Small Cap Value Report (Tue 25 Apr 2017) - BLTG, CPR, ABDP

Good morning! It's Paul here, I'll be doing today's report.

For those who couldn't attend the UK Investor Show this year, the video of my session has now been published. I was asked to interview Nigel Wray & Paul Mumford, which was a real honour, and I thoroughly enjoyed it. As you can see, the format didn't work perfectly this time, so we'll tweak it for next year. Although lots of interesting points were covered, so it was well worth doing.

Also, I wrote a section on Mporium (LON:MPM) results yesterday, emailed it to Graham, but forgot to attach the file. Doh! Anyway, I've re-sent it today, so Graham has kindly added my section to his report yesterday, which is here.

Back to today's RNSs, there's lots for me to cover, so this article will be gradually updated throughout the rest of the day.

Let's start with a profit warning.

Blancco Technology (LON:BLTG)

Share price: 158p (down 26.9% today)
No. shares: 58.2m
Market cap: £92.0m

Q3 Trading Update, Cash Flow Review and Funding - an ominous-sounding title for an RNS.

This is a very unusual announcement. The first paragraph, surprisingly, says that everything is looking fine as regards the P&L;

Blancco announces that trading for the third quarter to 31 March 2017 ("Q3 2017") has been strong.

Group sales in the period were up 48% year-on-year on a constant currency basis, comprising 36% growth in erasure and 189% pro forma growth in diagnostics.

In the first nine months of the year, Group sales increased 34% year-on-year in constant currencies, with erasure growth now at 26% and pro forma diagnostics growth at 137%.

The outlook for full year 2017 sales and adjusted operating profit remains in line with market expectations.

So why has the share price tanked then? It seems to be down to a shortfall in cashflow, as explained in paragraph 2;

Since the interim results on 14 March 2017, the Company has undertaken a review of its cash flow forecasts.

The Company has identified that costs associated with past acquisition activity, including earn-outs and advisors' fees, the later arrival of a large government contract and the slipping of larger contract deals to later in this current quarter will all build pressure on the forecasted cash available to the Company during Q4.

This strikes me as all rather amateurish. It's the job of the CFO to ensure that cashflow is planned on a prudent basis, allowing for contract slippages, and definitely allowing for the worst case scenario on things like earn-outs.

What is the company doing to remedy the situation? This next section explains;

The Company has revised its projection for group net debt to around £5.5m at June year end and requires additional funding of a minimum of £4m over the coming weeks to address the working capital position and increase the Company's headroom.

The Board is exploring a range of possible sources for this additional funding and is initiating discussions with its bankers and shareholders concerning the most appropriate way to fill the funding shortfall.  The Company is confident of a satisfactory outcome and will update the market further when appropriate.

It strikes me that an increased funding requirement of £4m is fairly insignificant, in relation to the market cap. Why did the company put out this RNS?

I would have expected a modest funding shortfall of £4m to be the sort of problem a decent CEO/CFO team could fix over the phone in an afternoon. Firstly you'd ring the bank manager, and explain that you need a £4m extension to the borrowing facilities. If he says no, you ring up the major shareholders, and do a quick placing. Or a good compromise might be to ask the bank for half, and a small number of major shareholders to put in £2m too. Problem solved.

This RNS makes me wonder whether the bank & major shareholders are reluctant to put in more money? The trouble is, putting out such an RNS is now clearly making the market jittery - could this be the tip of the iceberg, with more serious problems underneath, which management hasn't yet 'fessed up to?

Balance sheet - having a quick look at the last reported balance sheet here, it's very obviously weak.

NAV of £44.1m becomes negative when intangibles are written off.

So  NTAV is -£22.3m - indicating to me a significant funding shortfall, which would require the continued co-operation of the bank.

Working capital was tight too - current assets of £15.7m, less current liabilities of £19.3m results in a current ratio of only 0.81, which is very weak. As a rough idea, I normally consider 1.2 to 1.5 to be acceptable, and over 1.5 to be safe.

There's also another £19.3m in longer term creditors & provisions.

Put that together, and you've got a balance sheet which is already stretched, and hence unable to absorb any unforeseen additional pressure. So the warning signs were there, and very obvious for anyone who took the trouble to examine the balance sheet.

My opinion - I've never liked this company. Its past is leaning towards the murky side of things - previous management milked the company for excessive remuneration and fees associated with acquisitions. Plus they pumped the share price to anyone who would listen (turning up at numerous investor events to extol the virtues of the business), the purpose of which was obviously to generate buying interest, allowing major shareholders to exit at a more favourable price. All very cynical stuff I'm afraid. There was also a pattern of big Director selling a few months before profit warning(s).

Management has since changed, but judging by today's announcement, it doesn't look like they're any good either.

This could go either way. If the company can quickly sort out some additional equity and/or extension to bank facility, then the crisis could pass and soon be forgotten. The share price could then recover nicely. So if that scenario plays out, then what we have at the moment could perhaps be a good buying opportunity?

On the other hand, if today's news is glossing over more serious problems, and the bank & major shareholders might have lost confidence in management, then an emergency placing might have to be done at a deep discount.

Personally I don't trust this company, nor its adjusted figures. Graham wrote an excellent piece here expanding on the various issues at this company.

However, if you do like company, and think it can sort out a relatively small funding shortfall soon, then this might be a buying opportunity, who knows? It's one I'll pass on personally.

Note that the StockRank of 11 last night, was also flagging that this was probably one best to avoid.

One of the good things about the StockRank system is that it picks up factors that you or I might have overlooked - such as the gradually declining broker EPS forecasts over the last year.

Carpetright (LON:CPR)

Share price: 231.2p (down 5.6% today)
No. shares: 67.9m
Market cap: £157.0m

Trading update - this covers the 12 weeks to 12 Apr 2017, which is almost all of Q4 (as the company has a 30 Apr 2017 year end).

Key points;

Continued growth in the UK, with like-for-like sales up 1.4% despite tougher market conditions experienced across the period.

Rest of Europe continues to benefit from improving economic confidence and positive currency impact.

Full year profit expected to be within the current range of market expectations, albeit towards the lower end.^{(note 1)}   

  ^{Note 1 -} Consensus for the year ending 29 April 2017 is for Group underlying profit before tax to be £15.2m, with a range from £13.9m to £16.2m.

^{Its great to see the company give ultra-clear guidance on profitability - by publishing what the range of broker forecasts are, and then clearly stating what the company expects to achieve. This is best practice, and I'm delighted to see more companies & their advisers adopt this excellent reporting method. Everyone should do this.}

^{The proof is in the share price too - what might be considered a profit warning has only resulted in a 5.6% fall in share price today. I'm sure that calm market response is because the company has managed investor expectations well.}

^{Note the broker forecasts have been gradually declining over the last 12 months, so clearly there is some underlying problem here - probably just competitive pressures.}

^{Store refurbishment - note that the company has refurbished a lot of its stores (c.40% of UK stores).  That's great, but the trouble is, refurbished stores are really not valid as like-for-like sales comparisons. That the company has only achieved +1.4% LFL sales growth, after revamping a lot of the stores, suggests to me that the older, non-refurbished stores, would certainly be in negative LFL sales territory.}

^{In other words, the company is having to revamp its stores just to stand still, and not really move forwards. I think that is likely to be common problem for lots of retails in the coming years. They can't work out how to improve performance, so instead fall back on store refurbishments - which of course requires substantial capex expenditure, just at a time when performance is weak. So a potentially dangerous mix.}

^{I think Department Stores are a particular problem area in this regard - where enormous capex is needed to make a difference to performance, yet they're struggling to make any profit to start with. Hence why I ditched my position in Debenhams (LON:DEB) a little while ago.}

^{My opinion - this share looks priced about right, in my view. So it's a straightforward punt, based on whether you think the turnaround can deliver much better results (in which case the shares would be a decent buy). Or (more likely in my view), that the company is likely to do little more than tread water, against plenty of competition, and hence the share price might go nowhere, or even slip back down again.}

^{I can't see anything to get excited about here. It looks a mature business, making a very low profit margin, that hasn't paid any divis since 2011. Why get involved here, when you can buy Next (LON:NXT) (in which I have a long position) and receive an 8% dividend yield (including specials) from a business that is generating cashflow by the bucket-load, on a sector-leading high operating margin? Next is also doing very well with online sales too, so I cannot understand why investors would want to move down the food chain to low margin businesses like Carpetright? Why do that, when you can buy probably the best UK retailer (Next) on a lower PER of about 10?}

Ab Dynamics (LON:ABDP)

Share price: 571p (down 5.2% today)
No. shares: 19.1m
Market cap: £109.1m

Interim results - for the 6 months to 28 Feb 2017.

I've written positively about this company a number of times before here. It describes itself as;

a designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry

In the comments section below, I see that bestace (whose posts here are excellent, by the way) has flagged up that the cost of share options has hit these figures hard.

In the "financial highlights" section at the start of the RNS, it says;

Profit before tax, excluding share option costs, increased 9% to £2.5m (H1 2016: £2.3m)

Yet when you look at the P&L (or what seems to have been renamed these days as "statement of comprehensive income") then a much worse picture appears - with profit before taxation down 27% to £1.65m.

So, as bestace points out in the comments below, this means that about a third of the profit in H1 seems to have been dished out in share options to Directors (and possibly some employees too - but these things are usually, at most companies, heavily skewed to benefit Directors). Some people might regard that as excessive. Other people might be happy to share the spoils with Directors who have presided over an excellent share price performance in recent years.

I accept that share option costs are volatile from one year to another, and can often be very lumpy charges. So that's a good reason for stripping out such charges, or maybe smoothing it out by spreading the cost over several years in our calculations.

Although as I often point out here, share options are part of the remuneration package for Directors, so it's a cost that needs to be taken into account when assessing profitability.

Outlook - there's lots of interesting stuff about new products. Also strong demand for driving robots. 

The other interesting angle on things here is that the new factory construction is nearing completion (handover late summer). There seem to have been capacity constraints with the existing facilities. So that could provide decent upside, in terms of future growth & profitability.

I think this growth potential is the key area to focus our research on. The share looks expensive on current year forecasts (roughly 26 times FY 8/2017 at the time of writing), but that could be fully justified if the new, larger factory allows them to step up production, and hence future sales & profits.

Full year expectations are confirmed, which is reassuring;

"We are very pleased to report on a solid first half of the financial year. We have a good forward order book for the remainder of 2017 and well in to next year which gives us confidence in meeting market expectations.

Balance sheet - looks fantastic, really strong, and includes net cash of £14.8m.

You'd have to look at the latest broker research to find out how much of that cash is ear-marked for capex on the new factory.

The cashflow statement shows £6.0m received from a recent fundraising. I've been reading the RNS about the placing, and it sounds like most of the cash will be needed for capex & product development. The company seems to expense its product development (the most conservative approach), as there don't appear to be any intangible assets capitalised onto the balance sheet. 

To double-check, I've just looked at the fixed asset notes (note 9 ) from the last annual report, and there is some development spending capitalised into "Test Equipment", but the net book value was only £606k at year end. So nothing to worry about there - the accounting looks prudent to me.

One other point which jumped out at me from the annual report. The company seems to work on large contracts, and charges customers progress billings along the way. If things go according to plan, that should be fine. However, it does open up the risk that problems could build up under the radar, and then require a nasty write-off at the end of any problematic contract. It's just a potential risk to be aware of. Note also that profits seem to be booked along the way, which again would usually be fine, if contracts are going smoothly;

My opinion - this strikes me as an excellent company. I really regret selling my shares in it a while back, for a quick profit. It would have made much more sense to sit tight. Never mind, we can all be guilty of short-term thinking sometimes.

The only to bear in mind, with smaller companies like this, there's always the chance of something going wrong, which could have a material impact on future results. Just look at what happened with Tracsis (LON:TRCS) recently. Also, a few years ago now, Zytronic (LON:ZYT) shares plunged on an unexpected sales shortfall.

So, I tend to keep a mental note of companies that I really like, which are high quality companies & management, and if something untoward does happen, then I would swoop in and buy them on the cheap - because decent companies recover from such bumps in the road.

So far so good though, AB Dynamics doesn't seem to have put a foot wrong in its 4 year history on AIM, if only all AIM stocks were this good!

Looking at the StockRank, the Stockopedia computers have nicely encapsulated that this is a high quality company, but looking expensive now. There again, the Stockopedia computers don't know about the new factory - so this is possibly an example of where man can gain an advantage over the machine!

Work-in-progress - please refresh this page later