Small Cap Value Report (Thu 3 Oct 2019) - IFRS 16, RBG, ZTF, TED, SDY, WIN

2nd Oct '19 by Paul Scott

39 comments 8952 reads

Good morning, it's Paul here.

Timing - as you've probably gathered, I've settled into a routine of writing in the afternoons, which works best for me. I'm trying to persuade the boss to change the timing of the daily SCVR email to something like 5pm, so that it doesn't go out half empty or blank.

Estimated time of completion today is 6pm. So by all means check in before that, as sections are added, but the finished article will be done by 6pm, as I have no meetings or other distractions today. Update at 17:33 - today's report is now finished.

IFRS 16

I've noticed one or two investors & commentators are getting into a panic about IFRS 16.

From the enquiries I've made so far, institutions & banks are taking as much notice of it as I am - i.e. seeing it as a nuisance, and wanting numbers to be presented to them in the old way.

I've also been assured that banking covenants, facilities, etc, will continue to be based on the old numbers. The idea that IFRS 16 adjustments will "wipe out" companies, is as daft as thinking that Brexit is going to wipe out cross channel trade!

When I met management of Revolution Bars (LON:RBG) earlier this week, of course I wanted to talk to them about IFRS 16, as the notes to the accounts showed that it's going to involve some big new entries on future accounts. The CFO ran through all the details, leaving me none the wiser, as it's all so complicated. So I thought for a moment, then asked this question;

How much cash losses do your problem leases cause you, compared with if you could theoretically just ditch them all?

The CFO replied that it's about £1m p.a..

That's easily affordable, in the context of c. £12m p.a. EBITDA, so I was happy with that issue addressed. The problem leases are a bit of a drag on profitability, which was a known factor before IFRS 16 anyway. Most multi-site retail/hospitality operations have a tail of loss-making sites, which they exit when they can (when leases expire, or can be assigned on commercially viable terms).

A good follow-up question would be to ask what the break clauses or lease expiry dates are for each site - or an…

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doug2500

3rd Oct '19

Zotefoams (LON:ZTF)
I was assuming £82 M too which is approx the same as last year.

I agree on all your other points entirely, quite a disappointing TU in more ways than one.

sherpa

I have also been a fan of £ZTF in the past and like the long-term story. However, I don't see today's fall as an overreaction at all. The rating on the stock was sky high and priced in blue sky all the way. EPS forecasts are likely to fall to 16p or less for the year to Dec 2019 or a p/e of 21x and yield still under 2% at the current 340p. The warning also comes in the middle of a heavy expansion cappex phase that is pushing debt up towards £30m. Buyers beware!

john652

Hi Paul,

Any comment on Ted Baker, currently off 35%!! and down 75% ish for the year. Is this oversold, my it has to be a bargain voice is speaking to me but I avoid all retail, as it's just not for me but I like Ted Baker clothes, the brand, the model of shops online and only discounting in their own shops. Oversold?

Camtab

ITM looking interesting. I am a holder. Still a minnow but revenue up 40% to 4.6m (3.3m). This is important because much of their funding is and has been grants (12.9m v 10.8m). Grants should grow given increasing pressure on global warming front, but clearly corporates responding with interest rising and good sales pipeline. Linde Eng are taking a 20% stake by investing 38m. Additional 20m being raised in placing and open offer. Got 5m cash on balance sheet. 15 hydrogen stations now exist or under construction. 33 hydrogen fuel contracts in place. Valuation tricky 140m mkt cap v above revenue and loss from ops 9.3m (6.5m). Stocko gives it 22 rating (momentum trap). But isn't this always the case with unproven business models, new ideas. Not for everyone but I like it and will be taking up the offer.

NowOrNever

Great to see IFRS16 raised, Paul. As a CFO I think it's nuts - confusing the vast majority of people and moving the P&L even further away from cashflows. Ultimately it's important to remember that nothing commercially changes. I've been surprised at how unprepared some banks and finance providers have been for it; the shape of a lot of balance sheets is changing markedly, which has scared a lot of people, even though cashflows and commitments are completely unchanged.

Something for people to watch: you don't have to restate your prior year numbers when you implement IFRS16 (though you can choose to), so profit numbers will not be on a like-for-like basis. This matters most where a company reports EBITDA as their headline number. For most, IFRS16 improves EBITDA because rental costs are "swapped" for depreciation and finance costs. I fear people will try to be a bit sneaky with this, showing artificially stronger EBITDA growth.

At my business, we've tried to adjust our profit measures to simulate the pre-IFRS16 position because we believe it gives a more objective cash-based profit/loss number. But I don't see many others doing this so I don't know if that's now impeding comparisons with peers.

shipoffrogs

Ted Baker (LON:TED) - oversold?
Their very high inventory figure suggests there could be more bad news to come.

rmillaree

Zotefoams (LON:ZTF)
sherpa
Your points are spot on their operational gearing means it is a bit of a disaster if they spend to increase sales massively then don't - that's basically not an option if the business wants to deliver for shareholders.

I would say its probably wasn't exactly "blue sky all the way " previously in that their expansion seemed to have a ready and waiting market available to expand into in which case on the balance of probabilities the projections seemed more likely ro have basis in fact rather than picking numbers out of the air.

I did have one background worry with regard to the Nike deal - i am not sure how meaningful those numbers are now and are expected to be in the future - but being at the beck and call of a large company like Nike does mean you are reliant in factors way outside of your control.

Hopefully the dust will settle soon and some expectations for 2020 will be made know - in hindsight i have had a lucky escape with this share in that they could have had the same issues this time last year when i did hold. I guess its all swings and roundabouts though i recently added to B.P. Marsh & Partners (LON:BPM) only for them to have profit type warning 2 days later - there are more banana skins on the stockmarket than mario kart i think and mario kart isn't exactly short of them.

Trident

There are so many pluses and minuses regarding the discussion of leasing/owning. Even if you own property you face either amortisation questions or revaluation questions that can impact your profit line on a non cash basis.

From a practical perspective leases that provide security of tenure can be a good thing or an anvil around your neck, depending on whether there is an upward moving rental market or not.

For companies that have to be move on a short term lease, means refurb/fit out costs for new premises (as well as the ability to get out of onerous leases). For businesses that require uprooting IT structures IT, phone connections, all become material costs. So chopping and changing is not always a good thing.

For retail the considerations are slightly different, so sector relevance is applicable to a 'standard' IFRS approach, and therefore maybe comparatives should be the order of the day- though this requires apples being compared to apples.

I am always wary of companies that shift their accounting reference date, for the confusion this causes with benchmarking, and it seems to me this IFRS concern should be amplified in the notes to accounts rather than on the face of them - though some will say this is a way of burying an issue.

pj8

The people controlling IFRS are not academics but, as you advocate, leading people in business. The IFRS are set by the IASB - most, if not all, of the 14 people on the International Accounting Standard Board are working, or have worked, as accountants or finance directors in various commercial organisations.

doublelutz

Paul - you are obviously with a substantial company but although I am not up to date on accounting standards I think this will apply to smaller companies in a couple of years time. I am glad I no longer have to explain this to directors as they will not understand it and your description of "nuts" will be mild to their reaction. It will also be the reaction of smaller firms of accountants when they have to deal with it. I think it adds confusion and has been developed by academic minds to whom the cost of implementation is not an issue.

I am not surprised that banks are unprepared as from my considerable experience of dealing with them they will have few people who understand it.

The list of board members can be seen by searching for IASB board membership. This is a group of people from all over the world who have experience ranging from regulating financial markets down to the former chief accounting officer for Xerox. The outcome of their deliberations may be very relevant for multi-national companies but we are talking here about small cap companies. I would suggest there are few persons involved in the decision making that have had much involvement with the type of company that Paul was initially writing about. It also leads at times to total frustration and disconnect between the views of smaller firms of accountants and those of their governing body.

Sorry, I should have been clear - my comments were in the context of main market and AIM companies, almost all of which have to use IFRS. It doesn't matter whether you're big or small, under IFRS you now have to adopt IFRS16 for accounting years beginning on or after 1 Jan 2019.

I dread to think how small, under-equipped firms of accountants will deal with it!

jonesj

Thanks for the article Paul.

Only yesterday, I was having almost exactly the same thoughts about IFRS 16. However, I'm an Engineer, with almost no accountancy training & very capable of getting it wrong.
Therefore it's quite reassuring to see some analysis from an accounting pro.

Perhaps this is confirmation bias on my part.
For profitable sites, I just cannot see the sense in putting a lease liability which could be spread over 10 years on the balance sheet.

The Phoenix

Hi Paul

I know your probably stacked out most of the time but would there be any chance you could do a video using Stocko platform to show the more novice investors oh here how to do some basic balance sheet checks maybe 30 mins or so.

I've picked up from you things like being wary of low current ratio and obviously its easy to work out net debt on Stocko but another few quick wins on balance sheet training would be awesome.

No drama if its a ball ache.

Regards

Andy

Ted Baker (LON:TED) - I mentioned to my wife that Ted Baker had bad results. She said that she used to like them and bought for both of us but they have gone right off particularly on the women's side as well as being expensive. She says other brands have also gone off in her opinion including Whistles, Coast and Karen Millen. She buys mostly continental makes on the internet. It sounds as if Ted will have difficulty clearing his huge stock at a profit.

Gromley

Quite a shocker this morning from Zotefoams (LON:ZTF)

Also a shocker of execution by me. I looked at this a while ago and decided that I was nervous about the downward share-price trend since the start of the year. So what did I do? I reduced my position, in retrospect there was an element of FOMO and perhaps emotional attachment in that decision.

A new sign needed for my office wall I think - "DON'T BE A RABBIT".

I have sold out completely now, but like Paul I still like the business in the long term so will be back.

I believe gross margins in Polyolefins are in mid 30s % so a £6m miss probably means a £2m reduction in Pre Tax profit which would I think be consistent with the top end of the 15-18p that Paul suggests above.

However, I am puzzled by their statement

Anticipated profit for this period is impacted by our limited ability to change the operational gearing in the business in this timeframe.

I would have thought it goes without saying that Opex cannot be dialled down that quickly, so are they telling us something more? Perhaps there is some unrecoverable Cost of Sale also?

Equally if the revenue miss is actually bigger as rmillaree suggests then obviously my £2m would be an underestimate. So Paul's 15-18p does seem reasonable to me.

In and of itself that would not be a total disaster, but of course we are left wondering what about next year?

One to avoid I think until we see some clear signs of their markets recovering.

Paul Scott

Hi Gromley,

Re your post on Zotefoams (LON:ZTF) operational gearing, you said;

That was my thought too, hence why I estimated a bigger reduction in profit than would have been caused by just removing the gross profit on the lost sales.

In other words, I think we could be looking at a double whammy from lower than expected sales, and a lower gross margin too.

Regards, Paul.

xcity

Sounds as if she might have an interesting perspective on Coast and Karen Millen when they restart trading under Boohoo (LON:BOO) management.

6th Oct '19

Thanks Paul for your excellent write up on Ted Baker (LON:TED), not a bargain at all.

Tombholliday

30th Nov '19

zotefoams have risen 50% since their lows following the October profit warning on bulk foams any thoughts

Small Cap Value Report (Thu 3 Oct 2019) - IFRS 16, RBG, ZTF, TED, SDY, WIN

IFRS 16

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Paul Scott

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