Three small caps that generate cash

Bradley Mitchell, UK Equities Fund Manager at Royal London Asset Management tells MoneyWeek where he’d put his money now.

Bradley Mitchell, UK Equities Fund Manager at Royal London Asset Management tells MoneyWeek where he'd put his money now.

One of the strongest recent trends in the stockmarket has been firms returning surplus cash to shareholders through buy-backs or increased dividends. Market watchers have focused on larger firms that have been doing this, such as Vodafone, Diageo and Next. But some smaller companies have also been following this trend. Three worth taking a closer look at are Alexon (AXN), BPP (BPP) and BSS (BTSM).

Alexon: the cash machine

In what is likely to have been a difficult 12 months for UK clothing retailers, Alexon stands out because of its low valuation and strong cash generation. Alexon is the parent company for a broad range of UK fashion chains, including Ann Harvey, Dash, Dolsis and Envy. Roughly 80% of its outlets are housed in high-street concessions, such as House of Fraser and John Lewis, while 20% are stand-alone shops. Alexon isn't high fashion - hence its low valuation - but the broad spread of its operations removes some of the risks that fashion retailers can face. And the firm has shown it can trade profitably throughout the economic cycle.

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Alexon's trading strategy has hardly changed over time, but it has introduced a more flexible approach to its surplus cash flow. In January, the group bought back 900,000 shares, and it could well buy back 10% of its stock every year for the foreseeable future. The company's dividend outlook is more progressive than it has been in the past and, with buy-backs becoming a more regular activity, Alexon is looking very attractive. But the risk with this company is, of course, its exposure to the fickle clothing market. However, any weakness in its price, on the back of tough pre-Christmas trading, would create a good buying opportunity.

BPP: return of the graduate

BPP is a holding firm for a range of professional training businesses, the main areas of which are legal, financial and languages. Last year was tough for the firm. Legal and language training performed well, but financial training was a disappointment, resulting in a £1.5m loss for the firm.

So, why am I positive about BPP in the face of such losses? Because the poor performance of financial training was largely due to the fall-off in graduate recruitment and tightening of training budgets in the City. The outlook for 2005 is brighter - graduate recruitment has picked up and there has been a recovery in the City, which creates larger budgets for training. And following a four-year bulge in Capital Expenditure (CapX), it should reduce in 2005, with improved cash-generation fuelling share buy-backs and dividend growth. By 2005, when CapX is expected to fall back, free cash flow will exceed £14m, and buy-backs are also on the cards. One for the long-term.

BSS: a recovery story

BSS is a distributor of heating, plumbing and pipeline equipment to the new building and building maintenance markets. After a period of poor performance, it brought in new management in 2001. Their first task was to cut £5m from the cost base and get to grips with capital controls. At the end of 2002 their focus shifted to raising revenues, organically and through acquisitions. Now, earnings look set to grow by 17% next year and 11% in 2006. BSS also has a strategic value, given that it has a 14% share of the industrial market, and it seems likely its management would be more receptive to a bid approach once their incentive scheme matures next year.