Some smaller targets to consider – The Reject Shop, Cash Converters and Silver Chef

Founder and Chief Investment Officer of Montgomery Investment Management
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As private investors searching for value, it is easy to be daunted and overwhelmed by the amount of money in the share market controlled by fund managers. Indeed it can feel like turning up with a knife to a gun fight.

However, those gun-toting fund managers are only able to shoot in one direction – for example, they’re restricted to dealing in large companies, or mid-sized companies or small ‘caps’. For those carrying elephant guns, they need a Woolworths, a BHP or an ANZ to pass through their cross hairs before they can pull the trigger. Others can never shoot at cash and they have to have a ute-full of ‘trophies’ at all times.

But as a private investor we have the luxury of being as selective or as generalist as we like. We can use a shot gun or a water pistol and can even put the arsenal down and do nothing for a time.

Ok, I am starting to feel uncomfortable taking this analogy any further…

At Montgomery Investment Management, we have insisted on the same level of freedom as a private investor. I believe that the best value can be found in companies of any size and often it can be found in stocks that receive the least attention. Remember, you pay a high price for a cheery consensus. With this in mind, here are three companies (for you to investigate further and seek and take personal professional advice about!) that are unlikely to appear on the radars of the major funds.

The Reject Shop

The Reject Shop is a discount-variety retailer that I have written about on numerous occasions. Discount-variety retailers have the unfortunate perception among some consumers that they offer ‘junk’. But not all customers, and certainly not all investors, are turned away. Indeed, investors who take a second look at The Reject Shop will discover that it is an extraordinary business with an unrivalled brand awareness, if not an unrivalled distribution network within its sector.

The Reject Shop currently has a network of 267 stores across Australia, but its two distribution centres in Ipswich and Melbourne alone have the capacity to service 400 stores. This offers incredible and profitable growth potential. When you consider that management is aiming to open a third distribution centre in the coming years to service Western Australia, one can see the path of margin improvement quite clearly.

The strength of this network is demonstrated by management’s response to the recent failure of a major competitor. Retail Adventures went into voluntary administration in October 2012, and consequently many leases became available that were previously occupied by their stores (which included Sam’s Warehouse, Crazy Clarke’s and Chickenfeed).

The Reject Shop secured as many of these former leases as they could that suited the company’s store rollout. As a result, management is well on track to open 40 new stores this financial year – well above the number predicted by analysts, and their eyes are keenly set on securing a number of leases that are coming due next year. Analysts are not forecasting quite the same number of openings next year but we reckon they might be behaving unduly pessimistically.

Cash Converters

The next retailer worth researching is Cash Converters. CCV owns a network of stores that has grown along with earnings per share growth of 13% each year since 2004.

Cash Converter’s franchised and owned network of stores sell second-hand goods and provide short-term ‘micro’ finance. The business model has become so profitable that management is repurchasing stores from their franchisees to capture a greater share of earnings. The company has a lot of potential to increase earnings further in this manner. When one considers that half of the 104 stores in Australia and 161 stores in the United Kingdom are franchisee-operated, the profit growth potential from repurchasing and refitting stores becomes rather more clear.

Cash Converters’ main earnings stream is providing short-term finance to clients who typically have a poor credit rating. Over many years, Cash Converters has a built a vast database of its customers’ credit profiles, providing an intimate understanding of their capacity to repay their loans. This helps to mitigate bad debts while increasing customer loyalty. Over recent periods, management has been growing the loan book at a considerable rate in Australia and the United Kingdom – if bad debts are maintained at low levels, this will also contribute to higher earnings as the loans are repaid.

Silver Chef

The final retailer is one that you may not have heard of as a consumer – but you definitely would want to know about as an investor. It’s Silver Chef – a company that has grown earnings per share at an annual rate of 38% since 2004!

Silver Chef is a provider of the popular rent-try-buy model of capital-intensive goods for restaurants, coffee shops and takeaway outlets. Silver Chef’s rental programs put less stress on a business’ cash flow in their start-up phase – this has allowed the company to remain profitable during the recent downturn.

Silver Chef enjoys a limited competitive landscape because the banks and large finance companies are reluctant to deal with many small café owners. Indeed, this model has proven so successful that management has expanded into industries outside of hospitality under the brand name “GoGetta”.

Management believes that GoGetta equipment financing will be just as big as the café/restaurant business. This is an exciting prospect when you consider that GoGetta has $73 million of assets under management, while the hospitality division has $157 million of assets under management. The growth prospects for the hospitality division are just as promising, with the company experiencing initial success from its recent expansion into New Zealand.

The Reject Shop, Cash Converters and Silver Chef have a combined market value of just over $1 billion. This may not seem much when you consider that the market capitalization for the Commonwealth Bank of Australia is over $100 billion, yet we believe that these are excellent investment opportunities which should not be overlooked because of their size.

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.

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