Small Cap Value Report (Mon 30 Apr 2018) - SBRY/ASDA, UPGS, LUCE, IGE, REDS, SND

30th Apr '18 by Graham Neary

36 comments 24066 reads

Good morning! I’m back home after a truly fantastic week which culminated in the Mello 2018 conference in Derby. Congratulations to all the organisers of this event, particularly David. I can only imagine how much work was involved behind the scenes.

Monday morning news is plentiful:

J Sainsbury (LON:SBRY) - full-year results, plus a proposed combination with ASDA (owned by US:WMT)
UP Global Sourcing Holdings (LON:UPGS) - interim results
Luceco (LON:LUCE) - final results
World Careers Network (LON:WOR) - half year results

We also have trading updates from:

Redstoneconnect (LON:REDS)
Sanderson (LON:SND)

Edit; I elected to cover Image Scan Holdings (LON:IGE), instead of World Careers Network (LON:WOR), in response to a reader suggestion.

J Sainsbury (LON:SBRY)

Share price: 310p (+15%)
No. of shares: 2189 million
Market cap: 6,786 million

Full year results

Combination of J Sainsbury & ASDA

Results highlights look fine, overall. And the profit expectation for 2018/2019 is in line with expectations.

Underlying profit before tax increases by 1.4% to £589 million. Guidance for next year is £629 million.

Incidentally, these (unaudited) results are for the 52 weeks ending 10 March. We should reward companies who report in a prompt manner - much better than being kept in the dark for several months.

Despite the positives, note that return on capital employed has fallen slightly, from 8.8% to 8.4%, by the company's own measurements.

By Stockopedia's measurement, return on capital is lower than this:

Supermarkets don't seem to have a great track record when it comes to generating attractive returns on capital.

One of Terry Smith's best articles, in my opinion, was written in 2014 for the Financial Times on the subject of Tesco (LON:TSCO), and why he would never own shares in it. He includes the following chart:

This return on capital metric can be measured in different ways, but…

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H1 15

H2 15

H1 16

H2 16

H1 17

H2 17

H1 18

Order Intake

1.0

0.9

1.3

3.0

1.3

3.1*

2.0

xxx

30th Apr '18

Graham, I would be interested to hear your take on Lse: Reds.
They were several weeks late in producing the trading update and the figures are heavily adjusted...

Ben1

Second request for your views on IGE Image Scan Holdings please

LE4R

Good scuttlebutt Muzmanoz

nicobos

Graham - interesting views on J Sainsbury (LON:SBRY).

I concur that ROCE is poor in the sector and have not looked like improving any time soon. Sainsbury and Tesco have historically had very large freehold real estate footprints, so much so that they can be viewed more as property companies with a grocer on top! To this extent, you should really be expecting 'Utility' like returns from the sector.

This model worked well when Tesco was rapidly expanding (as Walmart did in the US) into white space and growing market share significantly at the same time from sub 15% to >30% which was an amazing achievement (and scale meant purchasing synergies etc which led to higher margins and increased profitability).

Now the market is saturated and suffering from competition from discounters and the internet, with such low margins, the realisation has dawned that their real-estate footprints are potentially too large to generate decent returns on capital.

There have been many attempts in the past to try and split these companies in to a 'Property' arm and 'Operating Company' to solve exactly this problem. The real estate arm can offer pension funds inflation linked rental yield whilst capital has been freed up from the Operating Company to invest in growth (Capex) or alternatively return capital to shareholders.

dscollard

re Redstoneconnect (LON:REDS)
altho their figures are always heavily adjusted and so are internally consistent and therefore comparable year on year... and directionally improving.

Can't really tell until they publish results so probably premature in trying to soothsay based on a few topline and adjusted numbers. My view is the TU was a rushed triage against the SP decline of late, it seems to have stemmed the haemorrhaging.

As for why they were late.... desperately trying to close business? a bit incompetent on comms? Trying to hold-out while attempting to close a deal? Who knows..... but full results will again give some insight: I am holding until I see more detail though longer term I am bullish on this opportunity space and £REDS' offerings. It just might be a bumpy road.

For now Mr Market seems to be giving the benefit of the doubt ...

Graham Neary

Have covered Image Scan Holdings (LON:IGE) - thanks, that was worth covering. G

Thanks for sharing your views on Redstoneconnect (LON:REDS), I've covered them now, too. G

mojomogoz

UP Global Sourcing Holdings (LON:UPGS) brands seem to be quite well represented in B&M stores still. I can't benchmark the volume of representation compared to x mths/yrs ago.

Perhaps Goodman have replaced them on bigger ticket electricals - dunno. I notice Sainsbury have been carrying things like hoovers from UPGS.

Beldray is their biggest inhouse home items. B&M ain't carry many electrical items from Beldray but they do have 70 altogether - https://www.bmstores.co.uk/brands/beldray/sort/datehigh/items/60 - overall seem quite good in that small low cost stuff that you need to fill out shelves with. Probably move quite quick and even if they don't they don't set back B&M much on outlay so as long as UPGS keeps prices down it gets repeat custom and less margin pressure than on bigger ticket stuff that doesn't sell so easily/quickly or the store get unhappy about not being able to shift.

Another inhouse electronics brand Intempo has 33 items - https://www.bmstores.co.uk/brands/beldray/sort/datehigh/items/60 - again a lot of small cost shelf fillers.

35 for George Wilkinson - https://www.bmstores.co.uk/brands/george-wilkinson/sort/datehigh/items/36

61 for Russell Hobbs with heavy skew to UPGS products (they don't have license all the UK lines) - https://www.bmstores.co.uk/brands/russell-hobbs/sort/datehigh/items/60/page/1

7 for Doddie Foreman - https://www.bmstores.co.uk/brands/george-foreman

They're always a bit vulnerable as they don't have supply agreements with customers...but as long as they are adaptable that probably means that they get to keep margin more than Goodman who have struck a volume deal with the devil :)

I'm a holder at price average of c.35p so I have an interest. UPGS seem to have the right business strategy and I think I'll get well paid for holding including dividends that will pay back a large proportion of that price over a few years.

Graham talks about how they have struggled without a recession. The main problem is that they had a massive burst of purchases from B&M and Action to fill shelve space as they expanded quick. They've gone through a cogitation period in the last 6+ months that has coincided with retail pains but still come out with £50m sales suggesting they are running a high base level.

There's a lot of uncertainty and opaqueness around the business model as such a recent IPO...and a lot of disgruntled and burnt investors. But from here this is a good investment IMO. They're showing they can handle short term headwinds.

Good write-up Graham: I reread my notes from my original analysis having read your write-up. Sometimes negative price action can cause one to become moribund: there are a lot of positives though the market currently seems to be either unconvinced or just not noticing.

A good catalyst is indeed needed: personally I would prefer if that was more on the demand side rather than financial engineering or returning cash as a divi.

Like you say, the margins are low, Redstoneconnect (LON:REDS) operates as a Systems Integrator (SI), Managed Services (MS) provider and a Software Apps(SA) vendor: a lot of the SI work literally involves fitting and cabling buildings with mobile hardware, screens, connectivity (as an e.g. Tottenham Hotspur's new stadium) . The margins vary across the sales mix with much higher margins from the MS and SA stacks: what will be interesting in the final results is to see how revenues have grown in the higher margin areas and whether Redstoneconnect (LON:REDS) is migrating from being cable monkeys to true smart environment operators, I suspect a lot of the MS revenues are in traditional IT data centre and desktop support roles.

They do have a very compelling mix of expertise, experience and products across the value chain. They also have a good footprint in blue chip clients with office space management solutions for Warburg and GSK using their OneSpace space management solution. That they seem to be retaining and growing these clients is testament to their offerings and delivery capability . They also recently bought AV specialists Anders+Kern to add to their offerings mix in smart environments and facilities management which complement their energy and HV management solutions.

In the absence of a compelling catalyst or more analysts coverage, it looks like a slow burn for the foreseeable and one for the bottom drawer .. or an acquisition potentially by a partner such as HPE

ricky65

herbie, I often sell before my stop loss is hit. The point I was making is that my stop loss saved me from a large loss in that instance.

ACounsell

A little bit of a generalisation I would suggest to draw this conclusion from the experience of one stock. For my version of Ed's NAPS I did have a automatic stop loss in place, based on Stockopedia calculation of volatility (Conservative/Balanced @ 15%, Speculative/Adventurous @ 20%, and year to date 3 out of the 4 shares have rebounded to significantly higher level - check the charts for the evidence. The stocks were Ab Dynamics (LON:ABDP) (now dropped back to only a 3% gain but did go much higher), Character (LON:CCT) (+19.5% since stop loss sale), Computacenter (LON:CCC) (+26% since stop loss sale) and the only 'success' Headlam (LON:HEAD) (-7.3% since stop loss sale). Consequently I'm not laughing and have reverted to using judgement if a stock reaches my stop loss alert - which has happened quite a number of times YTD and in most of these cases the shares have recovered to well above the stop loss. Consequently I don't share your view that stop losses work.

I didn't mean to offend anyone with my original comment. If it makes you feel any better, I've been stopped out of stocks loads of times and had them come right back up. That's trading! Stop loss protection is about protecting my portfolio from a major drawdown, or worse financial ruin; it’s an insurance policy. It no longer bothers me if my stop is hit. I'm not bothered about being 'right', my goal is to make money whilst limiting my downside risk. I don't have any control on whether the trade is going to be a winner or a loser!

You didn't mention re-entering any of the stocks where you were stopped out on. If I'm stopped out and the stock is good, it will almost always provide another entry point (I'll give it up to 3 attempts).

I don't conclude that stop losses work from the experience of one stock. It's from years of experience trading, and reading about other successful traders who use stops such as Minervini, and most importantly, the math.

In my experience, if you're getting stopped out repeatedly then at least one of three things are wrong:
1. Your entry criteria is flawed.
2. You are setting your stops too tight.
3. The general market is poor.

For those shares where you got stopped out and they rebounded, if you provide the buy dates, buy prices, and stop loss prices, I'll be happy to give my opinion.

Ricky

ken mitchell

Whatever works works, but fwiw a proven way to invest successfully is to buy quality and hold long term unless bad news. That’s the approach of the first ISA millionaire and VERY successful investor John Lee. Also dividends in time provide massive income and sometimes more each year than the original stake invested! Almost impossible to lose on an investment paying 100% or more dividend every year, and often with dividend increase every year too.

Trading may also work for some, but many of the shares I sold on stop losses, or simply because wanting the money so as to invest in something better, have since multi bagged.

Gromley

I had Image Scan Holdings (LON:IGE) on my watchlist for a possible re-entry having sold after the luke-warm December trading update which preceded the profits warning.

Their H1 performance was better than one may have expected immediately following the profits warning, although they are only "confident of meeting market expectations for the year" these were marked down significantly following the warning.

I find myself uncomfortable with the narrative in several places, which to my cynical eye reads a bit like mis-direction.

Revenues for the six months ended 31 March 2018 were £2.0m (2017: £2.1m). This revenue performance was achieved despite the loss of a £1m contract, 50% of which had been scheduled for delivery in the period.

Which infers that growth would have been 20% rather than a decline of 5%, if it were not for the cancelled order.

Except that, they will have booked the cancellation fee and have resold all of the units to other customers (quite probably at a markdown to shift them), so how much impact did this really have on the top line?

Order intake increased by 54% to £2.0m (2017: £1.3m)

Indeed it did, but is that actually 54% growth? I'm not so sure. I cannot think of a reason that their order intake should be particularly seasonal (not being an expert in this industry I could be wrong) and although H2 order intake has been significantly higher than H1 in the last two years, I think that may reflect the "lumpiness" of the business rather than a seasonal trend.

The Half year numbers for the last three years are as follows

	H1 15	H2 15	H1 16	H2 16	H1 17	H2 17	H1 18
Order Intake	1.0	0.9	1.3	3.0	1.3	3.1*	2.0

* H2 17 Excludes the £1m order subsequently cancelled.

Unless I am wrong and the business is significantly seasonal, then it seems to me that order intake is down (despite including they sell off of the surplus units). Given the lumpy nature of the business that may not be a disaster, but it is in sharp contrast to a 54% increase.

The Company finished the period with an order book of £1.1m (2017: £940k) and a cash balance of £752k (2017: £469k)

With reference to the previous point, note that the order book (ie the orders yet to be fulfilled) is only up a more modest 17%. In fact though, the item that really struck me was the impressive increase in cash.

That cash increase, however is misleading if taken out of context (as I believe it is in the above statement).

In H2 last year the raised £527k in a placing (at the time they said is was £525k gross and there is no clue as to the small anomaly.) Reviewing the cash flow, we actually see a net outflow of £501k, which admittedly is a small improvement on the £586k outflow in H1 the prior year.

I'm more minded to see that they started the 6 months with £1.25m and they now have only £0.75m left. Now they did generate £0.25m of cash (excluding the placing) in H2 last year. Going back to my earlier point unless the business is indeed significantly seasonal, the a positive cash flow in H2 is far from nailed on and indeed taking the negative view they may only have 3 quarters worth of cash left.

I may of course be being overly negative in all of this, but it does feel as though we are being subtly guided away from negative thoughts.

The kicker for me though is that the investment hypothesis here is the potential "game-changing" growth from "high demand for threat detection systems world-wide" ; however I note that the company prefaces that phrase with the word "continuing". That signals to me that the good time are already here, so where is the growth to come from?

If one is to take on the inherent risks of investing in a minnow like this then I think a degree of confidence in substantial upside is needed and I sadly I do not really see this now.

From what I have read on Image Scan Holdings (LON:IGE) I do like the company, but I do not like the risk reward from an investment perspective. Graham points out the low Stock Rank and the Stocko style is currently "value trap" but unless they significantly over-achieve in H2 I think this will become a "sucker stock".

I'd love to be proven wrong (and will keep this on the watchlist for that reason). I know that Image Scan Holdings (LON:IGE) were at Mello, can anyone who spoke to them there lift my gloomy view?

Colins2

1st May '18

I think the point that Ricky65 is making is that we are told by certain pundits that stop losses will only lose you money in the long run. That presupposes that we are able to monitor the markets at all times. Unlike those pundits, I am not able to do that and so am grateful to be able to use stop losses myself.

No offence taken just reflecting on my different experience with stop losses! Your point about downside protection and using stop losses as an insurance policy is well made and that was my original intention. I would have liked to get back into Computacenter (LON:CCC) and Character (LON:CCT) but they never really dipped again after the fall that triggered the stop loss. My stop loss (using a trailing stop loss) was set at 15% and 20% respectively for these two shares so I would hope these weren't particularly tight. As another example of why I am wary of automatic stop losses yesterday my alert on Stock Spirits (LON:STCK) (another with a 20% trailing stop) was triggered at 250.4 which would have stopped me out only to see it rebound by over 9% today! Maybe for long term holding is a better strategy than a trading one as somebody suggested in a previous post.

ed_miller

4th May '18

Re: Use of stop-losses for illiquid stocks - advice please!

I'm sold on the advantages of stop-losses (e.g. initial 10% stops widening as share price rises) and selling when the major up-trend appears to have broken down, but the reality of my trading experiences with illiquid stocks have been very much akin to ACounsell's and incline me to reverting to buying-and-holding only the best-quality micro-caps and small-caps and topping up upon what I think/hope are temporary set-backs (taking a business-owner's philosophy).

Do you have any advice for better execution with illiquid stocks please, Ricky? Do you have to use a traditional broker, or direct market access?

Regards,

Hi Ed,

I prefer market caps > £50M. Occasionally I will drop to say £30M or less if I think the stock is compelling. I only take small positions in microcaps as liquidity can dry up on profit warnings and you may have difficulty getting out.

Some microcaps are just too volatile for me, so I pass. Some of them can retrace 30% or more during a long term uptrend (something like Learning Technologies (LON:LTG) comes to mind). I’m not a fan of widening stop losses for micro caps. For some small and micro caps, I may give it up to 15%. In the past I used to go up to 25%. I think that’s a mistake as losses work geometrically against you. For example, a 15% stop loss requires 17.6% gain to breakeven, 25% stop loss requires 33.3% gain to breakeven. If I think a stock is so volatile that a 25% stop would have to be used to prevent me from being whipsawed out, the trade simply isn’t on for me. I'm not going to place a trade if I don't think I can manage my risk on it.

I place automated stops with my broker (Halifax). I’ve never used direct market access so I can’t comment on it.

Hope that helps

Rick

Re: Use of stop-losses & volatility in small-caps

Thanks Ricky. I've found high volatility in anything with a market cap of less than about £150M particularly expensive, made worse because of the large spreads. As you suggest, I think I'll need to pay more attention to the level of volatility in anything small, before I buy it. A brutal spike down in the price of Adept Telecom (LON:ADT) pushed me to sell on 15th January, thinking it was too vicious to be an MM 'tree shake'. It proved to be presumably just that, since it was ever so fleeting. I should have been looking back just a little further on the SP chart since it experienced a similar brutal but fleeting spike down on 22nd November. Clearly, I need to be much more on the ball if I am to take an active approach with small-caps - so far, my efforts to protect my downside and maximise my upside with them have been cack-handed, bungling and counter-productive!

Even if I manage to avoid those school-boy errors, I find illiquidity when trying to buy or sell in a hurry in response to news a real problem. Though I'm far from being a high-roller on the scale of Scott/ Stredder/ Boros, I'm not just getting started either, so I find attempts to quickly transact in any size from three or more times NMS a real problem. Paying for Level 2 data has helped a bit. I hope later this year I'll be able to get direct market access and I think that will help a bit more. I'm holding off using a traditional broker for the small stuff because I feel my usual transaction size is still a little on the small side to make me feel relaxed about the high fixed charges (on top of the percentage commission charges, which I think you get back through obtaining improved price and execution), and because I'm used to jumping online and transacting upon market opening in response to 7am news. As I say, I find execution ever so tricky in small stocks, and the prices one gets usually from discount online brokers poor to woeful, but thanks again for your tips and your views on trading small-caps.

Nick Ray

If you want to avoid stop losses taking you out on a temporary droop in a general uptrend you should probably set a trailing stop no closer than the "1yr Volatility" as quoted by Stockopedia, so typically in the range -30% to -50%.

The trouble with selling on a fall is that it builds in a negative bias. The opposite is to sell into a price rise. So a top-slice at a price rise equal to the "1yr Volatility" will build in a small positive bias while not taking you completely out of the stock. (This is also a simple volatility harvesting approach if combined with a regular rebalancing of the whole portfolio.)

Small Cap Value Report (Mon 30 Apr 2018) - SBRY/ASDA, UPGS, LUCE, IGE, REDS, SND

J Sainsbury (LON:SBRY)

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Graham Neary

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