Small Cap Value Report (Mon 23 Oct 2017) - PDG, TRAK

Good morning!

I am currently in an airport as I set out to spend the day with the Stocko team in Oxford.

Paul might be along with updates in a short while, but either way I thought I would open up the thread for reader comments.

Best wishes,

Graham

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Morning everyone, it's Paul here!

I'll also be heading for Stockopedia HQ in Oxford shortly. There's just enough time to squeeze in a few brief comments on some of today's RNSs.

Pendragon (LON:PDG)

There's a profit warning today from the UK's largest car dealers. This is rather surprising, since brokers were upgrading forecasts as recently as August, on the back on strong H1 results. So this suggests a fairly nasty slowdown in H2.

It says that underlying profits for 2017 will now be about £60m. It did £48m adjusted profit in H1, so that suggests only £12m profit in H2. The latest forecast I have from one broker suggests £71.1m adjusted PBT in 2017. So today's company forecast of £60m is a 15.6m shortfall - all of which has occurred in H2 remember - so annualised, it suggests a steeper fall in profits.

Reasons given for the profit shortfall are - declining new car sales, and a fall in used car prices. I suppose this was bound to happen, due to the boom in car sales in recent years. Furthermore, weaker sterling has increased prices, and there's no doubt that consumer confidence has weakened this year. So perhaps people are less inclined to make big ticket purchases? Although given that most private cars are now not bought, but are leased, then I question whether car purchases really are big ticket items any more? After all, if you can lease a brand new Audi A4 for £179 per month, and a car is essential for you, then would you really worry about signing on the dotted line? Also, a new car means little servicing or repair costs, so there's a strong argument for driving a brand new car, as opposed to a more thirsty & unreliable cheap older car.

Strategic review - whenever those words are mentioned by a company, I wince. It usually means there are some kind of structural problems. That in turn usually means exceptional costs, and a period of time for the business to be re-shaped, which in turn usually means a soft share price, at least in the short term.

A lot of detail is given, which I won't repeat here. In brief though, the company wants to focus more on online - sounds sensible - why has it taken them so long, one might ask? Also they're not going to continue expansion in the USA. Plus it sounds as if the company is going to close some UK franchises, if manufacturers don't give them a more profitable & stable deal.

My opinion - I've mentioned car dealers here before, as looking very attractive on low PERs, and with good tangible asset backing. However, my overriding fear was that it looked as if we had passed peak earnings, with declines more likely. That is borne out by today's statement from PDG. It is likely to have read-across for other car dealers too, so I'm surprised that competitors' shares haven't been harder hit today.

I can't see any reason to start buying shares in this sector right now. Although I might sharpen my pencil, and go through all the numbers again. PDG indicates that it expects profit growth in 2018, so who knows, there could be an opportunity at some point to buy these shares at a bargain price. I'm just not yet convinced that we're at that point yet. Although nobody ever rings a bell at the bottom, so who knows?

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Trakm8 Holdings (LON:TRAK)

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

Trading update - this is a small telematics company - serving the fleet, and insurance sectors.

In my opinion the company has come in for some justified, but exaggerated criticism in the last couple of years. That has mainly been over lack of cash generation - not uncommon at smaller, growth companies. However the lack of cash generation at TRAK is in stark contrast with competitor Quartix Holdings (LON:QTX) which is highly cash generative.

This is reassuring;

Trakm8 is pleased to report that trading in the first six months of the current financial year commencing 1 April 2017 has started satisfactorily and is in line with market expectations for the year as a whole.

Nice and clearly worded - take note PRs and brokers! If the updates you write don't contain similar words to the above, then they're not much use to investors. All we need to know is how the company is trading vs market expectations.

I also like the specific detail given, e.g.;

Revenues continue to gain momentum, up 12% year on year to £14.74m (2016: £13.18m). This like-for-like increase represents a strong growth in the continuing business activities of 24%, taking into account a revenue reduction of £1.02m due to the planned exit from the lower margin CEM activities made during the period.

Although I note that a lot of the increase seems to have come from the insurance market. A sector expert briefed me on this a while ago, explaining that insurance telematics is not attractive business. The reason being that drivers who use telematics devices on their cars at the behest of their insurance company are usually young drivers, who are forced to do so. The main risk is in a new driver's first year of driving. So if they have an unblemished record at the end of year 1, they can then rip out the telematics box, and get a normal insurance policy. Hence why, with little recurring revenues, this is not very good business for telematics companies. Fleet business is the attractive stuff, as it has much longer recurring revenues.

Net debt - there has also been criticism from bears about the cash/debt position, and trend. This sounds rather more encouraging today;

Net debt significantly reduced during the period to £2.31m* as at the end of September, a £1.56m improvement since the start of the financial year (H1 2016/17: £4.40m), (FY 2016/17: £3.87m). Cash amounted to £2.72m and the available undrawn revolving credit facility has increased to £3.70m.

*Net debt is defined as cash (£2.72m) less bank and hire purchase debt (£5.03m).

Mind you, remember that the company raised £2.1m in fresh equity in Mar 2017. Although that was just before the start of the new financial year. So the reduction in net debt of £1.56m since 1 Apr 2017 does sound genuine.

Anyway, it looks as if the company has plenty of headroom, since it has an undrawn borrowing facility available, plus cash of £2.72m. That looks very comfortable, so any worries about solvency have now disappeared.

My opinion - Stocko shows broker consensus of 7.23p EPS for this year (ending 03/2018).

The shares are up nicely today, to 102p. So the PER is 14.1 - which looks good value to me, considering that the company now appears to be recovering well from a previous patch of poor trading. That poor trading was caused by over-runs in cost & timing of new product development, and straightforward failure to achieve sales targets. I don't believe there was anything more seriously wrong with the company.

So who knows, we could now see a decent recovery perhaps? Although I'd like to see the next set of numbers before being 100% convinced that everything is alright.

Incidentally, this share is horribly illiquid - I put a buy order in just before the opening bell, prepared to pay the full market offer price, but was turned away. So the trouble with trying to be clever, and trading in & out of shares like this, is that you often can't buy or sell in any size when you want to - liquidity dries up whenever good or bad news is published, because the market makers typically don't hold any stock. So the liquidity only really comes when there is a balance of buyers & sellers, on no news days.

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Right, I have to dash now. Ed's told me that I need to be smartly dressed, as they want to take some updated photos!

Regards, Paul.