Investors chasing the next hot small company often assess management, the balance sheet, product and myriad financial metrics. Less considered is the company’s global footprint, capacity to expand rapidly offshore, and skill in entering new markets.
Expect to see more “born-global” small caps on the ASX in coming years as technology blurs market boundaries and as investors pay a higher valuation premium for companies that can scale their products or services into much larger offshore markets.
Consider the outstanding Domino’s Pizza Enterprises. About a quarter of its revenue is earned in Europe and 44% in Japan, after an astute investment in 2013. Or fast-growing law firm Slater & Gordon and its $1.2 billion acquisition last month of Quindell plc’s professional service division, making it the United Kingdom’s largest personal-injury law firm.
There are good reasons to prefer small caps with a global focus from the get go. Longer term, this market is too small for companies that focus on niche industries. After expanding rapidly in the domestic market, their growth plateaus, then stagnates. By the time they look overseas, it is too late.
A weakening Australian dollar also strengthens the case to buy born-global small caps. As commodity prices and the official cash rate fall this year , it’s a safe bet that the Australian dollar’s recent slide has further to run. In many instances, that means higher earnings for companies with offshore operations as profits are translated into Australian dollars.
Another benefit of owning born-global small caps is enhanced diversification. An Australian retailer with divisions in the United States, the UK, Asia and Australia, for example, has spread its operating risk much better than another with only domestic operations. That diversification and potential to grow in larger markets should lead to higher valuation premiums for such companies over time.
Below are six small-cap companies with interesting global growth prospects that are still reasonable value at current prices for long-term investors.
1. 3P Learning
The education-technology company, best known for its popular Mathletics, Reading Eggs, Spellodrome and IntoScience games, still trades below the $2.50 issue price from its 2014 IPO, despite exceeding prospectus forecasts and market expectations in its latest interim result.
About five million children, through 17,000 schools in more than 200 countries, use its products. More students in the UK now use Mathletics than in Australia and 3P has strong growth prospects in the US, a market where it is expected to make more investments or acquisitions. About a third of its revenue is earned offshore.
3P is a classic example of an Australian small cap that thought about global markets early in its lifecycle and will reap the rewards in the coming decade as it rolls its product suite into new markets. It looks better value than most tech stocks and is a high-quality, well-run business.
The maker of oral devices to treat sleep apnoea, a potentially life-threatening disease, is growing rapidly overseas. About 48% of revenue is earned in the US, 41% in the UK, and the rest in the Asia Pacific. SomnoMed offshore growth is quickening.
SomnoMed is not cheap, at least on domestic valuations, having rallied from a 52-week low of $1.37 to $2.75 after another strong half-year report. But it trades on a revenue multiple below similar medical-device companies in the US, despite having a rapidly expanding global footprint.
Sleep apnoea is a long-term growth market as higher rates of obesity cause more sleep disorders and breathing problems. Non-compliance with continuous airway pressure machines, made by ResMed and others, is also lifting demand for more comfortable oral devices.
3. IMF Bentham
As the market frets about the price tag of Slater & Gordon’s UK acquisition, it is easy to overlook the prospect of another law-related stock, litigation funder IMF Bentham. It funds class actions, a complex growth market with bigger barriers to entry than widely realised.
IMF Bentham now earns about half of its revenue in the giant US market, the global home of shareholder and consumer class actions.
It has plenty of growth options in the US. It opened a subsidiary in New York in 2011 and a Los Angeles office in 2013. Eighteen cases have been funded, of which five have been successful. Although competition for litigation funding is high, the company believes the US market knowledge of this type of specialist finance is at an early stage.
IMF Bentham has had more muted sharemarket gains this year than Slater & Gordon, Shine Corporate and booming intellectual property lawyer IPH, which listed last year. IPH’s growing footprint in Asia, which will need more intellectual property services, is also worth watching.
A Federal Court ruling in April that favoured ANZ Bank in the long-running bank-fees litigation brought by IMF Bentham has crunched the stock in recent weeks. An opportunity to buy the impressive litigation funder is emerging (there is some price support in its chart at $1.70).
4. Premier Investments
Solomon Lew-backed Premier Investment owns the Just Jeans, Jay Jays, Portmans, Jacqui E, Dotti and Peter Alexander retail chains. But it’s the outstanding Smiggle chain and its offshore growth prospects that have put a rocket under the share price.
Kids in Australia, and increasingly the UK, cannot get enough of its brightly coloured stationery. Premier’s target is 200 stores and revenue of $200 million in the UK over five years. UBS estimates Smiggle will have around 450 stores by FY25, possibly many more if its store rollout in Western Europe and Asia succeeds.
Premier has rallied from a 52-week low of $8.01 to $13.36 after its recent half-year result exceeded market expectations, and was among the better-quality profit reports. It is fully valued. Ten of 15 brokers have a hold or sell recommendation, and five a buy, consensus estimates show.
But Premier is definitely one to watch on any market pullback or correction. Few mid-cap companies have a product with as much offshore growth potential as Smiggle.
5. Retail Food Group
As the market cheers for Domino’s, one can underestimate the global prospects of its nearest listed rival, Retail Food Group. It owns the Donut King, Brumby’s Bakery, Michel’s Patisserie, bb’s café, Esquires, The Coffee Guy, Pizza Capers Gourmet Kitchen and Crust Gourmet Pizza, and last year bought the Gloria Jean’s and Di Bella Coffee chains.
Retail Food Group is rapidly transforming into a global franchisor and coffee wholesaler, thanks to transformative acquisitions such as Gloria Jean’s. It and the Cafe2U system give the company more than 500 international outlets.
About 10% of revenue in the latest half-year result was earned offshore, but watch that figure grow rapidly in coming years as Retail Food Group takes its popular franchise systems to China and western markets, and builds on its US footprint. Coffee and gourmet pizza are standout food businesses and likely to be in much higher demand as the number of middle-class consumers in Asia booms over a decade.
Retail Food Group has soared from a 52-week low of $3.67 to $6.90. Like some others on this list, it is best bought on price weakness during an inevitable market pullback.
The ship builder slumped after the GFC as demand for its military and commercial vessels sank. But it is recovering nicely from the 2012 lows amid strong contract wins from the US Navy, a rapidly growing order book, and greater global recognition of its product.
Austal has excellent growth prospects in the US and capacity to build a much bigger base of recurring earnings from maintenance and vessel upgrades. There was plenty to like about its latest contract win – two more Littoral Combat Ships for the US Navy and the option of a third.
The market expected a smaller order and the fact that the US Navy preferred Austal over larger rivals says a lot about its product and growth potential offshore. The company is trading near fair value after recent price gains and best bought on price weakness. But there is potential for a higher valuation multiple and further medium-term price gains as Austal wins contracts with other navies and builds it maintenance income.
– Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at April 9, 2015
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