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Five things we learned from the reporting season

By Richard Hemming, Editor at Under the Radar Report

The first thing... 

...to note about the recent profit numbers for the 12 months to 30 June 2015 is how tough conditions are at every level, big and small. Expectations were consistently downgraded and some of the big guns were hit hard. But amid this pain, we saw small caps hanging tough.

We learned that the market is now rewarding companies that had been trading on low valuations. Small and undervalued listed companies produced results that weren’t outstanding, but which investors were willing to overlook in the context of previously discounted expectations. This should continue while there is so much uncertainty surrounding economic conditions.

The winners included online jobs advertiser Seek and engineering contractors RCR Tomlinson and UGL. When you have a large business on a low valuation like UGL, by definition there is a lot of pain already in the price. These companies are not entitled to the same hope value as the market as a whole. But when there is uncertainty as occurred during the reporting season, companies such as this will be less affected.

Second,

...if you can find small listed companies (small caps) with offshore revenues or which have found a niche, the chances are that its stock will do very well.

A case in point is the organic baby formula provider Bellamy’s Australia. When we tipped it in March at $2.80 we thought it was expensive. It has recently gone above $8. Bellamy’s has managed to capitalise on what you could call the providence factor.

The company has benefited from the perceived quality of Australian branded product, as well as the trend towards organic. You could add that the market is still hungry for many Australian food producers, just look at almond producer Select Harvests and Capilano Honey, both of which have more than doubled in the past 12 months.

Third,

...discretionary retailers, in the main did very well. Companies which sell products that consumers want, rather than need, like furniture retailer Nick Scali, electronics goods retailers JB Hi-Fi and Harvey Norman and Premier Investments, were winners. Ex Treasurer Joe Hockey might claim credit that the government’s accelerated depreciation policy for small businesses has had some positive effect. There is also the fact that Australia’s population is climbing at above average rates, which also boosts consumer activity.

Fourth,

... banks prefer to raise capital than to cut their dividend. The big end of town have always been aware of (and in fact done more than anyone else to encourage) Australian investors’ addiction to franking credits. In the case of super funds, the benefits are much greater because the corporate tax rate is much higher than the super fund rate of 15 per cent, or even nil.

The banks could have maintained or improved their capital position by not paying a dividend, but instead they have chosen to raise capital.

The takeout here is to expect more capital raisings, which in turn means that it’s going to be ever harder for banks to outperform the market (which is in no small part because they are the market).

And lastly,

...the big miners are still out of favour. BHP Billiton remains below $23 and Rio Tinto is below $50. Value investors must be climbing into these companies, which we know aren’t going to go broke.

Under the Radar Report specialises in small caps www.undertheradarreport.com.au.

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