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M&G's three UK small caps capable of big things

M&G's Smaller Companies fund manager Louise Nash highlights three companies she believes have potential.

The M&G Smaller Companies fund invests in small businesses with big potential. Fund Manager Louise Nash and her deputies, Matthew Cable and Garfield Kiff, select investments from the bottom 10% – by market value – of the listed UK equity market that they believe can grow faster than larger firms. Louise’s approach – focused on companies with scarce assets, growth drivers and attractive valuations – has delivered strong returns since she began managing the fund in October 2010.

The fund underperformed its comparative benchmark in the third quarter of 2013 with Anite responsible for the largest drag on performance. The company delivers handset and network test equipment for the mobile wireless market and is benefitting from the new roll-out of 4G across the globe. The company flagged at its results that it would have a weak first half, but that they were confident that the underlying market conditions remained strong.

Despite this, the shares suffered a sharp de-rating. However, the fund recovered in the final quarter of the year and achieved top-quartile returns in its peer group returning 11.7% compared to the IMA UK Smaller Companies sector average of 10.1%. In 2013, the M&G Smaller Companies Fund outperformed the Numis Smaller Companies (ex- Investment Trust) Index, achieving a return of 38.5% compared to 36.9% for the Index.

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Company: Elementis

Sector: Chemicals

Market cap: £1.15bn

Share price: 251p

3-year total return: 252%

Held in M&G Smaller Companies Fund since: October 2010

In the beginning, there was mud

Elementis’s scarce asset may not be much to look at, but it’s remarkably versatile.

A chalky, white clay discovered in California more than 70 years ago, Hectorite’s main use is in rheology, the study of the ‘flow’ of matter. By helping to thicken fluids and control their viscosity, it is an essential ingredient in a variety of chemical and industrial applications. As owner and operator of the world’s only rheology-grade Hectorite mine, Elementis has a unique competitive advantage.

Diverse, dynamic growth drivers

Elementis’s Hectorite-related operations currently account for more than 60% of group sales and operating profits. The business is incredibly diverse, serving clients in a range of industries across both developed and emerging markets.

Coating companies, for example, come to Elementis to ensure their paints apply evenly and smoothly on a range of surfaces; cosmetics groups value this expertise when making beauty products such as creams, lotions and lipsticks; and even energy firms rely on the company’s rheology additives to extract oil and gas from increasingly difficult-to-reach areas.

Leading positions in these dynamic and distinct areas provide Elementis not only with a solid foundation for future growth, but also with protection against a cyclical downturn in any one sector.

A great investment

Louise Nash has followed Elementis for many years and has owned the stock since becoming manager of the M&G Smaller Companies Fund in 2010.

Regular engagement with the company – including a recent visit to its R&D complex in New Jersey – has enabled her to develop trust and conviction in management, while detailed financial analysis has helped to gauge the attractiveness of its valuation over time.

Despite more than trebling in price in the past three years, Louise thinks the shares still offer good value and that the company will continue to grow, both organically and through targeted acquisitions. On its way to becoming a bigger company, we believe Elementis will be a great investment.

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Company: EMIS

Sector: Software & Computer Services

Market cap: £426m

Share price: 674p

3-year total return: 95%

Held in M&G Smaller Companies Fund since: March 2010

Through its innovative technology, software firm EMIS aims to make patient data easily available to healthcare professionals across the country, cutting the cost of medical provision in the UK and improving its quality.

Since its founding in the 1980s, the North Yorkshire firm has made impressive progress towards achieving these objectives. The company has also had considerable financial success. The M&G Smaller Companies Fund – an investor since the initial public offering in March 2010 – has supported the firm in its expansion and shared in its success.

Healthcare without boundaries

EMIS’s scarce asset is not just scarce, it is unique. The company’s systems hold patient records for more than 39 million people – far more than those of any of its competitors – and are used by more than half of all UK general practitioners (GPs).

Storing patient information safely and securely on a hosted system is of immense value as it enables healthcare professionals to move away from inefficient physical records and towards a more flexible, user-friendly platform. This provides significant savings in both cost and waiting times.

Broadening horizons

But this is just the beginning, and EMIS has a much bigger vision. It is pursuing an ambitious “connect all” strategy designed to integrate the broader UK healthcare market – pharmacies, hospitals, community care and more – into its system.

These plans position EMIS in the forefront of government-supported efforts to join up the country’s fragmented health service in search of greater efficiencies.

Attractive valuation

Louise believes that these attractive long-term growth prospects are not reflected in the company’s present share price.

In her view, the combination of a strong existing business, which generates significant recurring revenues and cash, and reinvesting this cash into new products, warrants a valuation considerably above the current level.

Although the shares suffered earlier this year following the unfortunate resignation of the chief executive, Louise continues to believe in the company and has recently added to her holding. There is considerable strength and depth in the management team and Louise is confident that – with a unique asset, structural growth drivers and an undemanding valuation – it will be an excellent long-term investment.

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Company: Booker

Sector: Food retail

Market cap: £2.29bn

Share price: 132p

3-year total return: 237%

Held in M&G Smaller Companies Fund since: June 2007

Unglamorous at the best of times, in recent years tough competition and increasingly cost-conscious customers have given investors little reason to get excited about food retail. The industry has lagged the broader customer services sector and the UK market average over three and five years.

Booker is a notable exception. The cash and carry group stands head and shoulders above its peers in the investment returns it has achieved over the long term. The M&G Smaller Companies Fund has benefitted from being among the firm’s shareholders since June 2007.

Management, a key asset

Today, Booker is one of the UK’s leading food wholesalers. But it wasn’t always in such good shape.

When Charles Wilson joined the business as chief executive in 2005, Booker faced dwindling sales and mounting debts. The recovery plan he put in place focused on generating cash, controlling costs and establishing a winning corporate culture.

The turnaround strategy has borne fruit: Booker paid off its debts in 2010 and has grown sales, profits and dividends – initiated in 2008 – in each of the past five years. Through regular meetings with Charles and other senior executives, Louise has seen this process in action and developed confidence in the management team, which she considers to be Booker’s key scarce asset.

Opportunities for expansion

Despite the progress the company has made, Louise believes there remains considerable scope for future growth.

The recent acquisition of Makro, a rival wholesaler, adds to the group’s assets, expands its reach into non-food products and offers the opportunity to benefit from supply chain efficiencies.

Alongside its 172 UK stores and extensive national delivery network – online sales have risen from £15 million in 2005 to £704 million in the last financial year – Booker also has a growing business in India. The company currently has four branches in the country and plans to open two more in 2013/14.

A great investment

Booker has generated a total return of more than 500% in the past 5 years. The multiple at which its shares trade, relative to next year’s profits, has almost doubled over that period as the market has come to recognise the strength of the business.

Nonetheless, Louise continues to like the company and it remains a significant holding in the M&G Smaller Companies Fund. In her view, Booker’s experienced and disciplined management team and attractive growth prospects provide much to be excited about in an unglamorous industry.

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