Small Cap Value Report (Thu 2 April 2020) - G4M, BAKK, SAA

2nd Apr '20 by Paul Scott

93 comments 9241 reads

Good morning, it's Paul here with the SCVR for Thursday.

Estimated timings - as you might have gathered, I'm still struggling with fatigue, so can only do roughly 2 hour stints of writing, in between resting. It's currently 13:24, so I'll do another 2 hour stint, should be finished by 15:30. Today's report is now finished - sorry for unreliable timings this week.

Press reports say that a staggering 1 million people in the UK have applied for Universal Credit. I think that's likely to be the tip of the iceberg, as the policy of economic shutdown starts to bite. We're therefore heading for a severe recession. Investors have to decide whether we think this is likely to a V-shaped recession - i.e. short & sharp with a rapid recovery, or something more serious & extended. At this stage, I haven't made up my mind what is more likely. That is one of several factors which makes it so difficult to assess individual shares at the moment. I'm still leaning towards caution, and am generally holding back from buying most things on my watch list, until we have some more clarity.

Gear4Music (LON:G4M)

Share price: 170p (pre market open)
No. shares: 20.9m
Market cap: £35.5m

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

Gear4music (Holdings) plc ("Gear4music" or "the Group"), the largest UK based online retailer of musical instruments and music equipment, announces the following trading update for the financial year ended 31 March 2020, following the announcements made on 23 January 2020 and 18 March 2020.

This company is a rare beacon of light in current grim circumstances;

As a result of the commercial and operational progress we have made during the last 12 months, we now expect profits for the financial year ended 31 March 2020 to be ahead of previous expectations.

It is pleasing to see that the company has adapted, in order to continue trading normally by the sounds of it;

Following the necessary Government restrictions put in place to tackle the spread of COVID-19, we are pleased to say we have been able to quickly reconfigure our operations to ensure that we are keeping our teams safe. This has been due to the huge effort our incredible staff have made during this very challenging time.

The health and safety of our employees and customers has been our…

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Otemple3

2nd Apr '20

Interesting late RNS from Shoe Zone (LON:SHOE):

"The Group has a strong relationship with its lending bank and is in advanced discussions with it with respect to the provision of a new 4 year £10.0 million term loan (the "Term Loan"), to provide it with additional liquidity through the current disruption caused by COVID-19. However, should the Term Loan not be provided, or the proposed quantum of the Term Loan be materially reduced, the Group would need to seek to take further cost saving measures and/or raise additional capital by early May 2020, assuming that the 2019 Final Dividend is cancelled and not paid to Shareholders."

Michael C

Sink the boat? Couldn't do it. It's a lovely boat. The boat will continue to float.

xcity

I've often thought that Shoe Zone (LON:SHOE) could be a really good buy. And could be one for the bounce back. But every time I think that, I find I can't quite understand how they make their money. And that puts me off again.

This recession may well be severe, but there is no reason to believe it's fundamentally different in nature to what has gone before, or that recovery will look dramatically different.

But look at depressions. This is likely to be a depression, according to one or other definition at least. The key is whether there will be a recovery or the whole thing will stumble on. There may be reasons for optimism but also for the reverse. Seems very likely that western governments will seek to purge the vulnerabilities that have become apparent. Increasing resilience will come at a cost in terms of governmental controls as well as efficiency and productivity. Globalism will be under threat which would disrupt the whole of the economic system that has built up over the last thirty years.

brianm

3rd Apr '20

Covid-19 is an enveloped virus. This is why it's relatively easy to kill with disinfectant or alcohol. (break the envelope) I would think that an approach that removes the Capsid & DNA, and possibly Matrix from the centre of the virus, but leaves the rest of the envelope and envelope protein, should easily work. Train the immune system to attack the envelope protein with a vaccine that poses no infection risk (because the virus shell can't replicate without it's capsid and DNA) It's been done before, and imho, could be fast-tracked to be available in 6 to 8 months. If a biotech in China produces a vaccine as quick as Moderna has, I can't see the Chinese version of the FDA waiting 12 - 15 months to look for possible side effects if patients, or "volunteers", are producing T-cell / anti-viral immuno-responsiveness. Such a vaccine would be on the market in 6 or 8 months. On the cure front - a Chinese Biotech is already producing a bio-similar to Remdesivir (which was used against SARS, MERS and Ebola, but hasn't, because of the multi-million $ costs involved in a full FDA Stage 3, been officially fully approved) because they (the Chinese Biotech) think that Remdesivir is a cure

abtan

Hi Brian

A genuine question from a lay person if I may - isn't HIV also an enveloped virus?

As far as I know there is no vaccine for HIV.

Do you know if there is any reason why a vaccine for Covid-19 might be possible when one has not been made for HIV?

Thanks in advance

Paul Scott

4th Apr '20

Re SHOE - you said;

But every time I think that, I find I can't quite understand how they make their money

High gross margins on cheap, China-made shoes. Low overheads from cheap rents & short, flexible leases. Cheap shop-fits. Entrepreneurial management running a tight ship.

Proof of the pudding is prodigious divis in the past.

Regards, Paul.

Hi Tony,

Thanks for your thoughtful message.

To be fair, in times of market turmoil, I do give my general market overview, but am mindful that such comments are really not a particular area of personal expertise. There are many commentators & market participants whose knowledge & experience far exceeds mine.

Hence, I like to generally stick to musing on smaller caps, whilst keeping an eye on the bigger picture.

Having said that, it's fair to say that I was flagging up the potential risk of CV19 here in fairly rigorous terms, in early to mid February, well before most other commentators. It somehow felt a lot more risky & different. Hence why I hedged my own portfolio with some shorts.

Hi Beginner,

A very good point, thanks for flagging. I forgot to mention the FCA investigation in my update on SAA recently - in fact the tab of that RNS is still open on my computer, in the WIP section that was meant to be included in the report earlier this week.

Apologies for my oversight & thanks for flagging it up - great point.

Best wishes, Paul.

Panic buying or stocking up simply didn't occur to me. My view is/was that there's no reason to expect normal supplies of food & other household items to be seriously impacted overall. Hence over-buying by individuals just harms others, who then are not able to buy what they need.

How did reality compare with expectations, for me personally? The main problem was that I came down with CV19 in my London lodgings almost 3 weeks ago. So I had no control over food or other supplies when sick. Everyone in our household was ill, and food just became random & generally low quality. The nearest shop mainly sells booze, sweets, and frozen pizza. So when I was well enough to pop out, I bought junk food. Also, I shouldn't have been drinking any booze, but the pressure of everything that's been going on became too much at times, and we vented with beer & vodka about once per week over the last 3 weeks.

Also, being completely sedentary also results in other problems. Depression, constipation, muscle wasting (so that going up stairs is a struggle). This is all just in 3 weeks. You start to speak & feel a bit like a zombie, it's weird.

P.S. - also loo roll - WTF?! Why would anyone consider this an urgent purchase? I've always thought it is most hygenic to have a quick shower after every pooh. Hence no need for toilet paper at all. After all, if your dog accidentally smears her dirty bottom on your forearm, you don't just wipe it off with a tissue, you properly wash it off with soap & water. People have got their priorities all wrong!

Thanks David. Interesting colour.

Covid-19 is a positive-sense single-stranded RNA virus. As a BetaCoronavirus it has a multi-spike 'crown' of envelope protein. It is unique among known betacoronaviruses in its incorporation of a polybasic cleavage site. It sheds it's DNA load instantly upon successful attaching, so replication is rapid

The HIVs (1 &2) are also a positive-sense single-stranded RNA viruses, but from a different family - the Lentivirus subset of Retroviruses - which have slightly different envelope protein structure, (less spikes), shape, and, especially for HIV2 a different cell target and replication/cell dormant/latent period in/during which, unlike Covid, it can remain dormant in the human body for up to ten years after primary infection; - during this period the virus does not cause symptoms.

Having more envelope protein spikes makes Covid-19, in my book, a better candidate for "removal of DNA" type vaccine approach as described earlier, with a greater remaining amount of envelope protein to target by the immune system. But I could very easily be totally wrong. As I alluded to in the last post, BrightGene in China are making a 'remdesivir', which may shortly prove to be a cure, or treatment at least.

I agree Ken. I don't see any value in comparing this downturn with previous bear markets driven by completely different circumstances. We've never had a total shutdown of large areas of economic activity.

This is totally different to what any of us have experienced. Hence I think great caution is needed.

ken mitchell

Several replies as late as 3.53am Paul. Hope it’s just not being able to sleep and nothing more worrying. Or maybe your continuing coronavirus upsetting normal sleep patterns. Anyway it will be good to hear when you are at last feeling back to normal. You’ve done a great job here, providing so much interesting reading material for us in addition to the Investment angle, and managing to do it while so unwell too.

You’re the only commentator I’ve come across who has made that so obvious point that since there has never been total lockdown before there’s no point with comparing it marketwise with totally different events.

Is another fear that as a result of the shutdown, there will be widespread shortages in all sorts of areas, thanks to whole sectors of the economy at risk of going bust? Could that lead to hyper inflation? Demand way exceeding supply = much higher prices. That would solve the debt problem, but otherwise scary. As are so many of the potential consequences if total shutdown does not end within the next 2 to 3 weeks. Decisions are being made on the hoof, not only in this Country, without much if any thought of the long term economic consequences.

Gromley

Is another fear that as a result of the shutdown, there will be widespread shortages in all sorts of areas, thanks to whole sectors of the economy at risk of going bust? Could that lead to hyper inflation? Demand way exceeding supply = much higher prices. That would solve the debt problem, but otherwise scary.

It is an interesting thought Ken, but I don't personally think it likely to happen to any great extent.

Certainly some businesses will go bust if they haven't got the access to cash to tide them over. However, by and large if demand for their products and services still remains - then their creditors will lose out, but someone will buy their business out of administration and continue to fulfil the demand, but with an improved balance sheet and possibly a streamlined operation.

I suppose if it becomes uneconomic to 'relight' a mothballed factory (or other venture) to supply at the former prices, then this could be inflationary, but I would expect that to be quite limited.

Perhaps there might be some short term supply shortages as facilities come back on line, that might be inflationary in the short term, but I wouldn't really expect that to be a particularly lasting effect.

We might well also expect to see some areas where there is over supply, rationalise especially if there are any behavioural changes. Coffee shops / cafes would be an example imho. I have felt (just from local observation) for some time that there is significant oversupply - I noted a couple of years ago that almost every shop that closed down on my high street, seemed to come back as a cafe. I thought it was a recipe for disaster and indeed some of the new ones and some of the previously well established ones have gone already. If we become a little less keen on mixing, then I suspect some of them won't come back from this crisis.

Thanks for the interesting reply Gromley. I hope you are right and think you probably will be if lockdowns end within the next 3 weeks or so. The hyper inflation fear is if many Companies and their suppliers go bust if these lockdowns last longer. . Then there will be big supply problems ahead.

e.g in the clothes retailing sector. It’s great that Stocko subscribers will have the benefit of Paul Scott’s retail experience and knowledge for informed comment on this. But already there are fears that many of the cheap labour suppliers in Countries like Bangladesh will go bust just on the cancellation of mass orders from the likes of Primark and many others already. Those sources of exceptionally cheap clothes could be gone for a good while.

The effect on the prices we pay could be big as retailers struggle to find supplies.....and that assumes that many of the remaining High Street retailers don’t also go bust. (Online like BOO could thrive and be able to charge a lot more). Add a few similar examples and the need for much higher wages to compensate and clear recipe for serious inflation.

Tackle that via higher interest rates and a generation now thinking near zero rates are the norm will be in for a big shock with their mortgage increases. Add to that huge Government and other debt in so many Countries and it might have to be inflated away. And also need to be part funded with tax increases.....adding further inflationary pressure.

Hope the above thinking IS way out!

timarr

Hi ken

I know it's a horrible time but over 250 years markets have a 100% record of recovering from crises and going on to prosper.

On the specific concern of hyperinflation - it occurs, as you know, when too much money chases too few goods. Personally I doubt that's anything more than a very short-term issue - most people have no savings and the government bailouts are barely covering their expenses. However, should hyperinflation actually happen then the only safe places are gold and equities - we saw this in the Weimar Republic: cash and fixed interest get destroyed.

Of course, a recession is certain. On inflation, again, well chosen stocks are our best protection. In the short-term with interest rates at near zero shares will soar when dividends return. A depression is the only scenario in which shares don't do well and governments are doing the exactly opposite of what happen in the 1930's - it's very unlikely.

On retail. Retail stocks as well as those in leisure, travel, car dealers etc will struggle. It's worth noting that government is covering a lot of their non-discretionary costs but even so the weak will go to the wall. You have to be brave and knowledgeable to seek value in these sectors when basically everything else is either doing OK or will recover on a 2 to 3 year basis. Why even contemplate dabbling there?

I note that Keith Ashworth-Lord, lamenting the recent performance of the Buffettology fund, has this to say:

“I fear that both Revolution Bars (Revolution Bars (LON:RBG)) and Restaurant Group (Restaurant (LON:RTN)) need a large equity raise and bank forbearance to survive. What remains of the holding of the former represents only 0.11% of the portfolio. The older I get, the less enamoured with consumer-facing businesses I become.”

Why bother?

On the very specific point of Boohoo (LON:BOO) there's an article in the Guardian today about the issues in social distancing in their Sheffield warehouse. Quite why their orders for throwaway tat have gone up by a factor of three is beyond my understanding, especially when the staff could be redeployed to help the NHS. But there's obviously a risk they'll be forced to close for safety reasons.

However, if this ends up causing the collapse of fast fashion via sweatshops in Bangladesh and other countries then I think that's a good thing in the long run: people buying cheap clothes, wearing them once and throwing them away is criminal. We need to develop shorter supply lines, source more from closer to home and find ways of helping developing countries improve their own economies without creating more suffering.

The world will look different after this - but probably not as different as we think. And as for lockdowns - the science is leading, we will find a way out of this. Technology is being developed across the planet to ensure we can track and trace infections - that's the first step. Then we have research into existing drugs to alleviate the symptoms, there will be something. And eventually there'll be a vaccine.

I find it amazing that we have developed to the point that we can decide across the planet, across cultures, races and religions, to wage war on a virus. We didn't even know the damn things existed until 1892, now we're about try and do something never done before.

Remember, unmitigated Covid-19 was expected to kill 510,000 people in the UK - at the moment we might hold it at 20,000. Anything close to that is astonishing and will be achieved by an act of collective will across the nation. It's an extraordinary thing to even imagine let alone seeing it put into action.

And at the end of this there may be some good in terms of a general appreciation of the role of science in our society, who knows - even the climate science may start to be taken on board? Although given that we have imbeciles burning down 5G masts because they believe Twitter posts I'm not entirely hopeful of that.

timarr

Brilliant reply timarr. Thanks. I agree with most of it, but perhaps add property (e.g Investment Trust Reits) if hyper inflation?

5th Apr '20

Thanks. I agree with most of it, but perhaps add property (e.g Investment Trust Reits) if hyper inflation?

The evidence from Weimar is that property prices collapsed - people were paying over 95% of their earnings on food, rent was insignificant. Basically rent tends to be set occasionally, food prices change frequently and under hyperinflation you see massive daily changes in currency valuations.

I struggle to see any realistic hyperinflation scenario, though. Apart from on healthcare government spending is replacing corporate earnings. As long as the taps are turned off when the economy reboots it's very unlikely to cause runaway inflation.

Gold is probably the best protection. As it happens it's my single biggest holding - although only at 5% of the portfolio. Generally I don't hold it as I regard it as an unproductive asset whose value is based entirely on sentiment. However, when cash is yielding zero and we have rampant uncertainty it's a useful hedge.

Hi timarr

That was helpful too. I’ve just checked more recent Argentina hyperinflation effect on property and it confirms your opinion. So good to find that out.

I hope you’re right about little chance of hyper inflation; lack of comment generally suggests it’s not yet being seen as a threat.

One good thing is that afaiaa it doesn’t come out of the blue.

The right equities (easier written than done) seem obvious route. Index linked savings accounts too but doubt those would be available. Don’t know about Indy linked gilts.

Maybe best to save serious discussion on this for if it looks like becoming a reality.

Small Cap Value Report (Thu 2 April 2020) - G4M, BAKK, SAA

Gear4Music (LON:G4M)

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Paul Scott

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