Small Cap Value Report (Wed 24 Oct 2018) - ramblings, CAKE, ANG, YU., PHTM

Good morning, it's Paul here.

I rambled a bit off topic last night in the placeholder (Tuesday is stroll along the beach, followed by pizza and beer night), but seeing as it has 56 thumbs up this morning, I'll leave it in place. Sometimes I like to spice up the placeholder a bit!

In case you missed it, Graham kindly emailed me a piece about PCF (LON:PCF) after noting some reader requests here. So I copy pasted that into yesterday's report here. Apologies, but I didn't get round to looking at McBride yesterday. There seemed little point, as the markets were in freefall at the time, but later recovered in the USA with a strong late rally.

I see the American markets are all over the place at the moment - volatility is back.  I've no idea what's going to happen to markets overall. All I can say is that I'm seeing some potentially nice buying opportunities in UK small caps - good companies, reporting decent figures & outlook, that are now 20-30% cheaper than they were a few months ago.

Eurozone crisis

On the other hand, I can understand people being worried about macro factors. To me, by far the biggest worry right now is a potential breakup of the Euro. The so-called single currency is of course, not a single currency. It's actually 20 different Euros, pegged at parity.

All currency pegs eventually snap, because economic imbalances build up over time which make artificial currency pegs impossible to maintain. The Euro is no different to the Gold Standard, Bretton Woods, or the ERM. It's only a matter of time until it breaks.

The capital flows under the Target2 system look close to breaking point. I'm not an expert on this, but I can see a big problem is emerging. 10 times the size of the Greek Eurozone crisis, as Italian national debt is over E2 trillion - although much owned domestically, apparently.

Who knows how it's all going to pan out? The EU has a knack of cobbling together temporary fixes for these problems.

My worry is that, if/when the Euro peg snaps, then 20 years of economic imbalances would instantly reset. So the Greek Euro would instantly devalue maybe 50%? The Italian Euro might devalue say 25%? The German Euro would revalue say 30%.

That would then leave the nightmare of how to work out many trillions of contracts all over the world, denominated in Euros, but now subject to re-interpretation by many countries' Courts.

It would also leave nobody knowing which banks had made huge profits, and which had made huge losses. So like 2008, but on a much bigger scale.

A breakup of the Euro doesn't really bear thinking about - it would probably be the biggest financial crisis in history. Realising this, maybe the Germans would compromise, and give Italy's populist Government some accommodation after all? Things have a habit of sorting themselves out. It is worrying though.

Brexit pales into relative insignificance, in my view.

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In a sea of woes, when we're all so worried, I think it sometimes helps to stop and think how lucky we are.  We live in a world that is incredibly safe, comfortable, and affluent. Previous generations lived in cold houses, with little food, no protection against disease. They lived short, and often painful lives. Our lives are very much better.

Here's a picture I took last night, of the sunset in Bournemouth, isn't it beautiful? We are so lucky. Every now and then it's worth taking a moment to appreciate that. We're standing on the shoulders of previous generations, whose sacrifices made our lives so relatively comfortable. I would have loved to thank my Granny's brothers for their sacrifices in WWI, but sadly they had all died long before I was born.

(sorry, can't get the pictures to work)

It's not about glorifying war. It's about wanting to spend a moment to think about people who went before us, and gave up so much, to let us enjoy this peaceful and decent life - that we take for granted.

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Patisserie Holdings (LON:CAKE)

Share price: suspended
No. shares: 135.3m
Market cap: unknown

Corporate update - the financial scandal at this chain of cake/tea shops continues. 

Like many other investors, I'm still reeling from the turn of events here. This was not some dodgy overseas junk on AIM. Instead it was probably seen by most investors as one of the highest quality shares on AIM - highly profitable, expanding, impeccable growth track record, and with a Chairman and major shareholder who was one of the most highly respected businessmen in the UK, Luke Johnson.

There weren't any red flags. The only issues I had doubts about, was how the company managed to maintain such a high operating profit margin, and seemed unaffected by the downturn in High Street footfall that other retailers are complaining about. That didn't seem to make sense, but it never occurred to me that the figures might have been fiddled.

If the shares had been on a cheaper rating, I would have bought some. It was only the high valuation that kept me away.

What's the latest then? It's a brief update today, saying that the winding up petition has been dismissed by the court. That's just a formality, as the company had been refinanced, so the debt would have been paid.

Clarification regarding LTIP scheme -  a second RNS today, the company seems to confirm recent press reports that some share options were not correctly disclosed;

The Company¸ as part of the ongoing investigation, is seeking to understand why the grant of options relating to 2015 and 2016 have not been appropriately disclosed and accounted for in its financial statements.

My opinion - doesn't really matter at the moment, because the shares are suspended. They're not likely to come back until corrected, audited accounts are published. We obviously cannot rely on the previous accounts at all, as there was a massive black hole in them.

My hunch is that there's probably plenty more dirt to come out. Other people inside the company must have known, or at least suspected, what was going on - one person alone cannot fiddle the figures to this extent.

I feel very sorry for investors here. They thought they were buying into a quality outfit, and this situation was unforeseeable. It's a reminder though that risk can come at us from any angle, at any company.

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Angling Direct (LON:ANG)

Share price: 96.5p (down 3.5% today)
No. shares: 43.0m + 21.6m placing = 64.6m
Market cap: £65.6m after placing

Placing - I wouldn't normally mention a placing, but this is noteworthy because of its size. 

The company is raising £20m before costs, to significantly expand the business. 20 new physical stores are to be opened, plus further expansion online. It also mentions potential M&A opportunities.

My opinion - this is an interesting company, which I quite like (but don't currently hold). It seems to have out-performed FISH, whose shares have been suspended pending clarification - which usually means it's bust.

Because ANG is going down the route of having physical stores, as well as an online presence, then perhaps its shares may not command such a high premium as online-only companies. There's also the risk that the company might make mistakes in signing leases that turn out to be onerous. I would like some reassurance that the company is not signing any leases over 5 years, or for big rents.

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Yu (LON:YU.)

Share price: 123p (down 79% today, at 12:58)
No. shares: 16.3m
Market cap: £20.0m

Trading statement & accounting review - the title of the announcement alone is enough to send a shiver down the spine of anyone unfortunate enough to own shares in this electricity and gas supplier.

 When I saw that the share was down almost 80%, I initially assumed it must have been a 5 for 1 share split. That's usually the case when you see such a large price fall. Sadly not. It's actually a horrendous profit warning, caused by the admission of over-optimistic accounting.

These are the specific problems;

• Over-accrual of income - i.e. estimates which over-stated both revenues & profits
• Inadequate bad debt provisions - bad debts are "significantly above" previous estimates
• Lower gross margins, due to competitive pressure - another "significant" adjustment

What's the damage? It's horrendous basically;

The Board estimates the combined adjustments will lead to around a £10 million reduction in profitability when compared with current market expectations, with the Company reporting a loss for the current financial year.

The company thinks that it should bounce back into profits next year (but its reassurances are probably worthless, given the turn of events);

The Board are confident that the Group will achieve profitability for the year ending 31 December 2019, albeit at a lower margin than previous expectations, and is in the process of preparing detailed budgets.

Is it likely to go bust? probably not, I reckon. The company reassures today on its cash position. Although I note that this is a month end balance. I would have preferred to be told the current cash balance - which could be significantly lower intra-month, who knows?

The Group has significant cash reserves (£11.5 million at 30 September 2018) and has no debt outstanding.

Note that the company raised £12m in Mar 2018, through a placing at £10 per share! The share price is now down 88% on that level. My worry is that legal action could follow, since that fundraising clearly relied on false accounts.

I've just reviewed the most recent balance sheet, dated 30 Jun 2018, and it looks pretty solid actually - a decent cash pile, and no bank debt. Although we have to adjust it to reduce receivables by c.£10m, but it still looks pretty solid even after that change is made.

Therefore, I doubt the company is likely to go bust, providing more horrors are not discovered.

Directorspeak - the CEO eats some humble pie, and points out that he personally is the biggest loser;

"As founder and majority shareholder, nobody is more disappointed in this development than me. Our booked revenue from new sales remains strong and contracted revenue for 2019 is already £67 million as at the end of September 2018.
We have improved internal controls around working capital management and the Board is absolutely focused on restoring the profitability of the business."

My opinion - the net profit forecast shown on Stockopedia is £3.2m, so before tax that would be c.£4m PBT. To have to make £10m of adjustments to that, suggests a loss of about £6m.

Worse still, it looks to me as if the historic profit was probably fictitious too. Therefore, this company has probably never been profitable at all! The whole basis for its IPO, and roaring share price previously, therefore looks to have been based on false accounting.

A friend recommended this share to me previously, but I quickly dismissed the idea. Energy supply is a competitive space, with tight margins. Therefore it simply didn't make sense to me that a new entrant could come in, and deliver extremely rapid growth, and surging profits.

Also, I have a blanket rule to never invest in any companies which operate within a regulated sector, as this caps the profits, and is subject to political interference and posturing.

So I'm afraid Yu is completely uninvestable, as far as I'm concerned. It's filed in the "too good to be true" dustbin as far as I'm concerned. Often situations like this can be avoided by simply applying some common sense - do these numbers look reasonable, given the sector it's in? Bad luck to holders of this share.

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Photo-Me International (LON:PHTM)

Share price: 115p (up 15.7% today, at 13:51)
No. shares: 377.7m
Market cap: £434.4m

Trading update

Photo-Me International plc (PHTM.L), the instant-service equipment group, will hold its Annual General Meeting at 2:00 p.m. today. Ahead of the meeting, the Group announces the following trading update covering the first five months of its financial year.

The year end is 30 April 2019.

I'll summarise today's update;

• Trading in line with expectations
• Discussions with Dutch & French Governments (Brexit risk perhaps?)
• Japan restructuring going better than expected
• Laundry division expansion
• Kiosks division - profit expected, due to restructuring last year
• Banking booth - pilot starting in Paris
• H1 profit expected to be flat vs last year (excluding one-offs LY)

Valuation - the PER looks modest, and the dividend yield is astonishingly high, but only just covered by earnings. Is the big yield sustainable? It might be - after all, the company has a very solid balance sheet. It would probably be prudent to work on the basis that future divis might need to be pared back, if trading were to deteriorate.

My opinion - this looks a solid company, performing reasonably well, at an attractive valuation. So it gets a thumbs up from me.

I'm increasing coming to the view that this market correction is throwing us some nice opportunities, to pick up good companies at reasonable prices. PHTM could be one of them perhaps?