Four small-caps offering value and growth

We’ve put small-cap stocks under the microscope in recent days, after asking a handful of Australian fund managers how they find the best-performing, most resilient companies in the segment. 

The participating managers have outlined their preference for backing companies with proven business models and strong cash flow, while avoiding the temptation to chase the next hot thing. In part three of the series, our managers put theory into practice by sharing a small cap company that meets their criteria. 

Given their sector agnostic approaches, the four companies put forward by the experts offer exposure to industries spanning cloud communications and online recruitment through to residential housing and appliances. 

Read on to learn about four companies that pass the filters of small-cap specialists Simon Conn, Dawn Kanneleas, Matthew Booker and Harley Grosser. 

Dialling-in to the cloud comms explosion

Simon Conn, Investors Mutual 

One company that we like is MNF Group (ASX: MNF), the market leader in Australia in the provision of cloud-based communications software and services. MNF has been growing in recent years from the structural growth of voice communications over internet-based software-defined networks. This trend has recently accelerated due to the forced move to remote working during the COVID pandemic, with MNF’s products enabling the voice communications component embedded within many of the popular online communications platforms and apps such as Zoom, Microsoft and Twilio.

We anticipate MNF’s recent strong growth to continue as voice networks increasingly migrate to the cloud. Further, MNF has recently established a Singapore operation and is looking to replicate their product offering in that country which, if successful, they could extend to other countries in the region.

MNF is attractively valued on a PE of 20-times and a yield of 2.8%, has a net cash balance sheet and trades at a material discount to global peers.

A growth story dressed as deep value

Matthew Booker, Spheria Asset Management

Mortgage Choice (ASX: MOC) has been through a major reset in the last two years but is now on the cusp of a serious break out. Banks are terrible at selling mortgages, further they know it and are ripping out branch networks for cost-driven earnings growth.

As a result, broker share of mortgages has risen to ~60% and will continue to rise as consumers vote with their feet as the service and advice from a mortgage broker beats an unmotivated bank worker any day. We believe Australia moves towards 80% broker share in the long term, similar to the UK experience, which means a one-third expansion in MOC’s addressable market. Within this greater pie we believe MOC is on the verge of increasing its market share as its revamped franchisee economics attract new recruits and replaces unproductive ones that had seen it stagnate somewhat.

In addition, the company has heavily invested in technology and digitisation of the business which mean more leads and higher conversion. With the company trading on a PE of only 10-times with net cash of $6 million and a sublime dividend yield of more than 8% (fully franked) that is underpinned by a $54 billion loan book, we believe this a compelling growth story dressed up in a deep value outfit – an equation that is simply nirvana to us as the largest shareholder.

Wake up and smell the profits

Dawn Kanelleas, First Sentier Investors 

A stock we believe has outstanding growth and value prospects is Breville (ASX: BRG), an engineering-led innovator in the small domestic appliance space (perhaps best known for its coffee machines) that is not afraid to cannibalise itself with a strong pipeline of constantly evolving products. Breville’s targeted investment towards new product development, a scalable supply chain and effective marketing has led to phenomenal growth to date in the US and Europe, with enormous potential to increase their penetration in these and other markets.

Sales of Breville in the US are more than 2.5-times those in Australia, and the sales into Europe and the UK are also beginning to dwarf those of Australia. In this market, Breville is growing at high-single digits – and even double-digits this year. In the US, where the company is better established in its “premiumisation” push, its penetration is only 19% on a like-for-like basis adjusted for GDP per capita.

And in Europe – where retailers regularly sell-out of Breville product – penetration is less than 10%. In this region, as in the US, they’re also “premiumised” – and they’re as innovative and as high growth as any platform like Altium, Nuix, or other tech names. So, you’ve got to think a little bit differently than “I’m only going into software.” Because you’ve got to identify all the businesses who are successful in those other spaces.

Tackling the titans of recruitment

Harley Grosser, Capital H Management

My pick is Schrole Group (ASX:SCL), which provides an online recruitment platform to international schools – like a combination of Seek and LinkedIn.

US venture capital firm Andreeson Horowitz provides a good primer on what the firm does – particularly around the concept of “Deep Job Platforms”. And if it’s good enough for a16z, it’s good enough for us.

The company generates around US$4 million of annual recurring revenue each year and are approaching cash flow positive, which is solid enough for its US$25 million market cap, but we think they’re on the verge of a step-change in growth for two reasons:

1. Earlier this year it signed a company-making partnership with Faria Education, an 800lb gorilla in the international school market, and Faria acquired 20% of SCL. They’ve spent the months since building out the tech platform, but this will formally launch in 1H21. 

Faria has 3,000 international schools, roughly 10-times that of SCL today, and from early next year Schrole’s product will provide the entire recruitment piece to Faria’s ManageBac platform and have direct access to those 3,000 schools, with Faria well-incentivised to drive uptake.

2. COVID was a shake-up for international schools and their legacy recruitment processes. The old way of doing things was face to face recruitment fairs and networking, made impossible by lockdowns. COVID forced everyone to try new methods online, reflected in SCL’s rising ACV (to US$8k), 49% increase in candidate and 115% increase in school registrations for iFairs (online recruitment networks) in November this year.

It is worth noting that SCL’s product makes sound economic sense to international schools. It pays for itself after roughly 3 hires (vs the recruitment fee model) and when SCL have run free trials in the past their conversion rates have been near 100%.

The tricky part has been getting schools to change their old habits. To try something new.

COVID was the catalyst that forced the industry to change and adopt new, entirely online recruitment processes.

As economies open up and international schools resume normality SCL is well positioned for growth as they approach the formal launch of their partnership with Faria.

Any acceleration in sales is likely to push the share price a lot higher and compared to peers, SCL is trading far too cheaply. 

Stay up to date

Don't forget to follow my profile to stay up to date with my latest wires. You can access parts one and two of this small-cap collection via the links below:

1. How to find resilient, high-performing small caps
2. Fairytale growth isn't just a tech story