Beating low expectations: small cap reporting season wrap
· 40% of companies exceeded expectations with the retail sector a particular stand out
· Strong cost containment in the industrial sector with cost pressures in the mining sector
· Inbound M&A activities, increased dividends, and share buybacks are trends observed
Despite low expectations going into reporting season, in the end there was a lot to be positive about this cycle. Based on the analysis we've done at LSN, we had about 40% of all companies reporting beating our own expectations or consensus market expectations. This is slightly higher than historical standards.
Balance sheets are generally healthy, backed up by considerable inbound M&A over recent months. We are expecting the M&A activity to continue as companies look to compliment organic growth with acquired growth. Boards have been increasing dividends and there has been an uptick in share buybacks.
In terms of sectors, retail was clearly a standout. Despite low expectations forged over the past year, many of the higher quality retailers bucked the low expectation and have been winning market share. This has been supported by tight management of the cost base as well as solid consumer spending on quality goods, which has helped companies like JB Hi-Fi and Premier Investments through this period. Online retailers including Kogan and Temple & Webster also benefited from this trend.
At a broader level, top line revenue growth performed well and was supported by full employment, wage growth and savings despite the low expectations leading into the reporting season.
Another theme of this reporting season was cost containment, particularly in the industrial and retail sectors. The combination of post covid cost accountability, high inflation easing and the prospect of lower interest rates in 2024 drove management teams to focus on containing their expenses in the face of increasing cost pressures. This was a vast improvement on the cost pressures that were observed at the FY23 results just 6 months ago and is a positive trend going into 2024.
However, this containment was not enjoyed by all sectors. The mining sector remains subject to significant cost pressure, particularly in some of the small and mid-cap mining companies that have been impacted by low staff availability or rising input costs. The ability for mining companies to absorb these price pressures is something LSN remains focussed on.
Stocks that delivered
EQT Holdings are considered a quality operator across a range of Trustee services. They are the market leader in their sector with high barriers to entry. They have been able to leverage the growth of the financial services market with a strong set of numbers delivered in 1H24, and this has been reflected in a recent rally for the stock. Valuation remains attractive and we see plenty on upside from current levels.
Capitol Health is a diagnostic and radiology business in the healthcare services sector that was significantly impacted by Covid, staffing shortages and wage rises. However, the company has over 80% of their business linked to government funding and is an essential service. With demand is starting to recover, a large proportion of their clients are referred from GPs, which in turn, is starting to pick up after a challenging period.
oOh!Media is an outdoor advertising provider which is taking significant amount of share from traditional media formats such as free to air radio and television, as well as newspaper and other print media. The company is experiencing strong growth across its portfolio of assets that include road and rail transit (bus and train), with a recovery in airports. Another source of revenue growth is in the internal office building space which has high margins and is recovering post COVID.
Pacific Smiles, which is currently under takeover, delivered an outstanding result with exceptional cash flow. The company has wound back its store rollout of dental clinics which includes greenfield sites. The takeover offer was recently increased to $1.75 from $1.40 based on the growth potential and trajectory of the business. We think $1.75 still undervalues the growth potential of the business.
Stocks that disappointed
Hansen Technologies despite delivering a solid set of numbers, the stock was affected by the short-term losses stemming from their acquisition of Power cloud in Germany. However, in the longer term the business has excellent prospects for growth and the new acquisition is expected to generate earnings over the next 12 to 18 months.
Lifestyle Communities also disappointed with settlements in the current half falling well short of expectations, despite raising capital in the period. At the same time, they are rolling out a significant proportion of growth in their affordable land community businesses. We consider this reporting cycle for the sector as a pinch point, or a timing issue. In the longer term the housing shortage isn't going to disappear, and we see the opportunity for enormous earnings growth for that business over the next few years.