Source of alpha Andrew King, portfolio manager at Australian midcap specialist Concise Asset Management, is seeing a great deal of interest in the mid-cap sector from retails and instos, and indeed his firm recently won a mandate from JANA Implemented Consulting. The economy is in reasonable condition, he says, and skill shortages are leading to higher wages which will be a net benefit to the economy, while the market is well-placed to benefit in the medium-term from these improving conditions: for example, Adelaide Brighton in the building sector and APN in media. Mid-cap companies can source capital at appropriate rates and re-invest in the company, or acquire, and they’re usually the leaders in their industry. The gap between numbers one and two and numbers five and six will increase in the medium-term, says King, and the leaders will get stronger, compared with their competitors who have no pricing power.
Positives Chris Adams, executive director of small-caps boutique Fairview Equity Partners, sees three positives for his sector: 1. Currency: the high $A is good for retailers and there’s lots of them in the small-cap space (15 per cent of the sector) 2. Economic conditions pickup: stronger export volumes and commodity prices boost mining and activity in the mining services sector which is 10 to 15 per cent of the small-caps space 3. More buoyant economic conditions in general are helping in the following sectors: retail, mining services, financials, IT services, construction “The small-caps sector is more cyclical than mid- or large-caps, and therefore the benchmark will run harder when the economy is picking up,” Adams says. “It’s quite undervalued at present (with) the Small Ords at less than 12 times 2011 earnings – normally it’s 14 to 15 times long-term earnings.” Adams sees a lot of activity in the coal sector with mergers and acquisitions, and IPOs are also starting to pick up which suggests that investors are becoming more confident.
Mining services is a sector to watch, says Adams, pointing to Mastermyne which listed on Friday, 7 May, at $1, which was seven to eight times EPS. The company works in coal only and has “good prospects because it’s completely in underground long-wall and extensions so there’s massive existing work and in the future. It’s an outstanding investment.” Thinksmart in industrial services is another company singled out by Adams. It rents IT to small businesses, with markets in Australia, UK and Spain, and alliances with major retailers such as JB Hi-Fi. Elsewhere in mining, Adams is tipping Whitehaven Coal, which is large enough to have infrastructure and port allocations at Port Waratah (for coal from Werris Creek, Tarrawonga, Rocglen and Sunnyside) and future allocations (from Narrabri) with the Newcastle Coal Infrastructure Group. “This company has lots of value in the future: it’s currently trading at 19 times EPS, but we look at this on the discounted cashflow model,” says Adams. “The value is in the future work, and not in the current year.”
