Small Cap Value Report (Thu 23 Nov 2017) - MTC, NET, TCM, WINE, MNZS

Good morning, it's Paul here.

I updated yesterday's article in the evening with new sections. Here is the link.

There is very limited time available today, but I'll do what I can.

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Mothercare (LON:MTC)

Share price: 70p (down 16.2% today)
No. shares: 170.9m
Market cap: £119.6m

Half year results - for the 28 weeks to 7 Oct 2017.

The company calls itself;

the leading global retailer for parents and young children

I don't like the PR spin at the start of the announcement, which trumpets;

Continued transformation of the brand, converting into positive UK like-for-likes set against a challenging consumer backdrop

That's just meaningless, as it tries to sound positive, when the figures are actually poor. I'd rather not have a heading, if it's just an attempt to gloss over poor results. People aren't fooled anyway, as you can see from the 16% drop in share price, so what's the point?

UK LFL sales are indeed positive, at +2.5%, but that doesn't seem to have been enough to absorb cost pressures. The adjusted UK loss was -£9.6m, a deterioration from -£8.8m in H1 of last year.

International (the only decent part of the business, in terms of profitability), saw a sharp fall in LFL sales, of -7.7% in local currency. That's not good at all. Adjusted profit fell from £20.8m in H1 last year, to £14.9m in H1 this year.

Overall, the group couldn't even reach breakeven on an adjusted (i.e. favourable method of calculation) basis, with an adjusted loss of -£0.7m. There were £16.1m of adjustments (i.e. ignored costs) in reaching that figure. The list of things they have classified as adjustments look very aggressive to me - many are just normal costs of running a business, in my opinion (e.g. restructuring warehouses & retail sites, refinancing costs, etc). So in reality, the business is loss-making.

Recent trading - the UK market is softening, which to be fair,  lots of retailers are saying at the moment, and this is also confirmed by poor recent economic statistics;

"Towards the end of the reporting period, and in subsequent weeks, we have seen a softening in the UK market with lower footfall and spend which is consistent with recent industry reports. Not-withstanding this uncertain consumer backdrop, the Mothercare brand, whilst not immune, is in a stronger position with a much-improved product and service offer and a more robust business model.

Pension deficit - is falling, but still quite big at £68.9m. The company paid £7.1m into the pension fund in H1, which is a huge drag on a company struggling to breakeven. Younger competitors don't have this expensive historical baggage.

Net debt - has risen sharply, at £37.6m

Balance sheet - overall this looks weak. NTAV is only £4.0m.

Seasonality - looking at last year's figures, there seems to be an H2 weighting to profits, so a small adjusted full year profit looks the most likely outcome this year.

My opinion - this company looks to be in a rather precarious position.

With negligible net tangible assets, I wouldn't rule out the need for another equity fundraising. The trouble is, the company has been promising a turnaround for years now, and it never seems to get anywhere. Improvements made just seem to offset deterioration in other things.

The fundamental problem facing this company is online competition, and increasing costs - same as for any retailer selling products which can be bought more easily online.

If it didn't exist, would you invent Mothercare? Probably not. So for me, the shares are definitely to be avoided - unless/until the company can demonstrate genuine progress in improving profitability. That's difficult to imagine, with the various headwinds being faced by many retailers at the moment.

Note that the Stockopedia computers are also sceptical - rating it as a "value trap", and a low StockRank of 32. It reassures me when my analysis matches the emotionless Stockopedia algorithms.

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Netcall (LON:NET)

Share price: 43.5p (up 6.1% today)
No. shares: 142.7m
Market cap: £62.1m

AGM statement (trading update)

Netcall plc (AIM: NET), a leading customer engagement software provider...

The company has a 30 Jun year end, so this update is from Jul 2017 to date.

Things seem to be going well;

"The Group has experienced robust trading in the first few months of the financial year driven by growing demand for the Group's customer engagement software platform, Liberty and recently acquired MatsSoft.

I've looked back at previous announcements, and Netcall used its entire cash pile to buy MatsSoft, so it's a very important acquisition. Based on the RNS about the acquisition, it seems that MatsSoft is essentially loss-making (as it only produced a £0.1m adj EBITDA for calendar 2016), which makes me wonder why Netcall was prepared to pay £11.1m initial cash consideration for it. They say the acquisition is going well;

"The integration of MatsSoft is progressing well and the Group has already won its first contract cross selling MatsSoft's low-code software platform into an existing Netcall customer. In addition MatsSoft continues to win new customers including international sales.

Outlook - I'm not sure the balance sheet is robust any more, following the acquisition, but I'll be able to check that when the next results come out;

"The sales pipeline is healthy and this, combined with a high level of revenue visibility, a robust balance sheet and an expanded market opportunity, leaves the Board confident in the ongoing success of the business."

My opinion - this one looks potentially interesting. Looking at the historic track record, organic growth seemed to have fizzled out, so a big acquisition was made.

Note that the bumper dividends will now stop, as the company has used the cash to buy MatsSoft instead.

If you understand the sector, then this one might be worthy of further research. I don't feel able to assess whether the acquisition made sense or not, so will move on.

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Telit Communications (LON:TCM)

Share price: 162.5p (down 14.0% today)
No. shares: 130.7m
Market cap: £212.4m

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

Board changes & trading update (profit warning)

This is an Israel-based maker of internet of things modules.

It's surprising that this share has only fallen 14% today, given quite a nasty profit warning;

Early indications are that pressure on gross profit margins stemming from the transition from 2G and CDMA products (mature technologies with higher gross profit margins) toward LTE products (newer technologies with lower margins at this stage) has been greater than expected.

As a result, the Board expects adjusted EBITDA for the year to be materially below previous guidance. Revenues and adjusted EBITDA for the second half will, as usual, be greater than for the first.

Since the year end is quite near, 31 Dec, this implies quite a sharp reduction in performance recently. The company is extremely aggressive in capitalising costs into intangible assets, to the point that its EBITDA numbers are completely meaningless as a measure of profitability. I've covered that in depth in previous reports here.

The company is implementing a cost reduction plan, more details to come;

The Board remains committed to delivering a significant rationalisation of the Group's product lines and a reduction in its cost base, the benefits of which will be achieved in the coming financial year to 31 December 2018 and following years.

This article from me covers the 2015 results. This explains my main problem with the company's accounts, which is still very relevant today.

Since then we've also had the CEO exposed as a fugitive from US law, who resigned in disgrace. A further issue was that the CFO dumped his shares just before announcing to the market that the company was in breach of its banking covenants! (you couldn't make it up). Today the company reassures us that this is absolutely fine;

"We are aware of the concerns raised regarding share trading undertaken by Yosi Fait in July 2017. We have absolute confidence in his integrity and believe, having examined the share trading with the assistance of external legal advice, on this basis that it was lawful.

So presumably "on this basis" means that on another basis it wasn't lawful? I imagine a court & a jury might take a dim view of insider dealing whilst clearly in possession of price sensitive negative information.

Anyway, this share seems to have a coating of teflon, as no matter how many red flags emerge, buyers still seem undeterred.

Director changes - part of the reason for a muted share price fall today could be because a heavyweight new Chairman has been recruited - Richard Kilsby. There are other board changes.

My opinion - I'm happy to remain short here. The profit warning today reinforces my view that this just isn't a very good company, in terms of its inability to make genuine profits. Maybe the restructuring will change that, who knows? Falling gross margins suggests that it doesn't have much pricing power.

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Quick comments;

Majestic Wine (LON:WINE)

Interim results today look interesting. Adjusted profit has gone from breakeven in H1 last year, to £6.8m profit this year - an impressive turnaround. The main factor is Naked Wines moving from a loss to a profit. This seems to have been achieved by increased sales & margins, combined with a big reduction in marketing spend.  Naked Wines actually made slightly more profit than the core retail business. There's an in line with expectations full year update.

I haven't got time to go into more detail, but just wanted to flag it to readers as worth a closer look. 

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John Menzies (LON:MNZS)

An in line update today;

The Group has continued to trade well since the half year and the Board is confident of meeting its full year expectations.

Outlook positive;

Commercially the pipeline of opportunities is strong and we look forward to 2018 with confidence.

My opinion - I reviewed its last interim results here. For me, the very low operating margin, and its horrible balance sheet, rule this one out. However, trading does seem to be going well, so my worries may not be pertinent right now.

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I have to leave it there, as am off to Carmensfella's charity lunch.

Best wishes, Paul.