Micro Caps Under The Microscope

Owain Bennallack chats with Guy Feld, co-manager of the Marlborough UK Micro-Cap Growth Fund.

This is the second part of a two-part podcast transcript in which Owain Bennallack chats with Guy Feld, co-manager of the Marlborough UK Micro-Cap Growth Fund.

According to stock-market historians, you can beat the main market by a wide margin by investing in the smallest listed companies. Guy Feld, senior fund manager at Hargreave Hale, should know -- he co-manages the Marlborough UK Micro-Cap Growth Fund, where he spends his days researching, meeting with, and investing in tiny companies that are barely a blip on the typical fund manager's radar. Discover how he researches these micro-cap companies, and why he thinks this sector always presents the best opportunities for investors, in this episode of Money Talk.

You can read the first part of the transcript here.

You can listen to or download the full podcast here.

Owain:

OK, so if we look into some of your specific holdings, and you have kind of trailed a few of them so far, but we'll start with CML Microsystems (LSE: CML), which I don't think you've mentioned so far in the podcast.  What's the appeal of CML Microsystems?

Guy:

These are currently largest holding in the fund.  I look at the technology area.  This is a fabulous semi-conductor company, so fabulous means it doesn't own its own factory.

Owain:

Is that like a sort of mini-ARM?

Guy:

More like a mini-CSR, or something like that, so basically they don't own the chip factory, it's made on an outsourced basis.  Anyway, their chips are mixed signal, both digital and analogue-integrated circuits.  They go into wireless applications, like Tetra handsets for the police or the army, and in Flash storage applications.  This is all for companies, this is not for consumers, so it's the enterprise market. Now, the nature of these types of companies is, they have a very high fixed cost base, which isn't very good in a terrible slump, which we obviously had a few years ago, and we saw them hit the red big time, but if they sort their act out, and it looks like they very much have done in terms of recovering the customers, and coming up with new products, then you get a huge boost to earnings.  We just actually had figures today from CML interims, which were solid, and we continue to hold the stock, despite the fact that we made a lot of money out of this, and we're going to say to ourselves, look – there's still more upgrades here potentially.  We've had several upgrades here.  They've got a new product line coming out, with a new SATA chip for Flash storage, and although we've made a lot of money out of that stock, and a lot of people would say, look, it's gone up a lot – let's get rid of it, absolutely not – we love to maximise our winners, and we think there's more upside in CML.

Owain:

You mentioned the interims came out today.  I'm just saying that, as a general point, you're here in the studio with me, so you're clearly not poring over them – do you tend to ...

Guy:

It's much too late for that!

Owain:

I guess you've been doing that at seven o'clock!  Do you tend to, when those interims come in, do you tend to give them a quick look over, or do they go into some model immediately?

Guy:

No, I'm reading them on the train before I get to the office, and reading the research, and talking to the brokers.  The company's coming in this afternoon; we're preparing questions. There's a lot going on, but that's typically what we do.

Owain:

Right.  Another one that I noticed in your top holdings was API Group (LSE: API).

Guy:

OK, so API's looked after, George Finlay and Giles Hargreave.  This is their stock, and what it does is, it makes holographic security foil for cigarette packets, and laminates for bottles.  So we met the company in 2011, and paid 16p for it.  I think George in particular saw real value in the company, that had been bid for at 155p in 2005.  He liked the management; they did a successful JV in China, and they took some money out of there.  Then the management started delivering, and this is typical of what we do – when people start delivering, and we did that with CML, we will average up. We're not afraid to buy new highs, and that's what we did with API Group.  So today, we've got a market cap of 54 million, but it's generating at least eight million of cash, and that's pretty attractive.  Their client base includes the big global tobacco players, and you can guess those names, because there aren't many of them around, and they need to protect their brands with this technology.  So at the moment, I'm told they have US property probably worth around eight million sterling, which is in their books for nothing at all, and they can boost the margin from plant rationalisation, but to cap it all, it's in a bid situation, so it is a very interesting situation.

Owain:

That is a genuinely small company, at 50 million.  Again, I appreciate you don't follow this stock yourself, but as an aside about these sorts of companies, if you go and buy Diageo, as a sort of classic private investor, you know that Diageo's operating all over the world.  You know that they're big, they're in various markets.  The advanced holographic foil market, how do you have confidence that there isn't another one in India and another one in China, and another one ... not perhaps those companies specifically, but just in general, with small caps, how do you assess the market size, and how big these players are in it?

Guy:

Yeah, so it goes back to the points I made earlier on about the sources of information, and particularly my network that I draw on.  So I meet all these CEOs, so I do a lot of cross-referencing.  Now, you'll laugh at this, so one Israeli CEO told me he'd been bid for by another one, so he didn't know I knew the other chap, and gave him a ring, and discovered that actually that probably wasn't the case, or slightly exaggerated! – so there's a bit of that going on.  I've got access to a lot of very smart people, particularly the brokers, so in my sector, I mentioned technology recruitment.  I tend to know a lot of the faces, and you build up quite a good knowledge sense, so that's important. 

Owain:

OK, so let's look at one other one, which has the sort of science fictionesque-sounding name of Tracsis, and this a company that, well – you tell us what the company does.

Guy:

The attraction of Tracsis is the great traction it is getting on the railways.

Owain:

Did you prepare that line, on the train?

Guy:

On the train, that would have been nice! – but actually, no.  So that supplies scheduling and rostering software for the train operating companies.  It also has a hardware monitoring system that's very successful for monitoring the points and other trackside kit.  It pretty much dominates, almost to a monopolistic level, its market in the UK.  Again, as I said earlier on, what drew my attention to that, it had been flatlining for a while, and then we had a very positive trading statement.  It's got a lot of momentum now, a lot of steam behind it, I should say.

Owain:

Nice!

Guy:

And it's a textbook example of a small tech company that has a highly profitable and growing niche.  The trains, it was interesting, the presentation the other day – passenger miles have gone through the roof since they were privatised in this country.  I don't know if that's whether people want to drink, actually they're fed up with the car, the car's too expensive, whatever – not quite sure, but it's a very good place to be, and they dominate that niche.  It's gone up a lot, it has trebled over the last year or so.  However, a bit like CML, I can see a lot more upside here.  They were cross-selling in the UK, but also what they can do in Germany and Scandinavia and overseas, there's a lot they can do there, because there's a lot of railway infrastructure, and their kit is particularly efficient, very niche-y, and probably best in class, so there's more they could do with it.

Owain:

Yeah, that's the sort of, on the face of it, the sort of small-cap where, if it grows to be dominant in one geographical region, but it has a ubiquitous technology, you can't see why it couldn't go to another country and another country, become one of those big companies.

Guy:

Or even probably more likely, get taken out by someone who plays in that area.

Owain:

OK, well, those are the ones that I had a look at and thought, firstly that you owned a lot of them, and certainly they were the biggest share of the portfolio, but secondly they looked interesting.  Is there sort of a company that you would single out from the portfolio?

Guy:

Right, so Amerisur (LSE: AMER), Giles is very very keen on Amerisur.  He thinks it's extremely exciting.  It's an onshore Columbian oil company.  It's almost 500 million sterling market cap. They did 5,000 barrels last year, and they're supposedly going to do 10,000 barrels this year.  Giles thinks they can do nearer to 20,000 barrels, but the oil that they produce is very sweet, and commands a good premium, very high quality, and they get an $85 net income per barrel, which I'm told is very high.  Quite unusually for the sector, Amerisur owns 100% of its assets – that's quite unusual.  With the currently royalty rates, Giles is telling me he thinks it could generate $600 million of net cashflow per year.  If they can do that, then the share price has got plenty farther to go.

Owain:

It's obviously a much, much larger company that the other companies we've looked at, and what's the sort of rationale for bringing such a large company into the fund?

Guy:

So again, that's one of Giles's.  I think we had that from a much smaller valuation.

Owain:

OK, I see – it's one that's not growing, but growing nicely.  OK, well what would you say if all those companies that you've mentioned, you obviously see potentially bright prospects for, but for the sector as a whole, what do you reckon the next few years have in store?  Are private investors firstly going to get more interested, do you think, in smaller micro-caps? – and secondly, do you think the economy is going to be supportive of the ongoing business environment?

Guy:

I think it's crazy, for me to make a call on the economy, and the rest of my colleagues agree.  We don't call markets, we're not that smart, and some of the people running the Fed aren't even that smart, so that's a thankless task.  All I can tell you is, historically small caps are deemed to be more domestically-exposed, and clearly it is pretty glum over here, it's not the worst in the world.  If the UK economy does recover, then in theory that will benefit small caps, but I'm going to push all of that aside, Owain, because my view, and I keep telling people the same thing – there's always, always, opportunity in smaller companies.  It's such a heterogeneous sector.  There's so many different companies doing all sorts of different things, and hopefully I've given you a flavour for that.  There's always someone who's got a disruptive technology, or who's got a class-leading service, or a great brand, and they're doing really well.  We've made money in good times, and we've even made money in bad times, so we're very much bottom up – that's what we're saying.  When we're picking stocks, there's always opportunity there.

Owain:

OK, well I will certainly be watching your progress with interest, now that we've met.  As I said at the start, I was really fascinated to look through your holdings, and see these genuinely small, I would say obscure, but you've probably got posters of the CEO in your kitchen.

Guy:

I'm not that sad!

Owain:

For me, it was quite inspiring looking at them, and I will certainly be digging into them a bit more, and perhaps keeping an eye on the companies that you move into.  So we always end each podcast with a quote here on the Money Talk podcast, and today's quote comes courtesy of, strangely enough, Ronald Reagan, the former US president, who said: “Entrepreneurs, and their small enterprises, are responsible for almost all the economic growth in the United States.”  Strangely enough, he said that to students in Moscow in 1988, and I guess they were obviously listening, given what happened at the end of that decade, but even if we're not a communist country looking to become a capital country, we are a country that needs more economic growth, so let's hope that some of these small companies can deliver, and perhaps some of them will get listed on the stock market, and perhaps you and I and your clients will invest in some of them, and perhaps we'll have a good few years, so thanks very much, Guy.

Guy:

Thank you very much indeed.

That was the second part of a two-part podcast transcript in which Owain Bennallack chats with Guy Feld, co-manager of the Marlborough UK Micro-Cap Growth Fund.

In the first part of the transcript, discover how Guy researches these micro-cap companies. Just click here to continue reading.