Small Cap Value Report (Fri 28 June 2019) - AIEA, SDI, COST, CRW, CVSG, PVG

28th Jun '19 by Paul Scott

45 comments 11289 reads

Good morning, it's Paul here.

Let's get started today with a look at the profit warning yesterday from floor-coverings business, Airea.

Airea (LON:AIEA)

Share price: 56.5p (down 26% yesterday, at market close)
No. shares: 41.4m
Market cap: £23.4m

Trading update (profit warning)

Airea plc (LSE: AIEA), the manufacturer, marketer and distributor of floor coverings, announces the following trading update for the six months ending 30 June 2019.

This is what the company said, in a brief update;

Despite a very strong order book and first quarter and with continued growth from our export markets we will announce revenue slightly down and a lower operating profit for the half year compared with the corresponding period in 2018. This is due to significantly tougher conditions during the second quarter.

Like many UK businesses the economic headwinds are against us and we are experiencing a high level of market uncertainty; however, the business is well positioned to continue to prosper despite this continued economic uncertainty.

How on earth do we interpret that?!

If H1 revenue is only "slightly down" on 2018, then I presume profit should also be down a relatively small amount, providing overheads have not grown.

Looking back at H1 2018, the company reported revenues of £9.1m, and operating profit of £1.5m.

rhomboid1 contacted the company to query things, and posted his thoughts in comment no.50 to yesterday's report here. I don't think the company should have disclosed that information, but it's in the public domain now.

There don't seem to be any broker forecasts on the company, so I'm struggling to quantify things, or to value the company.

Valuation - stripping out one-offs, and normalising the tax charge, I calculate that last year EPS was about 5.8p. If we assume that this year might be a bit less, say 5p, then the current year PER might be around 11 - which looks about right to me.

My opinion - this is a nice little company, which has restructured and is now decently profitable. Yesterday's profit warning was a setback, but not a disaster.

The balance sheet is strong, although note there is a pension deficit. But it also has freehold property, and a very strong working capital position, including net cash of £2.7m.

I think the share price has correctly adjusted,…

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doublelutz

28th Jun '19

Revolution Bars (LON:RBG) has often been discussed on here. A RNS has just been released to the effect that Adrian John Williams now holds 3.43% of the company (1.7M shares). I don't know if any significance should be placed on this but it is a sizeable investment worth over £1M at present.

Trident

Just on the Buffetology fund interview, I wonder if this falls foul of some of the features of the Woodford curse of being trapped in some illiquid but sizeable positions.

It sound great that the Fund's size has grown on the back of its good performance, but exposure to reversals has previously shown some nasty consequences for investors and perhaps the market. Carney has intimated that fund behaviour can represent a systematic threat.

I think regulators will be pressing Funds harder to declare all their holdings, whereas they seem to resisting this due no doubt to fear of copycats, by giving only limited info, such as top ten holdings only etc.

timarr

Just on the Buffetology fund interview, I wonder if this falls foul of some of the features of the Woodford curse of being trapped in some illiquid but sizeable positions.

Woodford's main problems were caused by investing in unlisted companies, although he did have a long tail of small quoted companies too and the problem was compounded by poor stock selection. In theory the Buffetology fund would be less impacted by those problems - and while they may not quote their full holdings it's quite easy to reconstruct their entire portfolio by going back through monthly reports as new holdings and sales are all reported.

However, Mark Carney's comments on open ended funds from earlier in the week strongly suggest that regulation is coming. When the governor of the BoE starts talking about liquidity issues in these funds as a systemic threat to financial stability it becomes a matter of time before there's a change. If investors in these funds can no longer be guaranteed instant access to their cash - a guarantee that Carney describes as a "lie" - then presumably you'd expect to see them trading at a bigger discount to net assets than they currently do.

Personally I worry a bit about the cult of personality around the Buffetology Fund, Lindsell Train and Fundsmith. They've all had great performance, but as Woodford and many before him have shown, when people start investing on the basis of the name alone valuations can get out of kilter with reality. There are no free lunches in investing.

gary3980

rhomboid,

You spoke with management only a few hours after the RNS came out, so I'm wondering why they couldn't have released the RNS a day or two later and included it. Though if the NOMAD was strongly advising keeping it vague it wouldn't have made a difference either way. Releasing more of the info you have shared may have softened the fall somewhat, IMO anyway.

Whilst there is some positive narrative a point Paul picked up on is why revenue is only "slightly" down, and operating profit down. Does it indicate a problem with margins or other costs? I guess we are left guessing how much profit is down.

Anyway, thanks for sharing the detail from your conversation with them.

Paul Scott

Hi Pete,

Sorry, I don't normally cover the financials sector, and I know nothing about International Personal Finance (LON:IPF) so don't feel able to comment on it.

Regards, Paul.

Hi,
Given the length of time, I've been expecting French Connection (LON:FCCN) to say that takeover talks are off.
Therefore, today's update, saying talks are ongoing, seems encouraging to me.

Bear in mind that this is a lovely each-way bet;
1) Takeover would have to be at a decent premium, or Stephen Marks won't agree it, and
2) Even if takeover talks fall through, the company's back into profit, and the heavily loss-making stores are now disappearing (at last!). Note that the hugely expensive, and I reckon massively loss-making Oxford Street store has closed. I think that could, at a stroke, increase profit by possibly £3m-ish (my estimate of the likely losses from that one shop).

Therefore, if I'm right, even if takeover talks fail, we should get a positive trading update, saying that the company is heading for maybe £3-5m profit this year.
Plus the balance sheet is bulletproof, and as shops close, working capital reduces, hence there could be scope for a buyback or special dividend, possibly?

In a way, I'm hoping for the talks to fail, and the share price plunge to say 25p, allowing me to buy as many as I could afford, because at that sort of level it would be an insane bargain, now that the company is profitable again.

Regards, Paul.

kalkanite

An interesting link, thank you.

Marks as CEO and Chairman has been running French Connection (LON:FCCN) with an iron fist like operation. He has had many directors come and go, it appears he wants them to do as he says rather than allow their flair to progress the company (that's my take on it anyway).

Not sure if Mike Ashley is being genuine or whether that message was for potential buyers of the company. Why would you buy such a large chunk of FCCN in the belief that Marks the CEO and Chairman is the secret source when he is 73 years of age?

Marks is a self confessed hermit, not the kind of personality that you would associate with fashion. The brand appears to be fairly strong judging by the licensee and wholesale income.

Marks has been running down the unprofitable bricks and mortar part of the business for some time now, Mike Ashley could easily continue this while adding FCCN concessions to his House of Fraser empire something they appear to be doing currently.

I think the preferred option by SM and MA will be an outright sale but I wouldn't be surprised if MA makes a cheeky bid for high 30s low 40s if there is no deal and the share price gets supressed. My last calculations made the cash and stock in the business worth 40p alone, so he would get the brand and business for free at that price.

shanklin100

Hi Gary

Re Airea (LON:AIEA), it would certainly be interesting to know the basis on which seemingly the NOMAD gave such unhelpful direction.

In their recent PW, https://www.investegate.co.uk/somero-enterprises--som-/rns/trading-update/201906070700034551B/, Somero Enterprises Inc (LON:SOM) gave a fair bit of detail and nobody seems to have forced them to hide it from investors.

One wonders why the NOMAD here wants to keep useful information from investors.

N.B. Obviously anything in the RNS would need to be based on facts not speculation.

Cheers, Martin

SundayTrader

Just to put the counter argument to Paul's comments on Costain (LON:COST), any next government is going to spend more money on roads, and probably rail as well, all to £COST's benefit. The margins go with the business model, and are the norm for this sector - to my mind, the issue is the cyclicality, not the margins. Costain (LON:COST) has been around a long time, and has a reputation for management quality. The market seems to be overly spooked by Carillion - I would have thought this fall looks more opportunity than warning.

I don't hold, but I will be watching.

pete davidson

Okay no worries, thanks for the reply.

Regards, Pete

rhomboid1

Hi Martin

When you have a recent & material deferral of delivery across multiple clients a conservative approach is to not say it’s a temporary phenomenon until the numbers in terms of delivered product tell you so (rear view mirror)

So the NOMAD is factually correct...everything else is background colour imho

simoan

Personally I worry a bit about the cult of personality around the Buffetology Fund, Lindsell Train and Fundsmith.

Hi timarr,

For me, it's not about the name, it's all about the investment process. The outcome is just the result of that process and you can't deny the results of these managers over long periods when compared to the indices. I'd rather concentrate on an investment process that works and where the manager has conviction in their process than pay a fund manager to run a closet tracker, which many do. Woodford had conviction but a bad investment process and I don't understand why his funds were so popular.

They've all had great performance, but as Woodford and many before him have shown, when people start investing on the basis of the name alone valuations can get out of kilter with reality.

I'm not sure how valuations get out of kilter in an open ended fund? Are you saying because the funds you listed all fish in the same pond that some of the companies they are pumping new cash into have got too expensive? I can see that argument with relation to the Buffettology fund when you look at the top 5 holdings.

I only own one OEIC. It's not the Buffettology fund because of its size and the illiquidity of many of the holdings. I think there is maybe a possible issue there should things get nasty again but don't see it with Fundsmith where the companies are huge and very liquid by comparison. Tbh I don't like OEICs as a vehicle and prefer closed-end funds as a collective vehiclewhere I want access to an asset it is difficult to invest in directly.

All the best, Si

coniston

Thanks paul.
On checking Buffettology fund there have been large inflows into he's fund,i would of assumed he would be topping up on he's favourite holdings CRW being one,these type of quality stocks on extortionate ratings where the weight of money lifts them to perfection ratings, there's only one way it's going on disappointing results,quality stocks can have devastating outcomes for investors due to the double whammy of a derating.

I'm not sure how valuations get out of kilter in an open ended fund?

Hi Si

If you look at the style of investing that Fundsmith, Buffetology and Linsdell Train espouse it's actually quite similar: essentially they hold quality assets for long periods of time, rarely sell them and rely on earnings compounding to drive up valuations. The investment approaches vary but the types of stocks selected don't, really.

Now, under any circumstances that's an admirable investing style but it's been phenomenally successful over the last 10 years where low interest rates have magnified the value of these earnings compounders to the extent that PE ratios have risen quite sharply. In this environment investors rightly put a high value on the reliable earnings that these companies can generate year in and year out.

The questions, therefore, are: (1) is at least part of the success of these funds a facet of the attractive investment environment for these types of stocks? (2) are these types of stocks now overvalued based on historic valuations? and (3) are we likely to see a reversion to more normal valuation levels in the near future?

Personally I think the answers to those questions are: (1) yes, (2) yes and (3) no. However, when the answer to the third point changes - as it will, at some point, then these funds will be faced with a double whammy - not only will the fund values drop but the outflow of funds will force sales at - probably - temporarily distressed prices. Because we know, absolutely, that one of the problems of popularity in open ended funds is that you attract hot money and hot money moves when your performance drops off. And, of course, while you may value the investment process more than the manager that won't be true of a lot of people.

So, no I don't deny the results of these managers but I would argue that at any point in time there will be managers with similar results. It's just that they were the ones that were lucky enough to be running the right strategy at the right time: the investor's equivalent of the Anthropic principle. Of course, I think they'd have got good results anyway, but probably not this good.

On the other hand, if you're prepared to hold to infinity I still think these funds will give you a good return - but it may not be as good in future as it's been in the recent past.

JohnEustace

Buffetology is the only OEIC that I currently hold so overall I’m a fan. I’ve commented here before that Keith A-L has notably made some correct calls on situations where Woodford got things badly wrong. I’m not sure there’s any reason for the fund to be open ended other than that structure seems to generate higher fees? I generally prefer investment trusts for cost and liquidity reasons.

I do worry that the fund is getting too big for the pond it is fishing in. With the amount now flowing in being primarily added to current holdings that must be bidding up the share prices. We often see market prices move on surprisingly low trading volumes and Buffetology is investing many tens of millions a month. That inflow must be causing a positive feedback loop, while it continues.

I’m also a bit surprised by Keith A-L adding Rollins as a US holding. It’s a good company and I’ve held it in the past but it looks very expensive. Maybe that’s just him following the Buffet way. But adding just one US investment to a UK fund makes me think he was perhaps struggling to know where to put all the money coming in.

It’s entirely fair that Keith is very happy about the way things are going after the years of work he has put into the fund, but my contrarian instinct worries about complacency. I think of it as the Waitrose effect. A few years back they were the nations favourite supermarket and started to believe their own hype. It’s been downhill ever since thanks to the low cost competition.

29th Jun '19

I’m also a bit surprised by Keith A-L adding Rollins as a US holding. It’s a good company and I’ve held it in the past but it looks very expensive.

Buffetology also holds Berkshire Hathaway, If I recall correctly KA-L bought this partially as a hedge against Brexit, so perhaps the Rollins purchase is in the same vein? I've found some of the recent purchases a bit head-scratching - for instance, I can't see how Restaurant (LON:RTN) could ever meet a set of quality criteria, or be considered immune to competition?

KA-L does talk about the impact of strong inflows in his last monthly report, noting that it means he's not really able to make substantial purchases in "micro-caps" (defined here as sub-£100 million market cap). The latest purchase is London Stock Exchange (LON:LSE) which is a very fine business, but hardly cheap. But, there again, what is these days? Whether the fund's increasing reliance on larger cap stocks will impact its performance remains to be seen, but I think it's a different beast to what it was even a couple of years ago.

Over at Lindsell Train a couple of their recent reports have touched on both stock valuations and liquidity, and both are worth reading. On valuations they argue that the unique nature of the businesses they invest in protect those companies from effective competition so that they're resistant to reversion to average valuation levels. While their record suggests they're right there does seem like an element of special pleading in this - you can't hold stocks at elevated earnings yields unless you think there's a justification in doing so, and if you torture the data enough it will tell you what you want to hear.

And on liquidity they both reassure on their ability to handle large redemptions and warn that that future events might mean they have to sell at distressed prices: and this is on a £17 billion fund investing mainly in very large cap stocks. On the other hand L-T has never relied on anything other than very large, very liquid stocks so it's unlikely that the inward flow of funds will impact performance one way or another.

The thing about these funds, of course, is that it's entirely possible to replicate them ourselves without paying management fees or worrying about redemptions or being locked in. For passive investors this may be a reasonable option, but it's an interesting question to muse on why active investors would put their money in these vehicles ...

Golspie

Ref vets. Practice where daughter is head of department was sold by management to an aggregator, which was subsequently sold to Mars, so they recognise value.

mojomogoz

I've met and interviewed Nick Train about 4 times dating back to about 1998-2000 ish.

He's had ups and downs. For example, I spoke to him about media long-short fund he ran back in the day...not very successfully as he wasn't wired to manage the volatility that comes with shorts.

My view is that he may be a genius but I really can't tell. He has been perfectly placed to benefit from a period of relatively uninterrupted growth, rapid globalisation (great for his brands) and extreme policy support for financial markets. Its somewhat an echo of nifty fifty in terms of the extent to which structural growth stories have been liked and rewarded (although not the same macro circumstances).

I'm sure he has an acute sense of brand power and its durability and ability to see through noise. So I think he would always be a successful investor. But the extent of his success is remarkable and I believe one should factor in a big dollop of luck - right type, place and time.

Size, liquidity and opportunity is an issue that restrains him. One of his favourite stocks/brands is Celtic (LON:CCP) where he is the second largest shareholder behind Dermot Desmond. He'd like it to be bigger part of his portfolio. Its the only stock I know I share with him (been long term holder from approx 25p). He loves these niche brand stocks where he thinks the brand power is durable and underpriced.

I don't know K A-L but his buffetology fund is short track record and his performance has coincided with a period of exceptional performance for growthy AIM names. He may be great but I'd give high odds of a tough period and fund shrinkage.

andrea34

Re Revolution Bars (LON:RBG) is this the Adrian John Williams as per entrepreneur, Chairman and Owner DM plc? Does he have a record of acquiring things or building up stakes in companies? I'd be waiting for a trading update from them to see if things have got even worse or not....

1st Jul '19

On a regular basis I look at my portfolio and ask myself the opposite - why don't I just put all my investments into a fund. I think it's important to ask yourself that question when something like Fundsmith has blown away 99% of private investors returns on a risk-adjusted basis, since launch in 2012. Of course, I know the answer for myself, but going forwards if I want to spend more time enjoying life it is a serious option. Apart from anything else, do I believe I have the right psychology to engage the same rigorous approach of Fundsmith and to get the same results just by holding the same 27 shares? I'm not going to try and kid myself. In a word... "No".

Small Cap Value Report (Fri 28 June 2019) - AIEA, SDI, COST, CRW, CVSG, PVG

Airea (LON:AIEA)

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Paul Scott

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