Biggest smalls earnings surprises

The small caps sector is outperforming the bigger end of town in the earnings season stakes.

Small caps are outgunning their larger peers as we head into the last hectic week of the reporting season, with this trend likely to stretch through till early next year at least.

The Uncapped 100 stocks are up 5% on average since the end of July, while the S&P/ASX 100 Index is struggling to break even. The performance of the S&P/ASX Small Ordinaries is also pleasing, as the index is up a little over 4%.

We can thank the reporting season for helping emerging companies close the performance gap, although the Uncapped 100 is still 5.5% behind the top 100 benchmark over a one-year time horizon. I believe this gap will narrow further as foreshadowed in the article Small caps on a winter run back in March.

While only about a third of emerging companies in the Uncapped 100 have handed in their profit report cards, their results have been better than what sceptics had feared – the same fear that left investors scurrying to the perceived safety of big caps over the past several months.

But the quality of the results from smaller companies has at least matched the bigger-end of town, with about an equal percentage of Uncapped 100 and S&P/ASX 100 stocks surprising on the upside.

Around 42% of Uncapped 100 stocks that have released results have outperformed the market on the day of their profit announcement compared with 41% for the biggest 100 stocks on our market. But the average outperformance to the market (called alpha) is 4.34% for the Uncapped 100 compared with 3.53% for the ASX 100.

That’s a credible result given the poor sentiment towards the small cap sector. Unless the last week of the reporting season goes horribly wrong, I think small caps will remain in investors’ good books over the next few months. This is thanks to the big lag that still exists between small and large cap returns, the generally positive management outlook statements, and the removal of political uncertainty post the federal election.

Turning to the results so far, there have been a number of notable surprises. If I use “alpha” to quantify the surprise, gaming systems company eBet’s (EBT) result today would be the best standout, with the stock surging 15% this morning to $2.10.

While the 17% jump in normalised pre-tax profit to $2.9 million for the year ended June 30 this year is pleasing, the real surprise is its maiden dividend of 3.5 cents a share.

The pre-tax number was in line with management’s guidance, but I didn’t expect eBet to pay a dividend until 2013-14.

Assuming an equal dividend for the next half year (this would work out to modest payout ratio of about 40% based on 2012-13 profits), the stock will yield 4.7% if the franking credit on 50% of the dividend is added in.

The dividend declaration also gives me confidence about eBet’s ability to maintain its growth momentum and build a strong recurring revenue business, with 48% of total revenue classified as recurring in 2012-13. Management is looking to lift this to between 55% and 65%.

While the stock is no longer cheap compared to when I first recommended buying it at $1.13 on June 26, I believe the stock has room to climb as the stock is trading on a reasonable price-earnings multiple of around 12 times based on last year’s earnings.

Further, as I reported a month ago, institutional investors are trying to build a position in the stock. The latest result will only attract greater interest from professional investors and I reiterate my “overweight” recommendation on the stock.

On the flipside, consumer financing company ThinkSmart (TSM) is the second-biggest disappointment (based on its alpha) after drilling services company Imdex (IMD).  

But there is a stark difference in the quality of their results, in spite of what their share prices are indicating.

Imdex’s fall from grace is understandable, with demand for drilling services remaining under a dark cloud as new mining projects are put on hold.

However, ThinkSmart’s price drop is driven more by profit taking as the stock has rallied 80% over the past 12 months in anticipation of a turnaround in its financial performance.

ThinkSmart’s chief executive, Ned Montarello, has been promising this turnaround for over a year and he has been delivering on his promises since the February reporting season (See Three small caps at a turning point).

The outlook for ThinkSmart is bright, with its aggressive expansion in the UK market looking like perfect timing in hindsight. The UK is emerging from a recession and consumer confidence has rebounded strongly, with English retailers reporting good results and outlook.

That country accounts for 54% of group revenue and ThinkSmart has agreements with major UK retailers Dixons and Currys to provide rental financing for electronics. The company is rumoured to be close to signing up another large UK retailer outside of electronics.

ThinkSmart has an interest-free finance offering called Fido in Australia, which is offered through JB Hi-Fi. It is also worth noting that JB Hi-Fi delivered a solid earnings result and gave an upbeat outlook.

The 9% drop in ThinkSmart today represents a buying opportunity, even though some might feel the stock is looking full priced as it is trading on a one-year forward price-earnings of around 13 times – a slight discount to market darling and rival FlexiGroup (FXL).

Earnings expectations are also set high for 2013, with consensus estimates tipping a net profit of $2.5 million. This means ThinkSmart has lots of catching up to do in the current half, even after posting a $700,000 profit for the six months to June compared with a loss of $1.5 million for the same period last year.

Montarello would not provide guidance, except to say that the positive earnings trajectory is expected to continue until 2014 at least.

It’s a big ask but ThinkSmart might be able to pull it off as it’s only just starting to reap the benefits of its restructure, and the collapse of the Australian dollar to a three-year low against the British pound will only help bolster its translated earnings.

There is also no shortage of room for ThinkSmart to grow. The company recorded $6.1 million in new originations for Fido in the first-half of the year compared with FlexiGroup’s $200 million, and Montarello estimates that the companies have only 8% of the underpenetrated market.

Patient investors with a one to two-year investment horizon should use ThinkSmart’s price correction as a buying opportunity.

Think big, go smalls!

Brendon Lau owns shares in EBT and TSM.
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Uncapped 100 - Australia's most interesting small cap stocks

Small cap stocks covered by the Uncapped team
CodeNameRationaleMarket 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.1,206.65103.42Telecommunication Services
BRG Breville Group Well covered but good candidate for core holding due to good track record.1,114.9274.13Consumer Discretionary
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.940.5531.67Industrials
NHF NIB Holdings /AustraliaOnly listed health insurer. Widely held. Good performer.930.6936.64Financials
MMS McMillan Shakespeare One of the best performers since the GFC, but change to FBT rules is threatening growth.913.663.99Industrials
ARP ARB Corp Well covered but good candidate for core holding due to quality management.902.3927.67Consumer Discretionary
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.762.20171.14Consumer 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.727.9271.84Health Care
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.674.2833.49Consumer 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.670.046.92Materials
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.646.6257.45Financials
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.601.7048.6Consumer Discretionary
ACR Acrux One of the most successful Australian biotechs in recent history. Widely held by instos.552.85-17.18Health Care
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.540.47-38.38Energy
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.534.2364.3Consumer Discretionary
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.512.8772.21Consumer Discretionary
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.479.3372.67Telecommunication Services
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.473.2627.75Telecommunication 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.468.3985.78Energy
FGE Forge Group One of the better performers in its industry. Good track record and potential core holding.463.5910.85Industrials
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.462.0859.38Industrials
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.454.1120.27Energy
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.454.1068.07Financials
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.446.05-40.45Information Technology
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.419.1567.93Consumer Staples
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.410.8116.65Industrials
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.400.9045.57Financials
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?364.1959.36Industrials
UXC UXC Company has turned corner and enjoyed re-rating. What's next?361.4281.68Information Technology
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.332.0388.68Financials
TGA Thorn Group One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.325.3426.55Consumer Discretionary
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.322.12-59.53Industrials
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.315.54102.82Health Care
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.304.3010.49Information Technology
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.298.06-33.75Health Care
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.294.556.19Health Care
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 274.6054.43Financials
BNO Bionomics One of the larger cancer treatment developers in this market.265.23105.97Health Care
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.249.33-16.21Consumer Staples
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.247.95-11.8Health Care
IMF IMF Australia Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.242.7229.93Financials
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.233.3578Health Care
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.231.25127.44Industrials
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.229.9963.78Industrials
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.225.1620.35Financials
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.224.11200.19Consumer Staples
DWS DWS Will be a big beneficiary if governments start spending on IT again.212.447.07Information Technology
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.211.3312.02Information Technology
GXL Greencross Acquisitive vetinary group. Good profit growth and share price performance, but gets little press.204.57120.74Health Care
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 further201.44111.53Industrials
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.195.39-7.84Consumer Staples
NWT Newsat Potential large cap if it can launch its own satellite in 2015.194.21-31.73Telecommunication Services
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.192.06-17.47Financials
DTL Data#3 Well respected IT company that receives little press coverage.185.546.27Information Technology
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.183.98222.88Information 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.177.40#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.176.8016.1Information Technology
VOC Vocus Communications Telecom stocks are in favour but Vocus is one of the least covered176.7330.72Telecommunication Services
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?168.2175.05Consumer 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.168.16-25.66Materials
CKF Collins Foods One of the few food franchise listed companies.167.4069.81Consumer Discretionary
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.155.9680.86Consumer Discretionary
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.146.3816.83Information 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.145.08-33.85Materials
ACL Alchemia /AustraliaOne of the few biotechs with revenue stream. Good pipeline of oncology treatments.137.72-21.3Health Care
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.136.81-60.38Materials
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.133.27-13.1Consumer Discretionary
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.131.4211.9Materials
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.129.918.57Industrials
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.122.4017.07Energy
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.122.300Health Care
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage114.56148.65Information Technology
NEA Nearmap A stellar performer with an Interesting business that offers high quality ariel maps to companies & government.113.07900Information Technology
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.112.6982.09Consumer Discretionary
BGL BigAir Group The wireless microcap has gained strong following over past year or two but is often overlooked by investors and the press.112.3255.64Telecommunication Services
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.108.1938.04Industrials
DRM Doray Minerals Widely held by instos. One of the more favored gold explorers by brokers.101.431.02Materials
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.101.03-23.85Health Care
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.92.5026.77Health Care
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.83.9511.41Industrials
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.83.1942.76Consumer Discretionary
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.79.92-12.9Energy
AOH Altona Mining Noteworthy copper play with Xstrata pullout of Roseby project in Australia and the good ramp up of its Finnish project.77.17-52.46Materials
RUL RungePincockMinarco IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.73.5047.23Industrials
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 71.0628.57Materials
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.68.7228.05Consumer Staples
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year68.4114.74Health Care
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.68.24-56.72Industrials
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.66.4559.8Materials
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.59.27-18.91Information Technology
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.59.10-18.18Materials
TSM ThinkSmart Potential turnaround story worth keeping eye on.57.6273.17Financials
UML Unity Mining Growing Tassie gold producer with high free float. Valuation looks compelling too.54.76-32.17Materials
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.47.690.09Industrials
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.36.98-1.31Consumer Discretionary
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.33.71205.56Consumer Discretionary
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.29.56100Information Technology
MBO Mobilarm Unique product that could change global maritime safety practices with its man-overboard location beacon.19.51112.42Information Technology
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.14.7261.9Health Care
ISS ISS Group ISS delisted on Aug 9 after being acquired by by P2ESn.a.n.a.#N/A N/A
Source: Eureka Report, Bloomberg
Updated 21 Aug 13

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