Three small caps enjoying the $A fall

The stronger US dollar is providing a material positive impact for three small caps.

Summary: The sharp drop in the Australian dollar is good news for Australian companies that derive a high percentage of their revenue from the US, or that sell the bulk of their product in US dollars. A number of emerging companies in the Uncapped 100 generate almost all of their income in foreign currencies, including US dollars.
Key take-out: A fall in the exchange rate between the Australian and US dollars to US85 cents over the next year could represent up to a 17.5% tailwind to the US earnings for some companies.
Key beneficiaries: General investors. Category: Growth.

It was sobering to see the Australian dollar tumble to fresh 33-month lows against the greenback on Tuesday evening.

This makes the Australian dollar the worst-performing major currency over the last six months, and its fall from grace is unnerving many in the market who regard the strong Aussie as a symbol of everything that has gone right with our economy.

But the weakening exchange rate leaves a good number of small cap stocks on the cusp of an earnings upgrade cycle, as highlighted by Ian Verrender last month, as analysts have been caught off guard by the sudden and vicious drop in the Aussie. It plunged to a low of US93.3 cents yesterday, but has since recovered to around US94.5 cents.

This might surprise you, but the currency impact is being just as acutely felt, if not more so, among a select group of juniors than large cap stocks.

While it is true that smaller companies tend to have far more limited offshore sales exposure than their bigger rivals, a good number of emerging companies in the Uncapped 100 generate almost all of their income in foreign currencies.

In fact, around a quarter of the Uncapped 100 stocks (you can find the full list of the Uncapped 100 at the bottom of the article) make at least half of their sales in another currency, and these aren’t just made up of resource companies that sell mineral and energy commodities to the global market in US dollars.

Industrial stocks in the Uncapped 100 with the greatest foreign currency exposure

Company

Approx FY12 revenue in foreign $ (%)

Market Cap ($)

Astro Japan Property Group

100

215,749,728

iProperty Group

98

129,560,136

Sirtex Medical

>95

629,064,576

Acrux

89

604,473,792

Mobilarm

87

13,351,720

eServGlobal

>86

94,637,472

Infomedia

>72

138,127,472

Nanosonics

72

143,872,416

Mayne Pharma Group

58

244,886,064

Imdex

51

174,692,752

Source: Company reports, Bloomberg, Eureka Report

For instance, industrial companies like property investment company Astro Japan Property Group (AJA) and Asian real estate website operator iProperty Group (IPP) have next to no Australian market exposure.

However, it is not easy to quantify the earnings impact from the exchange rate because a number of these companies use derivatives to hedge their currency risks.

Take Acrux for example. Most of the biotech’s revenue comes from royalties that are paid in US dollars, but in its 2012-13 accounts the company said that a 10% change in the exchange rate would have an “immaterial impact” on its net profit as it uses spot and short-term forward sales of US dollars.

Further, trying forecast where the Australian dollar might go over the short term is hard enough, let alone guessing where it will average for the year, with the latter being more important in determining earnings.

With the financial year ending in just a few weeks, the Australian dollar is likely average $US1.03 for 2012-13, and a number of investment banks have been busy cutting their exchange rate estimates for the new year to between US85 cents and US90 cents. This could represent up to a 17.5% tailwind to the US earnings for some companies.

I’ll ignore the performance of the local dollar against other currencies for now, as the US dollar is the current focus. On the back of this, there are three companies that stand to benefit materially from the strengthening greenback.

Nanosonics (NAN)

When it comes to currency leverage, it’s hard to look past Nanosonics.

The stock is attractively priced, even if our dollar was at parity, and any fall-off in the Australian dollar will only make the stock more compelling.

The company has developed a device to more efficiently disinfect ultrasound probes and generates 69% of total revenue from North America.

However, unlike most of its peers, it manufactures the units and consumables (such as disinfection liquids) locally. This means a lower Australian dollar will not only increase its top line, but will pad its profit margin as well.

This can be seen if its 2011-12 accounts are used as a guide. Nanosonics’ chief financial officer, McGregor Grant, estimates that a 10% decline in the Australian dollar against the US currency would have added $1 million, or 17%, to its earnings before interest and tax.

What’s more, Nanosonics is not locked into any long-term hedging contracts and is well placed to benefit from the lower Australian dollar over the next 12 months.

The next catalyst for the stock could come in the next few weeks as GE, which has the exclusive right to distribute Nanosonics’ device in the United States, is expected to sign a new agreement with Nanosonics that could see the global conglomerate commit to a large order for the devices.

The stock is hovering close to its more than two-year high of 58 cents, but that is still comfortably under the average broker price target of 69 cents a share. The longer the Australian dollar remains on the back foot, the greater the probability that this price target will be revised upwards.

Unity Mining (UML)

Miners will be eagerly watching the declining Australian dollar, but those with onshore operations will be wearing the biggest grins.

This is because selling commodities in US dollars, but having most of your costs in Australian dollars, will enable the miner to report higher translated revenue from the stronger US currency and fatter margins as Australian dollar expenses fall relative to sales.

YTC Resources, Doray Minerals and Unity Mining are the only mining companies on the Uncapped 100 with all their assets in Australia, but only Unity is in production and can benefit from the current slump in the exchange rate.

The chief executive of the Tasmanian-based goldminer, Andrew McIlwain, told Eureka Report that a 10% fall in the $A/$US exchange rate will lift its earnings before interest, tax, depreciation and amortisation (EBITDA) margin by around 25%.

The floundering Aussie could mark a turning point for the stock, which has bounced 28.3% to 7.7 cents since hitting a record low of 6c cents in May due to the falling gold price and general market distaste for risky smaller producers.

There is value in Unity for those with a stomach for risk. The Henty gold mine, which is Unity’s flagship project, is cash flow positive and financially viable given its low cash cost of $900 plus per ounce including royalties.

Henty produced 4,831 ounces of gold in April and is on target to achieve full-year production of around 50,000 ounces for 2012-13.

All brokers polled on Bloomberg rate the stock a “buy”, with an average price target of 15 cents.

Sirtex Medical (SRX)

The market darling is starting to look fully valued after its share price doubled over the past 12 months, but the exchange rate is starting to inject some value back into the stock.

The liver cancer treatment developer is the ninth-best performer in the Uncapped 100 as investors have gotten excited that its technology is gaining serious traction around the world.

The downside to the success is that Sirtex is trading on an estimated one-year forward price/earnings ratio of over 25 times.

But with close to 98% of total revenue denominated in US dollars, brokers will probably be upgrading their profit forecasts on the stock if the Australian dollar remains under pressure.

Consensus estimates is currently anticipating a 43.5% surge in adjusted net profit to $27.4 million for 2013-14, but analysts are probably assuming that the Aussie hovers around parity to the greenback.

At US85 cents though, analysts will upgrade Sirtex’s net profit to just under $30 million as half of Sirtex’s earnings are naturally hedged because of its US manufacturing operations.

This means an 18% drop in the Australian dollar will see its bottom line increase by 9%.

This in itself won’t put the stock deep in value territory, but it will put the stock on a relatively attractive forward P/E of about 23 times, or about a 39% discount to global peers and 4% discount to Sirtex’s five-year average.

But one shouldn’t be thinking of Sirtex like a value stock. If you did, you would never buy it and would have missed out on its stellar run.

A company with Sirtex’s track record and growth projector will always command a market premium, and the trick is to get in with as small a premium as possible.


Brendon Lau may have interests in some of the stocks mentioned in the article.

The Uncapped 100 

CodeNameRationaleMarket cap ($m)Total return 1-year (%)Sector (GICS)
MMS McMillan Shakespeare One of the best performers since the GFC, but doesn't get much press or analyst coverage. Good management team.1,11942.3Industrials
NHF NIB Holdings /AustraliaOnly listed health insurer. Widely held. Good performer.1,01057.89Financials
MTU M2 Telecommunications Group Amazing growth story and well run company. High free float and strong insto support.94563.24Telecommunication Services
BRG Breville Group Well covered but good candidate for core holding due to good track record.92875.47Consumer Discretionary
ARP ARB Corp Well covered but good candidate for core holding due to quality management.82032.98Consumer Discretionary
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.77325.11Industrials
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.686172.26Consumer Discretionary
SRX Sirtex Medical A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.67897Health Care
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding64438.02Consumer Discretionary
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.63467.46Financials
ACR Acrux One of the most successful Australian biotechs in recent history. Widely held by instos.616-14.37Health Care
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.59466.77Consumer Discretionary
BDR Beadell Resources Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.5235.56Materials
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.48655.68Telecommunication Services
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.44352.24Industrials
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.43631.26Consumer Discretionary
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.41435.19Energy
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.414-31.16Information Technology
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.40762.18Consumer Discretionary
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.40760.11Industrials
SEA Sundance Energy Australia 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.40560Energy
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.40468.79Consumer Staples
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.39960.61Telecommunication Services
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.371-57.79Energy
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.37051.19Financials
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.36847.42Financials
FGE Forge Group One of the better performers in its industry. Good track record and potential core holding.366-3.83Industrials
UNS Unilife CorpThe 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.334-18.12Health Care
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.33127.21Information Technology
TGA Thorn Group One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.31453.36Consumer Discretionary
UXC UXC Company has turned corner and enjoyed re-rating. What's next?29274.02Information Technology
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?28230.74Industrials
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.282-62.69Industrials
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.27284.22Financials
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 25857.17Financials
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.246-13.69Consumer Staples
IMF IMF Australia Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.24459.07Financials
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.24267.53Health Care
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.238-40Health Care
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.22423.73Financials
WBB Wide Bay Australia 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.2199.33Financials
NWT Newsat Potential large cap if it can launch its own satellite in 2015.213-50.31Telecommunication Services
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.2110.63Consumer Staples
DWS DWS Will be a big beneficiary if governments start spending on IT again.19513.93Information Technology
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.194119.33Industrials
DTL Data#3 Well respected IT company that receives little press coverage18529.58Information Technology
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.18238.9Information Technology
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.179145.61Consumer Staples
GXY Galaxy Resources Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship. Stock has been suspended for rights issue.177n.a.Materials
GXL Greencross Acquisitive vetinary group. Good profit growth and share price performance, but gets little press.176114.03Health Care
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?16972.67Consumer Discretionary
CLH Collection House In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further16993.13Industrials
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.16755.77Industrials
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.166-56.09Materials
MCP McPherson's The personal care and household products supplier is relatively insulated from volatile discretionary spend and online threat.16414.52Consumer Discretionary
GID GI Dynamics IncLargely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal shealth on diabetics.160-35.63Health Care
VOC Vocus Communications Telecom stocks are in favour but Vocus is one of the least covered15913.66Telecommunication Services
CKF Collins Foods One of the few food franchise listed companies.15870.3Consumer Discretionary
BNO Bionomics One of the larger cancer treatment developers in this market.15222.03Health Care
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.14912.87Health Care
HSN Hansen Technologies Operates in a high potential/growth industry but is not covered by press or brokers.1466.59Information Technology
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.144159.84Information Technology
POH Phosphagenics Sizable biotech with a game changing FY14 year ahead. Good insto following.138-3.57Health Care
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.13715.25Industrials
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.136-27.88Information Technology
TGS Tiger Resources 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.135-29.82Materials
RCG RCG Corp 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.12753.54Consumer Discretionary
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.120-1.15Materials
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.1153.13Health Care
BGL BigAir Group The wireless microcap has gained strong following over past year or two but is often overlooked by investors and the press.10374.1Telecommunication Services
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.9968.86Health Care
ACL Alchemia /AustraliaOne of the few biotechs with revenue stream. Good pipeline of oncology treatments.99-28.24Health Care
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage9679.07Information Technology
SAR Saracen Mineral Holdings 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.95-70.64Materials
AOH Altona Mining Noteworthy copper play with Xstrata pullout of Roseby project in Australia and the good ramp up of its Finnish project.95-21.74Materials
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.91103.14Consumer Discretionary
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.8925.08Industrials
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.86-19.28Energy
NEA Nearmap A stellar performer with an Interesting business that offers high quality ariel maps to companies & government.82493.02Information Technology
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.80-20.59Materials
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 7730Materials
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year7315.15Health Care
RUL RungePincockMinarco IT company to resource industry. Turnaround potential under new CEO.7130.95Industrials
DRM Doray Minerals Widely held by instos. One of the more favored gold explorers by brokers.70-42.78Materials
JIN Jumbo Interactive Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.6564.55Consumer Discretionary
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.597.97Consumer Staples
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.5719.54Materials
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.55-12.41Information Technology
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.54-48.89Industrials
UML Unity Mining Growing Tassie gold producer with high free float. Valuation looks compelling too.54-38.4Materials
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.52-27.27Materials
KOV Korvest The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.5133.92Industrials
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.51-22.96Industrials
ISS ISS Group 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 100.44103.7Information Technology
TSM ThinkSmart Potential turnaround story worth keeping eye on.4217.78Financials
OTH Onthehouse Holdings Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a compeitive edge against REA.33-0.36Consumer Discretionary
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.33145.45Information Technology
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.20121.67Consumer Discretionary
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.1134.88Health Care
MBO Mobilarm Unique product that could change global maritime safety practices with its man-overboard location beacon.10-14.63Information Technology

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