Small Cap Value Report (Wed 16 Oct 2019) - LGRS, TSTL, AUG

16th Oct '19 by Paul Scott

48 comments 7786 reads

Good morning, it's Paul here.

Estimated time of completion today: 3pm.

Update at 14:49 - today's report is now finished.

Bregg-zit

It looks as if compromise is in the air.

FWIW, my view is that a last-minute compromise deal, or fudge of some kind, is probably the most likely outcome. That's normal for the EU whenever there's an apparently intractable problem.

As we saw on Friday last week, the merest sniff of a deal, triggered some spectacular large & mid cap rallies. Therefore, if some kind of vaguely acceptable deal is done, as now seems likely, then I imagine we could see a big recovery in bombed-out shares. That's why I've remained fully invested during this tough period - because there could be some significant re-ratings, if the market starts to see the glass half full again. Maybe.

For this reason, I'm drawing up a list of bombed out, but fundamentally sound, companies, with my finger poised over the buy button.

EDIT: please also see the comments section below, where we discuss small caps market despondency, and Woodford, amongst other topics.

Loungers (LON:LGRS)

Share price: 199p (price unchanged today, at 11:28)
No. shares: 92.5m
Market cap: £184.1m

Trading update

Loungers, the operator of 157 café / bar / restaurants across England and Wales which trade under the Lounge and Cosy Club brands, announces a trading update for the 24 weeks ended 6 October 2019.

This company listed at end Apr 2019.

My sector expert tells me that it's a very good operator. That may be the case, but I find the valuation too high. All too often, companies list on the stock market when the figures are looking great, only to plunge in value once the shine comes off trading.

The other problem is that when brokers float companies like this, they tend to place the stock in lumps with institutions. Resulting in almost no liquidity in the market, post float. A basic error that keeps happening. Why? Because advisers just want to bank the lucrative fees, for as little work as possible. Whereas they should try to distribute plenty of shares to smaller & medium investors (as well as institutional blocks), in order to ensure proper post-float liquidity. This issue really gets up my goat.

LFL sales - in H1 are still excellent at…

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Paul Scott

16th Oct '19

In my experience over the last 20 years in small caps, it's when everyone goes quiet & despondent, that you get the biggest pricing anomalies. Gutsy purchases now, could well turn out to be highly profitable decisions in future.

Therefore, I think this is a time to be excited about the considerable value that can (selectively) be found in small caps.

When I left work, to become a professional small caps investor, in Sept 2002, everyone thought I was mad. Markets were absolutely bombed out, and plenty of micro caps were trading below the value of their own net cash. After a wobbly start, for the first 6 months, I then went on to make about a million quid the following year (6 times my starting pot) on rapidly recovering small/micro cap stocks. Which goes to show that buying at the bottom, when everyone is terrified, or has given up altogether, is a great way to make money.

If a Brexit deal is done, this removes massive uncertainty. We could therefore see a strong recovery in business investment, takeover bids, consumer confidence, etc. Hence why I think investors need to be primed to act fast, and buy up over-sold, overlooked small caps, if a deal is done.

There's a lot to be said for being bold when others are despondent. Also, I think shares react more slowly to good news in times like this. That's another opportunity - as it gives us more time to dive into shares which are likely to go up.

What I do find very strange about the current market, is that many shares (especially mid caps, and high-performing small caps) seem very expensive. Yet other shares (especially ones which have had profit warnings) seem priced for Armageddon. It feels very disjointed.

Regards, Paul.

mojomogoz

PS GregM -> I don't think Mercia Asset Management (LON:MERC) is a fast mover. Will take time to unfold. Value play that may find good growth

Hi Gostevie,

I'm not sure there's anything much I can add on the Woodford debacle, that hasn't already been written & talked about elsewhere.

The fundamental problem seems to have been combining illiquid investments (lots of them in absolutely terrible, speculative rubbish), with open-ended fund structure. Thus a crisis ensued when people wanted to get their money out, forcing Woodford to sell holdings. The risk then is that the stuff that's sold is the liquid stuff, so people who stick with the fund, end up holding the illiquid rubbish.

We've seen that happen before. In 2008, a lot of open-ended funds used a technique of creating a "side pocket" of the illiquid holdings, which locked investors in, enabling more time to orderly liquidate the illiquid holdings.

Probably the other lesson from Woodford, is that when a previously good fund manager branches out into a new investment area where they have no expertise or track record, then the results are likely to be poor.

Anyway, it's easy to criticise. Everyone goes through bad patches. We can all make any mistakes we like with our own money, that's our business, but it's much more serious when it's other peoples' money for savings & retirement that is at risk. I do think Woodford was reckless, given that ordinary people trusted him with a huge amount of money. A bit more contrition from him would have been nice too.

After a disaster of this scale, I don't see any way back for him in the investment business. Who knows though, people have short memories.

Mind you, my portfolio has had a terrible time in the last 18 months, so maybe I shouldn't be in a glasshouse throwing stones?!

rmillaree

AA (LON:AA.)
mojomogoz
Mad?

Not in the slightest if you have done your research and are happy with risk. downside is only 100% and upside in scenarios like this is probably multibagger stuff.

I do like contrarian play myself where a company is morphing from one stuck with historical debt and has sufficient cashflow that they have a backup plan that whatever happens the debt problem should go away naturally - ideally at say 10% a year minimum.

I guess the main danger here is the idiocy of large cap directors paying out divis like there is no tomorrow to keep "whoever happy" to then suddenly realise all to late that a rights issue is needed at which point the shares are already down 40%/60%/80%/99.99% - in some respects its not their problem if shareholders are shafted if their multi million pound salary is already banked and spent.

I really can't comprehend how Thomas cook / HMV/Game and the like directors didn't see the need to raise capital if needed at the right time. - i am guessing that is the main danger with AA. if they were to take some sort of regulatory hit.

I have shares in £Mars where the debt is a little too high albeit well covered and long term - their plan to pay down debt is sell pubs rather than moderate the dividend. Ok they can justify it by saying its older not so profitable estate outlets they are disposing of but. Even moderating dividend slightly to show debt is trending in right direction naturally is a bit of a no brainer meethinks.

Hi andrea34l,

Are you going to share any of your list of "bombed out, but fundamentally sound, companies", Paul? Or do you fear that some people would take this as 'advice' and just buy the whole lot?

I've been wondering how long it would take for that question to be asked! :-)

It would not be a good idea to publish a list, because I think that would then be moving into the realms of share tipping - which is not what Graham & I do here. We're just analysing each day's results & trading updates, and giving our personal opinion on each one, to hopefully give readers some useful info & views to blend into your own investing process. The onus is then on subscribers to do your own research, and make your own investing decisions. Hopefully we help that process by explaining our own process (e.g. of assessing balance sheets, cashflow, etc), and also by flagging up risks or potential risks. After all, sometimes small caps feels like walking through a minefield - there's so much rubbish out there, but also a few hundred decent companies.

Best wishes, Paul.

moolahcoast

Just had a go at the screener... I think this is right:

Price below cash, market cap under £200m (excluding financials, mining, oil & gas). Nothing jumping out at me...

Ticker	Name	Mkt Cap m GBP
KIE	Kier	190.0
BSD	Bsd Crown	32.3
IQG	Iqgeo	22.5
MOSB	Moss Bros	17.9
AVGR	Avangardco Investments Public	12.5
CTI	Cathay International Holdings	12.3
THAL	Thalassa Holdings	11.4
EVE	Eve Sleep	5.2
PVCS	Pv Crystalox Solar	4.4
MSYS	Microsaic Systems	3.9
SIM	Simigon	3.8
BILL	Billing Services	3.2
FRM	Formation	2.6
MBO	Mobilityone	2.6
MTMY	Matomy Media	2.5
FSD	Field Systems Designs Holdings	2.4
ICON	Iconic Labs	1.4
MNO	Maestrano	0.9
SLNG	H C Slingsby	0.7
MOS	Mobile Streams	0.3

Lincoln Green

I think Mr Woodford was perhaps unfortunately believing all the hype himself, and is a lesson to all of us getting over confident. When you think you are it, you are finished. How often, when a sports team beat a good team, do they react like they have won the World Cup, only to get beaten up in the next game? And Mr Market can certainly beat you up. Now Mr Woodford is not as bad as people are saying. Keep your concentration.

dscollard

I was wondering if the decrease in discussion was a function of the new site design. The older format did seem more convivial and forum-like whereas the new look is much more functional and imo less engaging in the social media sense.

The mid cap rally has been pretty dramatic with some of the price action since last Friday being more akin to the small /micro caps that the relative behemoths in the 250. Of the 250 constituents, 119 have rallied more than 5% and 34 more than 10% since Friday : sector overviews below - home builders/household care , retailers and REITS/REIS have all outperformed. These sector rotations may well give clues to the nascent rally underway in the AIM and Small Caps

FWIW on market sentiment, markets YTD haven't been too moribund with the FTSE 100 up 7.3%, FTSE 250 +16% ( 6.5% in the past week) while the AIM All Share is only up 1.5% on the year - the 2019 AIM low was higher than the Dec 2018 low so arguably there should be less misery about on a comparative basis. A lot of the big story stocks have taken a pounding so that may well have reduced the volume of cheer leading from over crowed growth-at-any-price positions. AIM All-Share does look to have bottomed and is rallying off a good technical reversal although the prevailing longer term trend remains very much downwards. Given the speed of reversal in the 250, we may well see similar rapid re-ratings if herding continues. If nothing else it makes for great trading

Worth noting that for all the FTSE 250 outperformance in 2019, it still hasn't recovered its losses from 2018 so year-on-year it is down around 10% from the 2018 high ( which was an all-time-high)

The GBP rally will likely unwind some of the FTSE 100 safety plays . The likes of £ULVR has already retreated significantly from its ATH of a few weeks ago and has given back around 16%. Given the global macro is far from rosy then cyclicals are likely to struggle so the FTSE 100 may face headwinds given the weighting of oilers and miners. That said, if the Brexit bear is at bay then who knows..

Rusty2

Augean (LON:AUG) "Reading through the RNS, there seems to be a possible fine from HMRC of £4.6m, which the company is disputing."

I believe this is only a small part of the on going tax dispute with HMRC. If Augean (LON:AUG) loses this dispute it will be far more than £4.6m, that is just the fine for non payment.

Roy Edwards

Probably an issue, the overhang was looking at around 19% of the share issue. We have added to our stakes here and frankly are pleased he is getting out. He seems to be having to off load at 'the best' price he can get. Has an impact.

ambrosia

Boris still needs to get any deal through House of Commons and I cant see him doing that, in fact i'm not positive of his chances of getting a deal with EU to put before MPs thats not a copy of T Mays deal

although this is a good article about state of German economy

https://www.spectator.co.uk/20...

5mulf

Excellent financial analysis. Well done Paul. When will you be producing report on companies share prices knocked down by Brexit? Best Simon

Roger Baron

Not just the HMRC fine that is at stake but the extra tax they will need to be paying if the decision goes against them. Either way, been a great long term investment for me and I will take some more off the table if there is a further rise tomorrow.

AA (LON:AA.) -> rmillaree -> definitely a bit on edge.

I'll probably just keep talking about AA untll I convince myself I'm being dumb :)

I've done loads of work...but that can be the trap.

Note the AA were prevented by big shareholder from passing an item at AGM that would have made share issuance easier....they seem to want them not to dilute so far.

There's a complex payout profile for dividends with AA. Only £10m pa since big cut but you are right not the most useful thing. Hangover from dividend investor client base (Woodward). Covenants prevent cash dropping down for dividends payment in number of circumstances. They've got cash to cover it for few years in that pocket....but no more cash has dropped in last couple of years.

It complicated...on top of large debt throw in historic earnings manipulation (old private equity sourced management particularly old CFO). New CEO is tidying that up and letting it all come out plus is investing for the future (and to correct past bad investments)....pain in terms of earnings profile short term....but does it bring clarity, some growth and redemption...he prays :)

WDWombat

Quite correct and there is also a disputed penalty on Augean North of £2.9mn so seems to be £7.5mn penalty in toto. Net cash on the last results date at end June (which can be subject to manipulation) had seen a huge uplift to £23mn compared to a year earlier. It almost looks too good to be true but it does certainly look good on the face of it.

elviron

That prompted me to take a look at exactly what Paul wrote this morning, as i like others on here, read it that Paul was going to share said list on here, which I thought would be great of course, albeit very generous (competition-wise...generally these tips are only shared retrospectively, when the tip-giver has aready taken their full position!).

"For this reason, I'm drawing up a list of bombed out, but fundamentally
sound, companies, with my finger poised over the buy button."

Read again, I can see Paul was just musing about his own personal strategy - bit of a tease though!

Hi intuitive9161,

I've got to disagree with what you said;

The core number of private investors who make their own decisions through thick and thin is probably a very small number.

In my experience it's quite a large number. Especially somewhere like Stockopedia, which tends to attract more sensible, longer term investors, saving for retirement, over the long term, etc.

As previously stated the number swells during a bull market and shrinks quite noticeably during a bear phase. The first signs are declining bulletin board activity and cancelled subscriptions etc.

Ah, you're talking about speculators there, not investors!

intuitive6191

17th Oct '19

Hi Paul

I suppose it depends on the definition of large and small.

My observations are made over the years looking at the success (or otherwise) of the various services that support private investors. This includes online execution only brokers, tip sheets and investor websites etc. If there are large numbers of private investors these services would flourish. I am not sure that this is the case.

The history of online brokers closing and consolidating suggests a somewhat difficult market. Various investor websites seem to struggle to ever make a profit and there are very few tip sheets which have survived the various market cycles.

You are quite correct that in a downturn speculators leave the market – but some core investors also depart either holding cash or investing in other assets. It also has to be said that some well-meaning investors and their carefully crafted strategies simply fail. The daily anguish of looking at a declining portfolio is too much for them and they call it a day.

My involvement in on-line broking is many years old but it did suggest to me that the private investor market is niche and cyclical. I wouldn’t be surprised if it is still the same today.

Regards

Hi Snoo

Take £1bn off debt and then look at Diageo (LON:DGE) as a benchmark for what can be in terms of overall valuation and how equity and debt relate to each other. Both are high margin at similar 30% level (AA currently a little depressed due to heavy investment cycle) and non-cyclical revenue (to some extent the AA may be counter cyclical a little in that if people own cars for longer getting full roadside cover is more needed - but conjecture and not hanging my hat on that in any way). AA (LON:AA.) will still be a bit lower quality in terms of debt to revenue terms plus its not as big so not quite as much premium (on the same growth level), but on the bright side....

1) The AA has chance of higher top line growth than Diaego given current investments in roadside and insurance. There's a chance that FCA general insurance pricing investigation is net favourable for growth as AA is not general insurance (nor RAC) - its a membership and service company. Whereas all the upstarts are GI with the cost of the product hidden in that the guy who turns up to fix your motor can be good or bad (no service guarantees)...IMO if you have Green Flag its quite likely that the guy who turns up in van to fix car is very often not likely to be one of best mechanics from that garage...why have them on the road and/or working anti-social hours?! So there's a chance that 'radical transparency' from FCA investigation leads to a clearer valuing of AA services relative to upstarts. Again, not a thing I'm hanging my hat on...but just trying to look through the issue creating angst right now

2) RAC is weak competitor and there's no international competition. This provides the AA with revenue defence and maybe growth irrespective of the general insurance providers like Green Flag

3) The debt level is madness...but the debt holders have absolutely nothing to gain from pushing the company into administration or squeezing the life out of equity. There are no assets to cover much beyond c.3p in the £1 (and it'll be zero all costs in)....why push the nuclear button when there's a business with a predictable revenue flow that pays out on interest. Obvs it gets complicated due to rules around what debt investors permit themselves to do but if we have 'rationality' then its probable that a straight in EV terms debt for equity swap would see the debt holder make a capital gain pretty immediately on their holding....and the AA moves to being something Diageo-ish overnight. This is not a prediction by me just a point.

Anyway, undoubtedly the quantum of debt is insane and the AA should be a future study in how PE companies are scum (and how institutional investors can be stupid as hell)....

....but underneath all that I think the AA is currently a very mispriced piece of equity.....with a longer term eps growth story that could make for great returns. The best thing for me is no equity dilution and slow climb out of the hole and say managing to pay £1bn debt over 7+ years. Slow deleverage that will lead to reflexive shift from crap to quality over the years. I genuinely believe in 10-20x return...

BUT it is super risky as that amount of debt brings negative surprise risk. I'm right at the edge of my tolerance here. I couldn't cope with another AA in the portfolio rights now....and I have Shanta Gold (LON:SHG) as a debt unwind and emergent high quality story and think that is a safer bet (despite the political risks than AA!) (PS its underreacted to all the good news so far and still great value IMO)

Ciao

PS just to clarify. Obvs the AA (LON:AA.) has a general insurance part to business (home and motor)...when I said its not insurance I mean the way its roadside business is put together is not insurance like Green Flag. On AA's direct GI arm (1/4 of revenue approx) they are relative new boys and disrupters likely to be less impacted/criticised by FCA

Small Cap Value Report (Wed 16 Oct 2019) - LGRS, TSTL, AUG

Bregg-zit

Loungers (LON:LGRS)

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Paul Scott

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