Small Cap Value Report (23 Aug) - CAP, NMD, DDD, C21

Good morning! We're heading for a fairly civilised open, with the FTSE 100 Futures indicated up 16 points to 6,451.

As usual, I'll start with any news from shares in my personal portfolio. I'm encouraged by news of a successful Placing at Clean Air Power (LON:CAP). Regulars might recall that this is my favourite speculative share, given that it offers a new technology which is developed and already selling, with a major new market opening soon (the USA), with the shares at a reasonable price (in my opinion).

Their technology enables diesel-engined HGVs to operate on a hybrid basis, using natural gas some of the time, thus delivering significant fuel cost savings, especially given the boom in cheap shale gas in USA. There are two other companies doing a similar thing apparently, so it's important to remember CAP are not unique in this space, but that's usually true of everything.

I knew that CAP would need to raise more cash, and in the last few years that would have stopped me investing. However, in this case it didn't concern me, as I explained in my report here on 1 Aug 2013:

 

"I suspect they might need to raise a bit more cash in the not too distant future, but in a buoyant stock market, with interesting products, that should not be a problem. It's much easier to raise a smallish amount from Placings at the moment, there is just a lot more investor appetite than for the last five years, from what I've observed subjectively."

 

Before the Placing, the market cap was £16.8m, with the shares at 9.5p (there being just over 177m shares in issue). Today's successful Placing (i.e. it has already happened) raises another £5m, which should be plenty to keep them going for the time being (their cash burn in c.£2-3m p.a. from memory).

There are several positive aspects to this Placing:

• It has been done at a 10% PREMIUM to the prevaliing share price in the last 30 days. That is a positive sign, and is unusual (usually investors demand a discount) - that investors were keen to get involved, and are hence likely to be buying in the open market too.

 

• Two Russian billionaires (one being Roman Abramovich) offered to finance the entire Placing, but were scaled back to 1.5% of the enlarged share capital. That certainly gives CAP plenty of material to use for financial PR purposes. The enlarged share capital will be 229m shares, so at 1.5% Abramovich is only putting in £326k. Although he offered to put in £2.5m we are told.

 

 

Although one could argue that having Russian billionaires involved might be considered a negative - as it could potentially give a "whiff" to the company by association, and I don't suppose the target American market would be terribly enthused about buying products from Russians. So I think CAP were wise to scale back the Russians to a very small shareholding. The advantage is of course that follow-on funding should not now be a problem, so on balance it's probably more positive than negative.

Having solid funding in place should now hopefully iron out some of the volatility in the share price - look at the intra-day spikes in the chart for the last year:

 

Note also that CAP shares gapped up to 11.25p this morning, up 22%, so the market is clearly impressed. Although I suspect there are still some stale bulls in the share, judging by recent price movements, so we'll see whether the price rise sticks. I'm not selling any of mine that's for sure. As usual DYOR!

 

 

 

 

 

There are two profits warnings today, firstly from North Midland Construction (LON:NMD). This is a new one for me, as I've not looked at it before. It is a civil engineering group, based near Mansfield. Results today for the six months to 30 Jun 2013 show turnover up 19% to £89.4m, but a deterioration in profit before tax from £115k last year H1, to a loss of £480k this H1. Surprisingly, it is still paying an interim dividend, reduced from 1.5p last time to 1.0p this time.

The swing into a loss was due to underperformance at their building & civil engineering division, which lost £1.58m. The other division made a profit of £0.87m, so there could be some value here if the problem division can be turned around perhaps? It sounds messy, with the narrative referring to a "major problematical contract", but that this will be subject to a possible recovery claim (it doesn't say against whom).

At this stage I would normally just move on, but what intrigues me about NMD is its track record of consistently paying dividends in the years since the financial crisis. It was paying 8.5p p.a. between 2007-2010, which was then reduced to 5.5p in 2011, and 4.5p in 2012.

Chasing a high dividend yield can be dangerous though, as declining companies tend to continue paying dividends for too long, when they should be husbanding cash - this often hastens their demise (e.g. as was the case with HMV). So it's the dividend paying capacity of a company that is more important than the actual dividend paid, in my opinion.

In this case, having looked at the Balance Sheet, which is just about OK, the £2.3m net cash does not look like proper surplus cash to me, because with £54.8m in current assets, and £46.7m current liabilities, the ratio is 117%, which is acceptable, but not brilliant. Plus you could imagine that day-to-day swings in working capital would quite routinely take the company overdrawn at the Bank. They refer to problems getting customers to pay on time in the narrative, with longer payments becoming the norm, which ties up more working capital.

So on balance I don't think the dividend here is safe, which is reinforced by the interim dividend being cut from 1.5p to 1.0p. Hence I won't be buying the shares for the dividend.

Generally, I don't like these low margin building/engineering contractors. Life is so competitive for them, that wafer thin margins (if you're lucky) are all that is available, as competitors cut tenders to the bone in order to keep operating. There could be cyclical upside though? So it seems to me these shares are a straightforward gamble on a cyclical recovery enabling them to rebuild profits, especially once their problematic loss-making contract is completed.

The market cap is only £8.3m at 95p per share today, so as a special situation it might be worth a look, although I think a lot more research would be required to get to the bottom of the risks, and the potential upside. It's not for me, as I don't see enough upside to be worth putting in the work to research it properly.

On the positive side, they say that a return to profitability is expected in H2, and that the order book looks OK. I also very much admire the down to earth, straight-talking style of the narrative, which doesn't try to gloss over any negatives, it just tells it like it is. We need more of this - investors will give credit for honest Director-speak, and the obsession with spin & all the PR nonsense that you read in most results statements is refreshingly absent from NMD's results.

This is important, because I am more inclined to believe the Outlook statement, if Directors have been honest about things that have gone wrong in the current year. Whereas if they had let the PR people gloss over the truth, then I would take the Outlook statement with a pinch of salt too.

 

 

 

 

Today's other profits warning comes from DDD (LON:DDD). It is a software company specialising in turning video from 2D into 3D, from what I can gather. There has been a nice historical trend of rising turnover, and it broker into profit in 2012, after years of losses.

However, their trading update today for the half year to 30 Jun 2013 looks pretty grim to me. H1 turnover has fallen from $4.0m last year to just $2.4m this year, due to falling demand for 2D to 3D conversion software for PCs.  However, sales through TV chip manufacturers grew by 16%. The announcement says that H1 gross margin is expected to be 99% (!), but bizarrely the announcement does not give any indication of how bottom line profit is going to be affected by the sales slowdown.

Therefore, unless you know the company well, and can estimate the impact on profit, then today's statement just leaves you in the dark. The shares are down 23% to 10.4p at the time of writing, which values it at about £13.5m. I have no way of valuing the company, since the full year forecasts now look unlikely to be achieved (since they forecast $11m full year turnover, which would require a huge surge to do $8.6m in H2, over triple the turnover of H1).

So I'll pass on this one.

 

 

 

I see another Director has departed at 21st Century Technology (LON:C21). As @Fugwit quipped this morning on Twitter:

C21.L lose their Chairman, 2nd Dir resigns in 2 days. Oscar Wilde is ringing in my ears.

 

 

 

 

OK, I'm done for the day, and the week. Very quiet for news today, but next week is forecast to be busy for results.

I hope you all enjoy the long weekend. I am off to a fancy dress shop now to be fitted for my 70's pulsating disco outfit, for a party this weekend! Pictures may follow, possibly!

Regards, Paul.

(of the companies mentioned today, Paul has long positions in CAP and C21)