Small Cap Value Report (Tue 27 Jun 2017) - DEB, CPR, NGR, IGR, ZOO

27th Jun '17 by Paul Scott

28 comments 18647 reads

Good morning!

As you know, I like to keep an eye on mid to large cap retailers, as this gives a good feel for how consumer sentiment & spending are going, and sector trends. So here are some brief comments on Debenhams trading update today:

Debenhams (LON:DEB)

Share price: 43p (down 3.4% today)
No. shares: 1,227.8m
Market cap: £528.0m

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

Trading update - I was expecting a lot worse actually, so these figures aren't too bad.

LFL sales in the last 15 weeks are down 0.9% (41 weeks: up 1.8%)

Costs are rising by 3% p.a. - this is the big problem for all UK retailers (DEB also has overseas operations) - that they're struggling to generate any LFL sales increases, hence rising costs are hitting the bottom line.

Outlook for the full year isn't too bad;

We currently anticipate that 2017 profit before tax will be within the range of market expectations. However, should current market volatility continue, the outcome could be towards the lower end of the current range.

Overall, not a disaster by any means.

So why have I shorted this share?

Forex hedging is still protecting margins, but will unwind during 2018 (DEB has particularly long-dated forex hedging) - so gross margins likely to come under pressure.
Low operating margin, and high operational gearing - so the company could swing into losses fairly easily in future.
Dept stores are struggling big time in USA. They're starting to be seen as retail dinosaurs - so the same could happen here.
Improving performance usually requires heavy capex - because refreshing huge, multi-floor stores is very expensive.
Sentiment is against traditional retailers - just look at the charts. Investors seem mainly interested in chasing up e-commerce shares.
The all-pervasive Amazon threat.
DEB is stuck in long leases, that it can't get out of. That's not a problem if stores are profitable, but if they become loss-making, it is a problem that has killed many retailers before.
Weak balance sheet.

Therefore, rightly or wrongly, I've come to the conclusion that it might be best to bet against the current share price. As to the future, my hunch is that DEB might eventually need to do a CVA, to get out of problem leases.

Shorting is dangerous of course, and…

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gregatr0n

27th Jun '17

Hi Paul any chance you could look at lakehouse? Turnaround is in progress and very positive commentary but declining profit. Understand Bob Holts reputation but has the share price got ahead of itself. Cheers

Paul Scott

I'll do my best with the above requests, but am taking a break first.
That's probably as many as I can manage today, so preferably no more requests please, unless it's something spectacular!

P.

bwakem

Paul I agree Debenhams (LON:DEB) is in decline but you are going to have to pay out some hefty dividends on that short.

davidjhill

Anyone have a view on Northgate (NTG). Down 14% today on final results but that looks like a barking mad over-reaction to me.

trading on sub 10* earnings at 450p with tangible assets of 383p and a dividend of 4% (increased 8% this year) with reasonable cashflow.

Spain and Ireland business doing well and I suspect will continue to perform. UK business dropped a little but this seems to be all about UK management rather than market driven. They lost some market share even though 6% growth in market. mgmt changes have been made.

New CEO views 4 areas of growth after review of strategy and believes these can drive revenue forward.

on eps of 47p+ going forward feels like this should be trading much higher than 450p or 1.2* book value?

any thoughts?

TamzinPiworld

IG Design (LON:IGR) FY results interview here, summarises the main points

http://www.piworld.co.uk/2017/06/27/ig-design-group-igr-preliminary-results-for-the-year-ended-31-march-2017/

c.8mins

Paul Fineman, CEO
Introduction – 00:19

Anthony Lawrinson, CFO
Financials – 1:48

Paul Fineman
focusing on efficiency – 2:54
Design – 3:59
Regional Performance – 4:58
Maintaining momentum (the period ahead) – 6:22
The future (long term growth) – 7:49

IGR always seem to under promise and overdeliver.

JohnEustace

I just enjoyed an excellent pizza at the new Franco Manca in Reading which occupies part of the Debenhams storefront on the Riverside.
So they do at least seem to be making intelligent use of their space where there are opportunities.

I think I'll stay a customer rather than a shareholder of both businesses for now.

WDWombat

Thanks to tomps for the ;link to the IG Design slot link. Very useful. A really good company just a question of how much is in the price.
I don't want to pre-empt but I have just bought some D4T4 after looking through the comments on the earnings release. A software company that doesn't (seem to) capitalise R&D! That is not expensive (historic p/e x16.5 and growing)! And has net cash on the balance sheet! And is DOWN on really good earnings (net profit better 32%).

ricky65

"Shorting is dangerous of course, and not recommended.".

I agree. Consequently, I always make sure I use a guaranteed stop loss when shorting (or spread betting in general). IMO it's worth paying the extra premium - nothing worse than a large gap or big slippage causing a dent to the portfolio. I'm also short Debenhams (LON:DEB).

Aislabie

With a market cap of £481mm against a projected revenue of £20mm and a projected loss of £8.0mm Blue Prism (PRSM), which reported half year numbers today has to come up with some pretty startling figures to avoid succumbing to Stockopedia's "Momentum trap" classification.
On this occasion it has done so and the stock is up 7% even after an RNS showing that Schroders Management has off loaded 40% of its shares.
Revenue is up 133% and the loss before tax of £3.1mm is in line (if not slightly below )forecast. Cash flow discloses a substantial (£417k) share based payment and the company remains in a net cash position helped by £2mm licencing fees taken in advance.
Against that however I am not clear what drives trade receivables of £8.8mm in a half year with £9.3mm of sales some of which are taken from the deferred sales line.
This is a classic "blue sky" share but does anyone have further input?

Graham Ford

I think that Blue Prism's potential is hard to value even perhaps for IT specialists. But I note that they are putting considerable energy and cash into developing a wide range of resellers and channel partners to ensure they create a dominant, first mover position in this new market and accelerate the acquisition of new customers. Most of the new business now coming through from those channels. Anyone could state that this is their strategy, but when you look at the heavyweight partners they now have (EY, Deloitte, Accenture, IBM etc) there's little doubt that this is a major development. For these types of companies to think it's worth their while becoming partners they must see the potential as being very substantial indeed.

I hold a long position and have topped up based on the results today.

DAVIDJEARY

Has anyone got any comments on the rise today in the price of MOS - in which, I believe holds a long position. Thanks

Gromley

Re the £11.0m onerous lease provision for Carpetright (LON:CPR)

"However, there's a clear problem with this - the underlying numbers exclude losses from poorly performing stores! Yet those losses are real, cash losses which the business has to absorb in terms of cashflow. Sure, the provision might be spread over several years, but these are still real losses."

I don't think it is true. Surely the 'underlying' profit does actually include the losses (or very low profits) from these stores? What they have actually done though effectively is looked at these stores and concluded that they may need to (or in some cases have) close and they may be faced with no contribution to the ongoing lease obligation, if they cannot sell on the lease.

So that £11m charge genuinely is a one-off non-recurring and will not reappear in future years. (Unless of course further stores deteriorate and have to be written down - but that would be a forecast about the business rather than an accounting fudge. As these "writedowns" result from a strategic review one would expect that they have tested the potential future of all stores.

So where does this show up in the balance sheet?

(Not an accountant so would welcome any comments, but ) I think it appears within the LT liability :

"Provisions for liabilities and charges" 2017 -17.5m 2016 -12.6m.

That's a movement of only £4.9m rather. I think the £11m is offset by a £2.2m impairment reversal for closed stores that have now been sublet. Also some of the previous onerous lease provisions will have been crystalised as the rents have been paid and so included in the cashflow.

(As I say, grateful for any contradictory thoughts!)

The "Where we sell" section of the report actually gives a good story of how they are cleaning up the leasehold portfolio.

Overall therefore IMHO , the adjustments to get to "underlying" profit, do seem reasonable and the story seems a positive one with good management action.

My views on the near term pressures on discretionary retail mean I would not be interested in investing at this time, however I think one for the watchlist over the next 12months.

seadoc

I know Paul does not follow financials but this from Share (LON:SHRE) (announced at 14.01) may interest others:

http://www.share.com/find-investments/advanced-finder/company-overview/share-plc/news/2594/?pass=1&story_id=26116063&rns=1

I hold enough to get a discount on trading charges but might top up.

Regards,

Seadoc

gus 1065

Hi David.

Mobile Streams (LON:MOS) is a particularly fickle share that blows hot and cold periodically. Quite closely held (mainly by management) and liquidity is pretty thin. Tends to be subject to a fair bit of pump and dump on some of the "tabloid" bulletin boards. No news of note since a trading statement in March promising more jam from Indian expansion at some point in the future so today's rise is possibly driven by the whiff of an imminent positive update. For my sins I bought a few of these a couple of years ago as a "fun stock" although to date it has been anything but!

Gus.

Julianh

Re. the correct treatment of long term incentive plan (LTIP) costs and diluted or undiluted share numbers to calculate EPS:
I was interested in your flagging this as an issue to look at more closely, Paul. I had always just assumed that presenting costs excluding LTIP costs was just another way of window dressing to increase reported EPS. And, having looked at some numbers I think I was wrong. If the LTIP remuneration had been paid as a real expense (instead of in shares) then the share count would not rise and the correct calculation for EPS would be
(1) Profit (after all normal expenses including LTIP salary costs) / total number of shares in issue (not increased by the LTIP as this would have been paid out in cash
Therefore, (2) calculating EPS based by using profit (after LTIP costs) divided by diluted share numbers would in some way be double counting the LTIP costs.
Having said that, I have not yet checked whether the EPS calculation (1) above comes out the same as the one they actually use - (3) Profit (before LTIP costs) divided by the fully diluted number of shares. Assuming they don't I would still feel happier with option (1) above - treating LTIP as a real cost.
Does any of that make sense? Looking forward to hear a more definitive conclusion to this debate.
AND - thanks for a really interesting analysis of IGR. I hold. Although the new Stock report classifications put this down as a "neutral" stock it seems to me to have lots of the characteristics of a "high flyer"- high return on capital, consistent increases in revenue, profits and EPS, good cashflow... Although this column is called the Small Cap VALUE report the last few months have increasingly favoured good growth companies even if highly valued. I am increasingly persuaded by Warren Buffets saying (loose re-statement) "better to buy a good company at a fair price than a fair company cheap price. And I remember Charlie Munger saying something about good companies providing share price growth for years to come while an okay company at a cheap price will only re-rate to a fair price and then go no further.
Whoops! I've gone on for much too long here. Enough for now. And many thanks for the excellent column and comments

Miserly Investor

Re: Carpetright (LON:CPR)

I don't think it is true. Surely the 'underlying' profit does actually include the losses (or very low profits) from these stores?

Paul is largely correct.

Taking a very simplistic example of a store losing £200k per annum with 5 years remaining on the lease. It does an onerous lease review and books a £1m provision on its balance sheet. This "one off" £1m charge is excluded from underlying results. In future years the £200k "loss" from the store is booked against that provision so that it winds down to nil over the remaining lesae period. As a result these future losses don't show up in the P&L at all.

With a wave of the accounting wand we have just made the loss disappear (as far as underlying earnings are concerned).

I say "largely" correct though, as the above is over-simplified. In practice the provision should only consist of future unavoidable lease obligations, so this is not the same as future store losses.

Hydrus

Thank you very much Paul for writing about ZOO - I agree it is interesting but note the risks also.

Hi bwakem,

I don't see the Debenhams (LON:DEB) divis as being sustainable.

Investec said something similar in a note today, they reckon the divis will have to be reduced or scrapped.

Regards, Paul.

Effortless Cool

Julian,

I initiated a discussion on this issue here:

http://www.stockopedia.com/content/share-based-payment-costs-abdp-case-study-181371/

This is a confusing area. I'd be interested in your views.

Thanks Miserly - useful observations.

I didn't read it that way given that they seem prepared to be quite aggressive in culling underperforming stores (as well as reducing lease commitments) , definitely useful though to consider how else such a provision could be used.

I guess the lesson for us investors (other than 'trust no one') is to keep a careful eye on cash flows as well as profits.

Small Cap Value Report (Tue 27 Jun 2017) - DEB, CPR, NGR, IGR, ZOO

Debenhams (LON:DEB)

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Paul Scott

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