Mark Tobin

Well, another reporting season has come and gone. After sifting through literally hundreds of microcap results my assessment was that it was a very average reporting season for microcaps. A few standouts with good beats to guidance and strong outlook statements but the vast majority came in soft or missed totally. No surprises then when you look at the performance of the S&P/ASX Emerging Companies Index which returned a negative 0.35% for August. As opposed to the S&P/ASX Small Ordinaries Index which returned a healthy 2.49% in August. The bigger end of town seems to be benefiting from decent Australian GDP growth and world GDP growth. This growth doesn't seem to have really trickled down into microcap land as yet.  

MicroCap Stocks To Watch

Alcidion Group Limited (ALC: ASX)

Had a busy end to the year with the finalisation of their 2 acquisitions and the announcement of either new contracts or contract extensions with new and existing customers respectively. Post a busy FY18 it leaves ALC with a much bigger business providing clinical and patient management platforms to medical facilities in AUS, NZ and the UK. This year's acquisitions were all synergistic to ALC's existing business and transformative for the company. Now as a caveat transformational acquisitions in my experience don't have a great track record. However, we can't let our biases cloud our judgment in the here and now. To that end, I think if Alicidion can get these acquisitions bedded down and integrated successfully (a real live risk) over the course of FY19 I think it will make the ALC look interesting moving forward. ALC has early runs are on the board in this regard and I await an update on progress with above at the AGM. 

BuildingIQ Inc (BIQ: ASX)

Showed significant and pleasing progress in getting to cashflow breakeven and profitability. All metrics were up and heading in the right direction. However, the most eye-catching figure in their results was even though revenue was up 71% compared to the PCP opex expenses only increased by 12%. Demonstrating some of the inherent scalability and operating leverage of their 5i building management platform. While there were some one-off costs associated with its expansion into the greenfields building market, initial results have been solid with 29 of the 91 buildings added in the half being greenfields buildings. The nice part of BIQ's results is they give a few clear measurable objectives for the half and then measure up how they have done. All objectives were met or exceeded this half and it will be interesting if they can deliver again in the next half. More microcap companies should follow such reporting in my view. BIQ still has a little way to go but it appears to be on the right track and I will be monitoring their progress with interest. 

Universal Biosensors Inc (UBI: ASX) 

Continued to show steady if albeit slow progress. The company does, however, look like one which has a nice bit of value and optionality built into it. Its main blood glucose testing product LifeScan One Touch Verio which is a JV with Johnson & Johnson continues to be its bread and butter. A JV milestone passed last year where J&J now have the option to buy out UBI form the JV at 2X the annual revenue of the Lifescan product in the year the option is exercised. 1H18 revenue from the LifeScan product was AUD$12m (up 5% on the prior year) implying a buyout price of circa (2 * AUD$12m * 2 = AUD$48m) compared to the current market cap of circa AUD$41m. Now J&J just offloaded the business unit the JV sits in, to private equity for USD$2.1b with the deal only concluding the end of the year. In the interim quarterly services fee will need to be paid by the JV business unit to UBI. If these quarterly services fees keep rising so does the option takeout value. UBI has a USD$15m term loan due 1st of July 2019 hanging over their heads but with USD$19.6m in the bank and set aside for the payment that leaves them with circa USD$4.3mil free cash post payment and no debt outstanding. This residual cash balance equates to 15% of its current market cap. UBI has also launched another product in the market in a JV with Siemens and is working on other products. Given its proven ability to bring products to market through JV's with leading medical device companies, the Lifescan buyout option and current net cash levels, from a value perspective it seems interesting.

ASX Microcap Takeovers

Ok, I am calling it, as 3 is definitely a trend right? Just as we were about to pull up stumps for reporting season we saw a board supported bid come in for Zenitas Healthcare Limited (ZNT: ASX) from a PE-backed consortium which includes some of the company's board of directors at a 34% premium to the previous share price. I have heard from a few ZNT long-term followers that this price, despite board support undervalues the latent value in the business so possibly one to watch as this bid might not be game set and match just yet.

This bid for ZNT is on top of bids for Mituala Group (MUA: ASX) and Spookfish (SFI: ASX) which we have talked about previously. 

This suggests to me that international buyers/PE investors are seeing value in ASX microcap companies where equity market investors are not. We have now seen a bid in a non-tech space and these things tend to build a head of steam. I wonder if we are starting to enter a period where we see undervalued ASX listed microcaps attract more attention from outside buyers and end up getting taken private.

If boards and management feel they are not getting "adequately valued" versus local or international peers then why wouldn't you take the money.  

Microcap Fund Snapshot

We tally up the performance of all the Australian Microcap Funds in our quarterly Microcap Fund Performance Review. As part of this monthly newsletter, we will pick out one microcap fund and give a quick snapshot of the fund along with one stock that looks interesting currently from the fund’s portfolio. 

This month’s microcap fund snapshot is of The Cyan C3G Fund, which has returned an impressive 22.7% annualised over the past 3 years. The fund has been consistently one of the top performers in our Microcap Fund Performance Review on a longer-term basis. I give special thanks to Graeme for providing a stock pick this month given how busy the Cyan team were with reporting season. Graeme Carson is a Portfolio Manager at Cyan Investment Management and one of the more interesting stocks from their portfolio he highlighted was Acrow Formwork and Construction Services Limited (ACF: ASX).

What does ACF do firstly?

Is a provider of hire equipment to the Australian civil infrastructure and construction sectors. Historically it had been focussed on the scaffolding industry, but as it became commoditised, the company transformed itself to become a provider of higher margin formwork and falsework for the construction of large-scale motorways, bridges and tunnels. ACF is now well positioned to benefit from the increased infrastructure spend on the East-Coast of Australia over the next 5 years.

Why does Cyan like ACF?

ACF is exposed to a sector of the economy that is cyclical in nature, that is the construction cycle, be it infrastructure, commercial or residential. Generally this is something we avoid at Cyan, but in this case, there are a number of company-specific characteristics that we find very appealing.

1)   Turnaround strategy beginning to pay off 

ACF was capital constrained when it was spun out of Boral into private equity in 2010. The company had focussed on cost reduction and margin expansion since the new management team was appointed in 2013 and then repositioned to expand into civil infrastructure work into NSW and Victoria rather than the Queensland residential construction market. Through that time it managed to maintain revenue and expand group-wide margins.

2)   Investing for growth 

The business was recapitalised through its back-door ASX listing in April 2018 and is now in a sound financial position. For the first time in a number of years, we expect ongoing capital investment to be directed towards new formwork/framework equipment deployed into large infrastructure projects, with an expected return of capital of 40%. At 30 June 2018 the company had zero debt, is now generating solid operating cashflow and therefore has significant access to capital to drive growth. There is also headroom to complement organic growth with bolt-on acquisitions (the first of which has been recently announced).

3)   Leveraged to infrastructure spending 

The underlying market in which ACF operates looks strong with growth in transport infrastructure spending over the medium term expected to drive increased demand for formwork and falsework. The company is already working on a number of large projects and the pipeline of future opportunities is strong. Given the relatively small size of the company (current market cap ~$90m), it can deliver significant growth by securing a small portion of this work (hence we see it not as a large cyclical investment play, but rather a growth story).

Who is the management team behind ACF?

Group CEO Steve Boland was appointed in 2013 with a focus on the execution of a turnaround strategy. Under his control EBITDA grew from $3.3m in 2014 to $10.6m recently announced in FY18. Having guided the company through a cost reduction programme with limited access to capital he is now focussed on the company’s growth phase. ACF is Chaired by Peter Lancken who has extensive experience in the equipment hire industry through a long tenure as CEO of Kennards Hire. 

Does the valuation for ACF stack up in Cyan’s view?

ACF contains a number of key financial criteria that we look for in profitable but growing companies including:

1)   High return on equity: above 20% in this case.

2)   Low dividend payout ratio: expected to be ~30%, meaning the majority earnings are being reinvested in the business rather than paid out (resulting in a growing equity base with maintainable returns).

3)   Strong operating cashflow: Again meaning capital can be invested into growth initiatives.

4)   Solid balance sheet: Low gearing and strong tangible asset base.

5)   Margin expansion: We forecast EBITDA margins to rise steadily from ~16% to over 20% in the next couple of years.

Of course, these criteria have to be put into perspective in relation to the pricing of the business and its growth profile. In the case of Acrow, we believe it stacks up well. 

The growth profile is strong with EBITDA expected to grow ~50% in FY19 to around $15m and around 20% the following year. The pricing looks attractive with an FY19 PE ratio around 8x with EPS growth pushing 30%. The risk is in the securing and execution of contracts, but with confidence in management and strong underlying industry conditions, we believe ACF is well worth a look.



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