5 microcaps on our radar

Meeting with management from small cap companies is an important part of any professional investors process. Here we share our thoughts following recent meetings with the teams from 5 microcap companies on our radar, including Pioneer Credit, Gale Pacific, Joyce Corp, Blackwall and Zenitas Healthcare.

Pioneer Credit Limited (ASX:PNC) 

Meeting with Keith John (Managing Director) and Leslie Crocket (Chief Financial Officer).

As long-term holders of PNC, we’ve had a number of meetings with Keith and Leslie over the years - they continue to present well and do a good job explaining the potential of the business whilst at the same time ensuring expectations do not get out of hand. 

In FY13, PNC’s net profit was $3.9m. Profit for FY18 will have more than quadrupled over the five-year period to greater than $17m. PNC have a number of initiatives that should continue to drive growth:

• New revenue opportunities within its core business – i.e. a new market in collecting Lenders Mortgage Insurance residuals – see below.
• Building out its suite of personal lending products.
• Entering adjacent markets such as financial planning: PNC’s new app provides budgeting tools.
• Acquisition opportunities – whilst PNC have yet to make an acquisition in its 5-year history as a listed company, management continues to investigate suitable opportunities. 
• Management also believe consolidation opportunities may emerge as financially weaker participants come under pressure. 

Management is comfortable with the current economic conditions for their business. The key external driver of the business is consumer sentiment, which in most geographies remains low but stable. Given only a small amount of its customer base own their own homes, the PNC business model is relatively insensitive to interest rate movements.   

Cash collections (liquidations) have been growing strongly (+47% for H118) because of additional staff being onboarded and better-quality data analytics being generated. Additional hiring in the coming half will support further collections in future periods. While PNC are reluctant to provide productivity metrics per employee, they point to an expanding EBITDA margin as evidence that the enlarged employee cost base is more than offset by the increasing collections. 

The new market that PNC has created in LMI residuals looks like an attractive opportunity with the size of the market worth ~$50m.

PNC continues to target a $30m loan book through its new personal loan division, Credit Connect,  by December 2018. PNC has a significant data-base of consumers which have completed their payment arrangements and therefore PNC understands their financial history and risk profile. New business written is expected to be evenly split between those customers known to PNC and the public. 

Management is targeting to have Credit Connect contribute the same level of earnings as the existing business in five years, which will see PNC emerge as a significant diversified financial services business.

If management continue to execute on the growth initiatives outlined above, it is not unreasonable to expect its profit to triple again over the next five years. Despite this strong growth outlook, the stock currently trades only on ~10x FY19 earnings – a significant discount to the market.

Gale Pacific Ltd (ASX:GAP) 

Meeting with Nick Pritchard (Managing Director) and Matt Parker (Chief Financial Officer).

GAP’s core business is the development and manufacturing of high performance technical textiles, which are exported globally. 

The GAP management team remains positive on their US business, which has now become a bigger revenue contributor than the Australian operations, and GAP expect strong revenue growth out of the US over the next few years.

The US business currently is solely retail focused, with GAP selling approximately 20% of their product online as well as having distribution in all major US hardware chains. GAP sees the outdoor shade sail market in the US as being several years behind where it is in Australia, so they see real opportunity to become the market leader in that market as it develops.

There is not yet any commercial business in the US – so there is potential for GAP to accelerate this part of the business organically or through acquisition. 

In Australia, the retail market (currently approximately 70% of sales – the majority of which are through Bunnings) is somewhat mature, with GAP focused upon innovative new products to drive growth here.  Commercial customers (buyers of products as diverse as cricket pitch covers, school playground and carpark covers and scaffold screening) currently contribute 30% of GAP’s Australian sales and are expected to be the key driver of future Australian growth. GrainCorp is GAP’s largest commercial customer (grain covers) - its buying was down significantly this year due to drought and a weak grain season on the East Coast this year but FY19 is expected to be an improved season.

Longer term, GAP is targeting EBITDA margins of 15% (versus 12% in FY17) with revenue growth driven by increasing commercial and export revenues.

Joyce Corp Limited (ASX:JYC) 

Meeting with Anthony Mankarios (Managing Director).

JYC continues to see good growth across its three business units: online auctions, kitchen renovations and its Bed Shed franchise business. 

Management continues to see a particularly significant opportunity in the online auction market, where Lloyds  currently has market leadership positions in a number of categories including classic cars, fine arts and portable buildings. Key recent developments in the online auction business include:

• Recently undertaking an online auction of 90 new and used boats. Lloyds sees the boat transaction market as a new opportunity with significant potential to consolidate and capture market share in what is currently a very unstructured market.
• Securing a multi-million agreement to sell major branded electronic equipment.
• Lloyds is also seeing significant opportunity within the yellow equipment segment (graders/diggers/ dump trucks) as roading, infrastructure and mining contracts come to an end and contractors start to offload used equipment. 
• Lloyds recently purchased the Macquarie Auction group which adds another 3 sites in Bathurst, Dubbo and Orange and an expected $5m of additional auction revenue. One of the key reasons for the purchase of this regional NSW operation was to capitalise on the large infrastructure, roading and mining activity in that area. Lloyds now offer online auctions from a total of 11 sites nationally. 

Lloyds is expecting a strong second half after H1 profitability was impacted by significant one-off spending on TV advertising campaign and other marketing efforts to generate revenue opportunities. Lloyds are also expecting to receive a license to sell vehicles in Victoria this half (approval expected in April), which will enable its new Essendon, Melbourne site to be more efficiently utilized.  
 

Each of JYC’s business units are growing revenues strongly and each has their own strategic plan to expand their footprint nationally. 
 

KWB Group has opened 3 new stores in 1H18, which will contribute to earnings in 2H18. KWB continue to rollout improvements funded by suppliers’ contributions. 
 

Bedshed is expected to have one new franchisee open a store in H2 and 5 new franchised stores planned for FY19.

Blackwall Ltd (ASX:BWF) 

Meeting with Stuart Brown (Managing Director) and Tim Brown (Chief Financial Officer).

BWF’s flexible workspace business WOTSO continues to grow quickly in a fast-growing market. New locations in Chermside, Bondi Junction and Sippy Downs take the total WOTSO footprint to 13 sites – the next largest flexible workspace businesses by sites are Wework and Hub Australia which both have 5 sites.  
 

WOTSO’s annualized turnover is now at $8.4m while the current network has the potential to generate ~$19m in turnover. BWF are targeting EBITDA margins in the business of 25% (with rent at ~50% and operating expenses at ~25%). It takes around 3 years to reach these margins - the more mature WOTSO sites are now delivering operating profit margins at these levels.
 

WOTSO’s South East Asian roll-out is continuing with new locations set for Kuala Lumpur and Johor in Malaysia through its joint venture with its Malaysian partner property developer UEM Group (owned by the Malaysian Government). BWF is re-locating a manager to Kuala Lumpur to lead the design and roll out of the Malaysian sites. UEM Group, in addition to its Malaysian operations, has properties under development in South Africa, Canada and Melbourne, with potential for a WOTSO site to be co-located with one of these Melbourne sites in the near future.

There is also an opportunity for WOTSO to build on its relationship with Westfield which it has recently teamed up with to take flexible workspaces into shopping centres. In the case of Chermside, WOTSO was able to opportunistically secure a site on acceptable terms after a site originally intended for a major national retailer became available.  With the likes of Myer and David Jones relinquishing large areas in shopping centres, there is the opportunity for WOTSO to secure additional space on competitive terms and bring a new dynamic into shopping centres. - destinations where people can shop, eat and now work.

BWF continues to have approximately half its market capitalisation supported by its on-balance sheet investments, with the implied total value of its profitable WOTSO, funds management and property management businesses currently sitting at around $30m.

Zenitas Healthcare (ASX:ZNT) 

Meeting with Justin Walter (Managing Director) and Glen Dymond (Chief Financial Officer).

We met ZNT following the release of their solid half year results, where strong organic growth (7.5%) and the two major acquisitions completed in the second half of 2017 (the Nextt homecare business and the Dimple mobile podiatry business) contributed to a strong uplift in earnings for the period (1H18 EBITDA: $5.5m +67%).

ZNT noted that both the acquisitions were performing well. Nextt was now trading ahead of expectations, benefitting from a new Department of Veteran Affairs contract. Dimple is planning for its integration with Agewell – the national mobile physiotherapy business. ZNT see real potential here for revenue synergies and cross-selling services as there is minimal customer overlap, as well as cost synergies available. ZNT continue to focus on the development of a comprehensive mobile health strategy across several modalities including physiotherapy, podiatry and GP services.

While a key focus for ZNT is acquisitive growth, Management seemed most pleased about the organic growth coming through from the initiatives they have put in place over the past year, particularly from cross-referrals and the clear benefits of group marketing strategies. ZNT has confirmed expectations of 7.5% to 10% organic growth for FY18.

With strong coverage in Victoria across each of ZNT’s three key pillars Home care, GP and Allied health (20 sites and over 500 staff), we expect ZNT to move its focus to building out other geographies. We would expect Perth/WA (currently 17 locations and 200+ staff) to be a key near term focus.

The ZNT share price was weak during the month on no news. We suspect some of the selling may be related to impatience around the completion of new acquisitions. ZNT is also likely to be still feeling the impact of the large placement it undertook in late 2017, which has meant a lot of natural buyers of ZNT stock have already secured their positions in the placement, so are not buyers on market. We are long term ZNT holders and view the current share price as a particularly compelling opportunity.