3 global smaller companies that can thrive amid uncertainty
Over the past 13 years, bottom-up, fundamental analysis has come second to growth at any price. But how quickly things can change.
The extreme pent-up demand for services that was prevalent at the beginning of the year was quickly overshadowed by rising inflation and rising rates, and so the market is being tested. Now, the case for fundamental bottom-up investing has never been stronger and we’d argue valuations matter more than ever.
In an uncertain investing environment, businesses with strong underlying fundamentals and valuation support can help deliver more sustainable returns.
So, here’s three global smaller companies that fit this bill.
The value play - Johnson Outdoors (NASDAQ: JOUT)
Johnson Outdoors is a US listed family-founded outdoor company whose umbrella of outdoor brands are recognised for their high quality and customer loyalty.
The Johnson family IPO’d Johnson Outdoors in 1987 and today is run by Helen Johnson-Leipold the 5th generation of the Johnson family. JOUT still maintains a high level of family ownership (~44%) aligning with the interests of shareholders.
Credit Suisse research has continued to find that family-owned companies outperform their non-family-owned peers – “The Family-owned alpha factor”. Their research indicates that since 2006 family-owned companies outperformed their peers by ~370bps. One reason family-owned businesses tend to outperform their peers are their superior cash flow returns, lower gearing levels and a higher focus on R&D. These qualities are exactly what drew us to Johnson. JOUT also have a great culture of sustainability – another area family-founded businesses excel in.
Compelling valuation support
JOUT trades on a PE multiple of 7.5x and an EV/EBIT multiple of 3.9x. At these multiples, you are getting a quality company that is aligned with shareholder interest, has US$190m of net cash, 106% free cash conversion, a 3-year average ROTIC of 48% and a 2.3% dividend yield.
To put this into perspective, Johnson Outdoor’s market cap is US$630m meaning one third of the market cap is in cash alone. JOUT’s ability to fund their operations through internal funds rather than debt gives investors’ confidence in the sustainability and longevity of the business.
The market is pricing in sales going backwards despite camping, diving and watercraft sales all being up 17% in 1H22. We believe the market is underestimating the strength of its core fishing business as well as the growth JOUT is experiencing in its other segments.
With the market pricing in negative sales growth, a small beat would be enough to reinforce market confidence in our view. If a business does well, the share price will follow.
The quality trade - Biogaia (STO: BIOG)
BioGaia is a Swedish world-leading probiotic company that has been at the forefront of microbiome research for more than 30 years. BIOG’s history is rich, having transformed from a science-led company that focused on manufacturing and developing probiotic strains, to using this IP to become a leading product-led company whose bacteria strains are the pinnacle of their success in the consumable health space.
If you were to own a company for 10 years and never look at it again – Biogaia would be a good contender. BIOG has a favourably industry structure – one that is growing and relatively immature where quality and brand name matter.
Biogaia’s history goes back to the 1980’s at a time when HIV was discovered. Two scientists Sven Lindgren and Walt Dobrogosz were investigating different probiotics to see if they could help. They found many important properties and positive effects with L. reuteri.
At the same time, two Swedish entrepreneurs, Peter Rothschild and Jan Annwall, imported organic vegetables and exclusive yoghurt from France to Sweden. They were looking for an alternative way of preserving the vegetables during the long trip.
By coincidence, in a ski lift in Verbier some years later, Sven Lindgren came to talk to Peter and Jan. they came up with the idea of combining the need of preserving the organic vegetables with the accessibility of L. reuteri, which is a patented probiotic bacterium. Very soon they realised that L. reuteri was much more useful for other applications than preserving vegetables. It was in 1990, Biogaia was officially founded.
As mentioned earlier, BIOG’s reputation is founded in their scientific roots. Clinical studies with BIOG’s probiotic strains have been published in more than 200 articles in scientific journals.
A microcap with wide reach
BIOG’s products are sold in over 100 countries and are the 6th leading probiotic player globally and enjoys number 1 share in their home market Sweden.
The total addressable market for probiotics is ~US$5bn and growing at 7-9% p.a. as greater understanding around gut health is gained. BIOG’s sales have grown ~28% over the past 5 years and their US$90m in revenue leaves plenty of runway for future growth.
It has a net cash balance sheet of SEK 1,571m (US$156m) and an average free cash conversion of 90%. Management have continually demonstrated disciplined capital allocation, utilising their strong balance sheet to self-fund their strategic investments. Most recently BIOG acquired its exclusive distributor in the US. This vertical integration gives BIOG greater control over their distribution through increasing the direct-to-consumer sales – a future margin growth driver.
Compared to its much larger Danish peer – Chr. Hansen, BIOG enjoys superior margins and trading multiples. Furthermore, BIOG is only covered by 4 sell-side analysts versus Chr. Hansen’s 15, leaving significant opportunity for alpha generation.
BIOG’s PE ratio may seem punchy, however, we believe it is warranted given its quality. Purchasing companies with lower multiples might be attractive to those who invest with the assumption of “reversion to the mean”. We, however, believe that when you find an investment with the potential to compound over a long time you hold on tight. Biogaia is a rapidly growing company with cogent competitive advantages. The temptation to not take profits is a choice we hope will reward us – much like it has for early investors in Amazon for example.
BioGaia also has the advantage of not being dependent on China – 49% of revenue is from Europe, 27% from North America and 22% from Asia.
The cyclical play - Core laboratories (NYSE: CLB)
Core laboratories is a quality cyclical stock, with a rich history. Spheria bought CLB at a rock bottom price at the bottom of the oil cycle. CLB was first listed in 1995 and has thus gone through multiple oil cycles over this time.
CLB provides core and fluid analysis in the petroleum industry for reservoir performance and optimisation - an essential value driver for exploration and production. Making CLB even more attractive to Spheria is its market leading position holding number 1 share in the US reservoir description market thanks to their proprietary technology and long-term relationships with all the major E&P players.
Oil and gas companies are a commodity in which low cost is critical. The products and services CLB provide to the oil and gas industry are based on proprietary technology or patented information, which insulates them from pricing pressures. This means CLB can preserve their pricing power and profit margins much better than their broader peer set making it a standout in the O&G services sector.
Despite the positive tailwinds and strong oil prices, there is a disconnect in the share price. Whilst revenue has been under pressure for the past two years, medium-term earnings outlook and business fundamentals remain strong.
There is a growing market recognition of global underinvestment in supply. With the consistent elevated crude-oil prices and the tightening of supply, the industry is preparing for an increase in activity resulting in a multi-year cycle.
Current crude oil commodity prices are likely to drive a higher level of investment and urgency in international onshore and offshore crude oil development projects in 2022 and beyond. These crude-oil fundamentals are reflected in the gradual increase in the international oil rig count with more oilfield equipment coming under contract and expanded capital spending for 2022.
We see these as leading indicators of a growing multi-year international cycle. If oil prices remain high, E&P free cash flows will increase significantly, and these companies will be able to pay down more debt and take debt to new sector lows.
As the cycle strengthens, and IOCs, NOCs, and independents expand their investments in maintenance of existing fields and development of new fields for extensions operators will have to increase capital spending which is a big positive for CLB.
Despite this, we have not yet seen CLB’s share price run with the rest of the O&G players. This is because CLB realise revenues after the cycle has begun - wells need to be drilled and subsequently completed, stimulated, and cored, or have reservoir fluid samples collected before revenue is realised.
Superior fundamentals at a discount
CLB’s 2014 share price at peak revenue was trading at $191 – today revenue is only 2.1x less yet the stock trades 9.5x less, oil rig count is only 2.3x less – during this time however, net debt has improved from US$330m down to US$171m (an improvement of 1.9x). CLB has superior cash conversion with a 20-year average of 133%. Lastly, the valuation is supportive trading at a forward 11x EV/EBIT and offering plenty of upside even after accounting for a bear case scenario.
Once the international activity picks up CLB will benefit from the high operating leverage in the business and will have further capability to continue to pay down this debt.
The market often under-appreciates the role of oil and gas in the transition to net-zero. We believe CLB is being harshly discounted due to perceived oil and gas ESG risk. ESG positive stocks cannot and will not always provide alpha investors seek to generate, especially in a down market. The good news is that CLB is giving a free ESG option. CLB have exposure to carbon, capture, and storage (CCS) projects. It is currently engaged on a CCS project in our own backyard – off the coast of Gippsland Victoria for the Victorian Government.
Discover Spheria's approach to investing in smaller companies
Spheria Asset Management invests in growing small and microcap businesses with strong and predictable free cash flow, along with valuation support. Discover more about the Australian and global stocks in Spheria's portfolios at spheria.com.au.
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Aimee joined Spheria in 2019 as an analyst for the Spheria Global Microcap Fund. Previously she worked as an analyst at Bank of America Merrill Lynch. Aimee holds a Bachelor of Commerce from The University of Sydney.