Smalls in a sweet spot

Small caps have outperformed the broader market … and out of the laggards there are three with good opportunities.

Investors who have been holding back from the sharemarket must be feeling a little despondent, as the August reporting season has been one of the best for small caps in years.

While the profit season won’t be known for delivering spectacular surprises on the earnings front, the low expectations and more generous than expected dividend payments were enough to spark the greatest August rally for the S&P/ASX Small Ordinaries Index since 2009, when the market surged after shaking off the global financial crisis.

The small cap benchmark put on 2.6% last month, which is nearly one percentage point ahead of the 10-year average. The S&P/ASX 200 Index also performed well, but the 1.6% gain pales in comparison.

At last the pendulum is swinging back in favour of small caps. The sector had been a woeful laggard as it fell 8.3% in the red in the last financial year, while the top 200 stock index made a stunning 22.8% run-up in value.

Moreover, this is only the start of the outperformance for smalls as these juniors continue to pull ahead of their larger rivals this month. Barring an unexpected global economic shock, this trend is likely to continue over the next six months, although the easiest gains are gone.

If you had followed the 15 buy recommendations in Eureka Report from the end of June, you would have generated an average return of about 17.5%, or more than 10% above the Small Ordinaries and the ASX All Ordinaries.

The two “underperform”, or sell, recommendations I had have also panned out well so far. Crane hire group Boom Logistics (BOL) and mining software consulting firm Rungepincockminarco (RUL) have both underperformed the broader market by 5.6% on average.

The only missed opportunity was my “neutral” recommendation on engineering contractor RCR Tomlinson (RCR) on July 10. While I did acknowledge that “there is plenty more upside to its current share price of $2.25 if RCR can turnaround Norfolk’s businesses”, I had underestimated the earnings benefits RCR could squeeze from the struggling takeover target.

With the stock at yesterday’s closing price of $3.40, there isn’t sufficient upside to upgrade my recommendation and I have to regretfully keep it on “neutral”.

The bigger question now is whether there are still opportunities in the Uncapped 100 coming out of the latest reporting season.

The natural place bargain hunters would look is among stocks that have disappointed the market. After all, businesses tend to move in cycles and with management tackling the problem areas, they should be able to produce a better outcome at the next reporting season.

However, looking at companies that have recorded the worst “announcement effect” over the past few reporting seasons, that is only true around 50% of the time. Righting a ship can take longer than one might anticipate, and it is often more difficult than it looks.   

The announcement effect refers to how a stock reacts to the profit announcement relative to the broader market. Companies that post the biggest positive or negative earnings surprise should see their share price outperform or underperform the market on the day of the announcement.

Separately, it’s not easy finding opportunities among the laggards. Some, like engineering contractor Forge Group (FGE) have quickly regained most, if not all, of their initial losses; while stocks like airline operator Regional Express Holdings (REX) is weighed down by the lack of earnings clarity that is likely to persist for the near-term at least.

Silex Systems (SLX)

But there are three stocks that have caught my eye in the wake of the latest reporting season.

First, there is Silex Systems. The laser technology company underperformed the market by more than 6% when it released its full-year result on August 23.

Its underlying net loss narrowed sharply to $900,000 in 2012-13 from a net loss of $17.9 million in the year before, but investors’ attention was focused elsewhere.

It’s the collapsing uranium price that the stock is having trouble shaking off, with the nuclear fuel falling nearly 30% over the past year to $US34 a pound this week. This marks its lowest level in more than six years and is probably under the cost of production for most uranium miners.

The negative sentiment is spilling over to Silex because it is in the midst of commercialising its technology for enriching uranium. Using its laser, the process is far more efficient than the current centrifugal method used around the world.

Silex has received a $US15 million milestone payment from its joint venture partner, GLE (a consortium made up of industry heavyweights GE, Cameco and Hitachi), but the market is worried that the low uranium price would force GLE to postpone, or worse, abandon plans to build the first commercial plant using the laser in the United States.

The fate of Silex’s share price hangs on this decision, which is due before the end of the calendar year, and I believe this is a good time to be buying the stock if you have a long-term investment horizon.

Firstly, while it is very difficult to predict when uranium prices will recover, experts are almost unanimously forecasting higher demand for uranium over the next three to five years, despite the fallout from Fukushima. Where the uranium price will be over this time frame is more important to the decision for the commercial plant as it will take about that long to build it.

Uranium is also very different from other hard commodities, like iron ore. This is because buyers of the fuel are often happy to pay higher than market price in exchange for security of supply. You can’t just turn off a nuclear power plant because of a fuel shortage.

The other often overlooked aspect of Silex is its solar power plant business. This is a longer-term proposition for Silex, but its chief executive Michael Goldsworthy told Eureka Report that if the company achieves its goal of bringing the cost of power down to 10-12 cents a kilowatt hour, the earnings upside could be as great as its uranium enrichment opportunity.

The stock last traded at $2.55 and I have an “outperform” recommendation on Silex.

Universal Biosensors (UBI)

The medical equipment maker’s fall from grace is another that doesn’t appear linked to its results.

The stock lagged the market by over 6% on its half year result on August 1, and has struggled to recover since.

There was nothing sinister in the profit numbers or outlook from the maker of disposable test strips used in LifeScan’s (which is a Johnson & Johnson company) blood glucose machine.

WilsonHTM Investment Group analyst, Shane Storey, believes that investors may be selling out of Universal Biosensors and jumping into fellow medical equipment maker Nanosonics (NAN), which is up 16% since its results.

This is because Nanosonics is closer to turning in a maiden profit. It should hit that important re-rating milestone sometime this financial year, while Universal Biosensors is not anticipated to cross that line until next year, or the year after.

However, Storey believes there is a near-term catalyst for Universal Biosensors, which could come later this month, and he anticipates that the stock could double in value over the next 12-months.

“We must be very close now to Siemen’s launching Universal Biosensors’ second product,” said Storey. “I am hoping that the news will add a whole new dimension to the way people think about the company.”

Siemens has signed an agreement with Universal Biosensors to use its technology to make a blood coagulation testing device. The deal is similar to the deal with LifeScan and Universal Biosensors believes the coagulation opportunity can generate as much value as glucose.

I have an “outperform” recommendation on the stock.

ThinkSmart (TSM)

I have covered the consumer financing company’s results two weeks ago and the stock has not moved much since.

There were no red flags in its results or outlook, and if anything, investors should be reassured that the embattled company’s turnaround strategy is on track.

Investors shouldn’t read too much into the 7% drop in its share price since the earnings announcement on August 21 as it is probably driven more by profit taking after the stock doubled in value since the start of the calendar year.

Also, the fact that the stock is lightly traded and is only 30 plus cents mean that it doesn’t take much for the stock to register a large percentage movement over a relatively short period of time.

My upbeat assessment of the stock is shared by the few brokers who cover ThinkSmart. They have upgraded their share price target to around 45 cents.

I reiterate my “outperform” recommendation on the stock. 

Think big, go smalls!

Have you acted on any Uncapped 100 recommendations in recent months? I would like to hear about your experience and thoughts (good or bad). You can email me at brendon.lau@uncapped.com.au.


Brendon Lau owns shares in SLX, UBI and TSM.
Graph for Smalls in a sweet spot

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)
BRG Breville Group Well covered but good candidate for core holding due to good track record.1,148,741,69970.49Consumer Discretionary
MTU M2 Telecommunications Group Amazing growth story and well run company. High free float and strong insto support.1,120,080,07887.74Telecommunication Services
MMS McMillan Shakespeare One of the best performers since the GFC, but change to FBT rules is threatening growth.979,244,9347.66Industrials
NHF NIB Holdings Only listed health insurer. Widely held. Good performer.935,078,97937.75Financials
ARP ARB Corp Well covered but good candidate for core holding due to quality management.889,345,58126.96Consumer Discretionary
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.870,555,17625.99Industrials
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.775,860,291152.71Consumer Discretionary
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.769,489,38058.27Consumer 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.721,273,74315.82Materials
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.717,261,78066.06Health Care
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.637,312,80544.17Financials
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.625,934,20459.08Consumer Discretionary
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.581,794,86164.02Consumer Discretionary
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.543,419,067-30.57Energy
ACR Acrux One of the most successful Australian biotechs in recent history. Widely held by instos.535,367,3103.86Health Care
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.510,752,56359.49Consumer Discretionary
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.508,886,38332.82Telecommunication 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.499,620,97256.52Energy
FGE Forge Group One of the better performers in its industry. Good track record and potential core holding.492,455,93350.15Industrials
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.485,971,37592.16Consumer Staples
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.477,570,67979.99Financials
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.468,326,84367.79Telecommunication Services
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.467,137,57368Industrials
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?458,386,932113.71Industrials
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.445,266,72432.73Industrials
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.444,826,385-22.05Industrials
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.434,644,89711.34Energy
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.434,135,315-31.08Information Technology
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.408,942,35245.92Health Care
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.407,118,68348.32Financials
UXC UXC Company has turned corner and enjoyed re-rating. What's next?350,609,19243.14Information Technology
TGA Thorn Group One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.327,573,76128.12Consumer Discretionary
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.315,537,59863.64Health Care
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.299,938,01977.62Financials
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.291,064,056-29.31Health Care
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.275,809,4790.49Information Technology
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 274,603,36347.71Financials
BNO Bionomics One of the larger cancer treatment developers in this market.261,287,38493.56Health Care
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.260,105,438-14.04Consumer 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.256,678,528-13.53Health Care
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.249,388,779280.51Consumer Staples
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.248,391,08388.52Industrials
IMF IMF Australia Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.243,338,51641.07Financials
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.231,282,99022.6Information Technology
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.230,726,07479.59Health Care
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.230,536,31625.35Financials
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.227,800,949107.45Industrials
GXL Greencross Acquisitive vetinary group. Good profit growth and share price performance, but gets little press.225,470,779127.25Health 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 further212,501,74091.39Industrials
NWT Newsat Potential large cap if it can launch its own satellite in 2015.210,625,214-38.4Telecommunication Services
DWS DWS Will be a big beneficiary if governments start spending on IT again.207,809,540-2.79Information Technology
VOC Vocus Communications Telecom stocks are in favour but Vocus is one of the least covered197,004,80748.73Telecommunication Services
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.191,910,583-8.34Consumer Staples
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.191,540,95598.55Materials
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?188,391,40399.98Consumer Discretionary
DTL Data#3 Well respected IT company that receives little press coverage.184,000,0769.49Information 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.183,004,944-22.39Financials
HSN Hansen Technologies Operates in a high potential/growth industry but is not covered by press or brokers.182,684,54038.64Information Technology
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.173,709,290162.35Information 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.172,066,422-13.56Materials
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.167,326,187-33.98Materials
CKF Collins Foods One of the few food franchise listed companies.164,145,00465.04Consumer 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.157,744,736-27.4Materials
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.153,593,85775.05Consumer Discretionary
ACL AlchemiaOne of the few biotechs with revenue stream. Good pipeline of oncology treatments.150,680,374-19.83Health Care
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.141,003,70813.16Information Technology
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.132,599,99128.4Energy
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.125,458,344-19.92Consumer Discretionary
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.124,401,0540.96Industrials
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.118,802,40613.33Health 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.116,419,44951.45Telecommunication Services
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.113,885,08658.95Industrials
NEA Nearmap A stellar performer with an Interesting business that offers high quality ariel maps to companies & government.109,937,6751033.33Information Technology
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.109,638,44386.03Consumer Discretionary
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage109,580,238109.52Information Technology
DRM Doray Minerals Widely held by instos. One of the more favored gold explorers by brokers.100,725,4030.31Materials
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.95,528,80923.97Industrials
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.93,638,00857.85Consumer Discretionary
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.91,675,84244.48Health Care
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.90,821,472-28.8Health Care
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.79,919,868-10Energy
AOH Altona Mining Noteworthy copper play with Xstrata pullout of Roseby project in Australia and the good ramp up of its Finnish project.79,827,705-46.43Materials
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.73,612,976-66.29Materials
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 73,030,28112.12Materials
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.70,240,0823.49Information Technology
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.69,607,513-5.36Materials
RUL RungePincockMinarco IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.69,259,15522.22Industrials
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.67,286,98023.77Consumer Staples
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.65,883,804-62.16Industrials
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year64,968,96410.39Health Care
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.63,598,97657.18Materials
TSM ThinkSmart Potential turnaround story worth keeping eye on.57,619,019115.15Financials
UML Unity Mining Growing Tassie gold producer with high free float. Valuation looks compelling too.56,159,824-30.43Materials
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.50,126,70543.11Consumer Discretionary
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.45,572,8301.04Industrials
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.36,777,714175.86Consumer Discretionary
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.31,487,373104.17Information Technology
MBO Mobilarm Unique product that could change global maritime safety practices with its man-overboard location beacon.15,405,92261.92Information Technology
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.14,291,80965Health Care
ISS ISS Group ISS delisted on Aug 9 after being acquired by by P2ES0n.a.Information Technology
Source: Eureka Report, Bloomberg

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