Small Cap Value Report (Tue 11 Dec 2018) - MYSL, ZYT, PRES, CPR, BILB

Good morning, it’s Paul here.

I’ve got to finish yesterday’s report today, as well as write a new one, so plenty to do. I’ll focus on today’s report first.

Share price: 16.2p (down 53% today, at 10:08)
No. shares: 154.3m
Market cap: £25.0m

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

Trading update (profit warning)

• Turning the RNS into bullet points;
• Challenging conditions during Q4 (Oct-Dec 2018) 
• Revenue amp; profits for FY 06/2019 will be “significantly below market expectations”
• Small underlying EBITDA loss in H1
• Actions taken should lead to a “significantly improved” performance in H2 (Jan-Jun 2019)
• Small underlying EBITDA profit expected for full year

Overall then, this is clearly a disappointing update, but it’s not a disaster. Yet the share price has been is such steep decline, that it’s almost pricing the company to go bust. This is starting to look like a considerable market over-reaction. Has the company really lost nearly 90% of its intrinsic value in the last year, as the share price suggests? I don’t think so.

What’s gone wrong?

The principal challenge has been greater than anticipated market disruption arising from changes to general sales tax (GST) regulations in Australia, the group’s largest market…

Really? I’m surprised at this. Although given that I don’t know anything about these tax changes, probably shouldn’t comment further. But I will – surely companies should take changes to taxes in their stride?

It sounds like there have also been internal, logistical problems;

… exacerbated by the product mix and an insufficient proportion of the 1P (own-buy) inventory being located in the local distribution centre.

What’s being done to fix things?

 Action is being taken to improve the product mix and inventory availability with immediate effect. All senior management and product teams are being centralised in the Sydney head office to facilitate more local sourcing and margin improvement.

That all sounds pretty basic stuff to me. Leaving an impression that this business is perhaps not terribly well managed? Still, at least they are taking the necessary actions to improve trading.

Directorspeak says;

In response to this underperformance we have significantly accelerated and expanded our existing plans to streamline the business, reduce the cost base and make changes to the product strategy. The results of these actions will be realised in the second half of this financial year.

Is it going to run out of cash?

The main argument from bears in this stock, seems to be that MYSL burns cash, and is going to need to do a fundraising.

My view is that there’s no evidence this is true. The company raised cash at IPO in June 2014, and has not come back to the market for more since then. Cash balances have fallen each year, due to a deliberate policy of buying more own-buy inventories. This results in higher gross margins, as opposed to selling inventories owned by third party brands.

Also, some cash has been spent on bolt-on acquisitions.

In the last results statement, management indicated that cash balances would rise this year, as inventories and receivables unwound (due to closing physical wholesale sites).

So for me, the crux of today’s statement is not about reduced profits, it’s whether or not the company needs more cash? Today it says;

… as anticipated, working capital improvements have increased cash balances in the period.

That’s reassuring.

Disposals?

The group has commenced a review of its operations in the United Kingdom and South East Asia in order to assess how best to deliver maximum long term value to shareholders, including consideration of strategic disposals. Collectively these regions represented c.15% of group revenue in the last financial year. The board will update on the outcome of this review in due course.

This makes sense to me. If the core business is struggling, then ditching peripheral operations is a good way to free up management time from distractions.

Ourpay – this is the group’s proprietary buy now, pay later, product. It is already in use by MYSL itself, but the plan is to roll it out to third party retailers too. At present, the stock market doesn’t seem to be attributing any value to Ourpay. I think this could provide decent upside to the share price in future.

In addition, as previously announced the group has been preparing for deployment of its Ourpay ‘buy-now, pay-later’ platform with third party customers, and is pleased to confirm it has now completed the technology integration and is undertaking a live trial on the Australian website of a UK retailer. This is an important step in the commercialisation of the Ourpay platform, for use by third parties, and initial experiences have been encouraging.

The trial period continues and further updates shall be provided in due course.  At the same time the Ourpay platform continues to grow its penetration within the group’s own customer base and now represents in excess of 20% of transaction volumes.

My opinion – obviously I’m biased, as I hold the stock, having bought back in after a positive trading update in Sept 2018.

Were there warning signs that something was going wrong? The departure of the Chairman did worry me, although he does have extensive other eCommerce investments. A relentlessly falling share price, and no Director buying, was also a concern. Although the whole small caps market seemed to be selling off this autumn, so there was no particular reason to believe anything untoward was going on here.

I’m reassured that the cash balances are indeed rising, although we’ve not been given any figures on that today.

At £25m market cap, this looks a very considerable market over-reaction, to me. Sure, things have not gone well, but it’s hardly a disaster either. Management seem to be on the case, in terms of fixing things that have gone wrong.

I don’t believe the company needs to raise more cash. Although if the Ourpay offering takes off, it might need some bank debt to fund the receivables there.

It’s more a special situation now, obviously the company is not performing as well as we would like. However, if it was trading well, then the share price would be multiples of the current price.

Fundamentally, it’s a question of whether the problems are fixable, or whether the business is in structural decline? I’m leaning towards the fixable side of things, but not with huge conviction, it has to be said.

Management are saying that Jan-Jun 2019 should show an improvement over H1, therefore the next trading update could be positive, and drive a recovery in the share price.

Bear in mind also that the shares are very tightly held, by management plus Philip Green amp; Sports Direct. So it would be pocket change for them to take the company private. I hope that doesn’t happen at this bombed out valuation, because it would be good to participate in a recovery.

Well done to shorters here, who basically got lucky. They didn’t know that the business was trading badly, and their central point that the business was going to run out of cash has been incorrect. Or maybe that’s just sour grapes from me?!!

Anyway, bottom line, at this point in time, this one has been a failure for me. That’s life – some investments work well, others go wrong.

I’m not writing it off though, as there’s no evidence of financial distress, and it should recover in 2019. The percentage gain from a bombed out share price of 16p could be quite exciting, once they get the business back on track.

Also there’s something to be said for owning shares with overseas operations, given all the political uncertainty here at home.

Stockopedia doesn’t like it, rating it as a “Value Trap”, and with a very low StockRank. So the algorithms got this one right, and I got it wrong!

Share price: 345p (down 6.8% today, at 11:29)
No. shares: 16.0m
Market cap: £55.2m

Preliminary results

Zytronic plc, a leading specialist manufacturer of touch sensors, announces its preliminary results for the year ended 30 September 2018.

The figures look to be exactly the same as disclosed in the trading update of Oct 2018 here. Therefore the figures should be price neutral.

Key features;

Revenues down 2.6% to £22.3m

Gross margin down from 41.1% to 37%, due to some production inefficiencies

Profit before tax down from £5.4m last year, to £4.2m this year. Note that the £4.2m figure is stated after one-off costs of £300k due to what they call a spurious patent infringement case. That’s a lot of money to spend on something that is spurious, so I’m a bit concerned by that.

Dividends – a stand-out feature of this cash-rich company. Raised 20% to 22.8p, which is slightly higher than EPS of 22.7p. This gives an excellent yield of 6.6% – which is the main attraction of this share.

Outlook – sounds stable, but unexciting;

“We are in a strong financial position and cash generative which provides a strong platform on which to develop our business, and to grow profits and dividends for shareholders.

Revenues and trading are currently at similar levels as last year, and the focus will be to improve margins from production efficiencies and to secure new projects from the launch of the new electronic ASIC controllers.”

Balance sheet – is bulletproof, with one of the highest current ratios I’ve seen, at 9.6.

This includes net cash of £14.6m, or 26% of the market cap! Management seem to like the big cash pile as a comfort blanket, and insurance against something going wrong in future. I think there’s a crushingly strong case for at least half the cash pile being distributed to shareholders.

Although at least there is a big dividend yield, and plenty of cash to maintain the divis, even in a bad year (which is what has happened previously).

My opinion – demand is unpredictable, as the company generally sells in large projects, to a handful of major customers. So inevitably, there is bound to be the occasional profit warning, when a gap opens up in the order book. Historically such problems have provided smashing buying opportunities for investors.

Overall, this seems a very nice share for income seekers, given that it’s high yielding, and that’s backed up with a very strong, cash rich balance sheet. The downside risk is that you never know when a glitch in trading might occur.

Also there has only been modest revenues growth (albeit at improved margins) over the last 6 years. So arguably, the PER of about 14 looks about right.

At some point, I might tuck a few of these away into my SIPP, as a long-term, income share. As with everything, given current market conditions amp; uncertainty, it’s difficult to find a compelling reason to buy right now.

Some brief snippets to round off with;

Pressure Technologies (LON:PRES) – this small engineering group, serving the oil amp; gas industry, looks potentially interesting.

Previously I was concerned about the high level of indebtedness, however this appears to have been fixed through disposals. One subsidiary is apparently being partially sold via a listing in Canada. The proceeds are equivalent to a substantial portion of the market cap, so looks transformational, if it completes.

I also like the positive outlook comments today;

Clearly, the opportunities for growth that we anticipated at the beginning of last year didn’t materialise until later in the year.  However, recent trading performance, order intake and general bidding activity indicates that we’re seeing a period of increased market activity, particularly for oil and gas, so the Board expects a much better trading performance from the Group this year….

It is worth highlighting that the trading outlook for next year is much more encouraging, with year-end order books in our core manufacturing Divisions between 36-54% higher than at the same time last year.

Overall, this looks quite interesting, and none of this positive news seems to have been reflected in the share price, which is bombed out, pretty much like everything else at the moment.

Carpetright (LON:CPR) – I did some work on the numbers, at the time this carpet retailer did a CVA. My conclusion at the time, was that the damage amp; disruption from the CVA seemed to outweigh the benefits. In addition, there’s a lot of evidence that CVAs simply prolong the agony of failing businesses, by deferring eventual failure.

LFL sales fell 16.8% in Q1, and 8.9% in Q2, due to stock availability problems, as trade credit insurers curtailed cover. That should be improving now, but even so it’s a lot of lost business. I can’t see any current trading figures for Nov or Dec, nor any meaningful outlook comments. Therefore I assume current trading is also poor.

Going concern – this is the biggest issue. The going concern note in today’s results indicates that yet another fundraising will be needed imminently;

The Directors have also considered the future cash requirements of the Group, including the expiry of the principal banking facility at the end of December 2019, and are satisfied that the facilities are sufficient to meet its liquidity needs over the course of the next 12 months.

Notwithstanding the performance, the existing facilities mature in December 2019 and it is the Board’s intention to have completed a refinancing prior to the announcement of the full year results in June 2019.

CPR is very lucky, in having highly supportive major shareholders, who seemed determined to prevent it going bust. As they’re arguably pot committed, to use a poker term, then I imagine they’ll probably be prepared to stump up more money to bail out the bank. On what terms though? Without fresh equity, it looks like it could go bust;

If the Group’s forecast is not achieved, there is a risk that the Group might not meet the EBITDA covenant and, should such a situation materialise, the Group would have discussions with its bank lenders in order to ensure it continues to comply with the terms of its bank facilities.

Without the support of the banks in these circumstances, and assuming no additional financing, the Group and Parent Company would be unable to meet their liabilities as they fall due.

These conditions indicate the existence of a material uncertainty which may cast significant doubt about the Group’s ability to continue as a going concern.

That last paragraph is to me, a massive red flag, so I wouldn’t go anywhere near this share.

Personally I try to avoid investing in anything which needs fresh equity, as the terms are unknowable, and often dilution can be brutal to existing shareholders. Especially in market conditions like we have now.

The best I can really say about CPR is that it’s managed to survive (so far), and extricate itself from onerous property leases. Is there are great business remaining? Not that I can see.

Bilby (LON:BILB) – this is a building services support group. The figures don’t look very good – profit is down.

Outlook comments look like a mild profit warning;

Already in the second half, Bilby has secured a number of contracts and as a result, revenue visibility for the Group remains strong.  However, the full revenue and earnings benefits from these contracts will not be achieved until the next financial year.

The decision to cease servicing the MOD properties, the delay in a gas installation programme and the review of certain activities within the three divisions will impact this year’s financial performance.  Nevertheless, we anticipate that revenues and EBITDA will still exceed those achieved in the preceding year.  

I have zero interest in this sector, as something always seems to go wrong.

That’s it for today. Thanks for dropping by, and I hope readers are not being too badly hurt by current dismal market conditions. There are certainly some terrific buying opportunities around, if you’re prepared to think longer term, and look through the current chaotic political situation.

It’s becoming increasingly obvious to me that Brexit simply isn’t going to happen. We’ve been carefully managed amp; deceived by the establishment over the last 2 years, into abandoning it as too difficult – which is by far the most likely outcome now, in my view.

Therefore, shares should actually be rallying strongly, but they’re not (yet). Hence why I think this is a great time to be rummaging around for bargains, in line with my crudely hand-drawn venn diagram the other day, here it is again!

(Copyright: the Paul Scott school of art and diagrams)

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