Small Cap Value Report (Tue 30 Jan 2018) - QRT, SPRP, YOU, FTC, NWF

You have three real weird ones today, Sprue Aegis, some odd Directors and various deals make me back away from that one, NWF is in a decaying market with no growth opportunity and no strategic activity so looks like a company run just for the Directors while Filtronic, is always going to be lumpy and while I've worked with them on and off over the years they are generally a bit odd, think they live in Silicon Valley and no one else is bright enough to help them.

So three companies to leave alone

In reply to post #306713

Hi bobo.

Not quite sure why you have such a downer on NWF (LON:NWF) . Last time I checked most people were still eating so animal foodstuffs, agri oil and ambient groceries are hardly a decaying market. Growth rank is 59 (not to mention Stock Rank of 93) and with a dividend of a touch under 4% that has increased by about 5% compound for the last five years and 2x dividend cover it may be boring but hardly a barge pole stock.

Gus.

Thanks for the mention Paul.

I would hope and expect as we progress through 2017 that more Brokers will decide to at least put the research they write on their corporate clients out to the wider market.

Corporates want their house broker's research to be widely available, especially because the next time they want to do a raise they need to already be on the radar of investors if they are going to have a decent chance of building the book and completing the raise at a reasonable valuation.

As to the full coverage from the larger brokers, we are still in the very early days of MiFID II and the market will take a good few quarters to establish itself. By then it will be much clearer picture what the cost of just the research should be, compared to the cost of full service (ie calls, meetings, models etc). As this becomes clearer, there should be an incentive on both sides as Brokers can then more efficiently monetise the longer tail AND investors are on a firmer footing of what things do and should cost.

In the meantime there are going to be more frustrating developments unfortunately.

The Chancellor of the Exchequer of has written to the Office of Tax Simplification asking them to look at inheritance tax, including whether the current system distorts taxpayers' investment decisions.

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/677301/CHX_letter_to_OTS_on_IHT_review.pdf

Well it certainly distorts my investment decisions, and I believe that without it AIM share prices would be somewhat lower. I suspect the distortion particularly affects the larger capitalisation companies such as ASOS (LON:ASC) and Abcam (LON:ABC) and that the largest companies are most at danger from changes to Business Property Relief which was (I believe) originally designed to avoid the breakup of unlisted family business.

I know there has been speculation about this before, not least leading up to the last budget, but this affects us all due to the potential share price impact.

Paul (and other interested parties on here) - I recommend that you write to your MP. I always thought "ah what a waste of time that would be" but when I did actually do it (back in the days when Bank of Ireland wanted to steal their investors' PIBS) I was very pleasantly surprised that my MP took the matter up with some very senior government and regulatory figures and in the end the investors won through.

In reply to post #306718

Hi Gus,

You only need to take one look at their operating margins to be put off NWF. They made operating profit of £2.4m on turnover of £295.8m in the first half i.e. less than 1% operating margin (even supermarkets make 3% and good businesses are 15%+). It doesn't need much to go wrong for you to start losing money in NWF's markets. You can grow all you like but at that margin it won't make much difference. Hence they added £40m of turnover this half year for only an additional £0.2m profit. Enough said!

Re Luceco (LON:LUCE). Would be very careful of ex-owners EPE Special Opportunities (LON:ESO), Hornby and Brand quietly exiting by the back door as this steaming pile slides inevitably to its demise. This one stinks. The price action is out of all proportion to the information in the public domain. Ergo, there is information that isn't in the public domain available to those driving it. Wouldn't want them to exit at the expense of PIs. So until the information vacuum is filled, I would suggest that nobody here is on the other side of a rigged trade.

In reply to post #306633

Paul & Graham are unlikely to cover Goldplat (LON:GDP) due to it being a mining company so I thought I'd give you my 2p worth.

The shareprice as sold off slightly today so some people were clearly expecting better production figures. The main culprits are:

- a bit of production disruption in Kenya due to elections.

- Production decrease in Ghana vs FY17.

I think this is a case of people missing the wood for the trees. The quarterly production figures are always noisy as the company varies material and grade to optimise their equipment & stockpiles.

The key for me in today's update is the continued commitment of the management to Kenya trading profitably this year despite the election related disruption. Given that this subsidiary lost £1.1m last FY then this alone generates a step change in profitability for the company.

Given the operational progress in South Africa & Ghana plus stronger gold price I think that barring any major disasters a profit after tax of around £3m should be possible this FY even without production growth (outside of Kenya) putting the company on a forward P/E of about 5. This would blow VSA's £1.18m PAT forecast out of the water.

Of course a P/E is not a good metric for a company that is at peak profitability however Goldplat (LON:GDP) has a couple of initiatives that could give a further step change improvement in profitability:

- A tailings re-treatment program in South Africa

- Mercury Clean-Up in Ghana

Both of these have bureaucratic hurdles to overcome before they can progress but both have the potential to add significant incremental profits to the company.

Given its geographical location it should always be considered a high risk investment. Despite this I believe Goldplat (LON:GDP) has the potential to deliver good returns to those who are willing to bear this risk & do their own calculations rather than rely on the market forecasts. Due to it's size, geography & business it is the sort of company most people dismiss out of hand which means that the market will typically price it inefficiently.

In reply to post #306588

Re: EMIS
Although EMIS's loss of the NHS Wales contract sounds bad, Edison estimates that the impact on eps will be about 1% going forward so it will not really have a significant financial impact, assuming Edison's paid for research is correct.

In reply to post #306713

Hi Bobo ,

I currently hold Sprue but thinking of selling when you 'some odd directors' what do you mean ?

Any help you give me would be most welcome

Thanks

Ref MIFID
The whole EU project seems intent upon introducing centralized & often undemocratic control on matters which should be decided by countries, or in this case individual businesses & citizens. The centralized control aspect is contrary to the unique freedoms that once made Europe the wealthiest & most dynamic economic region in the world.

As for how to approach the issue, well I wonder what Lord Lee thinks of it ? A prominent investor, with obvious political connections.

In reply to post #306853

To be fair, the UK's own FCA was probably the prime mover behind MiFID II. Given the FCA's track record in terms of really protecting private investors I wouldn't be holding my breath for any substantive changes.

timarr

MiFID II is a gigantic version of  the 'cookie law', the EU directive that does nothing but cause everyone a nuisance every time we visit a website, and which is patently absurd in light of Snowden's expose.

In reply to post #306583

Hi ridavies,

Sorry no, I haven't looked at Luceco (LON:LUCE) before.

Looking back in our archive, Graham has covered it 3 times.

I've had a quick look at the last accounts, and the profit warning. It seems very similar to UP Global Sourcing Holdings (LON:UPGS) - i.e. business that seems to source product from China & sell it in the UK. So an intermediary/distributor. Both companies listed on the back of strong growth, and both companies then disappointed fairly soon after floating, with profit warnings.

This does make me wonder whether both floats might have been opportunistic?

I'll happily look at the figures from LUCE nest time it reports. Although getting the stock valuation wrong does of course mean that actual or forecast (I'm not sure which) were inflated. That's very worrying. Getting the stock valuation right at period ends is incredibly basic stuff. I see their Financial Controller left after the errors were discovered. It doesn't exactly instil confidence, does it? But the shares might be cheap now, I don't know.

Regards, Paul.

In reply to post #306608

Hi grumpy5,

Paul, I think you are being hopelessly unrealistic to expect PH's research for £500 p.a.! Remind me to tell you the true value of analysts over a beer or 2 at Mello....

I didn't say that I expected to be able to buy Peel Hunt's research for £500. I said that I would be willing to pay that (but have zero expectation of being able to access it for that price!). It doesn't make any business sense for PIs to pay any more than that, because otherwise the cost would become too high a % of our portfolios. Whereas fund managers can easily pay £10k p.a. for PH research, if they're managing a portfolio of say £1bn. That's the point I was making in the main article.

Obviously I fully understand that producing high quality research is expensive, and the research firms need to find a way of monetising that. Quite how that's going to work, we don't yet know. I think it's basically going to end up with City professionals having access to the best research, and PIs being only able to get hold of house broker notes. Plus there's likely to be an increase in commissioned research.

All bloody annoying, as it had taken me years to get good sources of broker notes lined up, and MiFID II has just blown that to pieces.

Paul.

A few things in Paul's write up of Filtronic (LON:FTC) prompted more thoughts from me :

It has a surprisingly high StockRank, at 80, but a "Neutral" style;

There was a Warning in December before today's so we have a 30-40% reduction in forward earnings - once this is factored into broker forecasts I would imagine the Value rank will plummet from the current 87 and I would imagine "style neutral" will become "fallen star"

I also think I can quite easily tie together two of Paul's comments to resolve a question :

• I don't really understand why this company is listed on the stock market.
• The number of shares in issue has more than doubled over this period, as
  money was raised from shareholders to keep the company afloat.

say no more, say no more. A nod's as good as a wink to a blind bat Squire!

Seriously though, I think the fact they have been able to raise funds reflects the possibilitythat a more exciting could be in the future - the progress on 5G I certainly found interesting. No conceivable reason to invest right now imho , but certainly worth having on the watchlist in case of material news.

In reply to post #306888

Amazingly even the EU agrees! The Commission is actually reviewing the cookie law, with a view to making it possible for anyone to set up their browser options to opt-in to all cookies. If this happens it this will only be after Brexit, so until the UK implements an equivalent law it'll just be us in the UK who'll be stuck with cookie notices ...

timarr

In reply to post #306863

Yes that's correct timarr.

Large parts of MiFID 2 legislation were effectively authored by the FCA, as has much of the EU financial regulation over the years. This makes sense because London is a global centre for finance in a way that Paris or Frankfurt could never be, and therefore we have the need and expertise to drive regulatory changes.

The problem has been that much of the regulation passed over the years has had almost no impact on the very things it aims to fix. Worse still, it has led to a thick layer of compliance that adds significant cost to the system, hugely slows down the rate of innovation, and protects the large incumbents at the cost of new entrants.

Thinking back to my credit suisse days I would see a constant carousel of compliance staff as they continually got poached by rival banks for a big wage rise, only to return a couple years later after being poached back, again with a big wage bump.

A mid-ranking compliance guy now commands £90-140k per annum... big banks need teams of these people and none of them generate any earnings... we live in crazy times...

In reply to post #306943

Hi Paul,

I would take a different position. Your expectation isn't unrealistic at all...The research definitely has a value but it is a small part of what fund managers actually pay for.

Only a few weeks ago, brokers were happy to distribute the research far and wide for free... The fundamentals of their businesses have not changed in 1 month... Most of their revenues from the Buyside have always come from the full service they offer, not the research.

The big paying clients we had at both my previous places paid top dollar because they were getting access to the analysts, their models, regular calls and meetings, and high-quality service from their sales contact. They would rightly expect to be one of the first phone calls for these guys when there was something important to communicate.

I don't think you're unrealistic at all to expect to get access to "research only" from these providers for the kinds of sums you mention. The amount they charge varies greatly depending on who the client is and there is certainly flexibility to offer lower prices for smaller firms or one-man-bands.

One of the main fears for these Brokers is they don't want to impact what they can charge their core clients (who do rightly pay material sums for full service) by transparently offering research at much lower levels elsewhere. This is backwards logic as those same clients were paying material sums last year when the "research-only" option was available to them for free... However, it means that, for now, they are focussing on those core clients and revenues and not the long tail.

My hope is that some of this focus will shift to the opportunity of monetising the long tail and that platforms like ours are the perfect, low-admin way to achieve that.

Cheers

Rob

In reply to post #307063

Couldn't agree more RMundy, I watched during my banking days Compliance (as a function) go from a noticeable, but not over-bearing presence to a monstrous machine seemingly intent on uncovering wrong-doing even where there was none.
Unfortunately, this is the consequence of previous wrong doing and excess, but as always the pendulum seems to have swung too far yet again.
The real purpose of MIFID II is to actually help PI's in collective investments, but not those who make their own decisions. It strikes me as a classic nanny state approach that in un-bundling costs to protect Aunt Agatha has led to an industry bloated by administrative and compliance costs at a time when revenues are under pressure as a result of previous regulatory change.
The upshot is there are no real winners as the PI's of investment funds that benefit from the changes are largely ignorant of the benefits that may result for them.
I agree Paul, its extremely frustrating but its worth noting there is no cosy cartel. The banks/fund management industry are in no way in cahoots with the authorities. My experience is that they are as bewildered and frustrated as you are.

A potential approach might be to form a syndicate, say protected by an NDA, where 20 people sign up to Peel Hunt each paying £500?   I would certainly be happy to pay that kind of amount for quality research.     As noted there is definitely more change to come as no one has really figured out the true cost of research.  I heard before Christmas that JP Morgan had undercut everyone for all its research.    I think they would allow access to all reserach for $10k, this makes Peel Hunt way over-priced by comparison.   If you consider Peel Hunt's market place, it may well be made up of smaller fund managers under-served by global trading operations and those fund managers will, to an extent, also baulk at £10k cost when considering they might have to sign up to 4-5 places.   So, I believe there is much more change to come.