Small Cap Value Report (Thu 24 Aug 2017) - RBG, ENTU, UTW, SPE

24th Aug '17 by Paul Scott

35 comments 16616 reads

Good morning, it's Paul here!

A theme which I keep coming back to, is the remarkable changes (mainly driven by technology) which are occurring across multiple sectors. This is causing a lot of problems (and creating opportunities) for investors. How do we pick the winners? Anything that looks like a future winner is probably already extremely expensive, because we're in a roaring bull market for growth companies. So that opens up a lot of downside risk, if sentiment on a particular share, or the whole market, suddenly falls.

Last night I read Howard Marks' latest memo, which (as usual) is utterly brilliant. He sounds the usual warning signals, which he is well known for. It's well worth a read, highly recommended. There seems little doubt to me that we're probably now in the euphoria stage of this bull market - i.e. near the end. However, that stage could go on for a while yet, and it's when the biggest profits are often made. Nobody knows when the bubble will burst.

Also, I see differences between now, and 1998-2000, when we had a massive bubble in tech, media & telecoms shares. Back then, all sorts of rubbish blue sky stocks soared to mad valuations. However, this time round, a lot of the very expensive stocks are actually fantastic, highly disruptive businesses (e.g. Amazon). We can argue about valuation all we like, but there's little doubt that once-in-a-lifetime changes are happening across multiple sectors. Just look at the difficulties retailers are facing from online competition, and the trail of destruction that Amazon and Google are leaving in their wakes.

Bargains?

In the past, once certain sectors became really cheap, you could buy them with the reasonable expectation that they would recover - mean reversion. However, that's no longer the case. With, say, struggling retailers, and whole sectors (e.g. car dealers) - lots of investors are wondering if those businesses will still exist in 10 years' time?

Take a look at Dixons Carphone (LON:DC.) which warned on profits today. The share is currently down 24% today, but was down 30% earlier. This is the latest in an increasing long list of big companies which are surprising on the downside.

The company said something very interesting about mobile phone handsets, and I'm wondering what other companies this may have read-across to?

...However,…

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rouleur1

24th Aug '17

Exactly what most of my family have done: gone SIM only awaiting newer models which we may or may not choose to go with. The dude in the shop said:"that's what everybody is doing."

Camtab

Seems to be one of those markets that pays buying on bad news at the moment. Investors just want to be in the market. True notably of Prov Fin and Dixons so far. Only a trading play but can turn decent money over short period.

JDW72

I can corroborate that. The whole family are on old phones with SIM only contracts.

Apple are encouraging app developers to withdraw support for old phone versions to encourage handset upgrades and the network companies (Vodafone et al) are encouraging people to spend money on network usage and not new kit.

Interestingly, the price of a second hand iPhone 4 and 5 has gone up a lot in recent months as people are forced off iPhone 3 (loads of apps don't work on 3 any more) but don't want to pay for 6 or 7.

bsharman

My conspiracy theory is that mobile phone manufacturers deliberately build in some kinda bug which makes phones nearing the end of a typical two year contract period slow down and become utterly useless. My Sony phone / O2 contract finishes in October and i'll have to buy a new handset because recently the phone keeps crashing, is super slow, keeps ejecting the memory card independently and when i make a call the phone goes black and it's impossible to turn off or exit the call if nobody answers!! I'm sure they can build phones which will last longer but deliberately build in faults/memory draining "updates" to increase their sales turnover.

http://www.huffingtonpost.com/2014/10/13/apple-new-iphones_n_5967626.html

tic_tac_toe

With the opening paragraphs of today's SCVR looking back at Y2k and the 2008 financial crisis, I am left wondering what stocks people look back at and think " if only I'd bought them back then' Does anyone here keep a list of market crash buys? A list of shares that they plan to take advantage of if (when) another market crash arises?

For me, I note BRK.B which traded at $45 in 2009, and now $178; Dignity (LON:DTY) which hit a low of £615p during 2009 and now trades at £2300p; Melrose Industries (LON:MRO) which could be bought for 7 pence in 2009 and now changes for £2.36; Photo-Me International (LON:PHTM) £0.07p to £161p

timarr

Lot of changes since 2008, you'd need to look for stuff that isn't likely to be fundamentally impacted by the technological changes happening around us. You could have bought Next (LON:NXT) in 2008 for about a tenner, it peaked at nearly £75 and has been sliding ever since - it's still a very good company but can it reinvent itself fast enough to see off the new generation of online retailers? Will banks, insurers and other financial companies be able to fend off the hoard of Fintech innovators out to eat their lunch? Are estate agents and travel agencies about to be disintermediated by low cost internet rivals?

I have no idea what will trigger the next crash or what form it will take - and I distrust anyone who thinks they do - but I'm fairly sure it won't look much like the last one. Hindsight - cherry picking the stocks that we should have bought - is a pointless exercise unless you can rationalise the reasons why you didn't buy them. Back in 2008 any company carrying a significant amount of debt was walking a death defying tightrope as bank funding dried up - many perfectly sound companies saw their share prices decimated because of this. Most of them survived and the charts looks amazing - but you'd need to have had guts of steel to invest in them in the depth of the crisis.

In my experience - which now stretches over 30 years (I'm slightly stunned to realise) - the main mistakes people make in the wake of a crash are a) to buy too soon and b) to buy the things that went up a lot before the crash, presumably on the grounds that they look cheap in comparison. Far better is to hoard cash and to look for real bargains: but what those will be will be dependent on the nature of the crash.

If it's a loss of confidence due to one of the FANG stocks missing target then you'd see anything technical and speculative hammered, and many might never recover. If it's a recessionary collapse in earnings then anything carrying debt and with a capital intensive business model would struggle to survive. If it's a Brexit induced trade crisis then anything relying on imports would be mangled - and some exporters might find themselves excluded from European markets, while others would be relatively unscathed.

Basically - I don't know, and neither does anyone else. But when it happens my solid advice is to panic early and worry about the problem from the safety of a small mountain of cash.

timarr

Hi timar,
thank you for your comment. Yes, my examples probably not the best out there, but these were just a quick scattering. And in any case buying something like Dignity in a moment of market panic is probably not a bad shout, as funerals will be required for the foreseeable. And BRK does look like it would hae been an optimum time to get into the stock.
For me, only began investing in 2008 (funnily enough, when I was working for a bank!) but I had little idea back then about the types of valuation measures I use today> So hindsight really would have been a wonderful thing in my case. That was my main reason for not investing back then - purely because I'd only just begun.

Your last point is sage, panic early and have the cash awaiting. I think that is the order of the day really. Don't be caught with pants down. Cheers

ed_miller

Regarding Sopheon (LON:SPE), I continue to be put off by the fairly large current receivables (=115 days' sales). Does anyone have a view as to why this is okay? Granted, they have come down a couple of million dollars to $7.9M, but last year they were increased due to an acquisition, if memory serves. No such excuse this time around, unless I've wizzed through these Interims too quickly. It's true also that cash is higher at $11.5M, and I know software companies often have large receivables, but 115 days' sales seems on the high side at almost 3 months' sales. Should I chill out given the good net cash (borrowings are ~$4.9M), the deferred income of $5.8M and current payables of $3.6M. I'm not thrilled either about EPS dilution of a little more than 1/3 from the deep-in-the-money convertible loans that Paul Scott highlighted, or the luke-warm growth figures (at least for an up-and-coming micro-cap growth company, anyway). But there are things to like (such as good progress in profitability and returns, to decent levels; good level of operating cash flow and a positive and perhaps even exciting outlook, which if it comes to pass would make the current price look attractive, perhaps even with the dilution).

Can anyone explain why the receivables aren't a touch too high, or do you think the factors I mentioned ameliorate the receivables sufficiently? I'd value other views if others care to share them. (I have no position in Sopheon (LON:SPE).)

Ed

Dignity (LON:DTY) would be a good shout - so would anything fundamental to living - Unilever (LON:ULVR), Diageo (LON:DGE), etc. But of course, everyone knows that those are safe havens, so unless there's a liquidity crisis among large investors - and in a liquidity crisis investors often have to sell their most liquid stocks first, and only then turn their attention to smaller, less liquid companies - these are often not the very best investments.

The key is to do your analysis - in a real crisis share prices often become completely disconnected from reality, either because of leveraged investors being forced to sell or because of psychological contagion. In the depths of 2008 I bought Ffyffes at (from memory) about 15p, which was trading at a 40% discount to net tangible current assets - I eventually sold a few years later at over a pound, with lots of dividends along the way. It was a genuine no-brainer, even with the world on the brink of financial collapse - and no one wanted to know.

Investing in a crisis requires proper analytical skill and no little courage. It's much more fun than the current shooting ducks in a barrel market ... but that'll change, it always does :)

timarr

steviej

Two rules in a crisis:

1. Don't panic.
2. Panic first.

Gromley

Sage words as usual from Paul on the general market. But whilst I'd absolutely agree that we don't have quite the same kind of brainless euphoria of the dot-bomb period; to borrow a phrase from Mark Twain :

History never repeats itself, but the Kaleidoscopic combinations of the pictured present often seem to be constructed out of the broken fragments of antique legends.

(More commonly quoted as the more concise "History never repeats itself but it rhymes" , but AIUI it's not totally clear to whom that quote belongs).

Even though there a lot of the 'disruptors' have a rational investment case, I'm already seeing much hyberbole about the fate of the "traditional" business. (I should clarify that I'm flagging this in general terms , not suggesting that Paul's warning was an example).

Of particular interest to me at the moment is the fate of "discretionary retail", I've been quite bearish on this sector for some while now (particularly with a UK focus) due to the economy. But you don't have to stumble too far to reach upon tales of how this "new fangled internet thing" is the death knell of the "Bricks & Mortar" retailers (although almost exclusively they are in fact "clicks & mortar).

I don't dismiss for a minute that online competitors present a serious continuing challenge to more traditional retailers, but it seems apparent to me that there is a great detail of over emphasis going on here.

And here I am personally expecting a 'rhyme' with the market in 2007-09 - I'm currently looking to undertake a fairly heavy duty "tyre kick" on businesses in this sector.

There are obviously never any guarantees with this, which is why the emphasis stressed by both Paulo and Timmar is spot on - you really need to do your research thoroughly. I am though very much taken by the pattern I see from the past :

Over an 18 month period stocks in this sector fell by around 60%.
Over the following 12 months they rose by around 100%.

The rise was actually (on average) relatively linear, so to reinforce one of Timarr's points - buying too early would be the much greater error , than missing the very bottom.

Equally the patient approach (& research- again) would also have helped to avoid some of the companies which fell by the wayside.

In general though, it seems to me that we are still too early in the cycle to be looking yet to buy the dips or crashes (except in exceptional circumstances as I view GAME Digital (LON:GMD) to be - although I'm not yet convinced I will want to hold this through the Christmas trading season). I do though think that there will be some substantial bargains at the right time , which is why I'm trying to get my research well underway early.

As a cheeky footnote I thought I would observe that I talk about "discretionary retail" quite deliberately as there are some businesses that are clearly somewhat insulated from the economic cycle and also maybe from disruptive change too.

IMHO Timarr made a decent call on this front by flagging Dignity (LON:DTY). But I was slightly amused that this was on the day that the BBC ran this story : Would you let a robot conduct your funeral?

Those darned disruptors get everywhere ;-0

coniston

That's a decent summary Paul.Howard mark's book, THE MOST IMPORTANT THING .is a classic imo it,s up there with the best,it's a must read for any serious investor,he emphasizes playing defensive whereby you miss out in a bull market (but still do okay ,) the draw downs are a lot less in a bear market."We don't know the future", he says,it's more relevant to me at this stage of the bull market.

25th Aug '17

Correction: 115 days is almost 4 months (I tried to edit the post but a slip of the mouse put paid to that, so forgive me also the lack of a question mark, which I'd noticed).

Must do better!
Ed

aflash

You owe yourself a pint for almost two months of waiting and some of the time under water I bet.

We shall probably not get a reply to this but unless you started buying at the LO on 29 June you were not doing well for a month and no better for 25 days afterwards.

Takes conviction and guts.

Laughton

Revolution Bars (LON:RBG) - It's not all over just yet:-

The Deltic Group has reported 1.4% growth in turnover to £102.2m for the year to 25 February 2017 and says of its outlook: ‘The trading performance continues to improve and there will be further improvements in the future from the continued refurbishment programme.’

Deltic CEO Peter Marks has told Propel his company is ‘very much in the game’ with regards to Revolution Bars, which has just recommended a £101.5m bid from Stonegate to shareholders, and is working to offer a counter bid.

simoan

Hi Laughton,

I noticed this too. See: http://www.propelinfo.com/pi-N...

It sounds like Deltic fully intend to make a counter bid although it's not easy to see where they will find the funding for an all cash offer. Interesting times...

All the best, Si

Matboulton

Great article, especially around Revolution Bars (LON:RBG).

I was interested to read the comments about Sopheon. I struggle to see how a company with such a broad range of solution areas can aspire to make an impact on such an established market place. Most industries have 2 or 3 major PLM companies who control the market, Sopheon is tiny both in market share and size. I would say that the best that could be hoped for would be an acquisition but their competencies seem so broad I cannot see how it's technologies would appeal to the market leaders (Siemens, Dassault, PTC, SAP, Aris et al) whose capabilities are more mature.

It's also not clear the split between service and licence revenue who could heavily bias the future growth potential.

Aris has a far more disruptive business model and they struggle to get proper traction in the market place and perennially tout themselves to the major players.

Maybe Sopheon have a significant differentiator (usability, configurability, ease/speed of deployment) but I would say this would be a challenge to a business of this maturity.

Rick802

26th Aug '17

Why bother renewing your phone every 24months.
SIM only is the way to go. Buying a top of range phone out right instead of a disguised HP contract can save you about £150 and there's no pressure to swap after 2 years.

cig

28th Aug '17

The value added of Unilever (LON:ULVR) and Diageo (LON:DGE) is premium product and aspirational branding. Rationally there's nothing fundamental to living when most of their products are available as generics for less than half the price. They are consumer discretionary. They seem to behave as if they were fundamental, which is somewhat curious.

Hi cig

Absolutely true, it's at least partly to do with habit and the power of brands, but these types of companies keep on churning out earnings increases year after year. I remember reading somewhere about the positive feedback effects they can generate because of their ability to recycle earnings into marketing.

On the other hand, I wouldn't want to invest in Diageo (LON:DGE) anyway, their capital allocation policies seem suspect in the extreme: spending a billion dollars on George Clooney's Tequila company just seems like the latest in a long line of dubious decisions.

timarr

Small Cap Value Report (Thu 24 Aug 2017) - RBG, ENTU, UTW, SPE

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Paul Scott

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