Having shown remarkable resilience since the Brexit vote of 2016, UK smaller companies find themselves under pressure once again, as thousands of them look to survive the financial implications of the imposed lockdown to tackle the spread of the coronavirus.
Despite attempts by the UK Government to offer financial support to businesses during the pandemic – including the Coronavirus Business Interruption Loan Scheme (CBILS), which grants emergency funding to firms – the speed of the downturn and the impact on revenues has hit these companies hard.
A total of 6,020 loans worth £1.1bn had been issued to small businesses under the CBILS by 14 April. However, UK Finance has said only 21% of the 28,460 formal applications had so far been approved for the government-backed loans, which are interest free for a year. It is understood up to 300,000 have made formal enquiries to access the scheme.
Research by the Corporate Finance Network, a research and accountancy network, found that nearly a fifth of all small and medium-sized businesses in the UK are unlikely to get the cash they need to survive by the end of April – suggesting that between 800,000 and a million firms nationwide may soon have to close.
But is there cause for optimism?
Since the market high on 20 February 2020, funds in the IA UK Smaller Companies sector have fallen by 26.5%*. At one point in March they were down almost 40%*.
However, history suggests you ignore smaller companies at your peril, if you are looking for long-term growth. The Numis Smaller Companies 1000 index has returned more than twice as much as the FTSE All Share in the past decade alone (94% compared with 48%)**.
The Coronavirus is also a unique black swan event, which has led to the downturn in markets, rather than a structural issue – meaning there is greater potential for a faster recovery, but no guarantee. Much will depend on picking those companies with enough cash to support themselves in these uncertain times.
Liontrust UK Smaller Companies fund manager Anthony Cross acknowledges the current economic and social situation is without precedent, but says the fund is well-positioned with limited exposure to classic UK consumer cyclicality and ‘person-to-person’ contact such as the travel, transport, pubs/restaurants, retailing, leisure and aviation sectors. Instead 60% of the fund is in industrials, technology (mainly software) and financials companies^.
Anthony says: “We entered this crisis owning a portfolio of companies that generate profits and have solid balance sheets: over two-thirds of them had net cash and a similar proportion paid a consistent dividend. This reflects the cash generative, low capital intensity nature of these stocks. Even those that do have debt on the balance sheet have only very conservative levels.
“Another feature of the small and micro caps stocks we own is that they all have a strong owner-manager culture. These teams have lots of ‘skin in the game’ and at times such as these, the practice of investing alongside management takes on a lot more significance.”
Elite Rated Marlborough Special Situations and Marlborough UK Micro-Cap Growth manager Giles Hargreave says he and his team have also been lowering exposure to businesses that are cyclical in nature (those whose revenues are most sensitive to the wider economic environment), and those with higher operational gearing (companies with significant levels of fixed costs that have to be paid regardless of what is happening to sales). They have also taken advantage of price weakness to add to their positions in companies they believe will be resilient during the crisis and beyond.
He says: “[In both funds] we have added to our holdings in Smart Metering Systems, which installs and operates smart meters on behalf of energy suppliers. In Marlborough UK Micro-Cap Growth, we have also added to our position in Augean, which manages hazardous waste. In both cases we believe these are strong businesses, well-positioned to weather the storm.”
LF Gresham House UK Micro Cap fund manager Ken Wotton says his team’s decision to hold a materially high cash weighting and focus on quality companies, with strong and sustainable market positions, has helped them in this bear market.
While undertaking some tactical divestment in highly valued or more cyclically exposed companies, Ken says the team has added to some names where valuations have become compelling. These include the likes of Inspired Energy, Finsbury Food, Domino’s Pizza and XPS Pensions.
Ken says: “In due course, the current market dislocation will provide almost unprecedented opportunities to back fantastic businesses at attractive prices either due to forced sellers in the market or through capital raises allowing companies to financially de-risk and survive the crisis and recover strongly.”
TB Amati UK Smaller Companies fund manager Paul Jourdan also believes there are reasons to be optimistic. He feels there is a fair chance that by the summer we will be in a position to limit isolation to vulnerable groups “because the healthcare system will be much better equipped to deal with the pandemic, and the number of cases will have receded by then.”
Paul says that his fund also carried additional cash throughout March as a precaution, before starting to add to companies the team felt were oversold towards the end of the month. He says: “The best example of this is Intermediate Capital Group, whose earnings will be relatively unaffected by the crisis, but whose shares had sold off by over 75% from the highs at one point. They have rallied strongly in April. Whilst there are still many significant risks arising from COVID-19 and the economic aftermath, we believe the portfolio holdings are resilient enough to be part of the recovery.”
*Source: FE Analytics, total returns in sterling, 20 February 2020 to 16 April 2020. The low was on 19 March 2020
**Source: FE Analytics, total returns in sterling for Numis Smaller Companies 1000 Excluding Investment Companies and the FTSE All Share, 15 April 2010 to 15 April 2020
^Source: Liontrust, March 2020 review