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Before all this selling began there were plenty of Aussie companies that brokers liked at current prices. So now that most Aussie stocks are trading below these levels – surely there are opportunities for profit when the turnaround comes?

The index that tracks the performance of small companies, the ASX Small Ordinaries index has dropped by 10.3% in the past six months – only marginally more than the ASX200, which is 9.9% lower. Like smaller ships at sea, smaller companies can capsize if conditions get too rough whereas large companies have experienced numerous downturns over the years, and have built up resistence, more or less. The market recognises this fact, and usually punishes smaller companies harshly.

So why has the Small Ordinaries index held up so well in recent times? Perhaps the tables have turned and it’s the larger ships that are unable to move nimbly through the eye of the storm. Having said that, there are some smaller companies that have been hit hard, such as shorters’ favourite Seek Limited, which is down more than 20 per cent in less than two months. (We look at Seek and three other companies below.)

The good news for investors is that many smaller companies have novel products and markets, are in new sectors of the industry or a run by innovative workaholics destined to succeed. Many of these small companies will become large, powerful businesses in the future. The trick is to pinpoint which ones – and buy when conditions get rough.

But where are the safe havens to park your hard-earned money? While no investment is “safe” the usual answer tends to include defensive consumer staples like Wesfarmers and Woolworths, gold and gold miners, and consumer energy suppliers like AGL and Origin.

While these options may help shelter you from the storm, they won’t necessarily provide you with spectacular capital growth. Below we look at four solid small- and mid-cap companies that have been knocked about over the past few weeks of volatility.

 Company Stock code Current price Price July 22nd % Change
 Reckon RKN $2.43 $2.56 5.1%
 Slater & Gordon SGH $1.98 $2.38 16.8%
 Seek SEK $5.26 $6.62 20.5%
 iiNet IIN $2.30 $2.51 8.4%
 ASX200 *XJO 4149.4 4602.9 9.9%

 

1. Reckon (RKN)

Broker buys:

Merrill Lynch – BUY, low risk, $2.78 price target

 Closing price $2.43
 % change since July 22 -5.1%

In times such as these, all investors are looking for low-risk stocks. And Merrill Lynch believes that Reckon (RKN) fits the bill, placing a “low-risk buy” on the financial software firm that has its sights set on growth. It has a $2.78 price target on the company, a 14% premium to Friday’s closing price.

What’s more, with several companies in a bidding war for Australia’s other software titan, MYOB, Reckon could well be next on the list. Private equity firms Bain, Kohlberg Kravis Roberts (KKR) and Sage were battling it out in a bid to gobble up MYOB for an estimated $1.3 billion. Bain appears to be in the box seat, which leaves Sage’s new CEO Guy Berruyer with empty hands. And a fat acquisition wallet. With RKN’s market cap at just $320 million, Sage – and the other private equity giant KKR  – would be able to easily pick up the company.

Takeover speculation aside, according to brokers RKN’s numbers and outlook look good. Recently it announced earnings growth of 8% for the 6 months to June 30, 2011, despite being adversely impacted by weak economic conditions in the UK and NZ, adverse exchange rates and a sluggish retail sector in Australia. “It is pleasing to see solid organic revenue growth in our core businesses, and that the continual push for further efficiency gains is bearing fruit,” said Clive Rabie, Reckon’s Group CEO. “Within the constraints of difficult market conditions, and the consequential delays in decision making, we continue our historical strong new product sales growth which in turn adds to our maintenance revenue base by adding new clients to the business each year.”

It says that its QuickBooks and Quicken accounting software has continued to experience strong growth in its direct business, although it has been impacted by weaknesses in the retail sector. However this retail sluggishness is being offset by substantial new customer growth as a result of their online offering, QuickBooks Hosted.

“The group is well positioned as we pursue cloud computing opportunities in all of our businesses, as well as expanding our addressable markets in both the Professional and nQueueBillback Divisions,” said Rabie. “Our relationship with Intuit remains strong and we are excited about the opportunities that could arise from this partnership over the coming years.” 

Intuit isn’t the only partnership that may bear fruit over the coming years. Earlier this year RKN took a 5% stake in Melbourne IT and announced that it was looking to work more closely with the IT company on a number of projects.

The financial software firm has been a standout performer over the past 10 years, hardly breaking its stride as the GFC rocked most stocks around the world. The 10-year chart below tells the tale: 

 

 

2. Slater & Gordon (SGH)

Broker buys:

Austock

 Closing price $1.98
 % change since July 22 16.8%

With a one year return of 26%, personal injury and commercial litigation specialist Slater & Gordon has richly rewarded investors when compared to the All Ords, which is down 10% for the year.

The firm wins an estimated 98 per cent of all cases, ranging from its no win no fee personal injury work to class action cases such as the Fincorp class action where Slater & Gordon negitiated a deal worth $29 million for the 5,000 affected investors only a few months back.

Australia’s first listed legal firm, SGH is a consumer law firm with 75-year history specialising in personal injury, commercial, family and asbestos-related law and has 40 offices Australia-wide. It has legal teams in multiple personal injury practice areas, commercial law & business services, class actions, and superannuation & insurance, to name a few.

SGH’s calling card is its “No Win-No Fee” arrangement with clients, where there is no fee if they lose, but must pay fees and a success fee if they win. With its win/loss percentage sitting at approximately 98%, this is a lucrative earner for the company. The No Win-No Fee arrangement is only available for personal injury law.

Since listing in 2007 SGH has grown through acquiring Trilby Misso, a personal injury litigation firm in Queensland, last August and then the NSW-based personal injury litigation form – Keddies Lawyers – in January this year.

Prior to the Keddies acquisition the company had a leading position in Victoria & Qld, so this latest acquistion puts them into a strong postition Australia-wide. Austock states that revenue is derived principally from the personal injury practice, which makes up approximately 80% of revenues, which it points out is both defensive & scalable. It also believes that the company’s brand presence is strong and underpinned by established referral channels & marketing. “Growth opportunities outside of Victoria are strong & well positioned with existing scale and access to capital to drive consolidation,” it wrote in a research note.

Austock’s Heffernan listed SGH as a buy in June, stating that the company “continues to progress in a quietly robust manner”. “Slater & Gordon represent a superior investment option among small industrial stocks in the current environment,” says Heffernan. He doesn’t believe that litigation will be affected by a slowing economy, and has a 12-month price target of $2.90/share. His DCF is $3.20/share.

Wilson HTM says that the Keddies acquisition fits into SGH’s strategy to grow in the Western Sydney area where it is currently under represented. “We maintain a BUY recommendation…SGH is also one of our conviction list stocks.” 

Ord Minnett has a hold on the stock and underlines some risks, such as integration risks from new acquisitions and regulatory change. “SGH have pursued a similar strategy to that which they followed in Queensland, building scale via acquisition of a key player in the target market,” says Ords. “The balance sheet prior to the Keddies acquisition was robust, having been given an injection of capital in June 2010 with the capital raising as part of the Trilby Misso acquisition.”

With a 98% win ratio and a strong history of earnings growth, the sole listed legal entity on the Australian market is in a solid position. Its growth through acquisition strategy appears to be paying off, and it continues to receive press via high-profile class action wins such as the recent Fincorp case. However as Ord Minnett points out, there is risk associated with the recently acquired practices and the company has some work to do to keep up its win rate, a huge drawcard for new cases.

3. Seek (SEK)

Broker buys:

Deutsche, Shadforth Financial Group, Lincoln, Shaw, SmallCo

 Closing price $5.26
 % change since July 22 -20.5%

Seek Limited (SEK) is quickly becoming a favourite with brokers as it expands its operations throughout South America and Asia. Notably it is no.2 in China, and has the no.1 & no.2 sites in both Brazil and Indonesia – giving it the no.1 and/or no.2 spot in three of the five biggest countries on the planet. And let’s not forget that it is also no.1 in Mexico, which holds the 11th largest population. Consider this – the population of Australia is around 22 million.  There are about 210 million people in Brazil; 243 million in Indonesia, and 1.3 billion in China.  While Internet usage in developed countries like Australia and New Zealand is high, some experts say internet penetration in countries like China, Brazil, and Indonesia is well below 50%. That is impressive growth potential.

SEK’s operating divisions include online job classifieds, and training and learning. Seek Commercial enables browsers to search for businesses and franchises for sale, while Seek Learning assists jobseekers with career development.

Andrew Inglis, Shadforth Financial Group has a buy on SEK, saying that strong market positions in China, Brazil and Indonesia provide an excellent platform for future growth as many of these countries still have relatively low internet usage rates. “It will also benefit from employers continuing to switch to online advertising,” he says. “Discounted valuations on the overseas subsidiaries and its education and training business, together with a solid balance sheet and strong growth outlook, present a buying opportunity.”

Back in late-May, Scott Marshall of Shaw Stockbroking analyst pointed out that the Internet is now the first port of call for those wanting a job, car, house, flight, product or service. Marshall said SEK was wasting no time taking advantage of a shift in search from printed materials to the digital space. He says it is an aggressive company that’s established dominant positions in the online Australian job ads sector, with almost 70 per cent. And Seek is now expanding into Asian and South American economies, with more on the drawing board. “The group has also established an effective strategy in the Australian classroom and online education sectors,” he says. “It’s also specialising in career enhancement for Australian and foreign students. We expect Seek to benefit from growth in online job ads numbers amid the related shift away from printed ads.” 

Rob Hopkins, Managing director of Smallco Investment Manager says that around 80 per cent of job ad volume is now via the Internet and job seekers seem to prefer the online space. But with its share of spend still only around 50 per cent, Hopkins says the opportunity for future upside is enormous. While international business accounts for only 15 per cent of SEK’s net profit, he says the long-term opportunity for it to eclipse the size of its domestic market shouldn’t be underestimated. As well as holding the number two job sites in China, SEK has the top two sites in both Brazil and Indonesia. Forecast earnings growth 27.6 per cent; dividend yield 2.6 per cent; and ROE 28.9 per cent.

And back in April in “Ride the Internet Boom” James Samson, of Lincoln Indicators said that the market reacted harshly when the company announced that its education division was experiencing difficult times, primarily due to the strong Australian dollar and regulatory changes for online student visas. He said online classifieds represents about 65 per cent of revenue, while weakened education accounts for 35 per cent. “Despite the adversities faced by the education segment, the company, on the back of a buoyant labour market, is expected to continue experiencing strong growth in its online employment business in the short-to-medium term,” Samson said.  Samson described the company’s financial health as strong and investors may find some value. 

4. iiNet

Broker buys:

JP Morgan (Target Price $3.35), Patersons, Lincoln

 Closing price $2.30
 % change since July 22 -8.4%

Many stocks in the telecommunications sector have been dismal performers over the last few years – but is that reason to give up on the sector entirely? According to one broker, there are a few smaller telcos that are beginning to buck the trend – including iiNet, Australia’s no.2 internet provider.

iiNet reported net profit for the year to June 30 of $33.37 million, down from $34.55 million in the previous corresponding period, due mainly to an unrepeated tax deduction in the previous year. Revenue increased 48 per cent from the previous year to $699 million, reflecting the first full year contribution from Netspace, which iiNet acquired for $40 million in March 2010. The company also bought AAPT’s consumer division for $60 million in July last year, and from October will begin moving those customers onto its own network and billing system. “In terms of profit growth in the next year, obviously we will get a bit more from organic growth, but the main game is about getting costs out of AAPT,” chief executive Michael Malone said.

iiNet added 7,700 broadband customers in the year to June, taking total subscribers to 641,000, whereas Telstra has 2.4 million fixed broadband subscribers. The roll out of the national broadband network (NBN) is seen by the company as a long-term growth prospect. “We are genuinely excited by the increased market opportunities the NBN will bring, doubling the available market for iiNet’s services,” Mr Malone said.

Within the telco sector as a whole, Telstra boasts the biggest market capitalisation by far at $32.4 billion at March 16, 2011, but it’s not on Lincoln analyst James Samson’s list of stocks to consider buying. “Currently sentiment in the telecommunications sector is poor, as political agendas and the National Broadband Network project portray a sense of uncertainty among industry participants,” Samson says. “This uncertainty has resulted in several great businesses trading at depressed share prices. Telstra has been a major drag on sector performance, but there are a few smaller companies bucking the trend.”

IIN is one such company and has grown rapidly in recent years after acquiring WestNet, Netspace, and AAPT’s consumer division. However the company is integrating its acquisitions and the share price may consolidate until synergies are realised. Samson says that as a result this may be a good time to consider buying. “IIN is also beneficiary of recent reductions in wholesale line rental costs.”

Hamza Habib of Patersons Securities also has a buy on IIN. “iiNet is the second biggest provider of broadband services in Australia (and) its own ADSL2+ network reaches about 4 million households,” he says. “Importantly, the company looks attractive for any acquirer looking to enter the Australian IT space.”

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au.You should seek professional advice before making any investment decisions.

More articles from this week’s newsletter 

18 Share Tips – 19 September 2011

5 Sold-Off Small Caps Going Cheap

Qantas Targets China

Filling Up Super At The Last Minute

China Buys US For A Bargain

Budgeting For A Downturn

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