Small Cap Value Report (Tue 16 June 2020) - macro, IND, DLAR, RNO, ECK

Good morning, it's Paul here with the SCVR for Tuesday.

Estimated timings - I have to stop by 1pm, because the XJS is going in for its MoT.
Edit at 12:49 - today's report is now finished.

I've got a bit more material left over from my weekend preparation session. Some of this is probably already out-of-date;

Commentator snippets

I like to review many sources of information & views, and have CNBC audio running in the background on my computer, during the afternoons, as there are often good interviewees (when they can get a word in edge-ways, as Joe Kernan’s questions are more like speeches, then he interrupts them within seconds of them starting to reply! Dreadful).

Plus some of the women have voices like an angle-grinder running at maximum rpm. And don’t even get me on to Jim Cramer. Hence the mute button needs to be kept close to hand.

In between those annoyances, there’s often some terrific commentary, from high profile guests. When I hear something interesting, I jot it down on my pad. Recent snippets;

Nikola - this seems to be a zero turnover US listed company, currently valued at c.£20bn. It is hoping to make electric cars at some point in the future. The share price has been a multi-bagger lately, as punters pile in, speculating that it’s the next Tesla (I’m short Tesla - yes, again! Glutton for punishment springs to mind). The name of the company is a hat tip to Nikola Tesla, the inventor & electrical engineer from history.

This was cited as an example of market mania, or “mass psychosis” as one commentator put it, which is currently gripping the US markets. His stance was that millions of “clueless retail investors” were chasing up junk shares (including essentially insolvent companies) using a platform called Robin Hood. They are often trend following, and using stop losses, therefore this is sowing the seeds for explosive boom & busts in many share prices. A very interesting point I think. Last week’s large & rapid pullback in the US markets (which spilled over into the UK market) seems to validate this view. With valuations so high, despite dire economic news, I think we should therefore work on the basis that there’s an elevated risk of more sharp pullbacks.

Automobiles - Jim Cramer pointed out that the public may be reluctant to use public transport. He therefore thinks that there could be pent-up demand for cars. Therefore we might see a surge in demand for new/used cars, as people shy away from both public transport, and ride-sharing schemes, possibly? That makes sense to me, hence why I’ve recently gone back into Vertu Motors (LON:VTU) on a small scale.

Carl Quintanilla made a good point, saying that whilst there seems to be pent-up demand as the economy re-starts, this could be a short-term boost only. How long will it last? Another good reason why I’m leaning towards banking gains on the re-opening trade, if such gains materialise.

Net debt - the brilliant, and hilarious, Mark Brumby of Langton Capital made an excellent point in one of his daily emails (highly recommended) last week. Namely that the net debt, and cash burn figures being reported by many companies, are not reliable. This is because other creditors are building up - such as withheld rent payments, trade creditors not being paid, plus of course large liabilities backing up with HMRC for deferred VAT & payroll taxes. None of these liabilities are included in reported net debt figures - which are only for interest-bearing debt.

Once businesses resume trading, and Govt support schemes begin to unwind, then these backlogs of creditors will need to be paid. This could be problematic. Therefore I think we would all be well-advised to not take reported net debt figures at face value. They could be the tip of the iceberg when other liabilities are included. A great point, thanks Mark! He also points out that auditors may refuse to sign off accounts, which is another point to watch & be aware of. Hence I think general solvency issues could well take centre stage again in the coming months. How many more placings can the market absorb, I wonder?

Mergers & acquisitions - accountancy giant PWC is apparently predicting a boom in mergers & acquisitions, due to private equity and sovereign wealth funds having so much available cash. It makes sense for the cash-rich to pounce, when assets are on offer at distressed prices. Trouble is, the massive & rapid action by central banks & Govts has caused markets to rebound so much, that it’s difficult to see many bargains around. It is noted that Warren Buffett has not been out shopping, which he did back in 2008-9.

Fed speech - I was listening to Powell of the Fed, give a speech last week, and it sounded distinctly gloomy in tone. This is what triggered the big sell-off in the US markets late last week. You could see the market searching for positives, realising there weren’t any, and then a fall started & seemed to gather pace with every sentence Powell uttered. The crux of his speech, is that interest rates will stay low into 2022.

I don’t see how interest rates can possibly rise now, maybe ever? Govts have too much debt, and need to keep the cost of servicing & rolling it over, as low as possible. If bond markets don’t want to buy the newly issued Govt bonds, then they just hit the QE button to create guaranteed, and potentially unlimited bond buying. Where does it all end? Nobody knows, but vast money printing historically has always ended in disaster, with debasement of currencies & hyper-inflation. Anyway, Powell said that the recession underway is likely to be worse, and last longer, than people might think. Clearly that’s taken some of the froth out of the markets, rightly so.

US Presidential election - CNBC said a few days ago that Democrat Joe Biden had inched ahead in the polls. He favours higher taxes, which would be negative for share prices - maybe a catalyst for a 10-20% market fall, if he looks like he might win?

My opinion - make of that what you will. I'm just reporting interesting things that caught my eye from the numerous news & views that cross my desk every day.

.

---

Re-starting of non-essential retailing

These days, I live in a slightly down-market suburb of Bournemouth, when I'm not in London.

Curiosity got the better of me yesterday, and I walked into the town centre, to see what the re-opening of non-essential retailing looked like. Would the town centre be thronged with shoppers?

It was, what I can only describe as, a damp squid. Mid-to-late afternoon on a Monday would never be busy, but it was not exactly thronging. Importantly, only a few, large, shops had actually opened - JD Sports, Zara, River Island, Primark, Debenhams, plus of course Boots & Superdrug had already been open for a while. Apart from that, most of the smaller shops, building societies, and of course all the restaurants, cafes, and bars, were shut. Hence there was little point going into the town centre at all.

Maybe Bournemouth is a secondary, or even tertiary town (dunno, who makes these things up?), but the grand re-opening was completely devoid of fizz. In fact, it reminded me how incredibly annoying youths on skateboards are, making that loud clattering noise, over & over again. Why would I want to share space with them, and hobos asking me for money? Buying stuff online is easier, and means that I don't have to rub shoulders with people I would rather completely avoid & pretend don't exist. Sounds harsh, but that's the reality for most of us.

Maybe things might improve in town centres, once the office staff come back, and populate the space in their lunch breaks, etc. But will they come back? Isn't it easier to work from home, and maybe have the occasional day in the office, until the lease runs out & it's vacated completely?

As it turned out, I bought a £3 meal deal from Tesco, and sat on a wall, feeding myself, and people watching. I noticed lots of other people enjoying (as I did) the town centre beginning to come alive again. But as we sat around on walls, I reckon many other people were probably thinking the same as me - what is this town centre actually for, when we can buy stuff online?

Possibly it might be better once the bars & cafes re-open? You can easily see which ones are preparing to re-open, and which ones have owners that have given up, and won't be re-opening. The ones that survive should have more market share.

Overall, I reckon it's likely to be a real challenge to get many smaller towns working again. V-shaped recovery? I don't think so.

---

IndigoVision

AIM - Suspension

I must mark the tearful passing of IndigoVision from the stock market. It's a Scottish digital CCTV company. It has been taken over, by Motorola, at a reasonable price of 405p per share, which was a very good 129% premium to the prevailing market price. The deal's gone through now, so the shares are being suspended forever.

My involvement here was interesting. I spotted the company's potential back in 2002, when many small technology shares that floated in the tech boom of 1998-2000, ended up crashing as much as 99% in value, from the dizzy speculative highs. Some of these shares saw the market cap drop below their own bank balances. I came up with the idea of agitating, as a shareholder activist, to persuade such companies to distribute cash back to shareholders, rather than continue burning the cash on a hopeless business model.

This worked very well. I set up 5 shareholder action groups, attracted a lot of attention from the press, and set up websites where other shareholders could pledge support, and discuss the situation. All 5 action groups worked well, and we achieved over 100% gains on all 5, over an 18 month period in 2002-2003. This was what convinced me to give up my FD job, and instead become a full-time shareholder activist in Sept 2002.

IndigoVision was next on my list, as it was only valued at £2m, but had about £10m cash in the bank! So I bought about 8% of the company, then flew up to Scotland to meet management & discuss what could be done to unlock shareholder value. The meeting went well, and I became convinced that the company's leading-edge digital CCTV systems, were the future. Management's revised, lower cash burning business model seemed to make sense, hence I swung behind management and supported them, rather than trying to oust them.

Business took off, and the shares 30-bagged, from 30p to £10. I made about £5m profit on it, but then lost the lot in the 2008 financial crash, due to having foolishly geared up too much in illiquid positions totalling well over £10m underlying. Unfortunately, my financial demise at the time also blew a £2m hole in Spreadex's balance sheet, which I feel very sorry about. Fortunately, they were very reasonable about it, and over the next few years we worked out a payment plan & haircut, and the matter is now fully resolved on a solvent basis. I made the last payment about 5 years early, since my new portfolio really took off in 2016 & 2017 onwards.

Hence why IndigoVision is seared in my memory, as the share that made me a millionaire originally, but then dragged me all the way back down again, when it crashed in the 2008 crisis (along with everything else). It's a good story, to remind people;

• Not to combine gearing with illiquidity - a toxic mix, and
• Try not to fall in love with a share that makes you a huge profit - this is very difficult to do, as many multibaggers fall most of the way back down again, hence being disciplined about selling, to bank the profits, is vital.
• Don't let success go to your head - as the hubris that sets in, sows the seeds of future disaster.

It's a good story, so thought I'd repeat it here for any newer subscribers who don't know about my previous successes & failures!

.

---

De La Rue (LON:DLAR)

Share price: 157p (up c.8% today. at 10:25)
No. shares: 104.0m
Market cap: £163.3m

(I have a long position, at the time of writing)

SFO Investigation Closure

Good news here - the Serious Fraud Office has decided to discontinue its investigation that started in July 2019. It is taking no further action.

I did wonder why this share price was zooming up yesterday, when everything else was collapsing. Clearly someone knew something - possibly it might have been announced elsewhere?

My opinion - I bought some of these shares, after a very bullish update recently. There seems a convincing turnaround underway. The balance sheet will need to be fixed at some point, but that doesn't bother me, because institutions seem happy to support fundraisings for companies which have a good recovery story.

I think there could be further upside here, if nothing else goes wrong. Hence I'm just running the position, and we'll see what happens next.

The recent share price recovery looks little more than a blip on the 10-year chart of shareholder value destruction;

.

.

However, if we zoom in to the last 6 months chart, you can see what a spectacular recovery there has been. Mind you, anyone who bought at the lows was taking a big risk, as the company looked precarious at the time. It's since pulled a rabbit out of the hat, with some good contract wins, so is now lower risk, hence the big share price rise;

.

---

Renold (LON:RNO)

Share price: 9.8p (up 36% today, at 11:16)
No. shares: 225.4m
Market cap: £22.1m

Final Results

Renold, a leading international supplier of industrial chains and related power transmission products, today announces its preliminary results for the year ended 31 March 2020.

This share is top of the leader board today, and it's a company that I've previously seen as having potential.

FY 03/2020 figures look a bit lacklustre - adj EPS is down from 3.1p LY to 2.9p TY (this year) - a PER of only 3.4

• Significant impact from covid-related factory closures in "final months" of FY 03/2020
• Operational efficiency improved in Chinese factory
• Torque Transmission division has traded well, profits up
• Restructuring successfully completed
• Bank covenants amended, increased flexibility to Sept 2021
• Key point - cash generative & profitable in the first months of FY 03/2021 - very important, and reasssuring
• No guidance given - due to uncertainty & volatile demand
• Confident it can manage through current period of disruption
• No divi due to covid

Balance sheet - this is the main problem. It's got too much debt in my opinion, and also a huge pension deficit. This is shown as a £97.6m liability on the balance sheet. However, with interest rates now effectively at zero for the foreseeable future, that increases the valuation of pension scheme liabilities. This means that shareholders probably won't be getting much in dividends in the future, as the company mainly exists to service the pension schemes & repay debt.

I can see possible upside on the equity, because the share price is now so low, that the equity is almost an option on the company surviving & recovering from covid disruption. The commentary today suggests that it should survive, and might be able to do so without diluting existing equity holders with a fundraising, possibly?

Overall then, looks to have speculative upside, in my view. But be aware of the risks from its weak balance sheet. Worth a closer look.

.

---

Eckoh (LON:ECK)

Share price: 63p (up 8% today, at 12:24)
No. shares: 253.9m
Market cap: £160.0m

Final Results

Eckoh plc (AIM: ECK), the global provider of secure payment products and customer contact solutions, is pleased to announce unaudited results for the twelve months to 31 March 2020.

The summary of these results is;

Results in line with market expectations; strong revenue and profit growth

Earnings - financial highlights look impressive. Adj diluted EPS is up 62% to 1.75p - a PER of 36.

Recurring revenues are 79% of the total - giving good visibility

Balance sheet - fairly good. Note that the cash pile is offset largely by creditors - i.e. Eckoh benefits from receiving cash up-front from its customers.

Outlook - sounds good;

· New financial year trading is encouraging, with Group revenue and profit comparable to the previous year

· Notwithstanding the disruption relating to COVID-19, the Board remains confident of the future prospects for the Group, underpinned by balance sheet resilience, high recurring revenues, excellent sales pipelines and the long-term market opportunity

My opinion - I've followed this company for many years, and it seems to at last be delivering on the potential.

If earnings growth continues at such a strong level, then this company could rapidly grow into its valuation. Therefore, looks potentially interesting, worth a closer look.

.

.

---

That's it for today. See you tomorrow!

Regards, Paul.