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Small Cap Value Report (21 Oct 2016) – VLK, DGS, RTC, MBH

Friday, October 21, 2016 11:06
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Good afternoon!

As usual on Fridays, I’ll update this article throughout the afternoon – it’s good to take things at a more relaxed pace at the end of the week, when there’s not usually much news.

The meeting I attended with Gear4Music (G4M) (in which I hold a long position) management yesterday was excellent. They’re very much the type of management I like best – hands on entrepreneurs, with the founder still owning 39% of the business, and clearly a very shrewd manager.

It’s been a remarkable re-rating in recent months, going from about 100p to almost 400p. People tend to anchor to the original price, and assume that it’s now expensive. That’s wrong, it’s actually good value compared with other similar growth stocks, on about 30 times next year’s earnings forecast. The forecast looks too low to me, so I think the actual PER might turn out to be nearer 20 than 30, but that’s just my personal opinion.

With only 1% of the estimated European market, and taking market share from larger competitors with apparent ease, I think this share looks very exciting. I think the starting price was completely wrong (far too low), so this was a lucky find. The valuation is now simply reflecting the stellar growth being achieved.

I think the 400p level is probably about the right valuation for G4M. Although as we’ve seen with other online retailers, the valuation can soar way above what seems reasonable. A friend chastised me recently for relying on the greater fool theory. However, I simply observe what happens in the market, and try to replicate successful investments. BOO worked brilliantly for us, hence why I’m focusing on selecting other mispriced and overlooked online retailers. There are so few to pick from unfortunately, and even fewer decent ones.

I was out amp; about yesterday, and my broker mentioned that Vislink (LON:VLK) had pulled a rabbit out of the hat - it’s agreed a sale of its core business for $16m, which will clear most of its bank debt. If the sale completes (expected by year end), then the company will be out of the woods. That would leave Vislink as a much smaller, software company. The share price has almost doubled in 2 days, which looks a good opportunity to exit from what has been a horror story for investors – which I blame on greedy, useless management.

Digital Globe Services (LON:DGS)

Well done to shareholders here – there’s a recommended cash bid today at a decent premium – the shares are up 73% today. Looking back at the original listing, I see that the same company which floated DGS at 159p is now buying it back at 60p! So they’ve stuffed investors for 99p per share overall, over a 3 year 8 month period, for a company which repeatedly under-performed whilst listed.

The company says that it sees “little benefit” from being listed on AIM, and that there is little liquidity in the shares. Hardly surprising when they floated it with large, lumpy shareholdings. Also hardly surprising that the market has little confidence in a company which floated amp; then kept missing its profit forecasts. Profits have turned into losses in the most recent year, despite rising turnover. So not a very good company, by the looks of it.


Shares in this minnow staffing company have plunged 23% today, but the only news I can find is that the Chairman sold £10k of shares.

Doh! What am I on about, I read the RNS wrong, sorry. The Chairman actually bought £10k shares after the profit warning. Profuse apologies.

Trading update - Aha, mystery solved, there are 2 RNSs today, with the other one being a trading update. It doesn’t sound too bad – a delay in a contract commencing;

RTC today announces that whilst trading in the first half of 2016 was in line with expectations, the second half has seen delays in the commencement of infrastructure projects that are impacting our trading. These delays have affected the short term performance of ATA, primarily in their permanent vertical market activities.

As a consequence of these delays, the results for the full year are expected to be lower than current market expectations.

The directors expect these infrastructure projects to commence in the near future and they remain confident in the overall future prospects of the business.

Ganymede continues to perform well and in line with expectations.

This is just par for the course with very small companies. Investors have to accept that they’re more vulnerable to something going wrong with individual customers, contracts, or staff. Larger companies can usually absorb specific problems like this. This is why smaller companies really should be on a lower rating than larger companies, but investors often forget this amp; chase up small companies to excessive valuations, then get burned when the price corrects.

My opinion – if you like the company, and are prepared to look through the temporary problems of contract delays, then this could perhaps be a nice time to buy? I sometimes do well on companies which are fundamentally sound, but where the shares are sold off because of some temporary, fixable problem. This looks like potentially that type of situation.

Although it’s too small amp; illiquid for me, with the market cap now down to about £5.8m. I hate dealing in things that small, as they’re so difficult to trade, and you often can’t get stock when you want it, and can’t sell without taking a horrible haircut on price.

To make it worthwhile taking on that level of risk, the reward needs to be exceptionally good in my view. There are plenty of larger, very cheap staffing companies out there, so this one wouldn’t be my pick.

The market seems to be pricing in an economic slowdown, which I think is sensible. There are nasty headwinds for the UK economy as we look forward to 2017. So I think broker forecasts need to be adjusted down in many cases, and that’s what share prices are already telling us in cyclical sectors.

Michelmersh Brick Holdings (LON:MBH)

Share price: 51.5p (down 18.3% today)
No. shares: 81.2m
Market cap: £41.8m

Trading update (profit warning) – I’m finding the explanations given for under-performance somewhat confusing. However the upshot is that this brick maker is not going to grow profits this year, as originally planned. The key sentence being;

…the Board has revised its financial expectations for the current year and believes revenue and profit will be at or around a similar level to that report for the full year 2015.

At least they have effectively quantified things, by referring to last year’s profit. Last year the company made 4.4p EPS, so if the same is achieved this year, that puts the PER at 11.7 – that looks reasonable to me, for a fairly basic, cyclical company.

I don’t have any figures for what growth in profits was previously expected, so at this stage don’t know what scale of profit setback this is. If any readers have information on that, please could you comment below.

Outlook comments sound reassuring;

The Board is pleased to report that the Group’s order book remains strong, 5 per cent. ahead of that at the half year and cost savings have been identified that help to mitigate the effect of negative market trends.

The operational issues at the Michelmersh site reported at the half year have also been addressed and the site is moving back to full operational capacity. Cash flow is also strong and the Group expects to meet or exceed the Board’s previous cash expectations at the year end.

…The Board reaffirms that strong long-term housebuilding and RMI market fundamentals remain in place for the forseeable future and that the Group is well positioned to grow market share in the coming years.

My opinion – I’m tempted to have a little dabble here. The last reported balance sheet is excellent, and today’s warning seems quite mild – reflected in a share price that has only fallen 18% today – compared with the more usual 30%-ish that normally accompanies a standard profit warning.

I don’t know anything about the dynamics of the brick market, so would only ever have a small position here, but it does look tempting.



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