Small Cap Value Report (Thu 9 April 2020) - ECK, OTB

Good morning, it's Paul here with the placeholder article for Thursday morning's readers comments.

Estimated timings today - should be mostly done by 1pm, but I expect to carry on until c.3pm. Edit at 13:52 - I'm going to leave it there for today. Today's report is now finished.

Lockdown - this is starting to become tiresome, but I understand the need for it. I'm going to have to dodge the over-zealous megaphone wielding rozzers, and get some exercise this weekend. A month of lockdown has meant an expanding waistline, driven by too frequent deliveries from Dominos pizza, and too much ice cream. We'll certainly be a nation of bloaters once this is all over.

Italian tech - one news item which amused me, was that an Italian Govt website for people to claim support money, crashed due to a huge surge in online applications. This prompted the website Pornhub to offer its technical expertise to the Italian Govt, since Pornhub's servers were also experiencing an unprecedented rise in traffic but had managed to continue operating as normal. It seems that Italians are using the lockdown to do more than just eat pizza!

US markets - I can't believe how much the US market has rallied. I think in terms of the Dow Jones Industrial Average, just because it's what I'm used to over the last 20 years. This peaked around 29,500 earlier this year. It then plummeted to about 18,500 in the coronavirus sell-off. It's now about 23,500. That's an 11,000 point drop, followed by a 5,000 point recovery - almost half! That makes no sense to me whatsoever, when reports from the US are that the country is in economic meltdown - something which could take a long time to recover from.

It may be the case that CV-19 is getting close to a peak, and that some economic activity may be able to resume (end May, perhaps?). What worries me is the unprecedented economic damage that the shutdown is going to leave behind. Can bureaucratic, poorly designed, rushed, Government schemes get money out there quickly enough? When have civil services ever managed to get massive projects done fast & efficiently? Never. When you think through the enormity of the UK schemes, where the Govt is basically paying the payrolls for vast numbers of companies, it's impossible to imagine how such a scheme could be administered effectively. I reckon it's likely to be a complete shambles. That may not get money to where it's needed in time to save some companies.

In terms of the overall market, in the US, I think risk:reward looks absolutely terrible, and I'm short of the Dow a lot of the time, which is the main thing that's kept me afloat in the last couple of months. As it is prone to powerful rallies, then I find it's best to bank 500-1,000 point falls, then even flip it round briefly to long, for the bounces. It feels very strange to be a trader of indices, but frankly I had to find something to make money, in order to absorb disastrous losses on my small cap longs.

Anyway, the profits from hedging/shorting have provided a nice pot of fresh money to buy up some small and mid cap bargains in the UK. Stuff I've bought recently includes;

Norcros (LON:NXR) at 128p - on the basis that its supply chain in China should be normalising now, and that once the lockdown is lifted then demand should return.

Walker Greenbank (LON:WGB) at 32p - I've always liked this company, and hope it should see business return to normal later this year. Could see horrible losses in the meantime though.

Vertu Motors (LON:VTU) at 20p. It hasn't bounced much yet, but as mentioned here many times before, I like the balance sheet (loads of freehold property), and see car sales probably rebounding later this year

Newriver Reit (LON:NRR) at 68p. Currently underwater. I looked into the borrowings, and balance sheet, and it looks conservatively financed. The key point for me, is that the assets haven't somehow evaporated. Once pubs & non-food retailers are allowed to re-open, then it can get to work collecting in the rent arrears, or letting empty sites to new tenants. Its debt looks secure.

Hammerson (LON:HMSO) at 56p. I got lucky with the timing of my purchase, the day before a huge jump. This one is probably more risky than NRR. Again, its assets have not disappeared, although the main risk is that assets might have to be written down in value to an extent that stretches bank covenants. As it's more risky, I've kept the position size smaller than NRR. I see more rebound potential in some landlords with sound balance sheets, than with retail tenants' shares.

Marks And Spencer (LON:MKS) - I couldn't resist this at 101p. Its recent update reassured that it has masses of liquidity, so should be able to get through this tough period. Launch of online food service with Ocado later this year could be a game-changer. Store closures should improve cash generation further. All the downside issues look more than accounted for at this price, in my view. Lots of its competition is disappearing, e.g. Debenhams. Last man standing?

Dunelm (LON:DNLM) - luckily timed purchase at 702p. I was really impressed with its last results. Big box type stores might be allowed to re-open earlier than traditional High Streets maybe? A good recovery share, in my view.

Brand Architekts (LON:BAR) - I picked up a few (very illiquid) at 122p, because that's around par with net cash. Hence risk seems well covered.

Bigdish (LON:DISH) - I've greatly increased my position here, because it's all set to re-start once restaurants are allowed to open. Enough cash for rest of 2020, and they finally cracked the business model in Jan-Feb, with a highly effective telesales team (currently furloughed) that produced excellent initial results. Possibility this could be a 5-10 bagger from this level, in my opinion. Definitely not for widows & orphans.

Hopefully that might give you some ideas, but as always, these are never recommendations, just a list of what I happen to have been buying myself. Given that I've had something of a reverse midas touch in the last couple of years, you might want to steer well clear of all of the above! Still, it only takes one big winner to pay for all the losses on everything else.

I'm not planning on buying much else now, as I think generally things have bounced enough, or too much, and risk:reward looks unfavourable to me now. I've kept a fair bit of cash on the sidelines, holding back so that I have firepower if markets take another plunge downwards (highly likely, in my view).

Right, on to today's news.

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Eckoh (LON:ECK)

Share price: 49p (up 2% today, at 10:43)
No. shares: 253.9m
Market cap: £124.4m

Full year trading update

Eckoh, the global provider of secure payment products and customer contact solutions, today issues a trading update for the year ended 31 March 2020.

The heading summarises things by saying -

Full Year Trading Update: results in line with expectations

I like a one line summary at the top of a trading update, providing it's truthful of course, which is not always the case if the PRs have been let loose on it! Other points;

• Double digit revenue growth
• Year end order book up 10% to £35.9m
• USA market - increasingly focusing on secure payments. Contracts include 2 of the 5 largest US retailers - sounds impressive
• Sales pipeline "extremely strong" but some delays due to Covid-19
• UK market strong in H2, with some early contract renewals
• Net cash of £11.6m at year end
• Covid-19 update - staff working from home. High level of recurring revenues. Cost control (e.g. freezing hiring & pay rises). Fall in call volumes in UK

Outlook - sounds like Covid-19 must be having some impact;

... the Board considers it prudent to withdraw financial guidance until conditions stabilise. The Board has also taken the decision that it will not propose a year-end dividend unless conditions change such that the outlook is clearer and supports us doing so.

Despite the short-term disruption to market conditions relating to COVID-19, the Board remains confident of the future prospects for the Group with an excellent sales pipeline in both the US and UK.

My opinion - this is a bit tricky. The company tells us above that everything's fine, but then withdraws guidance & passes the divi. That doesn't seem to reconcile, to my mind.

The share is priced at c.34 times FY 03/2020 earnings. Presumably earnings are likely to be lower in FY 03/2021. So we're being asked to not only look through the likely fall in profit this year, but to pay 34 times previous peak earnings. That doesn't strike me as an attractive proposition, when there are so many other shares with good prospects long term that are much cheaper.

Overall, I like the positive news on contract wins, strong pipeline, etc, but I feel the share price has not adequately discounted the precarious overall economic situation in the UK and USA. Good company, but the share price is too high for me.

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On The Beach (LON:OTB)

Share price: 267p
No. shares: 131.2m
Market cap: £350.3m

COVID-19 and banking facilities update

This share has been on my watchlist as a possible buy, but unfortunately I wasn't quick enough off the mark yesterday, and missed a big rebound, triggered by this update. In market conditions like these, it's completely impossible for one person writing these reports (part-time), to cover everything. Can people please bear that in mind when posting intensely irritating comments like, "I'm surprised there hasn't been any commentary on xyz plc".

OTB starts its update with an excellent explanation of its business model, which is worth repeating here in full;

In line with market-wide communications made by OTB prior to and since its listing in September 2015, the Group has an asset light, flexible, no inventory risk model and has no fixed commitments on hotel rooms or airplane seats.

For context, a tour operator or airline will generally have an almost immovable committed inventory cost (aircraft and/or hotels) and infrastructure cost of 60-70% of its aspirational total sales (transaction value) with or without any demand. An online travel agent like OTB without any inventory commitment only incurs inventory costs on each sale made and under normal conditions will have an underlying operating cost of approximately 8% of sales of which almost 70% is flexible marketing spend. If demand falls away completely then the fixed cost base will drop to c.3% of aspirational sales (or one twentieth of the costs of a similar sized asset heavy operator).

That's a great explanation of why I quite like online travel platforms like this, and also to a lesser extent, Hostelworld (LON:HSW)

Summary of other points;

• OTB does not rely on cash from forward bookings to trade - I think this is important, because recent events have shown how it's really very wrong that travel companies utilise forward cash paid by customers as if that cash belonged to the travel company, when it doesn't. I wonder if legislation might force travel companies to segregate and safeguard cash? If so, then many/most travel companies would need to refinance
• Marketing spend reduced to almost nil
• Cash costs currently £2m per month - but no breakdown of this is given
• Suspending earnings guidance, and divis - par for the course at the moment
• Salaries - CEO foregoing salary, other Board members taking 20% cut, no bonuses for anyone
• Banking arrangements extended, made more flexible, covenants relaxed - sounds positive
• Stress test - an excellent idea, the company gives a worked example of a severe stress test (zero sales until end Sept 2020, then slow recovery until Mar 2021). In this scenario, only limited drawdown of borrowings would be required, and plenty of headroom to take advantage of market opportunities. This is really reassuring, and all companies should be publishing stress test details.

My opinion - this is terrific stuff. What a pity I didn't spot it first thing yesterday.

It's clear that OTB should have no trouble getting through this incredibly difficult period. When it comes out the other side, there's probably going to be less competition, and backed up demand.

I think the strong rebound is justified, although personally I'm not interested in chasing the share price up any higher than the current level. that's because we've still got a probably long period of pain to endure, before the travel sector returns to anything like normal. Hence that needs to be reflected in share prices. Well done to holders who didn't panic sell in the recent plunge.

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I'm leaving it there for today. Have a relaxing weekend.

Regards, Paul.