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I always approach June 30 with a sense of relief. With my business and individual tax returns done, insurance sorted and last-minute bills issued, it is a time to reflect and plan.
The economic impact of the Coronavirus has made this End of Financial Year (EOFY) extra stressful for small business. Collapsing cash flows, rental renegotiations, JobKeeper, cashflow-boost tax eligibility…the challenges were unrelenting for many enterprises.
The upside is volatility can mean work for select companies that provide products and services to small business. My accountant, for example, has never been busier.
Volatility also creates investment opportunity. Listed companies that sell to small business were slaughtered during the March sell-off, even though some have defensive products.
One of them, Xero (XRO), was among this column’s first ideas during COVID-19. Accounting software is as defensive as it gets in business-to-business (B2B) services. Owners who install accounting software and manage their business around it, are usually reluctant to change providers.
JB Hi-Fi (JBH) was another of my early ideas during COVID-19. The boom in remote working was a godsend for JBH and Harvey Norman Holdings (HVN). So, too, the cashflow tax boost, as some eligible small businesses spent part of their government support on work devices.
Insurance is another example. I hate paying Workcover and other business-related insurance, but much of it is unavoidable. The market pummelled insurance brokers during the sell-off even though paying for cover is akin to paying for electricity: you cannot operate without it.
So, too, debt collection. I nominated Credit Corp Group (CCP) in this column on May 20 and remain positive on it. Having raised equity capital, CCP is in an excellent position to buy oodles of distressed debt due to COVID-19 and recover enough of it.
Of course, COVID-19 thumped many companies that service small businesses. Slumping credit growth and elevated bad-debt risks are a toxic combination for fintech lenders that lend to small and medium-size enterprises (SMEs). But some fintechs may have fallen too far.
There will be no rapid recovery for small business. An economic and mortgage “cliff” is fast approaching with JobSeeker payments and six-month loan-repayment deferrals due to end in September.
Then there is the risk of a second wave of infections in Victoria encouraging other state governments to delay easing restrictions, thus jeopardising the timing of any economic recovery.
Sadly, many SMEs, especially those in tourism, cafes and retail, will not survive. But that, too, brings opportunity. For example, Domino’s Pizza Enterprises (DMP), another favoured stock of mine, could increase its market share as many smaller fast-food operators close.
My point is: look for companies that sell defensive products and services to businesses, ideally larger ones that are better placed to withstand the crisis.
It is hard to imagine it now, but when the economy roars back to life in FY22 (my base investment cases) these three business-to-business (B2B) companies will benefit.
The software provider has lagged the tech recovery, even though its billing systems are mission-critical technology for utilities, telcos, energy and pay-TV companies.
Hansen has been a quality small cap for a long time. Its 10-year annualised shareholder return is 22%, Morningstar data shows. Over three years, the annual return is minus 8%.
Hansen tumbled from a 52-week high of $4.29 to $2.62 during the COVID-19 crisis, even though its May trading update said the company “did not envisage a decisive downturn (to its customers’ billing operations)”. Prudently, Hansen withdrew earnings and revenue guidance and now trades at $2.99.
The well-run, well-capitalised company has a relatively low market profile and few broking firms cover it – an opportunity for eagle-eyed investors.
Hansen has many challenges, but not even COVID-19 can stop the dreaded electricity, gas, phone and water bills – or the use of its billing software. Defensive, recurring earnings from critical services, always precious, are especially valuable during a pandemic.
Chart 1: Hansen Technologies
The market could not get enough of the insurance broker before COVID-19, its stock soaring more than 40% in 2019. Then, from a 52-week high of $4.10 in late February, Steadfast tumbled to $2.33 in early April. It trades at $3.40.
Before COVID-19, Steadfast said FY20 results would be “at the top end of guidance”. Sensibly, it withdrew guidance in March due to the uncertainty.
Steadfast’s monthly updates are encouraging. The latest this week said FY20 underlying earnings (EBITDA) to end-May are in line with the company’s pre-COVID expectations. Cost cuts are helping offset premium-rate increases and small volume reductions.
Importantly, Steadfast’s Gross Written Premium (GWP) is mostly sourced from medium-size enterprises. Just over 10% comes from retailers and other smaller businesses that are most vulnerable to recession and likely to cancel or downgrade insurance.
As Australia’s largest general insurance brokerage network, Steadfast has the scale and balance sheet to weather what will be an extraordinarily tough 12-18 months.
Steadfast management has done a good job so far during the crisis and the share price can continue rising, albeit at a slower pace from here, in expectation of a resumption in GWP growth from FY2022.
The stock looks moderately undervalued for long-term portfolio investors. Macquarie Wealth Management’s 12-month price target of $3.70 looks reasonable.
Chart 2: Steadfast Group
I agonised over including the fintech lender to SMEs in this column. Having plunged during COVID-19, Prospa’s valuation is factoring in deep, prolonged recession.
Prospa has low earnings viability. Nobody knows how many SMEs will collapse later this year and how that will affect bad-debt levels. Prospa is exposed to the problem’s pointy end: online loans for SMEs that need cash.
Prospa is a great idea in a growing economy. Simple, online loans for small business, some of which do not require asset security, appeals. In a sudden recession, the concept is an impairment nightmare if collapsing small businesses cannot pay loans.
However, every stock has its price. Prospa is down almost 80% from its $5.09 high. The stock hit 40 cents at its low and trades at $1.06. The offer price in Prospa’s 2019 float was $3.78.
Conservative investors should avoid Prospa. This stock is not for the faint-hearted given the risk of SME bad debts. However, long-term, experienced investors who can tolerate higher risk – and withstand further potential falls in Prospa – should read on.
In its June 2020 trading update, Prospa noted improving loan demand in Australia and New Zealand, albeit after two horrific months. Almost a fifth of Prospa’s SME customers on loan deferrals have returned to full repayments since mid-May, suggesting a muted recovery.
Loan origination this quarter will be sharply down with so many SMEs in hibernation. But as restrictions ease and more SMEs resume, some will seek new credit to fund expansion.
Either way, I have Prospa on my portfolio watchlist. I hesitate to buy stocks now due to lack of earnings visibility for most small lenders. It is impossible to value Prospa on future earnings.
It would not surprise me if Prospa falls below $1 during the next market sell-off. The key number is how many of its 5,501 customers on loan-repayment deferrals move to full repayments.
Technical analysis can help with situations such as Prospa. Look for the stock to make a base in the accumulation phase as the smart money builds positions. Buy when it breaks out of the sideways phase and convincingly starts to trend higher.
In higher-risk turnaround ideas, I prefer to miss some of the early share-price recovery and buy when a clear uptrend has begun. I have seen too many investors over the years buy turnaround situations too early, “catching a falling knife”, as they say.
Prospa could easily bounce around the bottom for some time or go lower, such is the uncertainty with SME debts. I suspect the stock, in a few years, will look cheap at today’s prices when the economy is in full swing again and SMEs are eager for credit.
Chart 3: Prospa