A dependable business that has scope to expand

How many years of solid profit generation does a small-cap company need under its belt before the market will start taking it seriously?

A cutting-edge technology venture, especially one that is blessed with a CEO with the gift of the gab, may not need to produce any significant profits before the market starts to grope madly for scrip.

However, if you are a humble manufacturing concern — even with a dash of entrepreneurial flair and management discipline — it will probably take several years of decent profits backed by cash flow and a rather generous dividend policy before punters give even a sideways glance.

Specialist packaging group Bowler Metcalf is probably a prime example, having produced meaningful earnings and dividends for nearly 30 years, and still not getting the market rating that it deserves.

Wood panels manufacturer and distributor KayDav does not have as long (or, indeed, nearly as impressive) a track record on the JSE as Bowcalf. However, the company has managed, under trying circumstances, to churn solid earnings and dividends for the past five years.

Clearly there is scant interest in KayDav, with the share price at 121c — which is not that far from an annual low. Trading volumes are pitiful, too.

At the ruling price KayDav is trading on an earnings multiple of just 6,5 and offers a rather handsome historic dividend yield of 4,55%. It could be argued that this modest market rating befits a counter that is linked largely to the sluggish local economy and, compared with other specialised light industries, boasts no rand hedge attributes.

But holds that KayDav is a well-managed little business capable of generating decent returns in the longer term. It’s by no means institutional fodder, but it is a value-laden micro-cap share that can be tucked away by patient small investors.

Of course, prospective investors need to get their minds around the fact that KayDav supplies wood panels mainly to the construction, furniture manufacturing and shopfitting industries. These are not exactly economic sweet spots. But management appears capable of running a very tight ship.

What stands out in the results to the year to end December is that while the gross margin crimped ever so slightly to 28% (29% previously), the operating margin shifted to close to 6% from around 5,6%.

Revenue was up a sprightly 13% to R865, helped by the acquisition of a small specialist packaging firm last year. But the core board division showed top-line growth of 9%, which should douse any sceptical contentions that the packaging acquisition was done merely to prop up top-line growth.

For the record, the new packaging assets chipped in R50m to the revenue line, and accounted for a chunky R5,4m of operating profit.

The big selling point at KayDav is its potential to pay sizeable dividends. The most recent distribution — a capital reduction, to be precise — was covered more than three times by earnings. Operating cash flows were down markedly in the most recent financial year, but KayDav remains lightly geared, with a gearing at 27% and a current ratio of 1,7 times.

Interestingly, KayDav has signalled that the packaging segment provides the most immediate opportunity for growth. The company is expanding its Gauteng operation and pushing new product lines. Selected acquisitions — perhaps cash-starved operations too small for the larger listed packaging contenders — might not be entirely out of the question.

The core board operations will no doubt keep pushing for profitable market shares.

Admittedly KayDav is not the most exciting investment opportunity on the JSE. But it is a dependable, dividend-paying business — with the scope to expand profitably without straining the balance sheet.

thinks KayDav offers good old-fashioned fundamental value up to 130c, especially at a time when sentiment in the mainstream market is increasingly fickle.