Small Cap Value Report (Thur 3 Jan 2019) - AAPL, NXT, VEC, COST, FCAP | Paul Scott

3rd Jan '19 by Paul Scott

40 comments 12740 reads

Good morning!

The following section was written by Graham Neary:

Continuing our China theme from yesterday, I note that Apple (US:AAPL) has blamed an "economic deceleration, particularly in Greater China" as its Q1 revenues are expected to come in 8% lower than the forecast it made only two months ago.

There are multiple layers to this story.

As many of you will have heard, the CFO of Apple's Chinese rival, Huawei, is currently on bail in Canada while the US seeks her extradition over alleged dealings with Iran.

This comes as Huawei is now beating Apple into second place in global smartphone sales for the first time.

There can be little doubt that US-China relations have frostened. Zero Hedge reckons that Apple is "indirectly accusing China of boycotting Apple products".

It's a grim situation and Apple's market cap is still so big ($700 billion) that it can seriously affect the US stock indexes, whose sentiment then leaks over to the UK indexes. The NASDAQ is down more than 2% in after-hours trading and FTSE futures look set to open in the red tomorrow.

Maybe not such a good morning after all!

End of Graham's section

The rest of today's report is written by Paul Scott:

Good morning! Haha, I see Graham got the date wrong, and originally put in 2018! I've corrected it now to 2019. Great to see that it's not only me who struggles with date changes.

Graham has passed me the reins. I hope we haven't confused too many people by sharing the report writing today.

Happy New Year to everyone! Let's hope the markets are a little more kind to us in 2019 than they have been in the last few months.

Just to reiterate, neither Graham or myself are traders. We tend to pick stocks we think are good, and take long-term positions in them. From time to time, some of those shares will go wrong. Over time though, the trajectory should be upwards. We're not trying to time the markets, that's not what we do.

I just thought it would be useful to clarify all this, given the comments last week from a reader who helpfully, and kindly, pointed out that my portfolio is not doing terribly well at the moment. With friends like that .... !

On to today's news.

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oscar247

3rd Jan '19

First Apple downgrade for twenty years! Another piece of negative news likely to add to an already battered IQE (LON:IQE) woes?

MrContrarian

My morning smallcap tweet:

Getech (LON:GTC), Corero Network Security (LON:CNS), Tracsis (LON:TRCS), Alpha FX (LON:AFX)

GETECH Group (GTC) $3.2m sale, majority will be recognised in FY18. Guides FY18 rev up 10%.
Corero Network Security (CNS) guides FY rev $10m up 18%, lower than expected. Blames "the longer time required to ramp up new go-to-market partners and secure contracts."
Tracsis (TRCS) 'significant' five year Framework Agreement with a major Train Owning Group. Believes it will will lead to significant recurring revenue opportunities. Helpfully states "at this point in time there will be no change made to current year forecasts."
Alpha FX Group (AFX) guides FY earnings ahead of market expectations.

LeoInvestorUK

Next (LON:NXT) trading statements are always interesting, both in themselves and for the read-across to other retailers. Here's the version with the weekly sales graph:
https://www.rns-pdf.londonstockexchange.com/rns/0183M_1-2019-1-2.pdf

There is a small cut to profit outlook for FY to Jan 2019, but enough to take the central profit forecast from +0.1% to -0.4%. EPS continues to grow due to share buybacks. For what it is worth, FY 2020 is for a 1.1% drop in profitability before buybacks. The current share price seems fair rather than especially cheap to me.

The takeaways for me were: a) Yes, November was bad, but not that bad and b) In the short term a shift from in-store to online sales adds costs (presumably due to mostly fixed costs in stores and mostly variable online).

timarr

The takeaways for me were: a) Yes, November was bad, but not that bad and b) In the short term a shift from in-store to online sales adds costs (presumably due to mostly fixed costs in stores and mostly variable online).

The increase in online costs is probably due to increased warehousing requirements, that's the usual pattern. I imagine that warehouse space supply is getting tight, so maybe that'll be a drag on performance too, although that would apply across the sector and Next (LON:NXT) is likely to be better prepared than smaller or less cash rich competitors.

The big issue is really around Brexit both in terms of consumer uncertainty and border issues. As they indicated in their previous report they've made extensive preparations for Brexit but can't control disruption at the border.

Overall Next (LON:NXT) looks cheap for a quality outfit, with a virtually guaranteed 4% dividend and equivalent buyback and robust forecasting. But at this point I'd like to see dirt cheap rather than merely inexpensive.

AlanJenkins2

Apple is quite big for a small cap :-]

The people here have no sense of humour !

InvestedGeordie

Good Morning Graham,

I note Alpha FX (LON:AFX) have advised they are 'ahead of market expectation. I wonder, should you have time, if this would be of interest to readers?

Thanks IG.

NB - I do not have any current position in £AFX

JohnEustace

The problem for Next (LON:NXT) is that their online sales are lower margin than in-store. So switching to online will allow them to survive but it will hit profits.
If a customer buys in store they take the goods away with them. If they buy online there’s the warehousing, picking and packing, delivery, and returns processing costs to bear. They offer free delivery over £50.

peterg

I'm not clear how true that is, for Next (LON:NXT). Costs per high street sale must be higher than online (or why is everyone doing it!). Yes there are return costs, but warehouses are much cheaper per item dispatched than shops. True, as timarr has said above, there are setup costs - new warehousing etc, but those are costs of growth, not ongoing costs (unless they keep growing - which I can live with).

The problem for Next (LON:NXT) is that their online sales are lower margin than in-store. So switching to online will allow them to survive but it will hit profits.

That's incorrect. Their last half year figures had retail margin at 7.9% and online margin at 18.3%. The two businesses are of roughly equal size, with online growing and retail shrinking.

In addition any store with an operating margin of less than 9% is being managed out. It's a very well managed business, probably one of the few that are managing the transition to online with relatively little disruption.

dmjram

Yes, its a problem for all retailers with a mixed store/online model.
The late Ken Morrison hated the idea of online shopping with home delivery for exactly this reason - too much extra work as he knew from his time delivering groceries to customers in Bradford on his bike. Much cheaper to have the customer come to you, choose what they want then take it home themselves.

Costs per high street sale must be higher than online (or why is everyone doing it!).

Actually, I think one possible explanation of why some retailers were rather slow to go online is that in the short term it makes little financial sense. Stores have mostly fixed costs so there is no "saving" of costs when a sale moves from in-store to online, only the additional costs of warehousing, delivery and returns. Of course on a longer timespan stores can be closed / moved to smaller locations (depending of course on the length of leases) and so savings are made from such canibalisation. But of course the main motivation should be that if you do not have an effective online presence then you will lose sales entirely to somebody that does.

Re Next (LON:NXT) I was remembering their commentary in their last annual report where they said:

Looking at last year’s numbers it appears that every Pound of full price sales lost in Retail cost us 60p whilst every Pound gained Online delivered only 19p of profit.
This margin erosion is partly a result of the shift in sales from Retail to Online. Retail carries large fixed costs (such as rent, rates and energy) which, in the short term, are unable to contract with reducing sales. On the other hand, the Online business has significant variable costs which increase with sales (delivery, warehouse picking, returns processing, call centre activity etc.).

https://www.nextplc.co.uk/~/me...

Camtab

I think that in part this discussion is a factor of the leases Next pay on their shops. Ware housing is cheaper but there are some very good deals going on via the high street. Frankly I wouldn't touch retail REITs.

brballs

Hi Graham,

I'd also like to have your opinion on Alpha FX (LON:AFX) . Yet another "ahead" TS this morning.

There was an excellent write-up at the start of Dec 18 by one of the commentators on here.

https://www.stockopedia.com/content/alpha-fx-expectations-beating-and-lt-compounding-potential-423543/

apad

Next closed down its store in St. Helier and opened a concession in de Gruchy.

doublelutz

"Costs per high street sale must be higher than online (or why is everyone doing it!)"

Irrespective of comparative costs they have no alternative but to sell online or eventually they will have no sales. We and many of our friends do not go out shopping - I mean my wife never, ever, goes out to buy food or clothes. We basically only go out for a meal or entertainment. Other friends do go to the larger shopping centres to look around but then return home to buy online. Was it a fund manager the other day who said that internet sales would not take much more of a percentage because people liked to shop - that is totally delusional! I can imagine a future where the only retail shops that can survive are those offering personal services (e.g. hairdressers) or convenience foods (to top up what people have not already had delivered). Retailers like Next will still want units in busier locations as much as an advertising space for their products but the online sales will continue to account for an ever larger percentage of their business.

Michael C

Very interesting and important discussion here about retail v online. I hope my response isn't too much of a ramble.
I was a chartered surveyor specialising in the management of very large retail estates for 20 years. In my last role I was on the main board of a large privately owned multiple retailer. I have also invested in property myself.
When online shopping first arrived I started giving out two warnings to anyone who would listen. To those who said online would only ever take 10% or 15% of trade I pointed out that for the typical UK shop that loss of turnover would be a big problem. To those who were investing in retail property I warned that in the long run rents were going to decline. To my friend who had built up a large business investing in secondary shop property I said that he should get out. He didn't and is no longer a wealthy man. A lot of people don't realise that when you walk through an average shopping centre some of the shops are holding over after a lease expiry on a nil rent basis, paying only the service charge and business rates, because the landlords are so terrified of voids. I echo the comment about UK retail REITs and propcos. In my mind they are all baregpoles at the moment.
Another thing I know a bit about is the shift away from using disposable income to buy stuff (most people's houses are rammed with junk that will end up in landfill) towards using it to buy experiences. I built a tourist attraction which is going well and will do even better next year.
And finally I have an appreciation of how difficult it is to make money by selling stuff online and delivering it to the customer. I study Amazon's accounts with amazement, and I have personal knowledge of how unprofitable a lot of their retail online business must be. It costs an absolute fortune to generate website visits, process sales, handle the merchandise, deliver it, and deal with customer queries and returns. Online shopping is really nothing more than the time-honoured catalogue shopping business with the catalogue replaced by a website. The websites are more popular than the catalogues used to be but the costs and difficulties of running the businesses are similar. And on top of all that people expect the online price to be less than the physical shop price. Madness.
Therefore I read the Next (LON:NXT) statement with great interest where it talks about online v physical shop business.
I personally think that Next (LON:NXT) will survive and thrive, and at a yield nearer 5% I will buy back in.
But a better thing to look out for, I think, based on my experience, is businesses who sell something special and hard to copy, which customers want in tangible form and don't often send back as returns, who have a physical estate which isn't hampered by legacy leases, and who have a well-run online presence. Games Workshop (LON:GAW) is a good example. I am looking for early-stage ideas like that.

Hi Michael

Excellent post. The cost to Next of the transition from retail to online is partially obscuring the performance, but even without that, compared to the other carnage on the High Street, their performance is admirable.

Just to note on your 5% yield requirement that if you include buybacks Next is already exceeding that by a significant distance. If they wanted to they could be paying out 8% without a problem. I know people have different opinions on buybacks, but Next is a shining example of how to use them to enhance shareholder value.

skyjacker

I think Apple is in a very serious trouble partly of their making and partly due to competition. Chinese manufacturers Huawei, Xiaomi, OnePlus and others are making excellent phones at very competitive prices. While Apple continues to increase prices to the point where many people are delaying upgrade or looking elsewhere for their new phones. I would typically upgrade my phone every 2 years and get new Ipad every 2-3 years for top of the range models but I can not justify spending £1,000 on phone or £750 for new Ipad.

Also their other product lines especially Mac is in quite poor shape: still selling 2013 MacPro, soldering memory, hard drives, design issues i.e. butterfly keyboards, bending Ipads. Also Windows have improved a lot while MacOS barely made progress since Jobs days.

Normally Apple would bounce back from bumps fairly quickly but this time there are more structural problems recent year may be high point which they many not reach for number of years. However, in comparison Apple trades at quite modest P/E.

patrick00

Paul what do you make of Taptica International (LON:TAP) announcement today?

They have "suspended [the] share buyback program as [they have] entered into preliminary discussions with a potential acquisition target."

The buyback was only announced on the 12th of December, as a way to return money to shareholders as "there are no conversations ongoing [with potential acquisition targets]". However, they only bought shares on the very next day, the 13th, then stopped.

Small Cap Value Report (Thur 3 Jan 2019) - AAPL, NXT, VEC, COST, FCAP

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