The Result Season And Small Cap Performance

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By Greg Peel

The August reporting season just past revealed patchier earnings growth amongst small cap stocks than in recent years, Citi notes. Forward growth guidance also came in below expectation, potentially suggesting weaker earnings growth in FY16 than that experienced in recent years.

Credit Suisse notes FY15 represented the fifth consecutive year of negative earnings revisions for small caps. Twelve months ago, consensus forecasts anticipated 13.5% earnings growth in FY15 while only 5.9% was actually delivered. Yet over the same period, forecasts for FY16 earnings have been revised up to 13.4% growth from 11.6% a year ago, prompting the broker to ask the question of whether forecasts are again too ambitious.

That said, over the period of the results season, which coincided later in the month with a significant macro-inspired market plunge, the Small Ordinaries Accumulation Index (dividends included) fell 5% compared to the ASX200’s 9% drop, Citi points out.

Among the sectors, Citi observes the consistent theme in Consumer was the weaker currency impacting on margins. Competition was a factor among the Telcos, while REITs experienced subdued rental growth but higher shopping centre values. The small REITs are now concentrating on using their firm share prices to raise new capital for portfolio acquisitions.

Among the resources, small Energy featured steps being taken to solidify balance sheets, but whether companies can find any growth opportunities that still generate adequate returns at low oil prices is uncertain. Materials simply remain under pressure from lower commodity prices.

Among the industrials, Citi’s biggest target price upgrade was reserved for GUD Holdings ((GUD)), which the broker also upgraded to Buy on the back of all business segments enjoying growth in revenue. Seven West Media ((SWM)) suffered the biggest target price drop given limited growth and increasing costs for new content and AFL rights.

Among the resources, Citi’s biggest target upgrade was for Paladin Energy ((PDN)) due to cost-cutting endeavours, while the broker’s own iron ore price and currency forecasts led to Arrium ((ARI)) copping the biggest target downgrade.

Citi has added Super Retail ((SUL)) to top picks portfolio given an undemanding valuation. Sporting Goods is experiencing strong growth while the company’s problem businesses are being unwound.

Citi’s top picks among small industrials are, alongside Super Retail, Aconex ((ACX)), Charter Hall Group ((CHC)), McMillan Shakespeare ((MMS)), MYOB ((MYO)), NextDC ((NXT)) and Qube Holdings ((QUB)). Karoon Gas ((KAR)) and OZ Minerals ((OZL)) are the broker’s preferences among the small resources.

Deutsche Bank has identified four broad themes emanating from result season among emerging companies under the broker’s coverage.

Software firms are investing to drive future revenues, including 3P Learning ((3PL)), Altium ((ALU)), Iress ((IRE)) and OxForex ((OFX)). Retailers are holding up with better sales and margins than expected, including Super Retail, Greencross ((GXL)), Kathmandu ((KMD)) and Pacific Brands ((PBG)), albeit the outlook remains challenging given a tough consumer environment and currency headwinds. Those headwinds represent tailwinds for others, including 3P Learning, Ardent Leisure ((AAD)), Iress, Mantra Group ((MTR)), SAI Global ((SAI)), and Village Roadshow ((VRL)).

Finally there were a number of companies creating uncertainty due to recent significant management changes, including Ardent Leisure, Cardno ((CDD)), FlexiGroup ((FXL)), Greencross, OxForex and Transpacific Industries ((TPI)).

A number of stocks enjoyed PE re-ratings following their results, Deutsche notes, having underperformed in the lead-in to the season or during FY15. They include Pacific Brands, Ardent Leisure and Village Roadshow. Those companies outperforming on the lead-in and subsequently suffering de-ratings include Veda Group ((VED)), Invocare ((IVC)) and Altium.

On valuation grounds, Deutsche upgraded Cabcharge ((CAB)) to Hold from Sell following its result.

Credit Suisse has identified its top small cap picks in the wake of result season.

Capitol Health ((CAJ)) is oversold, the broker believes, and is offering value from strong organic growth prospects, consolidation opportunities in a fragmented diagnostic imaging market, and limited scope for competition.

iSelect ((ISU)) offers a very strong revenue growth record and ongoing momentum in earnings growth, a strong balance sheet suggesting capital management potential, and compelling opportunities in new industry vertical integration.

Vocus Communication ((VOC)) is well positioned in the corporate data market, is set to benefit from integrating recent acquisition Amcom, and the broker has a three-year compound earnings growth forecast of 38%.

Small caps which enjoyed recommendation upgrades from Credit Suisse following earnings reports were Transfield Services ((TSE)), Huon Aquaculture ((HUO)) and Webjet ((WEB)). Huon’s upgrade came despite earnings forecast downgrades, which were also suffered by Bradken ((BKN)), Transpacific and Royal Wolf Holdings ((RWH)).

Earnings forecast upgrades were enjoyed by Ridley Corp ((RIC)), Fantastic Holdings ((FAN)), BigAir Group ((BGL)) and Webjet.

In the wake of results season, the UBS emerging companies analysts upgraded Ardent Leisure, Aconex, Cabcharge, Mantra and SMS Management & Technology ((SMX)) to Buy and FlexiGroup, Pacific Brands and The Reject Shop ((TRS)) to Neutral. Suffering downgrades to Neutral were Automotive Holdings ((AHG)), Cover-More ((CVO)) and GWA Group ((GWA)).

UBS’ key picks are now Ardent, Aconex, Adairs ((ADH)), Cabcharge, Gateway Lifestyle Group ((GTY)), GUD Holdings, Mantra, SMS Management & Technology, Tox Free Solutions ((TOX)) and Webjet.

The broker’s key “concerns” are Cardno and FlexiGroup.

Goldman Sachs has added Dick Smith Holdings ((DSH)) to its Small & Mid Cap Focus List following a result season de-rating on a weaker performance than the retailer’s peer group. The broker believes Dick Smith will re-rate as the company delivers on its store rollout plan, posts better cash flow conversion and hits FY16 profit guidance.

The other stocks in the Goldman’s Focus List are Austbrokers Holdings ((AUB)), Amaysim Australia ((AYS)), Genworth Mortgage Insurance ((GMA)), OxForex, SAI Global, Sirtex Medical ((SRX)), Super Retail and Tassal Group ((TGR)).

All the stocks in Goldman Sachs’ Focus List carry a Buy rating. The broker also maintains a wider market Conviction List of Buy-rated stocks the analysts are most excited about.

Goldman has now added Costa Group ((CGC)) to that list, following coverage initiation. Costa is the market leader in Australian berries, boasting 77% share in blueberries and 91% in raspberries. As Australian diets have increasingly become more health-focused, berry demand has grown an average 20% per year over 2011-14, the broker notes.

Costa has rapidly expanded its berry capacity, while also increasing glasshouse capacity for tomato production and shifting into mushrooms. Beyond FY16, Costa earnings growth should mostly be driven by its international segment, Goldman believes, given international joint ventures and royalty income will be supported by rapidly rising demand for berries in Europe and Asia.

The broker has initiated with a Buy rating and $2.79 target.

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