25-Feb-2011
G8 EDUCATION & SILVERCHEF
Child's play for small cap punters
ASX Code GEM, SIV

“Roll-up, roll-up, roll-up...”


That's the call I hear coming from the corridors of G8 Education (which is fortunate to have snagged the ASX code, GEM).

The provider of child care for kids aged “six week to six years” has delivered classic small cap returns of late. Its shares have climbed almost five-fold since the start of 2010, leaping from around 21 cents to about $1.00. This is the kind of return you are never going to get from its bigger brothers. And G8's market capitalisation is still relatively small at $183 million.
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Since listing in 2007, G8 has increased its shares on issue from 44 million on listing to the current 183 million in order to purchase ever-more child care centres.

Some call it a “roll up” strategy, others call it “consolidation”. Only this month it raised $18.9 million issuing 21 million shares at 90 cents each.

G8 Education is benefiting from the continuing fall-out from the demise of Eddy Groves' ABC Learning.

A lot of Mum and Dad-type operators bought and set up child care centres on the belief that ABC would pay ridiculously high multiples. ABC has largely gone, but these people's debt remains and G8 is proving to be a life-line, albeit at much lower prices.

G8 is expanding, having purchased 120 centres and is taking its model into Asia, having recently purchased Cherie Hearts in Singapore, which has another 20 centres.

Can it remain on a roll?

The company's managing director, Craig Chapman thinks so. He was previously the managing director of travel operator S8, which got sold to the failed MFS Group.

He tells this column that his company has its sights on “about 20 to 30 groups that have anywhere between 10 and 30 centres”.

It seems the chant of “roll-up, roll-up, roll-up” has reached the ears of many. One of the many small cap fundies that have flocked to the stock has a discounted cash flow valuation of $1.63. The stock which trades on a 2011 price/earnings multiple of 11 times.

With fundamentals like this, it's easy to see why fundies are finding it hard to get off the “roll-up” merry go-round.

Financial sense

The big theme that has dominated this month's earnings results for small caps has been the dual nature of the economy. The results for the vast majority of industrials have been ordinary or flat – the highlight being the dismal performance of retailers (with the notable exception of JB Hi Fi); in contrast, those companies in the resources sector, and in the resource services sector have generally been turned in good results, exceeding expectations that were already high.

One of the themes missed by commentators, according to small cap specialist Peter Mouatt of Adam Smith Asset Management is the strong performance of the junior financials, or credit providers.

These include ThinkSmart (TSM), Thorn Group (TGA), Flexi-Group (FXL) and Credit Corp (CCP). All have climbed strongly this month – in the case of FXL and CCLP by 30 per cent and 25 per cent, respectively.

The reason given by Mouatt, who happily (for him) just happens to own most of them is simple:

“All have been disciplined on pricing and costs; there is a background of reasonable growth, and they tend to operate in niche segments...they've had the ability to be immune from the chill winds of the economy.”

Of course, we shouldn't forget that one of their bigger brothers, the Commonwealth Bank of Australia, this month delivered a 13 per cent increase in first-half cash profit to a record $3.34 billion, while National Australia Bank unveiled an 18 per cent increase in first quarter profit to $1.3 billion

Still, most of the junior financials, are trading on PEs of close to 10 times, a discount to the small caps industrial market average of close to 13.

The one exception to all this is Silver Chef (SIV) which leases kitchen equipment to restaurants. At $3.75 before today's trading, its shares have declined by about 11 per cent from their record high earlier this month after producing one abnormal expense too many in its interim profit result.

Still, chief executive Charles Gregory tells me the future looks rosy because of the big banks' lack of appetite for the SME market post GFC:

“Banks have retreated from the market and the type of lending we do for small businesses...our biggest competitor is cash, people mortgaging their homes.”

In the light of the residential property market, he doesn't sound worried about the competition.

Karmel-who?

Lastly, an email from Ben Richards, a director and principal at Richney Capital hit the inboxes of some small cap managers around town.

Ben was spruiking a biotech, KarmelSonix - “The New Paradigm in Asthma Management”.

It is also a company, he says, that is raising $5 million. The thing is, the email came in on a g-mail account, Ben didn't provide a phone number and I tried googling his company Richney Capital and nothing came up. The smallcap fundies I spoke to are all putting KarmelSonix very much in the wait and see box. If you are going to go on and be the next Genentech, you need better PR than that.

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