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The Experts

Mark Tobin
+ About Mark Tobin

Driven and hard-working finance professional with over 10 years international experience. Valuable industry experience gained in back/middle office roles across Europe before relocating to Sydney, Australia in 2010. I then began my first Australian role at Wilson Asset Management. In 2012, I was offered the opportunity to move into an Equity Analyst role at Wilson. I have thoroughly enjoyed this change and am passionate about this area of finance. I have recently joined the team at Independent Investment Research. I focus on ASX listed nano caps and micro cap stocks. As these are stocks you generally won't hear about from other market commentators, fund managers, analysts, advisors or your broker. This is a truly under researched part of the market.

How to invest in a bear market

Monday, February 12, 2018

Well after a turbulent week in the markets, some people are asking if this is the beginning of a new bear market. Some might say, are we even out of the GFC bear market? Considering the ASX has not yet eclipsed its previous all-time high, which is in stark contrast to US & UK markets. 

While it’s too early to tell at this stage if this is a major downturn in equity markets, it’s probably a good time to think about how to invest if, and when, the next bear market or big equity market fall comes around. Whether it’s right now or next month or at some other point in the future, it will come, so best to be prepared. 


I have a watch list of what I think are really great stocks. These are stocks where the underlying business has good margins, high returns on equity, good cash flow, low debt and solid management teams.  

However, as that list of qualities suggests, these companies would be what every investor is looking for. Hence, they generally trade at high P/E valuations or in layman’s terms are generally very expensive, most of the time. 

So, I am waiting for somewhere around the nadir (you will never pick the absolute bottom) of the next bear market to hopefully pick them up at a more reasonable price, or better yet, at bargain basement prices.

Just like in the heady days of bull markets, when investor hubris can drive stocks to extreme valuations, in bear markets, despairing investors can cause extreme valuations on the opposite end of the spectrum just as readily. By way of example, let’s look at WAM Capital Limited in Feb 2009. I have simplified the numbers somewhat and ignored tax assets. 

Listed Equity Portfolio: $34.7m

Cash at Bank: $82.3m

Short Portfolio: $(0.4)m

Total Assets: $116.6m

Market Capitalisation $82m based on an average share price of $0.80 around the end of Feb 2009. 

In other words, you were getting the entire WAM Capital equity portfolio for free or in other words the “market” thought WAM’s entire equity portfolio was worth zero! 

WAM’s top 3 holdings per its Feb 2009 NTA were as follows

Reckon Limited (RKN)

Melbourne IT Limited (MLB)

McMillan Shakespeare (MMS) 

These are stocks younger investors who weren’t around in 2009 will even recognise today. 

A good few others from that NTA announcement are still around. Bear in mind that this was equity portfolio assembled by portfolio managers Geoff Wilson AO and Matthew Kidman at the time. Yet the “market” implied or communicated to investors via WAM’s share price that all their stocks picks would go bankrupt and WAM’s investors would be left with nothing from this equity portfolio. 

While good operating businesses are top of my bear market shopping list, I will also be keeping an eye on the LIC sector more broadly for bargains like WAM in 2009. Especially given the growth in the LIC sector in the past few years. 


Now, it’s great having a shopping list, but you also need the cash to buy these bargains at that moment in time. As is always the case, this is the exact time you don’t have cash. So, I already have a small portion of capital tucked away and earmarked to draw on for exactly these types of purchases in the next bear market. 

Having it set aside now with a designated future purpose also helps from a mental or psychological stand point. As many investors find investing in bear markets mentally very difficult due the high levels of uncertainty and the negative hype generated by the media. By committing the cash to bear market investing now I believe you will be better equipped mentally at least, to deploy it at the time. 

This capital is only making small returns in the bank currently. But the point is, I want to be able to put that capital to work at the time I need it. Could it be earning more by being invested in the market or somewhere else? Of course, it could. However, I am willing to take that opportunity cost so as to have dry powder ready when required. Hopefully the marginal opportunity cost lost now will be more than offset by the long-term gains from purchasing things like WAM in Feb 09 in the next bear market. This is where I am backing myself to find and execute on some bargains to some extent. Easier said then done but I guess in life you have to back yourself at some point. 


A bear market and probably a couple will happen during your investing lifetime. So, it’s better to make some plans for it now instead of trying to figure out what to do when the market (or your portfolio) is in the middle of being mauled by the bear. 

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How to Prepare for Reporting Season

Friday, February 02, 2018

Well another Ashes summer has come and gone and the ASX company results are about to start coming hot off the presses faster than runs off Steve Smith’s bat!

Reporting season, whether in February or August, is a great time to be an investor because we all get to find out if we're right or wrong on particular holdings in our portfolios. The other ten months of the year we are merely speculating. So, on that note I thought it would be good to suggest some things to watch out for when analysing results and how to prepare for the onslaught of data. 

Preparation is key

Before reporting season even starts try and confirm when exactly stocks in your portfolio are reporting and mark them all down in the calendar. This is tricky to do for microcaps but at least try and do it the best you can. In large cap stocks, results dates are announced well in advance or can be confirmed by the investor relations team well ahead of time generally pretty easily.

Go through each stock in your portfolio and pick out 3-5 key things you are looking for in the result. You want to be able to quickly scan the result and decide quickly has it hit the mark or not. This preparation is helpful if you happen to have a few results all coming through around the same time. By quickly scanning all three quickly, you can prioritise which one needs a more in depth look by virtue of the results deviating significantly from what you were expecting. Given that trading volumes are usually higher than average around results time you want to keep time free to take advantage of this volume either for buying or selling as the case maybe. The quick scan method can help free up precious trading time. This is particularly precious time when trading in microcaps. 

Market Expectations

The first thing to look for when results come out is has the result met market expectations? This could be in the form of specific management/board guidance around certain metrics, revenue, EBITDA, EPS etc. Or it could be the sum of where the sell side analysts covering the stock expect the key metrics in the results to come in at. Obviously not hitting the mark is a poor result and coming in above the mark is a good result and share price reactions are usually in tandem with which ever scenario eventuates. 

However, in these heady days, especially, in high PE/high growth stocks even meeting expectations and delivering big growth numbers may not be enough. This is one of the key themes I will be watching in the microcap space this February. Especially given microcaps have run hard this year. 

Quality of the Result  

You often hear analysts say that a result was “high quality” even though the company may have just reported earnings that have come in just above market expectations. So, what does this actually mean? Essentially, it means that the company delivered its results with no real one offs that made it look better than it actually was. For example, a company may have delivered 20% EPS growth as per market expectations but only because they had a lower than normal tax rate due to some off-tax benefit like the Trump Tax cuts for example. So yes, on a pure mathematical basis, EPS grew by 20% but if you had used the prior year tax rate it would have come in lower.

Other things to look out for that generate low quality results are gains on the one-off sale of non-core assets, government grants not generally received yearly, prior year comparative numbers which contain a lot of negative one offs which sets the base artificially low for year on year comparisons. Moral of the story make sure you are comparing apples with apples when looking at comparisons to prior periods. Try and factor out the one-off items as much as possible so you can get down to the cleanest set of core operational numbers as you can, both for the current period and the comparative period. 

Deep Dive

With close to 2,000 microcaps it is nearly impossible to stay across the story in every stock. During reporting season, I will quickly look at as many microcap results as I can. However, with stocks I am very interested in possibly reporting at the same time, I can’t generally give every result the focus I want to right there and then.  So, particular stocks and results which, on the face of it seem quite interesting I simply add their ASX code to my “Deep Dive” list with a little note or two on why the result looked interesting. 

In other words, this is a list of stocks where I will review the results in more detail post reporting season in March or September. I may then after reviewing the result in more depth during this period try and chat to management, build a working valuation model and think about is it really interesting or not. 


The main take away I guess like most things in life is that, preparation, planning and hard work eventually lead you to where you want to be or what you want. In this case its finding profitable investment opportunities. 

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Microcap managers continue to outperform ETF’s

Wednesday, January 31, 2018

We are half way through FY18 and microcap and small caps indexes have continued where they left off in Q1, and then some. Once again, microcaps significantly outperformed large caps. The S&P/ASX All Ordinaries Accumulation Index returned as you will recall a minuscule 1.0% for the Q1FY18. In stark contrast, the S&P/ASX Emerging Companies Index posted a robust 8.9% return for the Q1FY18 quarter.  The Q2FY18 score card reads as follows the S&P/ASX All Ordinaries Accumulation Index returned a respectable 8,2%. The S&P/ASX Emerging Companies Index however continued to power ahead with a hefty 15,3% return for the quarter.

Stand Out Sectors

The returns from microcaps is not totally unexpected given that the top sectors in the S&P/ASX Emerging Companies Index, constituting just over 43% of the index are material and information technology. The sector weightings of these two sectors are much more pronounced in the S&P/ASX Emerging Companies Index compared to the S&P/ASX All Ordinaries Accumulation Index or the S&P/ASX 200 Accumulation Index. In the large cap indexes the financial sector dominates driven by the big 4 banks.

Both the materials and information technology sectors have been very much in vogue right across the market in the last 6 months. Hence, the performance of these sectors has been driving index and manager returns alike.

Fund Closures and New Additions

The second quarter of FY18 saw plenty of action in LIC microcap space. Towards the end of the quarter we saw the successful IPO listing of the Spheria Emerging Companies LIC (SEC:ASX) on the boards. We have added the LIC to our universe and will report on its performance going forward. We will also follow with interest the performance of this vehicle with the near identical managed fund vehicle offered by the same investment manager as an interesting case study over time.

Also, just before Christmas we saw Contango Microcap LIC (CTN:ASX) change its name to the NAOS Small Cap Opportunities (NSC:ASX) owing to CTN shareholders voting for NAOS Asset Management to take over as the investment manager of the LIC. This brings our LIC universe to 9. Interestingly, 7 out of the 9 Microcap & Small Cap Focused LIC’s were launched in the last 3 years.

On the managed fund side, we are also adding two new names to our fund universe.

The Peak Opportunities Fund and The Prime Value Emerging Opportunities Fund

The Peak Opportunities Fund is a particularly interesting in that it offers a style of investing not available in the microcap space currently. At least not as a fully dedicated strategy or mandate. I would best describe it as special situations investing or strategy. The fund participates in microcap ipo’s, placements, underwriting of rights issues, reverse takeovers and seeks to enter and exit these types of corporate actions at a profit. The fund celebrated its 1 year birthday at the end of 2017 and recorded a 39% return. An impressive first year.

The Prime Value Emerging Opportunities Fund is an active, high conviction and benchmark unaware vehicle. It seeks to invest in companies with sound balance sheets, good management and with solid growth prospects. The fund has just celebrated its 3 year birthday in October and has returned 14.1% annualised per annum since inception

Stand Out Manager Performances

Stand out performances from the active managers in the quarter came from microcap vehicles managed by OC Funds Management, Wilson Asset Management and Acorn Capital. With Acorn’s LIC The Acorn Capital Investment Fund (ACQ:ASX) taking the blue ribbon registering a return of 19.4% for the quarter.

Most managers did manage to log double digit returns for the quarter which is not surprising given the strong performance of the index and the general equity market. However, the managers which lagged both the index and their peers for the quarter were The Boat Fund, MicroEquities and Naos. Now, my usual caveat applies, no investor should judge a manager on a single quarter performance no matter how positive or negative the performance was.

The table provided gives both the 3 month and 3 year returns for fund managers who have such track records. This gives some perspective on their longer-term performance and serves as a reminder to guard against reading too much into short term performance.

A passing glance, down through the list of the 3 year returns in the table below shows the majority of fund managers have outperformed both large and small cap benchmarks.

Microcap outperformance versus large caps and ETF’s

Over a 3-year time horizon, active microcap managers by and large have an excellent track record of delivering alpha to their investors They have also delivered superior returns versus that of the mainstream index funds and ETF’s. This evidence should be food for thought in investor’s overall asset allocation decision.

Stand out performers over 3 years continue to be Cyan, Perpetual and BT.

The Curious Case of the Microcap Benchmark

One of the most curious things about looking at the universe of microcaps mangers is the disproportionate use of the S&P/ASX Small Ordinaries Accumulation Index as the benchmark for the funds and performance fees calculations. No fewer than 15 of the 28 vehicles in our universe use this index as its benchmark.

Now some of the funds in our universe could be classed as small cap funds as they straddle the line in terms of the market caps of their holdings.  This makes classification a bit of grey area. However, if we take the Perpetual Pure Microcap Fund for example you would think that it would use the S&P/ASX Emerging Companies Index as it benchmark given the name of the fund and its investment strategy and mandate? Yet, it uses the S&P/ASX Small Ordinaries Accumulation Index for its benchmark.

Indeed, just 2 funds in our universe actually use the S&P/ASX Emerging Companies Index as their benchmark.

Now, I am not saying one benchmark is better than the other, but it is curious that so many funds use a benchmark which in name at least is perhaps not the most relevant or appropriate for the funds strategy and mandate. This is perhaps something investors current or prospective can query with the relevant managers to getter better understanding as to why one was selected over the other. 

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SRG Limited: could it be a Leighton’s 2.0?

Wednesday, December 20, 2017

SRG Limited (SRG) is a diversified mining, services and construction business that is starting to feel the uptick in both the resources sector and the Australian government infrastructure build programme. SRG is not unlike Tempo Australia mentioned in my last article which also looks set to benefit from the current macro environment. Similar to Tempo the board and senior management of SRG are replete with experience at much larger businesses, most notably in the case of SRG, with Leighton’s in one guise or another before Leighton’s was subsumed into behemoth that is CIMIC Group.

The company’s main commercial divisions are civil, mining and construction all about 30% of revenue. The bulk of its revenue is currently from Australia but part of core strategy is to grow international revenue which it has achieved some early success. It also has developed some of its own patented products and while only small part of revenue currently it is higher margin business compared to its traditional business. The products business is very complimentary to the projects SRG works on, as SRG can mandate using their own products as part of the tender which is nice point of difference to have from its competitors. Products can also be sold into the industry more broadly which opens up a nice additional revenue stream when they might lose the construction tender but still get the products sale for example as part of the winning bidder completing the job.

However, the most interesting development with SRG is its 50/50 JV with Tralyor Brothers, its American JV partner. Tralyor Brothers is a very similar business to SRG with Traylor Brothers bringing the networks, contacts and licensing in the US market to the JV. SRG brings its specialist dam engineering IP and knowledge to the partnership. Infrastructure in the USA is in a state of critical disrepair and in need of major maintenance and upgrading. Even as far back as 2 years ago John Oliver did a piece on infrastructure for his current affairs show Last Week Tonight. Since then we have the Flint water crisis which made international headlines and overall no real improvement in the situation. So, the day of reckoning is getting closer and closer and government can’t just simply keep kicking the can down the road any more. Even if a full-blown crisis like Flint or indeed a specific major dam incident is needed to get or find the money to pay for what needs to be done. Dams are a particular niche area where the JV is seeking to focus and capitalize on. The JV is only in its infancy and upfront costs are being incurred to get it setup as you would imagine. These setup costs should be by and large digested in the next 12 months. At that point, we should start see the benefits flow back to into profit line of SRG.

SRG currently trades at around $1.66 giving it a market cap of circa $110mil and I estimate an FY18 NPAT of about $8m. It has net cash on the balance sheet of $15mil which gives you an ex cash P/E of roughly 12 times for FY18. SRG also paid out a fully franked dividend of 7c last year and if they do the same again this year it puts SRG on a yield of approximately 4%. Based on some recent research I have seen, only 14% of companies with a market cap under $250mil market cap actually pay a dividend. Thus, it is relatively difficult compared to say an ASX 200 portfolio to get income into a microcap portfolio. So, where we can take a dividend and franking we will, provided the investment case still stacks up overall, I don’t believe in investing purely for yield.

SRG may not be particularly cheap at this current juncture but the JV gives it a nice option to further increase its offshore revenue. The JV has the potential to be an excellent source of long term incremental work in which the JV is seeking to make a claim in the US market as the leader in dam infrastructure. If we then align the US JV option with the backdrop of a broadly improving macro environment and the company guiding to improved revenue and margins for FY18 for its core business in Australia, a solid balance sheet and a healthy dividend one could say you are “getting paid to wait” on the JV option. Taking all of this in totality to me reflects a situation for SRG that appears interesting. 

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Mining services picking up tempo

Monday, December 11, 2017

Riding on the coattails

As noted in my previous article, keeping an eye on what other professional active fund managers are doing can be a great source of new idea’s. So, when I saw not one but two recent substantial shareholder notices lodged by both Lanyon Asset Management and Spheria Asset Management in a stock that had been on my watchlist for while, well, it piqued my interest even further. Both fund management teams are well regarded and one can assume that they wouldn’t have committed their investors capital unless they thought the stock was worth more than where it is currently trading today. That is not to say their respective investment thesis’s will play out successfully and both them, and their investors will exit with a healthy profit but it’s a flag, that should make one sit up and take notice.

Change of Tempo

The stock in question is Tempo Australia Limited (TPP) and it has been on my watchlist for about a year. Given its large cash backing of $22mil (now circa $15 mil after a recent acquisition) which meant cash on its balance sheet had been hovering around 50% of its total market cap for the last year or so. The company provides maintenance and construction services (roughly split 50:50 currently) to energy, resources, industrial and commercial clients. TPP has specific skills in providing structural mechanical piping, telecoms and data comms and electrical services for existing assets or new capital projects. The company has been heavily involved in the Gorgon LNG project for the last few years but that work is now tapering off substantially. However, while the company has been quietly going about managing the business through this difficult transition phase with the vast ramp down in its work from Gorgon LNG. TPP has been simultaneously doing some acquisitions to diversify its business and enhance TPP’s product and service offerings to allow it to target a broader range of customers.

Getting in new blood

As alluded to above TPP has made a number of acquisitions in recent years to try and diversify both its product offering and customer/industry sector base. This was a concerted strategy to avoid being so dependent on its tier 1 energy and resources customers in effort to de-risk its overall business. Its acquisitions of Corelogic and more recently KP Electric have allowed it to build out its telecoms and electrical divisions respectively. The most recent acquisition (July 17) of KP Electric looks on the face of it to be a solid acquisition. It gives TPP instantaneous national coverage in the electrical maintenance space and access to whole list of tier 1 commercial and industrial customers to which possible cross selling opportunities may present themselves from other divisions over time. We must nevertheless be cautious as all acquisitions are fraught with a plethora of associated risks. We won’t get a clear line of sight of the KP Electric acquisition impact on TPP’s results until they report their full year numbers in Feb 18. TPP are December year end company as opposed to a June year end. This result will gives us a better indication of the quality the of the KP Electric acquisition. Yet at a purchase price that implies a 2.5 times EBITDA multiple KP Electric looks good value and is earnings accretive immediately to TPP.

Board and management aligned

The annual report should also give us some indication of how management see the business tracking in 2018. Given the revival of the resources sector and the ramp up in government backed infrastructure spending there should be a decent cyclical/industry tailwind behind TPP. I would also advise reading in the annual report the career history of the current board which have prior management experiences at much larger outfits such as UGL, Clough, Woodside and Monadelphous. This breath of experience and industry networks and contacts are significant assets in TPP’s efforts to grow the company to at least a mid-tier player in the industry. The board and senior management also hold circa 36% of the share register so they are well aligned with minority shareholders. This is something I allows look for when looking at microcap stocks. Looking for a pickup in Tempo in 2018 I am not expecting a profit for the 2017 full year results coming up in Jan/Feb 2018 given the Gorgon LNG roll off. However, with hopefully a positive, possibly cautiously optimistic outlook statement in the annual report from management coupled with the full year impact of recent acquisitions 2018, cyclical/industry tailwinds behind it, $15mil in unrestricted cash still sitting on its balance sheet and respected fund managers taking decent positions in the company, to me TPP at this point looks interesting.

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A tale of two microcaps

Thursday, November 30, 2017

By Mark Tobin
When a 52-week low still looks expensive

Keeping an eye on stocks hitting 52-week lows and 52-week highs can be a good way to find new ideas for further research. For example, SMSF administrator Class1 Limited (CL1:ASX) has fallen about 35% in the last few months from a high of $3.65 to about $2.33. Despite this big pull back, it is still trading around a PE of 30 times, depending on what you think they will earn this year. That’s a pretty hefty multiple and for me it still seems expensive for what you are buying so it’s not interesting to me at this point, but on the watchlist, for further pullbacks in the share price. CL1 is a prime example of where a stock hitting 52-week lows can still be expensive. Although like beauty, what is good value, is in the eye of the beholder.
When a 52 week high looks reasonable value

On the flip side Energy One Limited (EOL:ASX), which is hitting 52-week highs at $0.70, is up 75% in the last 6 months which has been a great run. However even at current prices it only has market capitalisation of $14.2million and to me still looks reasonable value at these levels and interesting.
EOL’s main business is providing energy trading and associated software products and services to the electricity and gas markets primarily in Australia. It also has electricity customers in New Zealand, Singapore and the Philippines. Its products and services are primarily used by wholesale energy traders who are working in the wholesale energy market and trying to line up their supply and demand needs at the best possible price depending on what side of the deal they are on. This is niche product for a niche market but EOL have been quietly building out their offering over the last few years through product, geographic and customer diversification via organic growth and some complimentary acquisitions.
Market dominance in Australia

EOL’s software now accounts for 40% of all gas traded in the Australian market. The company has plans to launch complimentary products and services so that they can offer a single vendor solution for their customers’ gas trading needs. One such product in development is a capacity trading product, which is a major focus area for the industry, given the current energy market landscape. In the electricity market EOL’s customers dispatch over 50% of all electricity on the East Coast of Australia. Given it’s a software business the majority of EOL’s revenue is recurring via license fees or subscription services. A decent chunk of revenue does still come from consulting and project implementations. However, recent acquisitions mean they are targeting 70% of revenue to be recurring in nature by the end of FY18.
Spreading its wings internationally

The company has, over the last 12 months, started marketing and researching customers in European markets and concluded one small deal in the UK. They are partnering with local firms to enter these markets and believe that their current suite of products can work in these markets subject to some customization for local market nuances. The company has committed to spending $500,000 on this expansion project over the next 12 to 18 months but has stated that this cost will only be fully expended subject to positive feedback and certain milestones being achieved. In other words, they are not going in all guns blazing but taking a softly-softly approach. The recent deal in the UK supports the basic premise of the strategy and gives me confidence that their product can actually work in market. As we all know, the Australian corporate landscape is littered with monumental capital destruction stories from Australian corporates’ (US shale gas anyone or coal in Mozambique) big bold bets when foraying into international markets. So, the softly-softly approach is to be commended.
Getting set looking easier

EOL doesn’t have the greatest liquidity in the world but it is pleasing they are taking active steps to try and improve this in response to shareholders. The board initiated a dividend reinvestment plan (DRP) on the most recent dividend and Bell Potter fully underwrote the DRP and placed 100% of the shortfall. The board has also indicated that if the right acquisition comes along they will also consider coming to market for fresh equity. So hopefully in time it will become more liquid which should be to the benefit of all shareholders, current and perspective.
Solid track record

EOL has been profitable for the last five years and paid a final unfranked dividend of 1c fully franked this year. The company currently has a net debt position of about $1.5 million due to two acquisitions made in FY17. The two acquisitions in FY17 helped to build out both their product offering and diversify their customer base. The full year impact of the two new acquisitions, coupled with some organic growth, has seen the company guide to earnings before interest, tax, depreciation and amortization (EBITDA) of $2.5 million for FY18. This would be a circa 75% increase on the FY17 EBITDA number and put EOL on an earnings valuation/EBITDA multiple of just over six times. I estimate an underlying net profit after tax (NPAT) of approximately $1.2 million which would be an increase of 25% on the FY17 and put them on a PE of around 12 times for FY18, based on the current share price.
So, despite EOL trading at new 52-week highs and having had a big run, at these prices it still looks interesting.

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Threat Protect Australia Limited securing its future

Friday, October 20, 2017

By Mark Tobin
As noted in my previous article following a rollup acquisition strategy or seeking to become one of a particular industry’s consolidators in which a company operates in can be a lucrative strategy. Threat Protect Australia Limited (TPS:ASX) is seeking to be one of the industry consolidators in the highly fragmented private security industry in Australia. The company estimates there are circa 6,500 businesses nationally generating approximately $6.3 billion in annual revenues. So, it has a large addressable market in which to execute this consolidation strategy.
TPS offers all your standard security services for your home - alarms, remote monitoring, access control and responding to an alarm if you’re away etc. TPS also provides the aforementioned services to business customers along with your standard on site security personnel and some more high-end services such as private personal protection (read bodyguards), risk assessments and audits and counter surveillance.
TPS currently operates its head office out of east Perth in WA. Through two recent east coast acquisitions and with its east coast monitoring centre in Kingsgrove south Sydney, TPS has set itself up nicely for a full national offering of its services.
TPS has furthermore recently announced that it has received the required permits and licenses to operate in VIC.
The company currently operates two main divisions:

  • Monitoring: Access control, CCTV, Alarm response, Motion Sensors etc;
  • Guarding: Onsite security personnel, events security, risk consultancy etc.

Both divisions in FY17 contributed roughly equally to TPS’s revenue but the monitoring division contributed circa 90% of group earnings before interest tax depreciation and amortisation (EBITDA) and expanded its divisional EBITDA margin from 30% in FY16 to 56% in FY17. The increasing scale and profitability of the monitoring division drove the overall company to report a healthy net before tax profit of $1.2 million for FY17 up from a loss in previous year.
The monitoring division is the focus of the rollup strategy. TPS is seeking to leverage its largely fixed cost control rooms in Perth and Sydney through the acquisition of monitored security client bases. Acquisition of monitored security client bases come from its relationships with 480 resellers of its own monitoring service around Australia or from acquiring entire security businesses where the acquired business can provide other strategic benefits or capabilities to the overall group.
The current control room utilization/capacity indicated by the company sits at circa 30%, thus providing plenty of head room for TPS to grow into. The company recently announced it had bought back some monitored security client bases from resellers for a cost of just over $600,000. The conversion from a reseller account to a direct account delivers a roughly three times uplift to revenue for very minimal additional costs to TPS, given surplus capacity at its monitoring base according to the company’s announcement. TPS currently has 6000 lines/accounts it monitors directly out of total monitoring base of 37,000. Thus, the bulk it is monitoring services is conducted on behalf of its reseller base.
The company has a market cap of circa $20 million and it has traded around the same levels for the last 12 months despite improving business performance and execution of its strategy. This flat share price performance maybe due in part to its relatively debt high levels. The company has net debt of $6 million which is quiet high given its market cap. I am usually averse to debt in microcaps companies but as they say the devil is in the detail. The bulk of the debt is owed to Melbourne based wealth management company First Samuel rather than one of the big four banks or more standard commercial lenders. The debt is owed via a convertible note, the total of which is $9 million with a little over 50% of the note facility drawn down to date. First Samuel is also TPS’s largest shareholder with 8.26% of the share register currently excluding the convertible note. Now this debt situation is not your normal run of the mill debt financing. Given the fact that the largest shareholder is providing the majority of the debt funding (NAB are also providing some funding) which is specifically linked to funding TPS’s acquisition strategy, it makes the high debt levels more acceptable. The nature of TPS’s business means it is highly cash generative, so TPS should be able to service their debt requirements through operational cashflows. TPS traded cashflow positive in FY17, another important milestone in its evolution.
FY18 looks set to be a pivotal year for TPS. It will firstly have the benefit in terms of revenues and EBITDA contributions from the full year impact of its recent Apollo Security acquisition, which was a sizeable one in the context of TPS’s current business. Secondly, its recent licensing in Vic allows TPS to look at that market for acquisitions and/or expansion, which will enhance its national presence and footprint. Having a national footprint opens the opportunity to tender for much larger corporate contracts which demand a national presence as these corporate clients themselves have a national footprint of sites or assets that need security. Overall TPS appears to be operating in an attractive space and to date at least appears to be executing its clearly defined strategy effectively. Overall to me it’s interesting.

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HRL Holdings Limited: Another ALS in the making?

Friday, October 06, 2017

By Mark Tobin

As noted in a previous article, one of the ways to discover new ideas for further research is to look at stocks hitting new 52-week lows, or 52-week highs for that matter. One such stock hitting 52-week lows, which has come to my attention, is HRL Holdings (HRL:AX). The company operates primarily in the environmental services industry, providing inspection and testing services. It primarily focuses on hazardous environmental services (think things like asbestos) and geotechnical services in Australia and New Zealand.

While a microcap, it shares a lot of similar attributes to ALS Limited (ALQ:AX) or global behemoths like Bureau Veritas SA (4BV:GR) and SGS (SGSN:VX) in terms of the products and services it provides to its customers. The industry is split between very large players (as mentioned above) and very small private players with no real mid-tier player. HRL is seeking to be that mid-tier player through an acquisition based rollup strategy and an organic rollout strategy of existing brands to new geographic locations.

The company operates in three interrelated market verticals with various brands:

  • Hazardous Material Sampling & Testing (Octief & Precise Consulting)
  • Geotechincial Serives (Morrisons Geotechnic)
  • Specialist Hazardous Monitoring Software (Octfolio)

The company is in addition looking to enter new testing verticals most likely through acquisition of testing companies or laboratories in the air, water and food industries. This is in addition to expanding the number of testing services in their current business units. It has a strong focus cross selling services and synergies between business units as new acquisitions are integrated into the group. A key example of this was the Octfolio acquisition where HRL was one of its largest customers pre-acquisition. Thus, providing HRL with the opportunity to offer a more vertically integrated service to its clients and to cross sell HRL’s other products and services to Octfolio's database of clients.

The company achieved profitability in FY17, and while minimal, it does mark a key milestone for the business. Management has also indicated that corporate costs/head office costs are now largely in place and thus should not need to rise to any great degree as the business grows.

FY18 will see the full year contributions from the two most recent acquisitions of Morrison’s and Octfolio which should significantly boast revenues and improve profitability compared to FY17. This is before any other acquisitions that could be brought into the group in FY18 as part of HRL’s stated growth strategy. Some synergies and cost savings can also be expected to be realized from the two acquisitions, aiding FY18 margins.

The company has announced some notable contract wins in recent months including a 3-year service agreement with the Queensland Department of Transport & Main Roads. A smaller 6-month services contract with the Northern Territory Department of Housing which will contribute to the FY18 results. The company has furthermore been given approved contractor status with South32.

Obviously, there are two keys risks one must be coginsant of in relation to HRL’s strategy. The first is integration risk as all these acquisitions come with disparate systems and corporate cultures. These acquisitions somehow have to be carefully integrated into the HRL setup in order to realise synergies and cost benefits and be accretive to HRL’s earnings.

The second key risk is the board and management’s ability to allocate capital effectively i.e. not pay too much for businesses and ensure their due diligence avoids bringing a problem child into the group through legacy issues from the acquisition. To date, at least these two risks appear to have been satisfactorily managed by HRL.

The company currently has no geographic presence in the NSW or VIC markets and I would expect future acquisitions or organic expansion of existing brands into these geographic markets in order to give them a more national footprint in Australia. HRL currently has a very good presence in QLD and NZ. It also has a presence in the NT, ACT and WA.

As a previous mentor of mine once said to me, “the best time to own a business involved in a rollup strategy is the early days”. Rollups can be very successful and very profitable to investors in the early days. Just pull up some charts of G8 Education Ltd (GEM:AX) or Greencross Ltd (GXL:AX) in the first few years of their rollup strategy to see why being in at the start can be very rewarding for shareholders.

HRL have reached the profitability milestone and to date have shown they can both allocate capital effectively and integrate acquisition into the group. The management and board own just over 40% of the business so they are very aligned with external shareholder to make the business work and execute on the stated strategy. HRL has a market capitalisation of circa $19m, hitting 52-week lows despite improving business performance with an outlook for improved revenues and earnings in FY18. To me it’s interesting. 

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7 factors to look for in microcap investing

Friday, September 22, 2017

By Mark Tobin

With well over 2000 stocks outside the ASX 200, how does anyone go about systemically filtering down to a group of microcap stocks worthy of further due diligence and research? Here we look at 7 ways to screen the field.

1. Market cap below $300mil

Most people consider under $300mil to be a microcap stock but different funds use different benchmarks or cutoff points. Some may take $500mil as the cutoff or for others, it’s any stock outside the ASX 200 or ASX 300. However, if we take the $300mil for now that leaves you with circa 950 stocks with which to look at, a circa 50% reduction already on the 2000.

One thing to consider here, especially with new listings under $300mil, is should this company be coming to the boards now or at all? Is the business mature/developed enough for public markets? Or would they be better off being funded through private equity or venture capital at this stage of their development? Just because a business can list doesn’t mean it should. Or this is the correct phase in its evolution to list.

2. Management and board

Unlike the big end of town, microcap management is critical. However, assessing management and the board is a highly subjective process. Some possible key questions investors need to ask themselves are:

  • Can this team execute on the strategy?
  • The business idea might be great on paper but can they translate this into viable, successful business?
  • Can the CEO take the company forward from the private space to the listed space for example?
  • Can the CEO actually manage a business double or triple the current size?

An entrepreneurial CEO might be great in the early days getting the business off the ground but can they run a larger more established business which requires systems and procedures in order for it to run smoothly. Ideally, you are looking for what Ian Cassel from Microcap Club would describe as “intelligent fanatics”. Some Australian examples of CEO’s I would suggest that you could classify as intelligent fanatics are Rene Sugo of MNF Group or Jamie Pherous of Corporate Travel Management.

Also look at the board. Do you think they will hold the CEO to account? What skills/networks/experience are they bringing to assist the CEO in executing the company’s strategy? Is the board just stacked with friends of the CEO? If the CEO is also the Chair and largest shareholder how is board independence maintained and minority interests protected? A good quality board can be a huge asset to both shareholders and the CEO. 

3. Capital structure

How are the management and board aligned with shareholders? What is the incentive structure for them to execute on the strategy? In microcaps, a large majority of the CEO’s are perhaps founders or large shareholders which is great for alignment of interests with outside shareholders. However, one must be careful how these large shareholders treat small/minority shareholders. You need to be careful of the CEO/Founder or large shareholders treating the company as “a private company that just happens to be listed” as the old saying goes. This is where they disregard the interests of minority or independent shareholders.

It is also wise to be careful when a reverse/backdoor listing takes place, as legacy shareholders who previously invested in the company use the new listing as an escape route out of the old vehicle. This can weigh on the share price until all the old shareholders have exited and the shareholder register normalizes again.

4. Revenue in the front door

The next thing to look at is: are these companies generating any revenues at all? Typical companies that don't are junior resource companies, some tech stocks, drug developers, biotech and medical device stocks. I am not saying money can’t be made in pre-revenue stocks but the risks are higher and I would rather stick to a company with something coming through the front door on a monthly basis. I want to avoid “business idea risk”. This links back to point 1 and perhaps these types of companies are better aligned to venture capital and private equity investors.

5. Making a buck

Next, are they generating a profit? Here it can be demonstrating positive operating cashflow or having a positive EBITDA. Ideally, I would like the stock to be showing a solid NPAT and a track record of delivering consistent NPAT. I, do, however, give a little leeway here if it is clear the company will achieve profitability in the next 12 months. To me at least that’s an acceptable timeframe. However, there must be a clear line of sight to this point via a combination of strong business growth, and the company’s financials.

Given a lot of microcaps report quarterly via Appendix 4D announcements you can track cash flows relatively well and make some reasonable projections about the future based on the cashflow run rate. A lot of companies also provide a supplementary information on business growth and strategy execution. It is important to make sure business growth and the strategy remains on track. Even small hiccups can have big impacts. Appendix 4D’s are some of the most crucial announcements to look out for from microcap companies as their businesses are generally growing much faster than larger companies. Thus, cash inflows and outflows can be changing rapidly.

6. Cash is king

In a perfect world, I want to see no debt on the balance sheet. If there is debt on the balance sheet I generally avoid companies where net debt to equity is greater than 50%. High debt and microcaps are never a good mix. Having a well-funded balance sheet allows the company to deploy cash to grow the company via organic or acquisitive growth. It also allows them the chance to raise debt at a later date if required since they are not currently burdened by it. Cash on the balance sheet also avoids the need to raise equity unnecessarily and possibly at a deeply discounted price. 

7. Relight the Fire

A stock can look on the cusp of taking off for years but if there is nothing that is going to make the general market sit up and take notice then it’s worth a rethink. Or if the company has no sustainable competitive advantage, larger players can simply compete them out of the market or new entrants can easily replicate their offering, the company will never experience sustained growth and profitability and will forever remain small. In other words, more of the same won’t do. A catalyst to change the perceived market view can come in many guises, a new CEO revitalizing the business, expansions into new markets or new products and services, acquisitions, even turning profitable after many years of losses can all be a spark to set a fire under the share price potentially.

Obviously, this is only meant to narrow the field. You then need to study the form of each of runners still left a lot more closely. However, this should leave you with a decent collection of quality microcaps upon which you can conduct some further due diligence and hopefully lead to some new stocks in your portfolio.

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