Just to mix it up a bit, here are some thoughts about potential pair trades in the small- and mid-cap space (i.e. long a stock and short another to make one market neutral, but profiting from one stock’s out performance of the other).
A classic play is guessing that one stock is undervalued and growing faster than another higher rated, but slower growing stock in the same sector, therefore you are betting that one will essentially gain market share and re-rate upwards versus the other.
In a way, long a small cap (like Capitec) and short a blue chip (like ABSA) is a classic play against the former’s likely superior growth rate.
Anyway, theory aside, some disclaimers:
Firstly, I do not short stocks as a general rule, so my use of the word “short” below needs to not be taken literally.
Secondly, some of these long positions I hold in my Small Cap Fund, so I am bias/putting my money where my mouth is.
Finally, here are the thoughts…
Long AdaptIT/Short EOH
Then there is the significant acquisition that AdaptIT just concluded that will likely add more momentum to its growth trajectory, and suddenly as a relative play ADI is looking a lot hotter than EOH.
Long Rolfes/Short Omnia
While Omnia is on a PE of 10.6x, Rolfes is on one of only 8.4x. Just to add to this, per my models, Omnia is likely to see its Heps recover by c.20% in FY 16E, yet Rolfes (largely due to its game changing Bragan acquisition) looks set to deliver equivalent Heps growth of 60%.
So, not only does Rolfes have better industry exposure and its share is on a lower valuation, but it has better near-term prospects regarding growth.
Long Balwin Properties/Short Calgro M3
Similar structured business models in different parts of the same market: building homes.
Except, Calgro M3 is on a 17.3x PE and Balwin Properties is on an equivalent PE of c.8.5x.
Long CSG Holdings/Short Adcorp
What if I told you that you could buy a business with double the margins, less debt, more cash and at a lower multiple than an equivalent business?
Both are labour broking businesses in South Africa, but while Adcorp has bulked up its scale and pushed internationally, CSG has built out its services into related industries like cleaning, catering and industrial services.
While Adcorp’s international trajectory looks more glamorous, it has a problem: none of its returns to scale have ever found its way to its bottom line. They are all gobbled up long before they reach there…. See the CAGR of revenues, profits and Heps for 11 years ended FY 15 here:
Now compare Adcorp against CSG’s returns in the below graph:
Personally, CSG just looks like a better business.
Also, Adcorp has just put out soft results and its share price looks unlikely to re-rate any time soon for any reason. Yet, CSG is currently trading under a cautionary announcement (probably a material acquisition) and could well re-rate on any positive conclusion of this announcement.
Finally, there is the fact that Adcorp’s script is trading on a PE of 9.1x, while CSG (as the “better business”) is trading on a 8.5x PE.
So, CSG is “better”, more profitable and cheaper than Adcorp.
The above are just some interesting ideas, but like I said, I don’t think you should short any of these shares. You should probably not buy any either. In fact, rather just don’t do anything until you have done your own research.
This article was first published on SmallCaps.co.za here, and republished with permission.