Richard Hemming, Editor of Under the Radar Report discusses the reporting season for companies' full year results. He looks in detail at some Small Caps
which could surprise including Cabcharge, Villa World and Servcorp.
What is the big theme in Small Caps for this reporting season?
The average PE 16x; well above 10 year average of about 14 times. The reporting season is coming up next month and most believe that it will showcase a big juxtaposition at both the big and the small end of town.
Divergence in expectations Industrials lower & Resources on the rise
The average PE for the market is close to 16 times, which is well above the 10 year average of close to 14 times, but is reasonable considering the low interest rate environment. Earnings growth for the market is expected to be in the double-digits, but by far the biggest growth should come from resources companies, which are benefiting from a low base and bouncing commodities prices. Meanwhile, earnings expectations of industrials have been falling and the average growth rate is in the single-digits, based on consensus forecasts.
For the previous few years it has been the other way around, where industrials provided the ballast that has kept the ASX afloat, as the miners of the world suffered from declining commodities prices.
Risk to commodity prices; Focus on industrials outlook
At any point of time, however, when it comes to analysing their prospects, there major difference between these two amorphous sectors. No matter how good a mining executive might think he is, even if he’s Twiggy Forrest, he cannot influence the price received for his company’s commodity product. A mining company’s shareholders know that today’s profit can be wiped out quicker than Australia’s previous current account surplus turned to a deficit, by a downward spiral in those prices.
The commentary around the outlook is therefore much more important from those senior executives whose thoughts and actions have much more influence on their company’s profitability, which is in the industrial world. And the small end of town is where the real action of the reporting season routinely occurs, because it’s where expectations can be missed, resulting in big wins and losses for investors. Here’s three to keep an eye on during next month’s reporting season:
Why is there more potential in low P/E stocks?
Low PE stocks have some potential to outperform and fit into the value category. For these stocks, today’s earnings aren’t as important as whether the underlying business is being rectified to give the expectation that the future is different from the past. These include engineering contractors RCR Tomlinson (RCR) and UGL (UGL), taxi payments group Cabcharge (CAB) and ship builder Austal (ASB).
Look for positive re-rating on lower P/E stocks
Already we’ve had the wholesale marketing group McPhersons (MCP) come out with its unaudited profit result, which pushed its stock up almost 15% to $1.09 on Friday. We tipped that stock at 67 cents in late January.
McPhersons sums up why the market loves a turnaround story, and buys the shares when it sees the dollars coming in. The stock has exploded so far in 2016. It’s a good example of a low margin business getting its house in order by reducing debt and paying big dividends to reward shareholders.
Investors will pay up on stocks with strong outlook and low multiples
Value is central to our philosophy at Under the Radar. What we’re trying to do is to find Growth for a Value price. We spoke to Macquarie Telecom’s (MAQ) founders and senior managers this week and it’s worth re-iterating that this stock also sums up what we look for. When we tipped it around $5, and fund managers avoided it because it had a loss making business, the company was in transition and it had paid out a lot of cash and was not making an economic return.
BUT there was enough stock for a small investor to gain access to what we viewed as deep value stock which could turn into a fast growing business.
Fast forward today and it’s trading at $13.50 and there is a great deal of momentum behind it. Fund managers now cannot afford not to own it!
Are there surprises in store this reporting season?
There is often limited transparency, which is especially the case with these industrial services companies, which Macquarie Telecom is one example. So this is area where some of the biggest surprises can come. Many of these are in IT services, which include the companies we cover, Macquarie Telecom (MAQ), ASG (ASZ), Bulletproof (BPF), Empired (EPD) and Melbourne IT (MLB) which is one of our Best Ideas. You could also include the encapsulation technology provider Clover (CLV) because it services big consumer food providers.
Three stocks worth mentioning
Villa World (VLW)
We loved this stock below $2, in fact we tipped it a couple of years ago at $1.64. But shares in the East Coast residential property developer have raced up to $2.35 in the past month and clearly many investors think something good going to happen; we’re not so sure. Undoubtedly, the company will produce fantastic results for the past year; most the most important thing to look out for is its comments on its medium term outlook. After all, selling houses has been relatively easy in the past few years, but it might become harder from the big layoffs in the mining industry.
This serviced office provider has done really well, having transformed its business after aggressively expanding into the US market, just prior the financial crisis. We jumped on board in mid-2013 at close to $3.50 when its utilisation rates had stalled, but subsequently took off, along with its share price, which is now $6.70. In the past few year growth has slowed down, however. Investors will be listening out for commentary on the Brexit decision and its effect on Servcorp’s UK franchise. It will be interesting to hear what the never boring founder, major shareholder and septuagenarian Alf Moufarrige has to say.
Cabcharge Australia (CAB)
There is a lot of hype around the ride sharing service Uber, but Australia’s dominant taxi payments provider Cabcharge has steadfastly stayed Under the Radar and most importantly for us, its share price has climbed 40 per cent since we tipped it last year. The company fits into our strategic & special situation category, but hardly ever says anything to the market. In the main, the only time you get to see what’s under the bonnet, or approach any of the group’s executives is when it reports its results every six months. This doesn’t matter so much when you are making money.