Small Cap Value Report (Thu 20 Jul 2017) - IQE, EGS, UCG, BOOM, CARR, MTC

Good morning ladies amp; gentlemen. It’s Paul here.

They say that the early bird catches the worm, and that’s very true in stock market terms. I wish I could discipline myself to start work properly at 7am each weekday, but I can’t. It’s usually more likely to be a quick run through a few RNSs on my iPad, then back to sleep.

As luck would have it, I started work today at 5:30am, wanting to get the monthly accounts done for a share club where I’m treasurer. So by 7am I was fully functioning. That was good, as I spotted 2 companies in particular, where some really good news came out, and I was able to buy, or top up, at the opening bell.

So let’s start today’s report with those 2 companies.

Share price: 97.75p (up 15.0% today)
No. shares: 676.5m
Market cap: £661.3m

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

Trading statement – this is a Cardiff-based company which describes itself as;

the leading global supplier of advanced wafer products and wafer services to the semiconductor industry

I’ve covered this company here before, but have never really understood the sector, or the future potential – I just crunched the historic numbers. Several readers were well ahead of the curve, spotting the opportunity some time ago, and have been rewarded handsomely so far – the share price has risen a remarkable 5-fold in the last year.

Reading its trading update today, I was struck by the comments at the end, which look game-changing to me. In particular this bit;

…In light of recent progress and its increasingly confident outlook, the Board expects the Group will now exceed market expectations for the full year and whilst it remains early into the start of the mass-market adoption of our technology, it is possible that with the current contract momentum, a more significant upgrade to current market expectations could be delivered for 2018.”

We’re in a roaring bull market at the moment, so that’s exactly the kind of announcement which is likely to put a rocket under a share price. To a certain extent, this is the type of growth situation where the share price can easily detach from conventional valuation metrics (PER, etc).

I’m not really comfortable with that approach, but it’s where the big money is being made right now. So I think it makes sense to join the party, even though I’m very late compared with more switched-on readers, who researched the company properly.

Our Graham did spot the opportunity in his report here on 14 Dec 2016, and the share has 3-bagged since then.

H1 2017 performance – the company has a 31 Dec 2017 year end, so it updates on H1 today as follows;

The Group announces that it expects to deliver revenues of c. £70m for the first half, reflecting increased sales in each of its three primary markets. Notably, photonics continued to deliver strong double-digit growth, enjoying the early phase of a significant ramp in VCSEL wafer supply for mass market consumer applications. As a result, overall wafer sales are expected to grow by c.16% against H1 2016. This has also been supplemented by c. £1m of license income (H1 2016: £3.5m). 

That’s not particularly exciting, because most of the 16% gain comes from favourable forex movements.

Capacity expansion – existing facilities are not enough for expected demand, so a further increase in capacity is being implemented – so about £15m more capex, one broker suggests today.

Free cashflow - I’ve been concerned in the past that the company produced very little free cashflow. However, I’m coming round to the view, that in a bull market, this might be ignored. It’s all about new products, and strong growth – in particular from “photonics”, which apparently is a new computer chip which allows 3D sensing, for the next generation iPhones, and other products. I think one of our best reader/commentators, Jane, mentioned this in the comments section a few months ago.

Broker notes – I’ve seen 4 broker notes this morning, 3 of which are bullish. One mentions that the upside case could be EPS shooting up to 12-15p EPS, if the new products really take off. That would clearly be very bullish indeed for the share price, even after big gains this year.

Although one broker concludes his report today by pointing out that the share is far from cheap, especially on a free cashflow basis. Although on a PER basis, it doesn’t actually look particularly expensive, for a tech growth stock. Here are the Stockopedia valuation graphics from last night. Obviously the big share price rise today will subsequently move these numbers somewhat;

These figures are based on broker forecasts which look very conservative. The opportunity here is if the company absolutely smashes forecasts in future – which they clearly hint at in today’s update.

There’s an interesting post here on Stockopedia, from nickwild, who wondered if IQE is a Minervini stock in the making? I think he might be right, I can see similarities with Minervini’s highly successful approach.

Our own Ben Hobson interviewed Minervini in Mar 2017, here.

My opinion – there’s not a lot more to say really. Just that this could, potentially, be a very interesting company. The upside from making a new type of chip that is maybe about to take off in mobile devices, seems pretty exciting.

Also, on a PER basis (if you accept the basis on which the accounts are prepared), it’s not crazily valued. The best stocks are rarely cheap, and if you stick to low PER things, you’ll generally end up buying mostly junk, as I’ve learned the hard way. Sometimes it pays to push the boat out, if there are clear signs of something game-changing going on.

The risk with higher-rated, growth companies, is that if the market as a whole has a big correction, then often this type of stock gets hit hard. So it was a nervous buy for me today, being well outside my comfort zone! Reader comments on this one very much welcomed – as I’m learning from you on this one, rather than the other way around.

Share price: 93.4p (up 11.2% today)
No. shares: 22.7m
Market cap: £21.2m

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

Pre-close trading statement – this covers the 6 months to 31 Jul 2017, so H1 of FY 01/2018.

This is a software company, which describes itself as:

the back-office workforce optimisation company

It’s a positive update:

The Group is pleased to report that trading in the first half of the financial year has been strong. The Board now expects results to be ahead of market expectations with Revenue for the full year ended 31 January 2018 to be not less than £10.5m (2017: £8.2m) and Adjusted EBITDA to be not less than £1.9m (2017: £1.2m).

It’s interesting that the company is sufficiently confident at the half year stage, to forecast a beat on its full year numbers, and even give precise figures (always good). That suggests to me that the pipeline is solid, and there’s possibly scope for a further increase in forecasts in H2 maybe?

I’m less keen on trumpeting EBITDA as if it were a proper profit number, which of course it isn’t, especially for software companies which chuck a load of the payroll onto the balance sheet, instead of expensing it.

Looking back at the cashflow statement from the last full year accounts, this company has been capitalising about £1.5m p.a. of development spend. Therefore the EBITDA of at least £1.9m above, would really only mean about £0.4m in cash profits the way I look at things.

Therefore, even on improved performance, the business isn’t worth the £21.2m market cap, in my view. However, it’s all about the future. This company has a great client list, of big organisations, and seems to be on a roll, in winning new contracts. That could transform future profitability, if things continue in the same vein.

Order book – is also strengthening. As this grows, it should hopefully see a smoother progression of profits, instead of the erratic performance in the past.

Contracted orders of revenues to be recognised beyond the current financial year end have also increased by a further 14% to not less than £21.1m (31 January 2017: £18.5m) due to the increase in sales of the Group’s Managed Cloud Services, contracts for which are longer term in nature.

So that’s about 2 years’ revenue, in the order book, a decent underpinning. Although I think it’s spread over more than 2 years, so the company will have to keep winning new business on top of that.

My opinion – I’m still nervous about this company’s past, but am slowly gaining confidence that it might be coming good.

Share price: 10.0p (down 2.3% today)
No. shares: 81.4m
Market cap: £8.1m

Final results – for the year ended 31 Mar 2017.

This company calls itself;

the third largest chain of specialist retail carpet and floor covering stores in the UK

These figures look OK. This is a tiny, illiquid share, so I’ll only mention the key things briefly.

• LFL sales +1.3% – not too bad, in a tougher environment
• Revenue flat against last year, at £21.2m
• Profit before tax also flat, at £1.5m
• EPS of 1.58p, for a PER of only 6.3
• Sound balance sheet, with net cash of £2.6m
• Divis – note that the company has paid out bumper special divis, so there could be more to come perhaps?
• Current trading – “challenging”, but LFLs have remained slightly positive. However, marketing activity has increased significantly, so that might mean profits start to slip?

My opinion – a nice little company, which is now vastly improved from when it went bust a few years ago (due to onerous leases, as is usually the case). Obviously it’s cyclical, so dependent on consumer spending, although I think it serves the cheaper end of the market, so might be more resilient than others perhaps?

A while back, I made a nice little profit on this small company, and got some lovely divis too. If you strip out the cash, then the PER is really low. Although it probably should be low.

It’s too difficult to get in amp; out of this share, due to illiquidity, so it’s not one I would revisit personally.

(I’m taking a break now, but will aim to do a few more sections, probably this evening).

Stockopedia