Well, the first quarter of FY19 is behind us and it has been tough for microcaps. As I alluded to in my newsletter last month, reporting season overall was pretty insipid as far as microcaps were concerned. This is reflected in the performance of the index with the S&P/ASX Emerging Companies Index returning -2.50% for the quarter. As opposed to the S&P/ASX 200 Index which returned +1.53% for the quarter. So large caps have outperformed microcaps on a very recent basis.
Now, we must not get too despondent it is only the first quarter after all. As to how the active microcap managers performed in Q1FY19 or quarterly microcap fund performance review will be published later in October once all the numbers have been published by the relevant managers and we can collate the data.
Cellnet Group (CLT: ASX) announced an acquisition on the back of a solid set of results in August and this has seen the share price really take off in September. A mobile and electronics distribution company it's not a real high-quality business but they have been quietly managing their debt (just about net cash at June 30 FY18) and optimising their categories and customers in recent times. The company announced a reasonably chunky acquisition of a gaming software and accessories distributor for $6m ($4m cash & $2m in CLT Shares) With another $2m in cash possible if earnouts are achieved over the next 2 years. Given CLT's management have guided that the acquisition made $2m EBIT on $30m of revenue it will add nearly an extra 50% to CLT's EBIT figure for FY19. The share price has popped on the news obviously but integration and synergies will be the key to watch for throughout the rest of FY19. Distribution businesses are all about the scale and associated economies that come with it. After its run-up to circa $0.50c, it looks fairly valued but I am interested to see how the integration goes and what the additional scale and possible synergies will do for overall profitability.
Legend Corporation (LGD: ASX) also displayed similar price action to CLT above. The company announced that EBITDA was running 70% ahead of the PCP in the first 2 months of FY19. Now, a word of caution of here it only the first two months but still a significant data point. Factoring in this update and the recent acquisition in Feb18 I think LGD can make around $9m (FY18 $6m) in NPAT in FY19. Now, this business has never been a high PE multiple businesses. However, putting it on a PE of 11 times (which I don't think is unfair) would give you a market cap of close to $100m versus the current post runup market cap of $80m. LGD gives a reasonable 4% fully franked yield and any yield in microcap land is welcome. Like CLT the integration of the recent acquisition is key and managing the increased debt that came along with it. However, LGD has reported strong cash generation over many years thus the debt shouldn't be overly burdensome. The trading update certainly makes it an interesting story to follow in FY19.
Microcap IPO's with OnMarket
Recently the team at OnMarketcompleted their 100th offering since launching the platform in 2015. So, a 100 offerings have been completed in roughly 1000 days. The OnMarket platform has been a great success and for any investors who have taken up some IPO's conducted through the platform the majority have performed pretty well. I ask Founder & CEO Ben Bucknell of the 80 odd IPO's (we are excluding LIC's from the 100 total) what number were microcaps. Ben's told me 75 fell into what I define as a microcap stock which is anything with a market cap that is less than $300m market cap on a listing. So, as you can see the majority of the offerings coming through the platform are from microcap companies. The OnMarket platform has proven to be a great way for retail microcap investors to get access to a level playing field for IPO's. It has also provided small, emerging Australian companies trying to attract growth capital in order to build their business into a bigger business with an alternative funding source/platform. Anything that is good for retail investors and microcap companies I am in favour of.
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.
Microcap Fund Snapshot
This month’s microcap fund snapshot is of Prime Value Emerging Opportunities Fund. I asked Richard Ivers, Portfolio Manager at Prime Value about one of the more interesting microcap stocks in the portfolio and he highlighted GTN Limited (GTN: ASX)
Firstly, what does GTN do?
GTN provides real-time information to radio and television stations (affiliates) across Australia, Canada, UK and Brazil. Information is typically in the form of local content, such as live traffic reports. It pays a fee to the affiliates and in return is given advertising slots at the time it provides the traffic information. These can then be sold to generate revenue. Gathering the information typically requires aerial surveillance (helicopters) and access to road authority information.
This information is increasingly valuable as it provides local, time-sensitive information that keeps audiences engaged in a digitised world. Traffic information is particularly valuable for an in-car audience which is c. 60% of the radio market.
It’s a highly profitable business for GTN, generating $100m of revenue at 40% EBITDA margin in Australia alone.
Why does Prime Value like GTN?
GTN has multiple attractive qualities.
It benefits from scale, having proprietary information that can be sold across multiple affiliates.
In each market it operates, it is the largest player and has affiliate agreements for up to 18 years that make it difficult for a competitor to establish a position or for affiliates to group together. This creates a barrier to entry.
By offering to advertise across multiple affiliates, it has greater reach than one alone. This is attractive to advertisers looking to reach a mass market and results in a pricing premium.
Australia currently contributes c. 85% of earnings and is nearing maturity. However, moderate revenue growth will drive significant earnings growth as costs are largely fixed. The largest expense is affiliate payments and in Australia, these are now largely fixed under long-term agreements. The Southern Cross (SXL.ASX) agreement is for another 18 years, ARN (HT1.ASX) 4 years and Nova was recently renewed for 3 years with a moderate cost increase in FY19.
Canada and Brazil are GTN’s high growth markets and could deliver significant upside in the coming years.
Canada is growing solidly but would accelerate if GTN can reach an affiliation agreement with Rogers (RCI.TSX), the last significant network missing to date. This would significantly increase advertising inventory and more importantly pricing across the country. GTN generated significant pricing growth in Australia after it contracted Southern Cross and Canada could see a similar benefit.
Brazil is currently small at 4% of group earnings but is growing very strongly. FY18 revenue increased by 25% but was significantly negatively affected by the Soccer World Cup. We expect growth to accelerate in FY19. New regions and stations are being added in a cost-controlled manner and the market of 200m people is very large.
Importantly, GTN’s financials are also attractive. It’s a capital-light business with high returns on incremental capital deployed. Cashflow conversion is strong and the business has little debt.
The recent sell down by 40% shareholder GTCR has removed a stock overhang and liquidity should improve given it now has 100% free float. Its profile should also rise given it’s not particularly well know.
Who is the management team behind GTN?
GTN has local management in each of its 4 regions.
Two key management at the group level is Bill Yde (CEO) and Scott Cody (CFO & COO).
Bill has 35 years’ experience in the radio and media industry and was the founder of GTN. So his knowledge and understanding of the business industry and business are profound. He holds almost 4m shares.
Scott has over 30 years’ experience in the radio industry and he has a detailed understanding of the business.
Management is incentivised on EBITDA, EPS and relative total shareholder returns.
Does the valuation for GTN stack up in Prime Value’s view?
We think GTN fits squarely in the growth at a reasonable price (GARP) bucket.
We estimate GTN’s FY19 EBITDA will be $53m (+10% on pcp) which converts to normalised EPS of 15cps. At $2.10 the stock is trading on a PE of 14x and yielding 6%. We estimate a cash flow yield of c. 8%.
This compares favourably to the Small Industrials PE of 17x and yield of 4% while GTN offers superior growth.
Earnings growth of c. 10% p.a. is sustainable for a number of years on reasonable assumptions but would accelerate if Canada or Brazil deliver on their potential.
Upcoming catalysts include a positive AGM trading update, a strong FY19 result (it’s cycling a weak 2H19) and possible Canadian affiliation agreement.