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Oliver Haill and Adam Wayland talk to six leading growth company fund managers about their investment approach and, more importantly, their favorite stocks on the market

Bernard Fairman
Foresight Technology VCT

Favoured stocks at present
Oxonica
Mondas

Smartfocus

Alternative Energy and turnarounds

AIM-listed Oxonica, a nanotech company whose lead product is a diesel fuel additive that allows you to go six-eight per cent further than conventional fuel, is one to watch says Fairman. ‘Based on the strength of the offering they look like they’re going to do very well – it’s a very big product.’

‘In terms of investment strategy, I look for growing markets and energy is one such area. I’m interested in alternative energy deals because this arena is just going to get bigger. The Government is saying that they want this type of project to succeed and when you have them saying that they’re going to provide fiscal support and subsidies, you are in a first-rate position already.’ Oxonica has a market cap of £43.4 million with its shares trading at 118p each.

Fairman is equally drawn to turnaround stories, particularly Mondas, listed on AIM. ‘They sell software solutions to big banking. At the moment, the city has money and wants to spend it, putting Mondas in a fine position. They have a shrewd acquisition strategy that seems to work and have just agreed a deal with one of the top ten world banks to supply it with their Blue Curve research management software.’ The shares are priced at 18p currently, valuing the company at just £6.29 million.

‘Smartfocus is another AIM-listed company that I’d keep an eye on,’ says Fairman of the £14.6 million company. ‘They’re in electronic marketing and also have a canny acquisition strategy – they never seem to overpay for any deal they do.’

‘Every company needs to advertise,’ he declares, ‘and as most people seem to be aware these days, if you are marketing something, you have to have an online strategy. It’s a growth market and Smartfocus seems to have positioned itself well – I think Sportingbet have just recruited them for their online campaign.’ Other recent contract wins include T-Mobile, NSPCC and the American Automobile Association.

Chris Hutchinson
Unicorn AIM VCT

Favoured stocks at present
Invocas
Augean
Driver

Sustainable business models and cash generation

‘We could look at the consumer debt management market as an example of a growth sector,’ says fund manager Chris Hutchinson. ‘Everyone’s seen the figures regarding severely indebted UK consumers and if things progress as they have been there are going to be a large number of irrevocably troubled people.’

‘Invocas (see page 16), which has been trading quietly for about seven or eight years now, delivering attractive profits growth, now finds itself in a position where people are starting to realise the potential of the market. It’s a good medium-term opportunity that should do well if it has the infrastructure in place to cope with the increased demand. It just becomes a matter of process and efficiency.’ Invocas boasts a £52.9 million price tag at the current 185p.

‘Augean is a specialist in the disposal of hazardous waste. There was a temporary problem after it floated when the expected volumes just didn’t come through. The Environmental Agency had decided that there wasn’t the capacity in the UK that they’d envisaged and allowed hazardous waste to be disposed alongside non-hazardous, detracting from Augean’s business. They’ve now decided that’s not what should be done and are increasingly enforcing the law regarding what is hazardous and what isn’t, making sure it is properly disposed of.’

‘With its established locations in the Midlands and in the South, the company is well placed to handle waste from a variety of sources. The need for the disposal of waste from the Buncefield explosion should be beneficial for them, as will the preparation of the site for the Olympics in east London. They have a monopoly in the Midlands and the South and the scarcity of businesses offering similar services is a bonus for Augean. The company is firmly in recovery mode after a slight hiccup.’

‘Driver Group, which trades on multiples of 13 times, falling to 11 times earnings next year according to our forecasts, also appeals. It’s a consultancy business focusing on dispute resolution for the construction industry. They’ve carved out a niche for themselves and are very careful to avoid conflicts of interest by only representing contractors. As many people are aware, and as the new Wembley Stadium testifies, the construction industry is desperately prone to delays, which sends business Driver’s way. It’s a venture with a market cap of about £19 million, it’s not well understood, nor is it well followed, so at the moment it’s cheap in terms of its yield and its p/e.

‘A lot of small cap stocks have suffered of late and there has been a loss of liquidity at the lower end of the market. When there is an absence of buyers, market makers tend to set prices that don’t necessarily reflect the value of a company, so you get a lot of artificial price creation.’

Richard Plackett
Merrill Lynch UK Smaller Companies

Favoured stocks at present
Rotork, Spirax, Mouchel Parkman, Connaught, Expro, Sondex, CSR, Axon

Management needs to be able to control growth

One of the main requirements for Cambridge graduate Richard Plackett is that the management team at any business he backs ‘can control growth and also possess salesmanship skills and strategic clarity’. He then looks for ‘high barriers to entry, excellent cash generation, a first-rate balance sheet and either very strong recent profits growth or good order books’.

In his Merrill Lynch portfolio are a number of industrial concerns that meet these criteria – fully-listed activator-maker Rotork and steam specialist Spirax – and outsourcing companies Mouchel Parkman and Connaught, both fully-listed too and benefiting from the Government’s increased spending on outsourcing its services.

Another area of choice is oil services, ‘as oil companies are trying to expand production, which they’d be doing regardless of the high price’. Thus he holds profitable pair Expro International and Sondex in high regard.

In the technology sector he fancies wireless device manufacturer CSR – ‘as Bluetooth is going very strongly at the moment’ – and Axon, an IT integrator that recently released a trading statement boasting that full year results should come in ‘at least ten per cent ahead of current market expectations’.

The fund does occasionally invest in turnaround situations, but Plackett is adamant that ‘there must be a catalyst behind it’, citing retailer Mothercare as an successful example in the last few years.

‘But it’s not the best time at the moment,’ he makes pains to stress, ‘as we’ve had three years of recovery so any companies in turnaround situations should have done it already!’

Giles Hargreave
Marlborough Special Situations
Favoured stocks at present
Goals Soccer Centres, Powerleague, Internet Business Group, Interactive Prospect Targeting, Research Now, Gaming Corp

A personal approach

Since Preston-born Cambridge graduate Hargreave took control of Marlborough’s fund in July 1998 it has consistently outperformed the wider market – and the majority of his peers. Hargreave professes to being ‘very much bottom up’ in his approach to investing and prefers to meet companies face to face before investing.

His list of holdings is an eclectic one. A favourite area, although reaching 58 years old this year he admits he no longer plays, is five-a-side football, with Goals Soccer Centres and Powerleague taking 1.87 and 1.79 per cent of the fund’s total. ‘You’ve only got to go and have a look to see why,’ he argues. ‘I live near one of the Goals centres and it’s absolutely packed – you can’t get a pitch. So they’ve clearly got the demand for their product and have nice bars and changing rooms too – the local councils love it. They’ve both done very well, price wise, even though Goals did get a little too expensive – but we didn’t sell as we think it’s a good long-term hold’.

Another segment he and his team have a preference for is the internet, particularly internet advertising ‘where there’s lots of growth so it’s a pretty obvious call’. Internet Business Group is ‘particularly cheap’ and AIM peer Interactive Prospect Targeting gets the thumbs up too. A recent purchase is Research Now: ‘it looks a lot cheaper than YouGov [see page 21] for a start and is a very young company. On top of its low market cap, we met the management and liked them.’ Capitalised at £30 million, Research Now trades on 22.8 times prospective earnings compared to YouGov’s 25.8.

Gaming Corporation is ‘very interesting and very cheap. It’s fallen due to the recent online gaming bloodbath but is actually an internet advertising company. It’s very profitable and fast growing. It raised £9 million at 14p a year ago and is significantly cheaper now at just 9.75p and the directors have been buying recently.’

In the retail sphere, one of Hargreaves’ winners has been Domino’s Pizza. ‘It has successfully rolled out its concept and hopes to open 50 units a year and they can afford the advertising that most of the competition can’t.’ Elsewhere in the restaurant sector he likes Clapham House: ‘I strongly recommend its Gourmet Burger Kitchen chain and my daughter goes quite a lot – it’s trading extremely well.’

Michael Cunningham
Pennine AIM VCT

Favoured stocks at present
Supporta
Accuma
Waterline

Keep an open mind

‘I think its very difficult to be prescriptive when it comes to investing,’ says Cunningham, fund manager at Pennine AIM VCT, ‘you have to keep an open mind otherwise it becomes restrictive and you’ll miss some good stocks – there’s no point in putting a straight jacket on your investment strategy, because you’ll find that nothing emerges.

‘At Pennine, we are focused on AIM and so find that there are a number of opportunities to invest – the best times are often at or around the period of admission or when there are acquisitions going on.

‘Sometimes we invest in a company before it comes to AIM, with a view to it floating within the coming 12 months. We tend to avoid cash shells, we’re not very good at it and don’t understand them. What I favour is profitability, solid management experience – which is key – and stability and growth in the business. Contracted forward revenues and a sensible price are important factors too.

‘One company that Pennine is invested in is Supporta - it’s profitable and has top-flight management. The company provides care facilities to local authorities, payroll management to the NHS and property services to housing authorities. It is well positioned, benefiting from the drive to outsource services for the NHS and other Government bodies and growing very fast. We have been invested since its early days and have seen the company through a number of acquisitions – it should continue to do well.

‘Then there is Accuma [see page 8], in which we are now twice invested. I resisted investment on admission because I thought it was too early and frankly rather expensive. The company is in the debt management sector, providing Individual Voluntary Arrangements to indebted customers. It has long-term contractual agreements giving a fairly good view of revenues, in a growing market. Having recently made a number of acquisitions, it is one to watch.

‘Lastly, I can point to a really very cheap stock – Waterline – which is a profitable business that turns over around £80 million and pays a decent dividend. It is a kitchen supplier but, unlike most, which concentrate on the cheap end of the market, it looks to the premium end. It doesn’t manufacture anything, but acts as a supplier and has been going for a long time now. The shares are very cheap, trading at around seven times forecast earnings – a figure that should probably be double that.’

Daniel Nickols
Old Mutual UK Select Smaller Companies

Favoured stocks at present
Chemring, SDL, Connaught, Robert Walters, SThree, Abacus

A flexible fund management philosophy

With the market at a ‘crucial juncture’, Nickols has spent the last three or four months ‘taking cyclicality and risk out of the portfolio – although not yet fully defensively’. This is part of the ‘flexible’ fund management philosophy developed by head of desk at Old Mutual, Ashton Bradbury, meaning Nickols and the rest of the team respond to changes in businesses and in the market cycle in order to choose ventures that will perform best. ‘There will be top-down analysis to shape the overall tone of the fund but we have 400 meetings a year across the team. We hope to understand before the rest of the market why forecasts are too high or too low, so we can position ourselves ahead of time.’

Defence countermeasures group Chemring is the fund’s largest stake. ‘It’s now had a good year of forecasts being upgraded each time it talked to the market,’ he recaps. ‘In our view that process still has some way to run and we see significant upgrades still to come.’

Another favourite is translation services and information management business SDL: ‘I believe the forecasts were too low and so expect upgrades to come this year and for the price to react accordingly.’ Current estimates put the shares on a forward p/e of 16.8.

Nickols prefers to keep a well-balanced portfolio but does have favourite areas; at present he is ‘overweight’ in support services. Connaught, the provider of social housing repair and maintenance services, is one that Nickols says ‘benefits from strong secular growth drivers’ – defensive growth, so to speak, so it can grow regardless of wider market factors. He continues to be fond of the professional recruitment sector too – ‘prospects here are still strong’ – and likes the look of Robert Walters and SThree.

One of the ‘cheapest’ stocks on the market is electrical components distributor Abacus, valued at just over £100 million. ‘The key reason it’s so cheap is the failure on the part of the market to appreciate the benefits of its acquisition of Deltron. The current multiple of 8.7 times earnings for the year to September 2007 is too low and its peers are typically in the mid teens. And it’s not as if it needs to do anything spectacular to hit the
targets either.’