Small and micro-cap companies have taken the heaviest hits in recent sharemarket falls following the US sub-prime crisis.
The S&P Small Ordinaries Index has dropped 15.8% in the past three weeks. It had fallen to 3437.5 at 11.25 this morning, down 647.3 points from a high of 4084.8 that it reached just three weeks ago on 24 July.
Small and mid-cap shares in the financial services and resources sectors in particular have been suffered bigger drops in value than the general market, according to Pengana Investments small cap fund manager Ed Prendergast.
“Businesses such as NFS and the Allco Finance Group, [that are] perceived to rely on exotic funding, have suffered as have businesses that people can’t value with great confidence or that don’t have sustainable profits,” Prendergast says. “For example Silex, a company commercialising a uranium enrichment technology, was capitalised at a billion and a half six weeks ago without any reliable profit predictions, but has now lost nearly 50% of its value.”
Other small cap shares that have taken hits in the current market include Monadelphous, Ausenco and financial services company HFA, market watchers say.
And, Prendergast says, recent good results from many small-caps are doing little to stop the rout.
“It doesn’t matter what your result is, when the market starts selling like it did yesterday, it became totally irrelevant,” he says. “That point is illustrated by companies like Australian Wealth Management. It’s a business with good results, well diversified and in very good condition, but it got hammered just because it’s in a vulnerable sector, so it shows there is zero correlation between what’s happening in the market and actual results.”
Cynthia Jenkins, the head of small companies at Invesco, says much of the selling is being carried out by traders meeting margin selling requirements rather than long term investors.
“Margin call selling happens when people are forced to sell to meet debt obligations, and generally when you borrow against smaller caps you can’t borrow as much so you have to sell more quickly,” Jenkins says.
Debate continues about whether the current market volatility will prove to be a short term correction or something deeper, but even if there is a recovery, it appears likely that small and micro-caps will be the last to benefit.
Ben Griffiths, a senior portfolio manager with boutique small cap fund manager Eley Griffiths, says large caps will bounce back first, then small caps, with micro-caps lagging well behind.
“The main reason is a lack of liquidity, but also micro-caps tend not to have research coverage, so they may not have broker spokesmen for them, so it’s harder for them to build support – and, of course, in many cases they’ve had such a fantastic run they’re due for a substantial correction anyway,” Griffiths says.
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Some companies looking for expansion capital are already feeling the results of the credit squeeze and cash flow is becoming a concern for small business. However insolvency practitioners say there has been no sudden rise in companies in trouble or collapsing.
Julia Bickerstaff, partner growth solutions at Deloitte Growth Solutions, told SmartCompany that she has several clients just in the last few weeks who have been looking to raise finance – and she has found that decisions have now been put on the back burner. “They are being told ‘hold on let’s see what happens’ and of course things are getting worse not better, so they are feeling that their timing has been out by a few weeks.”
Christine Christian, chief executive at Dun & Bradstreet Australia, says cash flow has become an issue for small business, particularly for small companies (revenue of less than $1 million). “Cashflow is being queezed as there is not as much liquidity around, so people may not pay bills as promptly,” she says.
Christian says that large companies are taking longer to pay small business, so they are going to need to get a lot more assertive about getting payment, particularly if the environment gets worse.
But two insolvency practitioners, who have been in drought for the past 15 years, say there is still no sudden spike in insolvency activity. Jim Downey from JP Downey & Co says when confidence is shaky, as it is at present, anything can happen. “But we have certainly not seen any activity yet.”
A recent report from the tax office shows that 600,000 small businesses owed the tax office $6.4 billion. But Downey says the tax office, despite talking often about targets, is not moving on businesses that owe money, and has issued very few winding up applications.
David Purcell, partner at Walker Insolvency Lawyers in Sydney, says cheap credit is yesterday’s news. “This must have an impact but it is too early to see it yet. Debt is very high and the banks are reporting delinquencies are at record lows, so it is the secondary lenders that are the ones to watch.”
Greg Hayes, from Hayes Knight, says businesses should not panic. “If things start to look more serious you may need to make changes in business directions, but I would be discouraging anyone from any knee-jerk reaction. You should be tough on people paying late anyway, and making sound decisions,” he says. “So don’t create a stampede… but if it looks like getting worse, don’t be the last one to make changes.”
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The credit squeeze seizing international markets could have an impact on Australia’s economy and become a factor in deliberations on interest rates, Reserve Bank of Australia governor Glenn Stevens told a parliamentary committee today.
The volatility could bring markets back to more reasonable levels, Stevens says. “An adjustment to investor behaviour needed to occur, and was almost certainly overdue. Such adjustments often are not entirely smooth, and are frequently triggered, as in this case, by the realisation that credit terms had been too generous for too long.”
But, he says, there is a risk that the credit crunch could go beyond what is needed and have a negative effect on the Australian economy – which in turn could have an impact on interest rate deliberations.
“Sometimes, however, the ensuing retreat can go too far, resulting in a widespread withdrawal from the provision of credit that unnecessarily crimps the pace of economic expansion. We will, therefore, have to continue to watch carefully how this unfolds over the period ahead,” Stevens says.
In general, however, Stevens was upbeat about the Australian economy, with rising domestic spending and demand for exports fuelling growth – and also the risk of inflation.
“The possibility that the world economy might end up being weaker than assumed, due to a persistence of credit difficulties, is one that everyone will have in mind at present. At the same time, there is also the possibility that ongoing strength of demand in a fully employed economy might leave us with inflation pressure that is harder to manage than expected,” he says.
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Business groups are ramping up calls for more details on Labor’s IR policy, as rumours continue to circulate that a shift to a more business-friendly policy is being considered.
Master Builders Association NSW executive director Brian Seidler says there have been hints from Labor that it is looking at some form of safety net test that would allow AWAs above a certain income level to run their course.
“We have also been given indications that Labor will be releasing the details of its policy for the building and construction industry in the next few weeks. We have seen some shifts in terms of keeping the Australian Building and Construction Commission until January 2010, but we need to see more detail,” Seilder says.
Council of Small Business of Australia chief executive Tony Steven says there are many rumours flying around Canberra about a possible shift by Labor, although they are primarily coming from the press.
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The tax office revealed who it will be targeting for audits and close scrutiny this year yesterday, as covered in our featured Tax Update. High net worth individuals, the growing number of retiring business owners exiting their business, and business owners taking profits, are at the front of queue.
Craig Holland, tax partner at Deloitte, says: “Some transactions which will come under scrutiny include sale of shares, sales of pre-CGT shares, sale of businesses, scrip-for-scrip transactions, de-mergers and trust cloning.
“One common mistake people make is not giving proper regard to notional capital gains provisions when selling pre-CGT shares. Just because the shares are pre-CGT does not mean the transaction is tax-free,” Holland says.
But the Taxation Institute of Australia is worried that some areas that are being targeted need further clarification of the law. “One area needing clarification is hybrid capital raisings,” says Institute president Peter Moltoni. He says another possible area of concern is in relation to private equity transactions.
The tax office plans to undertake 200 risk reviews and 40 audits of high net worth individuals. It’s little wonder – last year audits of 22 rich people raised $280 million.
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The Australian dollar has suffered its biggest weekly fall since the floating of the dollar in 1983, by 12.41pm slumping to US78.87c from yesterday’s Sydney closing price of US80.42c.
This has caused the Reserve Bank of Australia to intervene directly in the foreign-exchange market for the first time in six years, Bloomberg reports.
The sharemarket, however, is back to just about where it was at yesterday’s close, but it has put in some hard work to get there.
At 12.41pm, the S&P/ASX 200 is up 0.2% on yesterday’s close to 5720.4, after shooting up to 5788.2 after opening and then falling as low as 5646.2 just before 11am.
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