Small Cap Value Report (Wed 7 Mar 2018) - RBG, RTN, BQE | Paul Scott

7th Mar '18 by Paul Scott

64 comments 21346 reads

Good morning, Paul here!

Apologies for yesterday's report being late - it's now finished, and covers results from;

A fairly detailed look at Luceco (LON:LUCE) and its latest profit warning. Is it a buying opportunity, or should we follow the excellent conclusion of Stockopedia's brilliant 2016 profit warning analysis, by selling first and asking questions later?

Q3 results from Begbies Traynor (LON:BEG) - (I am long)

LoopUp (LON:LOOP) results

Headlam (LON:HEAD) results.

Anyway, to get you started today, here is the link to yesterday's report.

I'm having insomnia issues at the moment, so got up in the middle of the night to write it. Not ideal, but there we go.

Also, please could readers kindly try to avoid having spats in the comments section? It's rather tiresome when that happens! Many thanks. Although I must admit that one (now former) reader flouncing off yesterday (I couldn't work out why), with his parting shot being to tell us that 99% of us are clueless, which gave me the best laugh of the day!

Revolution Bars (LON:RBG)

Share price: 148p
No. shares: 50.0m
Market cap: £74.0m

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

Brief comment

I've been wading through the reader comments for yesterday, and quite a few people want me to comment on recent results from Revolution Bars. I was quite pleased that Graham was working that day, as people already know that I'm bullish on the company, so thought it would be interesting to get Graham's take - which I can probably summarise as being lukewarm, at best!

I'm sure you've already worked out that Stockopedia gives Graham & I complete freedom to write what we believe to be true, at that moment in time, on all companies. We don't confer, or go soft on stocks that the other (or anyone else for that matter) happens to own. In any case, I welcome bearish views on stocks that I hold, as it makes me think more, and question whether I'm right or wrong.

There isn't time at the moment to write anything detailed on RBG, but to give you my…

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alpha2

7th Mar '18

I think I've made this point about RBG before. It is no easy task to improve the food offering. I expect that the vast majority of the products they offer are ready to reheat foods from the likes of Brake Bros. The only way of dramatically improving this offer is by having chef's capable of preparing and cooking from fresh which neither the culture or equipment is likely to support and would require an increase in menu prices.
This also means increasing the kitchen labour overhead when with all the casual dining chains discounting like crazy there is very little room to manouvre on prices. The other point is that these premises are built to be late night bars first and foremost and being able to convert them to premises which also appeal for all day dining is a very difficult trick to pull off. Weatherspoons do it but only by dint of going for the cheap and cheerful which does not suit the RBG brand.
I would not be expecting any dramatic improvements in margin to come from increased food sales. The money is made from the premium booze.

jonthetourist

For the record, I apologise for the use of a rude word yesterday. While I think it was a wholly accurate summary of the departed poster, based on content and style of the post, it was inappropriate in the context of this forum.

I was somewhat unhappy at the time because, having reiterated Paul's request for a bit of background on why people want particular shares covered, we had two posts in quick succession just giving Epics, then the "who do you think you are?" message. Instead of getting wound up by it, I should just have laughed at the statement "99% of the people are not or do not hold financial qualifications. "

Won't happen again.

Jon

tic_tac_toe

i might go to this, if just for free pizza and free laughs!

matylda

Welcome back :)

Vsihv

I just registered - for the pizza!
Would need to learn a lot about blockchain and cryptos in a short space to really benefit from the event.

I get the feeling that this event might be similar to how pyramid schemes host - uplifting music and promise of amazing lifestyle if only you are brave enough to participate!

Interestingly, the boutique investor relations company Cassi Peia Services (which I personally have never heard of), is also hosting an event for Seeing Machines on 16th March (not one I consider to be a high quality investment).
The founder "Some call her the ‘Lara Croft’ of the small capital investment community." has worked at Proactive Investors and Sound Energy (again, not the best quality imho)

Perhaps others know Lara Croft and her credentials, so maybe the sarcastic tone is utterly unwarranted.

What rude word - at best it was rude punctuation!
I agreed with your sentiments

Paul Scott

Hi xcity,

I did read the Restaurant (LON:RTN) results this morning. My impression is that the figures are not as bad as they could be, but the narrative seems to have been heavily PR'd to create a positive impression, when actually profits are falling, and likely to continue falling.

2017 results;

LFL sales down 3.0%
Adjusted profit before tax down from £77.1m in 2016, to £56.7m in 2017
Dividend held at 17.4p, but that not's well covered any more, by adjusted EPS of 22.3p

Current trading - "broadly in line", so slightly below in reality.

Outlook - this is cleverly worded to sound positive, but is actually negative. "Significant price investments" means cutting prices & discounting. So that's bad for profitability, if volumes don't increase faster than prices have fallen. The way I read this, it's a profits warning for H1, with hopes that H2 will be better;

The trading performance of the business in the first half of 2018 will reflect the significant price investments made in the middle of last year. We expect to benefit from our strategic initiatives gaining further traction as the year progresses.

On the positive side;

Strong balance sheet, although working capital looks odd, with very large trade & other payables
Little net debt
Great cash generation - so if it got into difficulties, it could cut capex to the bone, and ride out a recession, unlike many weaker competitors.
Management is implementing a turnaround plan, which should help (e.g. closing poorly performing sites, cutting costs)

It's difficult to exaggerate just how bad things are in the casual dining sector, due to big over-capacity & well publicised ongoing cost pressures. So this is probably a sector to avoid altogether, in my view.

I see no reason to close my (small) short position on RTN, based on today's results.

Regards, Paul.

Damian Cannon

If you're invested in Revolution Bars (LON:RBG) then this is a "must read" article about how they've massaged profits: https://philoakley.sharescope.co.uk/index.php/2018/03/07/can-you-trust-a-companys-profits/

I had a look, it doesn't actually say 'free pizza' so I didn't sign up. Clem will have you paying for it ;)

xcity

Re Restaurant (LON:RTN)

Thank you Paul.

My comment really reflected a degree of surprise in that the results today were clear and well presented and seemed to give an impression of a sensible and competent management getting to grips with the problem in their company and in the industry. A huge contrast to the shambles I remember with the last lot.

The results themselves are better than I had anticipated. They are explicitly saying that they have cut margins, but also indicating that their target market now have a more positive view of their offering, not that it is simply out-of-date, tired menus cheap. That sounds like a big turnround at F&B. Also quite a clear strategy going forward. No longer spending as much on maintenance refurbishment -that always felt like a tactic of throwing money at a problem without actually improving anything that mattered. I think I have a F&B I could check out; though I'm not sure I'll notice the difference even if I do remember going to one 5 or 6 years ago.

The cash flow and balance sheet was always their fundamental strength, and I now believe that they will able to trade successfully and will still be standing when all the blood and gore in the industry has been swept up. And then margins can improve again. AFAICS, there has been far too much over-optimistic expansion in the industry by chains which don't have the financial strength to deal with a little bad patch, let alone one which concatenates increased competition, lower footfall and increasing costs. Restaurant (LON:RTN) always had the financial strength, but seemed to lack management strength and to have lost customer appeal; now I think it looks better. I think it looks as if they can maintain the dividend, though I daresay they would have preferred it to have been lowered a little last year.

I agree about the PR gloss on the report, but impressed by the content too. I don't yet have a view on it as an investment, but I'm always a sucker for management that seems good and competent, and don't tend to be put off by their circumstances being tough. As you say, the first half is going to be down. These results were much better than the market expected, and, if the idea that unexpectedly good results leads to the share price drifting up is correct, the trend is likely to be up rather than down.

bestace

There's a lot of common sense in that article, particularly this comment with which I wholeheartedly agree:

The overriding point I want to make here is do not blindly accept a company’s version of adjusted profit. Try and consider whether exceptional and non-underlying items are reasonable and make up your own mind.

Any serious investor should be going through the numbers and making their own adjustments to the reported numbers as they see fit, so I don't wholly buy into this narrative about numbers being "massaged" or management "trying to pull the wool over the eyes of investors".

I would take issue with Mr Oakley on a few points:

Firstly this comment on the impact on future periods of Revolution Bars (LON:RBG) 's onerous lease provisions:

These profit improvements will not be treated as one-offs but will be included in future adjusted profits. The company is asking you to ignore the exceptional costs in the first place but will take the credit for adjusted profit improvements that come from them.

I don't think that is right. Look at the last annual report and it's clear that movements on the onerous lease provision in both directions are being included within exceptional items, so the management hasn't been taking credit when those movements serve to boost profits:

Even if they did try to pull that trick in future periods, there is enough information provided in the annual report for investors to be able to make their own adjustments for that movement, if they want to.

Secondly on bar pre-opening costs, I have no problem with treating these as exceptionals. They are costs incurred up front where the related income will be generated in future periods. In days gone by the 'matching' principle would have applied and it would have been possible to defer those costs on the balance sheet as 'prepayments', to be released to the income statement when the bar opened.

Mr Oakley's point seems to be that these costs are recurring due to the roll out strategy and are therefore not exceptional, but I think he glosses over the point that each year's costs will relate to different sites and depending on when sites open, the balance incurred at each period-end may vary considerably from year to year, thereby distorting underlying profitability.

Thirdly:

...accounting standards allow the company to create a provision for all the future rental obligations of these bars... Whilst perfectly legitimate, it’s hard not to see this as a form of ‘kitchen sinking’ to give the new chief executive every chance of improving profitability without improving cash flows.

I don't think that's quite right. If a lease has become onerous, it is not up to management whether or not to create a provision, they are required to do so by the accounting standards. There may be an element of kitchen sinking involved in the case of RBG, but if so that will have arisen from the assumptions and methodology used to calculate the provision, not from a decision to create the provision in the first place. Perhaps that is semantics, but when combined with my first point above, I think this has led to Mr Oakley over-egging the point somewhat.

'movements on the onerous lease provision in both directions are being included within exceptional items'

bidirectional movements in onerous lease provisions gives management a lot of control over how much profit they want to declare.

I do think that some of the more recent changes in accounting standards have made it harder for investors to understand what is really going on. It is important for investors to understand the extent of any pension risks a company carries, but I defy anyone to be able to sensibly quantify that risk from the published figures. Most people seem to deal with this by either believing that its a very big liability and the company should be avoided or its not a large annual payment and so its no problem. They either look at a very big tail or a very big dog and they can have no idea which is more accurate.

Ditto with onerous leases. Expecting to lose money annually on a ten year lease amounts to ten years losses - which can then disappear from the P&L. An improvement in trading, and its all change again. The problem is that these can be large numbers vis a vis the annual P&L and allow management to hide changes in trading. Wouldn't be such a problem if they only affected the balance sheet but they can have a large impact on P&L because of the impact on annual costs. I think Phil is correct to include these as a problem.

8th Mar '18

Hi,

I decided against looking at Volvere (LON:VLE) because time was short today, and also Graham has covered it before. It doesn't look controversial in any way, so doubt I could anything of value to what Graham has previously written.

mammyoko

This is an excellent spot re Revolution Bars (LON:RBG) - thank you for sharing it. Phil isn't quite correct because as bestace points out, the movement on the onerous lease provision is disclosed as an exceptional item whether it is a credit or a debit

peterg

Thanks Damian,

Very interesting article. A lot of the issues have been discussed here one way or another. However, one I picked up on, and hadn't previously noticed was this:

This is important as the financial performance targets for 2018 management bonuses are based on adjusted EBITDA and adjusted profit before tax according to the latest annual report:

“For the 52 weeks ending 30 June 2018,the financial targets will be measured based on adjusted EBITDA and adjusted profit before tax (“PBT”).”

I think it’s right for investors in any company to ask whether it is reasonable that over £3m of cash spent on fees and payoffs should be excluded from the calculation of their bonuses?

And

By creating a provision, Revolution Bars is expensing its remaining rent obligations on some bars upfront in full and treating the cost as an exceptional one which many analysts and investors are encouraged to ignore.

The future benefits to profits will not be classified as exceptional and will no doubt count towards management bonus targets

Peter

Thanks. The thing that I like about Phil's analysis is the way in which he guides us through his thinking with clear examples. I'd recommend checking out some of his other articles which are written in a similar style.

Thanks for a superb and detail response bestace - exactly the kind of discussion which I like to see. I know that I was being a little provocative with the word 'massaging' but to some degree that's a core skill for an FD!

Anyway it's interesting that onerous lease provisions are being adjusted both ways as exceptional items. I suppose the risk is that in the future the company can use their discretion regarding these provisions to improve profits somewhat (assuming that the loss-making bars come good).

On the exclusion of pre-opening costs I'm with Phil on seeing these as just a cost of business for Revolution Bars (LON:RBG). Sure these costs will vary over the years but they're in the game of opening new bars and this is an outgoing that will repeat year after year - so it's hardly exceptional. Similarly the costs of closing bars and redundancies shouldn't be adjusted out either as that's part and parcel of running such a business.

Fundamentally where I really agree with Phil is in feeling that companies should make as few adjustments as possible - especially when their bonus payments are based on the adjusted figure. Here they're being incentivised to make the figures look as good as possible within the restrictions set by their auditors.

Also most investors allow themselves to be guided by the company in looking at the reported numbers and, as we know, this can be dangerous. For sure we're all at liberty to dig into the figures and really try to understand them but I only do that for a minority of my investments - the hazard of being a part-time investor.

Damian

I am, sort of, with Phil on the Revolution Bars (LON:RBG) issues. The 'sort of' is because I think it is virtually impossible, even going through all the notes to the accounts in detail, to know exactly what was going on. And clearly the company don't either as they chose to restate the accounts for 2015 and 2016 for misapplication of accounting standards (Restaurant (LON:RTN) had to do likewise in their results yesterday, but to a much lesser extent). I go into more depth since it seems to be an active discussion, and quote from the accounts; please ignore if it is too abstruse for you. It is for me which is why I wouldn't hold Revolution Bars (LON:RBG).

Also require estimation and judgement

And quite a few other expenditures are exceptional, even if they occur regularly and aren't treated as exceptional by other companies

And onerous leases are very sensitive to assumptions about budgeted cash flow and about the risk free discount rate

A consequence of this is that it becomes very hard to work out the profit/loss on current trading, the extent of investment in new business, capitalisation of anticipated losses and changes in assumptions not directly related to their own business activity.

It's no wonder that everyone concentrates on cash flow.

simonp56

Reading with interest the comments re Revolution Bars (LON:RBG) & onerous leases but I think it doesn't have quite the impact some are hinting at.
Let's say that this year we make a provision of £90 for 9 years future rent at £9 per annum. This is an accounting entry only (non-cash) so we debit the exceptional item in P&L account and credit the provision, included in creditors in the balance sheet.

In year 2 though we actually pay the £9 annual rent & this is included as an ordinary expense so a loss of £9 is shown as EBITDA. Beneath the line though we now can release £9 of the provision so this is a credit to P & L. Overall there is no charge to P&L which is correct because the charge was made when the provision was established but actually the provision has not reduced the rent charge that is shown as an ordinary expense in the year.

Therefore, for instance, it has no effect on the profits on which management bonuses are assessed as referred to above or on adjusted EPS in those years.

Does that make sense? Maybe I'm completely wrong though so please say if I am!

GTrader

Thanks mammyoko, on the technical side the trade range 144-172 is still showing some healthy sell vols which is keeping the price subdued. Once the fickle holders are moped up, a break on good volume north of 172 would be positive. However the focus on more food traffic may be admirable but they are rowing against the current eat out headwind.

Small Cap Value Report (Wed 7 Mar 2018) - RBG, RTN, BQE

Revolution Bars (LON:RBG)

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Paul Scott

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