Three COVID-19 resistant Small Caps

Richard Hemming

Investment overview

Diversified revenue streams - limiting risk

After the health emergency is behind us, one lesson individual investors will take away is the importance of ensuring stocks that you own in a diversified portfolio are exposed to a variety of different sources of revenue. A long period of time where diversification was an abstract concept (achieved simply by owning an ETF) led many investors to ignore the need to divide their capital and expose their portfolio to a range of different drivers of revenue.

PE only means something only if you get a handle on E.

The average of all the companies’ PEs is the market. People talk about the market like it is a company. It’s not. You can invest in the market through index-linked securities like ETFs, but this is very different from investing in companies. Investing in companies is ironically safer during times of increased volatility because there are marked differences between those companies and their ability to handle the current conditions.
 
The key point is that there is increasing dispersion, which means that there is a widening divergence between the premiums or multiples investors are paying for the haves (consumer staples and the like) and the have nots (consumer discretionary stocks like travel agents).

Revenue is key

Hence if you are buying a company, you need to think about whether customers are still using its service or product. In this environment, more than any other time, revenues are the key, costs will be what they will be.
 
You’re still getting your telco bills; you’re still paying bank fees; you’re still buying groceries at the supermarket. So yes, we’ve been buying the banks, Telstra and the food retailers.
 
But we’ve been buying other stocks too.

THREE Small Caps that are COVID-19 resistant 

Essential government operations 

The shipbuilder Austal (ASB) is a key source of diversification in the Under the Radar’s small cap portfolio since around 90% of revenue is contracted from the US and Australian governments. We think companies will be able to rely on previously contracted revenue from government customers. Governments will be reluctant to allow their defence capabilities to diminish because of the impact of this virus.
 
There are big risks, but it helps if your operations are essential. Last week Austal announced that its US operations, employing 4000 people, are to remain operational, having been designated mission critical.

Strong demand for food products

Then there is Freedom Foods (FNP). It’s not hard to see why consumers are looking for its combination of dairy and plant-based food products, which include milk, nutritional powders, cereals, muesli bars and nuts. People need nutritious foods more than ever.
 
Last week on Tuesday, which seems like a millennium ago, the group said it is experiencing “strong demand for key products” including UHT dairy and plant beverages, cereals and snacks. Further, the company said it would be able to continue to supply domestic and export markets; namely its retailer customer base. Its shares spiked over 20% on the news to as high as $5.10 but have come back on market-wide selling.
 
The problems in the food supply chain are in domestic groups importing products because they are having difficulty getting access to labelling and brand packaging. Freedom does not seem to have these issues, as far as we are aware.
 
What it does have is debt of almost $200 million and climbing, having spent well over $700m on a number of initiatives, including upgrading its UHT dairy processing plant in Shepparton. There is no disclosure of debt covenants, but based on similar companies we think Freedom has enough room to move.

The riskier side

The specialist pharmaceutical company Medical Developments (MVP) is on the riskier side compared to the other two, but there is still a chance of achieving similar market penetration in non-opioid pain relief around the world that it has achieved in Australia, with its famed Green Whistle aka Penthrox.
 
Who doesn’t need a bit of pain relief right now?
 

About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

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