Chasing small-cap companies with low single-digit earnings multiples can be a hazardous strategy for investors.
Smaller companies — which don’t always have the most reinforced balance sheets — are often vulnerable to the vagaries of economic cycles, and their determination to grow into bigger companies frequently results in damaging missteps in merger and acquisition activity.
Of course, there are small companies that have rewarded shareholders wonderfully over decades (yes, decades) and that still trade at very modest market ratings.
Two such companies are packaging group Bowler Metcalf and vehicle retailer Combined Motor Holdings (CMH), both graduates of the class of 1987 listings boom.
Both have provided decent short-term returns to investors who backed the shares when they were languishing six months ago.
The share prices of Bowler, which recently sold off its investment in beverages business SoftBev, and CMH, which reported stout results in the year to end-February, have appreciated 33% and 22% in the past six months.
In both companies there is evidence of a no-nonsense and experienced management team, the corporate culture is without frills, cash flows are traditionally strong and the business model offers a considerable margin of safety.
There is also a singular operational focus and a simplicity to each business that shareholders might find reassuring after accounting debacles at convoluted conglomerates like Steinhoff International.
Could there be more such modestly priced small-cap gems on the JSE?
In terms of modest market ratings, two sectors are conspicuous: the technology sector and the human-resources side of the services sector.
On the technology front, micro-cap counters such as ISA Holdings and PBT trade on trailing earnings multiples of six. SilverBridge, which specialises in technology services to the financial services sector, is on a trailing earnings multiple of just over three.
Alviva, a slightly better-known technology counter, is accorded a multiple of eight, but its smaller rival Mustek is on a multiple of less than seven.
Counters with any connection to human resources — notwithstanding sustained profitability — are treated even more shabbily. Workforce and Primeserv trade on multiples of about three, with CSG Holdings (which has a growing security division) accorded a slightly better multiple of six.
On paper, the market doubts the sustainability of profits in these counters, be it because of changing labour regulations or doubts about technology spending in these threadbare times.
The Financial Mail, though, thinks there are a few counters trading on earnings multiples of about five that have the potential to prove as rewarding as CMH and Bowler.
Bell Equipment
There has been a major structural shift in this heavy-equipment specialist, with management showing much progress in reducing cyclicality in the business. Bell is no longer as dependent on the mining sector, and the push into the North American market looks extremely encouraging. The dividend was doubled in the past financial year, which must be taken as a sign of confidence in the company’s prospects, even if the payout was covered conservatively by earnings of 270c/share.
Hulamin
This aluminium rolled products and extrusion giant has not been treated well since being unbundled from food giant Tongaat Hulett more than 10 years ago. The profit performance, in parts, has been patchy, and has unfortunately disguised what is a world-class aluminium operation that produces high-quality product.
The brash utterances from US president Donald Trump about aluminium tariffs have not reinforced the already brittle market sentiment for Hulamin. Still, Hulamin pitches into some promising sweet spots in the beverages industry (which has a useful recycling attribute) and the automotive sector (with the growing electric or green car trend).
The company is tightly run, even if some market watchers think executive management is too conservative, and it is certainly capable of producing robust numbers in more favourable economic climes.
Verimark
This direct retailer has certainly endured its ups and downs — the latter usually triggered by a weak rand (which smacks the imported merchandise) or, less frequently, poor product selection. But over the past seven years, long-serving CEO Mike van Straaten has built a lean and mean operating structure that yields sizeable profits when the trading conditions are perfectly aligned.
Verimark has already indicated that headline earnings for the year to end-February will range between 29.5c/share and 34.3c/share, a performance that is likely to yield a generous dividend. If the company can show that it is capable of holding together another year of satisfactory growth in financial 2019, the share price might find decent traction.
Nu-World Holdings
This perennially profitable distributor of mainly electronic household goods is — like Bowler and CMH — a graduate of the class of 1987 new listings boom.
Nu-World has been boringly reliable over the decades, with strong cash flows underpinning a generous dividend policy. But the company’s most recent set of annual results showed that there is some vibrancy in the operations, and potential to grow profitably into select international markets.
The emergence of a significant equity holder in the form of Wild Rose Capital also adds an X-factor, remembering that the long-serving executives linked to the founding Goldberg family may soon be ready to bring fresh insight into the business.
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