Small Cap Value Report (Wed 8 Nov 2017) - TRCS, SDM, JPR, MKS, JDW, PSN, PVCS, ZZZ

Placeholder article posted the night before:

Hi, it's Paul here! A quick reminder that Tracsis (LON:TRCS) results will be out in the morning. I am interviewing the CEO, John McArthur, this Thurs. So if you have any questions, please email them asap simultaneously to me & John, using both the email addresses below;

Paul Scott:   QSCquestions@gmail.com
CEO of Tracsis:   J.McArthur@tracsis.com

I'm trying out an email system, as it saves me the hassle of having to set up an online form. Also it means that me & John both get to see the questions at the same time, so eliminates preparation time for me.

Please note that I added more sections to yesterday's report in the evening. So the full report now includes all the shares that were originally in the header.

Here is yesterday's completed report, to start you off with. It includes sections on;

• Intercede (profit warning)
• FeverTree (materially ahead of mkt expects)
• Blancco Tech (results)
• Johnston Press (EGM requisition - which has since been declared invalid by the company)
• Ideagen (trading update)
• Castleton Tech (interim results)
• UP Global Sourcing (final results)

I mention this because I was writing very late last night, so readers may not be aware that more sections were added.

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Good morning! It's Paul here for the usual small caps report.

I'll also briefly comment on some bellweather large caps today. I think it's well worth keeping an eye on what's happening to consumer-facing, and residential property larger caps. This can often have read-across for smaller caps, and helps me understand where the economy is going - vital information for deciding whether to buy or sell particular shares. I don't see myself as a bottom up, or top down investor - I do both. You have to, otherwise investing decisions wouldn't make much sense.

Marks and Spencer (LON:MKS) - interim results. Adjusted PBT down 5.3% to £219.1m. However, growth in international profits masks a 17.8% fall in UK adjusted operating profit. A stand-out bad number is that store staffing costs in the UK rose 10.3% to £532.5m - I think some of that is pensions cost related, but it's still a startling number. LFL sales growth is elusive, but costs are rising. So I'd be more inclined to go short, rather than long here. I can't see any current trading or outlook statement in MKS results, which seems odd. Maybe I missed it?

Note that Associated British Foods (LON:ABF) said (yesterday) of its Primark subsidiary;

Primark performed particularly well in the UK where sales were 10% ahead of last year on a comparable basis and our share of the total clothing market increased significantly.

Note that Primark eschews online sales, instead using its website to help drive traffic to its stores. The great success of this strategy does rather turn conventional wisdom on its head - the High Street can work, if it provides customers with the things they want, at the right prices.

Persimmon (LON:PSN) - worries about the housing market seem unfounded, judging from this upbeat update today. Market is being supported by cheap mortgages, and Help To Buy scheme. Problems - planning consents "challenging as ever" to obtain. Tight market for labour with key skills, and also key materials. Could be nice read across for Michelmersh Brick Holdings (LON:MBH) possibly?

My worry is what happens when HTB scheme, and cheap mortgages are withdrawn? No sign of a housing crash yet though - PSN sound positive today.

J D Wetherspoon (LON:JDW) - positive update here too. So (smelly) people are still drinking plenty of beer! LFL sales up 6.1% in Q1 (13 weeks to 29 Oct 2017). That strikes me as very good, #despiteBrexit - talking of which, Chairman Tim Martin delivers another extensive rant about Brexit here. As usual, he makes some good points - e.g. that a lot of nonsense is being talked about food prices - which should come down, not go up - since outside the EU the UK will be able to strike free trade deals with other countries to import cheaper food.

Note that Deltic (which wants to merge with Revolution Bars (LON:RBG) ) has also recently announced outstanding recent LFL sales - up 9.1% for the 7 weeks to 31 Oct 2017. It seems that students starting the new academic year, and halloween, are bigger events this year than in the past. Or at least people are getting more pished anyway.

I'm interested in what read-across there might be for Revolution Bars (LON:RBG) (in which I hold a long position)? Its share price has been relentlessly slipping from its 210p peak (driven by hopes of an improved offer than the [now lapsed] 203p Stonegate bid. Down to 165p to buy, I'm starting to get tempted for a top-up, but will probably hold out for 150p before hitting the buy button. Although the downside risk is that management distraction from the Stonegate bid may have harmed short term trading. Plus there are £2.5m exceptional costs relating to the failed bid, and CEO severance pay, according to one broker.

As always, I love to hear interesting comments from readers, so if you have anything useful to add, please feel welcome to post a comment below.

OK, on to some small caps.

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PV Crystalox Solar (LON:PVCS)

Share price: 28.0p (up 4.7% today) - update: ended the day at 24.0p (down 10.3%)
No. shares: 160.3m
Market cap: £44.9m - update: £38.5m at end of day

Arbitration award - this looks like the long-awaited decision on a highly material issue for this maker of solar panels;

PV Crystalox Solar plc (the "Group") has received notification of the final award rendered by the International Court of Arbitration of the International Chamber of Commerce in the matter filed by the Group in March 2015 and arising from an outstanding long term wafer supply contract with one of the world's leading PV companies as mentioned in our interim results.

The award requires the customer, who has failed to purchase wafers in line with its contractual obligations, to pay the amount of around €34 million including interest to the Group. The obligation to pay is not conditioned upon the delivery of 22.9 million wafers, outstanding under the contract, although the customer's right to seek such delivery is not precluded by the award. 

It doesn't mention legal costs - will PVCS have to bear its own?

I'm not close enough to the detail to know whether this is a good, bad, or indifferent outcome. The share price reaction so far suggests that it's about what was expected by the market. This is an interesting special situation, but requires too much research time for me - I'd rather stick to much simpler investing situations.

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Stadium (LON:SDM)

Share price: 88.5p (down 24.0% today)
No. shares: 38.2m
Market cap: £33.8m

Trading update (profit warning) - bad luck to shareholders here. The group is;

... a leading supplier of design-led technologies including connectivity solutions, power supplies, human machine interface products and electronic assemblies

I'm a bit rusty on this one, as I find it a rather unremarkable business, so am not motivated to monitor it closely. Looking at the last results, interims for the 6 months ended 30 Jun 2017, they look OK - normalised PBT up 13.6% to £1.8m for H1. There was a confident outlook statement (published on 5 Sep 2017), talking about "further accelerated growth in the second half and into 2018".

There's been a setback, announced today;

Whilst revenue growth and the development of the forward order book are in-line with expectations for the current year, the Board now expects single digit percentage growth in normalised profit before tax, which is below current market expectations.

This is primarily due to customer delays into 2018 for certain higher margin Technology Products projects, which had originally been expected to ship before the year end.

Looking back to the 2016 results, normalised PBT was £4.2m. So single digit % growth, if we assume to be 5%, suggests the company is guiding us to around £4.4m normalised PBT for 2017.

Apparently there is a global shortage of certain components, such as memory, which is causing upward cost pressures.

Net debt will be higher than expected at 31 Dec 2017 year end, due to these factors.

Order book - is at a record high of £32m.

Outlook - a bit mixed;

Although the Board recognises that the delays and some pricing pressure will continue to impact the Group in 2018, the forward visibility provided by the order book and the strong design pipeline of newly awarded projects, provides confidence that the Company will deliver double-digit revenue and profit before tax growth in the coming year.

That sounds reasonable, but the double-digit profit growth for 2018 will of course now be based on a lower 2017 comparative.

I really need some broker forecasts to sense-check my understanding of things.

Broker forecast - there's an update note on Research Tree from a decent quality broker, which has . This shows a revised 2017 normalised profit of £4.5m, which is very close to my estimate above of £4.4m. So that's the right ballpark.

Broker forecast for next year is £5.4m, an increase of 20%.

In adjusted, fully diluted terms, that is 9.1p for 2017, and 10.8p for 2018. That's a 15% reduction in forecast EPS for 2017, and a 17% reduction in the 2018 forecast. So the 24% fall in share price today is perhaps slightly harsh, but it's in the right ballpark.

Valuation - on the revised forecasts, the PER is as follows:

2017 PER:  9.7
2018 PER:  8.2

Whilst that may appear decent value, we need to take into account that the company has a material level of net debt - forecast to be £12.5m at end 2017, and £10.5m at end 2018. That's a bit higher than I'm comfortable with. The 2017 net debt is equivalent to 32.7p per share. So add that to the share price of 88.5p, and you get an enterprise value of 121.2p per share.

If I adjust the earnings forecasts to strip out the £0.4m p.a. interest charge (to model what profits would be on a neutral cash/debt basis), then we get £4.9m adj PBT, less 20% tax = £3.9m earnings, divided by 38.2m shares = 10.2p EPS for 2017. On an EV of 121.2p, that works out a a cash/debt neutral PER of 11.9 for 2017 (compared with a PER of 9.7 above). I hope you're following this! (and also hope I've worked it out correctly)

My opinion - my cash/debt neutral PER of 11.9 for 2017 looks about right for this type of business. Note that there is also a pension deficit on the balance sheet of £6.7m, which I haven't factored into the valuation above.

Overall then, I'd say this stock is not cheap, it looks valued about right. Personally, I'm not really interested in contract manufacturing businesses like this. Profit warnings are frequent, when orders are delayed. The growth here has come from acquisitions, with an associated increase in debt. Today's profit warning was unwelcome, but it's not a disaster - so I don't think shareholders need to panic.

On the plus side, margins are pretty good, so the company must have some expertise, and be adding value for its customers. The divi yield is reasonable, at about 3.5%, although I'm not keen on heavily indebted companies paying divis. Overall, I think there are probably better investing opportunities out there than Stadium.

As you can see from the chart below, Stadium has essentially gone sideways for 3 years - a period where there have been numerous multibaggers elsewhere. So there's been a big opportunity cost to holding this share. Also note that the long vertical red bars on the chart are when the company has disappointed - there seem rather too many of these for my liking. This suggests that the company has limited earnings visibility. The valuation needs to reflect that, by being cheaper than the market as a whole;

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Snoozebox Holdings (LON:ZZZ)

Appointment of Administrators - we wave a tearful goodbye to this innovative, but commercially unsuccessful operator of mobile hotels. It floated in May 2012, at 40p, and

The shares are worthless now, but the business will be sold as a going concern to whoever wants it, and the proceeds will be used to pay for the Administrator, any preferential creditors, and the bank. There won't be anything left for shareholders unfortunately, as they rank behind creditors in insolvencies.

Pity - it was a nice idea, but not scaleable, and not profitable. So that's the end of that.

One of the lessons to learn from this (aside from that jam tomorrow companies rarely succeed), is that when the first evidence appears of a business plan failing, then the sensible thing is to get the hell out of the shares asap. ZZZ had several attempts to relaunch, but to no avail. I was suckered into putting some money into a placing here, at around 10p from memory. Thankfully, it dawned on me that I'd made a mistake, and I exited for a loss of about 20% shortly afterwards. It's painful taking a loss, but at least smaller investors can get out (a big advantage we have over institutions, with small caps). I see that Kestrel have suffered a 100% loss with their 27.1% of the company - not the first time they've averaged down on very bad investments. It's surprising how many fund managers make exactly the same mistakes that many PIs do. We're all human after all, and a lot of human decision-making is actually driven by emotions, rather than logic - even though we all like to pretend otherwise.

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Johnston Press (LON:JPR)

Just a quick update from yesterday's news of a 20% shareholder lodging an EGM requisition, to remove & replace 2 Directors. The company today says the requisition is invalid, but doesn't say why. It sounds like some technical reason, so I imagine a revised EGM requisition is likely to be lodged shortly.

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Tracsis (LON:TRCS)

Share price: 522.5p (up 4.5% today)
No. shares: 28.1m
Market cap: £146.8m

Audited results - for the year ended 31 Jul 2017.

This is an acquisitive group of companies, describing itself as;

a leading provider of software and services for the traffic data and transportation industry

The headline figures look OK, but profit growth looks modest;

• Revenue up 6% to £34.5m
• Fully diluted adjusted EPS up 4% to 23.29p (giving a PER of 22.4) - this is 4.9% ahead of the broker consensus of 22.2p shown on Stockopedia.
• Full year divis up 17% to 1.4p per share (a yield of only 0.27%)

Looking next at the balance sheet and cashflow statement;

Cash pile has grown again to £15.35m (vs £11.39m a year earlier) - or 54.6p per share, which is 10.4% of the share price

Contingent & deferred consideration payable within current liabilities is £5.0m, so this should probably be offset against cash, to arrive at surplus cash of £10.35m

Share-based payment charges look rather high, at £1.3m this year, and £1.1m last year

Cashflow is impressive - there are no funnies in the accounts, this is a genuinely & strongly cash generative group of companies. The company doesn't seem to capitalise any development spending, which is prudent.

Segmental reporting - the lion's share of profit still comes from the rail technology & services businesses, which improved its EBITDA by 20.7% vs last year. The traffic & data services division saw EBITDA fall by 11.1%

Revenues are overwhelmingly (96.3%) generated in the UK

Large contract - I think this might have been the contract that gave rise to uncertainty over profitability earlier in the year, hence the wobble in share price (a nice buying opportunity, in hindsight). There were timing issues due to changes in rail franchises, I understand;

Significant multi-million pound contract win secured for TRACS Enterprise Software - largest software contract secured to date

Recent acquisitions going well;

Recently-acquired businesses On-Trac and SEP trading well and above expectation

USA expansion - promising noises are made about the long-awaited breakthrough in sales for its Remote Condition Monitoring (RCM) equipment. A reseller has been appointed, so hopefully some material sales might appear in future - I think this is one of the reasons that investors are happy to pay a premium price for TRCS shares, despite fairly modest profit growth this year.

More acquisitions?

The Group did not make any acquisitions in the year under review, but assessed multiple opportunities in line with our stated strategy.  Although no transaction was completed in the period, Tracsis' appetite for continued aggregation in selected traffic and transport markets remains unchanged and so too does the standard by which we critique potential acquisition targets.  Looking ahead, the pipeline of opportunities remains strong and Tracsis has never been in a stronger position to make further acquisitions.

Given that Tracsis hasn't put a foot wrong with its acquisitions to date, I think we can be fairly confident that when more acquisitions do happen, they will make sense.

Outlook - comments are fairly optimistic sounding;

The Group believes that the significant Software contract win, investment in Vivacity Labs, restructuring of its Traffic Data business and North American success all provide a good platform for growth in 2017-18.

My opinion - 2016/17 looks to have been a solid, if unspectacular year.

Overall, I think the shares look priced about right at the moment.

I look forward to chatting to the CEO John McArthur shortly, which I'll publish in due course on QualitySmallCaps.co.uk

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All done for today! See you tomorrow.

Regards, Paul.