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Small Cap Value Report (Thu 23 Feb 2017) – TTR, TET, TSTL, PURP

Thursday, February 23, 2017 9:16
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Good morning!

In case you missed it yesterday, Graham kindly emailed me some new sections on financial sector companies (which he covers, but I don’t). So yesterday’s report now includes sections on Lighthouse (LON:LGT) and NCC (LON:NCC) . If you wish, you can revisit yesterday’s report here.

On to today’s results amp; trading updates.

32Red (LON:TTR) – takeover bid – this looks a done deal, as management has agreed a bid of 196p cash + 4p dividend. Since management owns 43.3% of the company, and has agreement from holders of a further 27.8%, then it’s a done deal.

The premium is only 16.3% to yesterday’s closing price, which doesn’t sound good. However, the share price had been trending upwards beforehand. Possibly driven by insider dealing? Or it could just have been because of the fairly good trading update on 1 Feb 2017 – which does coincide with the price starting to move up, so it looks alright.

Prior to the most recent trading update, the share price was around 130p, so an exit at 200p (including an imminent divi) looks a decent outcome.

Where management have big personal shareholdings, this acts as a bulwark against opportunistic, under-priced bids. So in this case I think holders have to accept that management must have secured the best possible price, given that they own 43.3% of the company.

Online gambling companies don’t tend to attract big ratings, because the customer churn is pretty nasty. So they have to constantly spend heavily on marketing to recruit new players. That’s the reason I rarely invest in this sector. Plus there are regulatory risks too, due to the addictive nature of gambling, and that it is essentially all about fleecing stupid people – by providing them with games where the odds are against them. Poker sites being the exception, where considerable skill is involved, to become a good amp; profitable player.

Anyway, there we go, we’ll be waving a tearful goodbye to TTR in due course. Well done to holders of this stock.

Treatt (LON:TET)

Share price: 314p (up 20.8% today)
No. shares: 51.8m
Market cap: £162.7m

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

Trading update – this seems to be an unscheduled update, as I can’t see one at this time of year last year. So that either means a profit warning, or the opposite – that things are going well. Happily for shareholders, it’s the latter.

This update sounds very positive;

Following the AGM trading update published on 27 January 2017, the Board is pleased to confirm that momentum has gathered pace, with the results for the six months ending 31 March 2017 (‘Half Year’) now expected to show substantial progress compared with the prior year.

This has resulted from a combination of strong growth to revenues (currently estimated to be up in excess of 20% over the comparable period last year) driven by both new business wins and growth with existing customers, combined with improved product margins as we continue to add value by moving up the value chain.

Strong top line growth, combined with higher margins, is a smashing combination, as it should lead to an operationally geared (i.e. much bigger!) increase in profits.

I’m assuming that this is all organic growth, as no mention is made of acquisitions. To check, I’ve also quickly scanned the list of previous RNSs, but the only one I can find which relates to acquisitions, is for a business acquired in 2008. If any readers know differently, then please let me know.

Order books – are “materially up” on a year ago, and it sounds like the business is humming along nicely across the board;

All of our key product categories have delivered strong revenue growth since the start of the financial year, with citrus and sugar reduction solutions producing particularly strong performances.

Earthoil, the Group’s personal care ingredients division, also continues to perform well as recent investments begin to deliver returns.

As we enter the seasonally busiest time of the financial year, it is encouraging to see order books for the remainder of the current financial year, and into next year, across the Group materially up on a year ago.

Forex – is benefiting the group overall, due to translation of overseas earnings into sterling. They could have given constant currency figures in this update, but haven’t.

Net debt – is higher than a year ago, but expected to fall significantly in H2, per the usual seasonal trading cashflow pattern.

Outlook – this is the best bit!

With the continuing momentum being delivered by our 2020 Strategic Plan, strong revenue growth, and the beneficial impact from higher product margins, the Board now believes that profit before tax for the financial year ending 30 September 2017 will substantially exceed its previous expectations.

That’s a very strong statement to make, before H1 has even finished.

Broker forecasts amp; valuation – Stockopedia shows the current consensus as 14.2p (for y/e 09/2017), so we’re now being told the company will “substantially exceed” this figure. So I’m guessing we might be looking at say 17-20p EPS range?

I’ve seen one broker update this morning, which raises this year’s EPS forecast from 13.2p to 15.9p, a 20.5% increase. Their revised forecast for the following year is only to 17.0p, which seems rather pessimistic to me. Why assume that strong growth will suddenly shudder to a halt? A business on a roll like this usually continues performing well, so personally I’d be thinking more in terms of 20p+ for 09/2018 year.

Currently at today’s 314p per share, I reckon we’re possibly valuing this share at maybe 15-16 times next year’s earnings? That doesn’t strike me as expensive, for a growth company, providing that growth continues of course. It may not, I don’t know. It would be interesting to find out what is driving the increased customer interest in Treatt’s products?

Balance sheet – I’ve had a quick review of the most recent balance sheet. Overall it looks fine. Inventories are very high, but presumably that’s because the company needs to stock a wide product range?

Also there’s a £7.4m pension deficit, that would need checking out, to make sure it’s not an iceberg deficit.

There’s a bit of debt, but not a problem at all, in my view. So yes, everything looks fine here.

Capex could rise, as mention is made of a new 10 acre site being acquired.

EDIT: please see reader comments section below for more details on this, as it appears the costs of the new site are considerable.

My opinion – this is a very impressive update today. I need to learn more about the company, and why it’s performing so well.

I flagged this share to readers here on 27 Jan 2017, saying that it sounded as if forecast upgrades were in the pipeline. It just shows – careful reading amp; interpretation of RNSs can definitely reap rewards!

Stockopedia likes it too, with a StockRank of 86 last night.

Tristel (LON:TSTL)

Share price: 167.5p (up 11.6% today)
No. shares: 42.4m
Market cap: £71.0m

Interim results – for the 6 months to 31 Dec 2016

The last update from Tristel on 13 Dec 2016 didn’t look particularly great. It said that H1 PBT was expected to rise from £1.5m last time, to £1.6m this time. Good, but not great.

The actual H1 figures out today look distinctly better than that. PBT came in at £1.7m, up 15% on prior year. This is based on sales up a healthy 22% to £9.75m for H1. Although note that the net profit margin has slipped a little – i.e. profit has increased by a lower percentage than the sales increase.

This is despite the gross margin being up nicely from 71.4% to 74.4%, demonstrating that the company has good pricing power.

The culprit seems to be a hefty increase in “Adminstrative expenses – other”, which is up from £3.85m to £4.96m, a 28.8% increase.

Overseas sales have been particularly buoyant, up 45% to £4.2m, representing 43% of total sales. Germany stands out as both the largest, and fastest growing overseas market.

Future excitement could come from expansion into the USA, where products are in the process of (hopefully) gaining regulatory approval. That could be a good catalyst for future upside on this share. Entry into N.American markets is expected in y/e 06/2019.

Forex movements are helping profitability.

Dividends – the company has an attractive policy of distributing surplus cash to shareholders. So a 3p special divi was paid in H1, plus a 2.19p final divi.

Balance sheet – is excellent. This is a capital-light business, which I like.

The company ended H1 with £3.9m in cash, and no debt. So it is financially strong.

The company is only capitalising about £0.4m p.a. into intangible assets, which looks fine.

Outlook – the company basically saying to expect more of the same, i.e. 10-15% p.a. revenue growth, a net profit margin of 17.5%+, and more special divis when surplus cash builds up.

That looks an attractive mixture to me.

Valuation – I’ve got 2 emails from FinnCap today, one saying they’re raising EPS forecast by 8.8%, and another saying they’re not raising forecasts, so I’m somewhat confused!

Anyway, it looks to me as if about 7p EPS this year is on the cards. So at 167.5p per share, I make that a current year PER of about 23.9 – so certainly not cheap.

Is the earnings growth fast enough to justify that rating? Given that this year is benefiting from forex tailwinds, which may not repeat, or could even reverse, then I’m not convinced.

My opinion – I like the company, it seems a quality business with pricing power, strong finances, and decent growth. The divi policy is also attractive. So lots to like. There’s always the potential for a takeover bid too.

Valuation-wise, I’d say the price is looking rather full now, so I’m not convinced there’s much immediate upside on this price. It’s certainly the kind of stock that I would buy on any market correction though, if the opportunity arose to buy on, say a spike down of 20%. That’s happened in the past, and I’ve generally found buying the dips here to be a lucrative strategy.

Purplebricks (LON:PURP)

Share price: 265p (up 17.3% today)
No. shares: 247.8m + 22.7m new shares = 270.5m after placing
Market cap: £716.8m (after placing)

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

£50m Placing for US expansion.

There have been 2 RNSs, the first one was last night, explaining the decision to raise £50m in fresh equity to be issued at 220p per share, so negligible discount.

A second RNS this morning confirmed the institutional placing has completed, and was “materially oversubscribed”. So this is clearly a stock that the institutions are strongly behind. Woodford’s funds are (by far) the largest shareholders in the company, at 29.1%. They’re obviously not able to go above 30%, as that level would trigger a mandatory takeover bid.

Given that the market cap has now risen to a staggering £716.8m, I don’t suppose it really qualifies any more to be included in these small cap reports. However, it’s such a fascinating stock, that I might treat it like BOO, and continue reporting on it. Also it’s one I hold, and put into Beam Me Up Scotty, in a rather fluky purchase at 125p.

I think estate agency is clearly a sector ripe for internet disruption. I did some googling the other day, and found about a dozen or so online estate agencies. Then I checked all of them on . Sure enough, Purplebricks is the clear market leader, by miles – it was claiming about 62% of the market, but in last night’s RNS that has gone up to 67% (based on listings on Rightmove).

Although it is facing some well-funded competitors, such as HouseSimple. eMoov, Yopa, and plenty of smaller operators. As mentioned before, I am firmly of the view that this is likely to be a winner takes all situation. So I am hoping that PurpleBricks might become the Rightmove in this sector. Better still, PURP is tackling overseas markets too – it’s already doing alright in Australia, and amazingly, is now going for the USA.

There’s no denying this is an audacious plan, although reading last night’s RNS, it sounds well-planned, and is being done gradually, in a few target states to begin with.

I’m all for it. In my view, taking advantage of a massive market cap, by raising more cash, and crushing the me-too online competition, was absolutely the right approach. The £50m in new shares is only 8% of the enlarged share capital too, so existing holders can’t really complain. It’s also put a rocket under the share price today, as the overall opportunity for the company is now many times larger, due to the vast size (and exorbitant fees) in the US market.

There’s lots of detail about how PURP is planning to tackle the US market in the RNS last night. It also contains an in line with expectations current trading update.

Valuation – it’s impossible to value right now. On any conventional metrics, the shares currently appear vastly over-valued!

However, genuine market disrupters like this are not valued on PER, PSR, or PBV. People are buying the potential. The business model has been proven – in the last set of interims, the established UK operation was around breakeven. However, if you dig into the broker forecasts, you can see that the business generates lovely cashflow, which it then spends on marketing. So it can flex the marketing as it wishes, to dial up any level within a wide range of profit or losses.

Clearly it’s going to run at a heavy loss to establish its operations in even a few states in the USA.

My opinion – if this works out well, then this share could be a huge multibagger. I think they’re in with a chance, and do have first mover advantage in the UK.

This share polarises opinion like few others. Talking to friends earlier, they’re mostly disparaging about it. Several have dealt with PURP agents (so-called local property experts), and found them to be clueless. The trouble is that they don’t actually have local knowledge, because they’re covering such vast patches.

Also questions have been raised about aggressive management of the TrustPilot ratings, with some negative reviews being removed.

There again, the discount to a conventional estate agent is so huge (“£5,000 – that’s a new kitchen!” as a competitor’s TV ad goes, that for sellers, I think it must be a tempting option to go with an online agent. Once a market leader is established, I think that could become an unassailable position.

Wind it forwards 5-10 years, and if things go well, then the valuation on PURP could be gigantic. On the other hand, it might all go horribly wrong. Time will tell.

For me though, the upside, if it does work out, could be so big, that I’m prepared to have a punt on it. I appreciate that most readers will probably think this is bull market froth (you may be right!) and that I’ve taken leave of my senses.

There’s a really good video of the Directors doing an investor presentation, but I can’t find it. If anyone has the link, pls could you put in the comments below, and I’ll publish it here.

Work-in-progress – please check back later.



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