Small cap ASX shares have the potential to deliver big returns because they are starting from an earlier point in their journey compared to an established blue chip share. But how do you know which small cap company will go on to greater heights?
One fund manager has picked out Gentrack Group Ltd (ASX: GTK) shares as a major opportunity.
The ASX tech share is a software provider for utility businesses and airports around the world. It helps clients with efficiency and to deliver their customers better services. It's also helping utilities 'transform' in this 'sustainable era' to meet customer demand for how they purchase and consume energy and water. Gentrack says that "it is not a case of if utilities transform to meet these demands, but when".
Below is a snapshot of Gentrack's share price history.
The NAOS Asset Management investment team believes Gentrack shares offer considerable upside, saying it has a high level of conviction in the business as a core investment over the next three to five years. They give two main reasons.
Industry tailwinds for the small cap ASX share
NAOS said the first reason to be positive is the "significant" industry tailwind of all meter points globally transitioning to new IT systems.
According to NAOS, this represents an opportunity worth more than $1 billion across around 200 utility companies.
The fund manager noted that Gentrack has been able to secure new tier 1 and tier 2 customers and successfully implement their systems in a seamless manner, which was described as a "key risk" for any IT migration.
Gentrack share price valuation
NOAS says the small cap ASX share's valuation is also "extremely attractive".
The fund manager pointed out that Gentrack's customers operate in a highly regulated environment and are therefore "rather sticky clients".
NAOS analysts think the business generates excellent cash flow and has good cash conversion. It was noted that all of Gentrack's research and development is expensed (rather than spreading out the cost over multiple years, which is what a lot of other ASX tech shares do by capitalising those costs).
The fund manager pointed out that while Gentrack largely operates in three international markets, the small cap ASX share is now executing on a global expansion strategy. This was illustrated by the recent signing of a large utility company in Singapore. NAOS is particularly pleased by this foray because many ASX tech shares only operate within Australia and New Zealand.
The fund manager revealed how much future upside there might be with the Gentrack share price:
If management forecasts are to prove correct and in FY25 GTK produces $175 million of revenue and an EBITDA margin of 17%, then cash EBITDA for GTK would be ~$30 million. Of note would be the net cash position of the business which could reach close to $50 million. Using Objective Corporation Limited (ASX: OCL) as a comparative software business, which has similar attributes albeit a higher level of recurring revenue, OCL trades on 29 times EV/EBITDA. Even if you apply a 30% discount this would result in a valuation of $6.42 / share for GTK based on FY25 targets, which we see as particularly compelling given Gentrack's current share price.
