Small Cap Value Report (Thu 25 Oct 2018) - DEB, SCS, DIS, BEG, FTC, ALU, ECK

Thursday, Oct 25 2018 by

Good morning! It's Paul here.

Please see the header for the announcements that I intend reporting on today.

Do let me know, in the comments, if you spot anything else interesting.

Market comments

US markets were wobbly again last night, so we're probably likely to suffer more pain today in the UK. Such is life - corrections happen from time to time.

It seems to me that this market is now throwing up some bargains. Quite a few of the stocks that I own, or are on my watchlist, have reported good figures & outlook, yet in some cases are now 20-40% cheaper than they were only a few weeks ago. That doesn't make sense to me. Maybe they were over-priced to begin with, but not that much.

The falls in price have generally happened on lowish volumes, in most of my small cap stocks. I find that reassuring. It's a combination of a few nervous small shareholders selling up, and a buyers' strike because of concerns over the US markets falling, Brexit, Corbyn, Italian/Eurozone crisis, China, trade wars, and anything else you can think of!

In one extreme case, a very illiquid micro cap stock I hold, Malvern International (LON:MLVN) , some idiot sold a few thousand pounds-worth of the share, and the resulting fall in share price knocked c.£50k off the value of my shareholding! As you can imagine, I wasn't best pleased, but we have to accept volatility & illiquidity as the price we pay for operating in a very imperfect market. That imperfection is also what creates the upside opportunities. So it means that prices rise fast, when good news comes out. If you operate in the micro cap space, you have to learn to live with volatile prices.

It's important to remember that, with illiquid micro caps, the share price is quite artificial. It can go all over the place, in the short term, on tiny volume. Therefore the chart patterns in small caps mean nothing, and the share price isn't a very good way of valuing the company, in the short term anyway.

Someone reminded me yesterday of a good Buffett quote about wanting to be being greedy when others are fearful, and fearful when others are greedy.

Although as always, we have to be very selective in picking the right stocks. I'm thinking…

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Debenhams plc is a United Kingdom-based company, which is engaged in multi-channel business. The Company’s brand trades through approximately 240 stores in 27 countries. The Company's segments are UK and International. The UK segment consists of stores in the United Kingdom and online sales to the United Kingdom addresses. The International segment consists of international franchise stores, the Company-owned stores in Denmark and the Republic of Ireland, and online sales to addresses outside the United Kingdom. The Company's stores trade under the name of Debenhams other than the Danish stores, which operate under the Magasin du Nord banner. Its stores offer customers a range of services, including restaurants and cafes, personal shopping assistance, hairdressing and beauty treatments, nail bars and wedding or celebration gift services. Its Debenhams Direct ( offers a range of products and services for online customers. more »

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ScS Group plc is engaged in the provision of upholstered furniture and flooring, trading under the brand name, ScS. The Company specializes in fabric and leather sofas, and sells a range of branded and ScS branded products sold under registered trademarks, including Endurance and SiSi Italia. The Company also offers a range of third-party brands, including La-Z-Boy, G Plan and Parker Knoll. The Company operates from approximately 100 stores nationwide along with an online sales and also has approximately 10 distribution centers across the United Kingdom. The Company has operations in retail park locations and in House of Fraser stores across the country-as far north as Aberdeen and as far south as Plymouth, offering a range of upholstered furniture and floorcoverings. The Company also runs a made-to-order sofas, furniture and flooring concession within House of Fraser. The concession operates from approximately 30 House of Fraser stores across the United Kingdom and online. more »

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Revolution Bars Group plc is a United Kingdom-based operator of bars. The Company has a trading portfolio of approximately 60 bars located predominantly in town or city high streets, which operate under the Revolution and Revolucion de Cuba brands. The Company's bars focus on a drinks and food-led offering, and typically trade from late morning, during the day and into late evening. Revolucion de Cuba bars are characterized by their 1940s Cuban-inspired style, with dark woods, traditional bar counters, antique tiles, vintage furniture, Havana-style ceiling fans, and original Cuban artwork and photographs. Its bars are located in various places, such as Cambridge, Ipswich and Norwich in South East; Bath, Plymouth and Southampton in South West; Birmingham, Derby, Leicester, Loughborough and Milton Keynes in Midlands; Cardiff and Swansea in Wales; Blackpool, Chester and Huddersfield in North West; Sheffield, Sunderland and York in North East, and Edinburgh and Glasgow in Scotland. more »

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  Is LON:DEB fundamentally strong or weak? Find out More »

74 Comments on this Article show/hide all

Gromley 25th Oct '18 55 of 74

RE Filtronic (LON:FTC)

There are actually two potential interpretations of the guarded outlook view :

Whilst we continue to enjoy good baseload volumes from our long term defence contracts, the uncertainties regarding the timing of the market take-up for mMIMO and the rate of tail-off of our legacy filter sales make near term forecasting very difficult. However, we are confident that our position overall continues to strengthen and our outlook remains positive.

One interpretation is that this is leaving the door open for a profits warning before the end of the FY (May-19), Paul references the lumpy performance that they have often experienced and in that context it is indeed not unreasonable to take this view.

However, I took a different view. There is a view out in the market that 5G mobile networks will create transformational demand for Filtronic's mMIMO products, I outlined the speculative bull case here a few months ago . Various subsequent industry news, not to mention some comments that Rob Smith  made to SmallCompanyShareWatch , have reinforced these views together with the view that it could happen sooner than expected.

There was certainly hope in some quarters that today's trading statement would tell us that this acceleration has started to ramp up.

That was the context in which I took these comments, essentially to say that the potential future upside is still very much there, but that they cannot readily predict precisely when it will come.

So I remain pretty optimistic here and I'm not overly concerned about short term price volatility here.

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Gromley 26th Oct '18 56 of 74

Hello All,

I am trying to get a better handle on the lease commitments at Debenhams (LON:DEB) as I actually think the difficulty they face in right-sizing the estate over 3-5 years is very much overstated.

However, there is clearly something I am missing and I’m hoping that someone more knowledgeable than me can shed some light here.
I am working on the 2017 figures as there is important detail that I think we only get to see once the full AR is produced.

From the 2017 AR -note 30 (page 134) – we see the OPERATING LEASE COMMITMENTS by length of commitment.
These figures show “The future aggregate minimum lease payments under
non-cancellable operating leases” by duration of lease - the first two columns come from the AR, the 3rd column is my assumption and the last two columns are the derived result.

Duration (Years) Commitment Average Length [1] Annual Commitment % of annual
< 1 year 223.9 0.8 298.5 34%
1-5 905.8 3.0 301.9 35%
5-10 1,056.3 7.5 140.8 16%
10-20 1,463.1 15.0 97.5 11%
20+ 896.1 25.0 35.8 4%
Total 4,545.2 5.2 874.5 100%

[1] My assumption on average length based on the ranges.

Now these figure suggest that despite Debenhams (LON:DEB) having some EXTREMELY long leases, nearly 70% (by value) are escapable/renewal within 5 years – this was what I expected to be the case.

But here is what I do not understand, these figures suggest a total annual lease expense of £875m, however this compares with (Note 6 – page 104) actual “Operating lease rentals” in 2017 of £221.4m.
I must have hugely misinterpreted something here, but I just cannot see what. 

(I know that the forward figures probably include contractual rent increases etc , but even the implied figure for agreements with less than 1 year to run exceed the actual reported cost, so that is not the answer)

Could someone with more expertise in this area show me where I have gone wrong? (I'm sure it will be something stupid that I have missed, but I just cannot see it)

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rhomboid1 26th Oct '18 57 of 74

Hi Gromley

Is the larger number just the total annual comitted lease up to break points?

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grout123 26th Oct '18 58 of 74

I saw this comment from you yesterday
“In one extreme case, a very illiquid micro cap stock I hold, Malvern International (LON:MLVN) , some idiot sold a few thousand pounds-worth of the share, and the resulting fall in share price knocked c.£50k off the value of my shareholding! As you can imagine, I wasn't best pleased, but we have to accept volatility & illiquidity as the price we pay for operating in a very imperfect market”……
I am curious to discover why you felt why he/she was an idiot ?

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john652 26th Oct '18 59 of 74

In reply to post #411974

Hi purpleski,

That is interesting and those are big percentages, I’ve been waiting for a time to get into Scottish mortage IT (James Anderson) and this might now be the right time? I’m thinking a thread on ‘what’s of value now’ would be interesting, there are a lot of small caps I liked and still do but are now a lot cheaper. Value is opinion but 30% cheaper than two weeks ago is often worth a scale in position.

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LeoInvestorUK 26th Oct '18 60 of 74

In reply to post #412209

Gromley, re Debenhams (LON:DEB) low annual lease rentals compared to lease commitments.

My first thought was that perhaps they are continually agreeing lease extensions with reverse lease premiums thus deflating annual lease costs in the short term. Having such nefarious thoughts probably reflects badly on me.

However, in the last annual report it says:

Rentals payable under operating leases, net of lease incentives, are charged to the income statement on a straight line basis over the period of the lease.

Where property lease contracts contain guaranteed fixed minimum incremental rental payments, the total committed cost is determined and is calculated and amortised on a straight line basis over the life of the lease.
Included within other payables [£82.4m] are lease incentives received from landlords either through developers’ contributions or rent-free periods. These incentives are credited to the income statement on a straight line basis over the term of the relevant lease. Other payables also relate to the spreading of charges in respect of leases with fixed annual increments in rent (escalating rent clauses) over the term of the relevant lease.
This seems to eliminate my theory and also provide a maximum size for your contracted rent increase theory.

My next thought is whether the lease commitments are on a NPV or a gross basis. This could make a massive difference for the longer leases. Note 30 isn't explicit, but a reference to it is:

The Group's undiscounted operating lease commitments at 2 September 2017 under the current leasing standard, is disclosed in note 30. 

So these lease commitments are a clear over-estimate in present money terms. Not least because a deal could trivially be done with the landlord to discharge their commitment using the landlord's cost of capital as the discount rate.

AlsoI note the following clause in the depreciation policy:

Long leasehold land and buildings... : 1.0% or life of lease if shorter [straight line]

This could be taken to imply that they have some long-leasehold buildings with terms over 100 years.

This still cannot explain most of the discrepancy. Hopefully I will have time to look into this further later today.

Blog: LeoInvestorUK
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LeoInvestorUK 26th Oct '18 61 of 74

In reply to post #412209

Debenhams (LON:DEB) Lease commitments.

The first column is the payments due within that period for all leases regardless of length, not total payments for leases that terminate within that period. Thus the under one year figure is the next year's expected annual lease costs.

It should still be possible to infer something about lease lengths, it is just a lot more complicated to do so.

As I said earlier, the figures further out are significantly overstated for practical purposes because they are not discounted (i.e. not NPV).

Blog: LeoInvestorUK
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FREng 26th Oct '18 62 of 74

In reply to post #412254

Value is increasing. Shares magazine has just pointed out that Burford Capital (LON:BUR) is now 15% below the price the institutions bought at in the recent placing.

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Gromley 26th Oct '18 63 of 74

AHA - excellent thank you for that Leo - I had totally misinterpreted how the figures were presented.

Will have a futher look at that later then,

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FREng 26th Oct '18 64 of 74

Perhaps we could use as the placeholder for today until SCVR wakes up. I feel sure that Matylda won't mind.

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Snoo 26th Oct '18 65 of 74

Perhaps Paul indulged in one too many beers at Revolution yesterday?

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mojomogoz 26th Oct '18 66 of 74

In reply to post #411959

Sharmvr, on SCS (LON:SCS) ....

What's suspicious about the numbers? LFL in own store have been strong other periods during this tough environment and the update is not out of whack with historic.

They trade nearly exclusively in out of town retail parks targeting the space to be beside other furniture retailers and in areas that align with their target customer demographic. New openings happen but in controlled fashion as the new store must fit their profile. Currently they have 30 locations they want to open new stores in and are waiting for the right opportunity to arise.

Cash doesn't lie and SCS have been producing lots and paying lots out.

I've spoken to CFO in the past and I'm very impressed with how on the ball they are. They know what they do best, who their customer is, what they want and how to position to sell to them.

By comparison, DFS Furniture (LON:DFS) is a bit stuck in aspirational no-mans land...a strategic jumble with a stretched balance sheet. I'd guess that in these tougher times for those less affluent than your average Stockopedia punter that SCS are picking up custom from other stores.

As you can tell, I'm a fan and just surprised that everyone doesn't own some :)

Through a combination of organic growth, new stores and doing something with their giant cash pile I believe SCS can triple earnings per share on a 5 year horizon (a double is in the bag). That will be pretty impressive off of this valuation level.

mojo out (hopefully not delusional)

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mojomogoz 26th Oct '18 67 of 74

In reply to post #411949

Hello again sharmvr

I owned Vertu Motors (LON:VTU) but decided to sell. Its probably now very undervalued but I'm not tempted back as I think the evidence hints that have historically misallocated capital and really ridden the coattails of the car financing boom up rather than created specific value themselves. Here's why...

However, if the times turn rosier there could easily be a double in the price

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trader45 26th Oct '18 68 of 74

Hello Paul. I have just read yesterday's report and would be interested in your idea of forming a shares social group in Bournemouth. However whenever you are next in Bournemouth and you want a pint just contact me.

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sharmvr 26th Oct '18 69 of 74

In reply to post #412354

Hi Mojo,

Indeed I read that article which was very helpful and saved me some money!
To be honest, I am struggling to push the sell button on the valuation.
It is a small holding in a cyclical sector so I would suggest I should sell out or buy more and on valuation grounds - erring towards the latter.

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sharmvr 26th Oct '18 70 of 74

In reply to post #412349

To be honest my biggest problem with SCS (LON:SCS) is that I have watched it go up some 60% and missed out on another 15% in divis.
Nothing wrong with the numbers that I can see and I tend to agree cash doesn't lie - but then I had the same view of Patisserie Holdings (LON:CAKE) , albeit SCS has a lot more value going for it.
Also their bullet proof balance sheet has I think allowed them to gain market share while competitors went out of business.
My concern is on their operating margin - there really is not very much wiggle room in these businesses for a bad year or 2, then again, bullet proof balance sheet!
Presumably they can double EPS just by using cash to do a buyback

In short, I am a fan and if I wasn't anchored on a price closer to 150, I would probably have bought already - DFS Furniture (LON:DFS) is a joke in comparison.

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mojomogoz 26th Oct '18 71 of 74

In reply to post #412409

I think the balance of probabilities are you will make money from here on VTU

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mojomogoz 26th Oct '18 72 of 74

In reply to post #412434

You might be right re SCS (LON:SCS) operating margin. It is a negative I have heard from others. The top of the range for them is going to be 6-8% with their current business set-up. Revenue growth can be good and may hit high single digits LFL for a sustained patch if a really motoring but will never be absolutely flying (absent acquisition or large store opening programme). So a p/e multiple into the teens is top of sensible range. Netting out cash p/e today is approx 5.5 (allowing for working capital impacts) so that's a lot of multiple upside...and once a company like this is liked the market can particularly like a bit of leverage being employed to add to earnings (I'm not recommending that as I don't think its a sensible strategy for this sort of business...but whilst the story was good it was liked for DFS).

My analysis and discussion with the company has lead me to believe that the margin is quite robust to cyclical factors as they have a lot of flexible costs and ability to adapt to circumstance and they are very conscious of the need to do that. Of course, a massive secular drop in revenues would cause margin problems.

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Kiewit 28th Oct '18 73 of 74

@Paul Scott: Would your comment on momentum investors include the type of investors who follow Quantitative Investing and QVM (Quality, Value, Momentum) type of investors?

Also would a NAPS Investor also fall in this category?


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seadoc 28th Oct '18 74 of 74

In reply to post #411949

sharmvr, of course it was a quote from WB. In my defence I started a long time after him, am a bit younger than him and annualized return of 16% so doing OK!

"Purpose of this comment is to hopefully get some feedback from those more experienced than me and have lived (and invested) through not so good times"

There is an annotated reprint of Benjamin Graham - The Intelligent Investor. I picked it up in NZ at a charity shop for a couple of dollars, It is still on the boat in NZ so sadly cannot give you the exact reference but looking on Amazon was probably the fourth edition annotated by Jason Zweig

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 Are LON:DEB's fundamentals sound as an investment? Find out More »

About Paul Scott

Paul Scott

I trained as an accountant with a Top 5 firm, but that was so boring that I spent too much time in the 1990s being a disco bunny, and busting moves on the dancefloor, and chilling out with mates back at either my house or theirs, and having a lot of fun!Then spent 8 years as FD for a ladieswear retail chain called "Pilot", leaving on great terms in 2002 - having been a key player in growing the business 10 fold. If the truth be told, I partied pretty hard at the weekends too, so bank reconciliations on Monday mornings were more luck than judgement!! But they were always correct.I got bored with that and decided to become a professional small caps investor in 2002. I made millions, but got too cocky, and lost the lot in 2008, due to excessive gearing. A miserable, wilderness period occurred from 2008-2012.Since then, the sun has begun to shine again! I am now utterly briliant again, and immerse myself in small caps, and am a walking encyclopedia on the subject. I love writing a daily report for on most weekday mornings, constantly researching daily results & trading updates for small caps. Cheese! more »


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