Consider this: 12 of Australia’s top 20 companies by market value are uni-national. Having retreated from failed global operations, they only operate here or also in New Zealand.
Many of our largest companies are in heavily regulated industries, such as energy utilities or banking. They are mostly capital-intensive and often have low earnings growth prospects. Dividend yield and other capital-management initiatives support their share price.
Now compare that to companies outside the ASX 50, the so-called “mid-caps” whose capitalisations range from $2-$10 billion. Or the “small-caps” that fit between the top 100 and 300 companies. Many of the mid- or small-cap stars are growing quickly in global markets.
It’s an intriguing twist that has not had enough market airplay. In years past, investors who wanted offshore exposure bought ASX 50 companies. They were the multinationals that had diverse operations, stronger growth prospects and thus higher valuation multiples.
In contrast, mid- and small-caps were mostly Australia-focused. They were often described as a play on the local economy and traded at a traditional valuations discount to large-caps because they were supposedly inferior businesses and mostly operated only in this market.
The market used to shudder when small-caps announced they were expanding overseas or making acquisitions there, given the list of spectacular failures. Think Slater + Gordon and its ill-fated acquisition in the United Kingdom or, before that, ABC Learning Centres.
Today, small-cap industrials trade at a slight premium to large-caps – a change that might be more permanent than some commentators expect. The latest profit-reporting season again showed the best growth is from mid-caps with an expanding global footprint.
Think Treasury Wine Estates, which sells bucket loads of premium wine in China. Or Costa Group, which is exporting fresh fruit and vegetables to Asia. Or IDP Education and its booming business in placing international students at universities and providing English training.
Then there’s The A2 Milk Company and Bellamy’s, both of which are riding the dairy-products boom in China. And Breville exporting its clever kitchen appliances worldwide and Reliance Worldwide Corporation doing the same with innovative plumbing products.
In retail, Premier Investments is benefiting from international growth in its stationery star, Smiggle. Lovisa Holdings, a discount fashion-jewellery chain, is growing quickly overseas and Kathmandu Holdings this week announced an acquisition in the United States.
In technology, electronic-circuit-board designer Altium, and language-technology stock Appen, are booming in overseas markets. Targeting global markets from day one is a given for aspiring software companies these days.
I could go on with other examples. I could also provide examples of mid- and small-caps that have struggled overseas or failed to live up to their high market valuations. BWX, favoured in this column, is an example of a market-darling stock that has lost some gloss lately.
Domino’s Pizza Enterprises is another and even the giant online advertising platforms, such as REA Group in property, have struggled to grow their offshore operations as quickly as the market expected. Succeeding overseas remains as challenging as ever for Australian business.
But when assessing mid- and small-caps, the ability to grow sustainably overseas is becoming a bigger factor. Australia is a small economy: high-growth companies in smaller industries quickly outgrow it. They must target much larger offshore markets to warrant higher valuation metrics.
Investors should consider the company’s strategic rationale for offshore expansion, whether it is a copycat or has a unique exportable competitive advantage, and its management and board capabilities to grow overseas without wrecking the local operation.
The company’s balance-sheet firepower to grow overseas, its expansion strategy and timing and knowledge of international markets are other factors. Often, Australian mid- and small-caps come undone overseas because they misread local tastes or the regulatory environment.
For me, the key is management and competitive advantage. You want companies with the skill to take on foreign markets and, importantly, a product or service that is unique. Global markets are much more competitive than those in Australia; companies with a copycat product can get stomped on by foreign rivals with deeper pockets and local-market knowledge.
Cochlear and ResMed Inc are examples of Australian companies that have exported unique competitive advantages. CSL is another. They have technology that is hard to replicate.
Premier on the rise
Premier Investments, another globally focused Australian small-cap, looks interesting at the current price. Premier this week reported a strong first-half result for FY18, its share price rallying sharply on a result that beat market expectation.
I have written favourably on Premier several times for The Bull in the past few years, principally on the strength of Smiggle and its pyjama business, Peter Alexander. Smiggle reported 27 per cent sales growth thanks to strong like-for-like growth in existing stores and new store openings. Peter Alexander reported a solid 15 per cent sales growth.
I am bullish on Smiggle’s prospects and its potential for a much larger global rollout, particularly in Northern America and Europe. There are 332 Smiggle stores and analyst forecasts for 500 stores, once seen as overly optimistic, could be conservative.
Smiggle is a terrific concept. One need only look at how many children flock to its stores to buy its overpriced colourful stationery. It does not have the uniqueness of a patented medical device, but it would be harder for rivals to copy the Smiggle format than the market realises. And the company has a huge headstart on international expansion in this category.
At the current share price, the market is giving little value to Premier’s legacy fashion businesses, such as Just Jeans, Portmans and Jacquie E, even though their performance is improving. But they remain challenged businesses given online competition.
At $15.92, Premier is overvalued based on an average price target of $14.94, built from the consensus of 10 broking firms. The market is, and has been for some time, too bearish on Premier and underestimated growth in Smiggle. Doom and gloom about Australian discretionary retailing has weighed on Premier and other retailers.
Macquarie Group is more bullish: its share-price target of $16.90 for Premier over 12 months suggests a total return of 14.7 per cent, including dividends, the current price. Premier’s forward Price Earnings (PE) multiple of a bit over 10 times seems undemanding for a company with strong global-growth prospect and two earnings engines in Smiggle and Peter Alexander.
Chart 1: Premier InvestmentsSource: The Bull
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article you should consider the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at March 21, 2018.