Six small-cap stocks with room to run

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Investors who missed last year's rally in Canadian small-cap stocks can still find attractive bets in the sector.

Resource stocks helped to drive this space higher in 2016 as commodity prices rebounded. But a recent pullback in energy and other areas has produced bargains, while other small-company stocks remain under the radar due to little or no analyst coverage.

Some stocks also pay a dividend, making it a bit easier for investors to wait for an industry recovery or for the market to recognize a company's prospects.

We asked three portfolio managers to pick small-cap stocks that are good deals, or have much more room to run.

Don Walker, Norrep Capital Management Ltd., Calgary

• The pick: Pollard Banknote Ltd.
• 52-week-range: $7 to $9.75 a share
• Annual dividend: 12 cents a share for a yield of 1.2 per cent

Shares of the world's second-largest printer of instant lottery tickets are poised to gain should its cash offer to buy Innova Gaming Group Inc. succeed, says Mr. Walker, who runs the Norrep Entrepreneurs fund. Los Angeles-based Innova operates lottery-ticket machines with an interactive video screen. Pollard, based in Winnipeg, has a lock-up agreement with Amaya Inc. to pay $2.10 a share for its 40-per-cent stake in Innova. A committee on Innova's board is evaluating the proposal. Potential earnings and cost synergies from a merger would generate a lot of free cash flow to pay down debt and maybe increase the dividend, Mr. Walker said. Pollard's stock is compelling because it operates in a stable market where it's tough for a new rival to enter, he noted. "Its valuation looks quite attractive when I look at its earnings potential."

• The pick: Orbit Garant Drilling Inc.
• 52-week range: 72 cents to $2.21 a share

The stock of this Quebec-based mining driller should benefit from recovering metal prices, says Mr. Walker. "Eighty per cent of what they drill for today is gold, and gold seems to be leading the industry out of the downturn." Orbit's stock trades below tangible book value of $2.20 a share, but that is not really a true figure, he said. The company makes its own rigs, so their value is understated by 30 to 50 per cent on its books, he said. Orbit is also growing by acquisition; it recently bought a driller based in Chile. Orbit's shares, which peaked at more than $6, fell below $1 last year before rebounding. Lack of new mining investments since 2012 has squeezed the supply of metals and helped to raise prices. Orbit's earning power is "a lot higher than reflected in the stock today," he suggested.

Jason Whiting, portfolio manager, Invesco Canada Ltd., Toronto

• The pick: Cervus Equipment Corp.
• 52-week range: $10.41 to $16.52 a share
• Annual dividend: 28 cents a share for yield of 2.3 per cent

Shares of this operator of dealerships selling John Deere agricultural equipment have struggled amid weak crop prices and a dividend cut, but its stock has started to rebound. "I think commodity prices have generally stabilized," said Mr. Whiting, who oversees the Trimark Canadian Small Companies Fund. More than 60 per cent of sales come from its agricultural brand, while transportation and construction equipment represents the balance. Its main competitor is Rocky Mountain Dealerships Inc., but the two operate like a duopoly in Western Canada, so pricing competition is not a concern, he noted. Calgary-based Cervus just reported cash flow per share of about $1 for 2016, down from a peak of about a $1.50, but that could double to $2 a share in a recovered market, he suggested.

• The pick: Pulse Seismic Inc.
• 52-week range: $2.11 to $2.72 a share

Shares of this Calgary-based seller of seismic data fell into the bargain bin after the downturn in energy prices, Mr. Whiting says. Oil and gas companies pay a licensing fee to access its data, which help them decide where to drill in Western Canada. Pulse Seismic, which has about 35 per cent of this market, has "a very attractive business" because it doesn't have to compete on price since no one else has its particular regional data, he noted. Sales are off 80 per cent from the peak, but low operating costs allow it to still make money, he said. "It's a really great asset, so it's just a waiting game for a turnaround." The stock of Pulse Seismic, which has about $5-million in cash and no debt, could be worth about $5 or $6 a share in a better market or if it were to become a takeover candidate, he suggested.

Steven Palmer, president and portfolio manager, AlphaNorth Asset Management, Toronto

• The pick: Kraken Sonar Inc.
• 52-week range: 10 to 27 cents a share

Shares of this Newfoundland-based maker of underwater robotic systems have upside potential because of emerging uses for ocean drones, says Mr. Palmer, who runs the AlphaNorth Partners Fund. Oil and gas companies use them to monitor pipelines, while the military uses them for mine detection and surveillance. Kraken is a leader in sonar technology, and its approach is less pricey than that of its rivals because it takes a software-centric approach, he said. It reported a small profit in the third quarter last year, with 91-per-cent higher revenue compared with a year earlier. Potential catalysts include two contracts that could be announced in April, he said. Risks to Kraken stock include competition from technology and defence companies, but it is comforting that management has skin in the game with a 50-per-cent stake, he added.

• The pick: Cobaltech Mining Inc.
• 52-week range: 2 to 45 cents a share

This mining junior is a rare pure play on cobalt, a byproduct in silver and copper production, says Mr. Palmer. But cobalt demand is growing, particularly for batteries in electric cars, he said. Prices have surged to about $24 (U.S.) a pound from $10.80 at the start of 2017 amid news that some hedge funds are stockpiling the metal. Sixty per cent of the world's cobalt comes from the Democratic Republic of the Congo, but political instability and reports of child labour have buyers looking elsewhere. Cobaltech last fall acquired a past-producing silver and cobalt property near Cobalt, Ont., and will need to spend more than $2-million to get the mill back into running condition, he said. While the plan is to process the tailings, Cobaltech is still a speculative play, he said.