Most of the attention on the JSE is focused on the large, blue chip companies in the Top 40. However, the small- and mid-cap stocks that are often overlooked can provide compelling investment opportunities.
Speaking at The Money Expo on Saturday, Alpha Wealth fund manager Keith McLachlan pointed out that there are two major reasons why it makes sense for investors to consider including small caps in their portfolios. The first, is the potential growth that they offer.
“The small-cap sector on the JSE, as it does globally, outperforms the bigger, slowing growing big caps or clue chip sector over the long term,” McLachlan said. “It is more volatile, but that outperformance over years and years compounds to be quite serious.”
Secondly, there are diversification benefits to looking outside of the large cap universe.
“There are some really great small-cap companies with exposures and business models that do not exist in the Top 40,” McLachlan pointed out. “By investing in them you are adding diversification to your portfolio.”
Together with the head of investments at The Robert Group, Devin Schutte, and Vestact portfolio manager, Bright Khumalo, McLachlan presented The Money Expo with some great small-cap ideas for their portfolios:
Private education group ADvTECH owns and runs institutions under brands including Crawford, Abbotts College, Varsity College and Vega.
“The industry of private schooling in South Africa is a rising tide,” Khumalo said. “There are 13 million school goers in the country, but private schooling contributes only 5% to 6% if that. The demand is much higher. If you look at developed countries, about one third of all school goers go to private schools.”
ADvTECH is particularly attractive because of its high margins, and current attractive valuations.
Schutte argued that the company providing raise boring and drilling solutions offers a unique investment proposition.
“They have world class technology and incredible IP in terms of their horizontal raise bore rigs,” he said. “They are able to drill holes two to three times bigger than anyone else on the planet, and are doing it quicker and cheaper than their competitors.”
“Its fleet is about 3 times the size of its nearest global competitor,” he pointed out. “That is a massive competitive advantage.”
Trading on a price-to-earnings multiple of just seven times, the company also looks extremely good value at the moment.
Not only does Blue Label have a very profitable distribution business, where it sells virtual products such as airtime and electricity, but it has just finalised a deal to buy 45% of Cell C. McLachlan believes that the synergies this will create in an industry that is increasingly less dependent on capital spending makes this a very interesting prospect.
If Blue Label can make it work, it could be set for significant growth.
“I think Cell C is an under-appreciated asset,” he said. “Do you know of any single successful telco that is a small cap in this world? Successful telcos are blue chip companies, and Blue label has a real chance of making that transition in my mind.”
The asset-backed lender specialises in proving funding to taxi owners through its SA Taxi division. Despite some local governments introducing more efficient bus services, Khumalo believes this remains an attractive industry.
“Taxis are still very efficient,” he pointed out. “There are many of them and you don’t have to wait for more than 5 minutes to catch one. You can wait much longer than that for a bus, and sometimes it never comes. You can question whether the industry is growing, but it’s resilient. SA taxi funds one thirds of the country’s taxis and that is increasing.”
As McLachlan put it, the company that provides integrated record and information management is “the only way to go long on bureaucracy”. It provides solutions for the recording, storing and destroying of records, both in hard copy and digitally.
“They have been doing this for a long time, and are a big player,” said Schutte. “Add in an incredibly good dividend yield at around 6%, and that you’re paying a fair value of around 14 times earnings, and it looks like a great investment.”
Khumalo believes that the investment company run by deep value investors Piet Viljoen, Jan van Niekerk and Theunis de Bruyn is well placed to be successful in the current environment.
“Where markets are now, they can find businesses ripe for the picking,” Khumalo said. “And they have the research ability, patience, acumen and stomach to say this is not a bad business, it’s just going through a slump and I can buy it while sentiment is low and have the opportunity to sell later at a much higher price.”
The niche supply chain management company has very successfully entered international markets, where the opportunity is massive. It has a huge runway for the use of its technology solutions.
“It is not a South African business, but increasingly a global one and it’s very scalable,” said McLachlan. “It could be the Capitec of global logistics, and you can buy it on a single digit multiple.”
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