The bottom end of the small-cap space is where the stellar value opportunities lie in the UK market right now, according to Franklin Templeton’s Richard Bullas (pictured). 
The manager, who runs the four FE Crown-rated Franklin Templeton UK Smaller Companies fund alongside FE Alpha Manager Paul Spencer, looks to buy into companies that are between £100m and £1bn in value.
However, he says that most of the newer additions to his fund have been less than £500m in size, and two stocks out of his 44 holdings are actually below £100m due to the attractive growth opportunities they offer.
Since the start of the year, UK smaller companies have done well compared to blue-chip stocks, as the FTSE 100 index tanked during August’s ‘Black Monday’ following the nerves surrounding the Chinese market sell-off.
Performance of indices in 2015
Source: FE Analytics
However, Bullas believes the real opportunities lie in the smaller end of the companies within the FTSE Small Cap space due to strong balance sheets and the fact they are under-the-radar.
“If you look at valuations, they look attractive for small-caps vis-à-vis the rest of the market, but actually it’s the bottom third of our value range where we’re finding the real opportunities,” he said.
“That’s where the outstanding opportunities are in the small-cap space. While 80 per cent of the assets we hold are between £100m to a £1bn, we do take a look at companies between 60m and 100m in very special situations.”
In light of this, Bullas shares the small-but-mighty, under-the-radar stocks that he has been increasing his exposure to this year.
WYG Plc
WYG Plc is a global product management company which has a market cap of £75m, consists of a team of 1,500 specialists and is based in Leeds.
It is the fifth largest holding in Franklin Templeton UK Smaller Companies and makes up 3.12 per cent of the portfolio.
“It has been a bit of a turnaround situation and it has recovered back into growth mode now,” Bullas said.
“This offers a unique situation for me in terms of the potential upside. A new management team has been there for two or three years, and they’ve turned around the business so the opportunities they have in front of them now are significant. I see a lot of upside in this business on a three-to-five year view.”
The performance of the company rocketed in June, following the company’s announcement that it would remain independent and not accept a merger or a potential sale.
Performance of stock vs index over 1yr
Source: FE Analytics
Bullas believes that, while the stock’s past performance has been volatile, this strategic review will stand the company in good stead to continue to accelerate its returns. After the announcement was made, he increased his holding by more than a third from 2 per cent.
“Even though it’s at the very small end of the scale, it’s a stock that has become a high conviction position for myself,” he continued.
“When the business decided to remain independent, it was a sign that they could see significant organic growth potential in the business over the next few years.”
“It really crystallised my thoughts about the potential for the business given that strategic review – the opportunity is very large so I was prepared to put more of my assets into that stock to benefit from the significant upside.”
WYG Plc has a P/E ratio of 39.31x, a price-to-book value of 3.39 and a dividend yield of 0.88 per cent.
Vislink
Vislink is a telecommunications service provider that is based in Hertfordshire. It is currently the world leader in microwave, satellite and wireless communications systems which are designed to capture live events on television - earlier this month, the company provided a 4k wireless transmission for BT Sport, which was a technological world first.
The company is the 25th largest holding in the portfolio, but it is one of the two rare exceptions within the portfolio that are less than £100m in size. Currently, Vislink has a market cap of just £65bn.
“It’s a bit of a special situation in terms of its potential upside. The business operates in the broadcast hardware and software market and, for me, it looks significantly under-valued vis-à-vis its peer group and its competitors globally,” Bullas said.
While it was hit hard during the recession following a substantial dip in returns, it has since been on a steady road to recovery, which it has achieved through a combination of organic growth and partnerships and acquisitions.
Performance of stock over 10yrs
Source: FE Analytics
Pebble Beach Systems, a broadcast software company, was bought by Vizlink last year for £14.9m, and added £8.3m of revenue and £3.3m of profit in its first nine months, which exceeded the management team’s expectations.
“There is a significant strategy underway at the moment to grow this business over the next three-to-five years and I believe the current rating doesn’t reflect the potential over that time period,” Bullas said.
Vislink has a P/E ratio of 14.65x, a price-to-book value of 1.01 and a dividend yield of 3.2 per cent.
Clipper Logistics
While larger than the other two stocks, Clipper Logistics still sits in the bottom end of Bullas’ comfortable market cap at £250m.
It is the fund’s biggest holding and has a 4.44 per cent weighting in the portfolio, yet Bullas says the stock is still very much under-the-radar of most investors.
The company, which is based in Middlesex, deals in retail logistics such as managing warehouses and distribution centres – Clipper Logistics currently has contracts with the likes of John Lewis, Tesco, Asda and online clothing retailer ASOS.
“What is exciting about Clipper is not just its blue-chip base, but that these are long term contracts. The key driver for the online retail investor has been investing in departments that are able to handle the returns of items – that’s where Clipper differentiates itself from the rest of the industries,” Bullas explained.
“If you think about it, an online retailer is sending out a lot of clothes. One of the big issues is the returns and the amount of stock that comes back to them. Typically, ASOS and John Lewis are finding that between 25 and 45 per cent of clothing that is sent out is returned.”
“This becomes a huge logistical headache for the likes of a retailer as it has to be unpacked, the garment has to be manually checked for any damage and whether it’s been worn, whether there’s a button missing, and whether there’s a defect.”
“They have to do this in a relatively short period of time to maintain customer service and either give back a credit note, return the item to the customer, or actually say, ‘no. it’s been worn’. It’s a key battleground for retailers in the 21st century and Clipper offers these services.”
Since it came onto the market last year, the company has returned 144.81 per cent and performed particularly well in July and the first half of August, possibly because of the increased strength of the UK consumer.
Performance of stock since launch
Source: FE Analytics
Clipper Logistics has a P/E ratio of 37.33x and a price-to-book value of 16.03.
