Small caps on a high

Small cap stocks are pulling ahead in 2014, and their lead over larger rivals looks poised to widen.

No fewer than 26 juniors from the small cap index have hit at least a one-year high during this reporting season.

In contrast, there are only nine stocks on the S&P/ASX 100 Index that have achieved the same goal, although they easily overshadow the good earnings results from the smaller end of town with the likes of market giants Boral (BLD), Computershare (CPU) and Navitas (NVT) stealing the spotlight.

But, make no mistake, there is a turn in sentiment underfoot for emerging companies after a bruising 2013, which saw the S&P/ASX Small Ordinaries lag the top 200 benchmark by nearly 20%.

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It’s early days yet, but it’s encouraging to see the Small Ords starting to outpace their larger rivals since the New Year, with that many emerging stocks reaching highs – even though the market has lost some traction over recent weeks.

There are four emerging stocks that I have rated “outperform” that are sharing the leader’s podium, each having touched a 52-week or more high since the start of 2014. These stocks are mobile funds transfer technology company eServGlobal (ESV), consumer leasing solutions firm ThinkSmart (TSM), machine-to-machine (M2M) device maker NetComm Wireless (NTC) and emerging copper producer Tiger Resources (TGS).

The quartet look poised to rally even further, with eServGlobal’s joint venture HomeSend gaining significant market traction in the mobile remittance space as management delivered a sharp rebound in profits for the year ended October 31, 2013.

Net profit came in at $10.4 million for 2012-13 compared with a loss of $15.6 million in the year before. While management has not given a guidance for the current financial year, expectations are high that mobile phone users working in foreign countries will quickly adopt HomeSend as a means to transfer cash back home.

Meanwhile, ThinkSmart is winning over sceptics following the successful divestment of its Australian and New Zealand business. The company is better placed than before to deliver double-digit earnings growth as it focuses solely on the UK consumer market.

Notwithstanding the terrible floods in that country, the UK economy is the envy of Europe and consumer confidence is high. This bodes well for ThinkSmart, which has signed agreements with some of UK’s largest retailers.

The next few months will be a big one for NetComm as the company should start offering proof to investors that its M2M strategy is paying off financially after it struck a global supply deal with Vodafone. M2M allows different devices to communicate to each other and is used in things like smart meters and contactless cards.

NetComm is forecasting earnings before interest, tax, depreciation and amortisation (EBITDA) between $4.6 million and $5.1 million for the current financial year, which compares with the $803,000 it posted last year. This year’s guidance may turn out to be too conservative given the pipeline of deals management is pursuing.

There are also great expectations for Tiger Resources, with the ramp-up of its flagship Kipoi project in the Democratic Republic of Congo putting the miner among the lowest-cost copper producers of scale in the world.

From a valuation and risk perspective, Tiger is one of the most attractive junior miners on the ASX with more than 1.1 million tonnes of copper resources. I won’t be surprised if Tiger attracts corporate interest from the major mining houses in the coming months.

What’s also noteworthy is that all three companies will appeal to investors looking for offshore exposure as they are, or will, generate most of their sales in the United States or Europe.

As I stated last week, the February reporting season could provide an impetus for emerging companies to outperform for the rest of the year. We’ve since seen the likes of childcare operator G8 Education (GEM) and veterinary services and pet products retailing group Greencross (GXL) hitting a sweet spot with investors.

Both stocks have raced up to record highs this week on the back of their strong earnings outlooks. G8 enjoyed its best one-day gain of 6% to $3.50, while Greencross jumped over 1% to $8.70 on Monday.

G8’s ravenous appetite for acquisitions does not look to be abating, with the group announcing deals to buy 63 centres for $104.7 million. The centres will contribute $26.1 million to the group’s earnings before interest and tax on an annual basis, and this is likely to prompt analysts to revise up their 2014 forecasts (G8’s financial year is the same as the calendar year).

As it currently stands consensus estimates are predicting a $25 million increase in this year’s EBIT to $76.1 million, and the latest acquisition is estimated to contribute close to 70% of the increase. Management is likely to announce further acquisitions, as industry insiders estimate that around 80% of Australia’s 6,000 childcare centres are independently owned.

However, investors should keep an eye on whether G8 is able to maintain its sterling track record when it comes to buying centres, as competition is heating up. Newly listed Affinity Education (AFJ), which debuted in December last year, is looking to employ the same strategy.

What’s more, there are reports that Stirling Early Education is aiming for a $200 million initial public offer in the coming months. Cherry picking the best independent centres is bound to get more challenging.

Meanwhile, Greencross has reaffirmed its 2013-14 pro-forma net profit of $21.5 million as it delivered a 28% increase in half-year net profit of $4.4 million on the back of a 24% uplift in sales to $63.5 million.

The much bigger second-half number is due to the merger with pet supply retailer Mammoth, which recorded a 47% increase in net profit to $5.1 million for the six months to end December.

However, it will be a mistake for investors to assume smooth sailing ahead, even as management is guiding for double-digit earnings growth in 2014-15 as bedding down any large merger is challenging.

We don’t have a recommendation on either stock, but they are on our watch list.

Think big, go smalls!

* This article is part of the 'It's Time' series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.