The team at specialist small and microcap fund manager, Spheria Asset Management, have been busy looking at small cap ASX shares they believe offer investors exceptional cash flow.
Why is cash flow important?
Spheria Asset Management's Portfolio Manager, Marcus Burns, explained the importance of cash flow when looking at small caps.
He commented: "When it comes to investing in small caps, too many investors ignore cash flow, but when it comes to small caps, cash is king."
"Key to our investment process is buying businesses that generate predictable free cash flows at an appropriate multiple for the forecast growth profile. By default, this lends itself to screening out companies that don't generate cash, lack sustainability or are being priced nonsensically by the market."
"The cash-flow conversion rate is a key metric in this process, and we believe it's one of the most important characteristics for enduring small-cap returns."
Given that the Spheria Australian Smaller Companies Fund has returned 33.9% (net of fees) in the six months to January 31, it certainly pays to listen to what Spheria says.
Why ASX shares does Spheria like?
The three small cap cash flow kings that Spheria likes are listed below. Here's what it has to say about them:
A2B Australia Ltd (ASX: A2B)
The first cash flow king is A2B Australia, formerly known as Cabcharge. Mr Burns explained:
"The COVID-19 outbreak has hurt sentiment towards the business given reduced taxi usage from ongoing restrictions. While the company's short-term performance in its core mobility business is likely to remain patchy the balance sheet is more than strong enough to see A2B through ($24m net cash).
"The company has also begun to articulate a measured strategy to grow its payments business into the non-taxi space in Australia and its mobility platform solutions business globally. We believe the market continues to discount an overly bearish outcome on the core mobility business let alone any success on the latter two growth opportunities.
"A2B's fundamentals are incredibly strong – its long-term rate of cash flow conversions sits at 84%, it has net cash of around $24m, yet trades on an EV/EBIT multiple of around 4x."
Monadelphous Group Limited (ASX: MND)
Another cash flow king according to Spheria is this global engineering company. The portfolio manager commented:
"What's important about this construction engineering company is that it has two divisions, one is an engineering division where it builds something once-off, the second is a maintenance division.
"We believe the maintenance division is the company's most lucrative division and it has been growing to now account for around 63% of the business.
"Monadelphous has a long-term cash flow conversion rate of 112%. It trades on around 11x EBIT, has around $200m of cash on the balance sheet and we think it presents incredibly good value especially now that the business mix has improved over time. Monadelphous stands to benefit from the improved sentiment and exploration activity in the resources sector."
Mortgage Choice Limited (ASX: MOC)
Finally, Mr Burns feels that mortgage and home loan broker, Mortgage Choice, is another cash flow king for ASX investors to look at. He explained:
"During December, MOC was one of our microcap fund's largest contributors, clocking a 20% return. We were genuinely perplexed why the stock remained so cheap after posting a robust FY20 result. Since the day of that announcement, it has returned an additional 71% showing how microcaps share price performance can sometimes badly lag the fundamentals.
"The company still only trades on a PE of 10x with net cash of $6m and a highly attractive dividend yield of +8% (fully franked) that is underpinned by a $54bn loan book."
