Small Cap Report (22 Mar) - MOSB, JDG

22nd Mar '13 by Paul Scott

8 comments 17482 reads

Pre 8 a.m. comments

A fairly quiet day for results today, after an absolute deluge yesterday. As usual I'll take a quick look at the most interesting (to me) results and publish just before 8 a.m.. Then a more leisurely look at a few more companies between 8-10 a.m..

Given my retail background, I'm drawn to today's results for the 52 weeks to 26 Jan 2013 from Moss Bros (LON:MOSB). Performance is expected to be good, as the share price has already factored in rather too much recovery for a business that has struggled to be profitable for several years now.

At 66p and with 99.3m shares in issue, the market cap is £65.5m.

Basic EPS rose from 1.63p to 2.43p, so that puts them on a lofty rating of just over 27 times. The total dividend for the year has been more than doubled, but is still only 0.9p, for a yield of only 1.4%. Put another way, the quoted bid/offer spread would consume over 2 years dividends!

Although the 2.43p EPS figures seems to be well ahead of broker consensus forecasts of 1.88p.

MOSB have a particularly strong balance sheet, with £25.7m in net cash, although that is likely to be at/near a seasonal peak at the year-end date. Current assets total £44.2, and current liabilities are only £15.9m, so there is a very healthy working capital surplus of £28.3m. Long term liabilities are only £7.5m, so working capital less all liabilities is a very solid £20.8m.

This is important, as a strong balance sheet means the company is not likely to go bust - de-risking the investment for shareholders, and giving potential upside if something good is done with surplus cash (e.g. a special dividend, buybacks, acquisitions, etc). Cash also gives suppliers confidence, giving you the pick of the best suppliers & stock, and it means you can use your financial strength to increase profit, by e.g. paying suppliers cash on delivery if they give you a discount.

I note from the narrative that they are looking at refitting 90 stores over the next 5 years, so the business will be capex hungry, and cash could decline. Although it's also worth noting that EBITDA of £7.9m last year is considerably higher than PBT of £3.0m, which implies a fairly hefty depreciation charge of…

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Boros10

22nd Mar '13

A stunningly good piece of analysis for so early in the morning. Essential reading for anyone trying to get their heads around retail and the state of the retail commercial property market.

bobdouglas

Paul,
If you believe mosb has a good enough cashflow to finance the planned store re-fits then why does the company not offer potential investors the prospect of a meaningful dividend or special dividend or share buyback or anything to encourage people to put their hands in their pockets and invest in their company?

Paul Scott

Fair point bobdouglas. Remember that I'm typing up these reports as I'm reading the results, so I do sometimes contradict myself when a point becomes clearer, as it did in this case.

Blackthorn Focus

Remember, as per my message yesterday, that you can meet David Cicurel of Judges Scientific (LON:JDG) at AIM Investor Focus 2013 in London on April 17th.

AIM Investor Focus is a Blackthorn Focus event comprising presentations from Judges Scientific (LON:JDG), Mattioli Woods (LON:MTW), Portmeirion (LON:PMP), RWS Holdings (LON:RWS) and WYG (LON:WYG).

The event is free to attend, you can register your interest here:
http://blackthornfocus.com/aif2013

David O'Hara, Blackthorn Focus

shipoffrogs

Hi Paul

I dont really understand why a company growing by acquisition can justify treating the write off of intangibles as exceptional - they did the same last year, seems pretty normal to me: but then, bang go all the profits.

Monty9

Judges CEO presents the company in terms of return on total invested capital ("ROTIC") which neatly cirmcumavigates all the goodwill / exceptionals / derivatives issues. For the most part these (certainly in the past) have been dictated by IFRS's that don't really suit the Judges operation.

I hold at a cost of about £6 having waited for a cutback since £4.2. My own judgement is that there is plenty of life in the model yet as its increasing size makes the rating of its own shares higher relative to the target companies, or in line with larger targets. I still know institutional buyers who admire the operation but cannot (or will not) buy because it is just too small - potential aid to the future rating when it reaches a MCap of, say, £100M.

But then nothing goes up in a straight line .....

marben100

I dont really understand why a company growing by acquisition can justify treating the write off of intangibles as exceptional - they did the same last year, seems pretty normal to me: but then, bang go all the profits.

To understand that, you need to understand the nature of the intangibles. NB they are "amortised" not written off - those are two different things.

This issue is to do with acquisition accounting. Referring to the 2012 accounts, see note 16. The £3.29m amortisation charge comprises the following items (all non-cash, obviously):

Item	2012 £K	2011 £K

Non-compete agreements	238	188
Distribution agreements	302	219
R&D	502	76
Sales order backlog	792	221
Brand and domain names	492	94
Customer relationships	968	357

TOTALS	3,294	1,155

Due to IFRS acquisiton accounting rules, all of the above have to be capitalised (as part of the acquisition consideration) and then amortised over their useful lives. However, once the acquired businesses are integrated, further expenditure is not generally required, except in the ordinary course of business, to retain their value. In a sense, the amortisation charge is double counting costs such as marketing which are required to maintain/build the sales order backlog and customer relationships. We already have marketing accounted for and the organic growth reported shows that this spend is sufficient to not only retain customer relationships (for example) but build new ones.

Most importantly, from the perspective of the investor, if Judges didn't make further acquisitions then these amortisation amounts would disappear after a few years and we'd expect the reported profitability of the business to reflect actual profitability excluding exceptionals.

Acquisiton accounting is a minefield and can be used to hide a multitude of sins, so it is wise for investors to be wary (those that followed the RCG Holdings (LON:RCG) story will understand what I mean!). Judges track record of strongly growing operating cashflow and management's delivery on expectations gives me sufficient confidence to retain Judges as one of my larger shareholdings, though I have topsliced along the way.

Concerning the £1.6m of derivative charges which Paul refers to, this is a compex issue relating to redeemable preference shares issued when the company was floated. They had the effect of hitting reported profits whenever the share price rose! This has distorted the accounts for several years, but in 2012 the Board took the decision to change the T&Cs associated with them, which has permitted directors to redeem or convert nearly all of them, so this effect should not impact future years. I covered this issue at length in my report on their 2012 AGM *, where we voted on that change.

I also recommed this excellent article by CantEatValue to readers.

*Only accessible to ShareSoc members, but you can sign up here, FOC if you wish.

Cheers,

Mark

For an excellent summary of the issue of intangibles take a look at the following which comes from Warren Buffett's annual shareholder letter - 2012 (pages 12 to 13). Although he refers to US GAAP rules, IFRS differ little on this subject.

"I won’t explain all of the adjustments – some are small and arcane – but serious investors should understand the disparate nature of intangible assets: Some truly deplete over time while others never lose value. With software, for example, amortization charges are very real expenses. Charges against other intangibles such as the amortization of customer relationships, however, arise through purchase-accounting rules and are clearly not real expenses.

GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses when calculating earnings – even though from an investor’s viewpoint they could not be more different. In the GAAP-compliant figures we show on page 29, amortization charges of $600 million for the companies included in this section are deducted as expenses. We would call about 20% of these “real” – and indeed that is the portion we have included in the table above – and the rest not. This difference has become significant because of the many acquisitions we have made.

“Non-real” amortization expense also looms large at some of our major investees. IBM has made many small acquisitions in recent years and now regularly reports “adjusted operating earnings,” a non-GAAP figure that excludes certain purchase-accounting adjustments. Analysts focus on this number, as they should.

And that ends today’s accounting lecture. Why is no one shouting “More, more?”

http://www.berkshirehathaway.com/letters/2012ltr.pdf

Small Cap Report (22 Mar) - MOSB, JDG

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Paul Scott

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