Small Cap Value Report (Mon 3 Jun 2019) - LGRS, CAR, SCPA

Good morning, it's Paul here.

There's very little of interest to me on the RNS today, so no pre-8am comments today. Other than this;

Scapa (LON:SCPA) - expect a fall in share price today, as it announces a big contract loss in USA, and what looks like legal action by the customer. Loss of profit not yet quantified, to follow.

Argo Blockchain (LON:ARB) - increased in bitcoin price recently has boosted performance for this crypto mining company. Doesn't interest me.

KCOM (LON:KCOM) - a higher takeover bid has appeared.

Ah, I've just noticed that I've duplicated MrContrarian's work (see comments below), which I hadn't noticed when writing the above snippets.

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Loungers (LON:LGRS)

Share price: 220p
No. shares: 92.5m
Market cap: £203.5m

My video review of AIM admission document

It's quiet for results today, so you might want to check out my new video showing how I research an AIM Admission Document. This was a project that I embarked on last week, when Graham covered the report writing here.

Loungers is an interesting new float, on AIM. It operates a rapidly expanding chain of bar/cafe/restaurant hybrid sites across the UK. Therefore I'm interested in comparing its performance and valuation with Revolution Bars (LON:RBG) (in which I hold a long position). They're not direct competitors, as RBG is more focused on late night trade.

After studying its AIM admission document, my project was to review it on video. The purpose of my video is to encourage investors to read admission documents, who are perhaps too daunted by their sheer size (130 pages in this case), and the apparent complexity.

 This video is 36 minutes long, and covers my thoughts on about half of the admission document. If people find it useful, I will record a part 2 video this week. Please don't share this link elsewhere, as I'd like this to be for Stockopedia readers - since a small element of your subscriptions are paid to me in fees.

The format didn't quite work - in that I had hoped the text would be legible, but unfortunately the video compression has put paid to that. Although if you go into settings on youtube, and increase it to the maximum resolution of 480, then it's clearer. The idea is that you can open the admission document yourself on another screen, then pause the video, and follow what I'm saying. Anyway, let me know what you think, no rush.

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Carclo (LON:CAR)

Share price: 29.5p (down 8% today, at 08:20)
No. shares: 73.4m
Market cap: £21.7m

Change of results announcement date

Carclo plc ("Carclo" or the "Group"), a global manufacturer of fine tolerance injection moulded plastic parts mainly for the medical, automotive lighting and optics markets...

The last trading update from Carclo was here on 17 April 2019. It refers to full year results for FY 03/2019 being due for release in June 2019. Today, the company says this has been pushed back to 23 July 2019.

I don't like the sound of this update today;

Discussions are continuing, both with customers to strengthen the financial and operational position of Wipac, and with our bank in relation to the refinancing of the Group's borrowing facilities due to mature in March 2020. As part of these discussions, the March net debt to EBITDA banking covenant test has been deferred by the bank until 30 June 2019.

The group is clearly in a precarious financial position, which rules it out for me.

Although as I mentioned in Jan 2019 here, it does seem to have freehold property on the balance sheet, which tends to make banks more comfortable, as it's such good security.

My opinion - far too risky for me to consider buying any shares.

It's not just that the group has had a catalogue of operational problems, but also that the bank facilities need renewing, and it looks like there's a problem with the bank covenant(s) too.

Therefore there's a heightened risk that the group might need to do a fundraising (resulting in dilution), or worse still that the bank might pull the plug. That's very rare for listed companies, but it can happen. Why take the risk?

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Scapa (LON:SCPA)

Share price: 155p (down 47% today, at 11:22)
No. shares: 154.7m
Market cap: £239.8m

Notice of termination of material contract (profit warning)

I mentioned this earlier in today's report. It's clearly a negative announcement, but I didn't expect the share price to crash 46% in response, as it has at the time of writing. I'll take a closer look, to see if this might be a buying opportunity - as I'd always thought Scapa looked a decent quality company. I can't remember much about it, so am doing some background research first before writing more about it.

Having a quick skim of the last results, for FY 03/2019, adjusted EPS was 18.9p.

Balance sheet as at 31 Mar 2019 looks adequate, rather than strong, with NTAV of £20.3m.

Debt rose considerably last year, due to an acquisition. There's a pension deficit of £8.4m.

Overall then, it looks a fundamentally sound group.

This is what Scapa said today;

Notice of Termination of Material Contract
Scapa Group plc (AIM: SCPA) announces that on Friday 31 May after the market closed, Scapa received notice from ConvaTec Inc. (ConvaTec) that it was terminating the Master Supply Agreement (MSA) with Scapa Tapes North America LLC; accompanying the notice was an action for a declaratory judgment concerning the MSA filed by ConvaTec in federal court in New Jersey.

Neither the Company nor Scapa Tapes North America LLC accept that ConvaTec has any grounds to terminate the five year supply agreement in respect of which a three year term remains, nor to pursue its declaratory judgment claim.  The Company and Scapa Tapes North America LLC have instructed external legal counsel and will strongly contest and defend their rights under the MSA and in response to the New Jersey action in which it will assert and pursue all appropriate rights and remedies.

The MSA provides for a binding contractual commitment for a minimum circa. US$30m of revenue per annum.

The Company is assessing the potential profit implications and will issue a further update accordingly.

It's immediately obvious that we don't have anywhere near enough information to assess what the impact on future profit might be. My thoughts are;

Who are ConvaTec? What is there financial situation? A broker update out today (available on Research Tree) says that ConvaTec is a key healthcare customer, and is experiencing (unspecified) difficulties.

Litigation in the USA can be very expensive, so if Scapa fights, and loses, its case, then who knows what the liabilities could be?

The loss of $30m revenues per annum would have an operationally geared impact on the bottom line. This is also just the minimum contract annual amounts. What are the actual revenues from this contract? We're not told.

My opinion - this savage market reaction today might be a buying opportunity possibly, as this seems a fundamentally good business. However, we don't have anywhere near enough information to make a rational judgement.

The broker note points to at least a 10% downgrade to forecasts, but they are awaiting more information. Does this justify a near halving of the share price today? It seems an extreme reaction. I am tempted to have a small, speculative punt on this one. There again, catching a falling knife has been a consistently losing strategy for me over the years. So readers who try to talk me out of this idea are probably doing me a favour!

What are your views? I'd be very interested to hear them in the comments below.

When it comes to profit warnings, I like situations where the problem is a one-off, fixable issue. This might possibly fall into that category maybe?

EDIT: trying to put some numbers to this. Existing forecast for FY 03/2020 is 22.6p adj. EPS.

Let's drop that by say 20%, arriving at c.18p possible revised forecast. At 155p current share price, that's a PER of 8.6 - which looks quite good value.

Upside case - the share price might re-rate to a PER of say 12-13 over time, if the earnings hit is no worse than 20%. That implies c.40% upside from 155p.

Downside case - earnings might take a bigger hit than I've estimated, with a legal can of worms, another profit warning, and hence maybe another 30-40% downside on the share price.

Therefore, it could go either way. We don't have enough information to judge. Therefore it would just be a punt at the moment.  End of edit.

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Sorry, I didn't get around to looking at Kier (LON:KIE) as I thought it was more important to finish reading the Loungers (LON:LGRS) admission document, and to further research Scapa (LON:SCPA) - which I think could be a possibly interesting buying opportunity. So I've been reading the last results & the last annual report.

See you tomorrow.

Regards, Paul.