Two small caps with bright futures

Steve Black

Pengana Capital Group

In June last year, we wrote that Lifestyle Communities (LIC) was a sound long-term investment. With the stock having returned 16.7% since publishing, Livewire got in touch and asked us to update our thesis. We also discuss another small cap that has a long pipeline of growth opportunities.

Lifestyle Communities has a portfolio of over 2,000 homes across thirteen retirement communities. Located in Victoria’s semi-regional areas, LIC is able to keep costs low which assists with retirees’ affordability. The homes themselves are sold, on average, for 60% of the median house price, enabling residents to pocket around 40% of the proceeds from the sale of their houses. Whilst the residents own the home, they rent the land the home has been built on from LIC.

The softening housing market has spooked a few investors leading to the share price being unusually volatile over the last six months. We took advantage of this weakness to buy more shares as we recognised that the key trigger for residents to enter LIC’s communities is for improved lifestyle which has very little to do with the maximising of a capital gain they may receive on their principal place of residence.

Our enthusiasm towards LIC has not changed. Headed by founder and CEO James Kelly (who owns 14% of the company) the management team continues to execute on their conservative growth strategies. It’s these strategies that have led to 20% profit growth per annum, without the need to raise new capital.

So where to from here?

Our outlook for LIC is for more of the same. We expect around two new communities to be established each year from which they will sell 300-350 homes. An unintended benefit from drifting property prices is that LIC can secure land banks at prices well below what they have had to pay in recent year. As LIC does not record a development profit from their sales the lower land purchase prices will allow LIC to improve the quality of their product offering and/or lower the price of purchase for retirees.

As the population ages and more people enter retirement, demand for communities of the nature that LIC offer will only accelerate. As evidenced by each newly launched community selling out quicker than each before it and the referral rate from existing customers for those entering the communities increasing every year, (now above 50%) the larger problem faced by LIC is to find ways to grow quicker to meet the unmet demand. A quality problem to face for sure and we continue to back management to monitor and manage the risk of any developing growing pains that can occur from growing too fast.

LIC remains one of the fund's preferred investment ideas and top holdings.

Another exciting small cap

Another company we are excited about at is Equity Trustees (EQT). EQT is an independent provider of specialist trustee and administration services to fund managers and philanthropic groups. As one of Australia’s oldest and most trusted financial services companies, we are attracted to the group’s defensive underlying earnings. EQT is well positioned to take advantage of the inevitable outsourcing of the corporate trustee function by the banks post the Banking Royal Commission. With a well-priced and independent product offering we expect many years of growth as the full repercussions of the Banking Royal Commission unfold.

The share price has responded to improved management, leading to a turnaround in the performance of their Trustee and Wealth Services division and an acceleration of organic growth from their Corporate Trustee Services division. Layering on top of these core earnings have been acquisitions and partnerships announced with Sandhurst, AON Master Trust, Zurich, and OneVue.

What is clear from recent company announcements is that management continue to have a strong pipeline of both organic and inorganic growth opportunities to explore. Over recent times EQT has expanded into Europe with early customer engagement being very encouraging. Broadening the company’s reach into Europe through the leveraging of their existing Australian services in a measured and inexpensive fashion seems a very sensible strategy to us. We would expect future announcements of contract wins and acquisitions as key catalysts for share price performance.

Other positive attributes of the company include its proven track record over a long period of time, strong leverage to equity markets (funds under administration rises when the market rises), solid cash generation and little corporate debt. Like many other small cap companies that we like to own, EQT has been operating under the radar of investors with little broker-led research coverage and no representation in any of the ASX indices.

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Steve Black
Pengana Emerging Companies Fund, Co-Fund Manager
Pengana Capital Group

Steve is co-manager of the Pengana Emerging Companies Fund, and established the Fund in 2004 with Ed Prendergast.

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