Bursting the breakeven barrier - 4 ASX small caps discuss their path to profitability

While cashflow is king for small-cap investors, it’s important to understand which part of a business the cash is being generated from.

Specifically, the key question centres around whether companies are generating net-positive operating cashflows — making money from their core operations (as distinct from investing and financing cash flows).

In turn, “cashflow break-even” is a central concept — the point at which companies generate enough earnings from product/service sales to match (and then exceed) cash outflows.

So, how do companies themselves prioritise cashflow break-even? To gather different viewpoints from the executive suite, Stockhead saught commentary last week from four ASX small caps operating across different sectors — fintech, medtech, agriculture and insurance.

Growth priority

Interestingly, one consistent message that came out of our discussions was the preference for growth over profits — or at least a balancing act between the two.

On the investment side, fintech stands out as a sector where investors have been willing to focus on scalable revenue growth, with less of a priority on how that is flowing through to the bottom line.

And for Peter Cook, CEO of payments company Novatti (ASX:NOV), that was broadly in line with the investor feedback the company received when it completed a $10.2m share placement in June.

“I think at the moment investors in fintechs are looking at growth,” he said. “And looking at the general thematic of digital payments, they’ve seen the effects of COVID-19 which further decelerated the use of cash.”

“So in that regard investors are supporting companies that have a vision and have a track record.”

On the break-even front, Novatti’s 4C filing on July 30 revealed some strong momentum in the June quarter, with operating revenue topping $3m.

That result was in line with March, but a reduction in expenses saw cash outflows fall to just $16,000 (from -$543,000).

But prior to that, Cook said the company’s June raise was completed with a clear mandate from investors to top up its balance sheet as a basis to gun for growth.

“Our commitment to the market is actually to go back for growth, and the reason we raised the $10m was to aggressively pursue that,” he said.

Balancing act

While fintech as a sector stands out for its prioritisation of growth over profits, other companies we spoke to also said the break-even argument needed to be assessed in context.

“As a general rule you don’t want to sacrifice growth for profitability, and you don’t want to completely sacrifice profitability for growth,” Craig Cooper, CEO of cardio-health medtech CardieX (ASX:CDX), said

“It’s a balance, and it depends on the business sector you are operating in and what the specific value metrics are for that industry.”

Similar to CardieX, Bill Fry — managing director of organic honey producer EVE Investments (ASX:EVE) — says companies will ultimately be judged on their ability to generate profits, but it’s important to get the balance between profits and growth right.

“Profitability is certainly a key and necessary milestone to achieve, but it’s important to balance the need for profitability with the need to build brand and product awareness,” he told Stockhead.

“In order to achieve a long-term sustainable and successful business, you have to invest in developing the brand. And that may negate short-term profitability, but ultimately the goal is to generate long-term profitability.”

Profit priority

Of the companies we spoke to, only online insurance platform Ensurance (ASX:ENA), which does most of its business in the UK, flagged profits as a priority.

Chairman Tony Leibowitz told Stockhead that in the company’s capacity as a managing general agent (an insurance broker that can also underwrite coverage), Ensurance was focused on delivering two key profit streams.

“One is to our shareholders, which is often measured as a market comparison of core earnings (EBITDA), and the other is to our insurers (capacity providers) by way of underwriting profitability,” he said.

To achieve that, Leibowitz said the company had placed an increased focus on costs over the last two years, disposing of non-performing assets and “restructuring the cost-base significantly”.

From annual losses of more than $8m in 2018, he said the company was now very much “in play”.

“Those losses have ceased completely now and we’ve established a significant annual recurring base. So we see ourselves on the cusp of some very exciting results and news flow,” he said.

Looking ahead

Cooper highlighted that CardieX’s core medical device business had reached break-even over the last two years — up from annual losses of around $2m.

He added that most of the company’s cash-burn was now going towards new products. But in terms of the broader business strategy, Cooper pointed to the example of global e-commerce giant Amazon, which for years was famous for ploughing all its net earnings back into the business to drive top-line growth.

“Amazon CEO Jeff Bezos always said that investing in future growth was more important than hitting earnings targets,” Cooper said.

“So we are actively balancing our growth with our cash burn. And as we move towards subscription-based services and consumer device sales, the value opportunity for us comes from new customer acquisition and subscriber revenues. Those are key metrics for us going forward.”

Fry said EVE was devoting a healthy amount of new spending to its marketing budget, as it drove forward with its distribution push into US and Chinese markets, while Novatti’s Cook said the company was going for the “home runs”.

“We see this quarter (December) is going to be a lot about putting on extra management, working on additional partnerships, and doing the groundwork to accelerate growth in latter third of the year,” Cook said.

“So in terms of going back to the market, we’ve demonstrated we can get to break-even. But the cap raise really allows us to go back and aim for some home runs, and bring back a bit of a burn rate to go for growth.”