One of the commonest mistakes private investors make is thinking they’ve “missed the boat” on companies fast-rising in value on the back of impressive operating or financial updates. When you watch a small-cap stock double in price over a relatively short period of time (say a year) you might think the opportunity to own it has gone and there’s no chance the stock can run higher. Wrong. Remember in the small-cap space companies are coming off low profit bases so to quadruple their half-year profit from $5 million to $20 million is relatively easy compared to mid-caps quadrupling their profit from…
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One of the commonest mistakes private investors make is thinking they’ve “missed the boat” on companies fast-rising in value on the back of impressive operating or financial updates.
When you watch a small-cap stock double in price over a relatively short period of time (say a year) you might think the opportunity to own it has gone and there’s no chance the stock can run higher. Wrong. Remember in the small-cap space companies are coming off low profit bases so to quadruple their half-year profit from $5 million to $20 million is relatively easy compared to mid-caps quadrupling their profit from $50 million to $200 million for example.
Of course share prices are forward looking, but they’ll still follow historical earnings higher or lower over time and small companies that deliver consistent profit growth can see their share prices double, triple, or quadruple in quick time.
Take the eye-watering runs of Appen Ltd (ASX: APX), Altium Limited (ASX: ALU) and Wisetech Global Ltd (ASX: WTC) recently as evidence of this. As software-as-a-service businesses (SaaS) these companies share some of the same attractive characteristics as Gentrack Group (ASX: GTK), which is an Auckland-based business that provides software billing support mainly to large global utility companies and airports.
Today Gentrack’s ASX-listed scrip hit a record high of $6.40 and has nearly doubled over the past year.
So let’s take a look at some of the reasons the stock is catching a bid.
Consistent growth track record – Gentrack has grown revenues at a compound annual growth rate of 15% since 2009 with operating profit also growing consistently. It’s targeting a 15% compound annual growth rate in EBITDA (operating profit) over the “long term”. In other words if management delivers on its targets it should double EBITDA less than every 5 years. Last year’s EBITDA clocked in at NZ$23.9 million and remember share prices follow profits higher or lower over the long term.
Recurring revenues – Supporting this growth is the SaaS business model that means more than 90% of its revenues are from existing customers. In other words the revenues are recurring in nature so the company is well positioned to grow revenues year on year assuming it has good products. The SaaS business model also keeps a lid on costs, which means it should boast operating leverage as revenues can grow faster than costs.
Sticky revenues – the company boasts it makes “essential software for essential services” and its client turnover or “churn” is low as the software product ends up deeply integrated into clients’ daily workflows. The ‘if it ain’t broke don’t fix it’ mantra means that management teams using Gentrack’s software are reluctant to uproot it in favour of another service provider for example.
Good operational performance – Attractive economics on paper mean nothing if a company’s product is not selling, but Gentrack is winning new clients consistently thanks to the strength of its products. Its client list includes household names across the energy, water and airport sector in Australia and Europe. Just today the company announced it has signed a new deal with UK energy giant E.ON.
Management – Gentrack’s management has a good track record of delivering on its guidance via a healthy mixture of organic and acquisitive growth. It also seems to be investing sufficiently in growing its business via marketing, sales, and R&D, while paying growing dividend streams to investors. So there’s a lot to like about its future.
After recent acquisitions, Gentrack had NZ$42.5 million of debt and NZ$9.7 million cash as at Sept 30 2017. This means the balance sheet is in reasonable shape given full year EBITDA of NZ$23.9 million.
The company ticks all the boxes except perhaps valuation with the NZ-listed stock at NZ$6.80 changing hands for 45x NZ 15 cents in earnings per share on a net profit of NZ$11.8 million.
However if you back out NZ$3.9 million in (non cash) depreciation and amortisation costs from the net profit the earnings multiple becomes 34x based on EPS of 20 cents and 78.258 millions shares on issue. Investors in the ASX-scrip could buy on a similar FX-adjusted valuation basis.
Gentrack is expensive then, but worrying you’ve missed the boat may be a mistake if management delivers on its profit growth targets.
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The Motley Fool Australia owns shares of Altium, Appen Ltd, and WiseTech Global. The Motley Fool Australia has recommended GENTRACK FPO NZ. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.