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Fund managers’ top UK smaller company picks

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Written by:
21/06/2013
We ask the professionals what to look for when investing in UK smaller companies and which firms look most attractive.

For investors looking for high growth, the debate continues on where to park their money – in emerging markets or closer to home? 

Data from financial research company FE Analytics shows the top-performing UK small cap funds have beaten the best emerging markets portfolios over both five and 10 years.

Experts say it is a myth that during economic slowdown or recessions, smaller companies are most likely to be heavily affected.

In fact strong smaller companies are better able to adapt to changes and can take advantage of the situation.

Richard Plackett, co-manager of the BlackRock UK Special Situations fund, invests primarily in small and medium-sized companies.

He says: “Since the financial crisis began over five years ago, we have been in an environment where strong companies are getting stronger and the weak have become weaker.”

When looking to make an investment in a company, Plackett looks for high quality growth companies that can grow significantly and sustainably over the long-term and are able to withstand volatility and uncertainty.

Here are his criteria:

Management – An investable company must pass a management appraisal, in which its movers and shakers will be reviewed for their sales ability, control skills, strategic vision and equity involvement.

Strong market position – A company must prove it has a strong market position. If this is not delivered by the product itself, it must prove it has an unrelenting supply network.

The fund invests in UK companies, the majority of which have vast overseas earnings potential. In the developed world, both consumer and governments have a huge debt burden, while developing markets have stronger growth prospects and are less burdened by debt.

Cash generation – A company must possess or be in a position to be able to produce the funds for expansion. This may be considered a struggle for some companies following the financial crisis but many that survived the crisis emerged stronger than ever.

Good long term track record – A company’s track record will be carefully reviewed, any black spots from the past could indicate trouble in the future. Companies with potentially problems are scrupulously avoided.

Strong balance sheet – The final test, companies will have net cash and no, or very little debt. In an ever more competitive economic environment, the winners are pulling further away from the losers and the contrast between failure and success is only getting starker.

A company must be able to demonstrate that it is financially solvent and in recent years, those companies that survived the financial crisis have continued to improve on their financial strength.

 

Go to the next page to discover the most popular smaller companies…

So which companies does Plackett favour at the moment?

Howdens Joinery – this small cap manufactures and sells kitchens in the UK. Howdens has grown through market share gains and depot roll out, a trend he believes will continue in the future.

Domino Printing – a coding and printing technology business with a global network of 25 subsidiary offices and 200 distributors. The group sells to over 120 countries and has manufacturing facilities in the UK, China, Germany, India, Sweden and the USA. Although it is small, Domino printing has increased its dividend for the last 25 years

Senior – the international manufacturing group’s recent results has shown how a company, despite tough market conditions, can grow profits significantly.

Spirax-Sarco – provides products and services central in efficient management of steam or industrial fluid in plants. Spirax-Sarco has increased its dividend for the last 44 years.

 

And what smaller companies do other managers rate?

Anthony Cross, co-manager of the Liontrust UK Smaller Companies fund.

Wilmington – provides training and trade publications primarily for the legal, insurance and healthcare sectors.

This is an example of a company that has experienced tough market conditions but possesses strong economic advantage characteristics which encouraged us to look through the cycle when investing. The company is cash generative and was able to maintain a high dividend level through the downturn. Trading conditions for the company have since improved, a recovery reflected in its share price performance.

Smart Metering Systems – offers meter reading technology to UK gas distributors and has seen rapid growth in demand for its products and services. It is experiencing good take-up from the industrial and commercial market and the domestic side of its business is supported by legislation requiring the replacement of over 20 million domestic gas meters with “smart” functionality by 2020.

Dotdigital – runs digital marketing campaigns for companies using a “software as a service” model which in effect means clients access its tools via the internet. As consumers have switched from print media to online media, so too has companies’ marketing spend.

 

Fraser Mackersie, fund manager at Unicorn Free Spirit fund.

DotDigital – The recent acquisition of ExactTarget Inc, a large US peer, by Salesforce.com supports our view that this remains an attractive area of the market. The company is currently also pursuing growth opportunities in the US following the opening of a sales office in New York in November. DotDigital enjoys good revenue visibility from its SaaS model, has cash on the balance sheet and although it doesn’t currently pay a dividend management have stated they intend to review this position ahead of the full year results October.

Iomart– The company provides managed hosting services from eight data centres throughout the UK and continues to benefit from the growth in demand for cloud computing services. With substantial spare capacity in the existing estate and the further expansion of an existing site already under way the business is well placed to accommodate further growth.

Cineworld – Despite the recent strong run in the share price we the believe company continues to provide an attractive combination of income and growth. The pipeline of new sites is encouraging and the recent acquisition of the Picturehouse chain has broadened the company offering.

The business continues to improve its customer engagement through the MyCineworld and Unlimited propositions, which now enjoy over 2.4m and 320,000 members respectively. Longer term we see further opportunities for the company through initiatives in retail and advertising.

Giles Hargreave, co-manager of the Marlborough UK Micro-Cap Growth fund.

1Spatial – provides mapping software and customers include Ordnance Survey, the Environment Agency and the US Government. They made an acquisition recently after raising money through a placing and we are expecting positive things from them over the next year or so.

Iofina – has developed a new process in which iodine, which has a range of uses from diagnostics to paint and high-tech LCD production, is extracted from brine in disused oil wells. Iofina currently has two plants operating and by the end of the year is expected to have six, which will underline the success of the process and begin to make them a significant threat to the Chileans and the Japanese, who are currently the world’s major producers.

TT Electronics – which makes sensors for car manufacturers including BMW, currently has around £50m in cash, which we expect them to use for acquisitions. The company is already trading well and acquisitions are likely to enhance earnings.

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