High conviction small caps, straight from the experts

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After asking our panel of small cap managers what’s driving the stellar run in small caps, and the key themes to play, we asked them to nominate a high-conviction small cap idea that could produce big returns. Here are the ten stocks they selected.

Potential for 100% upside from here

David Allingham, Eley Griffiths Group

We believe mining services company, Emeco Holdings (EHL), can trade to 50c over the next two years, giving investors a potential 100% gain. Run rate EBITDA is $140m and grew 7% sequentially in the September quarter. On our forecasts the company can earn $200m of EBITDA in FY21 and the stock can trade on 8x EBITDA giving the business an Enterprise Value of $1.6B. Debt should have reduced to ~$200m by then which will see equity value for EHL of $1.4B or 50c a share.

EHL is now recapitalised, divested offshore assets and consolidated the Australian mining equipment rental market. There are now 900 machines in the EHL fleet with operational utilisation running at 58% up from 52% in June quarter. Lead times for equipment have increased over the last 12 months, with lead times for 240-tonne trucks up from 3 months to 10 months as an example. Used equipment prices have also gradually increased over the last 2 years as the market has tightened. This all points to a sustained lift in utilisation rates which underpin our EBITDA expectations.

A dividend paying, early-stage consolidator

Dean Fergie, Cyan IM

I’m going to go back to basics here and pitch the accounting consolidator, Kelly and Partners (KPG). With just 14 NSW based accounting practices under its banner, there is no doubt this company is in the early stages of its growth profile. Further, the macro tail-winds are clear: the Australian Tax Act continues to become more complicated; taxpayers will always want to find new ways to minimise their tax; and the government will always be looking to increase its tax receipts. This industry is not going away. And KPG, being a well funded, profitable, dividend-paying, early stage consolidator is likely to fare very well over the next few years as it expands its network and grows its margins.

Five stocks we like

Chris Prunty, QVG

Our top 5 holdings at the end of October were Afterpay, Motorcycle Holdings, Smart Group, Lovisa and MNF all are modest weights and none are what I’d define ‘high conviction’ (i.e. a 10% weight).

Afterpay is cementing its barriers to entry and growing rapidly but has a valuation to match these quality characteristics, which holds us back from a ‘high conviction’ weight in the portfolio.

After a recent and transformative acquisition of a motorcycle accessories business, Motorcycle Holdings is very cheap but is thinly traded.

Smart Group has more to go, but now has a valuation that has started reflecting its recent acquisitions and cash generative nature of the business relative to the auto finance peers with which it gets lumped.

Lovisa could be a global growth juggernaut as it rolls out its unique jewellery concept across the UK and Europe and trials stores in the US, but must first cycle some excellent trading in its Australian business this time last year.

Finally, MNF Group continues to be misunderstood but with the stock recently hitting all-time highs there are a few smarties starting to get on to the fact they’re a software business masquerading as a telco.

A microcap with leverage to the China theme

Matt Langsford, Terra Capital

We have a little-known stock in our portfolio called Abundant Produce Limited (ABT). The company has two sources of revenue, the first being sales of its intellectual property around vegetable seeds to large multi-national seed distributors.

The second leverages the company’s strengths in plant science by accessing the international market for natural cosmetics and nutraceuticals. The company has established sales channels into China and has recently announced its Tomato Infusion Daily Face Cream has been added to Alibaba’s, T-Mall Global “Must Buy” product list. This product is the first of many the company will produce and sell into China.

Value to be found in small cap healthcare

Andrew Smith, Perennial Value Management

As contrarian value investors we prefer to exit sectors once they become too hot – for example, we have sold out of our exposure to Lithium and Infant formula.

One sector which is under-the-radar at the moment is healthcare, after the sector was knocked around for several years as a result of changing government regulations. With the government recently taking a more collaborative approach to reforms we believe the risks have reduced in the sector while ageing demographics continue to be a tailwind.

Our preferred exposures are:

1) Lifehealthcare, which imports, develops and distributes high end surgical devices. The stock has valuation support (10.3x FY18 PE) and an energetic management team.

2) Integrated Diagnostics where costs are now coming under control courtesy of a new CEO and CFO. The stock also trades at a discount to peers (15.4x FY18 PE) despite having a strong balance sheet.

Disclaimer: Please note that these are the views of the writer and not necessarily the views of Perennial.

What’s driving the stellar run in small caps?

In the first part of this series, our contributors discussed the reasons for the surge in performance of small caps so far this financial year: (VIEW LINK)

The strongest thematics in small caps today

Small caps have put in more than 12-months’ worth of typical performance so far this financial year, and show no signs of stopping. However, the small end is far more diverse than the big end. So to help shortlist the strongest thematics, we asked the experts. (VIEW LINK)


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