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Five high performing small caps

Making money is not just about picking winners. It’s about taking profits to generate big gains. You need to recognise value because the market is a pendulum and you need to benefit from excess optimism as well as pessimism.

At Under the Radar Report, we’re not about making bets on the market. That is a losing strategy in our view. What we are about is recognising value.

We look for stocks to cash in on where sentiment has taken over from the company’s fundamentals (you know, profits, balance sheet etc) because investors are in love with the product, the management or most likely both. Sentiment is good to take advantage of, but any seasoned player will tell you, it can disappear very quickly.

The companies listed below are in fact good companies, which is why we invested in them. What we are saying is that we think it’s time to take some risk off the table. I can never say it enough, but the most important contributor to your returns is the price you pay. You could also add to this that you can’t live off paper profits (which I’m sure Lex Greensill knows all too well).

 

Seven West Media (SWM)

Having recommended the stock twice around 8 cents last April and May 2020 when it was a Small Cap, we investigated at the stock as a debt laden group that had potential because of a new CEO in James Warburton who was not attached to decisions such as inhouse television production.

The stock is now trading at 55 cents and we have been taking profits along the way. In the wake of the recovery from the depths of COVID, the risks of a distressed balance sheet kept many institutional investors away.

In the current quarter (3Q21) TV advertising revenue may be up to 10% higher, and 4Q21 has a very soft comparative. Operating leverage should continue to work in favour of an improving earnings pattern, although some of the easier gains have been realised. The company also announced a deal with Google, described as a partnership, in relation to Google’s use of its news output.

There could be more cream but SWM is a complicated beast which has done its job. It’s time to eat cake.

 

Kogan (KGN)

We’re on a hold in the online retailer right now but it’s a good stock to trade because sentiment is such a big part of the stock’s movements.

Kogan has performed fantastically since we were speculative buyers below $3 in the middle of 2017, as well as our bottom defining call to buy at $3.50 in Issue 387 on 19 March 2020, a price which turned out to be the COVID bottom. Since then, as subscribers will know, the stock has rocketed, until it recently began to roll over just after breaching $25 in October.

We’ve been taking profits into the strength because some of the benefits of COVID may prove to be ephemeral and the online retail world changes very quickly.

Kogan is continuing to scale its business in response to structural change and as a disruptor. While growth is expected to continue, the rate of growth will slow as its market share increases and competition intensifies.

 

Nick Scali (NCK)

This is a stock we have loved for some time but when you look at the big beneficiaries of COVID, you can’t go past this company. Many Australians have been looking after their bottoms with a new couch, but how many couches do you need? How often do you change a couch?

We have had success with Nick Scali over the years, picking it up initially at as low as $1.40 years ago, riding the premium furniture manufacturer/retailer all the way up, taking profits, upgrading again at lower prices, and then taking profits again finally before the pandemic hit. We upgraded to hold during the pandemic and have maintained that position since, as Nick Scali has produced stellar results despite our concerns about its exposure to the pointy end of discretionary consumer expenditure.

We like the vertically integrated business model which removes risks of distressed inventory. But high double-digit sales growth cannot continue in the medium term, and there is room for consolidation, although this is a well-managed company and should pay a substantial dividend.

 

Macquarie Telecom (MAQ)

This company is one that I have been in love with for some time. But like many things that I’ve loved, I’ve had to let it go, or at least half my holding.

I remember the struggle I had with this company to start with when it was below $10. The Tudehope brothers’ vision was not being matched by any sort of investor love. I played my part, but obviously it wasn’t enough. At least not for a while.

The stock has taken off on increasing demand for their data centres as well the niche the group has in the provision of government related IT services.

The data centre owner’s numbers were in line and its guidance for FY21 hasn’t changed from an investor event in December. What has is the obvious pressure senior management is under to grow the business, in the knowledge that its biggest ever capital spend of about $125m on one project has already achieved 90% occupancy. Much of the expected growth therefore is in the current price.

 

AVA Risk (AVA)

When we took profits on this stock at 63 cents late last year, we said that we couldn’t look past the fact that it had more than tripled since we first tipped it five months prior.

Sometimes when a stock climbs to nose bleed levels very quickly you are obliged to cash in. You can’t let your emotions get the better of you!

Late last year we said that its technology applications looked more interesting and indeed the company had matured. But let’s face it, how much maturing can you do in 5 months.

It’s trading at 10 cents low now and we’ll have another look at it. Who knows, we could come back and buy in again. It’s one that we’ll always keep a close eye on.

 

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Case Study: McPherson’s (MCP)

Cashing in on China is harder than it looks

When you look about the hype about cracking the Chinese market, the only real sustainable winners have been the big iron ore producers Rio Tinto and Fortescue Metals, but it doesn’t mean that there haven’t been profit making opportunities for investors elsewhere. Cashing in has been the secret, because some of that growth has proven to be illusory.

The experience of the wholesaler McPherson’s (MCP) highlights how the dragon can turn on you, having gone from trading well over $3 only six months ago, when Under the Radar Report told subscribers to take profits, to current levels of just over $1.

This time last year the market was very much in love with McPherson’s profit growth and its boss who talked up the business as a Cinderella story, going from a boring wholesaler to a company beautifying the Chinese, one face mask at a time. The company was promoting its joint venture with a Chinese company Access Brand Management, which operated through a ‘daigou’ structure of buying products in Western markets that can be marked up and resold in China. Exports of its beauty products branded Dr. LeWinn’s had almost quadrupled in the back half of 2020.

The stock was benefiting from the double whammy effect of earnings growth from China and the market recognising this and re-rating the stock higher.

I don’t know much about face masks, but fortunately know something about value, having covered the stock long enough to know what a fickle business wholesaling can be, let alone joint ventures (the image of two one legged men propping themselves up comes to mind).

Fast forward to today and the China growth engine has turned into something of a liability, as have the face masks. ABM has had difficulty placing sales into China, some possibly related to COVID; and in Australia sales are lower, having been impacted by the exodus of Chinese students.

The irony is that it’s boring Multix brands like cling wrap are holding the company up. In the first half Dr LeWinn’s lost $6.6m. Despite this loss, the profit before tax was $7.1m. Maybe there’s an opportunity if they shut this business down to double their profits? A thought for another day.

 

What were the red flags?

Back in February 2020 at its interim result the stock traded at $2.80 and MCP looked very expensive. Then CEO Laurie McAllister spoke words of caution: “1.4m Chinese tourists come to Australia each year, which adds $12bn to the economy; after SARS in 2003 there was a 75% decline in visitors. We need to be realistic.”

Despite his comments and despite the higher weighting of the second half to its profits, the company maintained its FY20 guidance of 10% profit growth, which was ambitious. At the very least it was probable that dividends would be cut.

MCP’s stock was even higher at $3 at its full year result in September 2020, but our nervousness was confirmed when the company made big asset write-downs. This fact on top of a deteriorating trading environment of Australian products in China, signalled real problems. It seemed that sales of beauty products to Chinese would be subdued, which was not what the market was saying!

For FY20 MCP had a decent “underlying” profit before tax of $22.8m, but its statutory profit was only $13.3m because of write-downs of $10.6m. Some of that was COVID-19 related, but it was clear that the majority of it was related to the growing business of beauty products being marketed to the Chinese.

You only had to look at the pain being experienced by other Chinese exporters like Treasury Wines (TWE) and the infant formula marketers like A2Milk (A2M) to know that McPherson’s wouldn’t be spared. But when you’re on a winner, it takes courage to heed the warning signs, look at the fundamentals, and jump off the tiger. After all, the Dragon’s in the detail.

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Richard Hemming, editor www.undertheradarreport.com.au , Under The Radar Report

Richard Hemming is Editor of Under the Radar Report (AFSL 409518). All prices and analysis at 5 March 2021. This information contained on this website is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, and we recommend seeking advice from a financial adviser or stockbroker before making a decision. All information displayed on the website, is subject to change without notice. UTRR does not give any representation or warranty regarding the quality, accuracy, completeness or merchantability of the information or that it is fit for any purpose. The content on this website has been published for information purposes only and any use of or reliance on the information on this website is entirely at your own risk. To the maximum extent permitted by law, UTRR will not be liable to any party in contract, tort (including for negligence) or otherwise for any loss or damage arising either directly or indirectly as a result of any act or omission in reliance on, use of or inability to use any information displayed on this website. Where liability cannot be excluded by law then, to the extent permissible by law, liability is limited to the resupply of the information or the reasonable cost of having the information resupplied. No part of UTRR's publications may be reproduced in any manner, and no further dissemination of its publications is permitted without the express written permission of Under the Radar Report Pty Ltd. Whilst all reasonable care has been taken by WealthHub Securities in reviewing this material, this content does not represent the view or opinions of WealthHub Securities.

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Richard Hemming, editor www.undertheradarreport.com.au

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