|Summary: High hopes for small caps are a cause for concern for some market experts who warn that profit growth expectations are still too optimistic. We look at two companies likely to meet them: M2 Telecommunications and RCR Tomlinson, and one which may struggle: RungePincockMinarco.|
|Key take-out: Some small caps won’t clear high earnings hurdle.|
|Key beneficiaries: General investors. Category: Shares.|
|Recommendations: Underperform. (RungePincockMinarco, Neutral (RCR Tomlinson), Outperform (M2 Telecommunications)|
Reporting season jitters will soon be upon us but it’s not the 2012-13 earnings investors should be anxious about.
It’s the current financial year’s outlook that is causing more angst as market experts are warning that profit growth this year is still looking too optimistic even though analysts have been steadily revising down their forecasts over the past year. Trying to work out which emerging company is at risk of disappointing and which are likely to meet lofty expectations is tricky in this volatile environment, and I suspect management teams won’t be giving much clarity in August with the date of the federal election still up in the air and before currency and commodity markets settle down from their big swings.
The 2013-14 earnings per share (EPS) estimates for the ASX Small Industrials Index is currently 9.3% lower in aggregate terms than it was at July last year; and while earnings expectations are the lowest it has been since December, consensus forecasts are implying around a 16% increase in EPS this year.
In contrast, small caps outside the resources sector are only expected to record a modest 3.6% median EPS growth for 2012-13.
This means the real downside risk to earnings expectations is for the current year, and I believe it won’t be until February when we get more of the “light at the end of the tunnel” outlook statements that investors are craving for.
Against this backdrop, I will highlight two fast growing stocks on the Uncapped 100 that are likely to meet high market expectations, and one that is at risk of disappointing.
Mining software and technology consulting company RungePincockMinarco is the one that I suspect will struggle to please investors as there seems to be a fair amount of optimism build into its share price.
The stock is up close to 40% over the past year and consensus estimates on Bloomberg is tipping a more than four-fold year-on-year increase in its 2013-14 underlying earnings before interest, tax, depreciation and amortisation (EBITDA) to $15 million.
That may be too aggressive given the challenging climate in the mining sector, and even its 2012-13 EBITDA estimate of $3.7 million, which is down around 60% from the year before, is too bullish given that its first half operating EBITDA crashed 87% to just $700,000.
Like just about all companies servicing the mining industry, management noted a significant drop off in demand for its services. This forced RungePincockMinarco to undertake a major restructure and write off the value of some of its businesses.
There is room for earnings to recover, but I don’t think it will happen quickly given RungePincockMinarco’s material exposure to new mining projects, particularly in the coal, iron ore and gold space.
Its other traditional source of income – providing advice to miners looking to list on the Hong Kong stock exchange – is also not likely to make much of a comeback unless sentiment towards the mining industry changes dramatically.
If the 2013-14 forecast is to be believed, it would imply that RungePincockMinarco’s earnings performance would be nearly as good as in 2011-12, which turned out to be one of the company’s best years thanks to buoyant market conditions.
What’s worst, on the current year’s estimates, the stock is trading on a price-earnings multiple of 8.6 times.
That may not sound onerous given that the stock’s five-year average P/E is 13 times, but I cannot see why RungePincockMinarco should trade at a premium to mining contractors, which are on P/Es or around six times.
I would recommend investors sell the stock for better opportunities in the mining services space.
M2 Telecommunications Group (MTU)
M2 Telecommunications Group has also some high hurdles to clear as analysts are expecting the fledging telco to deliver a 50% increase in EBITDA this year.
This comes on top of the expected doubling in its EBITDA for 2012-13 to $110.9 million, which is largely driven by its Primus Telecom acquisition.
This time, it is the takeover of Eftel and Dodo Australia Holdings that will help lock in the strong rise in EBITDA for 2013-14.
While acquisitions have been key to M2’s stellar growth over the past few years, the strategy has become a double-edged sword when it comes to valuing M2.
I say this at a time when M2’s share price is above even the most bullish broker price target reported on Bloomberg of $6 a share, which puts the stock on a P/E of around 14 times for 2013-14.
However, M2’s peers are trading on P/Es well ahead of the group. TPG Telcom is on 19 times, Amcom Telecommunications is on 20 times and iiNet is on 16 times.
The difference is that these companies have a track record in generating organic growth, while experts are not quite sure what organic growth for M2 looks like in the wake of its aggressive acquisition strategy.
This is why the market is discounting the stock, even though I believe M2 deserves to trade on par value with iiNet.
This means M2 should be trading closer to $7 to reach fair value. This, coupled with its gross-up dividend yield of around 6%, could potentially net investors another 20% over the next 12-months.
RCR Tomlinson (RCR)
RCR Tomlinson’s expected EBITDA growth of 33.2% to $78.1 million for 2013-14 might pale compared with the other two stocks, but that’s still a very big number given the poor outlook for engineering contractors.
But if its takeover of struggling Norfolk Group comes to pass (Norfolk shareholders will be voting on the deal next week), RCR should not have much difficulty in meeting expectations as Norfolk is expected to double RCR’s revenue base.
Norfolk came into strife because of poor management of its contracts, an over geared balance sheet and big restructuring costs.
RCR on the other hand, has a much stronger track record in delivering shareholder value. If RCR can extend its magic touch to Norfolk, the deal will create a lot of value for RCR.
The market is giving RCR the benefit of the doubt so far with the stock trading on a one-year forward P/E of 7.5 times, which is a close to 30% premium to its peers.
I believe on a relative valuation perspective, RCR is looking fully valued, although there is plenty more upside to its current share price of $2.25 if RCR can turnaround Norfolk’s businesses.
But until I see clearer signs of that happening, I would keep the stock on a “hold”.
Brendon Lau owns shares in MTU.
Uncapped 100 - The Real Top 100
|Small cap stocks covered by the Uncapped team|
|Code||Name||Rationale||Market cap ($m)||Total return 1-year (%)||Sector (GICS)|
|MMS||McMillan Shakespeare Ltd||One of the best performers since the GFC, but doesn't get much press or analyst coverage. Good management team.||1,313||65.57||Industrials|
|MTU||M2 Telecommunications Group Ltd||Amazing growth story and well run company. High free float and strong insto support.||1,072||89.56||Telecommunication Services|
|BRG||Breville Group Ltd||Well covered but good candidate for core holding due to good track record.||958||80.29||Consumer Discretionary|
|NHF||NIB Holdings Ltd/Australia||Only listed health insurer. Widely held. Good performer.||913||50.13||Financials|
|MRM||Mermaid Marine Australia Ltd||Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.||895||49.44||Industrials|
|ARP||ARB Corp Ltd||Well covered but good candidate for core holding due to quality management.||892||39.85||Consumer Discretionary|
|AAD||Ardent Leisure Group||Widely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.||720||58.07||Consumer Discretionary|
|SRX||Sirtex Medical Ltd||A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.||684||93.92||Health Care|
|GEM||G8 Education Ltd||Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.||674||171.85||Consumer Discretionary|
|SGN||STW Communications Group Ltd||One of few companies able to benefit from online shift. Widely held and good insto support.||645||75.63||Consumer Discretionary|
|AUB||Austbrokers Holdings Ltd||The insurance broker is a strong performer. Widely held and well liked by small cap investors.||627||61.13||Financials|
|ACR||Acrux Ltd||One of the most successful Australian biotechs in recent history. Widely held by instos.||604||-10.32||Health Care|
|RFG||Retail Food Group Ltd||Owns a number of well know franchise brands. Widely followed by instos.||586||83.81||Consumer Discretionary|
|CCV||Cash Converters International Ltd||Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.||509||84.71||Consumer Discretionary|
|AMM||Amcom Telecommunications Ltd||Well covered junior telco but good candidate for core holding.||494||89.18||Telecommunication Services|
|NXT||NEXTDC Ltd||The cloud computing company is an IT sector darling. Fairly widely held and followed.||475||41.8||Telecommunication Services|
|SEA||Sundance Energy Australia Ltd||Analysts have a favorable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.||453||73.45||Energy|
|CCP||Credit Corp Group Ltd||Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.||445||62.73||Industrials|
|SLX||Silex Systems Ltd||Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.||441||-40.46||Information Technology|
|TOX||Tox Free Solutions Ltd||Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.||436||34.64||Industrials|
|BRU||Buru Energy Ltd||Substantial size but not often covered by press. Widely held with good insto support.||423||-51.26||Energy|
|BDR||Beadell Resources Ltd||Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.||422||-12.3||Materials|
|FGE||Forge Group Ltd||One of the better performers in its industry. Good track record and potential core holding.||414||15.96||Industrials|
|HZN||Horizon Oil Ltd||One of better regarded small energy stocks that doesn't receive much media attention.||409||28.57||Energy|
|CWP||Cedar Woods Properties Ltd||Property developer with good ROE and earnings growth track record.||405||60.15||Financials|
|BGA||Bega Cheese Ltd||Corporate interest in Australian food companies makes the cheese maker worth following.||393||72.83||Consumer Staples|
|MYS||MyState Ltd||Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.||380||51.82||Financials|
|UNS||Unilife Corp||The developer of one-use prefilled syringes is close to an inflection point as the market is expecting the company to announce a major contract with a pharmaceutical giant in the coming weeks.||337||4.24||Health Care|
|RKN||Reckon Ltd||Fierce competition for cloud base accounting software puts it in firing line.||322||20.28||Information Technology|
|UXC||UXC Ltd||Company has turned corner and enjoyed re-rating. What's next?||317||92.15||Information Technology|
|TGA||Thorn Group Ltd||One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.||307||40.61||Consumer Discretionary|
|MYX||Mayne Pharma Group Ltd||Sizeable generic drug maker with interesting board members.||301||63.78||Health Care|
|RCR||RCR Tomlinson Ltd||Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?||297||32.02||Industrials|
|MOC||Mortgage Choice Ltd||Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.||284||86.8||Financials|
|NWH||NRW Holdings Ltd||One of the better regarded mining & civil contractors with good track record in delivering on projects.||265||-67.95||Industrials|
|SPL||Starpharma Holdings Ltd||Noteworthy for its good pipeline of innovations. Well run, widely followed.||263||-37.07||Health Care|
|AEU||Australian Education Trust||Well performing childcare centre property owner. Good yield story and outlook.||254||57.39||Financials|
|SIV||Silver Chef Ltd||Strong jump in the share price of the equipment financing group has attracted a good following.||237||161.25||Industrials|
|RIC||Ridley Corp Ltd||High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.||234||-13.52||Consumer Staples|
|IMF||IMF Australia Ltd||Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.||233||37.74||Financials|
|AJA||Astro Japan Property Group||Strong leverage to Japanese economy makes this an interesting stock to watch.||213||16.06||Materials|
|NWT||Newsat Ltd||Potential large cap if it can launch its own satellite in 2015.||210||-29.09||Telecommunication Services|
|SHV||Select Harvests Ltd||Noteworthy for turbulent past and exposure to soft commodity market.||210||196.31||Consumer Staples|
|DWS||DWS Ltd||Will be a big beneficiary if governments start spending on IT again.||200||13.36||Information Technology|
|CLH||Collection House Ltd||In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further||196||129.85||Industrials|
|WBB||Wide Bay Australia Ltd||The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.||192||-7.82||Financials|
|MXI||MaxiTRANS Industries Ltd||Transport equipment maker posted good interim result. Has appealing yield and growth.||192||77.44||Industrials|
|GXL||Greencross Ltd||Acquisitive vetinary group. Good profit growth and share price performance, but gets little press.||191||133.28||Health Care|
|NAN||Nanosonics Ltd||A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.||189||41.18||Health Care|
|MLB||Melbourne IT Ltd||A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.||182||43.11||Information Technology|
|PFL||Patties Foods Ltd||Illiquid stock but has suite of well recognised consumer brands. Defensive yield.||181||-14.4||Consumer Staples|
|DTL||Data#3 Ltd||Well respected IT company that receives little press coverage.||180||9.57||Information Technology|
|GXY||Galaxy Resources Ltd||Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.||177||n.a.||Materials|
|CKF||Collins Foods Ltd||One of the few food franchise listed companies.||170||74.18||Consumer Discretionary|
|VOC||Vocus Communications Ltd||Telecom stocks are in favour but Vocus is one of the least covered||163||18.44||Telecommunication Services|
|IFM||Infomedia Ltd||Interesting tech play in the car parts market. Strong share price gain but gets little air play.||161||182.86||Information Technology|
|IPP||iProperty Group Ltd||Worth watching as it is trying to be the REA Group of Asia.||154||-5.56||Information Technology|
|GID||GI Dynamics Inc||Largely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal shealth on diabetics.||151||-37.22||Health Care|
|SFH||Specialty Fashion Group Ltd||In early stages of turnaround. Can the women's apparel retailer sustain the momentum?||151||57.05||Consumer Discretionary|
|HSN||Hansen Technologies Ltd||Operates in a high potential/growth industry but is not covered by press or brokers.||145||5.43||Information Technology|
|BNO||Bionomics Ltd||One of the larger cancer treatment developers in this market.||144||17.35||Health Care|
|IMD||Imdex Ltd||Drilling company is well supported by instos and should benefit from any rebound in exploration activity.||143||-57.69||Materials|
|RCG||RCG Corp Ltd||The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.||141||63.36||Consumer Discretionary|
|UBI||Universal Biosensors Inc||Well regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.||131||32.74||Health Care|
|TFC||TFS Corp Ltd||The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.||130||-1.06||Materials|
|REX||Regional Express Holdings Ltd||Well run airline that is overshadowed by Virgin and Qantas.||125||9.56||Industrials|
|AZZ||Antares Energy Ltd||Liquid with good insto support. Already in production with exploration upside in Texas.||121||23.38||Energy|
|TGS||Tiger Resources Ltd||Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.||118||-43.55||Materials|
|MCP||McPherson's Ltd||The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but its latest profit warning shows it's not immune.||114||-15.81||Consumer Discretionary|
|AMA||AMA Group Ltd||Good turnaround story but under the automotive services group is radar of most.||109||152.48||Consumer Discretionary|
|POH||Phosphagenics Ltd||Sizable biotech with a game changing FY14 year ahead. Good insto following but accounting irregularities is a cloud hanging over stock.||102||-33.33||Health Care|
|BGL||BigAir Group Ltd||The wireless microcap has gained strong following over past year or two but is often overlooked by investors and the press.||100||62||Telecommunication Services|
|CLV||Clover Corp Ltd||One of the star performers in 2012. Operates in growing but relatively stable niche.||100||61.54||Health Care|
|ESV||Eservglobal Ltd||Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage||100||100||Information Technology|
|ACL||Alchemia Ltd/Australia||One of the few biotechs with revenue stream. Good pipeline of oncology treatments.||99||-42.45||Health Care|
|LCM||LogiCamms Ltd||Strong price performance and reasonable valuation attracting interest.||98||37.09||Industrials|
|NEA||Nearmap Ltd||A stellar performer with an Interesting business that offers high quality ariel maps to companies & government.||92||595.12||Information Technology|
|JIN||Jumbo Interactive Ltd||Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.||81||79.99||Consumer Discretionary|
|CAA||Capral Ltd||An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose.||73||32.14||Materials|
|PEN||Peninsula Energy Ltd||Widely held by instos and large free float. It's the only uranium miner on the list.||71||-27.27||Materials|
|CUV||Clinuvel Pharmaceuticals Ltd||Interesting skin disorder treatment developer that has done reasonably well over past year||70||-0.82||Health Care|
|AOH||Altona Mining Ltd||Noteworthy copper play with Xstrata pullout of Roseby project in Australia and the good ramp up of its Finnish project.||69||-55.93||Materials|
|RUL||RungePincockMinarco Ltd||IT company to resource industry. Turnaround potential under new CEO.||68||35.91||Industrials|
|DRM||Doray Minerals Ltd||Widely held by instos. One of the more favored gold explorers by brokers.||65||-44.29||Materials|
|SAR||Saracen Mineral Holdings Ltd||Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.||64||-78.92||Materials|
|TAN||Tandou Ltd||The only direct equity exposure to cotton prices. Also trades water rights and receives little press.||61||14.87||Consumer Staples|
|WDS||WDS Ltd||Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.||56||-5.41||Industrials|
|CKL||Colorpak Ltd||The small cap packaging company has grown via acquisitions over past few years.||55||19.99||Materials|
|BOL||Boom Logistics Ltd||Crane hire group is riding out the downturn in construction. It's widely held by instos and is very liquid.||54||-55.77||Industrials|
|KOV||Korvest Ltd||The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.||54||44.07||Industrials|
|YTC||YTC Resources Ltd||Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.||50||-22.45||Materials|
|UML||Unity Mining Ltd||Growing Tassie gold producer with high free float. Valuation looks compelling too.||50||-43.2||Materials|
|LGD||Legend Corp Ltd||Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.||48||-25.4||Information Technology|
|TSM||ThinkSmart Ltd||Potential turnaround story worth keeping eye on.||47||26.09||Financials|
|ISS||ISS Group Ltd||Good turnaround story from 2012 but the resource industry software developer under the radar of most. ISS has received a takeover offer after its inclusion in the Uncapped 100.||44||85.11||Information Technology|
|OTH||Onthehouse Holdings Ltd||Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a compeitive edge against REA.||36||0.88||Consumer Discretionary|
|NTC||NetComm Wireless Ltd||Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.||30||118.18||Information Technology|
|EBT||eBet Ltd||Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.||21||92.91||Consumer Discretionary|
|MBO||Mobilarm Ltd||Unique product that could change global maritime safety practices with its man-overboard location beacon.||18||100||Information Technology|
|PGC||Paragon Care Ltd||Emerging hospital equipment supplier that has been ignored by market.||14||65.79||Health Care|
|Source:||Eureka Report, Bloomberg|