The chart also shows how small cap industrials have only just risen above their pre-Covid peak, while large industrials are well above pre-Covid levels. With Bloomberg’s growth forecast* for small industrials well ahead of the forecast for the ASX 200 Industrials, this would indicate that small industrials can continue to close this performance gap. With Covid having washed through the economy, and the interest rate outlook stabilising, two of the major headwinds over the last few years for small industrials have abated.
Three small caps well positioned for growth
Three stocks which we think are currently well positioned, attractively priced and well placed to grow earnings, despite the ongoing cost pressures in the economy, are Kelsian, ACL and SG Fleet.
Kelsian (ASX: KLS)
Kelsian operates bus services across Australia, Singapore, the UK and, following the recent acquisition of All Aboard America, in the US. The Australian, Singapore and UK operations are underpinned by long term government contracts. Effectively the earnings under these contracts are inflation-protected, providing a defensive earnings stream with growth coming from new bus routes and generating efficiencies.
The US business operates under multi-year contracts with major corporates, again with no patronage risk borne by the company. Its competitive position is underpinned by the ownership of strategically located depots in the fast growing south-west of the country. Kelsian also operates a smaller marine and tourism division, which operates ferries and tourism assets in Australia. With several of the marine operations having long term essential service contracts and the increase in domestic tourism benefiting the tourism assets the outlook for this division is favourable.
With the revenue significantly contracted, recent tender wins in Sydney and the contribution from All Aboard America, Kelsian is well placed to deliver solid earnings growth over the next several years. Kelsian’s valuation is conservative in our view, on 13.5 times FY25 earnings3 and a yield of 4.4%.
Australian Clinical Labs (ASX:ACL)
ACL is one of three national pathology operators in Australia. Its operations are underpinned by a modern unified laboratory system which allows it to manage workflows efficiently, maximising utilisation and operating margins. This came to the fore during the pandemic when volumes fluctuated significantly due to Covid testing. During this period, it was able to maintain margins by carefully managing costs while maintaining a high response rate.
Australia’s ageing population ensures ongoing growth in testing volumes, as older people are more likely to have health issues requiring regular monitoring. The number of conditions able to be assessed by pathology testing continues to grow, also underpinning growth in volumes. These factors have seen industry testing volumes grow 5% pa, over the past three decades. However, recent “business as usual” volumes have been slower to recover to trend than expected due to doctor shortages and cost of living pressures. History indicates that these growth rates are likely to return to trend over time.
ACL has a strong balance sheet with minimal debt, providing scope for further bolt-on acquisitions. A merger with larger peer, Healius, was entertained by the company recently but has been withdrawn given Healius’s poor state of trading. The synergies from such a merger are significant, making a future transaction an attractive opportunity (subject to regulatory approval). Trading on only 12.3 times FY25 earnings and a yield of over 6%4 we believe ACL is attractively priced.
SG Fleet (ASX:SGF)
SG Fleet is Australia’s largest automotive fleet leasing provider, with operations in the UK and NZ. The company is effectively an asset manager of large corporate fleets and has benefitted from the gradual outsourcing of fleet management services across government and corporate. SG Fleet also operates a novated fleet-leasing operation in Australia, which is benefitting from recent government initiatives to promote electric vehicle (EV) take-up in Australia.
SG Fleet’s contracts are multi-year and provide a mix of recurring and one-off revenue as vehicles within the fleet are renewed over time. It has a strong history of renewing contracts and is the leader in adding services to its customers, for example “telematics” has been introduced more recently to allow remote monitoring of fleets which assists clients in increasing utilisation.
SG Fleet acquired competitor Leaseplan in 2021 and has been working to combine the operations since. Once complete in 2025, management has guided to significant synergies being attained, particularly from integrating IT systems.
Earnings in recent years have been impacted by a lack of supply of new vehicles and elevated trade-in values. These factors have overshadowed recent results, creating noise in the results and hence creating uncertainty for investors, weighing on the share price. However, with a solid balance sheet, and significant upside from the Leaseplan acquisition we believe any uncertainty around these factors is excessively factored into the share price. Indeed, the company’s half-year results reported in February 2024 highlighted the improving quality of the company’s revenue base, with new business revenues growing and revenues from residual values is declining. SG Fleet is very attractively priced, trading on 10.5 times FY25 earnings and a dividend yield of over 6%5.
All of these companies have the characteristics we look for in our quality and value mantra, which we have been following consistently since we started more than 25 years ago. They have strong competitive positions, are capably run, with a high degree of recurring earnings and a solid growth outlook. And crucially, all are reasonably priced.
Find out more about IML’s small and mid cap strategies.
