Time to sharpen the selection

Our small caps coverage has been refined to 20 outperform stocks.

If I’ve learned one thing over the last year at Eureka Report, it is the benefit of focus.

It’s a question of simple math. Focussing on 20 stocks offers you – the subscriber – a better service than if I cover an extensive list.

Stocks on my “buy” list have performed well, even though the latest bout of market volatility may be clouding the picture.

While the S&P/ASX Small Ordinaries and ASX 100 indices have shed 3.6% and 1.8%, respectively, over the past month, stocks that I have put forward with an “outperform” rating continue to pull ahead.

Up until now I have had 27 “outperform” recommendations that have generated an average total return of around 14% since we started issuing stock recommendations in June last year.

The total return is about 5% ahead of the ASX All Ordinaries and more than 9% better than the Small Ordinaries over the same comparative periods. On an annualised basis, my buy calls will have delivered a 33.3% total return.

Performance table of Lau's "outperform" calls since June 2013

NameCodeDate of recArticle NameTotal rtn (%)*Annualised rtn (%)*Alpha - All Ords (%)**Alpha - Small Ords (%)**Market Cap ($m)
eBetEBT26-Jun-13Small cap with biggest earnings upgrade160.13214.34141.09142.9944.44
WDSWDS14-Aug-13A mining services revival?122.60200.06113.75119.49162.83
Tiger ResourcesTGS3-Jul-13Why a dog can be an investor's best friend89.47122.9270.9675.22289.19
NetComm WirelessNTC5-Feb-14Earnings Season: Expect the Unexpected59.42445.5352.4854.1170.89
Mint WirelessMNW2-Oct-13Four new stocks for Uncapped55.56116.0950.1054.96113.08
ThinksmartTSM21-Aug-13Biggest smalls earnings surprises26.6444.8717.4324.5664.92
eServGlobalESV13-Dec-13Calculating Bitcoin's flow-on effect26.4393.9519.5620.20224.39
Collins FoodsCKF7-Aug-13The next dividend dazzelers17.1427.115.019.63185.54
NewsatNWT3-Jul-13Why a dog can be an investor's best friend11.3915.65-7.12-2.86269.37
M2 Telecommunications GpMTU10-Jul-13Big expectations for small caps8.2811.68-6.40-1.201111.11
Wide Bay AustraliaWBB16-Oct-13Appetisers from the agri stocks field7.3216.632.886.26210.91
NRW HoldingsNWH14-Aug-13A mining services revival?5.118.33-3.742.00302.59
NanosonicNAN6-Nov-13First profit, first choice for stock pickers3.619.442.304.44226.87
GI DynamicsGID17-Jul-13Five bargains for under a buck2.503.63-10.31-4.23239.84
Specialty Fashion GroupSFH18-Sep-13Small cap surprises for 2014-0.25-0.49-5.47-1.45173.01
Retail Food GroupRFG30-Oct-13Small consumer stocks at Christmas crossroads-2.10-5.22-3.43-0.18623.73
Ridley CorporationRIC16-Oct-13Appetisers from the agri stocks field-2.35-5.34-6.79-3.41255.49
Altona MiningAOH4-Feb-14Special Report - A small miner you cannot miss-7.35-54.02-13.76-12.3783.83
STW CommunicationsSGN30-Oct-13Small consumer stocks at Christmas crossroads-8.57-21.33-9.90-6.66581.51
Silex SystemsSLX3-Jul-13Why a dog can be an investor's best friend-8.84-12.14-27.35-23.09360.33
Horizon OilHZN17-Jul-13Five bargains for under a buck-9.34-13.54-22.15-16.07413.11
YTC ResourcesYTC9-Oct-13Xmas sale starts early for small caps-11.54-25.12-18.27-14.2975.36
Starpharma HoldingsSPL17-Jul-13Five bargains for under a buck-15.43-22.37-28.24-22.15226.31
LogiCammsLCM7-Aug-13The next dividend dazzelers-29.52-46.70-41.64-37.0268.51
Beadell ResourcesBDR28-Aug-13Short-selling gold signals-30.35-52.83-39.54-33.15476.44
AMA GroupAMA6-Nov-13AMA chief's double plan-31.51-82.33-32.82-30.6883.56
Universal BiosensorsUBI4-Sep-13Smalls in sweet spot-50.00-90.04-57.06-50.4959.71
Average14.3933.295.249.43
* Since recommendation was issued    **Difference in performance between stock and relevent index
Source: Eureka Report, Bloomberg

There were two “outperform” rated stocks that were downgraded over the period: the now infamous engineering contractor Forge Group (FGE) was downgraded to “underperform” in November last year, about three months before it went into voluntary administration; and packaging company Colorpak (CKL) was downgraded to “neutral” last month, locking in a 14% gain. If they were included, the total average return would still come in at a healthy 12%.

I believe small cap stocks are still well placed to deliver robust returns over the next 12-months, even though the “easy” gains (if there is such a thing) are largely gone. This is another reason why it’s a good time to review and trim my list.

Off the wish-list

The latest hard commodity rout may have taken the gloss off the resources sector, but the materials sector is still leading the charge as we predicted late last year.

I had put forward four junior miners to consider, and the group has delivered an average return of around 10%, thanks to the strong outperformance of Africa-focused copper producer Tiger Resources (TGR).

But this is an opportune time for me to take a step back from covering the sector. The stocks that I am dropping include fledging gold producer Beadell Resources (BDR), copper hopeful Altona Mining (AOH) and diversified miner YTC Resources (YTC).

I am also ceasing coverage of Horizon Oil (HZN) to concentrate my efforts on emerging industrial stocks, but my views on my resource “outperform” calls have not materially changed since I first recommended them.

Outside of resources, I am dropping coverage on engineering contractors WDS (WDS) and Logicamms (LCM), as well as telecoms group M2 Group (MTU). This has not been an easy choice as the decision to drop coverage is not generally based on a loss of confidence towards management.

Over the next few weeks I will be writing in more detail about the 20 stocks that remain on my “buy” list, but the table below outlines the brief rationale on each.

The 20 “outperform” stocks

Company

Catalysts

1)

AMA Group (AMA)

The automotive services and products group has staged an impressive turnaround over last few years under its new CEO, who has a plan to double earnings in the next three-to-four years. That growth ambition is not reflected in the share price and the stock will re-rate once there are signs of strong earnings growth.

2)

Collins Foods (CKF)

The fast food group is attractive for its ability to grow dividends over the next few years. Stocks that can do this have a high tendency to outperform the wider market.

3)

eBet (EBT)

The company is well placed to be a market leader for gaming management solutions in NSW, Queensland and Victoria. The three states have more than 170,000 machines, or 87% of the national market.

4)

eServGlobal (ESV)

The mobile funds transfer solutions company has developed enough scale in its business to grow significantly from here. The fact that MasterCard has bought into its joint-venture with European telco BICS is a testament of this.

5)

GI Dynamics (GID)

Its intestinal liner is proven to help with weight loss and the company is expanding its global network of clinics, but the real kicker for the stock is securing US approval to use its liner to treat diabetes.

6)

Mint Wireless (MNW)

Mint is a market leader in a rapidly emerging niche market. If its mobile credit card processing system can establish itself as the industry standard, the stock will significantly re-rate. The next 12 months is critical.

7)

Nanosonics (NAN)

Growing international acceptance of its disinfection device though its partnership with GE will see the stock trade well above $1.

8)

NetComm Wireless (NTC)

Management has positioned the company as a significant machine-to-machine (M2M) component supplier. The M2M market is tipped to grow exponentially and if NetComm can ride this wave, it won’t stay a $70 million market cap company for long.

9)

NewSat (NWT)

This is one of those “blue-sky” stocks. The company’s future hinges on a successful launch of its communication satellite in late 2014 or early 2015.

10)

NRW Holdings (NWH)

The engineering contractor is forecasting a pick-up in construction activity this year, but few are willing to give it the benefit of the doubt. The stock is very cheap if management is proven right, and few would argue that NRW has a strong reputation in the market.

11)

Retail Food Group (RFG)

Management is counting on its pizza franchise to deliver its next phase of growth. So far, the signs are good and I expect it to keep increasing dividends like Collins Foods.

12)

Ridley Corporation (RIC)

Ridley is expected to turnaround last year’s losses and post a profit. The stock is a good way of gaining exposure to the food export thematic and the stock valuation looks undemanding.

13)

Silex Systems (SLX)

The event that would set the stock on fire is the final decision by GLE to build a commercial uranium enrichment facility using the Silex laser. Some doubt this will happen due to the poor sentiment towards nuclear power, but there are signs that nuclear power will continue to be an integral part of the energy equation.

14)

Specialty Fashion Group (SFH)

The acquisition of Rivers should deliver substantial earnings growth to the group in 2014-15, and this is above and beyond the company’s initiative to improve its Millers stores.

15)

Starpharma Holdings (SPL)

Its condom manufacturing partner secured approval to sell product coated in Starpharma’s protective gel in Japan and approval from other parts of the world should be forthcoming. Starpharma also has dendrimer technology and I expect to see a major partnering deal this year.

16)

STW Communications (SGN)

I am expecting the rebound in discretionary spend to pick up speed this year and the advertising group is well placed to benefit from the potential trend. Further, its exposure to digital advertising means it is a less risky bet than traditional media stocks.

17)

ThinkSmart (TSM)

The consumer finance company has undergone a major restructure that will see it become a UK-focussed business. The market is still unsure how to value the stock, but there is significant upside to its valuation.

18)

Tiger Resources (TGS)

The emerging copper producer has been re-rated over the past six months, but the stock is set to head higher as it expands production in Africa. Further, its strong management team and corporate appeal makes Tiger one of the most compelling mining juniors to watch.

19)

Universal Biosensors (UBI)

Delays in the launch of its coagulation testing device are hurting the stock. Management now expects the device to reach the market in the September quarter. Management’s credibility is on the line. If it keeps its promise, the stock will re-rate materially.

20)

Wide Bay Australia (WBB)

There are two potential drivers for the Queensland-based financial services company: better-than-expected conditions in the Queensland residential market, particularly around regional towns; and earnings growth from its goal to become a full-service bank.

These 20 stocks have delivered an 18% total return since my first recommendation, which is 13% ahead of the Small Ordinaries. On an annualised basis, the 20 will have generated a total return of 47%.

On the flipside, the table below outlines the reasons behind the cull for each stock and my final thoughts are listed below:

Table of stocks removed from my “outperform” list

Company

Coverage cessation rationale

Final thoughts

1)

WDS (WDS)

Downgrade to “neutral” from “outperform” on valuation.

Management has done an exceptional job in navigating what can only be called a very challenging environment for mining contractors. But its strong outperformance has brought the stock close to fair value. There is probably still some upside left and its yield of around 6% will lend support, but the medium-term upside is relatively modest and there are arguably cheaper buys in the sector.

2)

LogiCamms (LCM)

Downgrade to “neutral” from “outperform” on disappointing first-half dividend.

Companies that can sustainably grow dividends have a 70% chance of outperforming the market, even if dividend growth is modest. I recommended the stock on this basis, but management was unable to deliver on this front.

3)

M2 Telecommunications Group (MTU)

The stock has grown too big.

There is further upside to the stock in my opinion and I think the market is underestimating M2’s organic growth potential. But the stock doesn’t quite fit the definition of a “small cap” as its market cap has grown too far ahead of the $1 billion mark.

4)

Horizon Oil (HZN)

Cutting back coverage of resources sector.

Horizon needs to secure the petroleum development licence from the PNG government before its stock can break out of its trading range. The licence will trigger a $74 million payment from Osaka Gas and will help offset the disappointing reserves downgrade at its Maari field.

5)

Altona Mining (AOH)

Cutting back coverage of resources sector.

I still like the emerging copper producer as its flagship Outokumpu copper-gold project in Finland has been delivering ahead of expectation. The key driver for the stock is whether it can find the capital to get its Queensland Roseby project up and running.

6)

Beadell Resources (BDR)

Cutting back coverage of resources sector.

This is one of the best placed ASX-listed gold miners. While costs have been rising, it is still one of the world’s lowest-cost gold producers. But the stock performance is driven more by the vagaries of the gold price than management, and that supports my decision to stop covering Beadell.

7)

YTC Resources (YTC)

Cutting back coverage of resources sector.

Construction of its flagship Hera project is progressing well but further exploration success will be necessary to drive the diversified miner’s share price significantly higher, and I believe YTC has only scratched the surface in terms of proving up the ore body.

Completing the clean-up

The clean-out will see another group of stocks dropped from coverage: mining juniors Cockatoo Coal (COK) and Heemskirk Consolidated (HSK).

Stocks that I have rated “neutral” or “underperform” will also be cut from the list, and this includes mining software solutions group RungePincockMinarco (RUL), mining services companies Boom Logistics (BOL) and RCR Tomlinson (RCR), Asian property website operator (IPP), aluminium products company Capral (CAA), payment card technology company emerchants (EML), medical facilities company Generation Healthcare REIT (GHC), salmon farmer Tassal Group (TGR), Agri-business Tandou (TAN), internet services firm Melbourne IT (MLB) and regional carrier Regional Express Holdings (REX).

On a final point, we are dropping our Uncapped 100 Index as part of changes to the Eureka Report team.

Think big, go smalls!

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