Small Cap Value Report (Thu 27 Jul 2017) - BON, BOOM, NXR, CWD, FOXT, MONI, KWS

27th Jul '17 by Paul Scott

38 comments 16208 reads

Good morning!

In case you missed it ("ICYMI" - which I keep seeing on Twitter, but have only just realised what it means) - I wrote 4 more sections in yesterday's report last night. So yesterday's report now covers;

LoopUp (LON:LOOP)

MySale (LON:MYSL)

Quartix Holdings (LON:QTX)

Vertu Motors (LON:VTU)

Joules (LON:JOUL)

You might like to revisit that report whilst I'm busy writing today's.

Bonmarche Holdings (LON:BON)

Share price: 101.7p (up 13.7% today)
No. shares: 50.0m
Market cap: £50.9m

Trading update - the market clearly likes today's update, judging by the share price rising 13.7% at the time of writing. This company is a value ladieswear retailer, operating from 322 sites, and online.

This update covers the 13 weeks to 1 Jul 2017, being Q1 in its financial year.

The numbers look good;

Total Q1 sales up 7.6% vs last year.
LFL stores sales up 4.2% - I'm impressed, as many retailers are struggling to achieve any significant LFL sales growth.
Online sales are up an impressive 39%, but bear in mind that is from a low base.
Overall, trading is in line with expectations for the full year.

You could argue that, as it's only an in line update, then the share price shouldn't really have moved very much, if at all. However, in this case I think there might be an element of relief that things are not getting any worse, after a period of considerable disappointment after the Dec 2015 profit warning. The share price has dropped by two thirds since then, from c.300p to c.100p.

Also the PER, and divi yield, are deep into value share territory. So a positive update should reinforce the market's perception that very generous divis may be sustainable after all.

BON has a solid balance sheet, with net cash.

My opinion - I mentioned in a recent report here, that the Q2 retail sales data from the ONS was actually very good. The total amount spent for Q2 was up 5.6% on the same period last year. For that reason, I'm more bullish on…

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Zipmanpeter

27th Jul '17

£BON's customer base is literally 'old ladies' who still want to go to the shop. Nice to do in good weather, not so much in winter. Hence , I think Bonmarche Holdings (LON:BON) got a disproportionate lift from the good weather.

Recall last years Q1 figures were for a store decline of 8.1% and decline on internet sales of 2,7% !! So just ahead of last year with more stores/concessions.

Remains a value trap for me (who is generally an optimist on the value still in selected retail shares).

Jamboreebop

Regarding the announcement from Bodycote (LON:BOY), I have professional experience of 3D printing, and I'm bemused by some of the hype that seems to be attached to it in recent years. It is an industry of constant change and competing technologies and these sorts of process improvements are a regular thing.

3D printing of powdered metals is not new, and to me, Powdermet reads like an enhancement of the process rather than anything particularly game changing.

I could be wrong, I haven't looked into the Powdermet process in detail, and I'm certainly not saying that Bodycote (LON:BOY) is a bad investment, but I'd say that today's 6% share price rise is good enough for now.

rhomboid1

Hi jamboreebop
Thx for the feedback, I think it was the language & tone of the RNS that was strikingly in contrast to the normal Bodycote (LON:BOY) restraint that made me suspect they believe they've got something special, and if they believe it I'm prepared to as well because they've been very credible in their IR over the years.

In any case it's all included for free as it's a quality operation at a realistic valuation in any case.

Agreed..it is a quality operation and it's good to see a 'boring old engineering company' doing well while we all get excited with the glamour stocks.

Not that I'm complaining about the way BOO, KWS and G4M have boosted my portfolio in the last year.

simoan

Bond yields will rise sooner than later and if Norcros can continue to trade reasonably rising yields will eliminate the pension deficit. Norcros has been adept todate in navigating a challenging trading environment and deserve credit for doing so.

Like bestace, I'm not sure bond yields will rise as soon as many anticipate. Of course, if bond yields and UK interest rates rise it will not necessarily be good for the business side of things for Norcros...

All the best, Si

Ramridge

Re Norcros (LON:NXR) and pension deficit.

There is an interesting piece of information (see table below) which is not reproduced in the RNS but is buried in Note 22 of the full 31/3/17 financial report available on the company's website.

What this says is an increase of 1% in the discount rate would roughly reduce the scheme deficit by £67m (other things being equal) .

Well, the current deficit resulting from the recent actuarial valuation is £62.7m. So a 1% increase in the assumed discount rate would do nicely for Norcros.

These discount rates are set by the scheme actuaries who take a very long term view (20 - 25 years) . Short term movements in gilt rates is not enough to move the needle. A lot of reading the tea leaves is involved but they will not admit to that of course.

yamaha865

Something I'm unsure of with Norcros, didn't they agree 10 year 2.5m payments with the pension scheme trustees? So the exposure is limited to that amount for that time?

yahama865 - yes and no. These are triennial actuarial valuations so that is fixed for the next 3 years until a re-valuation occurs.

Thank you for the clarification :)

bestace

These discount rates are set by the scheme actuaries who take a very long term view (20 - 25 years)

If only that were true; taking a long term view of rates would be far too sensible for actuaries and accountants! Those sensitivities relate to the IAS19 valuation which mandates use of discount rates based on "high quality corporate bonds", which in turn means they are subject to the vagaries of market movements rather than being set by the scheme actuary.

As a result of those market movements, notice how the Norcros discount rate used in the IAS19 valuation fell from 3.55% last year to 2.6% this year. Using those sensitivity tables, that 0.95% fall in the discount rate was enough to increase last year's reported pension liabilities by 15%, some £64m when their reported profit was only £8.5m this year.

Like I said upthread, the company is now a pension scheme with a sideline in selling bathroom products.

In addition, other things never are equal. The Norcros pension trustees, no doubt based on the infinite wisdom of their actuary advisors, have sold down a lot of their equities and moved the assets into bonds, absolute return funds and liability driven investments, all of which are sensitive to bond rates. So if rates were to increase by 1% yes the liabilities would fall but so would a lot of their asset values.

In other words the pension trustees have effectively locked in their deficit in the name of 'risk management' and in order to close that deficit they are now reliant on cash contributions from the employer (i.e. Norcros) and outperformance from the much reduced equities allocation of the assets.

It's not all bad though, they invested a chunk of their equities into Fundsmith in March last year, so that will be showing a nice gain. It's just a shame it's only a 6% allocation and no doubt in the interests of 'rebalancing' they will have sold down a chunk of that as well.

Paul Scott

28th Jul '17

I've been in bed all day, shaking off this cold, but I'll finish off the rest of this report on Friday.

Sorry for the delay.

Regards, Paul.

Re Norcros (LON:NXR) Excellent post, bestace. You clearly have a better insight and knowledge on the pension scheme subject and on the specific Norcros situation.
However I would like to disagree with your assertion that "the company is now a pension scheme with a sideline in selling bathroom products".
Let's consider the impact of the pension scheme size and deficit on each of the three primary areas of Norcros' full year 2017 accounts, namely profit & loss, cash flow statement and balance sheet.

Profit & Loss Accounts. The pension deficit has absolutely zero impact on the P&L. The deficit could be twice as high and the (adjusted or reported) net profit and eps will still be the same.

Cash Flow Statement. The Operating Cash Flow is £2.5m lighter, being the deficit reduction contribution agreed with the trustees. That represents 8.4% of the underlying OCF. Not a major item at this level.

Balance Sheet. The balance sheet bears the major impact of the pension situation. Norcros' net assets are £62.7m less than they would be and stand at £56.6m as at 31/3/17. However the company reports a ratio, net debt/ EBITDA of only 0.8 . Plenty of headroom to take on further debt if they need to. This ratio doesn't include the pension deficit and I believe lenders use this measure for lending purposes. If you include the pension deficit to net debt, the ratio comes to 2.8 .
The balance sheet can be strengthened by raising more equity or by taking on more debt. They have the option.

So my take is that if the company remains operationally in rude health, then the pension problem can be sorted.
The key question here is how healthy is the business? Well, here are broker forecasts for FY2018 taken from the StockReport. Net profit growth 101%, eps growth 44%. PE 6, PS 0.4, and dividend yield 4.5%. That’s pretty good by any standard.
To conclude, if Norcros can produce this kind of performance then the pension issue is a manageable and reducing problem. In the meantime shareholders are being paid above average dividends.

Declaration: I am neither long nor short

Samsgrandad

New company lists today , friday, a me too clothing retailer called Quiz.
"Overall the Placing raised GBP102.7m of gross proceeds at a Placing Price of 161 pence: GBP92.1 million of gross proceeds for the Selling Shareholders and GBP10.6 million of gross proceeds for the Company"
I don't think so, I'll pass.

Yes that comment was tongue in cheek and slightly exaggerating on my part. I'm sure your figures are correct but in response I would add a few more comments:

On the P&L/income statement, the pension deficit may have zero impact here but that's not the same as saying the pension scheme has no impact. The £2m charge for pensions admin costs and the £2.5m deficit reduction contribution, as well as the £5.2m actuarial loss in the year (which appears below the line but it could be argued this was a cost to the company) are all pretty large numbers in the context of a net profit of £8.5m.

On the balance sheet, yes on a debt/earnings basis it's manageable but as you point out, the net assets of £56.6m compare to the pension deficit of £62.7m, which does suggest the pension scheme is larger than the company. As does the fact that the deficit consists of £404m of assets and £467m of liabilities.

On cash flow, I think it is more appropriate to compare the deficit reduction contributions against free cash flow rather than operating cash flow. So the £2.5m accounted for 14.5% of FCF in FY17 and would have been 20% of FY16's FCF. Sure that's still manageable but neither is it small enough to ignore. And those numbers won't look anywhere near as good if we have a downturn.

I actually agree with you that operationally, the company is pretty sound and based on some modelling I've done on the pension scheme cash flows I think the pensions problem is less of an issue than the markets seem to think and it should be sorted over time.

But that's different to the point I was really making which I'll reformulate as: 1) the IAS19 standard is crap 2) that crapness means the pensions problem for Norcros is overstated 3) the markets won't agree with that analysis and therefore 4) the share price will continue to languish.

Finally, any Norcros watchers might be interested to know the pension scheme has its own website which has additional information not disclosed in the Norcros annual reports. It's obviously intended for members of the pension scheme, but investors in Norcros will find lots of relevant information such as their investment policy, annual accounts of the pension scheme and newsletter updates from the pension trustees.

The October 2016 newsletter discussed the last triennial valuation and contains this gem:

It is instructive, however, to bear in mind the Scheme Actuary’s ‘best estimate’ results – which use a set of assumptions that have a 50:50 chance of happening. On this basis, the Plan was considered to have a small surplus (an excess of assets over liabilities), even before taking into account any future contributions from the Company.

In other words if they didn't have to use ridiculously overprudent assumptions, there might not actually be a pensions deficit at all!

Broadening that point out to the 6,000 final salary schemes in the UK as a whole, how many countless billions of pounds have been diverted away from shareholder returns and away from productive reinvestment in the economy, in the interests of cutting pension deficits that might be grossly overstated thanks to some dodgy actuarial assumptions?

By the way ramridge, are you still mostly cashed up?

Hi bestace - excellent commentary and I agree with the points you have made.

Am I still in cash? Well I have been broadly following Minervini on this question. I was near 90% cash April/ May but since then moved to 50% cash. Which is where Minervini is, I believe. I don't intend to move from this position unless the economic/ political outlook improves dramatically. Doing OK so far; portfolio is up 32% year to date.

Impressive! even for this bull market.

jonno

Bestace and Ramridge thank you for an excellent and informative exchange on Norcros and increasing my limited knowledge on the black arts of pension deficits. On balance I am positive on the outlook for Norcros on the basis that the economy doesn't fall off the proverbially cliff. As you may have gathered I am long on the shares and about break even, excluding dividends over a couple of years. Hopefully patience will be rewarded. Time will tell. Once again thanks for the excellent posts. Also well done to Bestace 32% is indeed impressive.

Your congratulations should go to ramridge, not me, I'm some way short of his 32% returns!

I was invested in Norcros (LON:NXR) for about a year as a value play, but I've come round to the point of view that opportunity cost trumps the value card here: when I have other shares in my portfolio tearing ahead at double or even triple digit percentage gains a year, I was effectively losing out by being invested in Norcros and the dividend yield, nice though it is, is meagre compensation that amounts to a rounding difference when compared to the performance of those other shares.

Yes I'm being impatient, but I just don't think the markets are interested in looking past that pension deficit. That's why I'm so critical of the IAS19 accounting standard because in my view it vastly overstates the problem.

31st Jul '17

Hi Bestace
Apologies to Ramridge, like many on Stockopedia my portfolio has performed comparatively well this year but is very far from a 32% gain.

You make a very valid point about opportunity cost and the time value of money that I have given much thought to. However for the time being I have decided to stick with Norcros. Apart from the decent trading update, I take encouragement from the large holdings in the Company taken by Miton and Hargreaves Hale and the earnings upgrade now shown on Stockopedia. From memory Miton hold over 11% and I see that Hargreaves Hale have just gone over 15%. Arguably Gervais Williams and Giles Hargeaves are two of the best small cap investors around. However it all depends on how the economy unfolds and even Messrs Hargreaves and Williams occasionally get it wrong.

I would also suggest that pension deficits are not necessarily an impediment to takeovers. Aga in particular comes to mind, although the Aga brand has much more kudos than Triton showers.

All the best

That's very true about pensions not necessarily being an impediment to a takeover, although the existence of the pensions deficit surely narrows the pool of potential acquirers.

And of course, Norcros was taken over before by way of a management buyout in 1999. Back then this is how they rationalised the MBO:

the Board was disappointed to see that, despite the restructuring and the improvement in the Group's profitability, the price of Norcros Shares declined significantly over the three years leading up to the end of 1998... In the view of the Board, a key implication of this poor valuation environment was that Norcros Shareholders had limited opportunity to realise fair value for their holdings through the stock market.

It seems some things just don't change!

In FY99, their last financial year before being taken private, they made PBT before exceptionals of £15.3m on turnover of £197.2m and net debt was £10.5m. Fast forward 18 years and they are now making PBT before exceptionals of £22.9m on turnover of £271.2m and net debt is £23.2m.

Sure there has been a lot of M&A over the intervening period, but just on those numbers and after adjusting for inflation, they have barely moved on.

The big difference is the pension. Back in 1999 the triennial valuation was reporting a pension surplus of £53.5m with Norcros enjoying contribution holidays and negotiating refunds from the pension scheme. Now we have a deficit of £73.5m and contribution holidays are a distant memory.

Clearly other valuation metrics are available but on an enterprise basis, adjusting for net debt and the pension scheme, the £171m takeover price back in 1999 gave an enterprise value of £128m which compares to today's market cap of £109m and enterprise value of £205m, so on that comparison maybe it's not as cheap as it looks.

I think a savvy acquirer could create a lot of value from a deal but I'm not a fan of being in a stock where takeover potential forms a large part of the investment thesis. Good luck to holders though; I may jump back in at some stage as the underlying business seems pretty sound.

Small Cap Value Report (Thu 27 Jul 2017) - BON, BOOM, NXR, CWD, FOXT, MONI, KWS

Bonmarche Holdings (LON:BON)

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Paul Scott

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