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Shelter from the investing storm

Though few investors will begrudge a rising market, life is certainly becoming tough for bargain hunters. Indeed, with the benchmark All Ordinaries index currently at a 6 year high, or indeed at a record high when dividends are taken into account (as they should be), you can forgive the value-focused investor for feeling a little downhearted!

However, that’s not to say that bargains don’t exist; investors just need to search farther afield. One area that offers a fertile hunting ground is the smaller end of the market, a fact evidenced by the performance of the Small Ordinaries Index, which excludes the the top 100 companies by size, and instead focuses on the remainder of the ASX 300.

Whereas the All Ordinaries index has climbed about 35% in the past two years, the Small Ords is essentially flat. In other words, it’s been a tale of two markets, with the headline-grabbing gains being delivered at the larger end of the spectrum.

A case in point

One company worthy of closer inspection is Gale Pacific (ASX:GAP) which is mostly involved in the manufacture and sale of screening and shading products. Perhaps best known for its Coolaroo brand of umbrellas and shade cloths, Gale’s products are stocked by a variety of retailers, though the most notable is Wesfarmers (ASX: WES) owned Bunnings.

While defined as a ‘small cap’ company, and clearly tiny in comparison to the index heavyweights, Gale is no ‘ma and pa’ operation. With annual sales of over $120 million, the business employs around 800 people and operates on a global scale.

Not without challenges

Though the business has achieved impressive growth in the past 5 years, with earnings essentially doubling, Gale is a business that faces some pretty big potential challenges.

It operates in a highly competitive industry with few barriers to entry and with little pricing power. The industry is also reasonably cyclical, and indeed seasonal, with sales performing best in the warmer months.

The business also faces key customer risks, in particular with Bunnings. Having such a significant retail partner is somewhat of a double edged sword, and Bunnings can be counted on to put pressure on margins.

The company’s most recent half year results were also disappointing, with a number of supposedly one-off costs being incurred and a poor sales performance from the domestic division.

Rising to the challenge

Though these factors represent some real challenges for Gale, CEO Peter McDonald has made all the right moves in positioning the business for long term success.

The strategy has been to expand and diversify its product range into related areas, largely through acquisition, and to ameliorate key customer risk through international expansion. This not only acts to reduce risk, but of course broadens growth prospects.

The business is also determined to avoid low-end segments, and has a keen focus on product quality — a sensible move when your competitors are focused only on price.

Further, like all good operators, the business is resolutely focused on cost control. Manufacturing costs have been dramatically slashed with a purpose built manufacturing facility in China, and the business continuing to focus on efficiency gains. The business also continues to ramp up its international business with increased marketing efforts in key growth markets, such as South Africa and Europe.

Innovation and product development is of critical importance to a company like Gale, which it correctly recognises and as such invests appropriately. This is enabled by a solid balance sheet and strong cash flows, which also allow the opportunity for acquisitions, which the business says it is considering. If done sensibly, this should help boost earnings and diversify the company’s product base.

At the right price

Not only is the business well placed to overcome the challenges of a tough industry, but the share price is currently providing an attractive safety margin for investors. Trading on a price to earnings multiple of just 8.8 and offering investors a trailing dividend yield of 10%, Gale is far from expensive, with the market essentially discounting any growth potential.

Though the dividend yield is perilously close to the ‘too good to be true’ level, the maintenance of the first half distribution, a solid balance sheet and expectations for a solid second half provide a degree of comfort. Further, even if the dividend were reduced it would likely remain at a yield that is well above what most businesses are offering.

Investors will get a better idea of the business’ performance when full year results are released later this month, although the most recent guidance from the company suggests earnings will likely match those of last year; which is very respectable given a number of significant one-off costs incurred in the first half.

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Andrew Page is a Motley Fool investment analyst. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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