Small Cap Report (8 Mar) - IND, AGA, CUP, SCO, ATY

Pre 8 a.m. comments

I've been away from home, working on two tiny laptops this week, so have been not terribly well organised. So I forgot that it was interm results day for my largest shareholding, Indigovision (LON:IND) yesterday, and ended up reading the figures on my phone on a train in the afternoon!

It seems to me that IND's 3 year turnaround plan under new CEO Marcus Kneen is well underway, with sales growth accelerating in Q2, and a confident outlook statement that full year results should beat last year's, therefore the sales pipeline is clearly strong. It's all coming together nicely there, after many years holding the shares, the company's full potential appears to be (at last) emerging. I'm seeing the company next week, so will comment further then, but everything the CEO told me six months ago is happening, and the market has not yet woken up to the significant turnaround that is happening at IND.

There are some really good underlying signs, such as that "3 former top peforming members of the sales team have re-joined the business". Also IND has poached a top sales manager from its largest competitor in Canada, who has commented on IND's new product pipeline being so strong that it was a no-brainer to join them. These sort of signals can often be the precursor to a big improvement in financial performance in my view, so I am quietly excited about the prospects for IND later this year.

Gross margins fell sharply, but I discussed this with the CEO some time ago, and was satisfied with his explanation that margin simply go up & down (as they have with IND) depending on which particular products & markets happen to skew the sales mix in a particular reporting period. There isn't any underlying trend, so expect margins to fluctuate between 50-60%.

In the meantime IND have raised the interim dividend by 10% to 5.5p, and 12p forecast for the full year provides a healthy yield of 3.6%. The 70p Special Dividend last year also demonstrated management's focus on delivering shareholder value, so any suprises with dividends are likely to be on the upside.

The forward PER is about 10, as this year (ending 31 Jul 2013) is expected to be H2 loaded (which they have been saying for some time, so it's not an excuse) based on timing of new product launches, etc.

Given that the stock market is far more receptive to high growth technology companies now, in my view IND shares have the potential to explode to the upside later this year, if more serious sales growth does come through. In the meantime they are reasonably priced on current forecasts, which the company has by implication just confirmed with a positive outlook statement. So all looking good in my opinion.

Post 8 a.m. comments

Full year results from AGA Rangemaster (LON:AGA) are issued today. I like this company, and briefly held shares a couple of years ago, since it is clear that the shares could have serious upside potential in a cyclical economic recovery. They have delivered a not bad result, considering the poor state of their end markets, and restricted supply of credit for big ticket items.

Turnover is slightly down, but EBITDA and operating profit are both up about 6%. Adjusted EPS is flat at 7.1p, so the shares look apparently good value at 85p (once you factor in a geared upturn in profits from economic recovery).

However, the huge issue with AGA is the pension fund deficit. This is a good example of how nonsensical pension fund accounting rules are at the moment, in that AGA only show an £11m liability on their balance sheet. Yet the true underlying pension deficit is many times that size, as evidenced by the deficit recovery payments agreed with the pension fund trustees.

AGA has last year paid £20m (meaning that its cash pile is now down from £30m to £5m, bearing in mind other cash outflows), and whilst they have a break now until 2015 when £4m is due, from 2016-2021 AGA must pay £10m p.a., with another £30m payable in 2020! So I make that £94m in cash that AGA is required to put into their pension fund between 2015-2021! That's more than its entire market cap of £59m right now.

So these shares really should be on a very low PER, given that potentially all AGA's cashflow is likely to be gobbled up by its pension fund for the next 8 years! To me that makes the shares uninvestable, certainly at a share price which seems to be largely ignoring the pension deficit altogether.

The other interesting angle on this is that now bond yields are rising, then the pension deficit should reduce, so this is a problem which might just melt away over time. That certainly seems to be what the market is pricing-in, hence why I don't think there is much of a value opportunity with the shares at this price.

Interesting to see that the CEO of Cupid (LON:CUP) has just bought a whopping 865,000 shares at an average of 114.11p, and now holds 17.6% of the company. That's a pretty serious vote of confidence, although it's worth noting that this Director has previously sold considerably more Cupid shares in the past two years (see this RNS from 12 Apr 2011, and this one from 8 Mar 2012)

Also, the Director (Bill Dobbie) has taken the unusual step of making a reassuring-sounding statement which is quoted in the RNS today, which says;

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"Following such a strong set of results, my commitment to, and confidence in the Cupid business remains as strong as ever. The business is built on solid foundations and we will continue to execute on our growth strategy. We have, and continue to make significant steps to achieve our objective of 1m subscribers across 25 markets by 2017 and thereby doubling the size of the Company."

I see that my namesake, Scotty (LON:SCO) is the latest micro cap to announce its intention to de-List from AIM, although it will remain Listed in Austria. It is interesting to read the reasons they give as to why AIM has not worked for them, and these include:

• Difficulty in equity fund-raising
• Lack of liquidity in the shares
• Volatile share price (due to lack of liquidity)
• Significant costs to remain listed on AIM
• No need for a dual listing given the company's small size.

It seems to me that the first four points in that list are generic problems with AIM, and are caused by the archaic system of having market makers maintaining quotes for a tiny quantity of shares in AIM companies, at a ludicrously wide bid/offer spread. This just deters anyone from buying or selling the shares, unless they are desperate.

Nobody benefits from this system overall. It shuts down the market in smaller company shares, so although the market makers might make a fat profit on the bid/offer spread when someone occasionally trades, most of the time the shares are just dormant with hardly any transactions.

As I keep mentioning, the solution is simple and obvious - the market needs to move from a quote-driven, to an order-driven electronic order book. This SETSmm approach already exists, and works brilliantly for larger company shares. You can either get your broker to buy directly from a market maker, or if you want, you can get your broker to place an order directly on the order book at the price you would like to buy or sell at. Even better is if sophisticated investors can have direct market access (DMA) and place our own orders on the order book, by-passing market makers altogether.

AIM will continue to flounder until the authorities grasp this nettle, and fix things. I'd like to see a highly liquid, electronic market, instead of the stagnant, old-fashioned system we have now, which seems designed to ensure investors are fleeced by a whole load of unnecessary middle-men.

Many small cap shares would come alive if they were moved to the SETSmm order-driven system. Then more companies would list in London, the whole thing would spring into activity. Sure, there would be some vested interests who would need to find some other form of gainful employment, but they are slowly killing the small caps market at the moment, so will end up out of a job eventually anyway. Bold thinking is needed, but there seems little sign of that from the LSE, from what I can gather.

Results from Athelney Trust (LON:ATY) issued today are worth a read, if you have a few spare minutes, as they always contain interesting & topical comments on the markets, economics, and politics. I also marvel at how cheaply they maintain their AIM Listing and overheads. That said, it's utterly bizarre and cannot possibly make commercial sense to have an investment trust listed, with only £3m in net assets!

There was a very interesting talk from a lady representing Investment Trusts at the recent ShareSoc investor day, so this is an area which I am beginning to look into, where it might make sense to find some good investment trusts trading at a deep discount to NAV. It's interesting to note that ATY's NAV has risen from 120p to 160p in the past year, but the shares have barely moved, and are now at 125p.

The Directors must just run it for fun, as management costs of £59k, and other overheads of £67k for 2012 are amazingly low overheads for a listed company. But that's still about 4% of the fund's net assets each year in overheads, which just doesn't stack up as viable. However, it trundles on each year, just doing it's thing!

Regards, Paul.

(of the shares mentioned today, Paul holds a long position in IND, and no short positions)