simply sold out the rest of their Sterling holdings - either with Record's Passive Hedging, or with somebody else.

Taking a glance at the chart against the Euro, August was a particularly difficult month for Sterling, and Sterling sellers finally capitulated around then:

It's a bit disappointing that Record's Dynamic Hedging didn't prove its worth to clients over this period. But I suppose we are talking about a timeframe when there was no benefit to be gained by waiting to hedge, so there wasn't much of…

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rhomboid1

20th Oct '17

I’m not alleging any misbehaviour & would love to explain more but don’t wish to be venturing into legally problematic areas

A few points in this article might help clarify

http://www.thisismoney.co.uk/money/markets/article-3042471/CITY-FOCUS-David-Lenigas-money-mouth-is.html

Or the Shareprophets archives might help

Catstycam

Good day Graham, Paul

A general point:

An interesting comment was made the other day that companies that were releasing results that were even "in line" with market expectations were seeing their share price being marked down. It seems that the market is becoming harder to please with results and that unless results are ahead of market expectations then a mark down can not be ruled out. This seems to particularly be the case with the higher growth companies, companies which have seen their share price motor ahead over the last year or so.

So many companies now seem to be over valued that I believe we have to be extra careful when stock picking. We have been in a bull market for so long that many will not have experienced a market correction nevermind a bear market and are unaccustomed to what goes up inevitably will come down (to some degree) over time.

In two instances recently I have seen a high percentage of my profit wiped out by what may be regarded as over optimism (on my behalf) based on the latest trading update. Obviously the market was unimpressed and was looking for more. Likely the share price was already factoring in the news. There can be a belief that despite the share price movement South all is well and at any moment the trend will reverse. Many may be tempted to "average down" and pump more funds into a share. We need to keep our feet on the ground and be realistic and not get carried away with the hype and hope over any company, being careful of confirmation bias where we are looking for others to confirm what we believe or want to believe.

When good news fails to raise the share price and the slightest hint of disappointment hits it, is it not perhaps the first sign that the market is topping out?. One difference at the present time is that we have been in a very prolonged period of historically low interest rates. This may be one reason why the market is holding up. Indeed, even if interest rates were to double, the amount of interest on any modest sum invested in an interest bearing account is still small and would possibly be seen only as a defensive move to move capital.

There may still be some positive movement in the markets to come but I believe it may be limited. Time to pause perhaps before pushing that buy button.

Just my thoughts, open to different opinions.

Regards

CM

Beginner

It went ex-div on the 12th (4.5p) 7% and the spread is 2%, so an 8% fall is pretty good really! Congrats, you've picked a winner!

gsbmba99

Hadn't spotted the Property Franchise (LON:TPFG) and Belvoir Lettings (LON:BLV) exchange. The combination certainly makes a lot of sense. The list of principal objections put forward by TPFG suggests that they aren't averse to a deal but don't like the deal as currently structured. Specifically, they want 1) a premium 2) more shares/less cash with less resulting leverage and 3) more management/board representation. These look solvable if BLV is willing to compromise.

If BLV is successful could be good news for Mortgage Advice Bureau (MAB1). Belvoir bought Brook, a MAB affiliate, a couple of months ago to develop their financial services income as an offset to potential loss of tenant fees. Assuming TPFG isn't already a MAB affiliate, you would be talking about a combined group with nearly 700 outlets but less than 32 advisers (as of a couple of months ago).

Paul Scott

Hi,

Yes I hold IQE (LON:IQE) - it's my largest long position.

The announcement today re underpaid US tax is irritating, but not material - only £4.2m. This seems to have been paid, yet net debt is in line with expectations - which suggests to me that cashflow would have been running ahead of expectations, if this tax issue had not arisen. It seems to be a cock-up by their tax advisers, and sounds like IQE might sue them for damages, to recoup the losses.

More importantly, there's a reassuring trading update;

The Group has enjoyed a strong Q3 with continuing growth driven largely by the ongoing strong VCSEL ramp in support of a highly significant mass market consumer application, and the new Foundry expansion remains on course to open in H1 2018.

As a result, the Board remains confident the Group is on track to deliver full year expectations, including that of net debt.

The VCSEL ramp up in production is believed to be related to the iPhone X, 3D sensors.

However, what the market doesn't seem to have fully appreciated yet, is that IQE has multiple, major new product lines in development & for launch in 2018-2020. Therefore, we should see a dramatic increase in revenues & profits over the next 2 years. This is not yet factored into broker forecasts, which look far too low.

Indeed, Peel Hunt reckon that EPS could rise from c.3p currently to 12-15p over the next 2-3 years. If that happens, then clearly the share price would probably multibag again, from the current level.

IQE claims to be the world leader in semiconductor wafers, with 80% of global outsourced production. These products are getting more & more complex, so there's a tremendous opportunity in the years ahead for IQE.

I suspect it would also be a takeover target.

So IQE might look expensive on the historic numbers, but it could end up looking cheap once the new products really start to flow through. It's gearing up for much larger output, with increased capex. Hence free cashflow looks poor right now. I'm looking beyond that, which is where the excitement lies.

So whilst an irritant, the tax issues announced today are really just background noise, and irrelevant to the big picture.

Regards, Paul.

brownrigg

Any chance of a comment re POS? Recent announcement seems to be a game changer.

gus 1065

Hi Seadoc.

(Pedantic) point on the putative impact on the IQE (LON:IQE) valuation of the £4.2m fine. Given it's hopefully a one off, one time hit for this year only presumably the notional impact shouldn't be multiplied by the p/e but rather be taken as a simple deduction from the market cap? If it were expected to recur every year - say being hit for an annual royalty payment to a third party - you could make a case for a p/e multiplier effect you describe.

Gus.

Totally agree, old chap. There are possible synergies here, but Property Franchise (LON:TPFG) are rightly seeing themselves as being short changed. I think the egos may prevent any merger happening though. It will be interesting to see if this is the beginning of a trend.

MichaelFBS

Thank you rhomboid1. Understood.

Lolarose

Thanks Portsmouth pirate.
But I was not asking for advise just stating a few names to see his opinion, Have been trading for 30 years very successfully, can't see what all fuss was about, others asked his opinion, he invited people to ask so I did too.
I always make my own decisions.
The above stocks were of particular interest among many others.
Got into IQE at 30P and Boohoo at 40p

Thanks for your kind attention

Graham Neary

Hi lolarose,

We usually stick to names where news has been released on that same day, except when it's a slow news day or other exceptional circumstances. As daveinthelakes suggested, we might put this in our standard disclaimer.

Kind regards

Graham

Lion Tamer

Hi Seadoc

IQE (LON:IQE)

Thanks for your reply. I rate your opinion here so take notice of what you say.

I think IQE (LON:IQE) is an interesting bit of sport in the (rapidly growing) fun section of my otherwise boring & predictable portfolio of mainly safe dividend payers. However I've just calculated my stake and its only about 0.6% of my portfolio, so I'm long, but not as strongly long as say, Paul. I believe it may be a share that comes good in the mid to long term. I expect to have fun following it's progress.

The shorts positions listed in the link you provided are a warning and a manifestation of the fact some are bearish on this. I'm currently taking the view that those bears can (or at least believe they can) predict the short term future, but as I can't I'll play the longer term game. I suspect the longer term future is okay for IQE, for the reasons given in the replies by leoleo73, Paul and Gus1065, so will not repeat their comments here.

All the best in the markets!

seadoc

21st Oct '17

Lion Tamer,

Thank you for kind comment. I do agree with most posters (but who that Paul chap?) that the long term future of IQE (LON:IQE) is rosy. I think I have already said that I bought in teens and sold (too soon) in thirties. I will come back to that later. But as catstycam points out the market as a whole is looking more than a bit toppy. I have moved about 1/3 of my money into really boring things like REITs and property bonds maturing 2020. Most of that money came from cyclicals. Each month (well actually every 4 weeks) I go through the portfolios share by share and sell anything that I would not have on a watch list. The last couple of culls have been difficult, I had reservations about both Tristel (LON:TSTL) and Treatt (LON:TET) held but might have been better off selling. It was some comments by Paul that had me look at Spread-ex. I spent a bit of time looking at indices and FTSE100 shares. It is clear that machines do better than humans so caveat emptor.

As an aside I followed alphago move by move and the new "zero" version is worth a google. In summary the old version was given thousands of human games to study and beat humans, eventually the world champion. The new version needs an order of magnitude less grunt in terms of processing and was simply given the rules and allowed to play with itself (!). Within 40 days it was put against old version and won all 100 games. I also used to play a lot of chess and was interested to see that on youtube are many classic games that are played move by move and the comments are often what the "engine" would do and how that would have saved a grandmaster from defeat. It seems there is also a huge problem with cheating at the highest professional level and even an iPhone has enough computing power to beat a professional chess player. To come back to investing, almost all trades are now made by machines and I have no reason not to believe that the AI used is as good or better. So it is clear to me that day-trading is a mugs' qame, indeed investment on anything less than 6 month horizon is probably going to fail. On that basis, and out of curiosity, I have five hundred pounds in a spread bet account. It took much longer to crack Go than chess so I looked for smaller, much talked about shares with the longest expiry dates (June) and ended up shorting IQE (LON:IQE) and Purplebricks (LON:PURP) and one is doing better than the other!

To return to IQE (LON:IQE) my problem is not with the technology, simply with the BoD. When the Singapore plant was financed with a cash call, from memory 2005, there was a fantastic future reported in a weekend FT along lines of the production line running 24/7 and increased sales would go straight to bottom line. The share went up 4-5 fold but there was then a profit warning due to "de-stocking" I got out with 100% residual profit but share then fell to pennies (?3p). IQE (LON:IQE) was left on watch list and I bought back in teens and when in thirties made a decision to sell out (I think I got 41p for last tranche). Clearly "foolish" and could have held to 150p. Why are there some many shorters today? My guess is that there are professionals who had the same experience. They may also see the BoD granting themselves huge options and working the share price. The debacle of "forgotten tax" may be the tip of iceberg. And gus is right, the loss could be put against market cap and my indirect application via a high p/e was probably disingenuous. However the ROCE grew from single figures to peak in yr to 2015 but looks like it headed back to single figures. If you compare eps with cash flow per share there is a huge hole, part was that the published "adjusted" figures were what they would have got had they not taken an option to sell at a loss to the chip manufacturer in lieu of the cash they did not have. OK the perceived view was that IQE were better at running the plant which is why the RFD plant was "given" away.

Finally I did some traded options in 90's and it became clear to me that the only way to make money is to have a target and stick to it. So where will sp of IQE (LON:IQE) go? I think it could drop to 60p but will close my position at 80p. On the up-side I will close my position if the 200x is still climbing and both the 20x and 50x cross it. I can, and will, add more margin but looking at charts today, on that plan my loss would be up to £1000.

Sorry probably over-thinking this and totally wasted effort on my part given that I have less than 0.1% of funds invested in the shorts. But so is playing chess, go and doing the daily Sudoku and I do all three of those.

Regards and atb to you too,

Seadoc

nickwild

what is your go rank seadoc?

simoan

IQE (LON:IQE) was left on watch list and I bought back in teens and when in thirties made a decision to sell out (I think I got 41p for last tranche). Clearly "foolish" and could have held to 150p. Why are there some many shorters today?

With regard to people short of IQE (LON:IQE) - perhaps they understand the semiconductor industry better than those that are long? I believe some people even believe the technology industry is non-cyclical such is the length of the bull run since the boom caused by smart mobile devices started 10 years ago, and that the only way is up. This is wrong, the semiconductor industry has a long history of being cyclical, it's just that it's been so long since any kind of downturn that most people have forgotten.

I get a pretty good indication of how the semiconductor industry is going in my day job (although not specifically the compound semiconductors that IQE (LON:IQE) produce) and there is certainly no sign of it letting up yet, but at the same time I'm highly sceptical of some of the claims being made about future applications for IQE products.

Yes, it's easy to see the kind of technologies that will happen in future but the timing of when they will gain mass acceptance has proven extremely difficult in the past and as an investor the timing of revenue from these technologies is extremely important. It is certainly not the sure thing that I have read from comments I have read on here. Everyone saw smartphones coming but it was several years, and much later than anyone predicted, before they reached the kind of volumes that justified the money thrown at developing the technologies. I believe the same will prove to be true about the future technologies gaining lots of attention now e.g. driverless cars.

I've worked in the technology industry all my working life and if there's only one thing I've learnt, it's that it does hype and bullshit very well, and as an investor you really have to cut through that and concentrate on realities.

All the best, Si

22nd Oct '17

Hi Seadoc

Thanks for the thoughtful in insightful reply. I agree with your monthly review (mine is more like every six to eight weeks). My process starts with an export of portfolio data into a spreadsheet, and ends with a review of news and any scuttlebutt. Whilst the process has saved me from some upsets in the past, it also took me out of Greggs (LON:GRG) in August 2014, something I remind myself each time I consider a sale. As a result I tend to have a higher bar than many before selling, and trade very much less often than I suspect most do. Most of the time it works for me, eventually.

Unlike you, I'd not consider spread bets, least not until I change my mind. I'd certainly not entertain the thought of day trading. I was at an investor show some years ago and the topic of autonomous trading machines was discussed briefly in one of the sessions, at about the time when they were first becoming mainstream. I learned that as you say, the machines have the upper hand (can you say "hand" when discussing a machine?)

As an aside, did you see this?

Anyway with the gradually rising level of AI proficiency the machines are becoming harder for private investors to beat. Therefore my strategy is formed starting with the premise that I'm playing the "loser's game". This may seem at odds with my holding in IQE (LON:IQE), but part of my disciplined approach for my main holdings is to be allowed to play with some more exciting holdings on the fringe of my portfolio. Of course, I still want to win on these more speculative holdings, the point is I can afford to be a lot more reckless, scratch that itch, and still sleep at night. Sounds similar to your reasons for your spread betting account.

Thanks for the insights about the IQE (LON:IQE) BoD and for the history lesson. I've noted this on the scuttlebutt jotter I'll use for my next regular review, it might inform a different decision about if I continue to hold or not.

All the best

Edit: changed the link to the "loser's game" to a more fitting source.

Also the statement that my strategy is formed on the basis I'm playing the "loser's game" should be be taken to imply I only invest in trackers, as this is very far from the case.

nick,

I have no idea. I think the last time I played with better players was Cambridge in early 70s. On a 9x9 with Igowin I have to give the 'puter a couple of stones. What is your rank and what do you give Igowin?

seadoc

I learnt in early 70's at uni. Now I play on kgs web site (the best and most used). Handicap is 3 kyu Are you a doctor?.

Nick

martinmullane

23rd Oct '17

What impact will Mifid II (EU Financial Regulation) have on Stockopedia?

Nick,

Yes, surgeon, but well retired.

Seadoc

Small Cap Value Report (Fri 20 Oct 2017) - REC, ESG, BOOT

Record (LON:REC)

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Graham Neary

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