Small Cap Value Report (Tue 25 Jul 2017) - RBG, FEVR

Good morning, ladies & gentlemen! It's Paul here.

I appended some brief additional comments to Graham's report yesterday, on 4 more companies, to kill some time at Glasgow airport. The full article is here.

I had a wonderful weekend in Glasgow. Despite its reputation, I found it a smashing, and very friendly city. The occasion was an Aussie friend, who has lived & worked in London for about 10 years, applying for permanent leave to remain. I was happy to offer moral, and financial, support for a deserving friend. The only place with any Home Office appointment vacancies was Glasgow, so off we went.

Sorry if this is controversial, but the hoops that my Aussie friend was required to jump through seem ridiculous. This included numerous abortive attempts to pass a citizenship test that most of us would find difficult to pass (he's now something of an expert on Henry VIII and Mary Queen of Scots). Why are we putting such obstacles in the way of people who are a natural fit here? Whereas any old random can just wander in from Eastern Europe and seamlessly set up home here. How does that make sense? It clearly doesn't make sense.

Admittedly, my Aussie friend's ancestors must have done something untoward in the 17th or 18th century, to have ended up in a large and sunny penal colony. However, just as I don't feel any guilt for the Boer War, or any other human rights transgressions of the British Empire, his only crime now is singing to Kylie too loudly & out of tune, every weekend between the hours of 10pm and 3am. It used to alarm me, but now I find it amusing, and it gives me licence to sing to Chaka Khan in a similarly tuneless style. There are few things more effective at relieving stress, than howling to your favourite 1980/90s female vocalist, of a Friday night.

Anyway, I upgraded our group to business class, to celebrate the granting of UK permanent leave to remain to a very deserving antipodean case. A familiar refrain from the BA stewardess occurred, just as we passed over Birmingham, "I'm sorry, we've run out, you've drunk all of it!" Well, you've got to get your money's worth. Also, I was celebrating having accumulated enough tier points to move up from bronze to silver. So you have been alerted - a profit warning from International Consolidated Airlines SA (LON:IAG) is now a distinct possibility!

Continuing that theme, I see there's an update today from Revolution Bars (one of my largest long positions)

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Revolution Bars (LON:RBG)

Share price: 123.5p (up 6.9% tofday)
No. shares: 50.0m
Market cap: £61.8m

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

Pre-close trading update - for the 52 weeks to 1 July 2017.

This is a UK chain of cocktail bars, trading from 68 sites across the UK. It is opening about 6 new sites per year, in a self-funded roll out. The shares have been out of favour, following a bizarre profit warning in May 2017, which roughly halved the share price. Issues arose with the finance department seemingly surprised by widely anticipated (except by them!) cost increases, such as living wage, and business rates.

Many investors that I've spoken to seemed to have a hunch that another profit warning was in the pipeline, but thankfully not. Today's update is generally positive - hence the share price firming up. Although there are some nasties too, as I will detail below.

The company has seen the departure of 2 CFOs lately. Despite their protestations to the contrary, it seems that the finance function was badly run. It just shows, we never really know what's going on under the surface. An apparently competent individual can sometimes be a convincing front man for a shambolic finance function, as appears to have been the case here.

I met the new CFO a few months ago, and he struck me as a safe pair of hands. Although again, nobody really knows, unless you're an insider (which I'm not). Today's update seems to have the hallmark of a serious individual, applying more conservative accounting policies.

On to the detail from today's announcement.

Total sales for the Period increased by +9.2% to £130.4m (2016: £119.5m*). Like-for-like sales rose by 1.5%, down from the 1.7% reported after 44 weeks.

The terrorist attacks in Manchester on 22 May and in London on 3 June impacted business during the days that followed, particularly in the north west where the Group has a significant number of venues - five in central Manchester and five in Liverpool.   Like-for-like sales growth has since strengthened, up by 2.7% over the last six weeks.

That's a respectable performance. I particularly like that recent sales have been stronger, at +2.7% LFL. That should be enough to mop up increased cost pressures. I seem to recall reading somewhere that retail/hospitality companies need to achieve about +3% LFL sales, at static margins, to cope with increased cost pressures.

Roll-out - this is excellent news, in my view;

As planned, the Group opened six new bars in the Period. Revolución de Cuba bars at Harrogate, Reading, Aberdeen and Glasgow, all of which were opened in the first half, were followed by new Revolution bars in Southend (late April) and Torquay (late May).  Average weekly sales for the bars opened during the Period are ahead of the Board's expectations.

There was an issue, in the May 2017 profit warning, that costs were too high at new sites. I'm relaxed about that. Excess staffing is a good thing, at new site openings, as it should mean that customers get great service.

I'm an investor in a private pub/restaurant chain in Cheshire, and I'm urging our CEO to over-staff our next new site, which opens in a few weeks. I don't care about short term losses - I want the team to deliver terrific customer service, so that people keep coming back. We can trim the staff rotas later, when the business is humming like a well-oiled machine.

RBG takes the same view, and they are right to do so. Short term profits don't matter - good businesses are all about long term delivery. If you "surprise & delight" (my favourite catchphrase) the customer at every opportunity, then you'll probably build a terrific business, longer term. Each repeat customer is very valuable.

This is the crux of why I think this is an excellent, and significantly under-valued, share;

The business continues to deliver high returns on invested capital and the Group plans to open six new bars in the new financial year, including Belfast that has just opened, split equally between the two brands.

For now, the market seems blind to this terrific business model. Fortune doesn't favour the brave, it favours the patient.

Accounting changes - I'm aware that readers sometimes rely on me to explain accounting issues in plain english. However, I'm struggling with this bit;

As part of the year-end audit, the Group has reviewed its historic accounting practices relating to short life assets and supplier rebates and expects to reflect the following two changes in its financial statements.

Certain short life assets will be reclassified, reducing depreciation charges by approximately £1.0m in the 2016 financial year with an offsetting impact in operating costs. Profit before tax for the 2016 financial year will be unaffected by this adjustment.

 Also the treatment of supplier rebates in earlier years has been reassessed. A resulting adjustment is expected to lead either to an exceptional charge in the Period (relating to prior years) or to a reduction to profits in prior periods.  It is currently estimated that the adjustment will be no more than £1.0m at the pre-tax profit level.

I feel a charlatan, as I should be able to give a knowledgeable explanation of the above. However, in reality, I'm not really sure what it means. More detail is needed. However, I will say that it doesn't sound worrying, or extensive in scope. I quite like the new CFO tightening up accounting policies - it reassures me that he knows what he's doing, and that he has some clout within the business. A strong CFO is a good thing, as it can moderate the power of the CEO.

Overall, it's an in line with expectations update;

The Group's full year results, which are expected to be in line with the Board's expectations, will be announced on 3 October 2017.

It's confusing why they say the Board's expectations, and not market expectations. Why introduce an element of doubt? That seems absurd, to me. Much better to refer to market expectations, then put a footnote, stating what the company believes market expectations to be.

Part of the purpose of these articles, is to help educate PRs and brokers, as to what investors want to read, in updates. Any doubt, or confusion, which is introduced, such as in this RNS, is a bad thing.

If existing advisers are not capable of writing a crystal-clear RNS, then companies should find someone else to do it, who can.

My opinion - I think this is an excellent company, at a bargain price.

The company has no structural debt, and is a cash machine - just look at the cashflow statement.

The main risk with this share, is that LFL sales could drop. That would have a highly leveraged impact on the bottom line. One broker estimated that each 1% drop in LFL sales would cause a 10% drop in profit - a truly alarming statistic. Hence why I completely understand why many people would prefer not to own this share.

However, today's update seems to indicate that this business is in rude health. The EV/EBITDA is amazingly cheap. I reckon this stock is worth 200-240p/share, based on a takeover multiple.

I'm very positive about this value share, and am buying more. DYOR as usual, and I very much welcome negative views in the comments below. We must always consider the contrary view. Often bears are correct.

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Fevertree Drinks (LON:FEVR)

Well done to all readers who spotted the opportunity with this posh mixers company. I recall AstonGirl mentioning this company to me, one of many charming readers that I enjoyed a drink with at the Westminster Arms a few months ago.

Fever tree had a remarkable insight, that we pay perhaps £8 for a nice gin, as I did for some Islay gin this weekend in Glasgow. Then we pay pence for some crappy tonic water. I find the Schweppes advertising, that I am an "amatuuuuur" quite laughable. Counter-productive actually. In fact, Schweppes seem to have done Fever Tree's advertising for them!

Anyway , whether or not I like Fever Tree tonic water in my Gin + Tonic hardly matters. What matters is the commercial reality. 

These numbers are fantastic! 

I don't see any point in crunching the numbers. In a bull market, this stock looks likely to continue rising.

If something goes wrong, then you're buggered! But that's always the case with growth stocks!

My opinion - I'd be inclined to be bullish on this one. Well done to everyone who spotted the opportunity.

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You're going to have to manage on your own now - I'm retiring to my bed, for a sleep. My motto is this - if you're tired, then have a nap. If your work prevents this, then it's the wrong type of work.

This is the best career advice I copied from Twitter - find something you're passionate about, then figure out a way to earn a living from it. 

Regards, Paul,.