Glass skyscraper building

ShareSoc Leeds growth company seminar 19 July 2016 review (TOWN, FISH, INS & IHC)

Glass skyscraper buildingAs a North Yorkshire resident, I can’t generally justify travelling to London for investor events. So I was happy to receive an invite to the inaugural ShareSoc Growth company seminar in Leeds on Tuesday 19 July.

The Leeds seminar was apparently ShareSoc’s first Yorkshire event and featured presentations from four small-cap companies:

  • Town Centre Securities (TOWN)
  • Fishing Republic (FISH)
  • Instem (INS)
  • Inspiration Healthcare (IHC)

The evening followed a pleasant format, with a break half-way through and a buffet at the end, giving everyone a chance to speak to each other and to the execs from the presenting companies. Drinks and refreshments were available throughout and the organisation was excellent.

The location was a central Leeds hotel, just five minutes from the station and from a nearby multi-storey car park.

A similar event is planned in Altrincham in on 27 September and again in Leeds later this year, so if you’re interested in attending (it’s free), keep an eye on the Events page on the ShareSoc website.

Here’s a quick round-up of my notes from the event.

DISCLAIMER: Please note that these comments are based on my impressions from the seminar. They are not advice or buying recommendations. I haven’t looked closely at these companies’ finances but would certainly do so before considering investing. Please do your own research if you’re considering buying (or selling) these stocks.

Town Centre Securities

A small cap (£151m) REIT focusing owning and developing provincial retail property. Headquartered in Leeds, where 55% of its portfolio is located. Other major sites are in Manchester, Glasgow, Edinburgh and increasingly some of the outlying London towns, e.g. places like Watford.

Family owned, with the Ziff family controls a total of 61% of the shares, according to executive chairman Edward Ziff, who is the founder’s son. Listed since 1960 and has never cut its dividend — although the payout also hasn’t increased since 2011.

On the face of it, this looks a well-run company which has adapted to the decline of the small town high street by withdrawing from smaller towns and focusing on larger properties in key cities. The group is currently in the middle of its second successful foray into the parking business, although Ziff warned they might sell at an opportune moment, as they’ve done before.

One potential concern here is that gearing is high by REIT standards, with a loan-to-value ratio of almost 50%. This compares to c.35% for larger REITS such as British Land and SEGRO (disclosure: I own shares in SEGRO).

Ziff was unapologetic about this and says the group’s stable lease income has historically enabled the  firm to maintain high gearing without problems. He made the fair point that Town Centre Securities didn’t have to raise cash following the financial crisis, unlike a number of its peers.

A set of financial data for each company was provided by Stockopedia, which highlighted an interesting quirk. Stockopedia show’s the firm’s earnings per share falling dramatically in 2016. But this isn’t the case.

According to FD Duncan Syers, this is the result of accounting rules requiring the group to state earnings per share including a property valuation surplus. True earnings last year were 12.1p, inline with forecasts for the current year.

My view: Town Centre Securities currently trades at a 20% discount to NAV and offers a yield of about 3.7%. Earnings and dividend growth seems likely to remain slow, something Ziff blamed on the low interest rate environment. The shares look reasonably valued at the moment, but I might be tempted if they fell further.

Fishing Republic

Fishing Republic is a retail roll out that’s targeting the creation of a nationwide chain of large format (4,000 sq. ft+) fishing tackle shops.

The group floated on AIM in June 2015, and has opened or acquired four new stores since then, taking its total to 10. When questioned about expansion plans, CEO and founder Stephen Gross said that the group was comfortable with the rate of expansion it had managed since the IPO, from which I’d infer that four large stores a year is achievable, perhaps more.

Questioned about the size of the target market for acquisitions, Gross said that there were 2,300 tackle shops in the UK, of which about 100 are large enough to meet Fishing Republic’s requirement for a large format store.

Questions regarding the rate of stock turnover and working capital were raised in the context of Paul Scott’s comments on Stockopedia. FD Russell Holmes said that stock turn varies widely — some stock turns over very quickly, e.g. bait and consumables, while some is much slower. Overall he’d expect established stores to have a stock turnover rate of 3-6 months.

My view: I can see that a strong brand plus a large choice of stock in-store will help Fishing Republic build up a loyal client base. This will help to generate big ticket sales and gain market share. But it does seem to require the group to tie up a lot of money in stock. The company invested almost £1m in working capital last year, versus forecast sales for this year of £6.5m.

If historic operating margins of 10%+ can be maintained, along with decent like-for-like growth on top of acquisitions, then this model could work. The group recently raised £3.75m in a placing from a group of investors including former Tesco boss Sir Terry Leahy (disclosure: I own shares of Tesco). This year’s interim results should provide a more accurate view of progress.

Instem

Instem provides software and related services which helps life sciences and pharmaceutical companies manage and compile the data they need to test, develop and gain approval for new products. The company has an impressive roster of clients, including most of the big pharmaceuticals.

As you might imagine, developing and testing new drugs involves a lot of data. Because patent protection starts from a relatively early point in the development process, there’s money to be made from speeding up this timeline. Doing so extends the time during which the drugs can be sold with patent protection — i.e. at much higher prices. The impact of the ‘patent cliff’ seen over the last few years has brought this into sharp focus, both for investors and for the industry.

Instem’s goal is to make itself an indispensable service provider whose software helps speed up drug development. A 98% customer retention rate suggests that Instem’s products are quite sticky. Once years’ of test data are populated into a system, shifting to an alternative isn’t attractive.

Looking at the financials, Instem’s revenues have risen by 63% since 2010, but profits haven’t followed suit. The company says this has been due to investment in a more comprehensive global sales and support network.

My view: CEO Phil Reason says the firm’s expansion is now largely complete and that results should start to follow. Current broker forecasts are for earnings of 10.4p per share this year, putting the stock on a P/E of 22.

I can see that helping manage big data for pharmaceutical firms could be a big business. But I’d want to do more research to understand the size of the potential market and the position of Instem’s competitors.

I’d also take a closer look at the firm’s accounts — Instem is quite an old business and a quick look shows a £3.9m pension deficit that required a £427,000 cash payment last year. These are material figures versus a forecast 2016 net profit of £1.7m.

Inspiration Healthcare

Inspiration Healthcare arrived on AIM last year by reversing into medical equipment firm Inditherm. Thus all the historic financials available on Stockopedia and elsewhere for Inspiration Healthcare are misleading — they refer to Inditherm, not Inspiration.

Inspiration specialises in selling medical equipment for neonatal intensive care and operating theatre applications. It started as a distributor, but is moving progressively into selling its own equipment, which offers greater growth and profit potential.

The company was founded in 2003 by CEO Neil Campbell and sales director Toby Foster, who were at the presentation. They came across as expert and enthusiastic and clearly have a successful long-term partnership. There’s certainly a key person dependency here — if either were to leave the company, shareholders would be right to be worried, in my view.

The firm does a lot of business with the NHS — Campbell estimated that some of its core neonatal intensive care equipment has a penetration rate of 70-80% in UK hospitals.

Overseas growth — selling its own product range — is an opportunity that could deliver long-term gains. However, this may come at a measured pace, due to the time which can be required for regulatory approvals.

The UK’s leadership in medical training appears to be a key advantage in terms of overseas growth. Doctors from all over the world are trained here. They then do rotations in NHS hospitals, where they gain exposure to Inspiration’s equipment. On returning home they then act as advocates for its adoption in their own countries.

Inspiration stock is very tightly held by Campbell, Foster and the two other founding investors. Free float is just 20% and the spread is pretty painful. Campbell says they are aware of this problem and are working on a way to release stock into the market without (in their view) selling too cheap or spooking the market with an apparent founder exit.

My view: According to Campbell, the company has always been cash generative and remains so. Forecasts for this year and next put the stock on a P/E of about 17, which seems reasonable for a company with a track record of steady growth. As with Instem, I’d want to do more research to understand the competitive landscape and growth potential.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Onshore oil installation

Answering questions about Gulf Keystone Petroleum Limited

Onshore oil installationDisclosure: I have no financial interest in any company mentioned.

I’ve received a couple of emails from readers regarding Gulf Keystone Petroleum (GKP.L).

The bulletin boards are awash with complaints suggesting that the board of directors have failed in their duty to shareholders — and that a takeover bid at a ‘fair’ price may be just over the horizon.

Rather than responding to emails individually, I thought I would comment on some of the points raised here.

For what it’s worth, I think a takeover bid is unlikely.

I think the real problem is that shareholders have misunderstood the significance of Gulf Keystone’s debt. The interests of the firm’s lenders rank above those of shareholders. Because Gulf is in default, shareholders are not entitled to anything until the firm’s lenders recover both the money they’ve lent and the interest due on it.

This is  how corporate financing works — debt is senior to equity.

It’s exactly the same as when a homeowner is in arrears on their mortgage. The mortgage lender can repossess and sell the home without any regard for the interests of the homeowner (who is the shareholder in this scenario).

A takeover would be expensive

The other point is that Gulf’s debt would inflate the true cost of any takeover.

For example, in a regular takeover situation, a buyer would have to accept and fund Gulf Keystone’s $575m of bonds, plus interest. In April, Gulf said that $71m of expenditure would be required just to maintain production at 40,000 bopd. So that’s $646m in total, plus interest, without any production increase and with the shares valued at 0p.

Adding interest payments plus a notional (and very generous) 20p per share would take this total close to $1bn.

And that’s without considering the investment needed to increase Shaikan production to Gulf Keystone’s medium-term target of 100,000 bopd. We don’t know what the cost of this would be, but Gulf said earlier this year that $71m would be needed just to maintain production at 40,000 bopd, while $88m would be needed to increase production to 55,000 bopd.

It’s probably fair to assume that the total needed to get to 100,000 bopd would be significantly higher, or else the firm would have mentioned it in April’s update.

Given the low oil price and the difficulties that Kurdistan producers have in collecting payment for oil exports, an upfront investment of $1bn+ in Shaikan may not be a very attractive opportunity. The return on investment could be lower and slower than expected.

What next?

As I write this on Monday morning (18 July), the shares have spiked up by 20% to 3.8p. In my opinion, this is a good selling opportunity. I expect them to fall to the refinancing price of 0.82p and perhaps below in due course.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Stamps

Stanley Gibbons’ latest update reveals boardroom purge and aggressive accounting

StampsDisclosure: I have no financial interest in any company mentioned.

Today’s update from troubled stamp deal Stanley Gibbons (see here for my previous coverage) has triggered a further slide in the firm’s shares.

As is traditional, the update started with the good news. Targeted annualised operating cost savings of £5 million have now been secured, and further savings may be possible.

I’m also pleased to see that the company is likely to abandon its  misguided attempt to build its own eBay-like online marketplace and focus simply on selling its own stock:

the Company is undertaking a full review of its E-Commerce strategy which will refocus resources upon selling its own proprietary assets of high class collectibles and world renowned publications.

More good news — in my view — is that chief executive Mike Hall and his CFO Donal Duff are to leave the business. Mike Hall was the architect of Stanley Gibbons’ debt fuelled and ultimately unsuccessful empire-building push. It turns out that Hall and Duff were also the brains behind some quite aggressive accounting.

In an exceptionally long and hard to read paragraph at the end of today’s update, the firm provides an initial update on its new auditors’ findings.

It seems that changes will be required to Stanley Gibbons’ accounting policy for its philatelic business. As a result, “historic reported revenue and profit will be materially reduced”. There will also be a reduction in net asset value.

Aggressive accounting threatens book value

One of the things that consistently puzzled me about Stanley Gibbons’ accounts was why the value of the group’s inventories rose so quickly:

  • 31 Dec 2012: £20.7m
  • 31 Dec 2013: £30.6m
  • 31 Dec 2014: £42.1m
  • 31 Dec 2015: £53.8m

The group’s regular assurances that inventories were held on the balance sheet at cost led me to assume that the firm was simply buying everything possible into a rising market. Stock was also added from acquisitions.

This explanation would have been bad enough. I was already expecting big impairments in the firm’s next set of accounts. However, today’s update makes it clear that the true explanation may be even worse.

The group’s investment plans have drawn a lot of money into the rare stamp business over the last few years. One of their attractions (and I use the term loosely) was a guaranteed buyback facility. Customers wanting instant cash at the end of their plan could sell the stamps back to Stanley Gibbons, usually at pre-defined discount their current catalogue price.

These stamps were then returned to Stanley Gibbons’ inventories — but how was the cost booked? Today’s update seems to imply that they returned to the inventory at their repurchase cost, not the cost at which they were originally purchased into the business (my emphasis):

The necessary accounting adjustments will also increase the carrying value of creditors at 31 March 2016 and require the carrying value of a related element of stock to be reduced from the price at which it was repurchased back to original cost.

Presumably Stanley Gibbons justified booking stamps at their repurchase cost on the basis that they had been repurchased from a third party. There are two problems with this logic, in my opinion:

  1. The stamp is effectively being valued based on a discounted retail catalogue price. Subsequently describing the inventory as being held at cost seems disingenuous to me.
  2. This valuation isn’t based on a market transaction, it’s based on the company’s own catalogue prices. Most stamp experts I’ve spoken in the past agree that these prices are at the upper end of what’s commercially achievable. Now that the market appears to be cooling, there’s a real risk that the book value of some stock will be above its current market value.

This historic accounting policy may help to explain why Stanley Gibbons’ operating margins and cash flow collapsed in 2014 and 2015. I imagine that company was spending a lot of cash on repurchasing stock at potentially inflated prices.

This news may also shed some light on why the company’s previous auditors resigned in Februray. The outgoing auditors considered “the risks and uncertainties associated with the audit to exceed the level that they are willing to accept.” I suspect what they really meant was that having previously signed off on Stanley Gibbons’ aggressive accounting, they were not the right people to unravel and correct it.

Is Stanley Gibbons still a sell?

I think we can be fairly confident that Stanley Gibbons’ last reported inventory value of £54.9m is going to materially impaired in the firm’s next set of accounts. But that’s already reflected in the price, to some extent.

What’s less clear is whether market conditions have continued to deteriorate. Today’s update didn’t contain any information on that front, but the firm’s last trading update (in February) wasn’t encouraging:

The Group has continued to experience lower revenues throughout the business, with sales of rare collectibles to high net worth clients being at a lower level than expected and trading being particularly difficult in the interiors division.

Today’s update makes it clear that the company is having a boardroom clear out. The CEO, CFO, former chairman and another NED are all leaving the business. New chairman Harry Wilson has become the executive chairman and will take a more active role in managing the turnaround, alongside the new Group Managing Director and CFO, Andrew Cook.

I believe that Stanley Gibbons’ stock, expertise and reputation in the philatelic sector remain valuable. I’m impressed by the speed, confidence and expertise with which Harry Wilson (who is a stamp collector) appears to be taking control of the business.

My view is that at some point soon, Stanley Gibbons could become an attractive turnaround investment.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

A share tip circled in a newspaper share listing

Restructuring pays dividends for Fenner in tough markets

Disclosure: I own shares of Fenner.

Today’s third-quarter update from portfolio stock Fenner (FENR.L) was reassuring. The group said that trading was in line with expectations and that cost-cutting and restructuring were delivering the expected results.

The group’s medical business “is continuing to perform well” while efficiency measures and market share gains in the oil/gas and mining sectors are helping to improve results. A more stable outlook for the US oil and gas sector is expected to deliver profit gains in the new financial year (Fenner has a 31 August year end).

The update also touched on the referendum. As much of the firm’s revenue is in US dollars, sterling weakness will cause reported EBITDA and reported net debt to rise this year. The effect on Fenner’s net debt: EBITDA ratio (a key lending covenant) is expected to be fairly neutral and the company emphasised that this is a currency translation issue only. On a constant currency basis, net debt will be in line with expectations.

The overall outlook remains cautiously optimistic and full-year results are expected to be in line with expectations. Although the shares now look fully priced relative to current forecasts, I think that the outlook is improving for next year and that further earnings upgrades are possible.

I remain happy to hold as the recovery continues.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

CCTV security camera

Indigovision stays on hold after net cash increase

CCTV security cameraDisclosure: I own shares of Indigovision Group.

Last week’s trading update from Indigivision Group (IND.L) was broadly reassuring, albeit it revealed that like so many tech pioneers, the group is suffering from cheaper competition.

But the big news was that net cash increased to $4.6m at the end of June, up from $2.7m at the end of last year. This is presumably the result of falling inventories and/or improved working capital management. The increased cash balance means that about a third of Indigovision’s £10m market cap is covered by net cash.

Trading appears to be improving, with most of last year’s first-half loss having been eradicated, according to the firm. A full-year profit is forecast by the firm’s house broker, which is guiding for adjusted earnings of $0.24 per share this year. That’s equivalen to a forecast P/E of less than 7.

Given the discount to book value and strong balance sheet, I think the near-term downside risk is limited. I continue to hold.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.