Key points
- The small cap sector is often overlooked in this sort of analysis.
- Small trucking company Lindsay and regional airline Regional Express (REX) have potential.
- ARB Corporation knows its customers and its market well.
Outside of short selling, there are four main ways to play the oil-price collapse: buying blue-chips that benefit from lower fuel costs; identifying beaten-up energy producers; backing companies that gain from higher consumer spending; and, my preference, pinpointing small-cap industrial companies.
Heavy fuel users in transport and manufacturing are obvious blue-chip beneficiaries. But the likes of Qantas Airways have already rallied, airlines businesses are historically terrible to own, and listed aviation and manufacturing businesses are not well represented on ASX.
The second strategy – looking for value within the energy sector – has had less coverage in investment and mainstream communities. There is some merit in this strategy: Woodside Petroleum will, in time, be a good buy for self-managed super funds thanks to a stronger balance sheet that will allow it to mop up weakened competitors and lift its growth prospects.
Mid-tier producers, such as Australian Worldwide Exploration, are also well positioned to benefit from industry consolidation in the long run. But it’s too soon to buy energy stocks, such is the volatility and uncertainty as the oil price tries to find a floor.
The third strategy expects energy prices to stay low for a few years as oil supply takes time to adjust, and as global demand remains anaemic. History shows consumer-staples stocks benefit from a lower oil price as consumers have a few more dollars each week to spend on essentials. The iShares Global Consumer Staples Exchange Traded Fund is an interesting idea in this context.
The fourth strategy – buying small-cap industrial companies that benefit from a lower oil price – is more appealing, given this part of the market is often overlooked in such analysis. The goal is finding higher-quality small-cap companies at attractive valuations that are good investments in their own right, and treating the lower oil price as a bonus rather than the main reason to buy.
Caveats aside, these three small caps have interesting prospects in the next few years:
1. Lindsay Australia
The small trucking company has had a strong start to 2015, up from 40 cents to a 52-week high of 50 cents, before easing to 45 cents. The Queensland-based company has two key segments: transporting refrigerated produce and processed food, and selling rural merchandise.
Lindsay should benefit from lower fuel bills. But it is the long-term potential as a play on the Asian “dining boom” that most appeals. As the number of middle-class consumers in Asia increases more than sixfold to an expected 3.2 billion by 2030, Australian food will be in much demand and Lindsay’s position in the North Queensland “food bowl” will be valuable.
Buying a company that will move the produce – rather than grow it – has appeal and is perhaps a less considered strategy for the unfolding boom in food exports to Asia.
Owning one of Australia’s largest fleets of refrigerated trucks gives Lindsay some competitive advantage in exporting fresh produce, and it has increased its investment in horticulture and has developed a new transport-market segment, Lindsea, to service the seafood industry.
Lindsay had an almost 10% Return on Equity (ROE) in 2013-14 – reasonable for a small road-transport company, although down from 13.2% year earlier. Washington H Soul Pattinson and Co is the largest shareholder with a 16.6% stake, and some other good small-cap judges are on the register.
Chart 1: Lindsay Australia
[1]Source: ASX
2. Regional Express Holdings
The small airline is also trading at a 52-week high, up from 69 cents to $1.09 in the last six months. But REX’s five-year average annualised total shareholder return (including dividends) is almost zero, meaning it has plenty of scope for catch-up in 2015 and beyond.
As Australia’s largest independent airline, REX has obvious strong leverage to lower oil prices and cheaper fuel bills, already reflected in its recent share-price rally.
Until the past two financial years, REX had a history of high, consistent double-digit ROE – rare in the global airline business. The company said in November it had made more accumulated pre-tax profit in the past nine years than Qantas or Virgin Australia Holdings – a remarkable achievement.
But REX, too, has faced severe trading conditions. The fading mining investment boom reduced travel demand from fly-in/fly-out workers and general regional airline travel. A competitor, Alliance Aviation Services, downgraded profits because of the resource downturn and uncertainty in mining-company contracts.
REX warned of financial disaster in the aviation sector, with three regional airlines collapsing and Qantas and Virgin reporting huge losses. REX made $10.7 million in pre-tax profit in 2013-14, down 44% on a year earlier.
Longer term, REX has the potential to consolidate the regional airline industry and rebuild its ROE, after acquiring $56 million of assets in the past financial year to support faster growth. REX has the balance sheet and skill to snap up and integrate smaller, weakened competitors.
Deputy chairman John Sharp said at the annual general meeting in November: “REX Group is now well poised to take advantage of the upturn in the economy when that happens. Our passenger numbers have stopped declining and fuel prices have remained low during the first part of this financial year.”
REX’s turnaround, still in its infancy, will have further to run if oil prices stay low and the Australian economy slowly improves in the next few years.
Chart 2: Regional Express Holdings
[2]Source: ASX
3. ARB Corporation
It might seem a long shot to include four-wheel-drive accessories maker ARB Corporation in this list. But lower fuel bills are unambiguously good news for owners of gas-guzzling larger cars, and incentive to take longer road trips and spend more on car parts and accessories.
As an aside, impressive car-parts distributor Burson Group, a recent listing on ASX, is another potential beneficiary from lower fuel bills, as is smash repairer AMA Group, if cars are driven longer and repaired more often. Both are worth watching, although it’s too much of a stretch to suggest the lower oil price on its own is reason to buy them.
ARB is suffering from sluggish demand for aftermarket four-wheel-drive accessories – about 70% of the business. The resource-sector downturn is reducing demand for company-owned four-wheel drives and accessories.
Pre-tax profit for 2013-14 fell 1.2% to $57.3 million – a rare fall for a company with such a long history of consistent strong profit growth, although a $1 a share fully franked special dividend offset some pain.
At the Annual General Meeting in November, ARB said it had made an encouraging trading start to the financial year, but guided from modest profit growth due to lower margins on export and original equipment sales, and higher operating costs from its offshore expansion strategy.
Lower fuels bills should be a tailwind for stronger four-wheel-drive accessories demand, although it will take time to flow through to ARB’s earnings. A lower Australian dollar will help its exports sales, which are becoming a bigger part of overall of sales.
ARB’s biggest attractions are its exceptional long-term performance, its history of innovation, understanding of its customer base, and potential for store-network expansion. A 10-year average annualised total shareholder return of 17% shows the quality.
After falling from a 52-week high of $13.73 to $11.42, ARB is approaching value territory, although not a screaming buy at current prices.
Nevertheless, SMSFs that look to accumulate high-quality small caps and hold them for several years could do worse than consider ARB. Some analysts are concerned that the market is overestimating the company’s turnaround potential in 2014-15, given the slowing Australian economy. Although a valid concern, the lower oil price increases the odds in ARB’s favour.
Chart 3: ARB Corporation
[3]Source: ASX
– Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at January 14,2014.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.