Venture into the risky world of small caps
One manager’s buys from a well- priced universe
The
Canadian small-cap sector
presents some challenges to investors as many of these stocks are now priced for perfection plus there is the ongoing need to be mindful of the risks attached to investing in small caps, says Brian Pow, vice-president of research and equity analyst at Calgary-based Acumen Capital Partners Ltd.
Acumen Capital, which specializes in the small-cap arena, has, Pow says, still been finding some value in cases where companies are seeing positive changes in their fundamentals and this has not been fully recognized in the stock.. He cites the example of Montreal-based Stella Jones Inc., which makes wood railway ties and utility poles. “ The company has made an accretive U.S. acquisition and could also benefit from the aftermath of Hurricane Katrina.”
In this column, Pow has consistently cautioned that these “very small caps naturally carry considerable risks, as their prospects can and sometimes do changed rapidly — either positively or negatively.”
An example of a recent change in the fundamentals of a company “which has increased its risk profile” is: Rentcash Inc.
This Edmontonbased firm operates loan-brokerage stores and rent-to-own stores. It recently reported fully diluted earnings per share of 41¢ for fiscal 2005 ending in June. That fell short of Pow’s estimate of 66¢ .
“ We had not anticipated the reported administrative allowance provision of $10.3-million in the fourth-quarter fiscal 2005 report,” Pow says.
There was an increase in uncollectible loans by third-party lenders, Rentcash chose to “share in the losses associated with the no-rollover policy on loans introduced in January, 2005.” The administrative allowance provision covers actual write-offs against delinquent loans and a provision for future possible losses, Pow explains.
Rentcash at recent count had a market cap of $407-million. It was one of Pow’s recommendations in the Buy & Sell column of Nov. 5, 2004, when it traded at $4.52. He reiterated it as a “buy” in the column of June 8, when it was trading at $20.30 and noted that his 12-month target on the stock was $29. At that time, his fully diluted EPS estimate on the stock for the year to June 2006 was $1.52. He has reduced this estimate to $1.38.
The company has made some changes to the way in which it provides incentives to employees so as to encourage them to focus on creditworthiness, he says. Pow is also looking to Rentcash’s new chief financial officer, former banker Darin Coutu, to strengthen the financial side of the business.
Pow has a “speculative buy” recommendation on this stock, “given that the transition to its new business model make take longer than anticipated.” His 12month target on the stock is $26.
Pow provides more details on: Stella- Jones Inc.
This Montrealbased maker of pressure-treated wood products has bought the assets of Webster Wood Preserving Co. in the United States.
This will greatly boost earnings per share, Pow says. These will be comfortably above his earlier forecast of 79¢ for 2005 and 86¢ for 2006, he says.
He has a “buy” on this stock with a 12-month target price of $11.60. Its market cap is $101.7million. To Pow, “the risk-reward profile on Stella-Jones is compelling as it has been undervalued of late.”
Other “buy” recommendations: Omni-Lite Industries Canada Inc. This company has a market cap of just $16-million. Headquartered in Cerritos, Calif., Omni-Lite makes precision components using advanced composite materials and cold-forging techniques. Its products are used in a large number of areas, such as sports and recreation, aerospace, military and the automotive sector.
Omni-Lite has added capacity and has expanded its capability to serve the military and aerospace markets and this is fuelling significant growth, he says. The industry as a whole is highly fragmented and Omni-Lite has “the highest concentration of advanced cold-forging equipment in North America.” This business has “good operating margins and a high return on equity.”
Omni-Lite is looking to grow sales by 25% to 30% annually over the next five years, Pow says. The company reports in U.S. dollars. The brokerage’s estimates of earnings per shares on a fully diluted basis are US14¢ for 2005 and US19¢ for 2006. Acumen has a 12-month target price on the stock of $2.80. Savaria Corp.
This Laval, Que., firm makes accessibility equipment for the elderly and for the disabled. It is one of the largest producers in North America and has a market cap of $49.3-million.
Pow notes that the board and management of the company own approximately 65% of the shares outstanding. Savaria’s sales and marketing representatives support a dealer network of some 450 companies in North America.
The United States accounts for about 63% of revenue and Canada 35%. The company has grown both internally and through acquisition.
“ This stock is a play on demographics,” Pow says. Acumen is calling for strong sales and earnings growth over the next two years, based on the rationalization of recent acquisitions and continued enhancement of market share.
Pow cautions that a “critical factor in this regard is Savaria’s foreign-exchange exposure, although it buys components and completed products in U. S. dollars, which will provide a partial hedge.” Acumen is looking for the company to earn 15¢ a share in 2005 and 25¢ in 2006. The 12month price target on the stock is $2.90.
Acumen has a “reduce” recommendation on B.C.-based ACD Systems International Inc., which develops and markets digital imaging software. “The stock trades at the cash value per share of the company, but ACD is experiencing a high turnover in its senior management and there is a need for this to stabilize.” Acumen may hold positions in the securities mentioned or have participated in the financing of
some of these companies.