Small Cap Value Report (Thu 14 May 2020) - SCPA, WIN, CSP

Good morning, it’s Paul here with Thursday’s SCVR.

Timings – I’m on the case nice and early today, so we should have a decent report up earlier than usual. I’ll try to make some inroads into the backlog too, maybe with briefer comments later.

The most significant news yesterday was that a UK authority has given approval for a covid antibody test made by Roche, which has proven close to 100% accurate. The way I imagine how the future might look (important because small caps investing is fundamentally all about predicting the future), then I see an antibody test as being a game-changer an important step forward.

Take me for example, I’m fairly sure I had covid in March/April, because as I’ve previously mentioned here, in my London home all 4 of us came down with similar covid-like symptoms, at the same time. The eldest member of our household had to be hospitalised, tested positive, and died after spending a fortnight on a ventilator. The remaining 3 of us recovered, but it’s taken about 2 months to actually start feeling well again.

Hence for that reason, I am fairly sure I’ve had covid, recovered without any medical intervention, and hence probably have immunity through antibodies. Although scientists are stressing they don’t know for sure yet, nor how long the antibodies stick around for. As an aside, there’s a suggestion that the under-40s immune systems deal with it in some different, unknown way, so not everyone who’s recovered from it necessarily has antibodies apparently. Or maybe the tests didn’t detect antibodies that were there, who knows?

The point being that if we can test everyone, then we’ll know exactly who has had it, hence two things: (1) some kind of health passport could be given (maybe electronically via an app) to people who test positive for antibodies, and then allow them to mix freely with other similar people, in bars, restaurants, work, everywhere, and (2) we could then properly protect the vulnerable (e.g. in care homes) by only allowing contact with staff who have passed an antibody test. I think this could be the key to unlocking the whole situation, and allowing the economy to begin recovering from the catastrophic damage that the lockdown has caused.

In terms of shares, this makes me feel a lot more bullish on the bombed-out hospitality sector. As long as companies can survive a few more months, then business could realistically begin to resume in a reduced form. Whether that would be profitable or not, is the big question. It’s not viable to socially distance in many/most bars or restaurants, so I think the antibody testing is crucial in determining who can visit (and work in) such establishments. That does raise ethical issues though, so furlough payments would still be needed to support staff who do not have antibodies. Would some people then try to catch the virus in order to develop antibodies so they can subsequently return to work? I fear we may have to trample over some issues, in order to achieve a better overall outcome. But that’s for the politicians to worry about, and us to harangue them about!

The above also makes the risk of a second wave of covid much more manageable – i.e. it wouldn’t require another general lockdown, unless the nightmare scenario were to be that it mutates into something that nobody has immunity against, or the antibodies wear off, etc. If that were to happen, then we’re looking at an economic depression, not just a recession.

Economic damage

Newspaper articles are appearing which suggest that the UK Govt deficit this year could be a mind-boggling £300-500bn. Assuming GDP of roughly £2 trillion, then that’s about 15-25%. This is off the scale. The deficit (an annual figure remember), peaked at roughly 10% in both the early 1990s and the 2008-9 recessions. Then it gradually declined each year over about 7 years (I’m doing this from memory, so these are just ballpark numbers) to get down to the more normal levels of around 2% of GDP (which is scrubbed off by inflation effectively, so isn’t a problem at that lower level).

These articles are also reporting that the Govt is already considering tax rises, and a Govt spending squeeze, to bring the deficit down again. There will clearly be a one-off impact in the current year, with the deficit being so high due to one-off expenditure (furlough amp; other support schemes), and one-off reduction in tax receipts. Hence the deficit might naturally reduce in 2021/22 to something a lot lower, but still high in historic terms.

I mention this because we’re realistically looking at many years of so-called austerity measures from the Govt, where it once again has to squeeze the annual increase in public expenditure (which never actually goes down), and raise taxes. This is bound to have an impact on company earnings (e.g. if corporation tax is raised, as seems likely), and indirectly through slower GDP growth.

Company earnings forecasts

For this reason, I think expectations of a V-shaped economic recovery seem way too optimistic. Indeed, companies that comment on the outlook do seem to be generally saying that recovery could take several years – e.g. Land Securities said this in a recent update. This means that current broker forecasts for 2021 are probably way too high in many cases. Therefore, I think we need to treat all broker forecasts with a large amount of salt.

Hence why, as you may have noticed, I am largely ignoring existing forecasts in my articles here, unless a company has confirmed that it is trading in line with expectations, as something did yesterday, ah yes it was Focusrite (LON:TUNE) – a very nice (but expensive) share. The PIWorld video/podcast of its interim results was very informative, I listened to the podcast version last night, and it helped me better understand the business.

I remain short of the Dow, as I think the Americans are wildly too optimistic at the moment, and I reckon US markets are overdue another correction. The recent huge rally, went too far in my view.

In the UK, I think a lot of investors don’t seem to have fully grasped that company earnings are likely to be severely impacted this year, and only partially recover next year. Hence I think many valuations seem too high right now, but that’s something we have to assess for each individual share. If we’re being asked to pay top whack for shares where earnings are uncertain but likely to fall substantially, then where’s the upside? Risk:reward look unfavourable to me, for many of the shares I’m currently looking at.

I’m not convinced that UK investors will necessarily “look through” terrible 2020 figures. In my experience, when terrible figures are published, even if they were expected, there are often enough people spooked into selling, to do significant damage to the share price. Also, people often forget the effect of operational gearing – so even if a (say) 20% drop in revenues might not sound too bad in the current situation, that could feed through to wipe out profits entirely, or generate a thumping loss at a company which was only making modest profits before.

This strikes me as a terrible time to be gung-ho, or cavalier in our attitudes towards shares, we should be very wary I think – because valuations (especially for anything tech or healthcare-related) are high, and yet earnings visibility is awful for many companies. Just look at how many have completely withdrawn earnings guidance.

My portfolio – themes

Looking at my portfolio, nearly everything falls into 2 categories;

1) Companies that are trading well despite covid, and still look reasonably priced (e.g. Best Of The Best (LON:BOTB) , Gear4music Holdings (LON:G4M) , Intercede (LON:IGP) , Spectra Systems (LON:SPSY) ) – I have increased my position size in all 3 of these,

2) Special situations where I’ve taken on unusually high risk (potential substantial losses, even 100% loss), but see potential multibagger upside once recovery begins (e.g. Revolution Bars (LON:RBG) , Bigdish (LON:DISH) , Newriver Reit (LON:NRR) ) – these won’t suit most readers here for sure!

3) Larger, recovery potential shares, with less risk, but also less upside potential (e.g. Dunelm (LON:DNLM) , Marks And Spencer (LON:MKS) , housebuilders )

4) Companies which have recently refinanced, and are now seem in a more secure position for recovery amp; market share gains (e.g. Foxtons (LON:FOXT) ,

The main shares I’m trying to avoid at the moment are;

1) Too expensive, given uncertain outlook (this applies to most companies I look at, after the recent big rally!)

2) Balance sheet weakness, meaning a fundraising is likely. I’m worried that smaller companies could struggle to raise fresh equity, as the better companies seem to be moving fast, and might possibly exhaust investor appetite for refinancings? Especially if the market corrects downwards again, and funds might start to struggle with redemptions, and become forced sellers of their weaker positions, potentially smashing share prices – there was a lot of this in 2000-2002, and also in 2008-9 – forced sellers created amazing opportunities for anyone who held cash.

3) Very illiquid – hence I really don’t want to buy anything under £50m market cap, unless it’s a stupendously attractive opportunity. The reason being that if there’s another market plunge, then you can’t get out. Why take the risk? It’s not such a problem when things are humming along nicely, but in a time of recession/crisis, very illiquid shares are best avoided in my view.

4) Companies which have gone eerily quiet, and are not updating the market. This is usually a sign of trouble ahead. At times like this more than ever I need an up-to-date trading statement to decide whether a share is worth buying or not. Otherwise, it’s pure guesswork.

5) Speculative small companies jumping on the covid bandwagon, with little to nothing of any commercial value in terms of product or service – Filta Group (LON:FLTA) springs to mind.

You might want to completely ignore the above, and even do the opposite, as my strategy on long positions hasn’t really worked very well so far. In fact there have been lots of big losses – with my existing holdings being particularly hit by covid, although I don’t beat myself up about that, as I saw the risk, and hedged appropriately in late January – see SCVR 27 Jan 2020. Thankfully, my hedging/shorting activities have more than covered all the losses.

OK enough rambling, let’s take a look at some company updates today.

Share price: 208p (down 9% today, at 09:59)
No. shares: 124.5m
Market cap: £259.0m

Trading update amp; financing arrangements

This is a supply chain logistics company.

.

Revenues only down 15% in April seems quite good in the circumstances, given that many of its customers (e.g. retailers) would have been closed down. Some supply chains have shifted from stores to online.

Profits down, but it doesn’t indicate how much.

Furloughed 15% of workforce

Bank facilities - existing RCF of £141m, matures Oct 2023. Additional £40m RCF available for 12 months, but replaces accordion facility, so to my mind that means no change in total facilities. The bank has required that any divis paid in the next 12 months must be matched by a reduction in the RCF – interesting, but it indicates to me that the banks may not be entirely comfortable here. That increases the risk of an equity fundraising being needed. The comment below also hints at a possible future placing. Not surprising at all, given that Wincanton has operated with an imprudently weak balance sheet for years, and paid imprudent (reckless even?) dividends. Hence why the banks have restricted the company’s ability to pay out divis in the next year. Sooner or later weak balance sheets come home to roost.

We continue to monitor our trading and downside scenarios and will consider additional financing options in the longer term should they be required.

My opinion – I can see why this share is down 9% today. The balance sheet is stretched, there probably won’t be divis this year, and we don’t have much visibility on earnings. It sounds as if the banks might be grudgingly supporting the business, but reading between the lines I suspect an equity fundraising is likely to be necessary here at some stage. There’s also now little headroom if we see a second wave of covid, as the company doesn’t have the financial flexibility it would need. So this looks potentially quite high risk.

On the upside, revenues seem to be holding up OK, and with lockdown easing for retailers from 1 June, on a phased basis, then volumes should rise. Grocers seem to be its largest clients, so that’s ongoing revenues as they can’t shut down or we’ll all starve. The shift towards online selling still needs logistics, which must be replacing some of the lost physical retail revenues.

This strikes me as a good company, clearly experts at what they do, but hampered by a weak balance sheet. The share could bounce as volumes from retailers return, but that’s likely to be considerably less than before, and who knows what bad debt risk there is within receivables?

Overall then, I see risk:reward as unfavourable.

Share price: 307p (down 17% today)
No. shares: 405.0m
Market cap: 1,243.4m

Interim Results

I’ve been wondering why my housebuilder shares have been weak today. A look at the top % fallers today reveals why – mid-sized housebuilder Countryside is down a whopping 17% today on poor interim results to 31 March 2020.

I won’t go through the numbers here, suffice it to say that the numbers and the outlook have clearly disappointed.

Housebuilding sector generally

The 17% fall in CSP’s share price today has spooked me. Hence I’ve changed my mind on housebuilders generally, and decided to sell all my housebuilder shares today.

This also reinforces my general feeling that, once people see up-to-date figures from companies over the summer, we could see many shares drop heavily like this one. Therefore, the recent rally is looking increasingly like a dead cat bounce.

In this case, the H1 figures are to 31 March, which was only impacted by covid towards the end, yet profits dropped significantly. Maybe the bigger housebuilders are better set up, but I’m not going to stick around to find out!

Share price: 108.4p (up 1% today, at 12:25)
No. shares:
Market cap:

Placing result

30.8m new shares have been placed with institutions at 105p per share – only a modest discount, so this has been a success. Therefore, now refinanced, I’m more interested in taking a closer look at this company, which I’ve always quite admired.

(work in progress)

Share price:
No. shares:
Market cap:

Share price:
No. shares:
Market cap:

(work in progress)

Stockopedia