Hi, it's Paul here, with the SCVR for Tuesday.
Estimated timings - most of the report is ready for the 1pm email, but I'll keep going until about 4pm with extra sections.
Today's report is now finished.
Market thoughts
As always the macro/virus picture is very uncertain, and I'm constantly grappling with this, as I'm sure you are too. How do we balance up catastrophic short term economic damage, offset by unprecedented Govt support & stimulus? Lockdown is far too expensive (in economic & human costs) to continue, as shown in the recent OBR report.
There's big potential upside if/when an effective treatment, and then probably later, a vaccine, is created.
There's big downside potential, if/when subsequent waves of the virus happen before there's a treatment for it.
It's all down to timing really. Nobody knows with any accuracy how this is going to pan out, hence why I am wary of anyone that expresses their views/predictions with too much certainty. It's not "will", it's "might".
In the shorter term, now that the virus seems to be peaking & starting to reduce in many countries, then that is increasing demands for lockdown to at least be eased in stages. I'll be closely monitoring how that goes, as it's likely to be a key driver of share prices. It's also important to look at data, as this very often gives a different true picture, compared with the media attention given to tragic, but often atypical, cases.
Taking all that into account, I'm trying to position myself in shares where I see good recovery potential that hasn't yet been fully baked into the current price.
Recent purchases have been housebuilders (done well), car dealerships (only a small recovery in price so far), on the basis that they're likely to get back to business very soon. I foresee pent up demand for both.
Property REITS are another area I've bought, but made a loss, having jumped the gun.
These are more trades than investments, and I'm trying to buy liquid mid caps in those sectors, so I can ditch them any time, as the facts change.
Looking forwards, I think H1 company results could be so dire, that we might see another move downwards in the markets in the summer, once people see the full enormity of many companies' losses. Or investors might look through short term losses, I don't know. Remember that at the moment, some company liabilities are just being deferred, but still have to be paid at a later date (e.g. rents, VAT, payroll taxes, etc). The furlough scheme could get very complicated, as in many cases, it's likely to be cheaper for e.g. shops & bars to remain shut. Once furlough stops, then expect vast numbers of people to be made redundant. That could get very sticky, if handled badly.
I'm also looking at most refinancing situations. I did well on Joules (LON:JOUL) - but have now sold them, as the surge in price recently looks to have baked in the upside for now. I've also gone long of Foxtons (LON:FOXT) as I liked its refinancing (de-risked for now), and the lettings side of the business should keep it ticking along. Also, what it said about doing virtual viewings, etc, puts it in the category of companies which are innovating effectively, and continuing to do business with staff working from home, and using technology - another important theme.
I used Zoom last night for the first time, and found it enjoyable & it worked well. A valuation of c.$35bn is now attached to the company! I'm not sure how that makes sense, given competing products from Microsoft Teams, and Facebook, and that most people are using Zoom for free. On this topic, it's really good to see lots of initiatives in the shares world, with a big increase in webinars, etc on the internet, to enable companies to communicate with shareholders. I've not had any meetings in London for a while, which has saved lots of time. Mind you, I am looking forward to sinking a few pints in the Lord Aberconway (opposite Finncap's offices) with my investing friends, once meetings resume. Web-based meetings will have to suffice for now, but you can't beat a proper face-to-face meeting & subsequently comparing notes in the pub with other investors that you like & respect. Also, the staff in the Lord Aberconway are great - they retrieved, held & returned my suit jacket (with passport in pocket) once, as I tottered off into the balmy summer evening in 2019 or 2018, having completely forgotten that I had earlier been wearing a suit jacket at all, let alone that my passport was in the pocket. Good eggs, which I rewarded with a generous donation to their staff party.
Another point to consider, is that the indices are not the economy. US indices in particular are very tech heavy, and people see those companies as beneficiaries from the current crisis. Healthcare is also doing well, for obvious reasons. Whereas travel companies and others which are being hurt by the crisis, have seen their share prices rightly smashed downwards, then more recently some recovery as reduced lockdown is priced in. Markets look forwards.
Therefore, by looking at just the benchmark index (Dow Jones, or S&P 500), we're not seeing the detail that perhaps makes more sense than the headline index figure alone? Maybe it's not as incongruous as many of us thought that US markets have recovered about half the losses? I don't know the answers, but am thinking about this stuff all the time, and absorbing/processing views from many sources.
My hedges (shorts) worked extremely well from late January (as disclosed in the SCVR for 27 Jan 2020 which is interesting to revisit), but became too expensive (i.e. losses) more recently, so I closed my shorts on the Dow & most other things. My only (smallish) short currently is Rightmove (LON:RMV) . I don't really like shorting, and am not very good at it, but it's saved my skin in the last 3 months, more than covering all the heavy losses on my longs- many of my speculative small caps have been really whacked hard by Covid-19.
To summarise my current thinking (subject to change at any time), I'm long reasonably-priced companies where I see recovery potential, but am keeping a close eye on the exit. If specific shares recover to a point where they look fully valued (e.g. Joules) then I'm selling, and looking out for better value opportunities elsewhere. By July/August, I'm intending to sell more things, and have a higher proportion of cash, because I'm worried that H1 results statements could look a lot worse than currently imagined (people sometimes forget about operational gearing in downturns). But that depends entirely on how the big situation has developed by then.
Overall, I'm looking at things on an individual, share by share basis, rather than forming any particular view on the indices.
This is a time to be very flexible in our thinking, rather than sticking rigidly to a preconceived viewpoint. Isn't that always the case though?!
Lookers (LON:LOOK)
Share price: 20.8p
No. shares: 390.1m
Market cap: £81.1m
Recap - I reported here on 11 Mar 2020, when this car dealership chain announced it had found possible fraud in its accounts. The share price fell 30% to 26p on the day.
I reported here on 26 Mar 2020 on its Covid-19 update, which seemed to reassure the market.
Latest update (28 Apr 2020) - note that it has a 31 Dec 2020 year end.
Things were not great even before Covid-19 struck, with negative LFL sales of new & used vehicles, and margin pressure, in the 2 months to 29 Feb 2020. Cost-cutting measures were taken in Nov 2019.
As we already know, all its sites were closed on 23 Mar 2020. Since then 31 sites have been partially re-opened for repairs/maintenance of key workers vehicles.
Property disposals - 7 freehold sites sold (proceeds of £17.6m raised in 2019). More disposals planned in 2020.
Furloughed 7,000 staff. Board & senior mgt taken temporary 30% pay cuts.
Net debt - was £62.0m at 31 Dec 2019. Barely changed at c.£65m as of now. Bank facility is £250m RCF, expiring in Mar 2022, which seems to give LOOK lots of headroom.
Fraud investigation - Grant Thornton were brought in, the "initial phase" is now complete;
The initial phase of the investigation focused on the operating division concerned and identified certain misrepresented debtor balances in respect of bonus receivables together with a number of fraudulent expenses claims. These items are expected to give rise to a one-off, non-cash charge, in the 2019 financial statements of circa £4m.
I would have preferred a much clearer explanation. Fraudulent expenses claims is straightforward - that's employees stealing money via expenses. I'm not sure what the other bit relates to. Possibly fake invoicing, in order to trigger staff bonuses? It's not clear. But anyway, person(s) unknown with the company have been on the fiddle. That means previous profits were over-stated. £4m is a fair bit, not minor fraud.
Phase 2 is underway, looking at all other operating divisions within the group. This has unearthed what sounds like sloppy bookkeeping (being generous there), but again this would have meant previous profits were over-stated;
Initial indications have identified some operating divisions where certain non-cash balance sheet accounts have not been fully reconciled, in accordance with Group policy. These items are expected to give rise to a one-off, non-cash charge, however this part of the investigation is still ongoing...
Outlook - clearly Covid-19 is bound to have a major impact;
The Board is contemplating a range of post covid-19 reopening scenarios and is considering the challenge of managing the Group's cost base against what the Board considers will be materially lower volumes, as a consequence of continued social distancing measures.
It declines to give us any more detail, or any figures, which is a cop out in my view. Other companies are publishing base case, and downside case estimates. We really need this information. There again, financial control doesn't seem to be a strength at LOOK, so it's hardly a surprise it's vague on this issue.
My opinion - I wouldn't invest in anything with an ongoing fraud/accounts investigation underway, because they usually turn out to be worse (sometimes disastrously worse) than originally thought.
We're also not given enough information on likely current/future trading.
On the upside, it has a treasure trove of freehold property. I wonder if the inventories of vehicles might need a provision made against them, if dealers are forced to discount heavily once business resumes?
I'll be happy to stay on the sidelines until the accounting investigation is concluded & published. Hence not for me.
Valuations are so low in this sector, I do wonder if sector consolidation could be on the cards? Private equity could be attracted by the freeholds, maybe?
.
.
Synectics (LON:SNX)
Share price: 116p
No. shares: 16.9m
Market cap: £19.6m
Synectics plc (AIM: SNX), a leader in the design, integration and support of advanced security and surveillance systems, provides the following update ahead of its Annual General Meeting ("AGM")...
This company has an unusual 30 Nov 2020 year end date.
I've not looked at this company for a while, but must have liked it last year (BC) as it's still on my watchlist.
Latest update - it's monitoring & reacting to the situation.
Liquidity - this sounds reassuring. As it was already on my watchlist, then the balance sheet must have been OK last year;
The Company has a solid cash position and measures in place to ensure that it remains financially sound during this period of uncertainty and beyond. The Group's available consolidated net cash balance was £3.3 million as of 20 April 2020, with confirmed facilities of £5.0 million in place if required.
Actions taken - looking very similar to what we're hearing from so many companies;
- Furloughed 30% of staff, and applied for similar Govt schemes overseas. Others working from home
- Director & senior mgt - temporary pay cuts - why no mention of the percentage, a glaring omission?
- Conserving cash by cost & capex cuts, and cancelling divi
- Guidance remains suspended for this year (was withdrawn on 23 Mar 2020)
Operations - not good, but not surprising either. It's not quantified, but this sounds like it's going to be a big impact on profitability this year;
All the Company's business units are currently operating, but at significantly reduced levels of activity in every sector and geography. Reasonable levels of design and planning work are continuing for projects now expected to proceed later in the year than originally anticipated.
My opinion - it's impossible to value at the moment. The point is that losses this year could blow a big hole in the balance sheet. When last reported, as at 30 Nov 2019, it had about £19m in NTAV. However, if you look at last year's P&L, it made £23.3m gross profit, less £20.7m operating expenses, for an operating profit of £2.6m - that was on revenues of £68.5m.
So, if revenues drop by, say half this year (remember its products are capex for its customers, and so many companies are slashing capex), then gross profit could drop to say £10,0m (more than half, as customers would no doubt try to negotiate discounts to proceed with purchases in the pipeline).
On fixed operating expenses of £20.7m, that would turn into an operating loss of -£10.7m, compared with a £2.6m profit in 2019. If my estimates there are right, then the company would no longer have a strong balance sheet. The cash would be gone, and it would probably be using most of its bank facility. It would then need a decent upturn in 2021 to keep going. Bank covenants could be breached (I haven't checked) at that level of losses.
In practice, the company would be forced to drastically cut its £20.7m operating expenses, to reduce the losses. If those costs were cut by say a quarter, then we'd still be looking at an operating loss inn 2020 of about £5m.
Since I have absolutely no idea what the 2020 figures would look like, then how could I even consider buying the shares? I think investors who assume everything gets back to normal in 2021 might be overlooking the balance sheet damage caused by one diabolical year in 2020.
Hence risk:reward has changed a lot, for the worse. I don't think I would want to invest in anything that sells products which are capex to the buyer. I got caught out by that mistake in 2008, and it was a disaster. Overall then, SNX looks too uncertain, and is becoming much higher risk than it was in 2019. Time will tell how bad 2020 turns out to be, but I don't feel the current price has adequately factored in the risk.
Obviously, at this stage we have to completely ignore valuation metrics such as forward PER and divi yield, because broker forecasts are pie in the sky for now, mostly. Reality is likely to be far worse than current estimates, in my experience.
We can afford to be very picky at the moment, and only buy the best risk:reward situations. Hence anything uncertain is just best ignored, in my view. We can always buy at some point in the future, when the facts are clearer. Why take the risk now? There are no prizes for being loyal to a share.
.
.
System1 (LON:SYS1)
Share price: 97p
No. shares: 12.6m
Market cap: £12.2m
System1 Group, the international online market research agency, is today providing the following Trading Update for its financial year to the end of March 2020, together with updates on the impact so far of the Covid-19 pandemic and related matters.
This is another share that was on my watch list last year, as showing possible signs of something interesting happening, but that's likely to have been clobbered by Covid-19 & its economic effects. Marketing-type spend is an obvious thing to cut, as it's discretionary spending for SYS1's customers.
Anyway, let's have a look at what it says today, which is likely to be on a scale starting at bad, and ending at awful.
Actually before we do that, do have a look at my notes in the SCVR for 6 Feb 2020. It was clear at that stage, things were going wrong - poor trading, and loss of staff. That's BC (before covid-19) remember. Also the company annoyed me by apparently trying to gloss over the extent of its profit warning, with an update that left us to do the maths to work out it was likely to be running at around breakeven.
Today's update seems somewhat better than that, saying;
The modestly reduced sales for the full year, together with a 1% increase in overhead expenditure, is expected to result in a 2019/20 Profit Before Tax figure (excluding AdRatings and share-based payments) of approximately £2.9m, compared with £3.6m in the prior year. Whilst we acknowledge this was a disappointing result, it does exceed our previous expectations.
AdRatings is its startup, loss-making business.
Investment in AdRatings continued during the year, with expenditure of £1.8m recognised in the income statement, compared with £2.2m in 2018/19.
What that means, is the £2.9m PBT figure mentioned in the previous paragraph above, needs to be reduced to £1.1m to arrive at the total group profit for FY 03/2020. Moreover, the phrase "recognised in the income statement" rings alarm bells with me, in that it could mean more of AdRatings costs might have been capitalised onto the balance sheet, in order to massage profit upwards? Given that we've established in the past that this company's investor communications can be misleading at times, then I wouldn't put it past them to pull another trick this time.
AdRatings revenues are de minimis. Given the current crisis, this raises the question of whether AdRatings is worth pursuing at this time, given that its operations are consuming about two thirds of the profits (maybe more, in cashflow terms?) of the rest of the group? Maybe it should be shelved, given radically worse macro conditions? -
...an impairment charge of £0.9m has been taken in relation to AdRatings development costs in light of the continuing modest AdRatings revenues in the year (£0.05m).
[Paul: that's £50k annual revenues. For a £1.8m loss]
ITV - a glimmer of hope here, or just a shrewd client recognising that SYS1 is prepared to provide a service at way below cost price?
On the strength of the industry attention received by AdRatings, we have announced a strategic commercial partnership with ITV, the UK's largest seller of advertising space, to support its customers in creating ever more innovative and effective advertising. We expect to enjoy revenues from these arrangements although it is hard to quantify this while the Covid-19 pandemic continues.
It just feels the wrong time to be doing this. I imagine management must be agonising over this issue, and it's very unlucky timing. To be fair, it's easy for me to criticise, perched on a piano stool (to avoid slouching), in front of a computer screen/keyboard, but many highly successful businesses would never have got off the ground, unless entrepreneurs were prepared to take risks, and burn shareholders' cash in the startup stage.
Covid-19 update - unsurprisingly perhaps, this falls into the bad, but we're not telling you how bad category, which I find unacceptable at this stage. There again, SYS1 has repeatedly said in the past, that it has limited visibility, even in good times. So it probably doesn't know how things are likely to pan out;
Since the end of the 2019/20 financial year, System1's trading has inevitably been adversely affected by the global economic situation. The Board has concluded that it is difficult at this stage to provide guidance on the financial performance for the current year until a clearer outlook emerges. The Board will keep investors updated as the impact on the Group's performance becomes clearer.
I would have liked some scenario analysis, combined with what actions could be taken to handle each scenario. But maybe that's too dangerous to put into the public domain? After all, for a people business, mooting the idea of sacking staff, wouldn't go down too well (although people tend to work that out for themselves).
Actually, to be fair, they do say this;
...we are monitoring the trends in forward sales, evaluating a variety of plausible revenue scenarios, and taking decisions on our cost base when agreed trigger points are reached.
Mitigating actions to date include deferring employment costs, reducing the number of hours paid for where the volume of work has fallen, and taking advantage of government-backed business support and furloughing schemes in the countries where we operate. The Board and other senior executives of System1 have agreed to defer 20% of their salaries until further notice.
It's difficult to criticise that, as it sounds like common sense stuff, and must be very hard to manage, making potentially tough decisions. As investors it's probably not something we take into account enough, but at times like this, management of any organisation under pressure (be it private or public sector), it must be incredibly tough on a personal level for everyone involved. I certainly wouldn't want to be taking life or death decisions in Govt or civil service, nor having to agonise over which employees to furlough or make redundant within any business. Still, that's what the big salaries are for.
Liquidity - again, sensible actions taken, to give what looks like some headroom;
Given the emphasis on retaining cash in the current circumstances, the Board has decided to suspend both the proposed buyback programme of up to £1.5m of System1 shares as well as the payment of a final dividend for the 2019/20 financial year. Future returns of capital will be kept under review as the economic situation develops.
In addition, the Company arranged and drew down a £2.5m revolving credit facility in March 2020, ending the year with a gross cash balance of £6.6m (2019: £4.3m) and debt of £2.5m.
That all looks pretty smart to me. Survival first, then worry about recovery later.
Outlook - this offers some hope maybe;
At this difficult time we are working as closely as possible with our clients, sharing the latest insights on how Covid-19 has impacted consumer feelings and behaviour around the world and strengthening our relationships with them. We believe this will stand us in good stead and benefit our business when conditions improve.
Maybe, but how many clients are really going to have spare cash to do this? Maybe some big consumer brands?
My opinion - everything has a price, and with this market cap down to only £12m, combined with what looks like adequate liquidity for now, and a cost base that's flexible (people), I'm quite tempted to have a punt-sized dabble here. Potential upside could come from a future decision to put AdRatings on hold, for reduced cash burn, for a temporary period?
This type of business could maybe survive a severe downturn, by slashing its mainly variable costs (people). Maybe we should take a fresh look at people businesses for this reason. In the past, the issue has been that the talent walks out of the door every day and can get paid more elsewhere. Right now, I think the talent is probably working from home, and grateful to still have a job.
Incidentally, what's to stop employers furloughing staff, i.e. getting the Govt to pay 80% of salary up to £2,500 per month, with a quiet agreement on the side that the employee continues working from home, off the radar, and is rewarded in future? Surely that's better than twiddling thumbs and doing nothing of economic value whilst furloughed?
In terms of its investor communications, this needs a complete overhaul at SYS1. The commentary is often disarmingly honest - e.g. telling us repeatedly that it has no real visibility on revenues & hence profits. Yet in other places, it seems to create a maze of distractions & minor deceptions, to obscure bad news. Memo to John Kearon, CEO - Honesty is the best policy. Get rid of any advisers who encourage you to deceive investors - it destroys trust - e.g. publishing % changes in some metrics, in order to conceal the overall picture (a plunge in profits).
Overall - I'll put my paperwork on SYS1 into my "looks potentially interesting, unlikely to go bust, but risky" tray. Let's see how things pan out in 2020.
.
Iqe (LON:IQE)
Share price: 39.4p (up 1% today)
No. shares: 796.5m
Market cap: £313.8m
IQE plc (AIM: IQE) the leading supplier of advanced wafer products and material solutions to the semiconductor industry, announces its full year results for the year ended 31 December 2019...
This was a wonder stock a few years ago, popular amongst private investors. As you can see from the 5-year chart below, it multi-bagged, but has since come most of the way back down again, as the company failed to deliver on all the hype. That often seems to happen with fashionable shares!
.
.
The company says that its 2019 numbers are in line with the figures previously given in its trading update on 24 Mar 2020. I'll take that as read, rather than checking, as I don't intend spending long on this share.
Revenue down 10.4% to £140.0m
Adjusted operating profit down from £16.0m in 2018, to a loss of -£4.7m in 2019
Heavy capex again, of £31.9m - the big problem with this company is that it's capex hungry, but is not generating a decent return from that investment
Outlook comments seem quite good -
“Looking at this year, I am pleased to report that Q1 2020 trading was slightly higher than our internal expectations and the outlook for Q2 remains positive at this time. IQE remains well positioned to withstand the near-term uncertainty, and we are confident our technology will be a critical part of the world’s technologically driven future.”
Liquidity - this reassures -
"Increase to credit facilities to support navigation of challenging market conditions:
- £30m asset financing facility put in place, increasing total available facilities to ~£57m (£25m drawn down at 31st December 2019)
- Formal agreement in place to relax debt covenants in December 2020 and June 2021, as a precaution, to ensure continued access to debt facilities in severe downside scenarios"
Cashflow statement - is revealing. This shows that the company has been spending far more on capex in the last 2 years, than it has generated in cashflow. Even if capex now reduces, that suggests to me that it's really not a very good business.
My opinion - this company has disappointed over several years. The pattern is that it promises wonderful things from new products in the pipeline, but then nothing much happens with those either.
Overall then, I am deeply sceptical about this share. Why is it valued at £313m, given poor performance in recent years?
There's not much of interest in small caps, so here are a couple of noteworthy announcements which caught my eye from larger companies;
Plus500 (LON:PLUS)
A cracking update from this controversial CFD/Spread Bet company.
Everything seems to be going well, leading to another upgrade to expectations;
...the full year is expected to be substantially ahead of current consensus expectations, as revised following the Q1 trading update on 7 April.
Spread Bet/CFD companies thrive in times of market volatility. Memo to self - when markets go haywire, buy this sector. Ig Group (LON:IGG) and £CMD have also issued positive updates recently. PLUS is the riskiest out of these, as it has run into multiple regulatory, accounting, and ethical problems in the past. That said, these concerns are reflected in the valuation multiple, which looks cheap.
Personally, I think the boat has set sail in share price terms, so I'm not interested in chasing it up any further. Of course, as volatility subsides, then customer activity is likely to reduce back down to more normal levels.
This sector has been great of late, something to remember for the future.
Marks And Spencer (LON:MKS)
(I'm long)
There's a reassuring update out today.
- Banking covenants have been relaxed through to Sept 2021.
- Confirmed as able to borrow under Govt CCFF scheme - providing extra liquidity if needed.
- Has enough liquidity for next 18 months - removing any concerns about solvency. Last man standing in its sector, so should gain market share once it can re-open, in my view.
- Given a daft name to its restructuring: "Never the same again". Give me strength.
- No divis for 2020/21 - saving cash of £210m
- Food delivery via Ocado on track to start in Sept 2020. This is quite exciting in my view, and the main reason I want to hold this share.
My opinion - it's definitely going to survive, and I could see possibly 100% upside from the current level of 97p. However, figures are probably going to look dire in 2020, but everyone knows that - it's in the price already.
All done, thanks for reading & commenting.
Regards, Paul.
See what our investor community has to say
Enjoying the free article? Unlock access to all subscriber comments and dive deeper into discussions from our experienced community of private investors. Don't miss out on valuable insights. Start your free trial today!
Start your free trialWe require a payment card to verify your account, but you can cancel anytime with a single click and won’t be charged.