Small Cap Value Report (Wed 11 Oct 2017) - CCT, QUIZ, VTU, PHD, CRPR

11th Oct '17 by Paul Scott

57 comments 18282 reads

Good morning, it's Paul here.

It's not been a good start to the day. The council are cutting down a huge tree nearby, so I have the loud buzzing of chainsaws to contend with, making it difficult to concentrate. Plus there's been a profit warning from something in my portfolio - £CCT So let's start with that. I've put the tickers of companies of interest (which I intend reporting on here) today into the article header. I've got plenty of time available today, so there's probably also scope for 1 or 2 reader requests, within the sectors that I cover.

Profit warnings just come with the territory for small caps. Hence why I don't let them bother me too much. It's a straightforward decision - is the company in a downward spiral (which would make an immediate selling of the shares the most sensible decision)? Or, are the problems being reported limited, and fixable? (in which case I would hold, or buy more). Plenty of companies do recover from profit warnings, hence why I think the concept of automatically selling after a profit warning is far too simplistic. Each situation is unique, so there will never be a one-size-fits-all strategy that is guaranteed to work.

The fact that a lot of people do sell instantly on profit warnings (often due to stop losses on spread bet accounts) can create some nice buying opportunities, when fundamentally sound companies are sold off far too aggressively on a profit warning which might have no bearing on the long-term prospects of the company.

Character (LON:CCT)

Share price: 357p (down 19.8% today)
No. shares: 21.1m
Market cap: £75.3m

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

Trading update (profit warning) - I'm quite surprised that the market has reacted so negatively this morning to the latest update. The company had already told us here on 19 Sep 2017 that market conditions were challenging, and that a major customer (c.8% of total sales, estimated by one broker) Toys R Us, had filed for bankruptcy protection in USA & Canada.

Results for y/e 08/2017 - the company had already reported that results would be in line with expectations. This is reiterated today, as follows;

As reported in September, the business has had a solid finish to the 2017…

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Paul Scott

11th Oct '17

Hi Christoph,

Hi Paul. You've mentioned your own portfolio vs BMUS a couple of times over the last few weeks or so. It would be really interesting to get a better understanding of how your approach to your own portfolio differs to that when compiling BMUS. I get the feeling it may be technically more complex (using spread bets and other instruments), greater turnover (?) and have more large caps, but I'm only reading between the lines!

Yes, you're pretty much nailed it!

BMUS is just a simplified version of my personal portfolio. So I include all my real money main positions in BMUS, in roughly the same size proportion. So take Character (LON:CCT) for example - I've held a smallish long position in it for some time now, but now I've increased my position size today, it might go into BMUS. There isn't room for everything in BMUS, so I have to want to sell something, to buy something else. Whereas in my personal portfolio, I have no such restrictions because I can use gearing in spread bet accounts, thus giving more flexibility.

It's also just yet another thing to remember to do. I just haven't got the time to keep BMUS meticulously updated, so it tends to be something I do from time to time, when there's a spare few minutes. It's only an example portfolio anyway, and was initially just set up by Ed as a fun thing for all the Stockopedia team. Although I think he also had an ulterior motive, in wanting me to actually prove, with hard statistics, that my stock-picking approach does actually work well (in bull markets anyway!)

Regards, Paul.

IanMartin

Redrichmond

Where did you find the Contrarian Investment Strategies book? I can't see it on Stockopedia.

Thx
Ian

mojomogoz

Hello Paul/all

I reckon all the comment on Character (LON:CCT) and none on Vertu Motors (LON:VTU) tells us that Vertu is quite deeply out of favour. No-one can find a reason to like this company and sector...so its going to be hard work to prove a case out meaning valuation is low. Management need to prove out their model and competence. I am quite bearish generally so I am only interesting in things that are quite out fashion at the moment (that's a warning for how to contextualise what I say!).

Vertu's general results are cracking in the situation of 15% decline in new car sales which is significantly worse than the industry average. The exception to the positive is the operating cash flow being weak due to working capital impact.

On working capital there seems to be a bit of management rinky dink going on which will either prove to be a buffer against further deterioration in market environment or source of upside cash flow surprise for FY results. That said more work needed by me to make sure there isn't something odd. They've actually tightened inventories a bit but it is payables and receivables that has gone against them with a net working capital impact of -£30m. They are still cash flow positive by about £3-4m for the HY due to sale of some of property portfolio raising £14m. There's cash going out to capital investment too in HY (>£8m) which has been relatively high in recent years. This business has been generating good ongoing cash which has been deployed into acquisitions and investments, as well as supporting dividend growth.

On new vehicle sales they have underperformed the industry averages due to their mix which is low on high end motors (apart from Jags and Land Rover where they are slightly above averagely exposed) to the tune of something like -16% relative to industry average (-16% on the premium BMW, Merc, Audi sort of motors and if Toyota and VW are thrown in as part of premium then -24%). They are very exposed to the lower end stuff with Ford and Vauxhall being their most significant overexposure. That's quite a headwind as premium names have held up really well.

My guess (but not a reason I hold the stock) is that sales will at least normalise and perhaps recover going forward as the issue looks to be price sensitive buyers wigged out by the diesel fiasco (if you are on a budget then you can't throw money away on cars). Diesel sales down 20% whereas petrol is flat...electric/hybrid vehicles up 40% in Sept YoY! More price sensitive buyers are sitting it out to see what happens in the whole diesel-electric fandango...they will be cautious to switch habits. This is not (at the moment anyway) a story about the UK consumer being exhausted.

My guess is that management are being super conservative in their guidance for the full year and that upside should emerge for year end as long as UK hasn't gone over the edge. Earning growth at Vertu has been good but IMO suppressed by its acquisitive approach. Revenues have nearly tripled in the last 5 years but that has been partially achieved through issuing shares to acquire (share issuance has nearly doubled no of shares in same period). Earnings have risen approx 150% over same period.

Acquisitions tend to deflate earnings near term and take a few years to feed through into robust earnings for the acquired dealers. There is a bias to acquiring things that can be boosted/turned around. Some that may be seen in the average sales price per unit acquired being well below Vertu averages - typically acquired business run at 2/3rds to 1/2 revenue per unit compared to established franchises. There could be something dodgy in the data I have derived there or a timing factor but it could indicate both poorer sales performance that they can pick up (there's more for me to understand there perhaps through management Qs).

I think that management should hold back on acquisitions at this point and prove out their portfolios ability to produce positive cash flow even in a tough environment. If they do that they can re-rate plus show earnings growth and that puts them in a much stronger position to go back on the acquisition trail and create a new value add cycle through acquisitive growth.

I hold as I think that 'idiosyncratic' earnings growth will prove out (round number of 50% assuming no retail armageddon) and so a re-rating. This stick has held 14x PER in past and in US auto retailers have recently been at that mark. I see a double to triple in price in something quite dull with bearishness in the price and quite protected downside.

Best wishes

Paul

Redrichmond

On the guru screens.. im working my way through the screens ,reading the books (i have a small library now)..instead of buying another stock I buy a book. Im up 100k in a year in my SIPP.(38% up) Last year i must have bought 40 -50 stocks and lost about 40k on top of charges..

The dreman box k came from the US via amazon

I think in the benjamin graham book (hard reading) as was the tiny titans (what works on wall street) they did say stocks can be boring.. its like a itch.. i just dont scratch it..

Im also not checking my stocks 300 times in an hr.. :)

Once I get more confident I will buy in again, but it seems the trick is to hold for 2-5+ years

I was buying and selling every other day and holding for 4 months

Heres the link to the guru screen, the book was recommended on amazon via his other one which I have yet to read... his experience as an analyst really open your eyes

https://www.stockopedia.com/screens/guru/david-dreman-17/

medlar

I am also a holder of CCT. And take all Paul's points on board and agree with most of them. If there is a bear case then it's the structural shape of the toy market itself and CCT's over dependence on the UK market where inflation-adjusted consumer disposable spending is trending down 0.3% year in year.an NPD trade survey says that worldwide growth in toy sales is 3% with only the UK and Australia showing negative growth.
Apart from the loss of ToysRUs and the decline in UK consumer spending power, the other question marks over CCT might be demographics, and the possibility that CCT may not have the right products. (Bearish comments in the past have focused on the fact that Star Wars, a revived Disney franchise, may be eating into CCT's market share.)
It's also disappointing that CCT reports caution on sales in overseas markets when these are growing in terms of total sale volumes - source NPD. Or cd it be that Disney is taking the lions share of this growth with overseas distributors being cautious about the impact of Star Wars - the next Star Wars film is released December 15 and Disney is anticipated to release two a year for the next three years.

ed_miller

"His crucial insight is that if you search for only low PER stocks, you will actually be screening out almost all the future biggest winners. That was a huge eye-opener to me, so I'm now much more prepared to pay a high price for a stock that meets my most rigorous criteria."

- William O'Neil makes the same point in How to Make Money in Stocks. (I can hear Ben Graham sucking through his teeth from beyond the grave!)

Regards,
Ed

Thank you. I'd like to get away from being glued to the trading platform so an investment in education seems like a good idea.

LeoInvestorUK

lavinit, I agree with you about Vertu Motors (LON:VTU) and bought some more first thing on what I thought were outstanding results in the circumstances. Just a few things to add:

The working capital situation is well explained later in their results. As Paul Scott said, they are lent new cars by the manufacturers. Even better still (from a cash situation) they can reclaim VAT on the new cars before they've either paid for them or owe VAT collected from selling them. This must create an enormous temptation to keep committing to new cars even in a slow market, especially if you're short of cash. It is a very good sign both that Vertu have not done this, and that this is a potential cause of reduced margins and delayed financial distress by their competitors.

The second main cause of cash outflow was a relative increase in second hand stocks in advance of the plate change in the expectation of lower trade ins. Again, if you were short of cash it would have been tempting not to do this (even if you had the management foresight) and so again this is a source of competitive advantage.

I agree that they need to take care not to stretch themselves with acquisitions, but there is no sign of them doing this so far, and for the reasons highlighted above (as well as the unpopularity of the sector) there could be some real bargains if they hold out.

Yes, the dealership mix is unfortunate at the moment, but hopefully more defensive in the medium term.

I actually think it is quite likely that the UK new car market has peaked forever, with near term exchange rate / diesel headwinds being replaced with rising interest rates and then changing ownership models. But I think the decline will be slow and Vertu can still make a excellent return by a) being a consolidator in a shrinking market, like Trinity Mirror (LON:TNI) b) by selling off redundant freeholds above book price for housing (or at least, at prices inflated by the future possibility of such).

Finally as icing on the cake, they also have a small but significant pension surplus. This should act as a hedge against interest rate rises affecting new car sales.

daveinthelakes

Character (LON:CCT)

As suggested in earlier post- "Expect more, if not today, then over the next week or two."

Another 70,000 shares bought in adding to the 50,000 earlier.

"In continuing its stated objective to enhance shareholder value, Character Group (AIM: CCT.L) announces that it has today bought-back for cancellation 70,000 ordinary shares of 5p each in the capital of the Company ("Ordinary Shares") in the market at a price of 385 pence per Ordinary Share. The Ordinary Shares acquired for cancellation represent approximately 0.33 per cent. of the current issued share capital of the Company (excluding shares held in treasury)."

The 120,000 total equates to around 0.6% excluding treasury.

rivaldo

Paul, I have a small holding in Proactis and wondered if you could expand a little on your comment that "I note that a highly-regarded tech analyst has raised question marks over the wisdom of the Perfect acquisition". Please could you reply as to who this is and what the question marks were - or at least give the analyst's name so that I can contact him/her myself? I haven't heard such comments myself so would like to know more.

Cheers.

Brookeda

I sold CCT at 5.25 a few months back as I was cutting back in expectation of a summer pull back in the markets generally and was waiting for the long awaited correction. Whilst it's been a good earner for me its never going to be a 10x return stock and they are dependent on winning the licenses to be able to sell the products. A loss of say the Peppa Pig license would be significantly detrimental to its results.
Must admit to being tempted at sub 4 pound to go back in again.

Dan7710

They just renewed Peppa pig (for 3 more yrs I think) a few days ago FWiW. They've had the licence for donkeys years and are becoming the go to guys for new UK licences

Hi AstonGirl,

Scapa (LON:SCPA) is too big now for me to cover here.
But I did see its trading update today, and it looks very good - ahead of expectations. The share price probably already reflects that though, as it's not cheap.

Regards, Paul.

Hi rivaldo,

If I anonymise something, it's because I've been sent a broker note through a third party, and don't want to compromise my source.

Regards, Paul.

Ramridge

Re. Proactis Holdings (LON:PHD) Having analysed this share and in particular having reviewed the finnCap report, I am not as cautious as Paul is about it.
Yes, the negative NTAV is a red flag, but there is a lot to like about it.
Based on the finnCap report and focusing on the projected FY2018 data,
- sales are expected to grow by 142% to £61.5m
- adjusted and diluted eps expected to grow by 32% to 11.4 This takes into account the huge rise in number of shares resulting from the recent acquisitions
- operating cash flow goes up from 5.6m to 14.8m and FCF from 1.8m to 5.2m
- the debt position is well within acceptable limits. Net Debt/ EBITDA ratio is only 1.0 post recent acquisitions

On today's sp of 163.5p , the projected PE comes to 14.3, and PEG = 0.44. Their main competitors have much higher PEs. (SAP 27, Oracle 19)

So if management focus on bedding down the acquisitions and realise the identified synergies, the company's SP should be north of 20x earnings multiple.

decl.: no position long or short.

purpleski

Hi Ian

I think it is this one:

https://www.stockopedia.com/screens/david-dreman-low-pe-screen-57/

On my Kindle but not yet read!

KR
Michael

dustyie

12th Oct '17

With reference to Character Group price fall today , currency volatility must be adding to there problems also .

jonthetourist

While normally I have learned Paul is right to screen out weak balance sheets, the counterbalance with Proactis is recurring revenues. I haven't yet had a sniff of clients choosing to move elsewhere, which is my biggest worry.

Jon

Paul Welsh

Bid/offer spread quite annoying with CCT but I guess this is part and parcel of small cap shares. Being quoted 410p offer yet digitallook showing spread of 385.00p / 405.00p.

Life's too short so stuck in an order to buy at 405p and will leave it in the lap of the gods.

LongValue

The last time I looked at Character Group's accounts, it struck me how dependent its profits were on currency stability. Its royalty deals were largely in US dollars but its income was mainly in Sterling. I was wondering if anyone has done any analysis to figure out how currency volatility impacts its bottom line? Incidentally, am I right in thinking that most of the company's debtors are covered by credit insurance?

Small Cap Value Report (Wed 11 Oct 2017) - CCT, QUIZ, VTU, PHD, CRPR

Character (LON:CCT)

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Paul Scott

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