Small Cap Value Report (Thur 29 Mar 2018) - CVR, RM2, SOS, CMCX, QRT, DX.

29th Mar '18 by Graham Neary

50 comments 20553 reads

Good morning folks.

Stories on the radar today:

Conviviality (LON:CVR) - Notice of intention to appoint administrators
Sosandar (LON:SOS) - Interim Results
Quarto Inc (LON:QRT) - Final Results
DX (Group) (LON:DX.) - Interim Results
CMC Markets (LON:CMCX) - Trading Update
RM2 - Conditional Placing

Conviviality (LON:CVR) (suspended)

It is game over at Conviviality.

Last night, the company revealed there was insufficient demand to raise £125 million in new equity. It was looking at its options, but the dreaded phrase was used:

The Board believe that shareholders in the Company will receive little-to-nil value.

Today:

Unless circumstances change, and in accordance with statutory requirements, the Board intend to appoint administrators within 10 business days. The secured creditors can, however, appoint administrators without the requirement for notice.

It's amazing how quickly things can unravel.

Up until March 14, we didn't know about the surprise tax payment due to HMRC. We were expecting another weak financial performance this year after receiving another profit warning, but insolvency did not appear to be imminent.

Then, the shares were promptly suspended on March 14 as the company scrambled to find the £30 million due to HMRC.

But it turns out that £30 million would not have been enough. It said yesterday that £125 million was "the minimum amount required to adequately recapitalise the business." This is what the wheels falling off, looks like.

I've written about Conviviality plenty of times, covering it in 2016 and early 2017 on other websites (here and here and here), and also covering it in this report.

Despite being consistently sceptical towards it, I take no pleasure in seeing it fail. Hopefully, most employees will retain their jobs, or find similar jobs with whoever buys up their units.

It's certainly unhelpful news for the drinks industry. Matthew Clark is a structurally important wholesaler, and many suppliers and customers would much prefer for it to survive. It's only fitting that they, to the extent that they are creditors to Conviviality, will find that they are now effectively its new owners. There is a risk of…

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MiserableJacktPotato

29th Mar '18

Thanks for replying.
What’s your wife’s verdict on the clothes? :)

Gromley

I haven't looked at Quarto Inc (LON:QRT) before (and based on Graham's useful as ever write up I don't feel an urgent need) , but was interested in comments on the balance sheet - which clearly is an issue.

Graham said :

it looks like quite a good business. It just needs to do an equity raise to eliminate a decent chunk of the debt, focus on its core operations and ...

[My bolding]

Which sounds quite sensible, but what the company said was slightly different :

It has become clear that the competing pressures of servicing debt, paying dividends, and investing in the core business currently inhibit Quarto's ability to grow by acquisition. The Group is therefore looking at all options to strengthen the balance sheet and will keep all stakeholders updated with its progress.

[Again my bolding].

Given the mention of significant impairments of intangibles, I'm not sure I would be too impressed with a fund raise primarily focused around allowing them to acquire more overpriced companies. They didn't offer the pretence of replacing "grow by acquisition" with "add value through strategic acquisitions".

Not for me on this reading and that's useful research time saved, thanks again Graham.

samanddee

Hi - If we were to reverse the clock and look at Conviviality's Stockopedia reports earlier this year what were the warning signs that this train wreck was just around the corner?

xcity

30th Mar '18

Lots of indications that things weren't going well, but none that I can see about the train wreck coming just round the corner.

It will be interesting to looks back once we actually know what happened. We know what they were saying cannot have been true, but don't, I think, yet know what the truth was. Or whether they knew. How easy is it for any company to 'forget' an imminent payment to HMRC that's about half the size of annual profit?

timarr

The reports can only go so far - if the company's finance department and its auditors can't spot an incoming £30 million tax bill there's not much chance that anyone external can. When this type of mess happens there's an understandable interest in trying to figure out what the warning signs are but sometimes stuff just happens. We have to rely on a certain level of competence in the managements of listed companies.

For what it's worth the company was close to its leverage covenants and was still paying out dividends which is always a bit of a concern, and would be something I'd regard as a red flag - although I wouldn't invest in any business with this low level of operating margin anyway. And the Z-score indicated caution.

Graham has been consistently bearish on this, too. Too many exceptionals, too much of the profit going to management rather than shareholders - that's usually an indication that the management have a vested interested in boosting the share price.

But was there any indication of the possibility of a total loss of capital? No, I don't think so.

timarr

Housemartin2

Timarr
Re Conviviality (LON:CVR) I don't think that monitoring tax payment dates during the course of the year is really part of the audit process. This is fairly an squarely a company finance matter.

Difficult to disagree with anything else you say though

john652

RM2 £RM2 I remember looking at this and classing it as a story too far and an ‘other people’s money’ investment, and sure enough Woodford is heading for 68 %, wow. He seems to be in so many bad news stocks at the moment.

The Phoenix

Hi Timarr

I was just wondering if theres any chance of you giving us less experienced investors a brief overview on the stats you look at on Stocko when viewing a new stock for first time, one of the first things I view is average shares in issue if that number is increasing like confetti that ends it for me.
Be interesting to get your take if you have time as get impression your someone who knows his way round some red flag quick wins.

Thanks in advance no worries if its to much of a ball ache.

31st Mar '18

Hi Clarea

The first thing is to decide what sort of investor you are. I want to hold long term and so I’m looking for quality companies, preferably at a reasonable price. If I were looking for something else then I’d probably look at other metrics. So, firstly, I want profitable companies – I don’t invest in anything loss making. Obviously, I miss out on some wonder stocks at an early stage, but the chances of finding them are tiny and more importantly I miss out on a lot of rubbish.

I don’t want to pay huge amounts so I first look at P/E and P/FCF. Other people prefer PEG or P/S, but generally the aim to figure out whether a share is expensive or not. I don’t want to pay stupid multiples, but as I’m buying good companies I rarely expect them to be cheap. For instance, I bought Softcat (LON:SCT) in October 2016 on a P/E of 16.5 (moderately expensive) and a P/FCF of 11.7 (cheap). Now we’re looking at 27.6 and 33.3 – expensive.

Then, given my focus, my next port of call is the quality metrics – Return on Capital, Return on Equity and Operating Margin (or ROCE). Ideally I want a minimum 10% on all of these - companies with these sorts of figures have some kind of competitive advantage, which should allow them to continue to make similar figures. If you’re a long term holder this is where your research pays off, to figure out whether their moat is temporary or permanent. Again, looking at Softcat, their ROC and ROE were outstanding in October 2016 (54% and 40%) but Op margin was under 6%. I decided to invest anyway because they clearly have outstanding account management and are riding a technology refresh wave, but I don’t see any long term moat.

I then look at free cashflow and compare it to operating cashflow, and scan back across the years. Cashflow is hard to fiddle with and good companies throw off cash. FCF can vary for many reasons but it should be positive and, on average, a decent percentage of operating cashflow. Another way of putting that is that I dislike companies with large capex – it suggests they have to spend a lot to stand still. All things being equal you want a company that can make money without spending much – one reason why franchise operations are always worth considering. Again, with Softcat nearly all the operating cashflow drops through to FCF – their capex is low primarily because they’re hosting their customers’ technology or using cloud based platforms rather than paying for it themselves. Unsurprisingly they keep popping out special dividends, which is nice.

I then look at gearing – debt is always interesting. A company with net cash is safer, but potentially isn’t investing or returning as much as it could. However, I don’t want massive amounts of debt, so I generally want gearing to be well below 50%. In fact most of my holdings have net cash. Obviously Softcat does. Some companies with lots of cash tend to look for acquisitions but all things being equal organic growth is preferred, acquisitions can and do go wrong.

If the above stacks up then I’m definitely interested. You’re right that the average number of shares in issue is an interesting metric. I can’t say I ever look at it but I probably should. Generally companies that issue equity are diluting their existing shareholders, which isn’t usually a good thing unless the deals they’re doing are extremely good. Equally if the shares in issue are reducing then that implies a buyback – and that needs to be looked at carefully, because most companies exercise buybacks in the interest of the management, not in favour of shareholders.

You should also glance at the F-Score and the Z-Score. Given the metrics above these are very rarely concerning, to the point I usually neglect to look at them. But they’re good measures of company sustainability. Above all we want to avoid a total loss of capital of the type that’s afflicted Conviviality. No matter how far a share has fallen it can still fall another 100% (I still have my Marconi share certificate to remind me ...).

Other types of investor would look at other stuff – value investors would be interested in book value and yield for instance. It’s not something I generally care about unless we’re in a massive bear market, and then opportunities crop up to invest in near quality stocks at bargain prices. In 2008 I remember buying Fyffes at a stonking discount to net current assets and getting a huge return over the next 5 years. And momentum investors would be interesting in relative strength, etc.

Oh, and I usually try and find out who the major shareholders are. If there’s a major stake held by a single, non-institutional party then I want to find out something about them. Having management with real money in the game is good but you do find companies controlled by external parties and quite often they’re run for the benefit of those parties, not for shareholders.

I can and do invest initially based on the above approach. I often need the kick of ownership to investigate further – and sometimes when I do I decide I don’t like what I see and divest. So I actually buy and sell quite a lot for someone who is a buy and hold investor. But the things I like I usually end up holding for a long time and with quality companies good things tend to happen - I've seen bids for Fidessa (LON:FDSA) and NEX (LON:NXG) both held since 2012, in the last few weeks.

I’m also intolerant of surprises on the downside – unexpected profit warnings usually trigger an immediate sale. But I don’t do stop losses, I’d rather lose a bit more by handling a sale manually than be stopped out of a great company due to a technical blip. And above all, if you’re convinced you want to own a stake don’t be put off for a few pence one way or another. If you’re right then that’ll end up as noise and if you’re wrong then it’ll hardly matter.

But investing and risk is always a personal thing, and people should develop their own processes and tolerances based upon their stage of life, assets and ability to accept risk. Following other people thoughtlessly is a one way ticket to some very bad investing experiences, because we’re all different.

Good luck!

timarr

Damian Cannon

Excellent post timarr. Many similarities with my own approach and some useful checks for any fundamental investor.

iwright7

Timar - Yes a great investing summary on one page of A4! I am reminded of Frank Sinatra's song, "I did it my way".

I am sure there is a huge body of collective wisdom and successful styles in the Stockopedia membership, from which young beginners and old owls would benefit greatly. Its a shame that there is no mechanism to disseminate this I did it my way information more easily. Ian

LeoInvestorUK

jonno,

Majestic Wine (LON:WINE) should benefit from Conviviality (LON:CVR) 's collapse, at least at the margins. I bought £EZY immediately after the collapse of Monarch etc. and the shares / business did well with this subsequently being explained by less competition. However, when I looked into it Majestic Wine (LON:WINE) didn't really appeal to me.

Great stuff Timaar

Out of interest how many stocks do you hold in your portfolio on average and do you obtain your entire line at the start or scale in as the price moves up ?

Kind Regards

1st Apr '18

Hi clarea

Out of interest how many stocks do you hold in your portfolio on average and do you obtain your entire line at the start or scale in as the price moves up ?

Currently I hold about 95 positions - and, yes, I know all about diworsification ... On the other hand I've beaten the market, however you define it, in 16 out of the last 17 years, so it works for me. Stockopedia is a boon, however, as it allows me to set automated alerts.

As for average position size, well as you'd imagine it's probably a lot smaller than many around here take: I'm highly risk adverse, and regard diversification as the only free lunch the market offers. Given the relatively small positions I take I normally buy a full tranche at the outset but occasionally increasing familiarity with a company will prompt me to add to the position - I did this with Burford Capital (LON:BUR) and Bioventix (LON:BVXP) which worked out rather nicely :)

However, the broad diversification also allows me to ride out the dips with relative equanimity. No big company ever got big without blips along the way. Psychologically it's much easier to keep on holding a stock when it's only a relatively small part of your total capital.

Also in the event of a general market downturn I'll quite often top-up existing positions where I think they're offering value. Buying more of what you know when uncertainty is rife is a relatively safe thing to do.

Thanks again Timarr,

Blimey 95 positions do you trade full time and hold things such as OEICS and Investment Trusts within your portfolio ?
Also with reference to the price to free cash flow ratio what figure would you put at the top end of this ratio before you would be put off investing into a stock, I've noticed a few other sharp posters mention the ratio on here and its not one i've paid to much attention to in the past but clearly need to.

Again thanks for taking the time out to answer.

There is a great community on here and it seems to be one of the few sites where it would appear sharp operators outnumber the novices which doesn't happen on the likes of advfn.

Its good to learn at a higher level from some really top level posters such as,yourself, Orange Tree, Damion, Gus, Mr Contrarion and Matylada to name but a few.

Kind Regards

Andy

Hi Andy

Blimey 95 positions do you trade full time and hold things such as OEICS and Investment Trusts within your portfolio ?

Nope, I have a very full time job and equally full time life. It helps to have a buy and hold mentality, and I normally only get active during a market downturn. I hold a couple of mining IT's, a few PE funds and a couple of preference shares, but otherwise it's just normal shares. I skim the RNS's most mornings and do a few hours research most weekends, but that's about it.

P/FCF I treat like exactly like P/E. The thing to really look for is a big discrepancy between P/FCF and P/E - and then you need to figure out why FCF is hugely different than earnings. Remember: earnings are fiction, cashflow is fact :)

2nd Apr '18

Thanks again, I will stop badgering you now and let you enjoy what's left of the bank hol weekend truly awful weather this part of the country seems to have been six months of snow and rain.

Appreciate you sharing some really good information.

Regards

Andy

TheArb

I don't think I've ever seen anything escalate this quickly before.

A £30m tax bill to a company of this size should not have been fatal, however the key words in the company's statements a couple of weeks back were: "the Company is fully drawn under its term loans and revolving credit facility". No wiggle space. That with the very short time frame involved, March 30th, ( HMRC are not known for their patience), meant a drama rapidly became a crisis.

It's still unclear has this then escalated to a requirement for £125m. £125m!! for 'overdue payments to creditors and additional capital' - this does not give sufficient explanation, no wonder shareholders were not forthcoming, what chance have you got of of raising that in a hurry just before Easter and the directors risk prosecution if they continue to trade while insolvent.The almost immediate suspension also left no exit for shareholders, the final insult. As Paul says total incompetency, but not just in overlooking the £30m tax bill, but sailing the company so close to the wind in terms of cash liquidity that it was wide open to what Rummy would call ' a known unknown'.

It's no consolation to shareholders but the vultures will probably do quite well picking over the remnants. There may however be some pressing issues for Revolution Bars to resolve too.

12th Apr '18

Thanks to everyone for all their thoughts on this issue.

gus 1065

3rd May '18

After hours announcement from DX (Group) (LON:DX.) confirming they’re raising c.£4.8m gross from a placement of shares at 8.5p (compared to previously indicated 7.41p and market close today of about 9.6p) and cancelling an outstanding loan note issue.

https://www.investegate.co.uk/dx--group--plc/dx-/fundraising-and-loan-note-cancellation/201805031832240982N/?fe=1&utm_source=FE%20Investegate%20Alerts&utm_medium=Email&utm_content=Announcement%20Alert%20Mail&utm_campaign=DX%20(Group)%20PLC%20Alert

Placement and note conversion will take the Gatemore holding to about 36% requiring a waiver from the TOP avoiding the need to make a full offer for the company and also increases the new management team’s skin in the game. Proceeds to strengthen the balance sheet and finance business restructuring. Heavy dilution for legacy shareholders but not much of an alternative. Time will tell if the management can turn it around.

Gus.

Small Cap Value Report (Thur 29 Mar 2018) - CVR, RM2, SOS, CMCX, QRT, DX.

Conviviality (LON:CVR) (suspended)

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Graham Neary

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