Small Cap Value Report (Wed 1 May 2019) - RHL, CTH, CGS, PSN, NXT, BLTG, CNCT

Connect (LON:CNCT)

Ok let’s take an example Gromley - say they owe their biggest supplier 30 mill and that supplier goes pop - they then have the issue of finding a new supplier who will give similar credit. That could be a real issue. Look at the recent liquidation of Palmer and Harvey for an example of the knock on consequences that can happen from a situation one probably wouldn’t have really have even thought could be an issue beforehand where there wasn’t anyone else stupid enough to offer over generous credit terms simply to get a bit of business on wafer thin margins. 

Note I am not saying practically speaking I expect anything to go wrong it’s just that the balance sheet here really is ultra pants from my viewpoint and this seems to tally with the Altman numbers not that I am any disciple of that method which I do find to be  a bit pessimistic at times.

Excellent counter rmillaree, always good to get the contrary view.

Generically I agree with a lot of what you say, however, I would differ on how the specifics apply here,

On one point though, whilst I think caution is very important, I think one needs to contextualise.

so if only 20% of who they owe the £290 mill to wanted their dosh back immediately i can't see any way the company could cover this type of "cash call" from available resources.

Most individuals would be in trouble if their mortgage provider demanded immediate repayment of the full sum, but mostly I don't think lose any sleep over the prospect.

The bank loan elements of the liabilities  (c. £100m of the total ) is tied up until 2021 already - certainly there would be default circumstances where the banks can demand early repayment, but I don't believe that represents a likely circumstance - obviously more cautious investors could wade through the detail.

The other big ticket item in the liabilities is trade payables £179m as per these interims. Sounds like a very large number in the context of the companies market cap, but in fact is about 1.5 months turnover (you've caused me to spot a slight irregularity here, in that the company states the average payment terms at 31 days but as that was from the finals, there may just be a timing issue here.)

Certainly if the business were to stop dead , then this would become immediately repayable and cause a major problem. Firstly though, there are not any clouds to suggest such a likelihood and in any case if the business stops dead then the share price goes to zero (and not below)

To be honest this is a non-issue from a liquidity point of view, there is no realistic prospect that that the terms of trading that see Connect paid by customers before they pay suppliers so the only circumstance where this becomes an issue is if the business folds for other reasons (and in that case "debt" is actually good for shareholders.)

My problem with getting too "worst case scenario"  with balance sheets is that in the worst case, most of the numbers on the balance sheet prove not to be true and significant liabilities not previously on the balance sheet suddenly appear.

Being honest i can't see any reason why anyone would lend this company money or give credit based on this balance sheet.

I quite agree, but I can see why someone would lend to them on the basis of their dependable cash-flows.

I'm sure we wont reach agreement with regards connect, but that's all good, the share price would not be where it is if everyone had my sunny disposition ;-)

Connect (LON:CNCT)
Hello Gromley
In fact the calculation seems to be (Current Assets less Current Liabilities) / Total assets.
Connect has a negative figure here as it receives revenue before paying out costs, although the extent can vary dependent on the timing of the year end. – Significant revenues come in weekly, whilst costs are paid monthly as I understand it. It’s the nature of connects business that this figure is negative (unless they were to choose to hold idle cash in the bank). Certainly it makes them inherently slightly more risky, but I don’t see it as an indication of distress in this case.

I totally agree with the Altman scores that this is a "heed the ball" basket case with regard to balance sheet strength - it looks pretty similar to Flybe/HMV/Game/the old SCS - in that at its most simplistic if you owe more out than you have as easily available assets to cover those liabilities you could be in trouble big time anytime - the most obvious endgame would be their main suppliers removing their line of credit.

Lets look at the balance sheet

Plant  20 mill - necessary for business operations.

current assets 186 mill - of this 16 mill is inventories and 127 mill of trade receivables - i would exclude these 2 from calcs as they have to offer credit and have stock to continue trading as a going concern

This leaves 25 mill cash and 16 mill assets for resale - lets say £41 mill of cash -poss £5 mill more if the interest in joint venture has value

We have current liabilities of £238 mill - some debt and some trade payables and another 49 mill of loans over 12 months. so they owe out £287 mill in total with only .

so if only 20% of who they owe the £290 mill to wanted their dosh back immediately i can't see any way the company could cover this type of "cash call" from available resources. 

This isnt a problem if the market cap means they can easily have a rights issue - but £95 mill market cap isnt enough - literally one credit scare and i could easily see the share price at under 10p immediately. 

The only reason to invest would be if near term profits and cashflow are enough to dig them out the hole - at £287 mil owed out current profits look nowhere near enough to give any expectation that they can make a dent on that. Ok they may not need to but they may have to. Being honest i can't see any reason why anyone would lend this company money or give credit based on this balance sheet.

To me on a score of 1/100 i would give this 1 out of 100 for balance sheet strength - probably nil if i hadn't decider the starting point was 1.

The Connect (LON:CNCT) results are mostly as expected I think (actually a slight variant results at Smiths are slightly better and Tufnells slightly worse.) With the share price unchanged on the day, it seems the market agrees with me.

I can certainly understand anyone not being particularly interested to look further – in the good times it only enjoys an operating margin of around 2.5%. However, I still think there is an interesting prospective turnaround situation here and I’m just waiting for ‘a sign’.

A quick scan though at the StockReport today threw up one surprise , the massively poor Altman Z-score.

I have to say that I’m generally sceptical of this measure so I thought I would have a dig and see why the score is so bad.

Are liquid assets a significant proportion of the assets? Stocko describes the test as being the ratio working capital / total assets. In fact the calculation seems to be (Current Assets less Current Liabilities) / Total assets.
Connect has a negative figure here as it receives revenue before paying out costs, although the extent can vary dependent on the timing of the year end. – Significant revenues come in weekly, whilst costs are paid monthly as I understand it. It’s the nature of connects business that this figure is negative (unless they were to choose to hold idle cash in the bank). Certainly it makes them inherently slightly more risky, but I don’t see it as an indication of distress in this case.

Do reinvested earnings make up a significant portion of the assets? Retained Earnings / Total Assets – Connect scores -0.56 vs a threshold of -0.1355. I can understand the argument that perhaps they have over paid in dividends in the past, but I am not totally sure I can see the risk that this presents for a mature business like connect. (Happy though for views on that)

Are assets relatively productive in terms of earnings? Well they made a statutory loss last year, so this comes out as a fact negative. At the ‘underlying’ earnings level however this would be healthily positive if you accept the “one offs” as just that (in this case I do) you can consider this metric safe.

Does fair value compare favourably to its liabilities This compares Market Cap with liabilities and in the case of Connect again this is a big fat fail – the market cap is only 37% of the gross liabilities. A first observation this seems like a bizzare test – “the share price is low therefore it’s a bad risk” rather putting the cart before the horse. However, there is in fact some logic to this I think, If they needed to raise cash from sharholders to meet liabilities it would be a massive struggle. However, Connect is such a cash generating machine (even during it current difficulties) that this point seems entirely moot. Besides they have only drawn c. 50% of their committed borrowing facilities which are in place until 2021.

So really it seems to me that the incredibly poor Altman score is a big “over-reaction” in this case. But I almost hope that the market is put off by the apparently “parlous” state of their finances – on such misunderstandings are value opportunities born.

So today’s HY results (which I acknowledge I have hardly mentioned here!) reinforce for me the view that Connect would be a pretty ‘safe’ investment at these prices, but until successful resolution of the issues with restructuring and Tufnells are more clearly embedded there really is no reason to be invested here yet.

Great stuff Paul and good to hear you are on the mend.Just back from abroad to be deluged with admin and of course more frustration on Brexit.so not much to add other than some seem to be moving on sizeable stakes in Plus.....any views even though I recall you not being high on Israeli cos?

Just to say that Hargreaves Lansdown still haven't paid the 2 Somero (L0N:SOM) dividends due on 26th April in to client accounts. Apparently they have received a cheque in dollars from Somero. I phoned for an update and they are apparently working on it. I've only recently switched some of my ISA to Hargreaves as had read that they were very good and with excellent customer service. Hope that is the case and this is a one off. Other brokers did pay the Somero dividends on time.

Really liking the new format Paul. It's very useful getting an early-doors idea of what might be potentially worthy of comment. This also means that at the very least a short report is likely to appear every day!

Also don't beat yourself up about being ill - it happens to the best of us.

Damian

We've been having building work done in Edinburgh (large attic conversion) & I've spent a lot of time on site as I'm doing some of the work. We had an excellent team of joiners, who worked as sub-contractors, & I talked to them a fair bit about building quality & standards.
They were very complimentary about the design & standards for Housing Associations - and said the contracts were well managed & supervised.
For the big builders building on own account, they were very critical of pretty much all aspects. Time pressure on sub-contractors and poor supervision leads to all sorts of corners being cut - especially in less visible areas, notably insulation. Persimmon were singled out as being the worst of the lot.
Maybe we were lucky but, of all the people we had on site, the joiners came across as the most informed with regard to the overall building process, so I valued their opinions.

Not sure I'd count on Persimmon's reputation:
https://www.bbc.com/news/business-48113301
...not that all volume housebuilders aren't all the same

I am interested to see the environmental stocks have started to move since the Extinction Rebellion action last week. ITM up from 20 to 28. Might just be a fancy but you never know investors might have woken up. I do hold a few for the sake of transparency.

Hi Paul, regarding your comment about the logistics sector, do you put Clipper Logistics (LON:CLG) in this catagory as well? seems to be in the right space taking up the demand for online shopping. My main concern is around the general operating margin in that sector has always been pretty poor..

Thanks
Sean

Persimmon (LON:PSN)

I have sold out of Persimmon , i was a little worried their results may have peaked and that the right to buy freeby easy money may not continue flowing into the future at prior peak levels. Looks like everything is down a wee tad but certainly there doesn't seem to be any sign of the doom and gloom i was fearing. Looks like board are trying to restore reputation too - that may take some time. Still looks cheap as chips on pe of under 8 with reasonably "flat earnings" if we project similar into the future. I think i will remain firmly on the sideline though - when things do go its up in this sector we are unlikely to get any warning - then again perhaps Gordon Brown (no more boom and bust) was correct but just a tad early ! - thankfully my lips aren't for reading with the online nature of this forum.
All we need today is a Taxi for Carter - hopefully the same one that arrived and took Selby away so efficiently

Hope you're feeling better soon, Paul. I wish you well today because it's that time of the month when scanning the RNS'es quickly first thing on Investegate means you're wading through "Total Voting Rights" announcements.  What a pain!

BTW I see "our friend" John has officially stepped down from the Tracsis (LON:TRCS) board today. They've also announced another small acquisition.

Also a decent trading update from Nichols (LON:NICL) which is one of mine.

All the best, Si

My morning smallcap tweet: Bould sinks from the ashes of Photonstar.

Bould Opportunities (LON:BOU), Castings (LON:CGS), Augean (LON:AUG)

Bould Opportunities (BOU) [was Photonstar LED Group] open offer at 0.0125p, a 79% discount, to deliver on the new strategy as a cash shell. "This is a material discount to the Company's current share price, but equally represents a material premium to the Company's cash per share." SP a year ago 0.55p, 5 years ago 7p. Epic value destruction. What's not to like?
Castings (CGS) guides FY results ahead of market expectations due to strong demand which included some customer stock building, Credit to co for highlighting that - it may unwind if due to Brexit.
Augean (AUG) guides FY profit materially ahead of market expectations due to higher landfill volumes, increased radioactive waste profit and strong performance of both the treatment and North Sea businesses.