The gap between star small-cap stocks and the rest widened this year. Hot tech stocks soared to sky-high valuations and many more limped along.
Index investing, algorithmic trading and the changing structure of the broking/funds-management industry are disrupting mid-, small- and micro-cap investing – and creating greater pricing inefficiencies and opportunity in this part of the market.
Stocks that are not a member of a key share market index (i.e. the majority of small- and micro-caps) are missing out on index buying through Exchange Traded Funds. At the same time, fewer stockbroking analysts and specialist small-cap fund managers means less coverage.
Small-cap investing is always about company selection rather than top-down trends or themes. My preference for 2020 is identifying beaten-up small-caps trading at almost Global Financial Crisis-like valuations and badly out of favour.
That contrarian approach suits experienced investors who understand the risks of buying out-of-favour small-caps and allocating only a tiny fraction of their portfolio to these opportunities. Conservative investors should invest through funds or stick to large-cap stocks.
Here are 9 small-cap ideas for 2020:
1. Janison Education Group (JAN)
The market has been all over information technology, fintech and some biotech stocks. Less so education technology even through “edtech” has terrific long-term growth prospects.
Janison provides digital learning and assessment solutions. Janison Learning sells customised online learning platforms for companies and helps them manage compliance obligations around training. The Janison Insights business helps organisations centralise and digitise assessments.
Janison has rallied from 28 cents in August 2019 when I first identified it for The Switzer Report to 46 cents. It can go further in 2020 as the market focuses on rising demand for learning and assessment technology – and another half a billion school and university students globally by 2025.
2. G8 Education (GEM)
The childcare-centre operator can be a volatile stock. I became bullish on G8 Education’s prospects in mid-2018, believing the market had become too bearish on fears of childcare centre oversupply.
I turned bearish on G8 Education in early 2019 after its share price soared. The market hammered the stock when it downgraded occupancy rates.G8 Education has slumped from a 52-week high of $3.63 to $1.87, but the latest wave of selling looks overdone.
Granted, improvement in childcare-centre occupancy rates after Federal government reforms is taking longer than expected, but the industry still has good long-term growth prospects, amid population growth, higher female workforce participation and government childcare subsidies.
3. Myer Holdings (MYR)
I doubt the department store will make many “top small-caps for 2020” lists. A weak economy, consumers saving money from tax and interest rates cuts rather than spending it, and a department-store model that is dying a slow death is an awful backdrop for Myer.
Revenue headwinds for Myer will strengthen in 2020, but much can still be done to shrink floor space, introduce private-label brands, grow digital sales and sharpen the store formats and product mixes. Myer finally has the management team to fix things.
At 49 cents, Myer is on a FY21 Price Earnings (PE) ratio of about 10 times on consensus forecasts. Much bad news is priced into the stock, meaning even the slightest bit of good news – evident in the latest result – could fuel a slow re-rating.
4. Japara Healthcare (JHC)
Japara, Regis Healthcare and Estia Health have been hammered by negative market sentiment towards their sector during the Aged Care Royal Commission. Investors were right to be wary given the horror stories that emerged and the experience of bank stocks in the lead-up, during and after the Banking Royal Commission.
For all the short-term problems, the Aged Cared Royal Commission should bring much-needed structural change and reform to the sector and improve market confidence in it.
Also, smaller players might struggle with the extra costs from reforms, enhancing the competitive position of Japara and other larger players. Or be taken over by larger listed aged-care companies or private-equity operators that can see value in the sector.
Aged care is an obvious long-term growth industry given the ageing population and undersupply of aged-care beds available for the growing number of people aged 85 plus. That should underpin higher occupancy rates for better-quality aged-care centres.
Japara has slumped from a 52-week high of $1.55 to $1.00. It traded around $3 a few years ago. Watch the larger aged-care stocks attract more investor attention in 2020 as the market becomes more confident as the fallout from the Aged Care Royal Commission eases.
5. Praemium (PPS)
Shares in the investment-platform provider have fallen from a 52-week high of 79 cents to 48 cents, having slumped below 40 cents in June. A disappointing first-half result for the period ending December 31, 2018 sparked a sell-off that lingered for much of this year.
The company’s Australian operations performed solidly but the international operations underwhelmed. I believe the market over-reacted to the news.
Praemium rallied in October after announcing record quarterly gross inflows and record funds under administration.
Investment platforms are great businesses when they get traction – witness the success of Netwealth Group and Hub24 over the past few years. The market has shown far less interest in Praemium by comparison, despite growth in funds under administration.
6. Ardent Leisure Group (ALG)
I nominated the troubled hospitality group for this report in September 2019 at 95 cents a share and again earlier this month at $1.19. At the risk of repetition, I include Ardent in this list because it is one of the more interesting, albeit riskier, small-cap ideas for 2020.
To recap, Ardent shares plunged after the 2016 accident at Dreamworld that killed four people. Attendance at Dreamworld and other Gold Coast theme parks suffered as concerns grew about the maintenance and safety of rides, and consumers chose other entertainment.
The business was a mess, but looks simpler now after the sale of its marinas and bowling-centre assets, and the increased focus on Main Event, its US family entertainment chain.
The turnaround in Ardent theme parks could take longer than expected and I have concerns about those assets as kids show more interest in playing games on mobile devices than yet another visit to a theme park, some of which looked tired.
But at $1.17, the market is underestimating the turnaround potential in Ardent’s broader business. Morningstar values Ardent at $2 a share. I’m not as bullish, but believe it should show much-needed improvement in 2020.
7. Pact Group Holdings (PGH)
Pact fell from a 52-week high of $4.10 to as low as $2.08 as higher energy and raw-material costs crimped profit margins, market share fell and a stretched balance sheet that took the speciality packaging company closer to breaching its debt covenants spooked the market.
Pact said in its FY19 result that its balance-sheet capacity has improved and that near-term refinancing risks have reduced. Debt is still too high, but Pact should be able to refinance its debt over 2022-23, avoiding a dilutive equity raise.
Clearly, Pact is a higher-risk turnaround play that suits experienced investors. However, its valuation, at $2.76 a share, might be anticipating too much bad news: the stock is on a forecast Price Earnings (PE) ratio of about 11 times on consensus analyst forecasts.
8. IVE Group (IGL)
The communications group provides creative marketing services, digital campaigns, print production services, personalised marketing and data analytics.
IVE grew revenue by 4.1% to $724.4 million in FY19 and underlying earnings (EBITDA) rose almost 10% to $80.4 million. The dividend rose and the Return on Funds Employed was 17%.
IVE said it had several “meaningful” new client wins and contract extensions, and suffered no client losses. Improved cross-selling of IVE services also boosted revenue and is the key to a re-rating in the company’s share price.
The company has grown revenue and earnings steadily for the past four years and outlined a positive outlook in the FY19 result.
I wrote positively about IVE for this report on November at $2.05 a share. The stock has since rallied to $2.31 and can make steady gains in 2020.
9. Beston Global Food Company (BFC)
The micro-cap food company has had a tough time after seeking a minimum $100 million in an Initial Public Offering (IPO) on ASX in 2015. Beston’s 35-cent issued share hit 56 cents in early 2016, then steadily drifted lower, touching 8 cents this month.
The key to Beston is capital-management initiatives that free up capital to invest in new technology at its plants and boost margins and sales.
Like all thinly traded micro-caps, Beston is a higher-risk proposition that suits experienced investors. The share market is paying almost no attention to Beston’s turnaround prospects, but it should be considered speculative and a “roughie” on this list.
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 consider its appropriateness and accuracy 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 12 December 2019.