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April 3, 2015

Optimism abounds among small caps

A survey of 50 directors of small cap companies finds them optimistic bunch, with growth uppermost in their minds – though that includes wage costs.


The survey, conducted by small caps broker finnCap, saw the overwhelming majority – nine to one, in fact – of respondents say they expect to grow the top line in 2015, while two-third expect margins to improve.


The UK is, perhaps understandably, the main area where the directors see their main growth opportunities, with just over 70% listing good old Blighty as the most fertile land of opportunity, but 50% also had the US in their sights.


Having a broad geographic spread is rated very highly by some of the directors Proactive Investors spoke to.


Nicholas Flanagan at specialist engineer Hayward Tyler (LON:HAYT) emphasised the diverse nature of the sectors the company serves and the countries in which it operates; the firm has just opened up an office in Shanghai to get closer to existing and potential clients in Asia.


For a staffing firm such as Empresaria (LON:EMR), going global makes a lot of sense, not just because the recruitment business is fairly dependent on economic cycles, but because in this modern "have passport, will travel" age, global reach enables the company to serve multi-national companies more ably.


Empresaria's chief executive Joost Kreulen does not reckon it is necessary in this day and age for a recruitment firm to have a branch in every town; in his view, a solid presence in one city - usually the capital city - is enough to serve a region.


According to the finnCap survey, poor beleaguered Europe is not beyond hope, with a creditable 31.6% of respondents saying they saw growth opportunities "sur le continent", which was just ahead of Asia (29%).


Africa, with its dependence on depressed commodity markets, trailed in a distant fifth with just 7.9% - in case you are wondering about the arithmetic, respondents were allowed to select more than one region.


Europe, of course, is a large place, and although the survey did not drill down to country level, it is likely that the northern countries offer better prospects than the southern ones.


For Empresaria, Europe is virtually all about Germany, particularly as the staffing market is relatively immature. The Germans changed the regulations in 2004 to allow temporary staff to be employed, but the ever-conservative Germans are still trying to get their heads around the concept.


It seems that the days of the credit crunch are well in the past, with more than 60% of those polled listing ‘seeking out acquisitions’ as among their corporate priorities.


E-learning specialist Learning Technologies (LON:LTG) operates in a fragmented industry and has made no bones about being a consolidator, but chief executive Jonathan Satchell says getting a target with the right cultural fit is important, plus, of course, the price has to be right.


Satchell's strong preference is not to pay all the cash up front. "We say, we will not cash you out immediately. We'll give you some cash up front, but we expect you to take plenty of stock, and be committed to the journey and the mission that we are on."


The burden of debt was a big bugbear in the last decade, but concerns about gearing seem to be receding, with only 23% of those polled focused on paying down debt.


Hayward Tyler's Flanagan said that the company has issued debt to fund the expansion of its Luton facility, but has not been tempted by low interest rates to become over-leveraged.


The engineer aims to keep net debt to around two times annual underlying earnings (EBITDA).


Small caps are known for innovation, of course, so it is small surprise that just over 43% of those surveyed by finnCap cited developing new products as a key item on their corporate agenda.


That innovation will continue to take place in a benign interest rate environment, if the small cap directors are any judge, with the majority not expecting the first interest rate rise in the UK until 2016, while just over 40% predicted the hike would take place in the second half of this year.


Interest rate rises go hand-in-hand with combating inflation, of course, and here too the outlook is mild, with the consensus view (81%) being that the inflation rate will stay parked in the zero to two percent range over the next two years, and that’s despite more than four-fifths of respondents indicating that increased wage costs are likely to be the main contributors to a rising cost base over the next 12 months.


The survey does not indicate whether this increase in the payroll will be because of pay rises, increased headcount or a bit of both, but it could be the middle one, as close to three-fifths of directors said they are not seeing any evidence of a dearth of skilled workers in the marketplace.


True, Britain could do with a few more technical engineers – an area of need cited by 56% of respondents – whereas Britain is apparently now a nation of bean counters, as only one in eight respondents said they are finding it tricky to locate finance professionals.


Pumps & valves specialist Hayward Tyler is certainly fishing in the engineering talent pool, but does not feel it is a particularly shallow pool.


The company had been pretty successful with its graduate recruitment programme, in Flanagan's view.


"We've been able to attract a very good cohort of candidates, by being able to offer them an opportunity to contribute early," Flanagan told Proactive Investors.


A big part of the turnaround process at the engineer over the past few years has been an emphasis on people and processes, which, along with the flat management structure, makes Hayward Tyler an appealing place to work.


Finding new blood does not seem to be too much of a problem - the firm also operates an apprenticeship scheme - but luring wise old heads can be a bit more challenging, Flanagan ventured.


Hayward Tyler has been around for a staggering two centuries, but 2015 has already seen a fair few companies not even yet into their teens coming to market, and with the FTSE 100 roaring along to new highs, we could be seeing a lot more.


Some of these will be as a result of owners looking to cash in on some or part of their investments; close to half the respondents said the market would be receptive to private equity exits, and almost two thirds said the market is open to companies seeking to raise fresh capital while at the same time allowing the owners to cash in their chips.


The most popular scenario, though, was one where companies come to market seeking new capital and the original owners stay fully invested.


As has often been demonstrated, the City does like a firm managed by executives who have "skin in the game".



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