Two stunning small caps I have my eye on
One of the most interesting investing trends of the past two decades has been Britons' growing love affair with budget busineses, be they Ryanair or Premier Inn. Seeking to join this high-flying group is the aptly named budget gym provider Gym Group (LSE: GYM).
The company is growing quickly by offering customers 24/7 access to its 80 local gyms without having to sign a burdensome annual contract and at an average monthly cost of just £14. This has unsurprisingly been a popular proposition for those watching their wallets as well as their waistlines. Revenue over the past six months was up 25% year-on-year to £36.1m and the company moved into the black for the first time with pre-tax profits of £3.4m.
Gym Group is targeting 15-20 new locations each year, which should be accomplished thanks to a highly cash generative business that has only £2.5m in net debt. This growth will be important as all parties involved expect industry consolidation and shareholders will benefit from Gym Group being in a dominant position when it begins.
Now, rapid expansion is great, but what does the outlook for the entire sector look like? The bad news is that while increasing numbers of Britons are switching to budget gyms, the overall percentage of the population with a gym membership is only growing in the low single-digits each year.
That means that eventually growth will taper off for Gym Group. But with a highly cash generative business this won't be the end of the world. Once a gym is up and running maintenance and staffing costs are quite low. And, since many members rarely use the facilities, the company can sell an average of 5,300 memberships per site without gyms being overcrowded.
Valuation-wise, the company is looking pricey with shares trading at 38 times forward earnings. However, if it can continue double-digit top-line growth and improve on already-impressive 41.5% EBITDA margins then the shares could have significant upside.
One to watch
Another fast growing business that's caught my eye is Patisserie Valerie owner Patisserie Holdings (LSE: CAKE). Like Gym group, Patisserie is growing sales quickly by both expanding the number of locations and squeezing extra revenue out of existing locations.
In the past six months the group added 12 new locations, taking the total number to 177. This includes several smaller brands the group owns, but Patisserie Valerie remains the prized possession with 126 sites.
Each new cafe is funded by existing operating cash flow, which means the company has no need for debt and at interim results stage had net cash of £8.9m. Strong cash flow is one of the most attractive aspects of the business and is driven by operating margins that clocked in at 16.7% over the past half year. The company is able to have high margins thanks to a vertically integrated supply chain, which keeps procurement costs low.
It's not exactly cheap as the shares have a forward P/E of 23.7. But if analysts are correct and double-digit growth in revenue and earnings continues for the next few years, then this valuation isn't ridiculous. With a huge market to attack, dividends growing and a well-managed business, Patisserie Holdings is one to keep an eye on.
While Patisserie is growing quickly, its track record can't match the 19 straight years of sales growth that has been recorded by the Motley Fool's Top Growth Share.
This classic British brand has already seen share prices increase 250% over the past five years, but with international expansion just beginning the Motley Fool's top analysts believe the shares could triple again in the coming decade.
To discover this under-the-radar growth share for yourself, simply follow this link for your free, no obligation copy of the report.
Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Patisserie Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.