Growth Stories Feature For Small Caps

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-Potential in newer small caps
-Still tough for small retailers
-Structural growth a theme
-Base metal stocks key in resources
-Limited upside for some performers
 

By Eva Brocklehurst

One of the main surprises throughout August was the small cap sector which, having lagged the market over several years, recovered some lost ground. Going forward, Morgans notes several of the newer small cap stocks tap into macro positives and are also attractive in terms of valuation. A case in point is law group Shine Corporate ((SHJ)), expected to show strong earnings growth and potential value-enhancing acquisitions. Software provider GBST Corporate ((GBT)) could surprise with acquisitions and/or capital management, given its strong balance sheet. Accommodation provider Mantra Group ((MTR)) offers earnings growth, strong free cash flow and an attractive dividend, while RCR Tomlinson ((RCR)), a traditional infrastructure engineer, is outperforming peers by growing margins and earnings. Kathmandu ((KMD)) continues to stand out as a retailer from a valuation versus growth perspective, and the broker expects the confirmation of the CEO succession should release value in the stock.

Stocks which led the sector over the earnings season were Domino's Pizza ((DMP)), M2 Telecommunications ((MTU)) and Slater & Gordon ((SGH)). Ardent Leisure ((AAD)), Iress ((IRE)), Magellan Financial ((MFG)) and Mesoblast ((MSB)) also impressed Morgans. Those that lacked sparkle included Platinum Asset Management ((PTM)), Breville Group ((BRG)), CSR ((CSR)), Southern Cross Media ((SXL)), SAI Global ((SAI)) and UGL ((UGL)).

Small retailers continue to experience tough conditions and Morgan Stanley finds any improvement in the near term difficult to envisage. The broker prefers those companies with structural growth drivers, such as store roll-out or category expansion, or a demonstrated ability to grow through the cycle. This is best reflected in Domino's Pizza, which the broker expects to sustain strong double digit earnings for many years to come. Also, Pas Group ((PGR)), where growth from the rolling out of stores and new wholesale brand licences is not mirrored in the share price. The broker considers it too early to call a consumer-led recovery and expects improvements for retailers will only be in evidence in 2015.

On the broker's watch list are The Reject Shop ((TRS)), as there is significant opportunity to improve margins from all time lows. Fantastic Holdings ((FAN)) and Webjet ((WEB)) are yet to show signs of improvement and the broker retains Equal Weight ratings. Structural growth remains a key theme for Morgan Stanley. The infrastructure sector is still struggling to fill the gap left as resource spending declines. That said, the broker is not giving up on all resources and still expects improved base metal fundamentals will help those relevant stocks outperform. The broker also observes new listings were strong performers during August, with the majority delivering earnings beyond prospectus forecasts. The broker expects a continued re-rating of these stocks. Outperformance is expected to come from Automotive Holdings ((AHE)), Burson Group ((BAP)), CSG ((CSV)), Corporate Travel Management ((CTD)), Domino's and Mermaid Marine ((MRM)).

Goldman Sachs makes no changes to its Australian small and mid cap focus list after the earnings season. Key performers from the list are Dick Smith Holdings ((DSH)), Austbrokers ((AUB)) and Blackmores ((BKL)), which delivered excess returns to benchmark of 11.0%, 9.7% and 4.4% respectively. The key detractors on the list were Alacer Gold ((AQG)), Nine Entertainment (((NEC)) and Kathmandu, which delivered negative returns of 9.8%, 6.5% and 3.7% respectively.

Three small caps have grabbed the attention of UBS in the aftermath of reporting season. All performed well but are likely to find the going tougher in the year ahead. Flexigroup ((FXL)) has sustained volume growth, earnings certainty and a reasonable dividend yield. Additional costs, a strong recent run up in the share price and competition in key markets mean it may be difficult for the stock to outperform significantly. GWA Group ((GWA)) has leverage to the improvement in domestic housing but, with a strong bias towards late cycle construction and renovations, a meaningful uplift to earnings is yet to materialise. The stock is also expensive and trading at the top end of its historical range, in UBS' opinion. GUD Holdings ((GUD)) has an attractive yield but UBS suspects a lot of upside is already factored in.

Citi has reinvigorated its "big ideas in small caps" report, broadening the coverage of stocks from the Small Ordinaries index. Top industrial Buy calls are Nine Entertainment, iiNet ((IIN)), Flexigroup, Spotless Group ((SPO)), McMillan Shakespeare ((MMS)) and Veda Group ((VED)). The top Sell is nib Holdings ((NHF)). In resources, Beadell Resources ((BDR)), Resolute Mining ((RSG)) and Western Areas ((WSA)) are top Buy calls, while Paladin Energy ((PDN)) is the top Sell.
 

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