Small Cap Value Report (Fri 24 Apr 2015) - FCCN, SAL, CAMK

Good morning! Apologies for my duvet day on Friday, which was due to a group of us propping up the bar until about 3am the night before, at the Mello Workshops event in Peterborough. At dinner, I was delighted to be seated next to Gervais Williams of Miton (LON:MGR) so we discussed a number of small caps. I was moaning about the profit warning from Shoe Zone (LON:SHOE) and Gervais commiserated, saying that his firm holds 15% of the company, so he shares my pain, but on a bigger scale!

(at the time of writing, I hold a long position in Shoe Zone)

I see that shrewd trader Robbie Burns (aka. Naked Trader) also got caught on Shoe Zone, and he's posted some scathing comments about the company in his online trading diary. A consensus is emerging that the company's weather-related excuse for the profit miss is unsatisfactory, and directly contradicts what they said on 14 Jan 2015, so a proper explanation is needed I think. He reckons the shares are starting to look interesting as a bargain buy, and I'm leaning towards that view myself now. Risk/reward is starting to look interesting again with them having fallen all the way back down to 170p. It's looking good value on the lower, revised broker forecasts now. I'd be happier paying 150p for a top-up though, so let's hope it drops a bit more to give me a more favourable buying opportunity.

Profit warnings really are the bane of our lives, in the small caps space. You can't avoid them, so it's a matter of just dealing with them logically. It amazes me how overly emotional some investors become when a stock warns on profit, some of the things you read on Twitter for example are astonishing. It's part of life in this space, get used to it!

When a stock does warn on profit, we have to assess how significant it is, and the only thing that matters is whether the new, lower share price, now represents good value (in which case one should buy more), or whether the company is in a downward spiral and there is more bad news to come (in which case one should sell immediately). The market doesn't know or care what price we paid for our shares, and I agree with the gentleman in the audience at Mello Workshops who said that he totally ignores his original purchase price - the only thing that matters is whether the shares are a buy, hold, or sell, at today's valuation, on the information we have available today.

Mello Workshops was David Stredder's latest investor event, and once again his team have pulled off a fantastic event. Because he's a (highly successful) investor himself, David organises events that he knows other investors will find interesting & worthwhile, with less of a commercial bias compared with other shows (especially when it comes to the quality of the companies allowed to have stands!).

I was asked to participate in two panel discussion sessions, which were very interesting. Plus I also gave two talks - one on balance sheets, and one on the dangers of gearing - illustrated with real life examples from my own life, and the disastrous experiences I had in the 2008 financial crisis.

I'm fairly new to public speaking, and find it very stressful. So about a year ago decided to set myself a personal challenge to overcome this inhibition, and agree to do speaking engagements on shares when asked to, but only if the subject matter is a topic where I can add value.

The feedback from Mello Workshops has been very positive so far, or maybe the people who didn't like my talks are just being polite by not telling me! Hopefully by explaining how bad things got for me in 2008, I might have steered a few people away from the dangers of excessive gearing, in spread betting and CFD accounts. As with all disasters in life, the key thing is to learn from those mistakes, and not repeat them - so I am very careful with gearing these days, and suggest that for most people it's usually best to avoid gearing altogether.

Spreadsheet to manage risk

As mentioned in my "Spread betting disasters" talk (which the hotel had hilariously typed up wrongly as "Spreadsheeting disasters" on the schedule), I have created a simple spreadsheet to help manage risk in geared accounts. Let's hope it's not a disaster!

As promised, here is the link to Google Drive for anyone who wants to use this spreadsheet - just make a copy of it yourself, and then remove the example trades I've put in it, and input your own positions. I hope some people might find it useful. It looks up the prices in real time from Googlefinance, so that's handy & saves time from not needing manual updates on prices.

French Connection (LON:FCCN)

Share price: 39p (down 26% today)
No. shares: 96.2m
Market Cap: £37.5m

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

Profit warning - the last outlook statement from this fashion brand/retailer was on 17 Mar 2015 (with the preliminary results for y/e 31 Jan 2015), when they referred to "challenging" trading in their retail division, but better trading in their wholesale division.

Today's update basically says the same thing, so it's perhaps anomalous that the market has now punished the shares twice for the same thing. This is starting to look like a potentially very good buying opportunity in my view, but I'm holding fire for the time being, to see at what level the dust settles. It could go lower in the short term, as very often in situations like this people throw out the baby with the bathwater, as their emotional response to the profit warning blinds them to the potential upside.

Continued "challenging conditions" over the important Easter period (which is a large seasonal spike for clothing retailers, especially Good Friday week) now mean that H1 retail sales are going to be, "materially lower than expected". So clearly that's bad news. The retail division is a compete disaster area. It made a loss of £11.3m last year, on turnover of £103.3m. Today's statement reinforces my view that the sooner they can shut down the retail division, the better. It just doesn't work on a standalone basis, for whatever reason.

The wholesale business is trading in line with expectations, and orders are up against last year. This division was 42% of group turnover last year, and is strongly profitable - it made a £14.6m profit last year (up from £11.7m the year before).

Brand licensing (another very profitable part of the business) "continues to perform strongly".

Net cash is reported at £9.9m (down from £12.0m a year ago), and this should be close to a seasonal low for the year. So expect to see net cash rise back up to c.£20m for the seasonal peak of the next year end. Net cash was £23.2m at the last year end of 31 Jan 2015.

Further comments are that costs have been tightly controlled, and that more loss-making shops have been closed. The Directorspeak says;

My opinion - obviously this is a setback. It reinforces the point I've been making for a while now, that French Connection simply doesn't work on a standalone retail business. They need to close their retail shops asap. Once that is done, then what will remain will be a highly profitable wholesale & brand licensing business, which could be valued at 100-200p per share, in my view.

I draw your attention to the divisional profit/(loss) breakdown from the last accounts, which illustrates this point very well;

As you can see, if the retail division were closed down, then an £11.3m loss would be removed from the last year's figures, which would move the group to a £10.5m profit, and that's before allowing for any cuts in central overheads, which could push that figure higher.

So there is a business which could be making £10-15m p.a. struggling to escape from the heavy burden of a heavily loss-making retail division.

I suspect that their Oxford Street, London store alone is probably losing several £m p.a.. I searched online, and discovered that it has a massive rent, of £3.2m p.a., so business rates would be about half that amount again. However, shops on Oxford Street are very difficult to obtain, so there could at some point be a double benefit from FCCN disposing of this store, and not only eliminate heavy trading losses, but possibly even receive a premium for the lease.

There are several other highly rented central London stores.

Therefore, this share remains a special situation, which has enough cash to keep going, and with average lease terms of only about 4 years left, the loss-making shops will, over time, disappear. So I remain of the opinion (and to stress this for the umpteenth time - this is just my personal opinion, and never a recommendation or "tip") that risk/reward here is potentially very good for investors who are prepared to be patient. Those retail losses will disappear over time, as the shop leases expire, leaving behind a nicely profitable wholesale/licensing business.

The concern is that the retail losses mount to such a level that the cash pile is burned away. That's not happening yet, but it's something to keep an eye on. Based on this update, I reckon the company might be heading for a loss of about £3-4m this year (remember that it's a heavily H2-weighted year, so brace yourself for dismal interims). That is just about OK, but if they slip back towards c.£10m p.a. losses, then I think it would be time to ditch the shares, and move on. For the time being however, the cash pile looks adequate to keep the company afloat whilst they continue to gradually dispose of the loss-making shops.

It's too early to say whether the turnaround investment case will work or not, we just don't know yet.

Spaceandpeople (LON:SAL)

Share price: 60p
No. shares: 19.5m
Market Cap: £11.7m

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

Trading update - this share was my most problematic share of last year - it put a big hole in my portfolio when it warned on profits twice, in Apr and Sep 2014. Upsetting though this was, I approached it logically - asking the company what had gone wrong, and what they were doing to fix it. The resulting conversations gave me confidence that the problems would be resolved, so instead of selling, I bought more.

That is now starting to look like a sensible decision, as the shares are now recovering as well as can be expected after a series of major disappointments - it takes time to rebuild investor trust & confidence.

Today's comments are reassuring, and say;

Valuation - it is important to preface this by saying that, as part of the lessons learned from last year's problems, management have completely changed their forecasting process. So they now only plan for the continuation of existing contracts, and they don't factor in any growth into the base case plan. Of course they are actively chasing new business, but treat any wins as being icing on the cake.

Therefore, instead of warning on profits from ambitious plans, they now set out modest plans, and should hopefully out-perform.

On that basis, the broker forecast for this year of 5.62p EPS should be a fairly soft target, and it's good to see management confirm today that they have traded in line for Q1.

Dividends - the company has been a generous divi payer in the past, and despite last year's difficulties they still stayed on the divi list, paying 2p. This year broker forecast is for 2.33p, although personally I am hoping for nearer 3p. On the broker forecast, the yield is pretty good at 3.8%. If my estimate is right, then the yield would be nearer 5%.

Balance Sheet - the company has favourable cashflows, as it banks cash on behalf of the kiosk operators. As such it's not had any issues with solvency, and in my view there is nothing to worry about on this front.

My opinion - there is good upside potential from this shares, in my view, and I am hoping to see it roughly double from the current price in the next two years. This is based on my calculations for how much profit potential there is from the new mobile promotional kiosks. These have recently been trialled very successfully, and there is strong demand from both the operators, and the shopping centre owners.

There won't be much benefit in the 2015 numbers, but I will be looking closely at updates from the company on how the roll-out of these new kiosks is going. It has the potential to give a serious uplift to profits from 2016 onwards, in my opinion.

On the downside, the company is probably too small to be listed, and the shares can be illiquid, as with anything this small. Having said that, there are plenty of other smaller, and less liquid shares on the market. Also, investor mood towards this shares is still very negative, as you would expect. It takes time for sentiment to recover. However, one person's doom & gloom can often be another person's profit opportunity!

As always please DYOR, the above is just my personal opinion. As with all investors, sometimes I'm right, sometimes I'm wrong. The trick is being more often right than wrong! DYOR is more than just a slogan, or a disclaimer - it's the whole ethos of this website, and my personal philosophy - encouraging people to research shares for themselves, learn from our mistakes, and take responsibility for our own decisions.

Camkids (LON:CAMK)

I've been saying for several years that you cannot trust Chinese stocks listed on AIM.

Naibu Global International Co (LON:NBU) has disappeared without trace, as the Non Execs were not able to clarify the company's financial position. The game there was very simple - the Chinese were constantly offloading shares at whatever price they could get onto gullible British punters. The purpose of the listing was to extract money from British investors. Once that process had been completed, there was no further need for the listing.

It's looking increasingly likely that Camkids is in the same mould, in my opinion.

Final results - for calendar 2014 show an astonishingly strong balance sheet, with a current ratio of 10.2! Current assets includes about £40m in net cash. Despite this, the company cancelled the dividend. So the forecast divi yield of 21% has actually turned out to be a bit wrong! The yield is actually zero.

My opinion - these shares are worth nothing, in my opinion. I'm pretty sure it's a scam, like Naibu. It's really a complete disgrace that these companies were allowed, indeed encouraged to list in London, by the LSE - who have horribly mismanaged AIM, and turned it into the laughing stock it is today.

That said, these dodgy companies are actually quite easy to spot in advance. So investors who lose money on them really need to re-assess their own investing approach perhaps. It's hard enough to make money from genuine companies, without lengthening the odds even further by allowing scams into your portfolio.