Small-cap investing can be a bit of a hit or miss venture, but I believe looking to smaller stocks that are less frequently covered by analysts can unearth some great companies whose shares trade at bargain prices while offering phenomenal long-term capital appreciation prospects. And I think I’ve discovered two such under-the-radar options in speciality electronics manufacturer Acal (LSE: ACL) and chemicals producer Treatt (LSE: TET).
Exploiting its niche with aplomb
Acal started out as a pure distributor of speciality electronics for customers in sectors as varied as photonics, communications, magnetics and sensors. But after years of serving as a go-between for manufacturers and customers, it realised there were gaps in the market that it could fill with its own products.
And thus the company’s design and manufacturing (D&M) segment was born. This part of the business now accounts for over half of all sales and is growing at a rapid clip through organic expansion and acquisitions. In the year to March, sales from this division grew 28% year-on-year (y/y) to £175.6m and accounted for over 80% of the group’s £20m in underlying operating profit. On top of growing faster than group overage, operating margins of 11.5% last year were more than triple that of the distribution side of the business.
Now, the distribution business still has a role to play in gathering market intelligence, providing a reliable sales outlet for the groups in-house products and increasing cross-selling from its myriad manufacturing companies.
And for investors like myself who prefer their small-caps profitable and with a healthy balance sheet, its relatively small £30m in net debt presents a very manageable sum. With a great record of organic and acquisition-led growth, rising margins and a respectable 2.8% dividend yield, I believe Acal is a great business trading at a very reasonable valuation of 13.7 times forward earnings.
Growth with a citrus flavour
Another great small cap operating in a niche sector is Treatt, which produces ingredients for everything from scented oil for shower gels and shampoos to flavouring for juices, teas and sodas. The company has done particularly well of late thanks to increased consumer demand for the natural ingredients and citrus flavours it can produce, which helped boost revenue by 27% y/y in the half to March.
While a large part of this gain was due to the weak pound, the fact that H1 operating profits outpaced sales growth at 59% to hit £5.9m should be particularly welcomed by investors. This suggests the company’s plan to move up the value chain is paying benefits as it emphasises sales of higher margin products.
Looking ahead, growth prospects for the firm are quite impressive thanks to consumer habits, expansion into China proceeding well, and its US business growing so popular that is has reached capacity at its facility there. And with net debt of just £8m, the firm is well positioned financially to support expansion across the business.
However, the company’s share price has increased over 175% in the past year and is now valued very highly at 25.6 times forward earnings. I like Treatt’s business, but this is simply too expensive compared to its historic valuations to make me comfortable buying shares today.
