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Small Cap Value Report (10 Jan 2017) – BOO, SOM, CALL, TPT, WINE, GAW

Tuesday, January 10, 2017 8:13
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Good morning!

Graham is travelling today, so it’s just me reporting.

There’s tons to cover, so I’ll do my best to wade through as many RNSs as time permits. The list so far that I hope to report on today is:

  • BooHoo – another excellent trading update
  • Somero Enterprises – good trading update amp; increased divis
  • CloudCall – good trading update
  • Topps Tiles – Q1 trading update
  • Majestic Wine – Xmas trading update
  • Games Workshop – Interims
  • Focurite – update

Others that I probably won’t get time to report on (but you never know), include TCM, PGH, KBT, CARR, and Hamp;T. I might do quick comments on those at the end if there’s time.

Market getting toppy?

It’s all feeling a bit frenzied at the moment, isn’t it? I’m starting to get worried about a correction in the markets. That said, I can justify the valuations of everything in my portfolio quite easily, and I keep away from speculative stuff on daft valuations. So everything should be OK in the long run, even if there is a market correction.

These days, my portfolio is generally newsflow-driven. So I tend to buy after positive trading updates amp; results. That tends to make my portfolio quite resilient when market corrections occur. This could be because people are loath to sell shares in companies which are performing well, even in a market downturn. You can see this from the chart of Beam Me Up Scotty, my fantasy portfolio, which wasn’t affected at all by the sharp market correction in Jan 2016, and didn’t suffer too much on the Brexit vote either.

Talking of market corrections, I spotted a fascinating chart, posted by Urban Carmel on Twitter, see below. This chart shows very clearly how intra-year sell-offs are usually very good buying opportunities. The Samp;P usually finishes the year strongly up from its intra-year low.

So, unless there are serious macro-economic problems (like the credit crunch in 2007-8), then buying market corrections seems to be a very good strategy. Whereas of course our natural, emotional response to a market sell-off, is to panic sell. Usually that urge needs to be suppressed, as it can be very costly. I can’t be the only person who has, quite frequently, capitulated and sold a poorly performing share absolutely bang on the 5 year low. Only to see it rocket upwards immediately after I’ve hit the sell button! Then bought back in, 20% higher.

So perhaps we should be taking some profits now, whilst the market is so buoyant? I’m pondering that point at the moment, wondering if I should gently top-slice some of my profitable positions? (i.e. bank a small portion of the profits). Also, it’s a lot easier to sell into a rising market, than it is a falling one, especially if you have a big position in a small company.

Here’s that chart referred to above:

(chart caused formatting problems, so I had to delete it. Will insert later, or provide a link to it)

Right, on to today’s results amp; trading updates.

Boohoo.Com (LON:BOO)

Trading update – (I hold a small residual position in this share, via my local share club).

Just a quick mention, as the market cap of over £1.6bn is now way above my usual phasing-out upper range of £300-400m.

It’s another barn-storming update, in terms of top line growth. Full year revenue expectations have been raised again. Growth in USA is the most exciting bit, and I think this goes a long way to explaining why the shares are expensive now. The market is salivating at the potential now that BOO is making clear progress in America – constant currency sales up 188% to £19.6m in the 4 months to 31 Dec 2016. If the company wins the auction for Nasty Gal too, expect USA growth to shoot up considerably.

I’m seriously thinking about buying back into this share actually, as the future looks so bright, and forecasts keep increasing.

Now I’m sure some people will worry about the lower gross margins – down 260bps to 54.4% on the retail side (i.e. excluding wholesale). A couple of points on that – firstly, it’s a planned move. BOO has a specific strategy of being extremely aggressive on price, in order to gain market share amp; grow as fast as possible. I spoke to the company a few months ago, about how BOO would handle higher import prices – i.e. would they be raising selling prices? Absolutely not, was the reply. They want to shake up the market even more, and take more business from the High Street. So they’re planning a lower gross margin, but recouping the shortfall from reduced marketing spend (as a percentage of sales, but still rising in absolute terms). This is a brilliant strategy, and it’s working. So overall, the net profit margin is maintained, or even increased. People who look at the declining gross margin in isolation are therefore missing the bigger picture.

Secondly, the gross margin has reduced from outstanding (c.60%), to still very good indeed (nearly 55%). That would be a decent gross margin on the High Street, so for an online retailer (with none of the costs of a chain of stores), it’s a wonderful margin.

As has been proven to date, worries about BooHoo’s margins have been misplaced, and have simply resulted in people losing out by not owning a share they could have 5-bagged on from the lows. That’s a pity. Also, to be blunt, if people who know the sector well aren’t worried about BOO’s margins, why should other people be worried? It usually pays to listen to sector experts, such as Nick Bubb, Mark Brumby, and Peel Hunt, who together are the best 3 retail sector analysts in my opinion. They have all been very bullish on BOO for over a year.

Somero Enterprises Inc (LON:SOM)

Share price: 235p (up 8.0% today)
No. shares: 56.2m
Market cap: £132.1m

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

Trading update – a smashing update today, from this US-based maker of laser-guided concrete screeding machines.

I interviewed management a year ago, here’s the link for the audio, and here for the transcript. I’ll see if we can arrange an update telephone interview in the next few weeks. It’s such a nice company, and management were a pleasure to interview. Everything they said last time has happened, so they’re people to trust, in my view. Oh, and the share price is up 72% in the last year, which isn’t too shabby!

Performance has been strong;

In the six months since 30 June 2016, the Company continued to deliver profitable growth and cash generation.

Due to a strong finish to 2016 combined with continued margin improvement, the Board is pleased to announce the Company expects to report revenue slightly ahead of current market expectations and to report EBITDA comfortably ahead of current market expectations for the full year.

In addition, given the strong cash generation of the business, the Company expects to report net cash as of 31 December 2016 that is significantly ahead of market expectations.

I do wish companies wouldn’t report EBITDA as if it’s the main profit measure, because it really isn’t! I think this sends the wrong signal – it says to me that profit may not have risen by much (if at all), so they’re focusing on EBITDA instead. Actually, I don’t think that’s the case here, but that’s only because I know the company. So the RNS writer (probably the UK PR company) needs to re-think what they actually put in the RNSs. I know the team at Redleaf PR, so will bend their ears about this next time I see them!

The normal way of doing things is to report on how adjusted profit compares with market expectations. That is far preferable to just disclosing how EBITDA has moved.

Also, I don’t like all this “slightly ahead”, “comfortably ahead”, and ”significantly ahead”, all 3 of which are used in the first paragraph of the RNS. That might mean different figures to different people. Just give us the figures! Even if it’s approximate, or a range.

I would much rather read that profits will be about 10% ahead of market expectations (footnote: we believe market expectations for adjusted profit to be £x). That’s a much better way to do it. Note that the trading update from Majestic Wine (LON:WINE) is a good example of an announcement which gives a footnote clarifying what figure the company believes market expectations to be. Everyone should do this! It’s so simple, and obvious, and necessary.

Maybe companies don’t like to be too specific because of audit adjustments which might be necessary. Fine. In that case, say that adjusted profits are expected to be between 5-10% ahead of expectations. An approximate range, before figures are finalised, is fine.

So although I don’t like the imprecise wording of the RNS, the news it conveys is undoubtedly positive.

Outlook - comments sound positive too;

Following record results in 2016, the Board is confident in the Company’s ability to deliver another year of profitable growth in 2017 based on healthy market conditions in our core markets and encouraging growth opportunities in our other territories.

The Board’s confidence is further supported by encouraging pro-growth corporate tax reform and fiscal policy proposals in the United States.

Dividends – the dividend policy is being increased, from distributing 30% of PAT, to 40%.

The company also says today that it intends paying out surplus cash to shareholders later in 2017, as it has more than $10m in net cash (being its targeted level). So we can look forward to a special divi also – how wonderful!

My opinion – as you’ve probably gathered, I really like this company!

I should mention the downside risks though. If you look back to 2008, the company ran into serious problems, as demand fell off a cliff. It supplies big ticket capital equipment, so in a recession, demand will undoubtedly drop heavily.

Therefore this share is unlikely to command a high PER, because investors will want to factor in the big cyclicality into the valuation.

The PER is only about 10, which for a cash rich company that is trading so well, seems fundamentally under-priced. It wouldn’t surprise me at all if this was the next company in my portfolio to receive a takeover bid? It looks just the type of company (similar to Avesco in some ways) – management who are getting on a bit, plenty of cash, a lowly valuation, and operating in a specialist niche. All of which makes the company very attractive to potential bidders, I reckon.

With Trump apparently about to embark on an infrastructure boom, this stock looks well placed to benefit (most profits are made in USA). At this valuation, what’s not to like? I think 300p+ could be on the cards by this time next year, providing nothing goes wrong macro-economically.

Also, I forgot to mention that of course Somero earns amp; reports in US dollars, so its profits translate into much higher sterling amounts, due to dollar strength vs sterling. Clearly that has been a powerful tailwind, helping this share along. Expect more broker forecast increases, I imagine. In fact, let me have a rummage through my email to see if any revised figures are out today.

Broker comments – the house broker has upped its 2016 EPS forecast by 7.5% today, to US c24.4 for 2016. That translates to sterling of 20.1p, giving a historic PER of 11.7.

The latest forecast for 2017 from FinnCap is US c26.1, or 21.5p in sterling, giving a current year PER of 10.9 (based on current price of 235 per share).

When you factor in the surplus cash, the PER would drop lower still. So it definitely looks cheap to me, if you’re happy with the cyclicality issue.

I’m using the fully diluted (for share options), adjusted EPS figures from a FinnCap note issued this morning, for the avoidance of doubt.

Cloudcall (LON:CALL)

Share price: 77.5p (up 20.1% today)
No. shares: 20.1m
Market cap: £15.6m

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

Trading update – the update today reads very well, hence the 20% rise in share price today. Although it’s important to remember that this is still a loss-making, cash-burning company, and has a track record of disappointing against forecasts, and repeated fundraisings (not always executed well).

Key points (this related to the year ended 31 Dec 2016);

  • Revenues up c.50% vs prior year
  • Recurring revenue up 63%
  • Loss will be in line with expectations (no figure given!) – I think this is likely to be something like £3.5m, but don’t have any forecasts to hand.
  • Bullhorn amp; other CRM relationships are now key to sales effort, and it seems to be working.
  • Customer churn has reduced amp; customer service levels improved.
  • Good visibility for 2017.
  • Cash of £3.2m (but doesn’t mention the £0.9m loan, so I make that net cash of £2.3m)

My opinion – if this was a newly floated company, without a history of disappointment, then I think (in current market conditions) there would be considerable appetite for these shares. So there is the potential here for a dramatic improvement in market sentiment, once the stale bulls have been cleared out, and providing the figures keep moving strongly in the right direction.

Cash burn is clearly still a problem though. So it’s maybe too early to get wildly excited about this share. The revised strategy of concentrating on a few key CRM partners is a great improvement, and that’s reflected in high margins, strong top line growth, and low churn.

If sufficient scale is reached, then this business would transform into something highly profitable. However, there’s a long way to go, in terms of growth, to get to that point.

My approach is to ignore the past, and assess it fresh, as of today. On that basis, I feel risk:reward is improving. Good growth, and adequate (for now) cash, means that this time next year it should be not far from breakeven. As long as the strong top line growth continues, then I’m happy to hold. If top line growth dropped to say 20%, then I’d exit stage left.

Investors love high margin software companies with high recurring revenues amp; low churn. That’s the perfect combination. CloudCall has exactly those characteristics, but the key missing link is that there just aren’t enough customers (yet)!

On balance, I’m happy to run with it. None of the above alters the indisputable fact that this has been a very disappointing share to date. However, based on a strong update today, if you look at it freshly, I think there’s a fairly good chance that the upside could be pretty good.

WORK-IN-PROGRESS – pls update this page later.



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