Small Cap Value Report (Tue 6 Mar 2018) - LUCE, BEG, LOOP, HEAD

5th Mar '18 by Paul Scott

85 comments 27021 reads

Hi, it's Paul here.

Apologies for the delay. Somewhat later than usual, here is Tuesday's SCVR.

Let's start with the biggest percentage faller of the day, which must be a profit warning.

Luceco (LON:LUCE)

Share price: 50p (down 35.7% today, at market close)
No. shares: 160.8m
Market cap: £80.4m

Trading update (profit warning)

Luceco, the manufacturer and distributor of high quality and innovative LED lighting products, wiring accessories and portable power products, is today issuing the following update.

I am not familiar with this company. Thankfully, Graham wrote about it 3 times last year, so I'll get up to speed first by reading his 3 articles. I'll summarise them below;

Oct 2016 - floated by Numis on the full UK stock market, at 130p per share. Selling shareholders cashed out £67.1m-worth of existing shares (before costs). The link to the left is to its prospectus. A further £22m (net of costs) was raised to reduce existing borrowings.

3 Apr 2017 - very strong results for 2016 were announced. Adjusted operating profit up 53% to £17.6m. Strong outlook statement too.

11 Sep 2017 - strong interim results, with operating profit up 25% to £9.0m. Full year outlook in line with market expectations. Net debt £26m.

15 Dec 2017 - this is when things started going wrong - a profit warning. Gross margin weakness is blamed, and the financial controller resigned over the apparent error of not spotting it sooner. Forex & commodity prices are the underlying causes. Profit guidance for 2017 reduced by 21% to £13.2m (profit after tax). CEO sold 2m shares a few weeks before this profit warning!

It's interesting to look at the chart, and see that the best strategy in this case, would have been to sell immediately on the first profit warning. We've discussed that a lot in the past, and I am having a quick re-read (highly recommended) of Stockopedia's brilliant 2016 study of 245 small cap profit warnings.

The overwhelming conclusion of this data-driven study, was that selling immediately on a profit warning, has been statistically the right thing to do, on average. This chart says it all;

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xcity

6th Mar '18

Further thoughts on Luceco (LON:LUCE)
When they sold the Ross business in China last year, stock had to be independently revalued at approximately half book.
Profit estimate for full year implies a very small profit in the second half.
Unclear whether the problem is across all their divisions or concentrated in one or two. Important to remember it's only about 25% LED.

I get the feeling that this was rushed out when the new CFO realised the scale of the issues and the figures we have been given are those he has worked out so far

.PS I suspect that I would be sending someone out to China to check very carefully on the stock held there. Maybe they have already done it and it is safe to rely on current numbers.

AnonymousUser252054

I think Paul created a rod for his own back inviting requests every day. The pressure on both him and Graham to constantly produce in-depth analysis to demand must be taking its toll. Maybe it's time to consider reverting to them writing about whatever takes their fancy and not be afraid to keep it short and sweet sometimes rather than toiled over.

sevenccc

Headlam (LON:HEAD) ? Now who would that 'large customer' be do we think? Carpetright? Or do they supply some other sheds? If it's Carpetright I wouldn't expect a significant improvement soon. And the UK consumer is likely to be under pressure for most of this year unless we see wages pick up. Good solid business but the impact of this might take 12 months to work through.

Shall we adjourn and come back for the Interims or take a punt that today's reaction was overdone?

Paul Scott

7th Mar '18

Hi,

Looking at the reader requests, somewhat belatedly,

Yu (LON:YU.) - a spectacular share price rise. I missed this one completely. I don't understand this sector (provision of utilities), so it's not something I can add any insights on, unfortunately.

OptiBiotix Health (LON:OPTI) - there seems an almost constant stream of updates about contract wins. I'll wait for some hard numbers though, as it's too speculative for me at this stage.

Headlam (LON:HEAD) - this seems to have had the most requests, so I'll take a look at this.

Revolution Bars (LON:RBG) - (I'm long) looks OK to me, so I'll circle back to this at some point. The accounting issues are pretty irrelevant I think - indeed the onerous lease provision will actually boost future reported profits, so could be seen as positive. Roll-out of new branches going well (exceeding initial targets), almost debt-free. Current trading of -2% LFLs is a bit disappointing. Good to see new CEO & COO being focused (by the Chairman) on improving their food offering. This is key, and a big opportunity in my view. They already have big footfall, but if they could fill the bars with diners during the day, then a lot of upside - high margin sales, with little to no additional fixed costs. This share is woefully misunderstood by the stock market - we can buy now at under 150p, when a cash bidder was turned away at 203p quite recently. So the valuation clearly doesn't make sense. I am very confident this is likely to be a big win, but no idea when - patience needed.

LoopUp (LON:LOOP) - good results, but crazily expensive now, in my view.

LeoInvestorUK

Regarding Luceco (LON:LUCE) and their BG Electrical brand, 2-3 years ago I bought some universal sockets for my flat in Spain so that guests could use EU, UK and suitable US appliances without adapters. Such sockets are necessarily not covered by the BS testing regime, but it should be quite possible to make something as safe as a typical EU socket and safer than using adapters. On fitting I discovered that plugging in a UK plug was extremely hard and pulling it out destroyed the socket. All of the ones I bought were the same due to a design / manufacturing / quality control fault. I find it impossible to believe they had not had enough returns to realise the problem. Naturally I would never risk buying anything marked BG Electrical.

I notice that the BG Electrical brand is currently sold by Kingfisher (B&Q and Screwfix). I don't really understand their positioning - generally more expensive than LAP for products that are inferior on paper (e.g. single pole vs double pole switches) and only 25% cheaper than MK who are better on paper, look nicer and have some kind of reputation to uphold. Their brass / non white sockets look more differentiated.

Another brand Masterplug have long been an expensive but average quality product mostly sold in DIY shops, but with some reputation for RCD plugs.

Overall, I would say their wiring accessories brands may be overly dependent on a structurally declining and cyclical DIY market plus the fashion for brass etc. sockets.

FREng

Paul,
Your commments on Ed's excellent analysis of profit warnings prompts me to ask whether you or Ed have ever analysed profit upgrades in the same way? Should one (statistically) always buy immediately on a profit upgrade?

clouds

Just to add, I recently bought some Luceco dimmable LED bulbs, they did dim but made a buzzing noise. Returned them and bought Philips dimmable LED bulbs and they work very well, although more expensive.

I'd originally bought much cheaper LED bulbs that were dimmable, but made a louder noise than Luceco. These worked fine in non-dimming locations though.

The Luceco bulbs weren't cheap and it was disappointing that they didn't perform better.

Julian Rowe

Headlam.
I've some skin in this game.
Bought 2 players in EU.
UK profits down 4%...EU up.....is this a (toxic) combination of BREXIT fear effect plus doom and gloom on UK economy & forecasts?

I don't understand why people are getting so hung up about what constitutes a small cap, etc.!

Graham & I just write about the day's most interesting trading updates & results statements, with a main focus on small caps. What constitutes a small cap? I would say it's anything under about £400m market cap, but I'll flex that a bit higher, to say £500m if the company reporting is particularly interesting.

Normally if people request me to look at anything above £500m mkt cap, then I just ignore it.
Also if results look boring (in line with expectations) and there's nothing much to say about it, then I'll usually ignore it. The lower limit for market caps here is usually £10m.

Sectors - I don't cover: resources/oil/gas, property, pharmas/biotech, blue sky/story stocks.

My particular sector focus is retail/hospitality, so I'll sometimes write about larger caps within those particular sectors.

NB. The above are not hard & fast rules. They're just guidelines. We like to keep it flexible, so that if Graham or I think something looks interesting on the day, we'll write something about it.

Let's try to keep things a bit more light-hearted, there have been too many snotty comments here lately, which spoils the fun!

Regards, Paul.

Hi FREng,

Your commments on Ed's excellent analysis of profit warnings prompts me to ask whether you or Ed have ever analysed profit upgrades in the same way? Should one (statistically) always buy immediately on a profit upgrade?

That's a really good point. I think this idea was briefly discussed at Stocko HQ when I was last there, but possibly didn't get pursued. It's a very good idea though. My hunch is that often when companies put out "exceeding expectations" statements, then the initial rise can be the start of a larger, longer term rise. Mark Minervini calls this "post announcement drift", I think. It's certainly worked very well for me, on stocks like Gear4Music (which I still hold, but in reduced size), for example. The initial c.20-30% rise on a sparkling trading update in late 2016, developed into a c.4-5 bagger move. Which was very lucrative for people who spotted it early.

So yes, let's ask Ed if he would consider doing a study on positive trading updates, to mirror the study already done on profit warnings.

A good suggestion, thanks,

Paul.

timarr

There's research on this which suggests that companies that aren't closely followed experience post announcement drift as the news is only slowly assimilated. The same effect hasn't been found, as far as I know, with high turnover stocks so it looks like an investor (lack of) attention effect.

There are also over and under-reaction effects which it's suggested are due to limit orders. The idea is that if a stock issues a profit warning and drops that triggers automated purchase limit orders which counter the drop for a while. Or if a company issues a upgrade the full impact of that is temporarily mitigated by automated selling as the price rises.

One reason it's always worth trawling through the outer reaches of each morning's RNS's ...

peterg

The idea is that if a stock issues a profit warning and drops that triggers automated purchase limit orders which counter the drop for a while.

You might perhaps also expect the opposite effect, stops being hit causing an overreaction. Presumably the dominant effect is going the be the least expected one? If people are wary and set stops bad news will cause a large drop. If people are positive and looking for a buying opportunity the fall may be muted.

Peter

Possibly. It looks like a variation on the disposition effect where people preferentially sell winners and keep losers. Quite how that's implemented is probably not that important as long as the post-announcement drift offers an exploitable anomaly.

I'd imagine it's much more likely in small caps where there's less research and institutional interest, and where private investor attention matters more - but I've never done any research into whether there's evidence for that hypothesis.

dgold

Your point about more and less followed stocks sounds very logical. The obvious question that arises is how can we know which stocks are less followed than others? Would you say the only way to estimate this is by looking at market cap and/or average volume or are there better ways?

8th Mar '18

Turnover looks like the best proxy, although it would be interesting if someone could generate a list of the most discussed stocks on UK boards ...

But generally you wouldn't want this information to be easily available, because that would make it easily exploitable, and the opportunity would be arbitraged away. It's the fact that some effort needs to be expended to dig out the opportunities that makes it potentially valuable.

timarr

threeputt

Im sure I'm In a minority but I'd appreciate a look at Share plc (LON:SHRE).
With rising interest rates and increasing market share the results look ok to me:

Revenue and revenue market share reached record highs - helped by the emerging benefits of a major new partnership agreement and strong trading volumes
Revenue up by 28% to £18.7m (2016: £14.6m):
commission income rose by 51% to £10.6m (2016: £7.0m)
fee income grew by 7% to £7.2m (2016: £6.8m)
interest income increased by 14% to £0.9m (2016: £0.8m)
Revenue market share excluding interest (*) reached 12.81% (2016: 9.85%)
Assets under administration increased by 27% to £4.7bn (2016: £3.7bn)
Operating losses reduced by 41% to £0.8m (2016: £1.3m)
Profit before tax was £0.4m (2016: £1.0m) including respective one-off items
Underlying (**) earnings increased to £383,000 (2016: £4,000)

wildshot

Thanks for the review of Headlam (LON:HEAD) Paul, much appreciated. I agree it is fairly resilient although not punching the lights out in performance. About a year ago I was deciding whether to invest in Headlam (LON:HEAD) or Victoria (LON:VCP), I went for HEAD due to it's balance sheet, dividend and net cash. With the high P/E, borrowing and no dividend I was put off the great growth story of VCP. As you highlight there is an opportunity cost with HEAD and when I see that VCP has rocketed since I first started following it at £3 I really understand that.

WDWombat

A quick glance at Headlam, a distributor of floor coverings, suggests a pretty good company - a feeling reinforced by the release that Ruffer has just bought 5%. Low margins, I suppose as one would expect with a middleman, but good RoCE and RoE and low valuations. I think I would just like to get to the bottom of the demand profile from the 'independent retailers and flooring contractors' before I made any commitment, though.
For the record, if you see a presentation by the boss of Yu I defy you not to be swept up in his enthusiasm. He is just fabulous. Just a shame one didn't spot it or rather meet him much earlier.

jonno

Jonathan Ruffer is an astute investor, so the purchase of 5% of Headlam (LON:HEAD) is a positive endorsement of the Company as a long term investment.

robin66

9th Mar '18

Hi Jonno, Ruffer did already have a holding of 4.58% of Headlam (LON:HEAD) according to their website so this latest purchase is a "top up" though still a positive endorsement.

Small Cap Value Report (Tue 6 Mar 2018) - LUCE, BEG, LOOP, HEAD

Luceco (LON:LUCE)

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Paul Scott

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