Buy Hold Sell: 5 hot small caps on a high

The five stocks in today’s episode have appreciated by an impressive 243% on average over the last 12 months. Returns like this are usually divisive, with investors on both sides of the trade declaring them either structural winners, or overpriced hype stocks. High prices, high expectations, but with them, the chance of high returns.

Will the prices crash like Blackmores? Or are they set for years of outsized returns like CSL?

Tune in to this week’s Buy Hold Sell to hear opinions from Arden Jennings, Co-Portfolio Manager at Ausbil Investment Management, and Robert Miller, Portfolio Manager at NAOS Asset Management 

James Marlay: Welcome to Buy Hold Sell. My name's James Marlay, and today we're talking about small caps that have been on a tear. The stocks we're talking about today are up over 200% collectively over the past 12 months. Now are they over hyped or are there still opportunities that are misunderstood?

Here to help me get through these stocks I've got Arden Jennings from Ausbil and Rob Miller from Naos. Let's get into it.

Arden, iSignthis, big multiple, big valuation, bit of controversy. Buy, hold or sell?

Arden Jennings: Yeah. I think it's probably a weak hold at best. Tempting to put it on a sell, but really haven't done enough work to be able to get that conviction yet. It's obviously been an absolute rollercoaster of a ride with plenty of press lately, with some corporate governance concerns flagged by Ownership Matters, and well publicised in the AFR. It's a little bit difficult to get on top of the revenue model, but look, I think there's plenty of risks there at the moment, but still need to do a bit more work there. So, you have to have a pretty high tolerance for risk to buy this. So at the moment, hold until we do some more work.

James Marlay: Okay. Rob, have you've got a view on Isignthis?

Rob Miller: Yeah, I do. I do. I think it's a sell. I think it's gone up more than five times this year. It's on an EV to EBITDA probably about a hundred times, which is very significant. The remuneration structure for me, I don't think that's best in terms of best practise for shareholders. It's linked to revenue, not EPS growth or anything tangible for shareholders. Obviously in the headlines for all the wrong reasons at the moment, so it's a sell.

James Marlay: Okay, next stop, Jumbo Interactive. There was a big Powerball last week. Got everyone talking, everyone excited about that. The stock’s actually been around for a long time. It's been on a tear lately. Buy, hold or sell?

Rob Miller: Yeah, it's a sell for us as well. From an ESG perspective we don't own this business, but I think it's an excellent business, but it's price and excellent valuation as well. It's got great ROE and financial metrics. Big opportunity overseas. I'm just questionable in terms of their execution risk and what's already priced in with the Tabcorp stuff. So, for us it's a sell.

James Marlay: Okay. Jumbo, have you got a view? Buy, hold or sell?

Arden Jennings: Yeah. Some good points there by Rob. I think it's a hold. We do hold still a very small portion of our holding within the fund. It's obviously been a fantastic winner and we've sold the majority of that position as the share price’s run, just to take profits. Obviously huge benefit from the change in the Powerball sequencing, but also the jackpot sizes with a very strong start to the quarter, particularly for FY20. So, in the very short term I think you can hold it a little longer, but yeah, agree, the valuation is starting to look stretched, so it's a hold for now.

James Marlay: Okay. EML Payments, it's grown off shore taking these cards for gift vouchers, all sorts of business like that. Buy, hold or sell?

Arden Jennings: Yeah, I think it's a buy. Plenty of structural growth drivers here, both with the reloadable cards and the opening up of the online gaming market in the U.S. So, there's plenty of momentum within the business, with the earnings. The next catalyst is the upcoming AGM, which we're looking for an earnings update. We own the stock, we think it's a buy, and that we should get earnings upgrades coming through.

James Marlay: Okay. Arden's bullish on EML. Rob, have you've got a view? Buy, hold or sell?

Rob Miller: Yeah, look, I agree there with Arden. For us, again, don't own it from an ESG perspective, but I think it's a great business. Great momentum coming out of FY19 into FY20. We've heard some great customer feedback that the product they offer in some of the areas is excellent. I think that's a great sign for the business going forward. For us, again, it just comes down to an ESG perspective, but also you've got a key catalyst coming up at the AGM, so I think it's a buy.

James Marlay: Yeah. Okay. Next stock is, I've been told it on a PE of over a thousand times, Phoslock. Buy, hold or sell?

Rob Miller: For us it's a sell as well. Water treatment company. I think you've got questionable relationships there in terms of the business visibility of where they're making their money. I also think obviously that valuation is very scary. It's a conceptual business, so you're investing on a concept rather than an underlying core business at the moment. So, for us, it's a sell.

James Marlay: Management has been flushing some stock into the market lately. Phoslock, buy, hold or sell?

Arden Jennings: Yeah, definitely a sell for us too. They're operating in a segment of the market that should be quite attractive, cleaning up polluted waterways through their environmental treatment products. But yeah, as you point out, there's been insider selling lately where they've trimmed their holdings. They've also got links with the Chinese state owned enterprises, through the business, so there is some key man risk there. So yeah, along with the valuation that looks very stretched, we think it's a sell.

James Marlay: Okay. If we're talking overhyped and misunderstood, there's probably no better poster child for this segment than Afterpay. It's had people wrong-footed pretty much the whole story. The stock on the day of recording has added $800 million of market cap today. Buy, hold or sell on Afterpay?

Arden Jennings: Yeah. Look, we think there's still more to go. So, it's a buy. Obviously it's been a phenomenal success story within Australia and it's going into the 100, no longer really a small cap for much longer. So yeah, it's been a phenomenal story, the net margins are going up. We believe that their guidance for FY22 of hitting that $20 billion of GTV can definitely be exceeded. And also, the frequency of the customer usage as customers mature using the product and get used to it, we think that can surprise on the upside. So yes, the valuation looks stretched, but these are really large addressable markets they're operating in. U.S. has strong momentum. They're into the U.K. Management have executed fantastically. So, the low hanging fruit's been picked, but we think there's probably more upside to buy.

James Marlay: Okay. Rob, it's been a hard one not to own. Buy, hold, or sell on Afterpay?

Rob Miller: It's a sell for us. Look, I agree with Arden's points on the U.S. market and the total addressable market being very, very large. Key thing for us, I think the easy money has been made in this sector. You've got competitors now. It's almost a me-too game out there now with this buy now, pay later situation in Australia. Also, I think the consumer lending regulatory environment is ripe for some sort of review of some sort. Obviously there's the Austrac thing going on at the moment, but there might be more to come. Who knows? I think that's risky. So, for us it's a sell.

James Marlay: Okay. Well divided opinions. That's why some of these stocks are on a tear, and some of them are being overlooked.

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