Three solid smaller companies for tough times

Management experience and a good track record make this trio of companies jump out.

An artist’s impression of Macquarie Telecom’s new $80m data centre in Sydney

Australia has led the world in capital raisings following the outbreak of COVID-19. Effectively, ASX-listed companies have been giving with one hand, paying dividends, and then taking with the other, requesting injections of equity.

If you’re wondering what I’m talking about, look no further than NAB: at the same time as paying a 30c interim dividend costing it almost $900m, the big bank asked shareholders for money to raise $3.5bn.

In data compiled by Bloomberg, ASX-listed companies raised close to $14bn in April alone, compared with the $US11.1bn ($17.2bn) in the US, a market almost 30 times the size.

Why has this happened and what can we learn from it? It’s all about dividends. Because tax policy encourages paying out the ­majority of earnings in dividends, balance sheets can be left dangerously exposed when something goes wrong. In March and April, that something was government shutdowns imposed in response to COVID-19.

One reason I fell in love with small caps is the fast earnings growth they can generate, but this is only the case if they’re reinvesting the vast bulk, say 90 per cent, of their profits. In contrast, an income-producing company, say a telco, should pay out at most 50 per cent of its net profit after tax. In Australia, because of the tax benefits accruing to dividends, the average payout ratio is 70 per cent.

When a company has a high return on equity and reinvests its profits, it achieves a compounding effect, which is essential. It means the company is focused on growth. Here are three companies outside of blue chips that nearly fit the bill at this time. It’s no accident that two of them are family-controlled. As one of my colleagues said: a good owner is not interested in the financial chicanery paying out excessive dividends and weakening the company’s foundations.

Here’s a guide.

Infomedia

When I first spoke to the founder of this company, Richard Graham, he tried comparing the car parts publisher’s exploits to Johannes Gutenberg’s invention of the printing press. I didn’t buy that, but I bought the stock and haven’t looked back.

Now run by other people following some board infighting a few years ago, the company has continued to go from strength to strength, capitalising on the benefits its product delivers for car dealers, who need the extra income from parts when sales aren’t up to scratch.

Unfortunately, I’ve been using this stock to generate cash, nervous as I am about the future of its customer base of giant auto manufacturers and the company’s decision to raise $85m. It said it is effectively for a war chest to go ­acquisition hunting, but indicates it thinks its shares were expensive. Even quality has a price.

Macquarie Telecom

This company is also not at the “sexy” end of the IT space because it owns and operates buildings that house reams and reams of servers (aka data centres). The business was founded by the ­Tudehope brothers, who maintain control, and has always had a longer-term return horizon than most fund managers wanted.

Then after the evidence built over several years, the big investors rushed in. The company is not paying dividends this year as it concentrates on a major data centre-related expansion. Luckily, before COVID-19 hit it had all its ducks lined up, having secured the debt finance required.

Hansen Technologies

The family-controlled company has been around for almost 50 years and might be a technology company, but it’s not a “sexy” technology company.

It flies under the radar because it provides boring billing software for infrastructure companies and telcos. The thing is, its customers are blue chip and they stick. On top of that, the company only pays out dividends from its earnings.

Richard Hemming is an independent analyst who edits Under The Radar Report.

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