Pre 8 a.m. comments
Good morning! I'm struggling a bit to find relevant news, as due to the time of year, we're getting into the reporting season for large caps with 31 Dec year ends. Smaller caps tend to follow in March.
Animalcare (LON:ANCR) issues pretty decent looking interims to 31 Dec 2012 (so a 30 Jun year end). Their market cap is £29m at 139p per share.
Turnover is up 13% to £6.1m (rather low though, given the valuation), but margins are high, underlying operating profit of £1.5m (up 20%). Basic EPS is up 23% to 5.8p. Note how most companies are reporting a higher percentage increase in EPS than in pre-tax profits, because of the reduction in Corporation Tax. This should be noted, and adjusted for by investors, as it could lead to you over-paying for growth rates which are being flattered by reducing tax charges. So in this case, EPS has grown 23%, but the real underlying growth rate stripping out tax is actually 20%.
The interim dividend has been held at 1.5p, and net cash has risen 69% to £3m. So it all looks pretty good, and they confirm expectations for the full year. That is for 10.6p EPS, so at 139p the shares look priced about right on a PER of 13. So I can't get excited about this one.
Supplier of educational products, RM (LON:RM.) had looked a basket case in the past, but their results for year ended 30 Nov 2012 issued this morning look potentially interesting. Adjusted operating profit of £13.6m, and has net cash of £37.8m. It generated a staggering £33.5m of cashflow from operations. Bear in mind the market cap is only £66m at 70p per share, and this could be quite exciting.
On digging a bit further, most of the cash effectively belongs to customers, as there is a £26m deferred income creditor (to reflect cash paid up-front by customers). Also there is a big pension deficit. The 3p full year dividend is maintained, giving a nice yield of 4.3%.
Therefore RM (LON:RM.) is the one share this morning I would be focussing on to decide whether or not it's a buy, but it looks promising to me on an initial glance at the figures.
Post 8 a.m. comments
Having read some more of the results statement from RM (LON:RM.) I'm cooling on that one, as Tweeted at 8:11 a.m., as the outlook doesn't sound great. Inevitably they must be coming under pressure from Coalition restraint on public spending, so I'll pass on it for the time being, and maybe revisit when I have more time to go through the numbers in more detail. Although the 4.3% dividend yield looks appealing for long term investors.
It's also worth commenting on the difficulty in unravelling pension deficits in company accounts. There seem to be two methods of calculating the deficit. In the case of RM, the balance sheet shows a £20.4m pension deficit, which note 13 indicates becomes £15.7m after allowing for deferred tax. That doesn't sound too bad, in the context of RM's large net cash & cash generation.
However, on reading the accounts narrative, you then discover that there is a different, and much worse set of valuation figures for the pension fund, as follows:
The triennial valuation of the Scheme's position at 31 May 2012 for statutory funding purposes showed a Scheme deficit of £53.5 million (31 May 2009: £16.6 million). This significant increase in deficit was primarily due to a deterioration in market assumptions, such as government gilt yields, used to value the Scheme's liabilities. A deficit recovery plan over 15 years has been agreed with the trustees which includes provision of a parent company guarantee to the recovery plan, an initial payment of £5.0 million which was made in October 2012 and annual deficit recovery payments of £4.0m for the year to 31 May 2013, and £3.6 million subsequently. Total deficit recovery payments in excess of current service cost for the year were £7.2 million
So my point is that accounts presented using IAS 19 simply do not give an accurate picture of true pension liabilities, and the cashflows needed to rectify that deficit. This is something that the accounting profession needs to rectify urgently, as at the moment RM's accounts effectively seem to understate the pension liability by £33m, or about half the entire market cap of the company!
Therefore, there's no substitute for getting under the hood, and looking at the detailed pension fund figures. Ideally I avoid companies which have any final salary pension funds at all. In this case it has certainly put me off investing, along with the deteriorating trading outlook.
Pension deficits do perhaps present an opporunity at the moment though - as Gilt yields are now rising, which will push up the corporate bond yields which are used to calculate pension scheme liabilities. So rising Gilt yields will feed through into reduced pension deficits from now on, if that trend continues.
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Also in a more bullish market, many investors tend to completely ignore pension deficits altogether, so there is an opportunity to find shares that have been beaten down on pension fund concerns, but are now rebounding. The big one was Trinity Mirror (LON:TNI) of course, but I sold out way too early last year sadly. Never mind, we more than doubled our money from the 25p lows, so can't complain!
Interesting to see that the FTSE 100 is down over 70 points this morning, but my portfolio of small value shares is flat. The good thing about value shares is that they attract more stable investors, who don't dart in & out, but tend to buy & hold. This should mean less volatility. Although lack of liquidity can create its own problems. Compare that with frothy, over-valued momentum shares, where corrections can be swift and painful as people try to trade the fluctuations.
OK, I'm just rambling now, so will wrap it up. Sorry, there just isn't much small cap news to report today.
On a final note, I will shortly be closing my JustGiving page for my Brighton Half Marathon run last weekend. As reported here on Monday, it went really well, I ran all the way, in a time of 2hr 23m, and we beat my targets for charity fund-raising, with the grand total being £2,632 raised for MacMillan Cancer Care, and Sussex Beacon!
So a huge thank you to everyone who donated, as most of the donations came from people who read these reports. Of course if anyone would still like to contribute, that would be great.
I've signed up to raise money for Scope in the Royal Parks Half Marathon in October, and if any readers fancy joining me, we could run as a team!
See you same time tomorrow.
Regards, Paul.
(of the shares mentioned today, Paul does not have any long or short positions)
About the Author's Blog
Experienced UK small cap investor & independent analyst, Paul Scott (aka. "paulypilot"), casts his eye over results RNSs each morning. His reports are now published exclusively on Stockopedia in stages each morning - with a first comment just before market open at 8 a.m., then additional updates throughout the morning… ...read more or visit website »
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All opinions expressed are the personal views of Paul Scott only, and not Stockopedia. Opinions are believed to be true and therefore constitute fair comment. Paul's opinions NEVER constitute financial advice, and should not be misconstrued as such. Readers should take professional advice as appropriate in managing your investments. If you spot a factual error in Paul's reports, please let him know, and he will happily correct the article together with an apology as soon as possible.
Animalcare Group plc is a supplier of generic veterinary medicines and animal identification products to companion animal veterinary markets. The Company develops and sells goods and services to veterinary professionals principally for use in companion animals; operating directly in the United Kingdom and through distribution and development partners in key markets in Western Europe. Its principal product lines are licensed veterinary medicines and companion animal identification products and services. The Company’s subsidiaries include Animalcare Ltd and Naychem Limited. more »
RM plc is a United Kingdom-based company. The Company is engaged in the supply of educational products and services to schools, colleges and universities, local government and central government departments and agencies. The Company operates in three segments: Assessment and Data, which includes systems, platforms and outsourcing for testing and qualifications, and data analysis and dissemination services for teachers, parents and policy makers; Learning Technologies, which comprises classroom technology, including learning platforms, computer systems and interactive teaching equipment and infrastructure and managed services, including systems, networking, management information system (MIS), access control and cashless catering, and Education Resources, which involves curriculum-focused products, including teaching equipment and materials, furniture and software. On May 10, 2012, the Company completed the sale of ISIS Concepts Limited to ISIS Concepts Holdings Ltd. more »
7 Comments on this Article show/hide all
Hi Paul
I used to work in the education sector, where RM dominated for a good few years. They then slipped up not because of any faults in their products or services, but because of price. They were effectively undercut by competitors, some of whom were new to the block and others with established bases outside the UK. Educational establishments went for the cheapest options, and often suppliers were selected by people with no understanding of IT needs. The outcomes have been almost universally disasterous. The share price was, I think, also impacted by some sort of accounting error. Overall I think RM is a good company, offering excellent service. However there may be some time lag before it can really re-assert itself again in its sector, as IT re-tooling occurs only every few years. I hope this is some help.
In reply to Beginner, post #1
Hi Beginner,
Thanks for that. So it sounds like the usual public sector sourcing issue - that people with no commercial experience whatsoever are put in charge of making massive commercial decisions using taxpayers money, and usually screw it up in some way or another.
Depressing isn't it.
Rergards,
Paul.
Contracting out in the public service has been going on for 30+ years, to say that the people working in the public sector making the decisions have no commercial experience is I'm afraid outdated and an argument that doesn't really stand up. Increasingly the public sector have employed people from the commercial sector to run their big departments and have often been criticized for doing so because they then have to pay the type of salaries expected in the private sector to get the right people in.
I see it as six of one and half a dozen of the other, in that the public sector is increasingly looking to cutback, while the private sector that did well out of contracting out in the early days really do need to tighten up. Certainly some of the companies that have managed to secure large scale public sector contracts are not always looked upon as being as good or efficient as one might like. I can think of at least one big FTSE100 company that springs to mind.
And ask yourself this. Why is it that almost every major public sector project that the private sector takes on always goes over budget? Often massively. Don't the companies themselves have some responsibility to actually know the likely end cost of what they are bidding for? I suspect that many of them have seen the public sector as a bit of a gravy train knowing that once a bid is accepted it will most likely be funded to the end anyway.
There are a number of good companies doing business with the public sector, but at a time of cuts its difficult to get enthusiastic about many of them because the market may always mark them down regardless of their performance because of sentiment.
"Why is it that almost every major public sector project that the private sector takes on always goes over budget? Often massively."
In the industry that I know well, heavy civil engineering, this was often the case. But the people who defined the contract terms, carried out the investigations needed before the work, etc. were basically civil servants, who frequently got it badly wrong.
One road job I remember well from perhaps 20 years ago was contracted at £19m and the final account was settled at £57m, iirc. Don't forget that the contractor probably had 8 weeks to price that job, and the DoT worked on its design for perhaps 2+ years, but obviously got it badly wrong, as they only pay grudgingly when the contract entitles the contractor to extra payment.
Although this isn't "contracting out" in the sense you are discussing, it is indicative of an acute slopiness in the civil service when it comes to preparing and awarding contracts, which remained the same for the whole of my working life, including projects I've been involved in recently.
I could continue, telling you stories of several times when I've attempted to show a client that his contract was as full of holes as a cullender ( which were so bad that I could explain them to my 8 year old grandson), only to be told, after a supposed review, that the CC Engineers who issued the documents could find no errors in the specification or the bill of quantities, and no doubt were shocked at the eventual final account. But I'll leave it at that.
Regards.
Since interest rates are near an all time low, a contrarian might argue that good companies whose market value is being crippled by pension liabilities are worth buying. Interest rates (and inflation IMO) are only likely to rise if only to aid govt debt, and pension liabilities will come tumbling down.
Crusty
In reply to Crusty, post #5
Hi Crusty,
Yes, absolutely, that was very much my point!
Although I do think you have to look carefully at each situation, especially as the balance sheet reported deficit is usually greatly understated compared with the deficit used for calculating the overpayments. Pensions accounting rules are a total mess right now. I tend to focus most on what actual cash overpayments the company is having to make, and over what timescale.
AGA is an interesting one, good company, but being absolutely crippled by its pension deficit, where essentially all its profits are heading for deficit reduction. That's a fairly extreme case that I am steering clear of.
You're right though, there is generally a potential opportunity here for good companies whose pension deficits should now be reducing considerably with higher interest rates.
Cheers, Paul.
In reply to Crusty, post #5
The trouble with defined benefit pension scheme deficits/surpluses is that they're very sensitive to rate of return and mortality assumption. One year of bad returns can turn an apparent suplus into a deficit, or vice versa. The root of the problem is that deficit/surplus is the difference between two large numbers: gross assets and discounted liabilities.
Where the gross liabilities of a scheme are large compared to the market cap. of the business, that's a big problem for me. It turns an investment into a speculation on whether or not the scheme's assets will ultimatley prove sufficient to pay the bill, or whether shareholder returns may be forever dimished by the constant need to top up the scheme.
In RM's case, gross liabilities stand at £132.6m (as at 30th November 2011) , somewhat large against a market cap. of £72.5m - but not ridiculously so: I wouldn't rule it out on those grounds - and Crusty's comments make sense, if that's what's holding the SP back.
Cheers,
Mark