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[SMALL CAPS] Some early results from reporting season

By Stephen Wood

REA Group, one of the fund's longer term holdings (and one of the small number of midcaps owned by the fund) reported its half year result over the past week. It showed a continuation of the strong growth in revenue and profits of recent years. As we have opined in the past, this is in our view one of the best business franchises in the country and has most of the appealing characteristics we look for in a business. 

The internet real-estate classified business is a very “capital-lite” business model. It has very high returns on invested capital (ROIC) – currently around 60% pa, good operating leverage with improving margins – i.e. earnings growing faster than revenues (in 1H 2016 revenues +20%, net profits +28%) and continues to be in a growth sector with ongoing migration of real-estate advertising from print to on-line. Only around $550m of real-estate advertising is online today in Australia out of a total property advertising market of about $1.3b. The number one operator in these online marketplaces typically extracts a disproportionate share of the industry profits and becomes very hard to dislodge by new entrants (high barriers to entry). 

Realestate.com.au (REA's main Australian real-estate classified portal) still has a lot of room to grow within the market with about $400m of annualised online residential revenues although the mix has changed over the past 2-3 years from mostly subscription to now a model where agents are incentivised to upsell premium ads to their vendor clients. This shift will potentially increase the cyclicality of the business (a negative) but also reduces the pushback to price increases as real-estate agents are no longer paying for the ads themselves but instead passing on the cost to vendors who are less price sensitive (a positive). As an example the cost of the highest level "Premiere" ad is still typically less than 0.3% of the average property value in Sydney so is not yet at a level where one might see much pushback from many vendors.

The company has also now built up a strong international portfolio of equivalent online real-estate businesses. It has recently completed the purchase of IPP giving it a strong Asian footprint plus it continues to grow its position in Europe and has a 20% equity stake in the no. 2 US operator, move.com.

Gateway Lifestyle (GTY) was one of the 4 IPOs that we participated in during 2015. The company IPO'd in mid 2015 at a price of $2.00. The others being Link (LNK), Baby Bunting (BBN) and Eclipsx (ECX). ASCF still has a position in Link and Gateway while Microcaps currently has an exposure to Baby Bunting. Gateway is a provider of manufactured housing estates but unlike Ingenia (INA) it does not also deliver shorter term holiday style accommodation in the same estates. The models are different but aim to deliver the same outcome for retirees. To extract capital from the family home, provide value accommodation and still enable the retiree some access to the pension depending on the assets remaining after the family home has been sold.

The first meaningful result from an IPO naturally comes with higher risk. In this case however we were very pleased with Gateways maiden interim result and the company appears to be on track to deliver on its FY16 prospectus forecasts. EDITDA and statutory NPAT reported were $19.7m and $18.3m respectively. These numbers were 43% and 44% of the FY16 prospectus targets. In addition the company appears to have solid momentum in sales, opening up new estates, and very pleasingly 11 acquisitions of new properties. In these volatile markets the Gateway share price has accordingly been flat relative to the small ordinaries over the last month but very pleasingly has, after reporting for the first meaningful time, outperformed by over 40%.

Published on: Friday, February 12, 2016

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