Small Cap Value Report (Tue 11 Sep 2018) - JD., BRY, LUCE, UPGS, MAI, BLV, SBIZ, PIL, ONEV, MIDW, CYAN | Paul Scott

11th Sep '18 by Paul Scott

46 comments 15913 reads

Good morning!

I've had a quick look at the sparkling interim figures from JD Sports Fashion (LON:JD.) - it just shows that, even in tough conditions, the best companies can still deliver good figures. The numbers benefit from an acquisition in the USA. The narrative talks about further international expansion, including in the biggest potential market, the USA - which could be exciting. It looks very impressive, apart from the now loss-making outdoors division - affected by the hot summer (not many people buying outdoor coats for hiking, etc). Worth a closer look, when I have more time. Although I am uneasy about a highly profitable retailer distributing other brands' stock - there's the potential risk of big brands squeezing JD's profits at some point.

Here are some late comments from Monday's announcements. More people will see them if I put them into today's report (I wrote these comments below last night. They're brief, because I'm concentrating my energies more on companies which interest me.

Brady (LON:BRY)

A trading & risk management software company.

Interim results (6m to 30 Jun 2018) look poor (loss-making), but it expects a better H2. With 95% visibility on 2018 revenues, that seems well underpinned.

Balance sheet looks quite weak, but software companies get paid up-front, so can often operate fine with a weak balance sheet.

With such a poor track record, it's difficult to understand why this company is valued at anything like the current market cap of £55m (at 66p per share). Maybe the client relationships would be attractive to an acquirer?

The narrative talks about a 3 year turnaround plan. It doesn't interest me. Why pay up-front for a turnaround that hasn't yet delivered profitability?

Luceco (LON:LUCE)

Poor H1 results, but a more positive outlook for H2;

The Group's outlook remains unchanged from the July 2018 Trading Update. The second half of 2018 is anticipated to be a stronger period than the first six months with a return to profitability expected.

Although UK consumer confidence remains fragile the Group has moved into the third quarter with: a 30% increase in the UK Retail order book, lower commodity prices,…

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Paul Scott

11th Sep '18

Hi jasjones,

Yes, I sold my Next (LON:NXT) shares immediately when the last trading update wasn't as strong as I thought it would be.

I might have made a comment here, and/or on Twitter at the time.

I'll be going back in to Next (LON:NXT) at some point, but only if it drops back further. The share buybacks have stopped now too, which removes a support for the share.

My fundamental view on the company is still very positive, but these are uncertain times, and I don't want to be holding things unless I have 100% conviction on them, and the valuation is attractive.

The nice thing about Next is that it's so liquid I can move in & out instantly.

Regards, Paul.

Beginner

I totally agree Just (LON:JUST) looks very tempting. However they have let it be known, in a roundabout way, that they themselves have some misgivings over the impact of property values on the equity release portfolio, and that there is very likely to be a rights issue at some time, possibly giving a very large dilution. I formerly held but sold out recently at break even. I feel this is not one for widows or orphans! Lansdowne have recently declared the only a rise in their reportable short interest, at 1.49%. They are the only takers for this action at the moment, so the despondency is not too widespread.

Tortoise investor

Hi Paul - superb analysis from you since you've come back. I continue to be amazed at your ability to type out detailed high quality thought in such a short space of time!

I would like to add some further thoughts to your commentary on Debenhams (LON:DEB) yesterday. The current media speculation is obviously not just relevant to that retailer but companies with concessions. I have held QUIZ (LON:QUIZ) and been quite passionate about its online potential so saw it as a long-term hold, but I have sold my entire holding today because of Debenhams (LON:DEB) concerns. Why? Going back to its last annual results report it has a very high exposure to Debenhams (LON:DEB). At the end of December 2017 its concessions looked like this:

Recall that it recently said problems at House of Fraser would cost it £400k. Using a very crude simple multiplication we could guess that problems at Debenhams (LON:DEB) might therefore cost the company in the region of £4m (11 HoF concessions vs 103 Debenhams' concessions). Or perhaps we could more safely say 'millions'. This is significant when its operating profit in the last financial year was in the region of £8m - not including the long-term loss of revenue.

Own stores (c.70) and concessions (c.150) currently represent around 55% of its profits although this is rapidly declining (for 2017 financial year it was around 67%). I cannot see the company ever having broken down the profitability or revenue split between own stores and concessions so difficult to say exactly what the contribution from Debenhams (LON:DEB) might be.

Stockopedia users are at liberty to challenge me if they think my analysis is alarmist or wrong, or explain to me why the impact might be different. I am an amateur investor and not a retail expert, unlike Paul, and I am unable to properly guess what Debenhams (LON:DEB) might be up to. But while there is uncertainty I think I'd rather sit on the sidelines with QUIZ (LON:QUIZ) and potentially look for another buying opportunity when the share price better reflects risks to its Debenhams concessions.

Are there any other listed brands with strong Debenhams exposure? For example Fulham Shore (LON:FUL) recently said it had plans to open 30 Franco Mancas in Debenhams (LON:DEB) stores: https://www.drapersonline.com/...

shipoffrogs

JD Sports Fashion (LON:JD.) : " ...there's the potential risk of big brands squeezing JD's profits at some point".

That seems a stretch. Supermarkets squeeze their suppliers and JD now has a market cap. greater than M&S.

I'm taking a lunch break now, then have a long telecon scheduled for 2pm.

If I have enough mental energy left, I'll try to post some brief comments on some more company results/TUs later today, possibly this evening.

Regards, Paul.

MattM

This one is highly speculative and the energy storage market is fairly complex. In theory the technical parameters of the RedT Energy flow battery should be very well suited to certain applications but they will be competing against Li-ion batteries which have had billions thrown at their development from big players like SDI Samsung, Panasonic, BYD, Tesla CATL. So the question is will they beat them on price point, at the moment the market is all about li-ion and I struggle to see it being anything but li-ion for at least the next 5 to 10 years.
Also worth noting the Anglian pilot project is tiny, 300kW whereas there have been somewhere around 300MW of li-ion commercially deployed this year in the UK alone. Essentia appears to just be a framework, not sure who else has been appointed but i'd be shocked if it's only redt and no li-ion products.

Energy storage is undoubtedly going to be very big but the different revenues available to the technology are complex and largely under consultation currently. My guess is there will be a small number of very big winners and a big number of small losers but they'll lose big.

Having said all that I wanted to buy some Redt energy about a month or so ago but was too scared, it was 4p then so would have been more than a double bagger already for me...

jasjones80

Thanks Paul that's good to know.

Cheers,
Jason

davidjhill

I don't think there will be a rights issue at anywhere near these prices, though it is possible.
They can buy insurance relatively cheaply that offsets such exposure. Effectively a type of Credit default Swap (CDS).
They can issue tier 2 or 3 debt inexpensively, certainly cheaper than an equity raise. Fitch just reaffirmed them as A+ but downgraded from stable to negative until impact known and they also cited that they think management has plenty of capital options open.
I don't think Just (LON:JUST) let it be known they have misgivings on property impact values. They said that they have a good LTV and were priced for a 30% fall with no subsequent growth ever. I'd say that's pretty conservative.
On short interest, I agree that i don't think you'd want to be short. You don't short sell £1 of assets for 35-40p because your risk reward is horrible. Only takes one predator to wait until capital impact is known on 30th Sep, put a 150p takeover bid in the market and your position is completely screwed.

Camtab

Paul, I was interested to see you sold your Cloudcall out of the BMUS portfolio. I know you haven't been keeping this up but still interested in your thoughts with Call. I do own a few and we are expecting some results on 18th Sep.

chrisgb

I bought Redt Energy (LON:RED) a while back but unfortunately before it collapse to 4p so most of the recent gains have just put me in the black. It's an extraordinarily volatile share at the moment. Today it went up to 9.5p or more and back down to 8.8p which is crackers.

I bought a small position because the technology might be a winner. Might is the operative word. What they sell is Vanadium Flow batteries and they are enormous and heavy. They are unsuitable for cars, phones, etc but they are fine for sitting next to a wind farm and storing electricity when the wind blows and giving it back when the wind has stopped. Currently they are more durable than li-ion, recharge/discharge as much as you like, wont catch fire, and cheaper. Redt now seems to be getting some contract wins but whether it will be the long term winner is impossible to tell. It could be that the winner in the energy storage market isn't a battery at all - it could be using spare electricity to turn water into hydrogen.

dscollard

odd price action in JD Sports Fashion (LON:JD.) today as it dipped to 480p on the open and has since rebounded to challenge previous all-time highs. be interesting to see if it does break-out or if this fails

I have been long it for the sheer momentum over the past couple of months...rumours it may be on for FTSE100 entry seems to have boosted it this afternoon

As you mention Paul, it is a bright spot in an otherwise dim and dark sector.
It is conspicuous by its absence in the ranks of short interest, many of the top UK most shorted shares are retailers; the proverbial legion of the damned

5b97d100ec8352018-09-11_15_25_00-Daily_S

Hi Camtab,

I still hold Cloudcall (LON:CALL) in real life. The "selling" in BMUS recently was simply to reduce BMUS down to my Top 8 largest holdings only. I don't want the hassle of updating a big public portfolio, and I concentrate my real world portfolio very heavily anyway (my top 8 positions are over 75% of my total portfolio of c.25 stocks, by value).

I like CALL, and think it's oversold right now. It wouldn't take a lot for it to potentially dramatically re-rate, because it has many features which are highly prized at the moment - good growth, very high gross margin, high recurring revenues, low customer churn, SaaS.

The reason it's cheap is because it has repeatedly missed forecasts on growth & cash burn. I'm happy to stick with it, and try to be rational about it, rather than letting emotions creep in (disappointment mainly)

It's a good example of a company that floated on the stock market far too early. Most companies have growing pains, but these need to be endured whilst a private company, then float once the business has matured.

ezlifeme

12th Sep '18

Paul - Many thanks for the sterling effort as usual, especially amongst the IT Gremlins

AlexW

Very good analysis, with graphic too. I avoided QUIZ (LON:QUIZ) but was interested in £FULHAMSHORE but I'll pass on then for the moment...thanks.

gbjbaanb

Absolutely, its not a mainstream thing at all yet, but the specs for the flow batteries are much more suitable for utility style positions, so I think these tiny pilots are just that - the companies figuring out that they work as expected and advertised.

Li-ion are mostly used because that's all that's been readily available so far. They're a poor solution to this space, and that's why I think these are a bit different. The cost effectiveness of this will be proven in time (and perhaps if li-ion become more in demand with EVs and the like, and a shortage of lithium may push the price up, so these flow batteries should become cheaper options), which is why I highlighted it today. A year should see the results of these pilots proving the tech compared to li-ion.

MichaelFBS

Hi Greyster

To show the ticker in blue (that then links to the Stockopedia page) then simply add £ symb9l in front of the ticker so £ MIDW (with no space between the £ and M of MIDW) becomes Midwich (LON:MIDW).

As an aside it doesn’t work where the ticker has a number in it.

Hope that helps.

Michael.

BIACS

I'm no expert on this, but I seem to recall reading in the Just (LON:JUST) statements that every 0.25% change in the implied deferment rate would affect their 'own funds' position by 80m and every 0.5% change to property volatility assumption would affect this by 30m. The PRA proposal is for an absolute minimum 1% deferment rate and for 13% volatility (these are up from JUST's 0.5% and 12% respectively) so that would wipe out somewhere between 220m - 540m of their 'own funds' (there may be other impacts also within the proposals I expect). So we should perhaps anticipate that JUST could be reduced down to only just about covering the 100% capital requirement and would need to find funds of say around 100m - 300m or so to get back to a decent level of capital cover that would support their business (and to satisfy their banks / financing arrangements). This is fairly serious money for a company with a market cap of less than 700m. If they raised this with debt this is going to be an additional finance cost burden and a drag on profits (plus increased risk through leverage) going forwards. If they raise equity then there's dilution. So looks like there are reasons to be fearful here for holders. If the insurers manage to convince the PRA to do something less drastic (and/or if they agree a long lead in period to the changes over a number of years etc.) then the impact could be a lot less - especially if the discount implies is only adjusted to 1% and not the full 2%. There may well be a big contrarian opportunity here, I don't dispute - but it's always one for the brave when nobody has any idea what the regulator will come up with ... The comments from JUST are (of course!) very bullish and they point out all the nice conservative things they are already doing to manage their risk, but it looks like the PRA has a very different view of the industry and required practice and it's unlikely that JUST will emerge unscathed from the new rules when they are announced - the main question is how bad will it be and has that already been factored in through the 50% share fall over the past months? It may well be, but I don't have enough of a feel for this to be confident I could get it right...

hawkipa

13th Sep '18

Hi David,

I've never looked at Just (LON:JUST) but I know its name from the bond market as a relatively recent issuer. This chart of its tier 3 debt in yield terms. As the underlying govvie hasn't really done much the spread graph will likely be similar.

To the point about them being able to issue more debt, I think that is possible but it would come at an incredibly expensive price and with a bucket load of covenants. Debt investors in this kind of scenario are open to a deal but far more aggressive than I have ever seen equity investors as it will basically play out, 'what yield do we need to pay you and with what security', so the debt investors will hold the whip hand and you will possibly get distressed guys coming in offering good terms but with equity conversion rights demanded.

To put the yield in context Phoenix tier 3 is trading at 3.54% so a discount of 155bp is substantial. I suspect in this case the debt will be a first mover in this scenario as they will now be crawling all over the company and gaming what might happen using PRA expert consultants who will know the process inside out. They will also have access to management that equity investors likely won't have right now. So it might be worth watching the bond price for signals.

Regards

Paul

All good points BIACS and hawkipa

my broad hypothesis is this. Capital impact to be circa £200-350m. They have a surplus of £700m so actually could continue without a raise but that would impact upon growth. Seems Fitch appear to have a not dissimilar view. To mitigate they will (1) Insure some of the back book to reduce impact and (2) raise somewhere in the region of £100m in the debt market at circa 5%. Impact of both of those actions circa 1-2p off EPS and reduces over time as back book rolls off.

will certainly be watching the bond market for signals though if YTM rises much higher than 5.5%

Small Cap Value Report (Tue 11 Sep 2018) - JD., BRY, LUCE, UPGS, MAI, BLV, SBIZ, PIL, ONEV, MIDW, CYAN

Brady (LON:BRY)

Luceco (LON:LUCE)

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Paul Scott

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