Mark Tobin

Well, one of the roughest month in a long time is behind us and November has seen a bit of rebound in share markets. Microcap's were one of the worst hit in the last month, with the S&P/ASX Emerging Companies Index returning -10.91% for the month! Other indexes faired somewhat better, in relative terms at least with the S&P/ASX All Ordinaries and S&P/ASX Small Ordinaries indexes down -6.47% and -9.60% respectively.  So there wasn't really any part of the market spared the pain. However, this has brought some stocks back to appealing valuations. 

Skyfii Limited (SKF: ASX) announced their 4c and provided a great presentation on the business during Oct. Skyfiiprovides business intelligence software and platforms to venues. Places like hotels, casinos, shopping malls, etc use Skyfii's products in order to get a better understanding of their customers usually through the aggregating data from the guest wifi but it also neatly pulls information from social media, foot counters, CCTV, POS systems all into one system. All of this big data is then refined into analytics that can help venues optimise the experience for their patrons while at the same time helping to drive revenue for the venue. The business is still cashflow negative, however, management note in their latest 4C that they do not need to raise any further capital to maintain operations. The company has cash at bank at the end of the quarter of $1.1m and had a cash burn of just under $400k for the quarter. The cash burn dropped just over $200k from the last quarter of FY18. The also recapped a slew of new contracts signed in the first quarter of FY19 and guided to 1HFY19 revenue to be up 68% on the PCP. At this sort of run rate profitability and cash flow positive operations are not far away. Getting to that point could be an interesting turning point for the company.

Laserbond Limited (LBL: ASX) also had their AGM in the month. They are one of the first company's to do so as AGM season only really ramps up now in November. The share price has been on a big run over the last year as the business has started to kick some goals with new markets and products coming online. They are forecasting 1HFY19 revenue growth to be up 36% - 45% on the PCP and EBITDA to come in around circa $1.8 - $1.9m vs the PCP of $0.6. The company also pays a small fully franked dividend which is always nice. As I have said in the past in the microcap end of the market where dividend income can be scarce any dividend is great and certainly marks a company out from the crowd in a positive sense. The share price has had a good run over the last 12 months as I said and thus the stock is not super cheap by any means. However, these new growth drivers are making it looking interesting on a longer-term view.

Microcap Boards

Recently I read some very interesting research about the boards for US microcap companies. I won't bore you with the full 62 pages here but I will pick out some salient or interesting data points below. 

78% of microcaps companies studied had been listed for 5 years or more. So not exactly in the startup phase of their lifecycle, as you might have expected. 

Only 14% of microcap companies in the study had the founder as CEO. So founders seem to move on possibly to the Chair or to the background as a major shareholder when these companies hit the public markets. Founder seem to prefer to appoint an inside or external CEO to run the day to day operations. 

61% of microcap companies have no female board members. A lot of work still to be done on getting better gender balance on boards compared to even large caps which are not exactly models of gender diversity themselves. 

34% of companies studied had 50 employees or less. Showing a lot are really comprised of tight-knit groups where the levels between the CEO and the front line staff is minimal. Thus a hands-on CEO is critical to the success of driving day to day operations. As I and others have said backing the right jockey is one of the most critical parts for investing in micro/small caps given the influence they can have. As opposed to the influence the CEO of Apple or Telstra can have on the day to day operations. 

I haven't seen research of this nature on ASX microcaps but it would be interesting to compare and contrast at some point in the future. 

Microcap Fund Snapshot

This month’s microcap fund snapshot is of the Saville Capital Emerging Companies Fund. I asked Jonathan Collett Principal at Saville Capital what was one of the more interesting stocks from the current microcap portfolio and he highlighted IDT Australia Limited (IDT: ASX)

What does IDT do firstly?

Established in 1975, IDT operates in the pharmaceutical industry providing a flexible and comprehensive service from early stage API (Active Pharmaceutical Ingredient) development through to finished drug formulation, clinical trial research and scaled commercial manufacturing for global distribution. Based in Boronia (Victoria), IDT’s manufacturing facilities are fully cGMP compliant and are regularly audited by the US FDA and Australian TGA. IDT is predominantly focused on high potency and very specialised drugs, having undertaken work for multiple global pharmaceutical companies including Pfizer, Johnson & Johnson, Roche and Bayer.

Why does Saville Capital like IDT?

IDT appealed to us as a classic turnaround story with significant valuation support (it was trading below NTA when we first started researching the Company), combined with potential upside from exposure to the burgeoning medicinal cannabis sector, without the risks of being an owner/producer. 

By way of background, while IDT’s business model had proven to be successful and generally profitable over time, in order to extract greater leverage from its expertise and materially increase utilisation of its manufacturing capacity, it undertook a strategic shift in late 2014 by acquiring 23 US generic drug products for US$18m. However, the reasons behind this decision were quickly undermined as the barriers to entry for new US generics were substantially lowered via shorter review periods and the number of potential buyers significantly reduced due to consolidation in the wholesale sector, leading to pricing erosion of between 5% and 60% across IDT’s portfolio. 

Following a strategic review, IDT decided to sell the majority of its generics portfolio to ANI Pharmaceuticals for US$2.3m in April 2018, and instead focus on advancing a select generics portfolio (primarily Temozolomide, an oral brain cancer drug distributed by Mayne Pharma) and build upon its existing Contract API and Development businesses. In a further positive development, IDT entered into an agreement with Cann Group Limited (ASX: CAN) during August 2018 to provide manufacturing support in relation to medicinal cannabis-based product formulations intended for supply to patients.

After an initial meeting with management, our interest in IDT was piqued upon a thorough review of its FY18 result, particularly its 2H. Revenue increased from $5.0m in 1H to $8.3m in 2H, while its underlying P&L improved from a loss of -$3.1m in 1H to a profit of +$0.2m in 2H. Most importantly, it transitioned from a gross operating cash flow deficit of -$6.2m in 1H to a surplus of +$1.2m in 2H. When coupled with an NTA of $31.2m, underpinned by a net cash position of $14.0m and PP&E of $18.7m (over half of which is land and buildings), the investment proposition appeared compelling when compared with a market cap of $31.8m (it has since increased to $41.5m). 

Furthermore, if we look back over time, only a decade ago IDT was generating revenue of >$30m, EBITDA of >$12m, NPAT of >$7m and an ROE of >20%, with much the same fixed asset base as what it has today. Hence the turnaround potential of this business was clear, should management be able to execute.

Interestingly, since our entry into the stock, IDT has announced an on-market share buyback of up to 10% of its issued capital (commenced on 10 October), citing its improved financial performance over the recent period and noting its forward projections indicate that a portion of its cash position is now surplus to requirements. Since then the buyback has been quite active, purchasing the stock at prices up to $0.17 (the allowable limit is $0.1785). 

Who is the management team behind IDT?

IDT is led by Dr David Sparling who became CEO in July 2018 after he had served in that role in an interim capacity since February 2018. Prior to that, David was Vice President of Corporate & Business Development, having joined IDT in May 2013. David holds honours level degrees in both Veterinary Science and in Law. He is an experienced senior executive, having previously held roles as CEO and Chairman level in ASX listed companies.   

Does the valuation for IDT stack up in Saville Capital’s view?

Assuming IDT can grow its revenue back to >$30m over the next 5 to 10 years and restore EBITDA margins to c.35% (they peaked at 40%), then we value the Company at $0.25/share (vs current share price of $0.17 and our entry price and NTA of $0.13). This DCF valuation ignores the upside from potentially becoming a manufacturer of choice in the medicinal cannabis sector. 

Saville Capital is forecasting revenue to grow from $12.9m in FY18 to $17.4m in FY19 and $22.6m in FY20, with EBITDA growing from -$2.0m to +$2.5m and then +$5.5m over the same period. If our forecasts are correct, then IDT is trading on an FY20 EV/EBITDA multiple of 5.6x and an FY20 P/E of 15.3x with still considerable forecast growth potential thereafter, particularly if it can get back to its peak historical earnings (or beyond). 



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