Small Cap Value Report (Tue 10 Mar 2020) - FCCN, BAR, SRT, SBIZ, SSTY

Estimated timings today - I'll be doing 2 stints of writing today, as I hardly got any sleep last night. Therefore the main report will be ready by noon, then I'll add some more bits late afternoon. Edit at 16:37 - today's report is now finished.

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(I wrote this first bit late last night)

Good morning, it's Paul here, with the placeholder article for Tue morning.

This is partly to allow subscribers an early opportunity to post your thoughts about the 7am RNS.

Also, of course, in this time of market disruption, for you to all have a good old rant about anything (shares-related) that you want. I read all comments with interest. Community is really important at times like this.

I've closed almost all my hedges (short positions) now, because I think the 20-30% price fall is probably enough. So my focus is now on adding little positions to my small caps portfolio. Although I have to say, this crisis has really made me wonder (again!) about position sizing for small caps. After all, if you cannot get out, then risk:reward might be not so good.

I topped up these stocks yesterday (NOT recommendations, we have to do our own research);

Beeks Financial Cloud (LON:BKS) - I tried to buy 25k shares at 80p, but only got 10k. Had to up my price to 82p to get the balance.

Cloudcall (LON:CALL) - dropped sharply. My buy order was not filled at all.

Zytronic (LON:ZYT) - same. I didn't get a fill, nothing done - lack of sellers.

Altitude (LON:ALT) - complete punt, got 50k at 27.25p. Not convinced by mgt. At all. We'll see.

Revolution Bars (LON:RBG) - took me all day to get 50k shares at 50p. Half done, to work the balance. Again, no sellers to speak of.

Several others - put orders in, got nothing.

Overall, this gave me the feeling that small caps seemed to be bid-less and offer-less. In other words, existing holders have stopped or given up trying to sell, and buyers know there's no stock around. This feels to me like people sitting on the sidelines, waiting for a recovery, to buy, rather than a stampede of sellers.

After that, I just scanned my watchlist for signs of sellers. Then I gave buy orders to my broker at or slightly above the bid price. Let's see what happens.

Overall - I'm seeing things in a more positive light. Major indices have corrected about 20%, that seems enough.

We need to protect our senior citizens, and everyone with weakened immune citizens. Also, I really think we need to ask questions about globalisation. It's NOT good to make things in China, then ship them around the world. It's a nasty dictatorship, and we need to re-shore everything essential to life, back to the USA/EU/UK, for strategic reasons. If we value our freedom, then that's what we should be embracing.

Incidentally, Priti Patel studied economics at Keele Uni, 4 years after me. Isn't it depressing when leading figures of the day didn't witness me streaking naked around Hawthorns Hall! Or similar events from 1986-1990. I feel she really missed out.

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(this section written early on Tuesday morning)

Good morning. I've woken up feeling a lot less sanguine about the whole situation, and with a slight hangover. There's been a big relief rally overnight, as I hoped, but as a reader points out, this may not stick. We do seem to be in a situation where large relief rallies occur, but are then quickly overwhelmed with more awful news related to coronavirus. In particular, Governments are understandably trying to slow down its spread, but in doing so they're doing huge economic damage. It's a very tricky situation, and I really don't know how things are likely to progress. Will we have another lurch down? Possibly, but nobody knows, as it's all down to sentiment.

Small businesses

This is my main concern. Not specifically stock market listed small companies, but I'm thinking more about the millions of jobs which are dependent on small businesses - e.g. the cafes, restaurants, retailers, bars, etc, that makes up so much UK employment & economic activity. The UK is of course a services-based economy these days:

The service industries include the retail sector, the financial sector, the public sector, business administration, leisure and cultural activities.

In 2018, the service industries accounted for 81% of total UK economic output (Gross Value Added). Services accounted for 84% of workforce jobs in September 2019.

[source: UK Parliamentary briefing]

If parts of the UK are put into lock-down, like Italy, then this could have a devastating economic impact. We could see many small businesses go to the wall. Apparently the new Chancellor of the Exchequer, Rishi Sunak, is expected to unveil measures to help businesses harmed by the coronavirus. Thinking back to the last financial crisis, one of the most effective measures was HMRC quietly and without fanfare, giving decent businesses more time to pay VAT & PAYE/NICs. This makes sense, because forcing struggling businesses into administration over unpaid taxes just cuts off the Govt's own income stream from future taxes. Giving them lenience over payments makes a lot of sense to me, so I hope this is done again. HMRC also has all the detailed records, so already knows which businesses are fundamentally sound, and pay on time when they can, and hence deserve some support now.

Forecasting

I was discussing this by email with an analyst friend a few days ago. My view is that it's currently almost impossible to forecast how companies' profits might pan out in 2020. That's because we seem to be in the early stages of a pandemic, and nobody knows where it goes. However, you'd have to be living in a cave not to already know that. Therefore, surely the bad news is now already baked into share prices? Or it is to some extent anyway.

Anyway, I'm not relying on any broker forecasts for 2020, and am working on the assumption that most are likely to turn out to be far too optimistic in cyclical sectors. In terms of buying shares now, I'm generally looking for resilient companies, with mainly recurring revenues, which are dirt cheap. It's not easy actually - even after recent plunges, I wouldn't say this market is particularly cheap.

My current strategy

Everyone is dealing with this their own way. My hedging strategy went badly wrong initially (since daily swings on Indices were so violent), but has now paid off handsomely. Therefore I've got a war chest of fresh cash to deploy in looking for bargains.

I've made a watchlist of beaten up stocks that I like based on fundamentals, but am only buying things that are down heavily on the day, and down at least a third since the crisis began. I cannot see the point in putting precious new capital to work, buying things that are only slightly down. Hence am also sitting on cash on the sidelines, and waiting for genuine bargains to fall into my lap. Hence overall, I'm feeling cautious, but also looking for bargains.

Right, that's killed a bit of time until the 7am pings start coming through, so let's see what fresh horrors are being served up today...

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French Connection (LON:FCCN)

Share price: 18.5p (unchanged today, at 08:14)
No. shares: 96.6m
Market cap: £17.9m

(at the time of writing, I hold a long position in this share)

Preliminary results

French Connection Group PLC ("French Connection" or "the Group") today announces results for its financial year ended 31 January 2020.

Things were starting to look up here (in 2019), but then H2 trading deteriorated. This was flagged in a profit warning on 31 Jan 2020, which coincided with the sale process being ended. Therefore, the figures this morning don't really contain any major surprises. The £2.9m underlying loss is a bit worse than the £1-2m expected loss, which itself was worse than the c.£1-2m profit that had originally been planned for this year.

The balance sheet remains strong, so there is not any issue with solvency.

I'm losing patience with this one, as the turnaround keeps stalling.

The only attractive thing about this share currently, is the tiny valuation. It's taking an eternity to shrink the heavily loss-making retail division, but wholesale and licensing are still doing well, and there's some reasonably upbeat commentary about those divisions. Retail remains a thorn in the side, and it's not likely to improve any time soon, if at all, given the likelihood of coronavirus restrictions on movement.

Overall, I'm too stubborn to sell my shares in this, but won't be buying any more, unless it drops significantly lower.

There's value here in the profitable divisions, but the losses in the retail division are not shrinking as I expected, which was the main reason for owning this share. I think it's going to be a long haul, so am just parking my shares to one side & will forget about them (it's not a large position).

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Brand Architekts (LON:BAR)

Share price: 126p (down 22%, at 09:26)
No. shares: 17.1m
Market cap: £21.5m

Interim results (profit warning)

Brand Architekts Group plc, a market leader in the development and supply of beauty and personal care brands, announces its interim results for the 28 weeks ended 11 January 2020

This used to be called Swallowfield. I wonder why it is reporting 28 weeks, not 26 weeks figures?

It disposed of the manufacturing division in Aug 2019. Therefore we need to use the adjusted figures for comparison purposes, which as you can see show profit falling;

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Outlook - this is why the share price has fallen sharply today;

...However, the Board has reassessed its outlook for the rest of the financial year and based on the continuing challenging market conditions and the slower pace of sales in the first half, has reduced its revenue expectations.

In addition, given the level of competitive pricing and promotional pressure experienced in the market, the Board anticipates that the Group's operating profit will be impacted resulting in a significant decrease to previous market expectations.

Balance sheet - strength is a stand-out feature of this share, following a substantial disposal. It has £20.0m cash sitting on the balance sheet, almost the same as the market cap! However, before we get too excited, remember to deduct £2.6m in interest-bearing debt. Plus we need to account for the substantial pension deficit, showing as a £9.5m liability. I'm trying to avoid companies with pension deficits at the moment, because they are getting worse due to a combination of lower bond yields (which has the effect of increasing discounted liabilities), and also possible exposure to falling asset values if pension schemes hold equities.

My opinion - potentially interesting. This share is really a bet on the new CEO doing something sensible with the cash pile. The corresponding risk is that the new CEO might blow the cash pile on a poor acquisition. He's joining BAR on 4 May 2020, so it might be worth keeping an eye on what happens after that.

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Srt Marine Systems (LON:SRT)

Share price: 31.75p (down 2% today, at 10:29)
No. shares: 154.8m
Market cap: £49.1m

Trading update

SRT Marine Systems PLC (SRT), a global provider of maritime surveillance, monitoring and management systems, today announces a trading update for the current financial year ending 31 March 2020.

Contract delay - M.East contracts worth £65m (highly material) are delayed beyond 31 Mar 2020 year end. Reason given by clients is prioritising spending on coronavirus situation. Sounds like £14m revenues will move from FY 03/2020 into FY 03/2021.

Helpfully, the company gives us revised guidance;

The effect of this change to the current financial year will be to reduce expected year end revenues to £17.5m with an expected loss before tax of approximately £3.8m. The impact on the next financial year however will be to substantially increase our revenues and we will provide market guidance once these contracts are signed.

My opinion - contract delays are a recurring feature of this company, stretching back many years. Dealing with Governments around the world must be incredibly frustrating, having to go through layers of bureaucracy & long delays being the norm.

This is a massive profit warning today, but the market is giving the company the benefit of the doubt.

Even after recent falls, the £49m market cap doesn't strike me as a bargain, given that forecasts are rarely, if ever, met. Personally I would want a much deeper discount in the valuation, to reflect the lumpiness of contracts, and almost complete lack of visibility of sales/profits, and extremely long sales cycle - it can be many years from initial lead, to actually delivering product. That makes valuing the shares impossible.

Note that the 5-year chart starting, and ending price, are the same. So no shareholder value has been created in 5 years;

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Simplybiz (LON:SBIZ)

Share price: 190p (up 8% today, at 15:40)
No. shares: 96.8m
Market cap: £183.9m

Full year results

SimplyBiz (AIM: SBIZ), a leading independent provider of compliance and business services to financial advisers and financial institutions in the UK, today announces its audited results for the twelve months ended 31 December 2019.

These are quite fiddly numbers, with various adjustments, IFRS 16 complications, and acquisitions.

I'm not really interested in running through all the detail, so let's settle on this for valuation purposes;

That works out as a PER of 14.2

Balance sheet - for me personally, this ruins everything. NTAV is heavily negative, at -£36.7m - in other words, acquisitions have created a balance sheet that is top-heavy with intangibles, and has too much debt at the bottom.

The counter-argument is that SBIZ has strong recurring revenues, at high margins, therefore this type of business can sustain high levels of debt, providing nothing goes wrong.

My opinion - I like the business, but dislike the balance sheet. On balance therefore, I'll give it a miss.

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Safestay (LON:SSTY)

Share price: 18.5p (down 7% today, at 16:10)
No. shares: 64.7m
Market cap: £12.0m

Trading update (profit warning)

Safestay (AIM: SSTY), the owner and operator of an international brand of contemporary hostels...

It's hardly a surprise that an operator of hostels is seeing a downturn in trade, due to coronavirus fears. That's why the share price is only down 7% today, as the price had previously anticipated this very obvious downturn.

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This is what it says today;

...the spread of the COVID-19 virus is having an impact on bookings across the hostel network.

We have experienced a material reduction in new bookings over the last week against our expectations and there have been a growing number of group bookings from schools and colleges which have been cancelled or postponed.

It is too early to say what the full impact from COVID-19 might be in the current financial year, as it is not known how long the virus will continue to impact travel and spending patterns in Europe and the UK.

My opinion - this is the worst type of profit warning - in that it tells us there is a problem, but refuses to give any idea what the financial impact is going to be.

The way I look at it, SSTY is a capital-intensive business, that wasn't generating any economic return before coronavirus started. Therefore things can only be getting worse.

It is trying to reduce flexible costs, but the problem is that most costs are fixed, or can't be reduced below a certain level (e.g. staff costs on-site).

I don't see any appeal to this share, before, let alone during coronavirus.

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That's it for today. See you tomorrow!

Best wishes, Paul.