3 Small-Cap Stock Picks

VIDEO: Smaller companies have been hit hard this year but Henderson Smaller Companies investment trust manager Neil Hermon has high hopes for UK pubs

Holly Black 25 August, 2020 | 10:53AM
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Holly Black: Welcome to Morningstar's 3 Stock Picks. I'm Holly Black. With me is Neil Hermon. He is Manager of the Henderson Smaller Companies Trust. Hello.

Neil Hermon: Hi there.

Black: So, a tricky period at the moment, particularly for smaller companies but you're going to talk us through three stocks you're very positive on at the moment. Where would you like to start?

Hermon: So, we'll start with one of our top holdings. It's number two or three in the portfolio. It's a company called Team17. Team17 is a computer games developer and publisher. It came to the market in mid-2018, so quite a recent entry to the UK equity market. But it has been a huge success. It's up 270% since it IPO-ed back two years ago. Where Team17 has its strengths is its ability to search the market for high-quality independent games and then co-develop those products. This greenlight process as they call it is a core strength of the business and certainly been developing over the number of last few years. Given Team17's success they have a lot of independents looking to work with them. It means they can pick and choose and get the best games to develop over time.

Black: Cool. Okay. Well, let's move on to stock number two.

Hermon: Okay. So, number two again is another big holding of ours in top 10, a company called Clinigen. It's a diversified pharmaceutical services business. It's involved in the sourcing of comparator drugs such as labeling and packaging and distributing and clinical trials, sourcing hard-to-find and unregulated drugs for clinicians and hospitals and pharmacists and managing drug programs for pharmaceutical companies. Why it's interesting now is the share price has been relatively weak recently. Even though its operating market was fairly defensive – I mean, if you think about pharmaceutical and services are generally defensive in this environment – it's seen some impact from Covid-19 as clinical trials have been delayed and postponed and also we're seeing oncology treatment reduce as hospitals are focused on treating Covid-19. We see those issues as short term. We think there's potential opportunity for this company to bounce back its growth in the coming years.

Black: It's quite interesting to hear about that other side of the pharma industry at the moment because obviously so many companies' results and the share prices have been cropped up by hopes of a Covid vaccine. Is Clinigen not involved in any of that?

Hermon: Well, it will be involved in some of the clinical trials around Covid-19 providing services into those trials. So, we've seen some of the more traditional sort of global trial operations diminish as they've been sort of sidelined, but they are seeing some benefit, it is marginal though.

Black: Okay. Let's go on to stock number three.

Hermon: Okay. Something completely different now. So, our third stock is Mitchells & Butlers which is a pub company. It owns brands such as Harvester, Ember Inns, All Bar One, Toby Carvery, Miller & Carter for example…

Black: Well, presumably, the last few months have been atrocious here.

Hermon: Well, exactly. I mean, this is the opportunity in some sense really. I mean, obviously, yeah, it's been deeply impacted by the Covid-19. Its operators have been shut for the last three or so months. Pubs have just only reopened on July the 4th. They are open again. Trade is not back to where it was to previous levels and the company is essentially at the moment operating profitably and generating cash but not at the levels it was back in 2019. The government is doing a lot to obviously aid the industry. We've seen significant measures around paying furloughed staff, business rate relief, temporary cutting VAT on food and non-alcoholic drinks and obviously, the gimmick of the half price meals Monday to Wednesday in August which is essentially to try and remind our muscle memory of going out.

This is a stock we've been buying recently. The opportunity here is – as you said, things have been really, really difficult, but the share price reflects that. The share price is down 65% this year and in the mix M&B look very good value. It may take time but in my belief we will return to some degree of normality from kind of low-ticket item purchasing from consumer perspective. I think essentially in the medium term I don't believe the U.K. consumer has lost its appetite to go to the pub. On that basis, it's trading a 50% discount to its kind of book value in order, free hold and about 4.5 times historic earning. So, too cheap for a well-invested business in a very defensive space and the opportunity is because the share price has been so weak this year.

Black: Neil, fantastic. Thank you so much for your time. For Morningstar, I'm Holly Black.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Holly Black  is Senior Editor, Morningstar.co.uk