Category: Small Cap

Companies that are listed on a stock exchange like the ASX can be categorized according to their size, which is most frequently measured by market capitalization, or market cap. The S&P/ASX Small Ordinaries index represents ‘small caps’, those members of the S&P/ASX 300 Index that sit outside the S&P/ASX 100 index. It is a benchmark for small cap Australian shares.

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Shares Small Cap Technical Picks

Vornado Should Benefit From New York’s Office Recovery

The company now generates about 90% of its net operating income from New York City. While the focus is certainly on premier office properties, Vornado continues to invest in high-quality retail. Around 60% of companywide NOI comes from New York office properties, with New York retail generating around one fifth of total NOI.

In contrast with its New York office REIT peers, Vornado has made a concentrated bet on developments in the Penn District submarket just east of the Hudson Yards megaproject. The new development should have positive knock-on effects by increasing foot traffic and rents, as the project adds activity to a once-drab slice of Manhattan. Despite investor concern about oversupply in the region and the spectre of a massive rise in remote work due to the coronavirus pandemic, New York will remain a hub for global talent in the long run. With its enviable roster of blue-chip office and retail tenants, Vornado should benefit from healthy rent collections despite the coronavirus crisis.

Vornado only owns two non-New York properties in well-located central business districts in Chicago and San Francisco. In San Francisco, 555 California Street has benefited from healthy tech office demand in a supply-constrained region. In Chicago, the Merchandise Mart has likewise performed well, emerging as a hub for tech office users in the Midwest. With the completion of the Art on the Mart digital exhibition in 2018, the building is set to continue to benefit from its great location and iconic status within the Chicago office market.

Financial Strength

We view Vornado’s balance sheet as a slight concern, with the firm carrying more debt than many of its already bloated office REIT peers. We forecast 2021 debt/adjusted EBITDA to be around 11 times, with adjusted EBITDA/interest of 3.4 times. We forecast debt/EBITDA to decline gradually over the next 10 years. As a real estate investment trust, Vornado Realty is required to pay out at least 90% of its income as dividends to shareholders. Vornado’s 2020 dividend payout represented an elevated 110% of its funds from operations figure, although this is slightly obscured by acute COVID-related cyclicality.

Company’s Megaproject

Vornado’s well-located portfolio of office and retail assets attracts the highest-quality tenants. Developments near the Hudson Yards megaproject should pay off as the company benefits from increased property values in that region. Vornado’s Chicago and San Francisco properties represent some of the best assets in those markets.

Company Profile

Vornado owns and has ownership interest in Class A office and retail properties highly concentrated in Manhattan, with additional properties in San Francisco and Chicago. It operates as a real estate investment trust.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Expert Insights Shares Small Cap

Canopy Offers Attractive Investment Exposure to the U.S

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Although we expect the medical market to shrink as consumers turn to the recreational market, we forecast more than 10% average annual growth for the entire Canadian market through 2030, driven by the conversion of black-market consumers into the legal market and new cannabis consumers.

Canopy also exports medical cannabis globally. The global market looks lucrative, given higher prices and growing acceptance of cannabis’ medical benefits. Exporters must pass strict regulations to enter markets, protecting early entrants like Canopy. Partially offsetting the global markets’ potential for Canadian producers are threats of future production from countries with cheaper labor— the single largest cost. However, many Canadian companies have pulled back expansion plans given ongoing cash burn. We forecast around 15% average annual growth through 2030.

Besides hemp, Canadian companies typically have no U.S. operations, given legal limitations. However, Canopy has a standing deal to acquire Acreage Holdings, a U.S. multistate operator, immediately upon federal legalization. We thought Canopy paid a good price and acquired an attractive option for an accelerated entry into the U.S. Canopy also owns 27% of U.S. multistate operator Terrascend on a fully diluted basis. The U.S. market is murky, with some states legalizing recreational or medical cannabis while it remains illegal federally. We expect that federal law will be changed to recognize states’ choices on legality within their borders. Based on our state-by-state analysis, we forecast nearly 20% average annual growth for the U.S. recreational market and nearly 10% for the medical market through 2030.

Constellation Brands owns 38.6% of Canopy with additional securities that could push ownership to 55.8%. We see the investment as supportive of developing branded cannabis consumer products while also providing a funding backstop and foothold into the U.S. non-THC market.

Company Profile

Canopy Growth, headquartered in Smiths Falls, Canada, cultivates and sells medicinal and recreational cannabis, and hemp, through a portfolio of brands that include Tweed, Spectrum Therapeutics, and CraftGrow. Although it primarily operates in Canada, Canopy has distribution and production licenses in more than a dozen countries to drive expansion in global medical cannabis and also holds an option to acquire Acreage Holdings upon U.S. federal cannabis legalization.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.               

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Shares Small Cap

Kellogg Company Benefited From Pandemic-Related Gains

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Kellogg’s dividend growth has been modest over the past five years, at an annualized rate of 2.9%. However, Morningstar analysts anticipate a higher rate going forward: “We forecast Kellogg will raise the shareholder dividend in the mid-single-digit range annually on average during the next 10 years.”

In their Best Ideas report, the analysts made the following case for the stock, which trades at an 18% discount to fair value: “Kellogg has benefited from pandemic-related gains in the retail channel (which drives 90% of its sales) as consumers continue to spend more time at home. Even before the pandemic, we thought Kellogg was taking steps to profitably reignite its top-line trajectory: abandoning direct-store distribution in favor of warehouse delivery, divest-ing noncore fare and stock-keeping units, and upping investments in its manufacturing capabilities and brands.

Although we expect more muted gains over a longer horizon, we think the company is using the current backdrop to sharpen its edge.

“We believe actions to expand its category exposure beyond cereal (with 50% of sales now from on-trend snacks versus 20% from North American cereal) will prop up its sales growth potential longer term. Further, we like the changes to its pack formats to include more on-the-go offerings, which should allow for increased penetration in alternative outlets. We also think recent acquisitions (including smaller, niche startups like RXBAR) afford the opportunity to grease the wheels of Kellogg’s innovation cycle to more nimbly respond to ever-changing consumer trends as they relate to health and wellness and taste.”

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Small Cap

O’Reilly Starts 2021 Strong as Sales and Profitability Move Sharply Higher, but Shares Seem Rich

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We suspect near-term volatility will remain high (stemming from the pandemic and lapping increasingly difficult comparable growth through 2021), but our long-term targets are still mid-single-digit top-line growth and roughly 20% adjusted operating margins on average over the next 10 years. In our view, O’Reilly remains the strongest of the auto-parts retailers we cover, but we suggest investors await an entry point that affords more of a margin of safety.

Management updated its 2021 guidance, now calling for $24.75-$24.95 in diluted EPS based on a 19.9%-20.4% operating margin (previously $22.70-$22.90 and 19.0%-19.5%, respectively). The exceptional start to 2021 will lead our prior targets higher (from 19.4% and $23.67, respectively), likely toward the top end of each range. Weather and stimulus effects contributed to the brisk sales, as a cold winter spurred vehicle repair needs and customers found themselves with more funds that could be directed toward keeping their cars and trucks on the road and maintained. With vehicle miles driven recovering but still around 10% lower than year-ago marks (as of February, the latest data available from the Federal Highway Administration), we suspect demand will remain robust. We are encouraged that O’Reilly saw strength in its do-ityourself and professional segments; although the former sector drove growth for much of 2020, we expect the latter to maintain momentum as rising vaccination rates lead more Americans who had the option of working from home back to the office. Although this creates some margin pressure (the DIY segment is more lucrative), cost leverage should be a powerful offset, and the professional sector should remain the industry’s long-term growth engine.

Capital Allocation

O’Reilly’s balance sheet remains hearty despite its footprint growth, with modest near-term debt maturities and an appropriate level of indebtedness. Management targets adjusted debt to be 2.5 times adjusted EBITDAR, with the company’s strong performance leading O’Reilly to undershoot that level for the past several years (most recently 2020, when it posted a 1.9 mark). Under CEO Greg Johnson (and his predecessor, Gregory Henslee, who retired in 2018), leadership has prudently prioritized maintaining investment-grade credit ratings, helping to ensure flexibility and continued attractive inventory financing terms.

The firm’s investment approach is noteworthy, as O’Reilly has done well to invest in expanding its store network (and associated cost leverage) while maintaining a top notch distribution infrastructure that is essential to providing industry-leading service levels. This high standard of part availability draws professional and DIY customers and is difficult for rivals to replicate. The company’s recent acquisition of Mayasa Auto Parts in Mexico should mark the start of increasing investments in the new market, but O’Reilly’s successful approach to domestic store network expansion gives us confidence that the firm will act prudently.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

The Pinnacle at Backing and Growing the Right Horses

This allows Pinnacle to benefit from earnings upside as its affiliate boutiques grow in scale and realise operating leverage. A well-known brand and extensive diversification (across managers, asset classes and client cohorts) strengthen Pinnacle’s ability to attract and hold on to FUM across market cycles. Regardless, capital intensity is higher than pure-play asset managers. Dilution from capital raisings, increasing leverage and deploying capital at low rates of return are risks.

Key Investment Considerations

  • Pinnacle’s reputation as a quality growth partner for high performing boutique managers helps attract high calibre asset managers and investors seeking varied investment solutions. Diversity in asset classes, boutiques, and client cohorts provide stability in FUM growth across market cycles.
  • We anticipate ongoing growth in demand for Pinnacle’s solutions due to the increasingly competitive and regulated funds management landscape.
  • Earnings prospects are strong. Notably, there are upsides from the scaling of fixed costs as affiliate boutiques grow in scale, new money from increased distribution and new boutique additions.

Company Profile

Pinnacle Investment Management Group is an Australian-based multi-affiliate investment management firm. The principal activities of the firm are equity, seed capital and working capital, and providing distribution services, business support, and responsible entity services to a network of boutique asset managers, termed as “affiliates.” Apart from deriving revenue from its services, Pinnacle also earns a share of profits from its affiliates via holding equity interests in them. The business is growing rapidly with number of boutiques and FUM more than doubling to 16 and circa AUD 71 billion in December 2020, respectively, from seven and AUD 23 billion in December 2016.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

Nine’s Estimates Updated for News Supply Deals with Digital Giants

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We see competitive intensity continuing, preventing any sustained improvement in Nine Network’s margins. The same is true for digital division, which operates in the equally competitive digital advertising space. However, Nine Entertainment has a strong balance sheet and is a high cash-generating business. This provides management with significant flexibility, allowing it to invest in marquee television content, diversify into digital businesses, and engage in capital management initiatives. The group has been executing admirably to date and culminated in the merger with Fairfax (consummation in December 2018), using mostly Nine shares as consideration.

Key Investment Considerations

  • Despite boasting a portfolio of entertainment-based divisions, Nine Entertainment’s key asset is Nine Network, a free-to-air television business that operates in a structurally challenged industry.
  • The group has a strong balance sheet, giving management the luxury to invest in content and emerging delivery platforms to fortify the current revenue base.
  • Benefits of the merger with Fairfax hinges on synergies management extracts from the combined entity. We forecast cost savings of AUD 62 million, but this may be conservative, given the potential upside from collaboration and savings on news-gathering resource rationalisation.

Company Profile

Nine Entertainment operates Nine Network, a free-to-air television network spread across five capital cities, as well as in regional Northern New South Wales and Darwin. It also owns Australia’s third-largest portfolio of online digital properties, one that reaches more than 60% of the country’s active online audience. The merger with Fairfax combines Nine’s top-ranked TV

network and the second-largest newspaper group, topped with a collection of quality digital assets in Nine Digital, subscription video on demand operator Stan, and Fairfax’s 59%-owned Domain. It ensures the merged entity remains relevant in the eyes of audiences and advertisers.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

Sales Surge at O’Reilly Automotive Inc

The firm has profited from increases in miles driven and average vehicle age as well as the benefits of its expansive distribution network in ensuring part availability, leading to adjusted returns on invested capital that have grown more than

900 basis points since 2010, to 22% in 2019 (before a pandemic-related surge led to a 30% 2020 mark).

With a strong operational record and national presence, O’Reilly features a highly productive infrastructure, with strong margins despite investments in service and high levels of part availability. While other chains have attempted to adopt a similar dual-market approach, we believe O’Reilly’s expertise and customer relationships give it an advantage that will take time for peers to match. This should keep O’Reilly’s relative positioning strong among the national retailers as the industry consolidates, with large-scale participants like O’Reilly increasingly favored due to their ability to provide hard-to-find parts to commercial (and, to a lesser extent, DIY) customers more quickly, reliably, and efficiently. We estimate the firm should achieve meaningful share growth in both segments, to 12% in DIY and 8% in commercial from 10% and 6% before the pandemic, respectively, over the next decade.

While O’Reilly’s operating margins grew from 13.6% in 2010 to 18.9% in 2019 (pandemic-fueled cost leverage led to a 20.8% 2020 mark), we see room for expansion as it leverages fixed costs and as house label products gain increasing acceptance and adoption. The strength of its brand, coupled with its cost advantage, should enable the firm to foster new and deepening relationships with its customers by providing a better standard of service, protecting O’Reilly’s results from competitive threats from smaller and like-sized peers. Although the pandemic’s sales surge should ease in mid-2021 as vaccination rates rise and comparisons become challenging, O’Reilly’s long-term strength remains rooted in its competitive advantages.

Company Profile

O’Reilly is one of the largest sellers of aftermarket automotive parts, tools, and accessories, serving professional and DIY customers (41% and 59% of 2020 sales, respectively). The company sells branded as well as own-label products, with the latter category comprising nearly half of sales. O’Reilly had 5,616 stores as of the end of 2020, spread across 47 U.S. states and including 22 stores in Mexico. The firm serves professional and DIY customers through its store network, and also boasts approximately 765 sales personnel targeting commercial buyers.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Small Cap

Link Administration Holdings Ltd

The acquisition of U.K.-based Capita Asset Services in 2017 reduced the proportion of revenue from Link’s Australian businesses to around 60% of group revenue. We expect the key earnings driver for both the U.K. and Australian businesses to be cost reductions over the next three years, underpinning an EPS CAGR over the next decade of around 10%.

  • Link benefits from high customer switching costs and relatively low marginal costs, which underpin its narrow economic moat rating. The capital-light business model should enable returns on invested capital to comfortably exceed the weighted average cost of capital.
  • We forecast EPS to grow at a CAGR of 10% over the next decade, driven by revenue growth and margin expansion from acquisition-related synergies.
  • Questions remain around earnings growth drivers beyond planned cost cuts. Link may use acquisitions to drive earnings growth, but this strategy has associated risks.

Link Administration has created a narrow economic moat in the Australian and U.K. financial services administration sectors via its leading positions in fund administration and share registry services. Client retention rates exceed 90% in both markets, underpinned by inflation-linked contracts of between two and five years. The capital-light nature of the business model should enable good cash conversion, regular dividends, and relatively low gearing. Earnings growth prospects are supported by organic growth in member numbers, industry fund consolidation, and continued outsourcing trends.

The company was formed via numerous acquisitions made since 2005 under the ownership of private equity firm Pacific Equity Partners, banks and AMP, which have a reasonably low probability of outsourcing. The remaining 30% comprises a combination of government-owned entities and relatively small superannuation funds, which are likely to have outsourcing lead times of months or years.

Bulls Say

  • We expect Link’s EPS to grow at a CAGR of 10% over the next decade, driven by a revenue CAGR of 5% per year, in addition to cost-cutting and operating leverage.
  • Our base case assumes Link’s Australian fund administration market share grows by 2.5 percentage points to 32.5% over the next five years.
  • The capital-light nature of the business model should enable regular dividends, and low financial leverage creates the opportunity for debt-funded acquisitions.

Bears Say

  • Both superannuation fund administration and share registry services are reasonably commoditized, and sizable competitors exist in both segments.
  • Link’s core businesses may struggle to grow meaningfully beyond low- to mid-single-digit growth rates.
  • Superannuation fund administration and registry services have become more efficient as a result of increasing use of software and automation of processes. However, this raises the prospect of disruption by new software-based solutions.

Source:Morningstar

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

Digital Giants Finally Click Like Button on Nine’s News Content

Management projects the deals to propel an AUD 30 to 40 million EBITDA uplift in fiscal 2022 for the publishing unit. Some of this increase will likely be driven by continuing cost cuts and efficiency improvements. However, we believe the bulk of it is from the new content supply deals—juicy high margin arrangements which finally shift the image of the much-maligned and structurally-challenged division to one that can now much better monetise its (albeit still dwindling) journalistic resources.

Our fiscal 2021 earnings forecasts for Nine are largely intact. But we have increased our EBITDA estimates from fiscal 2022 by 6% on average, giving effect to the uplift from the new content supply agreements (up to three years with Facebook, five years with Google), as well as lifting the expected benefits from management’s relentless focus on costs in the publishing business. More specifically, from our fiscal 2021 publishing EBITDA forecast base of AUD 124 million, we now expect fiscal 2022 EBITDA to be AUD 158 million, up from AUD 120 million. Investors and, more importantly, the journalist community will be keenly watching how these digital platform deals change management’s resource and capital allocation to the publishing division in the future. Judging by the 26% premium that no-moat-rated Nine shares are trading at relative to our intrinsic assessment, it appears investors are betting the publishing unit will become an even bigger cash cow that Nine will milk, in order to fund its growth ambitions for the digital-centric units such as 9Now and Stan. On the other hand, competition is intensifying in the digital space, and we prefer to remain on the conservative side.

Company Profile

Nine Entertainment operates Nine Network, a free-to-air television network spread across five capital cities, as well as in regional Northern New South Wales and Darwin. It also owns Australia’s third-largest portfolio of online digital properties, one that reaches more than 60% of the country’s active online audience. The merger with Fairfax combines Nine’s top-ranked TV

network and the second-largest newspaper group, topped with a collection of quality digital assets in Nine Digital, subscription video on demand operator Stan, and Fairfax’s 59%-owned Domain. It ensures the merged entity remains relevant in the eyes of audiences and advertisers.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

Federated Hermes MDT Small Cap Growth

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He is responsible for the model and research and draws on seven managers/analysts. Frederick Konopka also became a manager in 2008 and handles portfolio construction and trading for the team. MDT looks to group companies into different baskets producing various streams of alpha potential using valuation, growth, momentum, and quality indicators.

By using classification and regression tree analysis, the team can test thousands of potential combinations of factors based on 30-plus years of U.S. stock data to find the best mixtures of alpha using a three-month investment horizon. Still, such a short investment horizon can be difficult to implement. It leads to annual portfolio turnover that can be lofty and varies greatly. Over the past five years, turnover ranged from 188% to 227%, well above the 59%-66% range for the typical small-growth. The portfolio’s holdings have varied from 150 to 250, suggesting some opportunities may be too illiquid and costly to pursue unless they’re spread out across more holdings.

Since Mahr became lead manager in August 2008, the Institutional shares’ 11.9% annualized return through April 2021 lagged the small growth category’s 12.2% gain and the Russell 2000 Growth Index’s 12.2% rise. The fund has performed better since the team’s 2013 process switch to multiple decision trees, but the fund’s high volatility has kept its risk-adjusted results in line with the index.

Quantitative approach with short focus

MDT groups companies into different baskets of alpha potential. The team forecasts three month returns using valuation factors based on structural earnings, tangible book value, and forward earnings estimates; growth factors like analyst conviction and long-term earnings growth; quality factors measuring free cash flow, leverage, and reliance on external capital; and momentum factors like relative stock price trend. The team uses classification and regression tree analysis to test thousands of potential combinations based on 30-plus years of U.S. stock data.

Prior to 2013, the team used one large decision tree to forecast alpha, but that approach was subject to overfitting issues. Switching to regression analysis using multiple decision trees resulted in combinations of subsets of the factors with the best alpha potential. This leads to the fund holding stocks with different avenues to produce alpha, potentially leading to more opportunities to outperform. The MDT team continues to refine its model, usually updating the model twice a year. These revisions are typically on the margin, though. In 2020, for example, they adjusted their structural earnings indicator by using an industry relative basis.

Diversified, but high turnover

The strategy’s short-term approach has led to higher turnover than most smallgrowth peers. Its annual portfolio turnover range of 118%-227% the past five years is much higher than the median range of 59%-66%. The fund might struggle to maintain its fast-trading ways if assets hit the team’s $8 billion-$10 billion estimate of its small-cap capacity, which includes this strategy, Federated MDT Small Cap Core QISCX, and Federated MDT Small Cap Value. So far, the team is not near that limit, with around $2 billion across its small-cap charges. However, the portfolio’s number of holdings has varied from 150 to 250, suggesting some opportunities may be too illiquid and costly to pursue unless their potential alpha is spread out across more holdings. This could become more pronounced as the asset base grows

Performance – Volatile

The fund’s absolute and risk-adjusted returns lag the Russell 2000 Growth Index during lead manager Dan Mahr’s tenure. Since Mahr took over in August 2008, the Institutional shares’ 11.9% annualized return through April 2021 trailed the small-growth category’s 12.2% gain and the Russell 2000 Growth Index’s 12.2% rise. It has done so with more volatility than the benchmark, resulting in subpar riskadjusted performance measures, like the Sharpe ratio. Most of the fund’s underperformance has come during market turbulence. Mahr’s Aug. 31, 2008,start date means he took over amid the credit crisis, and the fund barely edged the benchmark through that period’s March 9, 2009, bottom. The fund lagged the bogy’s ensuing trough-to-peak (April 23, 2010) performance by 26.6 percentage points, annualized.

(Source: Morning star)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.