Small Cap Value Report (Mon 23 July 2018) - UCG, SRT, MCLS, Financial Distress, MCGN

23rd Jul '18 by Graham Neary

29 comments 10398 reads

Good morning!

Of interest today we have:

United Carpets (LON:UCG)
SRT Marine Systems (LON:SRT)
McColl's Retail (LON:MCLS)
Begbies Traynor (LON:BEG) (red flag report re: financial distress)

We had in-line-with-expectations updates from Restore (LON:RST), Instem (LON:INS) and Judges Scientific (LON:JDG). Keywords Studios (LON:KWS) announced a small acquisition.

United Carpets (LON:UCG)

Share price: 7.625p (unch.)
No. of shares: 81 million
Market cap: £6 million

Final Results

(Please note that I currently hold UCG shares.)

This floorcoverings and bed retailer is a legacy holding for me, from the period when I was focused on dirt-cheap micro-caps.

Most of those dirt-cheap stocks have by now exited my portfolio, but I've never quite been able to press the sell button on this one. It has always seemed to be priced at an extraordinarily cheap level.

So even though I'd ideally prefer to own something of higher quality, I've been unwilling to sell this one so far.

When it comes to achieving a higher rating for the stock, the low market cap itself is a problem. Plenty of people don't want to analyse companies worth less than £10 million, and for good reasons.

In addition, the CEO, Commercial Director and Finance Director own nearly 54 million shares between them, so I think there are only about 28 million shares in the free float. That makes for an illiquid stock.

So I may end up being locked up in this one for a while longer yet.

Fortunately, many of the reasons I originally bought into it remain in play.

Let's review.

Strong balance sheet - despite having paid a very large special dividend (1p per share), UCG finished FY 2018 with net funds of £2.64 million. It has equity of £5.3 million, nearly all of which is tangible.
Strong returns - the capital-light franchise network model has enabled it to earn very high returns. I estimate that return on equity was 25% in FY 2018.

Stability - the managers have been satisfied to focus on the existing…

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andrea34

23rd Jul '18

Please could you comment on Microgen (LON:MCGN) results, Graham?

Hugh Jass

A second request for Microgen please if you have the time

BIACS

Trading update from Mission Marketing (LON:TMMG) this morning reports "an excellent start to the year" and "double digit" profit before tax increase over first half last year.

Debt is up by around 1m but given they shelled out 4.5m on an acquisition in this period that essentially means most of the acquisition was paid for without debt. I'd like to see borrowing reduced a little from here, but they should be able to reduce this by at least 2 - 3m by year end and then things will look pretty good. On a P/E of 5 and with a 4% dividend covered almost 5 times this looks ludicrously cheap and the market is clearly worried over potential cyclicality - however this is starting to look very priced-in and with no sign of any imminent slow down to date.

Positive, but fairly muted, market reaction to the update with shares up 4%. . Would be interested to hear your thoughts on this one Graham.

JohnEustace

Yes, I think Restore will see a double hit in the comparatives. They have benefitted from one off charges for fetching documents out of store and destruction, but the main income for archiving businesses is in the ongoing passive storage. Their ideal customer puts boxes into store and forgets about them. This update tells us that base income level will have reduced as a result of GDPR, but they don't tell us by how much.

LeoInvestorUK

Graham, indeed you did, and the comparisons with Carpetright (LON:CPR) were particularly useful.

I do take your implied point that ultra small, ultra cheap, low growth stocks are generally neither the best or the easiest way to make money. I think they probably work best for long term holders with small portfolios.

Sunny350

Hi Graham, could you please cover RST if you got time. Thanks!!

Graham Neary

Hi andrea, ok! re: Microgen (LON:MCGN)

Hi jjis, re: McColl's Retail (LON:MCLS), yes it was worth a look. Thanks. G

Tortoise investor

These comments in the United Carpets (LON:UCG) statement unnerved me:

"While the Board believes that United Carpets is well placed to compete, it does not expect the trading environment to improve dramatically in the short to medium term. Combined with inflationary pressures impacting on the cost base, the first half of the current financial year is expected to be very challenging and the Board do not anticipate the first half profit levels of the previous year to be achieved" (my emphasis)

It'll be interesting to see any broker forecast but on this basis I am assuming we could see EPS as low as 1p for 18/19 so at 7.5p United Carpets (LON:UCG) looks less attractive given it rarely seems to trade on a PE above 8. If I held already I would hold and collect the dividends but I reckon we might yet get a more attractive entry point especially as the heatwave this summer looks set to continue for a couple of more weeks yet.

DJCP

I'm not sure there's much Graham could cover re Restore (LON:RST) that's not already in the RNS. The only reason I pointed it out initially was the GDPR aspect.

I'll be requesting Graham's viewpoint in September when the actual results are announced, so he has some figures to work with, and as long as he has time, of course.

I have an insider at Restore (LON:RST) (well, only someone that works for them! lol), and initially bought after looking into the company when helping him prepare for his interview. He's always telling me how busy they are, and more importantly (for me), they appear quick to solve problems arising from integrating their acquisitions - i.e listening to employees, and actually doing something.

TamzinPiworld

Redleaf/Newgate PR organised a morning on AI. We recorded all the sessions. Here is the first, given by James Corcoran, Global Head of Products and Solutions for Kx (part of First Derivatives).

He covers off, Machine Learning – the growth of Predictive Analytics.

https://www.piworld.co.uk/2018/07/23/newgate-redleaf-ai-conf-kx-machine-learning-the-growth-of-predictive-analytics/

The whole series of 7 presentations are well worth a listen, to give an insight to what's happening in AI. The sixth is a particularly good one, discussing the impact on society, otherwise more about the actual functionality. I'll be posting them daily over the next 7 days.

Hey DJCP et al, thanks for the comments on Restore (LON:RST). Not one that I will be covering today, but may take a look at it when there is a more substantial announcement. Cheers. G

Housemartin2

Ref Begbies Traynor (LON:BEG) report on companies in financial stress.Not just rising interest rates but the effect of Brexit as well. While any Brexit will be an economic shock, it looks to me that like the most likely option will be a hard one and that will be a big shock. Whatever the outcome, the disruptive effect on weak businesses - the zombie businesses with to much debt particularly - seems to me that we will have a glut of failures.
Does anyone else feels that the Market generally is too laid back on this score ?

Gromley

One additional important thing to note from the McColl's Retail (LON:MCLS) announcement is this :

In addition, it is noted that we are one of a number of companies that is in ongoing discussions with HMRC relating to a review of National Living Wage and working hours. This may lead to a further adjustment in the full year, the impacts of which cannot be reliably quantified at present.

I have seen one complaint (relating to unpaid extra hours at the start and end of shift, plus having to work through the unpaid lunch break) dating back to 2013, so there will potentially be multiple years of back pay (there are no even lukewarm words of being confident of compliance).

It's impossible to say if it is limited to just some of the stores or all of them, so we can't really get a gauge of the scale. It is however, not inconceivable for it to be a seven figure sum if the issue is found to be correct and widespread.

Personally I would want more clarity on that before considering investing.

Lord Gnome

Given the negative comments on MCLS, it is interesting to note that they currently have a stock rank of 81 which, I would have thought is a bit generous.

shanklin100

LG

IIRC CVR had a very high SR not that long before its demise.

rmillaree

McColl's Retail (LON:MCLS)

I quick look at the balance sheet here reminds me of other retailers that have now gone to the ball, to be honest it looks a bit of a basket case unless you believe they have the ability to generate decent profits / cashflow going forward. Retailers assets tend to be worth diddly squat without a continuing profitable business attached to them.

Looking at the balance sheet we have

land and buildings 50 mill (at last annual report date) - hmmmm - i cant quikly see if this may have value above or below this level - mention of a decent amount of freeholds though.
They mention sale and leaseback of 10 premises last financial year so i am guessing the crown jewels are being sold?

Other plant (50 mill) and stock (75 mill) i will say is worth nowt practicably speaking.

Retirement benefit asset - (13 mill) i will say is worth nowt.

Ok we have trade payables 43 mill
and cash 39 mill

Thats about it 83 mill of useful assets being the last 2

They have trade payables 198 mill
provisions 14 mill
loans/borrowings 148 mill

so monies owed out 360 mill

strewth how can any business that is not desperate for their custom give this company credit?

Presumably is the normal suppliers who are "happy" to give decent extended credit and take the risk - just cos they don't want to turn down the business.

A look back at Game/HMV/SCS tells one that once the suppliers get twitchy over the extended credit terms thats it. I can't imagine they would get anything of value back on their owed bills if the company went pop.

I can't see why anyone would want to invest here unless there is some hidden value in the property or they believe 1000% in the business plan the company have. Perhaps i am missing something.

I'm not invested in McColl's Retail (LON:MCLS) personally, but would be interested if it were not for the uncertainty about the minimum wage piece (ongoing impacts as well as the back pay)

And I do think you are missing something - the nature of the business. This company is nothing like Game/HMV/SCS it is operating in a growing sector with no real disruptive internet competition (until the skys become full of amazon drones offering free 5 minute delivery on the pint of milk you've just run out of) - convenience grocery.

I don't know actually what their official credit rating is but rather than being risky I'd say they are incredibly safe. Certainly they don't have massive asset backing, but they do have very reliable cashflows and profits and a lot of their stores have a pretty effective moat - proximity.

Someone made a good point the last time we discussed them, that the moat actually belongs to the Freeholder rather than directly to McColls, which is why the sale and lease-back might seem illogical although I know it will be seen as "capital efficiency". In fact though I would say there is a tremendous advantage to being the "sitting tenant" in the event in the event that a lease renewal were "contested".

As I say, I have no position at the moment, but I do think to effectively dismiss them as a retailer with a dodgy balance sheet is to fundamentally misunderstand them.

McColl's Retail (LON:MCLS)

As I say, I have no position at the moment, but I do think to effectively dismiss them as a retailer with a dodgy balance sheet is to fundamentally misunderstand them.

Reference the reliability of profits - they made £14 mill last year adjusted profit on 1.1 billion turnover

The latest 6 months they are down to 1.5 mill from 3.2 mill last year

So thats probably on target for 10-12 mill profit on over 1 bill of turnover - 1% of turnover as profit.

That leaves no room for nasties - Strewth even the big boys like Tesco have struggled to deliver consistent profits over the last 5 years.

It would be interesting to see how their credit worthiness stacks up now compared to a couple of years back when i think debt was much lower.

Via Lactea

24th Jul '18

Rmillaree

Would you say about Tesco, “Strewth how can any business that is not desperate for their custom give this company credit?”

McColl's 2017 annual report gave its long term credit rating as AAA to BAA1, whereas Tesco's website gives its own rating as only BB+ to Ba1. So, who is the safer?

Sure, today's interims won't have helped, but the underlying figures are not hugely different from H1 2017 and I would expect the credit agencies to give them some benefit of the doubt for now.

Moving on to the investment proposition, there are advantages that McColl's has over the big food retailers. The former is entirely in a growth subsector of food retailing, it is refurbishing its estate and moving to sell more chilled produce, it has a new supply contract giving it better quality produce at more competitive pricing. If well managed from the centre, McColls should be able to grow sales for the next few years. Will it be enough to more than offset the increased costs of the business? Well, that's the hope.

If McColls' H2 doesn't improve enough, then the shares could take another hit. However, either Morrisons or Sainsbury have better buying power than McColls and both have good delivery infrastructure. They must know they could operate the estate of 1600 convenience stores more profitably than McColls. So, is there effectively a takeover put for McColls' shareholders?

Small Cap Value Report (Mon 23 July 2018) - UCG, SRT, MCLS, Financial distress, MCGN

United Carpets (LON:UCG)

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Graham Neary

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