Investors munch on minnows

By Shoeshine

Friday 9th July 2004

So-called micro-cap firms often conjure up images of shoestring companies with faint earnings prospects, scant assets and lots of debt.

It's little wonder then that few analysts cover the sector, particularly in this country where such companies typically have a market capitalisation of less than $50 million.

But big is not always beautiful.

With the NZAX market gaining momentum, a handful of smaller companies are starting to get noticed and their well-kept secrets are being spilled.

The recent successful float of Just Water International has raised the temperature further and some institutional researchers are now taking a more active interest in the sector.

Broking house ABN Amro has just released an equity handbook for the NZAX, profiling the 17 companies so far listed.

This has advantages and disadvantages for investors.

On the one hand they have more information to base their investment on.

The perception that small companies are risky has in the past often led to a venture capital type of approach, where investors buy into a "high-risk" venture that may or may not work.

Access to more information will allow them to also find a safety margin that companies with a high yield and a low P/E provide. In other words, small companies operating like big companies.

On the other hand, some stocks that don't get much attention or are generally overlooked can trade at significant discounts to the value of their assets or potential earnings.

The under-researched area of the market provides the shrewd investor with untapped value stories. So shouting to the market doesn't necessarily benefit everyone.

Furthermore, micro-caps can offer the potential for rapid growth in emerging market niches offering an investor handsome returns if the venture works.

Another negative is that shares of the smallest companies are inherently tightly held, particularly the best companies, so investors will find it increasingly difficult to get their hands on stock.

ABN Amro also notes the earnings visibility for NZAX stocks are generally low, making it difficult to accurately forecast future growth.

This is because of the size of the companies, the types of industries involved and management inexperience in interacting with the market.

Apart from a few early teething problems the NZAX has been a strong performer in its short duration.

Most companies have reported a lift in trading since inception on the NZAX in November last year and they are also experiencing a lift in value.

A six-month review shows the companies on the AX board have realised an average price gain of 14.8% since listing.

The number of monthly trades has increased from just over 150 in November to 604 in May, mainly due to the number of new listings but also reflecting an increased interest in the sector.

Companies such as Seeka Kiwifruit Industries and Comvita New Zealand have outperformed the market significantly.

Seeka has been around for ages, yet until recently it has largely been unheard of outside Te Puke.

The company reported a record profit for 2004, with total revenue rising 19% to $51 million.

That gave it the ability to lift its full-year dividend to 18c a share, giving the stock a gross yield of 5.8%.

Seeka is the only vehicle for investors to get exposure to the production and supply side of the kiwifruit industry, which has one of the few fruit still in demand for growing overseas.

The company operates alongside a number of other firms but a strong management team and good track record mean it is well positioned to strengthen its market share through acquisition.

Comvita has also been around for a long time and is now establishing export markets into Australia, the UK and Asia.

It essentially makes health products out of honey, including dietary supplements and skin care products, and has oodles of medical research behind it.

The big news for investors is the progress the company is making in Asia, where it generates 45% of its sales. With a solid exporting business already established, the company is changing its strategy to concentrate on international marketing of natural health products and health solutions.

The wine industry is another area showing good potential.

Although there is a lot of concern about the sector because of excess supply around the world, the two companies on the NZAX appear to be in quite good heart.

The NZ Wine Company, with its Grove Mill brand priced to the premium market in the UK, should be able to gain international shelf space for its other up and coming varieties.

The company owns 67ha of vineyards, leases another 30 and has contract growers with 120ha, all in Marlborough.

A bumper season this year should help the company with its target of doubling its production to 2000 tonnes by 2007.

Oyster Bay is another Marlborough-based wine company benefiting from the rising demand for New Zealand Sauvignon Blanc and is sitting on valuable wine-growing land.

In total, Oyster Bay represents about 8% of current vineyard plantings in the region, from which it harvests more than 3000 tonnes of grapes.

One company creating a lot of interest is Christchurch-based Smith City Group.

With 53 million shares on issue the stock is more liquid than other AX companies, despite its two major shareholders holding 25%.

While its trading locations are exclusively in the South Island, the company is expected to expand north soon and is on the lookout for acquisitions.

In a sector where many of its high profile peers have struggled, Smith City has recorded consistent sales growth during the past five years.

Its share price has climbed 33% since January 2003 making its holders the envy of their beleaguered counterparts on the main board.

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