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3 small caps with income and growth

Photo of James Marley By James Marley

min read

The Small Ordinaries has been a strong performer this year. Learn about 3 companies the experts are looking at.

“The Small Ordinaries itself has been a strong performer through this year. It’s been outperforming strongly vs. the ASX 100; it is my strong opinion that those stocks are set to continue and extend that outperformance. I believe the quality of our benchmark is as good as at any time I’ve seen in 15 years of looking at this space.” – Ben Griffiths, Portfolio Manager at Eley Griffiths Group, manager of $1.4b in small cap strategies.

At the recent sold-out Livewire Live forum at the ASX, 14 of Australia’s most respected and successful fund managers shared how they’re making money and managing risk in today’s markets. As part of the event, three smaller companies specialists have taken the time to share a stock that’s catching their eye, and what sets them apart. Ideas come from Roger Montgomery, Chief Investment Officer at Montgomery Investment Management, Geoff Wilson, Founder & Chairman at Wilson Asset Management, and Ben Griffiths, Portfolio Manager at Eley Griffiths Group.

Roger Montgomery:
Vita Group is an Australian electronics and telecommunications reseller headed by Maxine Horne (deservedly Australia’s wealthiest female executive) comprising six brands; One Zero, Fone Zone, iConcierge, Vita Networks and Sprout Accessories. The 100 Telstra retail stores and 17 Telstra Business Centers it operates generate virtually all of the company’s earnings.

There are two sources of Vita Group competitive advantage; first, the Telstra brand affords Vita Group a range of benefits including an ability to leverage Telstra’s substantial marketing budget ($421m in FY15). The firm’s second and much harder to replicate competitive advantage is its sales culture. I believe without the right culture your business and your customers have nothing, but under Maxine Horne’s passionate leadership, an incredibly successful and repeatable sales and service culture have emerged.

Initially, management expected that at maturity, the Telstra retail stores would generate average EBITDA of $250k p.a. They soon exceeded this target, and it is now over $500k per store. Management expects further growth, boosted by product launches that have a positive impact on profitability. Operating cash flow is exceptional, like-for-like EBITDA growth of >20% has been evident for some years, and through Retail, SMB and Vita Enterprise Solutions, the company is aiming for $100m of EBITDA compared to $33.5m in HY16.

Vita Group’s pursuit of growth in the small & medium enterprise market should follow the enterprise business. In our view, it appears to offer value and upside based on even a conservative estimate of future earnings.

Geoff Wilson:
We are currently following news media company APN News & Media Limited (ASX: APN), which recently moved to spin off New Zealand Media and Entertainment (NZME) and raise $180 million through an entitlement offer. Following the demerger from NZME, APN plans to sell its regional newspapers, leaving the company to focus on the growth of its two best-performing assets – radio and outdoor advertising.

These growth assets constituted 84% of pro forma financial year 2015 earnings before interest, tax, depreciation and amortisation. Over the last five years, APN subsidiary Australian Radio Network has consistently outperformed its competition and grew revenue 9% in the first quarter of the calendar year 2016 and 5% in 2015. The outdoor advertising subsidiary Adshel delivered 17% overall revenue growth in 2015.

We believe the demerger makes sense, as there is limited operational overlap between APN and NZME. Shareholders are scheduled to vote on the demerger and a share consolidation on June 16 and given the market’s positive reaction we expect this to be approved.

APN is targeting a 40-60% dividend payout ratio of underlying net profit after tax. We expect the company will grow its net profit by close to 10% this year, which puts it on a price to earnings (PE) ratio of 8.5 times.

Ben Griffiths:
Aventus Retail Property Fund listed on the ASX at $2 last October to a mostly unreceptive audience, as other more beguiling IPO's caught investor's attention. Our confidence in the property trust sector had been building at this time, prompting a closer look, and eventually, participation in the initial public raising. The story attracted us with its prized east coast land holdings, progressive management and a superior outlook for earnings and distribution growth. Eley Griffiths Group went on to add to its holding in the weeks after the float and in the recent raising.

Aventus’ portfolio comprises of 15 (soon to be 20) large format retail (LFR) property assets, predominantly in metropolitan/major regional areas in the SE corner of Australia. The nation's leading retailers comprise 83% of the property portfolio.

Central to their growth strategy is the acquisition of LFR centres in what is a highly fragmented industry. They will look to enhance value through redevelopments, optimised centre utilizations and favourable rent reviews across these acquisitions and with existing centres.

Likely property revaluations over the months ahead should assist with lowering balance sheet gearing to more reasonable levels and provide some flexibility for future acquisitions.

It is reasonable to expect unit earnings growth moving forward, enhanced by acquisitions and a lower cost of debt following the RBA's recent interest rate cut and move to a more accommodative stance. Given H1 FY17 guidance of 7.75cpu, investors might assume a full year FY17 distribution yield of 7.1% based on a $2.19 share price.

About the author

The sold-out Livewire Live forum provided investors with a unique opportunity to hear how 14 of Australia’s most respected investors outperform the market and where they see the big opportunities of tomorrow. To watch the video highlights today, please register here.

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