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Run any ruler you like over recent ASX-listed stock performance and smaller caps have consistently been able to outperform their large-cap counterparts. As at 31 March 2011, the Small Ordinaries Index had delivered 9.9 per cent over the six months, 28.4 per cent over the financial year to date – and 15.5 per cent over 12 months. By comparison, the S&P/ASX200 Index managed to deliver 7.7 per cent, 16.4 per cent and 3.4 per cent over these three time frames respectively. Of course, this is skewed somewhat as it doesn’t include the dividend yield that many of the large caps pay out.

Much of the out-performance by small and micro caps can be attributed to the stellar run-up experienced by resources sector, courtesy of record high commodity prices. But since the peg between the A$ and exchanged traded commodities broke down late April, there has been a notable selloff in commodity-related stocks.

Held back over concerns about policy tightening in China, the Resources Index – up only 2.3 per cent for the quarter to 31 March – displayed its most significant signs of weakness in over a year. With demand from emerging markets expected to experience further deterioration, commodity prices look vulnerable to further downward correction.

Much of the sharp pull-back at the small and micro cap end of the market following a strong run-up, has made finding value within resource names a more challenging proposition. As a result, small and micro cap funds have started to reduce their overall resources exposure in favour of industrials expected to buck the sluggish earnings growth presiding over the sector at large

Having been oversold following the ‘flight to quality’ in the wake of Japan’s earthquake, and ongoing nervousness over the global economic recovery, Australian small and micro caps present investors with some attractive buying opportunities. So with small and micro caps looking well positioned to benefit from economic expansion, TheBull asked analysts and fund managers specialising in this space to identify their favoured stocks – ex-resources.

Rob Hopkins
Managing director
SmallCo Investment Manager

1)    Oohmedia (OOH):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Is a regional outdoor media business with a significant presence in regional centres and metropolitan roadside markets. Adding to the sector’s upside was SMI data release 18 months ago that proved conclusively both A) The effectiveness of outdoor media at helping to sell products, and B) that it wasn’t receiving the pricing it deserved. While most other advertising mediums have been experiencing flat or negative growth, outdoor display advertising was up 14.5 per cent for the four months to 11 April, and up 7.5 per cent for the month of April. Attractively priced on a current P/E of 8.5, OOH has grown revenue consistently each year since 2002. The company delivered 35 per cent EPS growth last year, and Hopkins is forecasting 30 per cent EPS growth in 2011 on the back of a strong growth trajectory. Currently trading at a 42 per cent discount to Hopkins target of $0.30.

2)    Somnomed Ltd (SOM):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Operating in the same market as Resmed, SOM is involved in the stgelopment, manufacturing and marketing of dental stgices for the treatment of sleep disorders. Its core product offering is the SomnoDent MAS, an oral appliance known as a mandibular advancement splint (MAS) designed for the treatment of SDB. While Europe has been the strongest region for growth, much of the company’s future upside is in the US. Instrumental in opening up the US market are recent regulatory policy stgelopments over the suitability of oral appliances and their eligibility for reimbursement for sleep apnoea (SA). Given that 14 per cent of Americans’ are insured under Medicare, new policy is expected to increase SOM’s market size exponentially – with Hopkins expecting EPS of 7 per cent in 2011, to soar to 155 per cent in 2012. As an extra kicker in the US, health insurance companies have started to focus on the oral appliance as an alternative to a respirator for treating SA – while one of the larger firms, Kaiser has selected SOM  as it preferred provide in this space.  Current market cap $54 million, Hopkins expects the stock to be progressively re-rated as global volume continue growing. Currently trading at $1.34, Hopkins expects to see a doubling or tripling of the share price over the next few years.

3)    Ludowici (LDW):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Australia’s leading supplier of Hydraulic and Pneumatic Sealing products, LDW trades on a discount to peers on a P/E multiple of around 9 times. A notable kicker to future earnings is the recent acquisition of WA-based Rojan Advanced Ceramics which is expected to broaden LDW’s product offering to the mineral processing and related industries. LDW looks favourably wired to future volume increases and Hopkins is forecasting EPS growth of 15 per cent in 2011 followed by 25 per cent EPS growth in 2012. Last year management was focused on consolidating mining exposure, and recent acquisitions, including the Johnsons Mining business have positioned the company to capitalise on the robust demand cycle. Currently trading at a 45 per cent discount to Hopkins target of $7.00.

Boyd Peters
National distribution manager
Contango Microcap (CTN)

1)    McMillan Shakespeare (MMS):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Is a provider of workplace benefits administration in Australia, with services including the administration of salary packaging services and fleet management. MMS acquired Interleasing in March 2010, positioning it well to increase its opportunities, particularly within the private sector. Scale benefits allow MMS to drive a higher margin advantage over its competitors, with this forecast to improve further over time as the company demonstrates double digit growth. Peters is looking for net profit to rise from $27 million in 2010 to $58 million by 2013. He also expects P/E to narrow from 23 in 2010 to 11.9 in 2013, and yield to rise from 2.5 per cent to 5.2 per cent over the same time frame.

2)    Decmil Group (DCG):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Is a multi-disciplined design, civil engineering and construction company focused on delivering integrated solutions to blue-chip clients in the oil and gas, resources and infrastructure sectors in WA through a group of wholly-owned subsidiaries. Previously known as Paladio Group Limited, DCG changed its name to Decmil Group Limited in June 2009 to leverage value from its major subsidiary Decmil Australia’s 30-year history, recognisable brand and established reputation with blue-chip clients. Peters is looking for net profit to rise from $19 million in 2010 to $37 million by 2013. He also expects P/E to narrow from 21.3 in 2010 to 10.9 in 2013, and yield to rise steadily to 2.5 per cent in 2013.

3)    Forge Group (FGE):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Is a WA based engineering and construction company operating three wholly owned subsidiaries specialising in industrial services to the resources sector. Cimeco provides civil and concrete, mechanical, electrical and maintenance services, Abesque Engineering specialises in the provision of engineering design, construction and project management services, while Webb Construction (West Africa) provides comprehensive construction services to the resources sector. With over 15 years of operational experience in the West African region, FGE is well recognised for its ability to perform in remote and difficult environments. Peters expects profit to grow more than 10 per cent for the current 2011 financial year to $33 million. He’s looking for net profit to rise from $30 million in 2010 to $49 million by 2013. He also expects P/E to narrow from 15.9 in 2010 to 11 in 2013, and yield to rise from 0.9 per cent to 2.0 per cent.

4)    Slater & Gordon (SGH):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Is a law firm specialising in personal injury, commercial, and family law. SGH is well known for it’s “no win no fee” arrangement where if a claim made by its client is unsuccessful, the client does not pay any legal fees. If the claim is successful, the client is charged legal fees which may include a success fee. Aside from its initial operations in Victoria, SGH has made two substantial EPS-accretive acquisitions focussed on Queensland and NSW over 2010 and 2011. Peters is looking for net profit to rise from $20 million in 2010 to $42 million by 2013. He also expects P/E to narrow from 14.4 in 2010 to 9.3 times in 2013, and yield to rise from 2.0 per cent to 3.7 per cent over same time frames.

5)    G8 Education (GEM):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Operates Long Day Care (LDC) centres in Australia and Singapore, with 215 centres currently being managed under five brands: Payce Childcare, Early Learning Services, Local Kids, Kindy Patch and Cherie Hearts. Industry demographics look positively wired to strong future growth – with the child care market forecast to grow at 5 per cent by revenue annually over next five years. There are a reported 1.7 million children 0-4 years of age in Australia, 22 per cent of which are in LDC centres – which have grown at 6.8 per cent annually over the last 12 years. GEM management is led by Chris Scott (MD) and Craig Chapman (CEO), the people behind S8 (travel and accommodation) – which delivered 53 per cent annually over six years to investors. Events Peters is monitoring to drive share price include the smart acquisitions of childcare centres over the next 12 months. He’s looking for net profit to rise from $4.5 million in 2010 to $21 million by 2012 – which would put GEM’s P/E on 7.7 times at current prices – and is anticipating a 6 cps dividend in 2012 to provide a yield of 6.9 per cent.

6)    TFS Corporation (TFC):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Develops Indian sandalwood plantations on behalf of international institutional and domestic retail investors. The creation of a stream of sandalwood will allow TEC to create a vertically integrated model supplying sandalwood oil to the fragrance industry, the Indian foodstuffs market and in funeral supply inputs. There are also current trials involved in the use of skin-care products. The company is trading on a P/E multiple of five times and has a dividend yield of 4.7 per cent. While the supply dynamics for Indian sandalwood are particularly advantageous for TEC, Peters says a medium to long-term investment view is necessary. He expects a significant P/E re-rating as the institutional sales gives more confidence regarding ongoing sales and surprises the market on the level of sales. He’s looking for net profit to rise from $44 million in 2011 to $50 million by 2013. Over the same period P/E is expected to narrow from 4.6 in 2010 to 4.3 in 2013, and yield to rise from 5.7 per cent to 6.6 per cent.

Chris Prunty
Equities analyst
Ausbil Dexia Ltd

1)    Prime Media Group (PRT):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

The regional affiliate of Channel Seven, PRT is a turn-around story based on A) a dramatically improved balance sheet, and B) efforts by management to strip costs out of the business. PRT’s licensed viewing area covers the regional locations of Northern and Southern New South Wales, Victoria, the Gold Coast area of eastern Queensland and all of regional Western Australia. PRT’s 10 commercial radio stations in Queensland also reach a potential 1,131 262 listeners every week. Recent capital raisings have also been used to significantly tidy up the balance sheet. Prunty expects the stock to be positively re-rated on positive earnings growth, and further operating costs being stripped out of the business. Between them, Paul Ramsay, Channel Seven, Lachlan Murdoch, plus a handful of institutional investors control a sizable block of the business. Prunty expects PRT to deliver double-digit earnings growth, and assuming the payout ratio returns to historic levels, he’s expecting a dividend yield north of 7 per cent.

2)    Credit Corp Group (CCP):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Specialising in receivables management, debt purchase and debt collection, CCP is currently benefiting from increased consumer savings rates – which at 10 per cent have hit their highest levels since the early 1990s. By providing our clients with the benefit of its operational improvement through attractive PDL pricing, CCP has secured a solid pipeline of $75 million for the year. Based on this pipeline, and its ability to significantly reduce balance sheet debt, Prunty expects CCP to continue delivering strong EPS growth and dividend yield north of 5 per cent in 2011. Currently trading at $5.06, he says CCP’s share price could reach $6 over the next 12 months on the back of further earnings upgrades.

3)    Thorn Group (TGA):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Provider of electrical and household appliances under the Radio Rentals brand, the company’s defensive qualities include a core client-base less exposed to rising interest rates. With cash and credit currently stretched, demand for rental products and short-term loans is expected to increase. The stock is still trading on an undemanding P/E multiple of 9x, and a yield of around 5 per cent. Currently trading at $2.04, Prunty says the share price could trade higher given forecast earnings growth of 10-15 per cent. The acquisition of National Credit Management Limited, a leading provider of integrated receivables management services in Australia, is expected to be accretive to Thorn EPS in FY2012 by around 10 per cent.

4)    Kathmandu Holdings (KMD):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Bucking the flat trading environment for retail, this outdoor clothing and equipment retailer reported a 31.6 per  cent rise in third quarter sales, with same store sales for the 13-week period up 23.2 per cent. Contributing to company’s successful Easter sale promotion was particularly favourable weather, especially in Australia. The company is on track to deliver strong year-on-year sales and profit growth, and Prunty is expecting EPS growth of over 20 per cent in 2011 followed by 10-15 per cent in 2012. Currently trading at a modest P/E of just 11 times – attractive given its prospective earnings growth.

5)    CSG Ltd (CSV):

 Chart: Share price over the year to 27/05/2011 versus ASX200 (XJO)

Is an IT services and consulting company offering end-to-end technology solutions and services through two business divisions: Technology Solutions and Print Services. Trading on an undemanding P/E of 5.5 times, Prunty expects the full benefits of the business acquired from Canon, plus significant federal government contracts to help deliver strong EPS growth north of 20 per cent in 2012. Should the stock re-rate to a market multiple of 12 times P/E, He says there is scope for significant share price appreciation over the next 12 months.

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