Small Cap Value Report (Thu 10 Aug 2017) - SIV, DFS, TCM

Good morning!

I had a discussion with our Graham yesterday. We both agreed that readers clearly want more prompt reports from us. So we're going to experiment with the format, and aim to get our reports up much earlier in the day. So it might take the format of an initial quick review, then some more detailed stuff (which takes longer to research) later, each day.

We've got a bit sloppy, so it's time to pull up our socks! Although I don't really like rushing to get things out, as that increases the likelihood of mistakes slipping through.

In case you missed it, yesterday's completed report included sections on - Telit (TCM), Tasty (TAST), SCS, and Water Intelligence (WATR) - here's the link for that.

So here are today's quick fire comments from me;

ST Ives (LON:SIV)

Probably the most interesting update that I've read so far today. This marketing company updates us today on the year ended 28 Jul 2017. The key bit says;

The board reports that the overall results for the year are expected to be at the top end of the range of current market expectations.

Stockopedia shows consensus of 12.9p EPS. At the time of writing, the ungodly hour of 08:20, the share price is currently up 12.6% to 61.4p. That puts SIV on a PER of only 4.8 - strikingly cheap.

However, bear in mind that this company has a lot of debt, and a pension deficit. Its balance sheet is very weak - as I explained here when reviewing its figures after a profit warning in Jan 2017.

Bear in mind also that forecasts for this year were reduced considerably after that profit warning, so hitting the top end of forecasts is actually still a performance well below recent years' previous results.

Note that there have been some property disposals of £9.9m, to improve the net debt position. Also that agreement has been reached on pension contributions - at £3.8m in the new financial year, and £3.0m p.a. thereafter. That is an increase from £2.4m p.a. previously. So a fairly hefty drain on cashflow, with money that could otherwise have been paid out in divis. This needs to be factored into your valuation of the company, as a negative.

Overall, whilst I don't like the weak balance sheet here, I think this share could possibly have scope to increase further, now that trading seems to be stabilising.

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DFS Furniture (LON:DFS)

Share price: 214.75p (down 6.8% at 08:40)
No. shares: 211.5m
Market cap: £454.2m

Pre-close trading update - I mentioned this furniture retailer in passing yesterday, when reporting on lower-priced competitor, SCS.

You might recall that DFS warned on profits in Jun 2017, which I reported on here. Re-reading that, to refresh my memory, the stand-out point about DFS is that it has a diabolical balance sheet. So considerable caution is needed when looking at this share. NTAV is negative £242.9m! How is that possible, let alone legal? I don't think companies should be allowed to list on the stock market unless they have positive NTAV.

Mind you, we've seen with some other companies, e.g. Wincanton (LON:WIN) that in certain sectors, favourable cashflows (where customers pay up-front, before creditors fall due) can sustain a terrible balance sheet indefinitely. Furniture retail possibly falls into that category, although it's worryingly cyclical - making it quite likely that badly financed furniture retailers quite often end up going bust in recessions.

It sounds as if trading is still difficult, but perked up a bit in July;

As announced in June, revenue in the second half has been weaker than we expected owing to significant declines in store footfall and customer orders across April, May and June. We believe this to be an industry-wide issue, resulting from the uncertain economic environment and unexpected general election, exacerbated by warm weather in May and June. Our summer sale, however, started satisfactorily in July, consistent with trends we have seen in offline and online sector indicators.

Helpfully, the company quantifies what full year results will look like;

Overall, Group revenues for the second half were 4% lower than the prior year, following an increase of 7% in the first half, to deliver growth of 1% over the year as a whole.

Consequently, EBITDA for the year will be at the low end of the £82-£87m range previously given, with revenue impacts being partly offset by cost flexibility and the early benefits of operating efficiency initiatives.

Looking back to the update in Jun 2017, that update also mentioned an EBITDA range of £82-87m, i.e. the same range given today. So things haven't got worse - it's just that the company is at the lower end of that range. That's not too bad in my view.

Outlook comments - sound mixed;

Positive long-term prospects despite a currently very challenging market.   
While the UK furniture market is currently very challenging with the outlook still uncertain, we remain focused on our growth strategy to deliver substantial long-term returns for our shareholders.

Although revenue growth is likely to be harder to achieve in the short term than in the recent past, we have identified opportunities to drive operating efficiencies and product margin growth.

As announced on 3 August 2017, our refinancing on more favourable terms will also deliver an annual saving of approximately £1m in the cost of the Group's debt financing.

There are also some positive-sounding initiatives, such as the recent aqcuisition of Sofology's 37 stores, and a forthcoming "Joules" branded collection.

My opinion - for me, the awful balance sheet is a deal-breaker, and makes this share uninvestable. That's a pity, as it looks an OK business. As currently structured though, I think it might struggle to survive a recession - because the business is too reliant on bank debt, and customer deposits.

That said, it generates much higher operating profit margins that SCS. So in that respect, it's a much better quality business than SCS, albeit with a badly structured balance sheet.

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Telit Communications (LON:TCM)

Just a quick comment on this highly controversial situation.

I had a fascinating email exchange yesterday with a reader who is a senior executive at an electronics company (verified by me), which happens to buy product from TCM. This is the gist of what he said;

• Telit's products are good, and its engineering support to customers is excellent.
• There's a lot of investor interest in internet-of-things, but the profits are not going to be made by component manufacturers. It's the end products, which add value to customers, where the profit margins are.
• Telit's cashflow is indeed poor, so at some point they need to demonstrate the ability to generate decent cashflow.
• Shares could have another leg down, in his view, before recovering.

So overall, I think these interesting comments make me feel less bearish about the share. Although my feeling is that the CEO is likely to be hung out to dry, if the allegations of property fraud years ago, turn out to be true. That could then lead to a kitchen-sinking of the accounts - which the market might end up seeing positively, after an initial plunge?

Are the bank likely to pull the plug? Probably not, is my inkling, but we don't know. If the allegations are true, then I think it will need a thorough clear-out of management, and a full confession of everything that's wrong in the accounts, moving to more prudent accounting, to reassure investors.

So there could be more bad news to come, is my gut feel. However, I'm growing more sceptical about the likelihood of the shares going to zero, as there does seem to be a proper business here, with decent products. Anyway, time will tell. It's far too risky to go long, in my view, at this stage.

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I'm having a rest now, and will write some more after lunch. This early start really has not agreed with me lol!!