Under the Radar: Silver Chef

PORTFOLIO POINT: This small-cap equipment financier employs a low-risk business model that’s set for further high returns.

Sometimes there is great money to be made in industries you’ve never heard of and Silver Chef Limited (SIV) is a good example. Its capitalisation may be small, at about $73 million, and its key business may be niche, but this company has big ambitions.

While we usually don’t cover companies worth less than $100 million, Silver Chef certainly warrants attention and we wouldn’t be surprised in any event to see the company grow far beyond our usual cut-off size in the coming years.

Listed since 2005, the Brisbane-based Silver Chef has a 24-year trading history as Australia’s pioneer hospitality equipment financier. The company story began when founder Allan English decided to import a container of pizza ovens to sell to local pizza shop owners.

Today, the company leases $109 million worth of equipment to 6000 clients, mostly small businesses and franchises. About $86 million of these equipment assets are leased to the hospitality sector with the balance rented to other clients under Silver Chef’s generalist division GoGetta, launched in 2008, which provides businesses with everything from compact constructors to trailers or gym equipment, on lease and hire purchase agreements.

These days English is the company’s chairman, having appointed former Flight Centre Limited (FLT) executive Charles Gregory as chief executive. English retains about 39% of the company and small-cap investor Peter Guy is another major shareholder, as is fund manager Wilson Asset Management.

With a tightly held structure and about $62,000 traded on a daily basis, liquidity can be a problem for some retail and large investors seeking exposure to Silver Chef, but if you’re small and nimble enough, or one of the 400-odd existing holders, the company has proven attractions. Not only have shares almost doubled from this time last year, but the company’s dividend track record is excellent.

Silver Chef has maintained a yield above 5%, since its first fully franked dividend was paid at the end of 2005-06. Based on the company’s closing price of $3.25 on October 27, it has an estimated forward yield of 6.15% for 2010-11 and 7.08% for 2011-12, based on forecast accumulative payouts of 20¢ and 23¢ respectively.

While the company’s small market capitalisation means it won’t tick the boxes for all investors, its earnings per share (EPS) growth and return on assets (ROA) certainly do. In 2009-10, for instance, Silver Chef delivered ROA of 8.76% on an annualised basis and EPS growth of 31.66%.

With brokers forecasting 2010-11 EPS growth of between 14.56% and 21.24%, from 2009-10’s earnings of 28.02¢ per share, and 2011-12 EPS growth of between 14.02% and 18.82% based on increases from their respective estimates, it seems Silver Chef would meet all our Golden Rules in the years to come as well.

As far as valuations go, assuming forward earnings of 40¢ per share by 2011-12 and a target price/earnings multiple of 10.2 times (being Silver Chef's five-year average) we can arrive at a simple target price of $4.08. If we were to combine that with discount cash flow valuations, this time using broker assumptions, the figure would be a little lower; but either way I can see short-term value in the company's share price.

But again, like so many other small-cap stocks, the real story is in Silver Chef’s growth potential. It may be a great business in the present, but the prospects look even better in the future.

Silver Chef currently only operates in Australia but it does have foreign ambitions, which is part of the reason Gregory, who grew Flight Centre’s corporate presence overseas, was brought on board. Nevertheless, even if one only considers Australia, prospects for domestic market share growth are significant.

As much as it leads in its niche, the company has – on most recent estimates – only penetrated 3.9% of its potential market: businesses that meet its stringent criteria for equipment financing. Indeed, Silver Chef currently only approves 50–60% of clients for credit and has made sure that no client is worth more than 1% of its order book.

This model proved resilient during the global financial crisis when many small businesses went out of operation and consumers cut back on discretionary spending. Further, Silver Chef actually grew during the GFC. Between June 2007, when it reported full-year earnings of 11.27¢ per share, and June 2008, EPS grew 39.33%. Between 2007-08 and 2008-09 it grew a further 35.52%.

The company’s share price did decline during the period but at current prices this only proved to be an opportunity for astute investors who had their eye on the bottom line, not the share price chart. Silver Chef will be updating the market on growth potential at its upcoming AGM.

Compared to its peers, the company also looks good both on a relative value basis and on bottom-line performance. FlexiGroup Limited (FXL) is by far the largest listed company in the equipment rental space, but its focus has been on generic office equipment and mediocre cash flows give us slight cause for concern. Thorn Group Limited (TGA), which we profiled in this column in June and has since seen its share price increase 38%, is meanwhile focused on the consumer market, which is far more serviced. As for the big names in the industry – Kennards and Coates Hire – these are in private hands.

Perhaps the most attractive thing about Silver Chef, however, is not its outperformance but its safety. Not only does this company display strong financial health a robust balance sheet, but it manages its business risk very well. About 95% of its equipment assets are in circulation, earning income with all leases on a one-year minimum term and insured with a 13-week rental bond. Silver Chef’s average lease contract lasts 29 months and although terms are very much client-focused, 80% of the cost of equipment is recovered during the first year.

Of equipment returned, 80% is subsequently re-leased or sold and the business model has proven to pay itself time after time with top-line revenue growth comfortably exceeding cost growth. While Silver Chef has a $74 million facility with the Commonwealth Bank, a $30 million interest rate hedge is in place at 6.46% to April 2012, which represents about 71% of existing borrowings. A 60% margin between the company’s weighted average cost of capital and the average rental rate further insures the model, as does a very low default rate. Indeed, even at the height of the GFC, bad debts only amounted to 3.2% of the total book.

While Australia’s banks are suffering assaults from both sides of politics and are facing a situation where growth is both elusive and unrealistic, smaller companies like Silver Chef are proving that money can still be made in providing basic financial services to markets that bigger lenders prefer to outsource.

The company operates in a growth environment yet is conservatively managed and generates $45 million a year in internal funding. Its dividend reinvestment plan preserves cash and the business model delivers a recurring annuity-style income stream of 70%. Clients and staff are kept happy, with Silver Chef being this year awarded a BRW Great Place to Work gong, and further expansion is in place with franchises and larger clients being targeted, Subway, Nando’s and Domino’s Pizza Enterprises Limited (DMP) having already joined.

It’s no wonder that SIV has returned such good capital growth to investors thus far and we don’t see that dynamic ending anytime soon. On the menu of investment options, Silver Chef is a tasty choice.

Michael Feller is an equities analyst at Lincoln Indicators. Lincoln develops Stock Doctor, Australia’s premier fundamental analysis research service. The author or the Lincoln Australian Share Fund may have interests in any of the companies mentioned.