Profit Warning

Shares In Tricorn Group Tumble Amidst US/China Tariff Uncertainty

9th October 2019 admin

Shares in UK-based Tricorn Group (LON:TCN) today slumped 40% in early trade as a trading update revealed that an increase on tariffs on their products entering the US from China have led to delays as prices are renegotiated. The share price dived but has since recovered, but still leaves us well down on the day so far:

Tricorn would have been a mediocre investment for longer-term holders. Since debuting in 2001, the share price has seen extreme volatility and could be deemed to be roughly cyclical, dropping as low as 4.25p and threatening 40p at one stage with no real trend. Negligible dividends have been paid in this time. Last year one was paid, but for an amount of 0.2p this was not enough to get investors excited.

Tricorn are a group of companies, all specialising in tubing, specifically customised tubular assemblies. There are plenty of applications for this as demonstrated by their operating systems, in Energy and Transportation. Rather than grow organically its method of expansion has been to acquire other small niche companies.

What’s gone wrong at Tricorn?

The trading update today makes reference to two main reasons. The first:

The Period started encouragingly with the new paint facility in the USA integrating well and ahead of plan. Demand in the USA has remained broadly in line with expectations, but the USA operation has seen some short-term pressure on margins. This has been due to a lag between the impact of the increase in tariffs in the USA on goods sourced from China and the time taken to negotiate price increases with customers.

There is a certain irony in this, in that ‘The Donald’ was adamant that China would be bearing the brunt of tariffs. In all likelihood it seems both sides will have to take a hit. Products here would come under ‘building materials’ and be hit with a 25% tariff. This is significant for Tricorn as North America accounted for £10.6m of its £22m turnover last year.

We also have a sharp drop-off in the UK:

In the UK demand slowed significantly through the second quarter resulting in revenue for the Period being around 12% lower than the six months ended 30 September 2018 (the “Corresponding Period”).

This is a common theme across many industries. Robert Walters (a recruitment company) reported a similar decline yesterday. The profit warning is therefore not surprising:

There is a strong pipeline of opportunities and the Board continues to evaluate the impact of new business inload and the extent to which this can offset the impact of weaker underlying market conditions. However, the Board now anticipates that full year results will be materially lower than market expectations.

There are no new broker notes to guide us on this, but there was one (available on Research Tree) at the time of the last results, which estimated this years profit before tax to be £1.1m, which was up from £0.8m. Given that that turnover may be lower than last year it seems as if profits will come in at lower than this figure as well.

Flat Top Line Revenues, Spending Cash

Tricorn could be perhaps described as a turnaround story. There has been little in terms of revenue growth over the years but there has been a trend towards profitability (figures taken from Stockopedia)

Suggesting that either operational efficiencies have come into play, or higher margin products. As the research note suggests, there could be a large degree of operational gearing at play and an uptick in sales could lead to a disproportionately large increase in profits as many costs are already fixed.

This also isn’t a business where cash is being accumulated. Capital expenditures have eaten up the majority of what has been generated by operations, and whilst it is not the case that cash has been drained out of the business and needs to be replaced, the cash balance has gone nowhere: in effect treading water.

Problematic Debt

The company carries debt, which has not been repaid. The amount on the last financial statements was £3.6m and with an interest charge of £246k we can see this is not a cheap loan. A look at the notes says this is an invoice discounting facility, and typically interest rates for these are fairly high. The accounts note that interest rates paid are up to 12%.

The balance sheet shows a positive tangible asset value – there is £4.67m in property, plant and equipment, but it does not seem feasible that any of these could be sold to repay debt. Given the number of acquisitions it has made, there are very little intangibles on the balance sheet and depreciation charges are small.

Limitations of Size

At a market cap of just £4m, this is one of the smaller companies covered here. Buying in, and conversely selling out will be quite difficult. There is also the possibility of a firm being de-listed at this stage as there seems to be very few benefits of using the stock market.

Comment

On a price to earnings ratio, this appears very cheap, although many sites will be still using the old forecasts to calculate a forward P/E, and the profit warning today pretty much makes it known that those forecasts will not be met.

Due to operational gearing, a decrease in turnover could be quite bad for profits. A 10% cut, for instance may be enough to see any profits wiped out altogether. While the RNS stops short of mentioning numbers this sort of scenario is a possibility.

The reasons mentioned in the profit warning also appear to be quite ominous in the sense that they are not short-term fixes. I believe that the US-China tariff war will rumble on for some time yet, and in the UK economic uncertainty will not simply disappear on 31 October.

Debt is the main worry here, whilst it is possible it could be taken over a look at the share price chart shows there were no takers in the past few years. The next set of results could be very important, and I would not want to hold the shares before then. 2/5.

Profit Warning 100: Analysis of Profit Warnings By Stockopedia Stock Rank

7th October 2019 admin

This is the next in the series of my analysis of profit warnings from the data I have collected. In the past week I did look at warnings grouped by company size, you can read about it here. Here, we saw that smaller companies performed better after profit warnings than larger ones. There is not enough data to state this as fact, additionally many warnings are still very new and more time is needed to see whether the trend continues.

This time we will look at Stockopedia Stockranks (SR) as a factor. I use Stockopedia quite a lot and am a fan of it. If you are not familiar with this term, a Stockrank basically is their take on a company put into a percentage figure. It is comprised of three different characteristics, Momentum, Quality and Value and appeals to a wide range of traders.

Let us begin by reminding us of the limitations: we cannot claim to have captured every profit warning in the past year, some have slipped by, other companies have also warned more than once. Additionally, the Stockranks bring in their own limitations. They are backward looking metrics, and rate a company on what it has done, rather than its forward prospects. In general companies with higher SRs are deemed be better than ones with low ones, but this is not exclusive: there are some companies I would not touch with very high ratings, and some that are very good with very low ratings.

For reference, the Stockrank is collected on the day of the profit warning. They tend to jump about a lot and in some cases can be quite volatile.

Again, hopefully we will expand the list of data and will have more insights in time. The total number analysed goes up to 102 as it incorporates a couple of warnings issued in the last week.

Highest and Lowest Stockranks, Distributions

The highest rank was that of Plus500 (99), and the lowest was Eve Sleep (0). It seems that rank does not affect the possibility of a profit warning at all. The median SR of a company warning on profits was 56, and the average was 55.

The distribution is quite even:

We are unsure of the distribution of Stockranks for all companies, but it appears from this data that profit warnings affect companies of any SR fairly equally. With the 61-80 category being the most popular, it appears that picking companies with reasonable ratings is no real protection from future profit warnings. This makes sense in line with the ‘backwards-looking’ metric.

Performance of companies grouped by StockRank

This brought out some interesting results. Let us re-iterate that the data set is still small, and as such limited conclusions can be drawn. Price changes are from the average of first hour trading following the warning.

Companies with 81+ SR fared worst of all with a massive loss of -26.71% on average. In fact many of the very top rated stocks are yet to make any recovery, such as Plus500 (-26.53%), Royal Mail (-45.37%), and Nexus Infrastructure (-19.37%) all being 98 or above. In fact only three companies out of the 21 in this category have gone on to have a higher price since their warning, for interest these are Character Group (+15.71%), Galliford Try (+10.71%) and Portmeirion (+0.43%)

In addition, the SR picked out some businesses that seemed to have structural decline issues facing them, such as Bonmarche (85), Moss Bros (91), and some such as Goals Soccer Centres gave some really bad news in the form of accounting irregularities. Some of the worst performers were in this category.

Companies with SR of 61-80 was the most populous segment with 26 companies. The performance was middle of the road, with a average of a 9.3% decrease (this is pretty much in line with the average of the whole dataset. The distribution of profits was much better, with 10 out of the 26 being equal to or above their profit warning price. There were some big losers and winners here, Flybe had a rank of 70 and was a wipeout, KCOM had a rank of 65 and was taken over at a large premium.

Companies with SR of 41-60 overall outperformed and were up be 3.43% overall from 21 entries. In fact, more than half (11) of all companies were at higher prices than at the profit warning date. Surprisingly, there are only two companies where the share price dropped by more than another 50%: Superdry (-50.96%) and Xaar (-73.64%). This result is perhaps slightly skewed by a big outsider which was bought out: WYG had a SR of 45 but its takeover price represented a near 200% premium of its profit warning price.

Companies with SR of 21-40 were the second worst group, delivering an average loss of 19.95%. In this category, there were a couple of wipeouts: both Debenhams and Thomas Cook were not good investments. Brady (-91.22%) also lost most of its value, whereas CVS Group (+110.52%) doubled since its warning.

Companies with SR of 0-20 fared best of all, although this was on more limited data (16 entries). The reasons why jump out straight away, there are two companies which more than doubled in value: Frontier Smart (+123.18%) and the star performer Ten Lifestyle (+294.07%). There were a couple of big losers: MySale (-85%) and LoopUp (-62.71%). The big winners have skewed the results, and it’ll be interesting to see what happens on a bigger set of data.

So there we have it. The rough conclusion at present is that companies with a higher StockRank suffer more when they issue profit warnings, and the ones with the worst may actually fare better.

Some of this isn’t particularly a surprise to me. Companies with a high rank are often ‘flavour of the month’ type companies, and are often well bought. Because momentum is a component in the ranking, they also tend to be at high prices. A profit warning often derails momentum, and so these types of shares have further to fall.

Companies with lower ranks tend to be lacking this boost, and may be unpopular with investors anyway. But so far we can see that overall performance says currently that overall, companies issuing profit warnings have shown no profit and are very dependent on big outliers delivering results.

SIG Shares Tumble 20% As Construction Downturn Add to Woes

7th October 2019 admin

Shares in construction supplier SIG (LON:SHI) today dropped 20% as it revealed that poor construction sentiment was affecting its sales. We have a drop in early trade of around 20%:

The share price has oscillated around over the past couple of years and we are back to levels seen in 2016. The price has remained in a reasonably wide range of 100-150p as Brexit uncertainty has weighed heavily on this share and today is no exception.

SIG could be described as roofing specialists, and distribute products and services to small and medium enterprises to mainly UK and European users. Given that every building has a roof, this is not a bad niche at all to specialise in, and over the years they have built themselves into supply chains and become an integral part of overall construction.

It sounds impressive, but on first looks results-wise this seems less so, and SIG are quite similar to many of the contractors they supply: slow top-line revenue growth, small margins and some heavy losses due to business impairments. As we can imagine, the business is heavily tied to the fortunes of the wider construction sector, and this hasn’t been plain sailing in the past couple of years.

What’s gone wrong at SIG?

The warning comes in today’s trading statement. It’s not good news:

The Group has been reporting during the year a deterioration in the level of construction activity in key markets and highlighting a number of key indicators pointing to further weakening of the macro-economic backdrop, notably in the UK and in Germany. This deterioration in trading conditions has accelerated over recent weeks, and political and macro-economic uncertainty has continued to increase.

This perhaps comes as no surprise with Brexit due to commence at the end of October. This commentary has formed the basis of previous profit warnings for SIG as well.

Some balancing actions are mentioned:

Management is taking ongoing actions to address the continuing market weakness. Further benefits from transformational initiatives and the Group’s normal seasonality are still expected to deliver a stronger second half. However, the recent further weakening of the trading backdrop as the Group has entered its traditionally strongest trading months of the year means that the Board is now anticipating, in both the specialist distribution and roofing merchanting businesses, significantly lower underlying profitability for the full year than its previous expectations.

Not a single number mentioned in the whole statement: it would have been useful for this to be quantified, even if it is a broad number.

Perhaps some welcome news for investors:

The Group is today separately announcing that it has entered into agreements following competitive processes to sell its Air Handling Division and also its Building Solutions business, which when completed will significantly strengthen the Group’s balance sheet.

This could be significant: a look at the accounts shows that Air Handling produced £148m in revenues and £14.2m profit.

A Quick Skim Of SIG Business

One unsatisfactory thing that jumps out straight away is the heavy use of adjustments which give a misleading look to those interested in the top line figures. For instance, the 2018 profit before tax was £75.3m, this drops to a measly £17.9m after tax, as there are adjustments of £46.9m. Some of these costs refer to the exit (and impairment) of businesses, but the main item is a heavy £27.7m of restructuring costs. This item also featured heavily in the year beforehand, and given the large number of moving parts to the business, restructuring may not even be that exceptional. At the very least, this trend will continue.

This effect does not seem to be reported on the broker notes (available on Research Tree), and in my opinion it would be an error to calculate a value for business based off the back of this.

A bit of better news is that the business is heavily cashflow positive, perhaps not a surprise given that they are selling real products for real money. Heavy depreciation charges saw cash flow from operating activities at £95.6m after tax, although there have been plenty of expenses along the way to make this neutral for the cash balance. Dividends are a major expense, totalling £22.2m, as well as finance costs of £14.1m. Going against this are the sale of business units, and the repayment of debt, which has been heavy (over £130m in the past two years).

Capex costs are relatively large and previously ate up almost half of cash flow, although this number has come down sharply in the past two years to around 25%. With something like 265 locations to maintain it may be possible to envisage that even a low maintenance level of capex would be quite significant; capitalising £100,000 of plant and equipment per branch per year already leads to £26.5m. There is also a small pension deficit.

The debt pile could be a worry here. Total borrowings stood at £274.3m, although this figure has come down. Adjusted for ‘real’ profits this could be seen to be quite a high level of debt, but covenants are not mentioned. The sale of the Air Handling segment could make quite a large inroad into this pile depending on the price. The current pile of cash is large and there should not be immediate worries.

Is It Good Value?

Sentiment could not be worse currently across the wider construction sector. There are plenty of warnings out there from companies such as Kier, Brady, Keller to name a few. Although in different sectors the commentary is quite similar: an unmentioned Brexit being responsible for macro conditions being poor, and many customers holding off on spending for a while until clarity resumes.

Whether it is good value depends on your view on what these numbers will be, as no forecasts are available apart from the significantly under expectations comment. The sale of business divisions should bring the balance sheet back to a healthy position, but there is no real guarantee on how long this might take, or what the proceeds of these sales are. What we do know is that there are plenty of adjustments to be made to profits. There are many moving parts to the business and continued restructuring seems inevitable at a time when many of the rules change.

A further black mark is that as recently as 2018, the company had an accounting scandal which resulted in employees leaving after profits were over-stated. This may be historical but enough to give this a swerve from now on. Should there be signs of their divisions being sold at a good price and an end to restructuring there could be a good recovery, but it seems that at present, things will get worse before getting any better. 3/5.