It is said that a journey of a thousand miles begins with a single step. Unless such a journey is across the Nullarbor, the likelihood is such that a journey naturally encompasses its fair share of twists and turns. This was certainly the case through the February reporting season, a time that represents a worthwhile, yet ultimately, small step on our long-term investing journey within the small-cap investment universe.
As has been the case since mid 2016, the largely flat investment returns across the broader small-cap indices belie the significant range of outcomes experienced by the many underlying constituents over this time frame.
Nick Scali (NCK): The never-ending drive for improvement
The front end of reporting season kicked off with an excellent result and upgraded outlook from one of our largest small-cap positions in Nick Scali (NCK). The result embodied the performance of a high-quality company, run by a top-shelf management team, albeit one benefitting from housing related tailwinds.
First half revenue for the higher end furniture retailer was up by 16% to $118.4m, while reported profit surged 45% to $20.5m – figures that supported our pre-result assertion that this was a business set to demonstrate significant operating leverage. The balance sheet remains pristine with net cash, while cash flow was again solid.
The outlook remains positive, with NCK guiding to continuing double digit growth in same stores sales. When coupled with a multi-year store roll out, we see reasonable scope for continued growth over the medium-term.
RCG Corporation (RCG): Somewhat beaten, by no means broken
In reviewing the result from RCG Corporation (RCG), we ultimately see a minor detour on a long-term road that still offers the promise of meaningful growth, all of which is now offered at a more attractive price.
The footwear-focused company pared back full-year earnings expectations but still expect to deliver double-digit earnings growth both this year and next. Backed by an experienced, high quality management team and a vertically integrated business model, we believe the business remains well positioned to deliver a sound mix of growth and income to investors over the medium-term.
As it stands, RCG trades at a discount to intrinsic value, a forward P/E of 13.2x and a fully franked yield approaching 6.0%. While risks related to the Australian consumer remain, we now see the entry price and resulting reward potential as being more than appropriately compensated.
Elanor Investors Group (ENN) & Folkestone (FLK): Targeting bespoke opportunity in property
We saw results from both Elanor Investors Group (ENN) and Folkestone (FLK) as being ‘rock solid’ as both groups continue to build the foundations of what may become much larger organisations in the future. ENN continue to see opportunity in the hotels, tourism and accommodation sectors while also taking advantage of ongoing client appetite for regular, sustainable income. With solid operational momentum and some latent value held on balance sheet, we believe ENN is reasonable value. The group concurrently offers an attractive yield of around 7%.
FLK’s first half result was solid and we believe the outlook particularly impressed. Backed by a suite of industry veterans, we see the scope of opportunity emanating from Folkestone building by the month. Backed by strong investor demand, we see FLK launching at least two new unlisted property funds (possibly more) in the near-term, realising performance fees on another established fund while taking strong first steps in successfully building out its seniors living platform.
When added to the management fee income stream being generated off its various syndicates and the substantial childcare focused REIT, Folkestone Education Trust (ASX: FET), we see bright prospects for growth over the medium-term.
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