Winters warm for small caps

Date: Friday, November 30, 2012
Author: Jonathan Ratner, Financial Post

Technical indicators are looking up for Canadian small caps because the TSX Venture Index in December has risen nearly 80% of the time over the past decade.

Steven Palmer, president and chief investment officer at Toronto-based AlphaNorth Asset Management, tracked the index back to 1982 when it had a different name and found December, January and February are by far the year’s best-performing months.

He noted Canadian small caps are down roughly 50% since March 2011, while the S&P/TSX composite index and the S&P 500 have done quite well.

“It’s gone through one of these brutal bear markets, but I believe that we hit a bottom in June,” he said. “TSX Venture stocks don’t tend to meander sideways for very long. They tend to either go straight up or straight down, and they’ve been basically going straight down for a year-and-a-half with just minor relief rallies.”

If Palmer’s call proves correct, returns for micro and small caps could be quite dramatic given the depressed levels these stocks are currently trading at.

“I also look at sentiment indicators, which look very similar to the first quarter of 2009,” said the hedge fund manager, who also runs the AlphaNorth Growth Fund. “I can identify many companies trading at less than cash value or where the fundamentals have improved considerably, but the stock is lower.”

Palmer’s been bullish on the broader market since the fall of 2011 and his portfolios have been fully invested in recent months.

The fund’s sector weightings are roughly 43% technology, 27% metals, 12% biotech, 11% energy and 7% precious metals.

“Resources have been hit the hardest in recent months on concerns that China is slowing,” the manager said.

But some of the life science companies he owns have performed well of late. “It’s been forever since we’ve seen that,” he said. “Nothing seems to be working in resource land, so perhaps investors are circling back to sectors that have been in a bear market for much longer.”

BUYS

Huldra Silver Inc. (HDA/TSX-V)

The position: Recently added to position held for about four months.

Why do you like it? Huldra recently started processing ore at its 100%-owned silver mine in British Columbia. “We like that the asset is in Canada and is high grade,” Palmer said.

His valuation of approximately 2x earnings in 2013 is based on current commodity prices.

Biggest risk: A short mine life, but the resource could significantly expand with modest drilling next summer.

BSM Technologies Inc. (GPS/TSX-V)

The position: Ongoing purchases since new management took over in 2008.

Why do you like it? BSM, which tracks mobile and fixed assets using GPS, has been a turnaround story, Palmer said. “Management has done a great job of lowering costs while winning some significant new contracts.”

He noted BSM’s cash position has been building in recent quarters and the company has been buying back shares. “We believe it on the cusp of significant gains,” he said.

Biggest risk: Contracts don’t roll out in a timely manner and follow-on orders are weak.

Trimel Pharmaceuticals Corp. (TRL/TSX)

The position: Added on weakness since purchasing at IPO.

Why do you like it? Trimel’s most advanced product for male testosterone replacement therapy will announce Phase III data in the next couple of months.

“The interim data has been very positive and we believe the odds of a successful trial are much higher than most Phase III trials,” Palmer said. “Upon successful results, we expect a partnership deal and a New Drug Application filing, which would add significant value to the company.”

He also noted the company is developing other products to treat female sexual dysfunction and Parkinson’s disease.

Biggest risk: An unsuccessful trial.

SELL

TransCanada Corp. (TRP/TSX)

The position: Avoid.

Why don’t you like it? Despite the lack of earnings-per-share growth over the past six years, analysts are forecasting 20% growth in 2013 and 11% in 2014 for TransCanada, which trades at a price/earnings multiple of 20x 2013 consensus earnings.

“Investors should be skeptical as analyst estimates have been revised down in each of the past four years,” he said. “There are many growth companies that trade at less than 10x earnings which offer better risk/reward.”

Potential positive: Investor risk aversion persists, causing yields to further decline and provide support for stable dividend-paying companies.

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Manager: Steven Palmer, AlphaNorth Asset Management
Fund: AlphaNorth Partners Fund
Description: Long-biased hedge fund focused on Canadian micro and small caps
AUM: $75-million
Performance: 1-year: -15.4%; 2-year: 18.8%; 3-year: 28.8% (as of Oct. 31, 2012)
Fees: 2% management, 20% performance