A good number of fund managers are probably sweating in their seats, as the sky isn’t likely to fall this reporting season.
That may sound like a contradiction, but volatile prices and predictions of a collapse in commodity prices have forced professional investors to dump anything resource related and huddle in defensive high-yielding stocks.
These investors have been waiting for the impending capitulation in mining and mining services stocks before wading back in, and that investment psychology was underpinned by a number of high-profile strategists prophesising the imminent plunge in BHP Billiton (BHP) to under $30 a share.
However, investors didn’t get that buying opportunity as the sector bottomed well above those dire levels (BHP only went as low as $30.81 in June before rebounding close to $37), leaving many underweight on miners and engineering contractors at a time when the outlook for commodities is improving.
The fear now among fund managers is shifting from owning a mining disaster to the fear of underperforming as the S&P/ASX 200 Resources Index charges ahead 16.8% since July compared with a 9.5% gain by the broader market.
While it’s early days, the results and outlook statements from the current reporting season are giving rise to confidence that these sectors are finally on a sustainable path to recovery. Some examples of stocks rallying on pleasing earnings news include Rio Tinto (RIO), Bradken (BKN) and Downer EDI (DOW). See Tim Treadgold’s article on Downer EDI today, Downer's big recovery drive.
This doesn’t mean the sector is without risks. But the poor-quality result from crane hire company Boom Logistics (BOL) that was lodged after the market closed on Tuesday isn’t likely to hurt sentiment towards other contractors. There is still enough good news out there to offset the earnings miss and sombre outlook from Boom (more on Boom at the end of this article).
From that perspective, I suspect there will be a “supply” issue for quality mining and mining services stocks due to strong demand and a lack of sellers if the reporting season continues to unfold to my expectations.
The strong demand won’t only come from portfolio managers scrambling for stock, but it will also come from a “short-squeeze” where short sellers have to buy back a stock they have borrowed to sell as they look to profit from falling prices.
Mining and mining services stocks make up half of the 20 most short-sold stocks on our market, according to the latest data from Australian Securities & Investments Commission, which is a week old.
While there is value to be found in both miners and contractors in the Uncapped 100, I’ll focus on the latter in this article as I believe they have broader appeal to both growth investors and dividend junkies.
Except for Boom, these contractors have yet to report their full-year results, although a number of them have effectively pre-announced their numbers in updates issued over the past few weeks. Energy and mining services firm WDS (WDS) is one example when it did the unthinkable at the end of July – it issued an earnings upgrade saying that net profit will come in a little ahead of its guidance of $6 million to $8 million, thanks to its liquefied natural gas (LNG) contract in Queensland.
WDS has since rallied around 60% to a nine-month high of 59 cents, but that still puts the stock on an attractive 2013-14 price-earnings multiple of around 8.5 times with consensus forecasting tipping earnings per share (EPS) growth of 21% and a gross-up yield of close to 9%.
I rate the stock as “outperform” as WDS is likely to be well supported on dips, and I see another 15% to 20% upside.
However, the stock that I think has even more upside is NRW Holdings (NWH). Its earnings have been de-risked since it released an update on Monday stating that its full-year result was expected to match its June guidance when it said contract delays would see group revenue come in around $1.3 billion and net profit between $73 million and $76 million.
This implies only a slight downgrade to its February guidance, but the stock had crashed below $1 on fears of further earnings cuts given that NRW is exposed to construction work, which implies a bias towards new projects. Miners have shelved plans to build new facilities and are instead looking to increase production from existing mines to cope with a drop in commodity prices.
Further, NRW has traditionally a bigger exposure to civil infrastructure construction, and the outlook for the sector remains downbeat, although state and federal governments have been talking up a number of new transport projects around the country.
The question now is the shape of NRW’s order book for the current financial year, and I suspect its outlook statement will be similar to Bradken in that management will indicate continuing challenges in the first-half but a pick-up in activity in the six months to June 2014.
While the stock has rallied 15% on the profit update, it is still down about 60% over the past year, which puts it on a low 2013-14 P/E of a little over five times and an unbelievable yield that’s over 13% once franking credits are included.
The crazy yield and low P/E reflects investors’ belief that NRW’s earnings will fall off sharply, but I think its results next Thursday will reassure the market and trigger a re-rating in the stock, and I recommend investors buy the stock ahead of the result.
On the flipside, I think it is better to stay away from Boom Logistics as its results look bad no matter how you look at it.
The company’s posted a $2.5 million statutory net loss compared with 2011-12’s $19.7 million profit due to one-off impairments, restructuring and other costs; but its operating earnings before interest and tax (EBIT) of $26 million represent a 27% fall from the previous year and were 10% below consensus forecasts.
EBIT margins have also fallen by 2 percentage points to 8%, and are likely to remain under pressure due to competition and Boom’s material exposure to coal, a commodity that is doing it tougher than most.
There aren’t many bright spots to its result, although Boom has a net tangible asset of 51 cents a share compared with its current share price of 15 cents, and is planning on selling surplus assets.
The company is looking to use its free cash to buy back shares on-market, and that may offer some support to the stock. Boom may also be a takeover target as the industry is ripe for consolidation, but I think investors should be selling into any rallies.
After all, there are plenty of other higher-quality value buys in the sector.
Think big, go smalls!
Brendon Lau holds shares in NRW Holdings.
Uncapped 100 - Australia's most interesting small cap stocks
|Small cap stocks covered by the Uncapped team|
|Code||Name||Rationale||Market cap ($m)||Total return 1-year (%)||Sector (GICS)|
|MTU||M2 Telecommunications Group||Amazing growth story and well run company. High free float and strong insto support.||1,194.16||105.44||Telecommunication Services|
|NHF||NIB Holdings||Only listed health insurer. Widely held. Good performer.||972.39||41.89||Financials|
|BRG||Breville Group||Well covered but good candidate for core holding due to good track record.||965.96||52.94||Consumer Discretionary|
|ARP||ARB Corp||Well covered but good candidate for core holding due to quality management.||964.73||43.37||Consumer Discretionary|
|MRM||Mermaid Marine Australia||Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.||899.15||34.68||Industrials|
|MMS||McMillan Shakespeare||One of the best performers since the GFC, but change to FBT rules is threatening growth.||822.00||-2.2||Industrials|
|GEM||G8 Education||Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.||743.08||186.81||Consumer 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.||711.09||67.43||Health Care|
|AAD||Ardent Leisure Group||Widely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.||673.28||34.76||Consumer Discretionary|
|AUB||Austbrokers Holdings||The insurance broker is a strong performer. Widely held and well liked by small cap investors.||649.52||58.8||Financials|
|SGN||STW Communications Group||One of few companies able to benefit from online shift. Widely held and good insto support.||617.86||57.65||Consumer 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.||605.00||-2.85||Materials|
|ACR||Acrux||One of the most successful Australian biotechs in recent history. Widely held by instos.||547.86||-16.72||Health Care|
|BRU||Buru Energy||Substantial size but not often covered by press. Widely held with good insto support.||534.56||-42.9||Energy|
|RFG||Retail Food Group||Owns a number of well know franchise brands. Widely followed by instos.||531.63||64.75||Consumer Discretionary|
|CCV||Cash Converters International||Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.||530.89||77.05||Consumer Discretionary|
|AMM||Amcom Telecommunications||Well covered junior telco but good candidate for core holding.||492.78||77.51||Telecommunication Services|
|NXT||NEXTDC||The cloud computing company is an IT sector darling. Fairly widely held and followed.||478.58||36.71||Telecommunication Services|
|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.||474.18||138.37||Energy|
|SLX||Silex Systems||Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.||473.29||-29.44||Information Technology|
|CCP||Credit Corp Group||Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.||459.33||73.41||Industrials|
|CWP||Cedar Woods Properties||Property developer with good ROE and earnings growth track record.||444.56||69.32||Financials|
|HZN||Horizon Oil||One of better regarded small energy stocks that doesn't receive much media attention.||441.13||25.33||Energy|
|FGE||Forge Group||One of the better performers in its industry. Good track record and potential core holding.||426.54||13||Industrials|
|BGA||Bega Cheese||Corporate interest in Australian food companies makes the cheese maker worth following.||417.63||67.32||Consumer Staples|
|MYS||MyState||Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.||407.00||49.55||Financials|
|TOX||Tox Free Solutions||Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.||401.54||19.2||Industrials|
|UXC||UXC||Company has turned corner and enjoyed re-rating. What's next?||364.51||101.26||Information Technology|
|RCR||RCR Tomlinson||Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?||347.63||69.13||Industrials|
|MOC||Mortgage Choice||Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.||332.03||101.79||Financials|
|MYX||Mayne Pharma Group||Sizeable generic drug maker with interesting board members.||326.81||116.15||Health Care|
|TGA||Thorn Group||One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.||323.11||40.37||Consumer Discretionary|
|NWH||NRW Holdings||One of the better regarded mining & civil contractors with good track record in delivering on projects.||310.96||-57.06||Industrials|
|RKN||Reckon||Fierce competition for cloud base accounting software puts it in firing line.||310.77||16.47||Information Technology|
|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.||288.83||7.45||Health Care|
|SPL||Starpharma Holdings||Noteworthy for its good pipeline of innovations. Well run, widely followed.||284.43||-32.3||Health Care|
|AEU||Australian Education Trust||Well performing childcare centre property owner. Good yield story and outlook.||270.22||54.78||Financials|
|RIC||Ridley Corp||High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.||255.49||-15.29||Consumer Staples|
|BNO||Bionomics||One of the larger cancer treatment developers in this market.||254.95||144.57||Health Care|
|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.||249.69||-17.82||Health Care|
|SIV||Silver Chef||Strong jump in the share price of the equipment financing group has attracted a good following.||243.05||140.32||Industrials|
|IMF||IMF Australia||Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.||242.72||35.36||Financials|
|MXI||MaxiTRANS Industries||Transport equipment maker posted good interim result. Has appealing yield and growth.||239.19||94.32||Industrials|
|AJA||Astro Japan Property Group||Strong leverage to Japanese economy makes this an interesting stock to watch.||229.19||24.62||Financials|
|NAN||Nanosonics||A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.||228.10||81.25||Health Care|
|SHV||Select Harvests||Noteworthy for turbulent past and exposure to soft commodity market.||220.66||202.29||Consumer Staples|
|IPP||iProperty Group||Worth watching as it is trying to be the REA Group of Asia.||214.05||24.21||Information Technology|
|DWS||DWS||Will be a big beneficiary if governments start spending on IT again.||213.10||11.9||Information Technology|
|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 further||207.79||115.72||Industrials|
|PFL||Patties Foods||Illiquid stock but has suite of well recognised consumer brands. Defensive yield.||200.25||-6.13||Consumer Staples|
|GXL||Greencross||Acquisitive vetinary group. Good profit growth and share price performance, but gets little press.||195.98||122.83||Health Care|
|NWT||Newsat||Potential large cap if it can launch its own satellite in 2015.||191.55||-29.7||Telecommunication Services|
|IFM||Infomedia||Interesting tech play in the car parts market. Strong share price gain but gets little air play.||187.02||220.41||Information Technology|
|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.||184.82||-21.27||Financials|
|DTL||Data#3||Well respected IT company that receives little press coverage.||181.69||2.36||Information Technology|
|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.||177.43||#N/A N/A||#N/A N/A|
|HSN||Hansen Technologies||Operates in a high potential/growth industry but is not covered by press or brokers.||172.80||18.71||Information Technology|
|VOC||Vocus Communications||Telecom stocks are in favour but Vocus is one of the least covered||172.02||29.11||Telecommunication Services|
|CKF||Collins Foods||One of the few food franchise listed companies.||167.40||66.85||Consumer Discretionary|
|IMD||Imdex||Drilling company is well supported by instos and should benefit from any rebound in exploration activity.||164.17||-50.13||Materials|
|SFH||Specialty Fashion Group||In early stages of turnaround. Can the women's apparel retailer sustain the momentum?||163.40||80.68||Consumer Discretionary|
|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.||155.20||-22.03||Materials|
|MLB||Melbourne IT||A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.||151.75||23.82||Information Technology|
|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.||145.90||66.94||Consumer Discretionary|
|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.||132.45||-40.67||Materials|
|REX||Regional Express Holdings||Well run airline that is overshadowed by Virgin and Qantas.||131.01||11.87||Industrials|
|MCP||McPherson's||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.||130.37||-13.6||Consumer Discretionary|
|TFC||TFS Corp||The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.||128.63||6.98||Materials|
|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.||125.79||18.03||Health Care|
|NEA||Nearmap||A stellar performer with an Interesting business that offers high quality ariel maps to companies & government.||121.15||1109.68||Information Technology|
|AZZ||Antares Energy||Liquid with good insto support. Already in production with exploration upside in Texas.||118.58||19.23||Energy|
|ACL||Alchemia /Australia||One of the few biotechs with revenue stream. Good pipeline of oncology treatments.||116.66||-35.14||Health Care|
|ESV||Eservglobal||Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage||109.58||137.84||Information Technology|
|POH||Phosphagenics||Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.||107.15||-25||Health 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.||105.76||49.88||Telecommunication Services|
|LCM||LogiCamms||Strong price performance and reasonable valuation attracting interest.||104.63||45.74||Industrials|
|AMA||AMA Group||Good turnaround story but under the automotive services group is radar of most.||104.40||98.47||Consumer Discretionary|
|DRM||Doray Minerals||Widely held by instos. One of the more favored gold explorers by brokers.||94.34||-8.58||Materials|
|CLV||Clover Corp||One of the star performers in 2012. Operates in growing but relatively stable niche.||94.15||38.04||Health Care|
|PEN||Peninsula Energy||Widely held by instos and large free float. It's the only uranium miner on the list.||88.80||-3.23||Energy|
|WDS||WDS||Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.||85.40||17.61||Industrials|
|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.||79.27||50.96||Consumer Discretionary|
|AOH||Altona Mining||Noteworthy copper play with Xstrata pullout of Roseby project in Australia and the good ramp up of its Finnish project.||76.70||-50.85||Materials|
|RUL||RungePincockMinarco||IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.||73.50||49.25||Industrials|
|CAA||Capral||An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose.||71.06||28.57||Materials|
|BOL||Boom Logistics||Crane hire group is riding out the downturn in construction. It's widely held by instos and is very liquid.||70.59||-52.38||Industrials|
|TAN||Tandou||The only direct equity exposure to cotton prices. Also trades water rights and receives little press.||70.15||39.79||Consumer Staples|
|CKL||Colorpak||The small cap packaging company has grown via acquisitions over past few years.||68.08||60.74||Materials|
|CUV||Clinuvel Pharmaceuticals||Interesting skin disorder treatment developer that has done reasonably well over past year||64.97||13.33||Health Care|
|TSM||ThinkSmart||Potential turnaround story worth keeping eye on.||62.49||97.44||Financials|
|YTC||YTC Resources||Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.||57.79||0||Materials|
|LGD||Legend Corp||Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.||57.07||-11.84||Information Technology|
|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.||51.66||5.16||Industrials|
|UML||Unity Mining||Growing Tassie gold producer with high free float. Valuation looks compelling too.||51.25||-30.48||Materials|
|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.||39.44||24.16||Consumer Discretionary|
|EBT||eBet||Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.||30.95||169.33||Consumer Discretionary|
|NTC||NetComm Wireless||Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.||25.70||81.82||Information Technology|
|MBO||Mobilarm||Unique product that could change global maritime safety practices with its man-overboard location beacon.||17.97||114.29||Information Technology|
|PGC||Paragon Care||Emerging hospital equipment supplier that has been ignored by market.||14.29||60.98||Health Care|
|ISS||ISS Group||ISS delisted on Aug 9 after being acquired by by P2ES||n.a.||n.a.||Information Technology|
|Source: Eureka Report, Bloomberg|
|Updated 14 Aug 13|