17/12/2013 - 06:53

The great stock exchange cull

17/12/2013 - 06:53

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It is said that in space no-one can hear you scream. Amusingly, in a dark sort of way, the same can be said of the stock exchange during a crash because it’s unlikely that anyone heard a peep from the 54 (yes, 54) companies that disappeared from the Australian market over the past six months.

It is said that in space no-one can hear you scream. Amusingly, in a dark sort of way, the same can be said of the stock exchange during a crash because it’s unlikely that anyone heard a peep from the 54 (yes, 54) companies that disappeared from the Australian market over the past six months.

In what could turn out to be the start of a mass extinction event similar to that which wiped out the dinosaurs a few million years ago, ‘the departed’ of the past six months comprised a mix of companies that have been acquired in a takeover or, more significantly, been delisted for non-payment of listing fees.

The inability to pay listing fees is the most significant development because it confirms what every investor with an interest in the small end of the market had suspected for some time – that an entire generation of small listed companies has effectively run out of money.

The problem is two-fold. The owners of capital are on strike, and banks have closed their doors to everyone other than the least risky.

Names which have disappeared since June for non-payment of fees include: Carpathian Resources; Neo Resources; UCL Resources; Kalgoorlie Resources; Arafura Pearls; Strathfield Group; and Henry Walker Eltin. Stocks taken over include Azimuth, Avocet, Clough, Moby Oil, and Endocoal.

While companies come and go all the time, there has been a noticeable acceleration of departures during the past six months.

Long-term observers of the Australian stock market have seen the culling process, but it is unlikely they have seen a cull as big as the one just starting.

Two measurements best illustrate the size of the problem – the amount of money small companies have in the bank, and the market value of small companies.

Several recent surveys have revealed an alarming number of small mining companies whose cash balances have dropped into the danger zone of less than $1 million, and in some cases less than $200,000, which is barely enough to pay for the next quarter’s operations.

Market capitalisation, the value of the company on the stock exchange, is a second measure of the crisis washing over the small end of the market.

The latest list of total market capitalisation shows that almost 1,000 companies on the ASX have a value of less than $30 million, and several hundred have a value of less than $3 million – which is what a classy house costs in Perth’s western suburbs.

For a stock exchange-listed company to be worth the same as a suburban house is obviously an absurd situation, and one that cries out for change, with the only likely change being the departure of most of the minnows, or zombies, to describe companies which are essentially the walking dead.

There are three ways of looking at the situation:

  • accept it for what it is, a natural part of the boom-and-bust process whereby an oversupply of new stocks flood the market during the boom, followed by a great clean-out as failed companies are removed from the system;
  • recognise that the departed are likely to be restructured, recapitalised and make a return when the small end of the market booms again (which it will); and
  • have a close look at the cheap stocks with an eye on management and asset quality, because some turn out to be your investment of the decade.

That final point is loaded with risk. Most of the small stocks that have run out of money and have a share price of 1 cent (or less) will probably not survive, but some will make a return. And it isn’t much of a heavy lift to rise from 1 cent to 3 cents, though a move like that represents a 200 per cent gain.

In past busts, speculators with an appetite for risk have posted handsome profits after assembling a portfolio of 1 cent stocks (the classic penny dreadfuls) and then waited for the recovery, when some of their picks will rise sharply, offsetting the flat and the departed.

Much more will be said and written over the next few months about the great cull that has just started, and will become a feature of the market over 2014. 

Treat it as an amusing reminder of the boom, or see it as a way to play the recovery.

 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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