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Video: Richard Hemming on Small Cap Reporting Season08.03.2016

 

What trends have emerged from the last reporting season?

Reporting season was good for Under the Radar’s stocks. Those that outperformed were priced to disappoint, but stocks like McPhersons, Specialty Fashion and UGL rose 30-40% on the day.

 

Why is there a focus on headline numbers when it comes to small caps?

Small Stocks are not analysed very often by the market. So results are more important because you don’t have many people covering these stocks and they don’t come out with releases very often

Richard speaks about the importance of analysing the composition of the profit numbers a company reports as well as its outlook statements; and being able to interpret them for share price performance.

 

When there's market volatility, should your trading strategy be different for small caps?

The question of taking advantage of over and under exuberance is addressed. In small caps where there are liquidity constraints, this is a key area.

 

Value Stocks

Richard talks about small cap stocks including the wholesale consumer products distributor McPherson’s, the fashion mass market retailer Specialty Fashion, the contractor UGL, the organic baby formula marketer Bellamy’s and the taxi payments group Cabcharge.

Cabcharge is a classic value stock. It’s about as unsexy as it gets at the moment but it is maintaining it’s 7% dividend yield – it has come of 80% in the last few years but its free cash flow is amazing. It’s operating cash flow is $20M. Compare this with Uber, that has a market cap of $62m but its going to be a long time before Uber makes a profit and an even longer time before it delivers a dividend. Cabcharge meanwhile is making a profit and giving a solid dividend to shareholders.

 

Low quality companies are rising to the top this reporting season

Wesfarmer’s chief executive Richard Goyder is the latest in a long line of businessmen to talk about Australia being a dual speed economy, which in his conglomerate’s case is evident because Coles is performing well, while coal is not.

In the world of Small Caps this dual speed is also evident. Investors have been paying a premium for perceived growth; as well as buying companies whose earnings growth relies on the wealth effect that has arisen through rising asset prices, which are in turn a product of record low interest rates.

 

Opportunities in low earnings stock

Elsewhere, they are throwing out everything else, which consists of stocks whose earnings are not going anywhere.

This reporting season it is those “everything else” stocks that have been the big performers, which is fine by us because it’s our sweet spot. When a company is trading on a single digit PE, all it has to do sometimes to get people excited is prove that it can pay dividends.

These are often companies that don’t have the high 40 per cent plus gross profit margin and return on equity of a Bellamy’s or a Sirtex Medical. What they have had were shares priced for further disappointment.

Just look at the 42% and 33% per cent spikes in the past two weeks two of our recent tips, UGL and McPherson’s. In comparison, Bellamy’s and Sirtex have both declined about 20 per cent.

 

McPhersons's

Take the consumer products wholesaler and marketing company McPherson’s. Two weeks ago, no one else would.It’s a small cap stock which brokers and many fund managers have long abandoned (not Under the Radar though). But after its result investors decided they loved a turnaround story which was finally producing the dollars to match. On our numbers, its EBITDA/Sales margin has climbed from just over 7 per cent in FY15 to current levels of 10.5 per cent, although it needs to be noted that this number is vulnerable to a weaker Australian dollar.

The really good news is that its current dividend yield of 9 per cent can be maintained due to the announcement that it will receive $20 million in business sale proceeds on 31 March, 2016, which will go to reducing its $109 million or so of debt.

 

Is the current price justified by future growth potential?

While we have been on the band wagon of some of the growth plays like Bellamy’s, Sirtex Medical and Medical Developments, after a big run, it is always prudent to ask whether the current price is justified by the future growth potential.

When you are buying a stock in any company it’s crucial to know what the expectations are for its future profits. People get carried away at both ends of the spectrum.

About the Author

Caroline Mark

Caroline is the publisher of Under the Radar Report. She has a diverse background, from producing financial publications, to fundraising and marketing.

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