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Small Cap Industrials In Focus

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Oct 07 2015

This story features JAPARA HEALTHCARE LIMITED, and other companies. For more info SHARE ANALYSIS: JHC

In This Week's Weekly Insights:

– Small Cap Industrials In Focus
– Audio, No Video
– Bob Farrell's 10 Rules of Investing
– Charts To Ponder About
– Rudi On Tour
– Rudi On TV

Small Cap Industrials In Focus

By Rudi Filapek-Vandyck, Editor FNArena

Look beyond the global worries and the day-to-day volatility and you see that something's different in the Australian share market this year.

That something might have consequences for how investors are going to perceive "risk" and "opportunities" moving forward.

Consider the following:

The ASX200 lost 3% in September, but the Small Ordinaries Index only lost 0.5% during the month.

This observation becomes even more intriguing if we add that the Small Resources index lost 10% in September, with total losses accumulating to -24.9% over the past three months and to -37.6% year-to-date.

Taking all of the above into account, the Small Industrials index has shown itself a beacon of strength with a gain of 1% in September. Over the past three months the index is up 0.3%. Total gain since January 1st is 3.1%.

The difference in index performance is backed up by anecdotal observations. Grab a price chart for Japara Healthcare ((JHC)) or for Burson Group ((BAP)) and you'll be hard pressed to see any evidence of the extreme volatility that has plagued the local share market over the past two months.

Then there are the extremely strong performances by the market darlings du jour, including Bellamy's Australia ((BAL)), Blackmores ((BKL)), Hansen Technologies ((HSN)), IPH Ltd ((IPH)) and iSentia ((ISD)). No doubt, I am forgetting a few. If you are not following any of these stocks, do not look up their performances as it is going to hurt.

Of course, to complete this picture I should also include the fact numerous small cap industrials have proved far less resilient throughout the market turmoil. Infomedia ((IFM)) comes to mind. And Ansell ((ANN)). Freedom Foods Group ((FNP)). Thorn Group ((TGA)). And many others.

Regardless, I think an important point has been made: at a time when many of the local blue chips are lacking growth and/or investor confidence, quality small cap industrials are providing an alternative.

More Growth, Less Worry

While a one-off outperformance does not automatically imply a new trend, there's a lot to be said in favour of small cap industrials. For starters, when panic hits global trading desks and the Australian share market is being hit with large orders, either Buy or Sell, there is little, if any, focus on minnows that do not even feature in the major index, or only represent negligible weight. Those maligned High Frequency Traders also are more interested in high volume stocks, such as the Big Four banks, BHP Billiton ((BHP)), or even CSL ((CSL)) instead of ARB Corp ((ARB)) – who?

But this is by far not the whole story. The market's main concerns are/were continued slowing in Emerging Asia and that first rate hike by the US Fed. Arguably, such concerns are more appropriate for Australian banks, for BHP and Rio Tinto ((RIO)), for Amcor ((AMC)), Brambles ((BXB)) and Ansell rather than for Hansen Technologies, IPH Ltd or even Bellamy's Australia.

This is also the market segment that offers targets for foreign suitors, as again proven by local tech company UXC Ltd ((UXC)) receiving a non-binding, indicative offer from US-based CSC. We already have an offer on the table for Veda Group ((VED)), with the initial indicative price now raised, as well as for PAS Group ((PGR)), and others.

Insofar as "growth" is concerned, how does 32% and 26% sound for this year and next for Sirtex Medical ((SRX))? I'd say it sounds a lot better than -0.9% and 2.8%, the current consensus expectations for CommBank ((CBA)), or the -52% and +2% currently forecast for Rio Tinto.

Equally important, the above market growth forecasts for many of the small industrials mentioned seems to be locked in through recent acquisitions or they are simply backed up by very favourable market dynamics. In other words: market confidence towards these companies remains high and investors perceive the risk to their forecasts as a lot less than one might be inclined to think given overall shaky market sentiment and the much smaller size of these companies.

Note also, none of the small cap industrials I have mentioned so far is trading on a low or even medium high Price-Earnings ratio. iSentia is on 23.6. Sirtex is on 34.8x. Bellamy's is on 38.6. I wouldn't chase any of them at present prices, but the point I am trying to make (again) is that while investors and funds managers remain inclined to search for value amongst beaten down, low PE stocks, they miss out on the superior growth stories the share market has to offer if automatically deterred by a high PE.

Admittedly, trading volumes can be a concern, in particular if risk appetite would retreat significantly. I think I saw one day's total volume shrinking to circa 12,000 shares for 3P Learning ((3PL)) the other day, but on average there's plenty of volume. Stocks like Sirtex, IPH Ltd and Blackmores are firmly on the radar of funds managers too.

Different Dynamics

I am by no means suggesting investors should sell all their large cap shares and replace them with small cap industrials only. The objective observation is that a well-picked portfolio of small cap industrials would have outperformed in 2015, but also that most of the stocks responsible for this outperformance appear to have had a good run. Smaller cap industrials, on my observation, are often less constrained by stockbroker targets and valuations. It only takes a little of positive momentum plus a little of growing popularity to push share prices well above what seems justified on broker estimates (if there are any).

See for example Ansell above $30 earlier this year (now around $18). I worry a little bit about Blackmores shares now they've reached $150 (like a rocket, dare I say it). iSentia trading above $4 looks fully priced too.

So even if investors are prepared to cast an eye over this particular segment to add extra growth/performance potential to the portfolio, Harry Hindsight is probably not your best guide. Do note that FNArena is running a special news section on the website, called "Small Caps", where we have recently highlighted stocks like Japara Healthcare, Costa Group ((CGC)) and Mantra Group ((MTR)), among others.

Stockbroker Favourites

Small Cap specialists at JP Morgan (they call it "emerging companies") recently highlighted two stocks: one positive, wet wear retailer SurfStitch ((SRF)) which continues to grow strongly and certainly the stockbroker is expecting more and more, which seems at odds with recent share price weakness. The second one is a negative nomination in that JP Morgan believes the risks attached to UGL Ltd ((UGL)) shares remain way too high, because of Ichthys and what appears too optimistic guidance for FY17.

Goldman Sachs' Small & Mid Cap Focus List gained 2.1% in September which is noticeably better than the Small Industrials Index. The list has twelve constituents: Austbrokers ((AUB)), Amaysim Australia ((AYS)), Blackmores, Costa Group, Dick Smith ((DSH)), EBOS Group ((EBO.NZ)), Genworth Mortgages Insurance Australia  ((GMA)), OzForex Group ((OFX)), SAI Global ((SAI)), Sirtex Medical, Super Retail Group ((SUL)) and Tassal Group ((TGR)).

In addition, stockbroker Morgan's Model Growth Portfolio contains a number of smaller cap industrials (alongside the usual suspects such as Macquarie Group, Ramsay Healthcare and CSL) including IPL Ltd, Corporate Travel ((CTD)), Beacon Lighting ((BLX)), Kina Securities ((KSL)) and Lovisa ((LOV)).

In addition, technical analyst Violeta Todorova, has provided a list to Morgans clients advising which companies look oversold. The list includes Capitol Health ((CAJ)), Credit Corp ((CCP)), Cedar Woods ((CWP)), Collection House ((CLH)), Decmil Group ((DCG)), Fisher & Paykel Healthcare ((FPH)), IMF Bentham ((IMF)) and Seven Group ((SVW)).

Stocks that look overbought include Bellamy's, Blackmores, Gateway Lifestyle Group ((GTY)), IPH Ltd, Murray Goulburn ((MGC)), Mantra, Nufarm ((NUF)), Recall Holdings ((REC)), SMS Technology & Management ((SMX)), Spotless ((SPO)) and Tassal.

All-Weather Performers

For what it's worth, the FNArena/Pulse Markets All-Weather Model Portfolio had a positive performance in September, beating the ASX200, the Small Ordinaries and the Small Industrials Index, though Goldman Sachs' Small & Mid Cap Focus List still performed better.

Audio, No Video

Earlier in the year I gave a presentation to clients of financial services provider Invast in Sydney. My underlying thesis was the current bull market for equities looks a lot different from what we've experienced in the past. Investors better not assume business as usual.

I was promised a video recording would become available, but something somewhere in the technical process has gone wrong and, apparently, the damaged file cannot be repaired. So no video.

Invast has put the audio recording on its website, which is not quite the same, but for those who don't mind, here's the address:

http://www.invast.com.au/research-analysis/live-events/Australian-Market-Outlook-Opportunities-Rudi-Filapek–Vandyck

Bob Farrell's 10 Rules of Investing

While reading through a number of overseas reports on the weekend, I came across Bob Farrell's 10 Rules of Investing. Since I have been quoting a few domestic experts in recent editions of Weekly Insights, I simply felt an obligation to now repeat the gospel by this market icon who became famous and legendary while at Merrill Lynch, in much different times, it has to be said.

See below. Enjoy.

1) Markets tend to return to the mean over time.
2) Excesses in one direction will lead to an opposite excess in the other direction.
3) There are no new eras – excesses are never permanent.
4) Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
5) The public buys the most at the top and the least at the bottom.
6) Fear and greed are stronger than long-term resolve.
7) Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
8) Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend.
9) When all the experts and forecasts agree – something else is going to happen.
10) Bull markets are more fun than bear markets.

Charts To Ponder About

Credit Suisse's latest selection of valuation charts gives investors plenty of material to think about. Such as be careful when you assume that US equities are now "cheap" -see second chart below- as this only seems to be case in a relative sense vis-a-vis exceptionally low government bond yields.

Australian equities are still priced above the long term average (chart 1) but, as we all know, the index combines "cheap" looking banks with beaten down resources and expensively priced industrials. The third chart is where things get interesting (see also story above).

Rudi On Tour

– My next presentation will be to clients and contacts of Affinity Wealth (affinitywealth.com.au) on a boat in Sydney Harbour, Friday,October 16.

Rudi On TV

– on Wednesday, Sky Business, Market Moves, 5.30-6pm
– on Thursday, Sky Business, noon-1pm, Lunch Money
– on Thursday, Sky Business, between 7-8pm, Switzer TV

(This story was written on Tuesday, 6 October 2015. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).

****

THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

****

MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Odd as it may seem, but today's share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of September available. Just send an email to the address above.

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CHARTS

3PL AMC ANN ARB AUB AYS BAP BHP BKL BLX BXB CAJ CBA CCP CGC CLH CSL CTD CWP DCG FNP FPH GMA HSN IFM IPH ISD JHC KSL LOV MTR NUF OFX REC RIO SMX SUL SVW TGA TGR

For more info SHARE ANALYSIS: 3PL - 3P LEARNING LIMITED

For more info SHARE ANALYSIS: AMC - AMCOR PLC

For more info SHARE ANALYSIS: ANN - ANSELL LIMITED

For more info SHARE ANALYSIS: ARB - ARB CORPORATION LIMITED

For more info SHARE ANALYSIS: AUB - AUB GROUP LIMITED

For more info SHARE ANALYSIS: AYS - AMAYSIM AUSTRALIA LIMITED

For more info SHARE ANALYSIS: BAP - BAPCOR LIMITED

For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED

For more info SHARE ANALYSIS: BKL - BLACKMORES LIMITED

For more info SHARE ANALYSIS: BLX - BEACON LIGHTING GROUP LIMITED

For more info SHARE ANALYSIS: BXB - BRAMBLES LIMITED

For more info SHARE ANALYSIS: CAJ - CAPITOL HEALTH LIMITED

For more info SHARE ANALYSIS: CBA - COMMONWEALTH BANK OF AUSTRALIA

For more info SHARE ANALYSIS: CCP - CREDIT CORP GROUP LIMITED

For more info SHARE ANALYSIS: CGC - COSTA GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: CLH - COLLECTION HOUSE LIMITED

For more info SHARE ANALYSIS: CSL - CSL LIMITED

For more info SHARE ANALYSIS: CTD - CORPORATE TRAVEL MANAGEMENT LIMITED

For more info SHARE ANALYSIS: CWP - CEDAR WOODS PROPERTIES LIMITED

For more info SHARE ANALYSIS: DCG - DECMIL GROUP LIMITED

For more info SHARE ANALYSIS: FNP - FREEDOM FOODS GROUP LIMITED

For more info SHARE ANALYSIS: HSN - HANSEN TECHNOLOGIES LIMITED

For more info SHARE ANALYSIS: IFM - INFOMEDIA LIMITED

For more info SHARE ANALYSIS: IPH - IPH LIMITED

For more info SHARE ANALYSIS: ISD - ISENTIA GROUP LIMITED

For more info SHARE ANALYSIS: JHC - JAPARA HEALTHCARE LIMITED

For more info SHARE ANALYSIS: KSL - KINA SECURITIES LIMITED

For more info SHARE ANALYSIS: LOV - LOVISA HOLDINGS LIMITED

For more info SHARE ANALYSIS: MTR - METAL TIGER PLC

For more info SHARE ANALYSIS: NUF - NUFARM LIMITED

For more info SHARE ANALYSIS: OFX - OFX GROUP LIMITED

For more info SHARE ANALYSIS: REC - RECHARGE METALS LIMITED

For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED

For more info SHARE ANALYSIS: SMX - SECURITY MATTERS LIMITED

For more info SHARE ANALYSIS: SUL - SUPER RETAIL GROUP LIMITED

For more info SHARE ANALYSIS: SVW - SEVEN GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: TGA - THORN GROUP LIMITED

For more info SHARE ANALYSIS: TGR - TASSAL GROUP LIMITED