Small Cap Value Report (Tue 20 Nov 2018) - KCOM, AO., TUNE, PLUS

Good morning, it’s Paul here.

To get you started today, I’ve belatedly written last Thursday’s report, which is here. It covers 3 interesting shares;

Norcros (LON:NXR)
Card Factory (LON:CARD)
Swallowfield (LON:SWL)

It’s almost time for the next Mello investor show, run by my friend, renowned investor, David Stredder. Click on the blue title above to visit Mello’s website, where tickets are available.

** STOP PRESS!!! ** – David has just messaged me with a £25 discount code for Stockopedia readers: MLStocko25

Many readers here will have been to previous Mello events, and experienced what positive, friendly, and informative events these are. David is highly selective in choosing which companies  and speakers are allowed in to present to investors. So think decent quality companies, not scammers trying to get the gullible to part with their money, as is sometimes the case at some other investor shows.

The schedule of presentations has just been published, here – with some really excellent speakers.

The Stockopedia team will be there – Ed’s talk at 2pm on Monday will, I’m sure be a highlight.

I shall be doing the Small Cap Value Report live, at 1pm on Monday. Graham will be doing the SCVR live on Tuesday morning at 9:20 – I refused to do the morning slot! Then at 4pm on Tuesday I’ll be doing a talk on small caps – themes amp; ideas.

We have socialising amp; poker in the evenings too, so I wonder if Graham and I can make it a SCVR clean sweep again?! (I won the poker tournament at Mello Derby on day 1, and Graham won it on day 2!)

I’m very much looking forward to catching up with many of you at this event. I’m not interested in, and won’t be appearing at any other investor shows – to be honest I hate doing talks, as it’s incredibly stressful. But the atmosphere at Mello is so warm amp; supportive, that it’s a pleasure to meet up with many investor friends who attend Mello events, and chat about small caps for 2 days!

Share price: 56.2p (down 39% today, at 08:54)
No. shares: 516.6m
Market cap: £290.3m

Trading update amp; revised dividend commitment (profit warning)

This is an IT and communications services group.

I last looked at it here, in June 2013, so can’t really remember anything about it. As usual in such a situation, my first port of call are the Stockopedia graphical history, below;

Declining revenues amp; EPS paints a picture of a mature, or declining business. So why has the PER steadily gone up in the last 5 years (graph 4 above)? Graph 5 suggests that the generous divis attracted investors. Although I note from the StockReport that divis were not covered by earnings – the dividend cover being only 0.73 (forecast, before today’s profit warning).

So it didn’t look very appetising even before the profit warning.

What’s gone wrong?

The Board now believes that the Group’s trading performance for the current financial year ending 31 March 2019, on a pre-IFRS 15 basis, will be weaker than originally expected.  This is principally the result of flat revenue (driven by lower than expected order intake) in the Group’s Enterprise segment and continued customer churn in the Group’s National Network Services segment (“NNS”).

It is the Board’s view that these trends will continue into the following financial year.

Impaired goodwill – a £32.2m exceptional, non-cash charge will be booked.

The most profitable segment (Hull amp; E Yorks) of the business is still performing well, with a positive outlook due to new product launch.

Quantifying the damage – not too bad this year, but sounds worse for next year;

As a result, the Board now expects EBITDA (pre-IFRS 15) for the current financial year ending 31 March 2019 to be c.5% below current market expectations. 

However, as a result of the factors outlined above, it is also the Board’s expectation that EBITDA (pre-IFRS 15) for the financial year ending 31 March 2020 will be significantly below current market expectations.

It’s a question of getting hold of updated broker forecasts, and then seeing if the share looks attractive.

Net debt – has shot up to £108.5m at 30 Sep 2018, which is £40.7m up on a year earlier.

Year end (31 Mar 2019) net debt is expected to be 10% higher than market expectations.

Dividends – sensibly the Board has decided that paying uncovered divis does not make sense. So the expected 6.0p divis for this year will now be halved to 3.0p.

Uncovered divis, at companies with a pile of debt, are rarely sustainable. So income seekers clearly made a mistake buying this share.

Balance sheet – I’ve had a quick look at the most recent balance sheet, dated 31 Mar 2018. It’s not very good. Only £13m NTAV. Quite a lot of debt (as mentioned above).

My opinion – not my sort of thing at all. I have no interest in the telecoms/IT services sector, as it’s very difficult to pick the winners.

This share is however a good lesson in making sure that big divis are (a) well covered, and (b) sustainable, in terms of both cashflow, but also balance sheet strength. The big divis here were not covered by earnings, and the balance sheet was weak – so an accident waiting to happen really. I’m not tempted to catch this falling knife.

Share price: 112.2p (down 10.4% today, at 09:20)
No. shares: 458.8m
Market cap: £514.8m

Interim results

AO World calls itself “a leading European online electrical retailer”, but it’s really a UK company, with a struggling, loss-making, sub-scale European operation too. Looking at these numbers, I think it’s probably only a matter of time before they have to face reality and close down the European operations.

Revenue growth in H1 is only +9.9% – that’s not enough to justify the sky-high rating.

It’s loss-making at the adjusted EBITDA level – due to heavy losses in mainland Europe of -£12.3m on £69.4m revenues – an awful result. UK is EBITDA profitable at £6.9m.

Outlook – the dreaded H2-wighting;

Our peak trading period began on 9 November with the launch of our biggest ever Black Friday and I remain confident of achieving long-term sustainable growth across the Group.

We expect full year results to fall within the range of Board expectations, albeit more second half weighted than previously anticipated.”

My opinion – I think this share is worth 20p, tops. Why it is still over 100p, I have no idea.

It’s just not a very good business model – low margin box-shifting, in a highly competitive market. Do customers really care about service levels, for one-off purchases? I think most people just shop around for the best price.

Bottom line is, it doesn’t make any money, and isn’t growing very fast. So what’s the point? This looks a good potential shorting opportunity, in my view. It amazes me how the valuation of this company has remained so high, given lacklustre performance, for so long. We’re now in much more sceptical market conditions, so perhaps that might be about to change?

Trading update – just a quick mention, as it’s not a small cap.

Another positive update today from this CFD provider;

… the strong momentum reported in its Q3 Trading Update issued on 23 October has continued into November to date.  Accordingly, the Board believes that the Group’s results for the financial year ended 31 December 2018 will be ahead of previous market expectations.

Outlook comments are also positive.

I’ve long ago given up trying to work out what the prospects are for this company!

It would be interesting to find out how much of its growth amp; profit has come from crypto-currency punters? It looks as if that bubble is blowing up at last, with Bitcoin now at “only” $4,400, compared with its peak just under a year ago of about $20,000. Of course, the actual value of bitcoins amp; other crypto-currencies, is nil. It’s just been a giant speculative bubble.

Where will that leave Plus 500, once its punters have run out of cash?

The profits amp; cashflows at Plus 500 are real, it’s whether they’re sustainable that is the crucial question? It will be fascinating to see how this pans out in the long-term. Today though, the market loves it, and PLUS shares are up 8.7% to 1397p.

Focusrite (LON:TUNE)

Share price: 427.5p (up 1.4% today, at 10:46)
No. shares: 58.1m
Market cap: £248.4m

Final results

Focusrite plc (AIM: TUNE), the global music and audio products company, announces Final Results for the year ended 31 August 2018.

The financial highlights look really good. This looks like a modest earnings beat – Stockopedia shows consensus of 17.0p normalised EPS expected, versus 17.6p achieved;

Balance sheet – is terrific, very strong, with plenty of cash.

Cashflow statement – also excellent, but worth noting that it capitalises a fair bit into intangibles for development costs presumably. That was £3.9m this year (£1.1m higher than the amortisation charge), and up from £3.1m last year. So profits are being slightly flattered through this accounting treatment, but it’s not a big issue. I’m just mentioning it for completeness.

Valuation – is quite high, at a PER of 24.3. That looks deserved, on the historic performance, but obviously that doesn’t leave any room for future disappointments.

Outlook – on first reading this, earlier today, I thought it sounded slightly wobbly. However, the market seems comfortable with it, as the share price is up at the time of writing;

Last year, we had a record period pre-Christmas driven by a burst of demand for the Group’s more consumer-oriented products such as Launchpad, resulting in a weighting in favour of the first half.

As anticipated, trading in the first few months of this financial year has been broadly similar to the results achieved in the same period last year.

The Board expects the current year to follow the Group’s more usual seasonal pattern and, at this early stage, believes that Focusrite is well placed to deliver further growth for shareholders.

That seems to be saying that performance in the current year-to-date is slightly down on last year. To me, that’s not a strong enough outlook statement for a stock on a PER of 24 times.

I don’t have any updated forecasts for the new financial year, but have found 17.0p and 17.2p as (possibly out of date) estimates – barely changed from what has just been reported for the past year.

My opinion – this is an excellent company, which has performed very well in recent years.

However, as alluded to above, I question if the PER of 24 is justified, given that forecasts seem to assume negligible earnings growth. That is reinforced by a not particularly strong outlook statement.

Investors need to be very comfortable that the company will out-perform again this year, to justify the toppy valuation. It’s done very well in the past, so many continue to do so.

The trend over the last year has been for steady increases in broker consensus, so that’s reassuring. Maybe the same pattern might once again play out this year too?

All done for today. I’ll add some brief additional company comments into tomorrow’s article, so that everyone sees them.

Regards, Paul.

Stockopedia