Small Cap Value Report (Wed 16 Jan 2019) - SOM, NXR, OPM, HEAD, CLIG

16th Jan '19 by Graham Neary

44 comments 12910 reads

Morning all,

A busy round of updates. This list is provisional:

Somero Enterprises Inc (LON:SOM) - trading update
Norcros (LON:NXR) - proposed acquisition and trading update
1pm (LON:OPM) - interim results
Headlam (LON:HEAD) - trading update
City of London Investment (LON:CLIG) - trading update

Somero Enterprises Inc (LON:SOM)

Share price: 337.5p (+15%)
No. of shares: 56 million
Market cap: £190 million ($244 million)

Trading Update

Well done to holders, as Somero delivers that pleasant phrase: "ahead of expectations".

Key points:

2018 revenues and EBITDA "moderately ahead of market expectations". (EBITDA was expected to be $29 million)
net cash "more significantly ahead of expectations" (it was expected to be $25 million)
no change to dividend policy

The company is excited about its new product, the SkyScreed 25, which you can watch in operation at this link. It will be officially launched later this month.

A booming US construction industry is responsible for Somero's outperformance, as Europe, China and Latin America were all down by varying amounts.

My hunch that it will be impossible to penetrate China is unchanged after the company says its efforts there "have yet to gain full traction".

Outlook

Confident of more profitable growth in 2019.

My view

Stocko shows a forecast for net income of $21.4 million for 2018, rising to $22.7 million in 2019.

"Moderately ahead" - is that a 3%-5% beat? Perhaps 2018 net income was $22 - $22.5 million? And 2019 income could be $23 - $24 million?

Let's assume that the enterprise value is in the region of $210 million, after deducting an estimate for Somero's big cash pile.

So I would put the cash-adjusted P/E ratio for 2019 at c. 9x. Stockopedia's 9.4x estimate for the rolling P/E ratio is possibly too high:

Whichever way you look at it, the company is cheap on conventional metrics and is a top performer when it comes to return on capital, operating margins, etc.

So it's difficult for me to argue against the view that the shares are still undervalued, and perhaps structurally undervalued due to…

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FREng

16th Jan '19

Another SuckerStock GetBusy (LON:GETB) updates

" Following on from the Group's strong trading in the first half of 2018, trading in the second half has continued at a similar pace. The Group expects to report that total revenue increased approximately 20% to £10.9m, on a constant currency basis. Adjusted EBITDA is expected to be in-line with expectations while cash as at 31 December 2018 was substantially better than expected at £2.5m, compared to £2.4m at 30 June 2018.

Growth in the Group's high quality recurring subscription revenue, at constant currency for the full year, was 22% with the growth rate in the UK accelerating to 17% following strong order intake and the transition to a pure subscription model. Annualised Monthly Recurring Revenue at 31 December 2018 was £10.3m, an increase of 19% at constant currency."

The broker forecasts a breakthrough into profit when 2018 figures are released on 5 March, but that normalised EPS will show a loss that year and the following year.

GetBusy (LON:GETB) passes the R&D Breakthroughs screen.

[no position]

Graham Neary

Hi jonno, 1pm is in there now. Cheers. G

Clementwether

Graham, there is a Cenkos note on £1PM today (on Researchtree). This also compares the balance sheet of £1PM to PCF (LON:PCF), but states that price/book for £1PM is 0.73 versus 1.6 for PCF (LON:PCF).

Different calculation? Any thoughts?

(holder of both companies)

Peter171

Good to see some independent copy on SOM. I have been in and out of this (at the top) and been watching its steady decline. Now have gone back in. The introduction of the new Skyscreener is a no brainer excuse for getting back in. As far as I am aware there isn't a similar piece of kit out there. Labour cost savings will have a big impact on building costs and I can see this being a world class beater and the price has just broken out of its 4mth down trend so to my way of thinking it is providing another chance to make a few bucks!
Paul I am watching SOS but not as excited as I am about SOM!

Presumably it's the inclusion of intangibles at 1pm (LON:OPM) responsible for that difference. G

Steves cups

Rm and Leo
Re Norcros (LON:NXR) it may also be a factor in their calculation that they have some unrepatriated funds in RSA and the FX risk may be more or less equivalent to buying this small operation. EDIT sorry did not see Zip man's post

Just a thought

Disclosure - I hold

Steve

barnetpeter

The government announced yesterday that the (no) fees to tenants bill will become law on 1 June 2019. From that date there will be all sorts of restrictions on what can be charged to tenants, deposit levels and so on. Very good news for tenants, less so for landlords and very bad for letting / estate agents. Income from letting is more important to most agents that sales income. Stocks like Countrywide and perhaps Purp and others will need to invent themselves. With the bookmaker gaming machine limit due soon, which I support, this change and the constant closing of larger stores by M and S amongst others I cannot think what the High Street will look like next year. Far fewer bookmakers and estate agents won’t be a loss I guess. Planning changes will allow change of use of shops to residential. All this has to have a big impact on other companies apart from retail. Landlord insurance is a definite growth area for instance. Small and medium sized building firms are so busy at the moment. Lots of others will do well I am sure

andrea34

Nice to have you back Graham, a very comprehensive update, as usual

langley59

Patisserie Holdings Patisserie Holdings (LON:CAKE) update states that the extent of the fraud was even more extensive than previously thought....thousands of false entries in the ledgers!

https://www.investegate.co.uk/patisserie-hldgs-plc/cake/company-update/201901161553543018N/?fe=1&utm_source=FE%20Investegate%20Alerts&utm_medium=Email&utm_content=Announcement%20Alert%20Mail&utm_campaign=Patisserie%20Hldgs%20PLC%20Alert

Reacher

It sounds as if they haven't uncovered half of what was going on: "among other manipulations, this involved thousands of false entries in the Company's ledgers." This seems to have impacted the assessment of current trading which Patisserie Holdings (LON:CAKE) gave back in October 2018.

Are the systems so corrupted that an assessment of trading from 1 October cannot be made? Are there any consequences for those complicit in the fraud? Also, what value did Grant Thornton's audit provide insofar as they were unable to detect this material misstatement, and the significantly deficient internal controls?

rmillaree

Patisserie Holdings (LON:CAKE)

The only useful information that they should be able to give us is what is happening about trading from the day after the bad bod was chucked out. Presumably the first thing they would put in place is a simple system to log stuff in a reasonably accurate manner from that point on the bad egg has gone.

all they say is the following

It will take some time before a reliable trading outlook can be completed

What a joke that the management / directors backed by their forensic specialists and big buck accountants cant have set something up so they could add up the figures for the period 11/10/2018-10/1/2019 - 3 months new clean slate stuff and release within 7 days. The lack of anything useful other than ii's worse than we feared makes me think this may be a terminal situation in the near future or a situation where only the very best outlets are pre packed and shipped out to someone in the know for a fiver or 5 veggie sausage rolls picked up from Greggs. Hopefully its not that bad as there is loads of jobs on the line here for the actual staff in the stores who do the real work serving customers every day and sorting out deliveries behind the scenes etc.

wavewarrior

A lot of favourable reaction to Somero (SOM) but no comment on the High Risk Earnings Manipulation according to Stockopedia

Hello wavewarrior

Somero Enterprises Inc (LON:SOM)

but no comment on the High Risk Earnings Manipulation according to Stockopedia

Your wish is my command albeit i sometimes comment plenty of gibberish and this is the first time i have dug into this useful stat.

First up i am kind of guessing the fact we have passed the year end but the final accounts aren't submitted means we should expect the current figures to be out of date pretty soon once "last" years finals are released and processed.

Ok stocky is fantastic all green and red boxes - that makes it simple.

Margin/asset quality/sales growth excessive/depn stable/sales expenses out of control (like that one kinda auto "don't invest" flag that one) /financing stable / accruals nice and low (all dodgy accounts come with high accruals did you know)

ok stocky has green safe mark for all of these tests - thats looking good.

Ok the big red fail is on "are receivables increasing in proportion to sales" - presumably this is an auto fail in a similar manner to my comments on accruals.

Ok we have a bonus in that stocky gives the overall package a number with some nice comments that are whoosh over my head.

The exact Beneish threshold varies depending on the relative error costs of missing out potential manipulators versus mis-classifying a non-manipulator (Type 1 vs. Type II). A -1.78 threshold implies a 13.8% chance of mis-classifying a non-manipulator, which Beneish suggests is a reasonable compromise level.

Ok the number for somero is -1.75 - oooooh thats so close a miss as not really a miss.

However it is a miss so i would say there is a 13.765432% chance that something could be dodgy - pick a number between 1 and 8 and hope that aint the number at the bottom of this page.

ok lets drill down to the dodgy numbers

2016 receivables 6.3 - 2016 turnover 79.4

2017 receivables 11.00 - 2017 turnover 85.6

WTH (eck) thats a 74% increase in receivables and an 8% increase in turnover - that sounds incredibly dodgy on a comparison of the numbers - so one can see why there is a red flag.

Time for a sanity check and back to real life what about the debtor days

thats about 42 days for 2017 and 26 days for 2016 - in the real world 26 days for debtors is eceptional and 42 days is probably fair to middling.

ok lets look for comment from the company

even with the year-end increase to accounts receivable driven by particularly strong sales in December 2017,

Ok thats a perfectly simple explanation that rubbishes my calculations of debtor days - fair play to the company for explaining it so simply.

Lets chuck in the provisions for good measure - ok less bad debt in 2017 but one would expect this to be fact based number so nowt to worry about.

As of December 31, 2017 and 2016, the allowance for doubtful accounts was approximately US$ 859,000 and US$ 743,000, respectively. Bad debt expense was US$ 141,000 and US$ 400,000 in 2017 and 2016, respectively.

in summary i have zero concerns and the red flag is on just a red flag and a pretty dubious one at that - that's what mechanical filters do though - its not like they could ever program a computer to beat the best Go player on the planet (the look on the poor Lee's face when he realised the computer had outsmarted him and the game was lost was classic)

Further thoughts re Patisserie Holdings (LON:CAKE). If there are thousands of false entries in the ledgers I would guess these must be false cash sales postings as surely no other items of income or expenditure would run to thousands, hence revenue and cash balances would have been overstated. Which begs the question why would someone falsely inflate the takings? And yes standard accounts preparation and audit procedures ought to pick this up through bank reconciliations.

Gromley

Interesting (if I might say a little quirky?) run through of the Somero Enterprises Inc (LON:SOM) earnings manipulation risk score rmillaree, thanks for that.

As you point out the only sub metric on which Somero Enterprises Inc (LON:SOM) fails is the "Are receivables increasing in proportion to sales?" and then only marginally.

This can be a useful indicator as it can show that a business (in order to make it's numbers look better) is recognising revenues that it may not actually be entitled to, perhaps because the particular contract milestones that would make the revenue contractually due have not been completed (and perhaps if things don't go to plan may never do so), or worse perhaps because there is an active deception going on in order that someone can meet their targets.

I have some indirect experience of the latter having happened.

Of course the answer can sometimes be much more benign and simply reflect, as is the case here, that it you make a lot of sales late in the year where the payment terms mean the cash will come in next year then this ratio will look elevated.

This isn't the first time I have seen "false flags" from the earnings manipulation risk score.

Fairly recently I was looking at a company that failed three of the eight tests of the M-score.

It failed the receivables test for precisely the same reasons above - selling lots of product near the year end.
It also failed the increasing depreciation test - The M-Score suggests this could indicate a change in depreciation policy designed to flatter profits. In this case the answer was more prosaic, they had installed a lot of new kit (now depreciating) in order to service growing demand.
Finally it failed the increasing SG&A test - essentially this was the OPEX associated with running all of the aforementioned new kit.

So to my mind the Beneish M-score (earnings manipulation) causes one to ask some useful questions, but if those can be answered satisfactorily I am personally totally comfortable.

On the other hand the stocko description of the measure says

Beneish's research implies a ~86% probability that the firm is manipulating earnings

Some while ago I had a dig into some of this research (until my eyeballs started to bleed - why are statisticians incapable of using clear language?)

Anyway I think (happy to be corrected) that the was that

86% of companies manipulating their earnings will be flagged by the Beneish tests.

And not that

86% of companies that are flagged by the Beneish test are manipulating their earnings.

An important difference and like rmillaree, I cannot see a real concern in this case.

Snoo

I can think there might be several reasons why this would be done - for instance employees might be assessed on this metric and it might be tied to bonuses.

Understood ...but thousands. That must imply the same thing happening across many branches

17th Jan '19

ref - posting of thousands of thousands of false transactions I am presuming it would be pretty simple for one individual with master admin rights to post that volume of transactions without any difficulty - it’s probably as simple as keeping the garden neat and tidy during summer for a fit retired individual who has 8-10 hours per day spare with not much else to do. Posting 25 transactions a day to keep any nasties out of sight and keep the fake summary numbers ticking over would probably take at most 10% of their daily effort that’s 5k a year - probably their easiest task of their day if no one is really closely checking what they are doing. Ideally one would like to think that this could never happen but so many business owners hand the keys to the safe to their trusted staff that - all they may then want to here at the end of the month is what they want to be told - ie yes boss you made a shedload of dosh - I am guessing this case could potentially be as simple as that despite this being 400 million pound business at that time. Motives of one random individual could be anything and may have started out as simply not wanting to disappoint a somewhat stubborn boss who may not want to hear bad news or be overly unaccepting of the person presenting bad news that is not their fault, it could be someone with a desperate need for cash short term or any of the other psychological traits that would lead them down that route.

smilingmickey

20th Jan '19

stockopedia's financial warning signs should be followed by some simple analysis to see if there is really a reason to have concerns. As Millaree,s analysis shows there should be nothing of concern wrt an easily explicable increase in receivables from one year to the next. A simple price increase at year end can bring forward sales and result in an increase in receivables.

Small Cap Value Report (Wed 16 Jan 2019) - SOM, NXR, OPM, HEAD, CLIG

Somero Enterprises Inc (LON:SOM)

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Graham Neary

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