Small Cap Value Report (Wed 19 Feb 2020) - KETL, RPS, GHH, EBQ, COG

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19th Feb by Paul Scott

35 comments 7255 reads

Good morning, it's Paul here with the SCVR for Wednesday.

Estimated completion time - as usual, it will be mostly done by the 1pm official finish time (when the emails go out), but I might carry on adding more material after that, if there's anything interesting on the newswire.
Edit at 14:59 - today's report is now finished.

By the way, as I'm using the new site now, I don't see any thumbs down votes at all, which makes me happy!

China & coronavirus

This is still the main pre-occupation for investors right now. The quandary is that, we know this is a temporary issue, but we have no idea how serious it might become. So far, China seems to have done a remarkable job in containing it as much as they can. But the measures taken are so extreme (shutting down transport & factories in many areas) that they cannot possibly continue. Therefore, as China begins to return to work, after the extended new year holiday, the big question is whether the virus begins to spread more aggressively, or not, once people are mixing in close contact again, on public transport & in the workplace?

We only have to look at the devastation caused on the cruise ship, by confining people in close proximity. It may have quarantined the ship from the rest of the world, but it caused the rapid spread of the virus on the ship. Thus proving how contagious this thing is. I'm no expert on germs, or science, but as a layman, I can see that there still seems to be a very considerable risk to health and wealth, from this problem.

As regards shares, which is the topic here, it sometimes feels inept to be focusing on that when people are dying, but we have to. The issue for shareholders, especially in volatile small caps, is that we have to balance the fact that China supply chains are starting to be significantly disrupted. The press is full of reports that factories are running low on parts from China (Jaguar Land-Rover saying they only have enough for 2 weeks, and are rationing things like key-fobs (1 per car, not 2), and flying small items into the UK in suitcases). Complex, just-in-time supply chains are obviously the most at risk.

It's clear that we have become far too dependent on…

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Lawman

19th Feb

China import problems: How do we identify ‘China related companies’? If the test is reliance on imported products from China, this could affect most manufacturing companies and many pharmaceuticals.

Brookeda

The supply chains are getting a lot of focus on the corona front and whilst its giving a lot of companies food for thought from a business continuity perspective I assume they will get back up to speed when it either becomes another strain during flu season or goes away. Of a bigger concern to me at present is the impact of tourism, I noticed on the BEEB they were saying footfall at the Bicester outlet center used by a lot of tourists on their way from Stratford and the coltswalds was down 40%.

I walked into the old town of my city the other day and noticed how quiet it was and the throngs of Asian tourists coming in on the river cruises just weren't there, and actually the boats have stopped. Restaurants that were normally awash with Japanese and Chinese tourists were empty.

Looking at the markets I wouldn't be comfortable being in airlines, hotels, restaurants and other tourist driven businesses. I think it'll take a couple of years for people to be comfortable traveling again.

Howard Marx

"There's an old stock market saying that "profit warnings come in threes". Ed and the team did some excellent work expanding on that. "

I must have seen a different version of Ed's 'Profit Warning Survival Guide', because the copy I read definitively refuted this adage (!)

5e4d3c8910e6cprofit_warnings_in_threes.j

FREng

Paul, On Rps (LON:RPS) you say

"Otherwise, I can't get excited about this share, based on the information provided today. Stockopedia likes it though"

... and show the current QVMS bars. But these are based on data before today's results. of course, and may be downgraded once the data has been analysed.

Laura Ashley Holdings (LON:ALY) issued an RNS at lunchtime that holders may have missed:

Further to the announcement on 16 February 2020 in response to press speculation, the board of Laura Ashley Holdings PLC (the "Company" and, together with its subsidiaries, the "Group") is pleased to announce that discussions between Wells Fargo and MUI Asia Limited relating to the Group's immediate funding requirements have concluded and the Group should be able to utilise requisite funds from its working capital facility with Wells Fargo to meet its immediate funding requirements. As previously announced, this is not a cash injection by MUI Asia Limited into the Group.

The Company welcomes the support from MUI Asia Limited and continues to review its working capital needs on an ongoing basis. The Company will update shareholders in due course in relation to the review of its working capital needs.

rmillaree

Ref profit warnings interesting - i must be unlucky/stupid buying into the 5% brigade so often when it goes wrong.
Hey ho Fevertree Drinks (LON:FEVR) is currently on 2 warnings not out so perhaps i should be looking at the above stats with confident for the future :). Shame i topped up after profit warning number 1 - sigh.

cmpeckham

Good point! I think it depends on what is a "warning", over what period you measure it (this often drags out over several years, so what's a new warning and what's a follow on warning? I don't think you can limit the look-back to 12 months) and what set of data you're looking at (i.e. not just 3 years of a bull market as in Ed's piece). I've seen a report (a while back) that was in the US that suggested the saying was valid; not to say that there were literally three warnings, but that bad news/good news was serially correlated.

Either way, whether subsequent price action is due to a "warning" or not, something causes the price to fall further, long after the first warning, on average. So buying after the first warning is, on average, a bad idea which is the key point that I was making above. Do you disagree?

Paul Scott

Well spotted FREng, thanks for posting that info on Laura Ashley Holdings (LON:ALY)

It would have been interesting to be a fly on the wall in those discussions. I wonder what assurances or deal was given to Wells Fargo to persuade them to extend their exposure?

Sounds like a temporary sticking plaster, but the more fundamental problem ALY has, is that it needs to do a CVA, or pre-pack Administration, to ditch the loss-making shops. Hence equity probably still worth nothing.

Hi FREng,

Yes that's true. But since the results from RPS were in line with expectations, then I wouldn't have expected the Stockopedia figures to change that much, so that's why I put them in.

The sharp drop in share price today would improve the value scores, if anything, I imagine.

Regards, Paul.

Agreed cmpeckham, that was another of the empirical observations in the 'Proft Warning Survival Guide' - share price recoveries post a profit warning are drawn out affairs, on average.

5e4d5eca26e12profit_warnings_delay_in_pe

Camtab

Paul, can I be a thicky? Why does Strix have no return on equity?

DWit199

Liabilities exceed assets, so there is no equity to have a return.

Graham Ford

Hi John

I used to need to analyse the global pharma manufacturing industry in a previous role. I believe the situation is rather more complex than the 80% made in China mentioned in the article, which provides no source for this statement.

The first question is are we talking volume or value?

Many generic drug active ingredients are high volume but very cheap. By contrast many of the patented products are many times more expensive.

The active ingredient manufacturing of generics is mostly done in China and India these days, but unless the Chinese have somehow been massively more successful than India in the last few years I very much doubt that they have 80% of that market by volume.

If we are talking value, some of the value is captured by the companies involved in secondary manufacturing. For example, acetaminophen (known to most of us probably as paracetamol) used to be made in the West but manufacturing of the bulk active ingredient was discontinued in the West several year’s ago as the West became uncompetitive and India and China had progressed to the point where they could meet the necessary quality standards. So, now a pharma company in the West May buy the bulk active ingredient from Asia but then turn it into a finished dosage form such as a tablet or capsule (incorporating various excipients to do so).

However, this is generic drugs. The situation with drugs still under patent is much more diverse with USA (including Puerto Rico), Western Europe and Japan all having significant share of active ingredient manufacturing for those products. (Even if the manufacturers of those products do have some of that manufacturing in China - e.g. GSK)

So, the impact is most likely to be on some generic medicines and much less on the patented products. So for the article to imply that 80% of medicines may have supply problems seems like an exaggeration to me.

Thornabian

Toscafund increased stake in Ted Baker (LON:TED) again today, up to 17% now.

marklucas8809

If I remember correctly, the key takeaway on profit warnings was that there is no rush whatsoever to buy following a profit warning. On average you can safely take a year. Great research!

I recently put this insight to use after Avast's recent RNS. Not exactly a profit warning, but definitely a bad-news event which slashed the share price. So happy (sort of) to sell and wait to see what happens when the dust has settled.

john652

Hi Graham,

Re cronavirus/medical supply chains If you follow the link to 'tesimony before congress' you'll find the testimony mentioned in the article:

https://energycommerce.house.gov/sites/democrats.energycommerce.house.gov/files/documents/Testimony-Gibson-API_103019.pdf

you'll find all the details such as below. Which 1, is worrying not least from supply chains, but from an indication that we have no real idea as individuals how pervasive the china impact is. And 2, also, enlightening how China has operated and maybe why Trump is following the tariff attack. So not looking to really drill into the specific example, but to highlight we often know very little about an area so large.

''The United States can no longer make penicillin. In 2004, the last U.S. penicillin fermentation plant in Syracuse, New York announced it was closing. The attached graph from the European Fine Chemicals Group, the trade association of pharmaceutical ingredient makers, illustrates how it happened.
Chinese companies formed a cartel and dumped penicillin ingredients on the global market at very low prices beginning in 2004, the same year the New York plant closure was announced. It could not compete with China’s illegal trade practices and its government subsidies. China’s cartel also forced the closure of penicillin fermentation plants in Europe and India. After four years, when China gained a chokehold on global supply, the Chinese cartel increased prices dramatically.
This is China’s playbook: drive U.S. and other manufacturers out of business by selling below manufacturing cost for several years and then raising prices when its domestic companies achieve global dominance.
To be clear, the United States has also lost virtually all of its other antibiotic raw material production capability.
Mothers who give their children generic antibiotics for ear infections; seniors who take generic antibiotics for pneumonia, and patients in the hospital with life-threatening sepsis are likely dependent on the mercy of China to supply core components.''

Hi John

Many thanks for the link. I’ve had a quick read and will read again in detail later.

But my quick thoughts are....

The author has an axe to grind. She’s written a book in a highly emotional style and has a vested interest in creating a panic to promote further sales of her book. Her criticism is as much about poor business practices in China (unfair competition, predatory government directed cartels, insufficient inspections by FDA and lack of supply chain vigilance from the secondary manufacturers) as it is about over dependence on China.

But that’s all going off topic. In terms of how dependent the US is on China and we are on China, one of the more telling sentences seems to be this.

“ The Association for Accessible Medicines reports that 8.5% of generic drugs sold in the U.S. are made in China.”

Now, if I read that correctly, that’s the figure around the time of her testimony and so I don’t see so far how 8.5% becomes 80% dependency on China unless she’s saying that the Chinese fine chemicals and intermediates industry has a stranglehold on the rest of the world supply. She makes some comments about India media reports but as her style is so emotional I struggle to know whether she may have verified the truth behind those reports or not. It could be the equivalent of citing the Indian version of the Daily Mail for all I know.

Anyway, I do expect that there may be some shortages on some generics. I said this to a friend just the other day. However, I don’t think it will be as much of a problem as the scary 80% number suggests. China needs to keep their API plants producing to supply their own country too.

xcity

“ The Association for Accessible Medicines reports that 8.5% of generic drugs sold in the U.S. are made in China.”

Problem is said to be to do with intermediates and raw materials, so this figure doesn't tell us much. I read somewhere the 80% in regard to India rather than US, so I suspect the base data (which i don't know) is being misused sometimes. India is an important supplier of generics to Europe, and presumably to US. Many NHS prescriptions are manufactured in India.

Re Cambridge Cognition Holdings (LON:COG)
CANTAB - the underlying product(s) - is OK; has been going 30 years. There are many alternatives. Largely peddled as an iPad app. A lot of research is needed to stay up-to-date, and most research done in the field is done by unconnected academics and clinicians. Originally all about Alzheimers. The emphasis in recent years on early diagnosis and MCI doesn't seem to have produced substantial profits. Now targeting clinical trials. I doubt if there's much about the app they can patent (and there are competitors who seem to stay in larger markets), which leaves the neuroscience research as the copyright bit. I've never thought much about it because I have always struggled to see how it will achieve substantial scale or dependable profits; not impossible, but i would have expected them to get there by now if they were going to do it. Maybe the clinical trials market will offer better opportunities - it's certainly less price sensitive.

“ Problem is said to be to do with intermediates and raw materials”

Not quite. China and India manufacture the bulk API (active pharmaceutical ingredient). This is the component in the finished product (pill, capsule, etc) that gives the medicinal effect. However, rather than starting with basic raw materials, API manufacturers may choose to buy in intermediates to reduce the complexity of their processes. The suggestion is that Indian API manufacturers may be over dependent on Chinese intermediate manufacturers. And the same for raw materials.

It is not possible to start up manufacturing of an API or a finished product quickly In another plant because the process has to be validated. However, as you go further back in the supply chain towards more and more basic raw materials this regulatory hurdle gets progressively less. So, APIs are a bit more tricky than the intermediates or raw materials.

In addition to the supply chain for the API, there is also the supply chain for the excipients. These are not medically active but part of the finished product and may be substances like binding agents, colourings, coatings and so on. So secondary manufacturers who turn the API into the finished product cannot do that if they cannot get hold of the excipients either. So, it may not even be the API supply that stops production of the finished product.

It is quite complicated and I expected that no one has really fully analysed the dependencies.

Small Cap Value Report (Wed 19 Feb 2020) - KETL, RPS, GHH, EBQ, COG

China & coronavirus

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Paul Scott

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