Small-cap standouts

Small listed companies have made the most of the strong economy. JOHN COOK looks at some of the sector’s winners … and losers.

Small companies have enjoyed buoyant times on the Australian Stock Exchange in recent years, outperforming the big end of town. The good times continue during the recent profit reporting season, as many small caps rode strong economic conditions in the six months to December 31 and posted excellent results. For others though, capacity constraints and cost problems meant they took a hit.

Even so, small caps have been a great investment in recent times. Over the past three years the small-cap index has risen by 104%, compared with 96% for the main index.

Here is a look at 10 small companies, winners and losers from the reporting season:

WINNER Regional Express Holdings: Otherwise known as REX, this regional airline has enjoyed a great run on the ASX recently. Decent economic conditions, an expansion of services to new country centres and, crucially, falling oil prices, has meant investors have piled into the stock. Shares in REX have doubled in value since last August.

A successful strategy for REX has been doing deals with local councils, who financially back its flights into new regional centres. It also wants to double the revenue it gets from charter services. Most of that business comes from executive travel in the resources sector, a market that has money to spend.

REX has also capped its fuel levy, in some cases below that of QantasLink – with which it competes on some routes. It also wants to have more flights on current routes, which will be helped by the arrival of new SAAB aircraft this year.

Shareholders were rewarded with excellent news in regards to the half-year profits. REX delivered an $11.5 million net profit, a 23.7% increase from the previous corresponding period.

WINNER APN Property Group: It can be difficult for a small property company to make an impression on the ASX. But APN has been a startling success, almost trebling its share price in the past couple of years.

It helps having experience. Some of APN’s management used to work for the big Melbourne property developer Bruno Grollo. In fact, the Grollo family has an investment in the company.

The company’s big strength is in property funds management. It has also set up some funds that invest in European shopping centres. One of these is already listed on the ASX, but other unlisted ventures have bought shopping centres in Austria and Poland. APN has found that retail assets are cheaper to buy than elsewhere.

APN recently announced a $10.4 million net profit before tax, compared with $5.9 million a year ago.

LOSER Geodynamics: Renewable energy is a popular market for investors at the moment, although solid profits could be a long time coming.

The company drills for “hot rocks” that are found kilometres underground and used to heat water for energy generation. Cold water is pumped into the ground, where it is superheated and returned to the surface to provide steam to power generators.

Geodynamics hopes to supply the national electricity grid with the power it produces. To help with that, Geodynamics recently bought a $32 million rig to help with drilling.

It has great prospects but its recent results were disappointing, as it made a net loss of almost $2.5 million. The future looks bright, however, and investors are interested: the company’s shares rose by more than 30% in February.

WINNER Adacel Technologies: The simulation and software engineering company increased its earnings before interest, tax, depreciation and amortisation (EBITDA) by an impressive 116% to $3.5 million in the first half of 2006-07.

Much of Adacel’s business comes from the North American market. It claims to be the market leader there in simulation, having signed deals with the US Air Force to supply simulation packages. It also provides software for air traffic control purposes, including in the US and Europe.

The company’s result was boosted by cost cutting and research and development assistance. Its shares have been up and down in recent months, but have outperformed the general market in the past week.

LOSER Fone Zone: The company may be Telstra’s biggest mobile phone reseller, but it blamed the telco for its big fall in profits. Its EBITDA was down 41% to $6 million.

Founders David McMahon and Maxine Horne started as an Optus reseller, and the business grew quickly by opening stores in shopping centres and other acquisitions. They switched to selling phones for Telstra in 1995.

But the Telstra link has been problematic this past half-year. Fone Zone blamed the profit fall on Telstra launching its NextG network with a limited range and supply of handsets.

Fone Zone was a market darling a couple of years ago, after a long stretch of fast growth. Its shares, however, have been falling of late because of the poor profit result and a previous surprise earnings downgrade. It does forecast improved EBITDA for the second half.

WINNER Tassal: Five years ago the Tasmanian salmon producer was in receivership with debts of $33 million. Since then the turnaround as been impressive, resulting in a net profit of $13.03 million for the six months to December. That figure was 117% more than a year ago.

Chief executive Mark Ryan says the company has great growth prospects until at least 2011. It is aiming to further increase the size of the salmon it grows and process them more efficiently.

The company has a new marketing plan to help maintain 20% domestic sales growth. It also wants to expand internationally, helped by new processing techniques that aim to increase survival rates among the fish it harvests.

LOSER PCH Group: The scaffolding and construction equipment company has disappointed of late. Its net profit was $2.5 million in the first half, compared to $11.3 million a year ago.

The 2005-06 financial year was better for PCH, which has operations in Australia, the United Arab Emirates and South-East Asia. Last year three big projects meant good news, but now timing lags between projects means less revenue.

Earnings growth is coming, however, and the strategy to undertake large amounts of capital expenditure in the first-half could pay off. Demand across most of its markets is increasing.

Its shares have surged recently, due to it considering a non-binding and conditional indicative takeover offer from London-listed company Cape. The discussions are preliminary at this stage.

WINNER Newhaven Hotels: The licensed hotel market is booming and some incredible money is being paid for pubs all round the country. One good, and small, performer in the market has been Newhaven.

A big winner for the company has been the performance of its hotel at Terrigal. After closing it for extensive refurbishments, it re-opened in July last year and has performed above expectations every since.

The company is following that strategy for its Bateau Bay Hotel. It was refurbished during the first-half and should have improved trading in the six months to June this year.

It posted a 60% rise in first-half net profit recently to $1.2 million. Revenue was almost 50% higher to $12 million. The company used to be known as Newhaven Stud Park, but licensed hotels have proven to be a better business

WINNER Centrebet International: Who would have thought tapping into the Norwegian online gambling market would be so lucrative? Centrebet takes online bets from all over the world, but Scandinavia is one of its best markets.

Sports betting is the company’s main business, but it also takes bets on events such as the Academy Awards, reality television shows and national or state elections.

Centrebet would like to expand its operations in Australia but has problems with some state regulations that make it difficult to advertise. Therefore, it is concentrating instead on gaining more of a foothold in European markets.

The company only listed last July and forecast a full-year profit of $11.6 million at the time. It is already more than halfway there, announcing a first-half net profit of $6.9 million.

LOSER McGuigan Simeon: The wine glut and the drought has cost the winemaker dearly; its profit fell by an alarming 90% for the half-year.

Even so, it still went ahead and bought South Australian brand Nepenthe Group for $25 million, funded by a private share placement among institutional investors. Management says the purchase will plug a gap in McGuigan’s product range.

Chairman David Clarke has told shareholders the industry is unlikely to return to its previous boom. Besides the grape glut and the drought, consumers are shifting towards cheaper wines which mean tighter profit margins.

Prices for 2007 are strengthening, however, and exports are strong, the industry clearly needs good rain, Clarke said, when presenting the annual results.

See 50 ways to improve profits: Growth resources > Better sales.