The first quarter of 2020 was jittery for the markets due to the novel coronavirus-triggered recession. However, expansionary monetary policies have supported growth and infused liquidity in the financial system. This has translated into a big surge for equities. Going into 2021, I am optimistic as the global economy gradually returns to normalcy.
Small corrections should be used to accumulate industry leaders. At the same time, investors with a higher risk appetite can consider exposure to fundamentally strong small-cap stocks with positive industry tailwinds.
For an academic perspective, InvestorPlace asked Surya Chelikani, PhD, associate professor of Finance at Quinnipiac University. In an email exchange, he shared an interesting insight:
A review of historical market data indicates that small-cap stocks have performed very well post-recession relative to their large cap counterparts. During the past few weeks, the Russell 2000 index (the small-cap stock index) has risen almost 8% while the S&P 500 index rose 3%. Going into 2021, overweighting their portfolio with small caps is feasible investment for those who can tolerate the risk.
I do believe that there are dozens of small-cap stocks that can deliver robust returns in 2021. This column will discuss seven small-cap stocks that are worth holding through the next year.
- Frontline (NYSE:FRO)
- Aurora Cannabis (NYSE:ACB)
- Patterson-UTI Energy (NASDAQ:PTEN)
- Nautilus (NYSE:NLS)
- Tattooed Chef (NASDAQ:TTCF)
- Antero Resources (NYSE:AR)
- Lifeway Foods (NASDAQ:LWAY)
Small-Cap Stocks to Buy for 2021: Frontline (FRO)
FRO stock is among the top small-cap stocks to consider for 2021. Frontline is engaged in seaborne transportation of crude oil and other oil products globally. Year-to-date, the stock has declined by 50%.
However, the downside has been due to the pandemic-triggered economic slowdown. Global GDP is expected to shrink by 4.4% for the year. However, for 2021, GDP growth is expected at 5.2%. Growth revival can trigger strong upside for FRO stock.
It’s worth noting that Frontline has continued to report positive EBITDA even as spot tanker day-rates remain sluggish. For the coming quarter, the company believes that the average fleet break-even will be $19,500. Once day-rates surge, cash flows will swell.
FRO is also worth holding as the company currently has a dividend pay-out of $1.70 and a dividend yield of 26%. If day-rates improve in the coming year, the dividends are likely to sustain.
From a supply-demand perspective, the tanker order book is already at a 20-year low. With an increasing number of vessels reaching retirement age, the day-rates are likely to be supported at higher levels.
Overall, FRO stock looks attractive after a deep correction in the last few quarters. The company is positioned to increase cash flows and potentially de-leverage in the coming year. This should trigger a sharp upside for the stock.
Aurora Cannabis (ACB)
Aurora Cannabis shares remained depressed for most of 2020. However, with Joe Biden set to office in January, ACB stock is up more than 50% from a post-election decline and currently trades above $10.
I believe that the stock still has potential upside with the House of Representatives passing the bill for decriminalizing marijuana. On the flipside, the bill is unlikely to get a vote in the Senate. However, with the process initiated, I see positive progress. In all probability, the worst is over for cannabis stocks for now.
From a business perspective, the key trigger for ACB stock is the company’s guidance to achieve positive EBITDA by Q2 2021. Its divestment of non-core business, coupled with cost cutting, the guidance seems realistic.
In addition, Aurora Cannabis launched value-added products in December 2019. The company’s premium and premium-organic products have the potential to boost EBITDA margin.
Aurora Cannabis has also been working on clinical trials for medical marijuana. Research-backed medicinal cannabis can be another game changer for the company. Currently, there is only one approved “CBD product, a prescription drug product to treat two rare, severe forms of epilepsy.”
Overall, ACB stock might still be a risky play. However, if EBITDA turns positive and the U.S. decriminalizes cannabis, the stock can double from current levels. I would therefore advise some exposure to the stock instead of a big position.
Patterson-UTI Energy (PTEN)
The energy sector has been one of the worst performers for the year. The pandemic-triggered recession has translated into sharp downside for energy stocks. However, the worst is likely to be over for the industry and Patterson-UTI Energy is an attractive bet for 2021.
As a matter of fact, PTEN stock has surged by 61% in the last month. However, on a 12-month basis, the stock is still lower by 43%. With Brent touching $50 a barrel, I am bullish for further upside.
As an overview, Patterson-UTI Energy is a provider of onshore drilling services in the United States and Canada. For November 2020, the company reported 61 operating rigs, that compares with 123 operating rigs in December 2019. This provides an insight on the demand destruction in the last few quarters.
However, according to the company’s Q3 2020 report, it expects “profitability will be at or near an inflection point in Q4 and move higher in early 2021.” The basic assumption is that commodity prices remain around current levels.
Besides the industry recovery factor, both its strong balance sheet and technologically advanced fleet are the reasons to like Patterson. Once oil exploration companies increase their rig count, PTEN stock should be among the key beneficiaries.
Nautilus is a provider of cardio and strength fitness products in the U.S. and Canada. NLS stock has skyrocketed ninefold. Even after the big rally, I believe that NLS stock is worth holding through 2021.
Quite simply: The pandemic has triggered demand for at-home fitness products. Witness Peloton Interactive’s (NASDAQ:PTON) near 350% rise this year. It’s expected that at-home fitness is likely to outlast the pandemic. There is data to support that view. Nearly 60% of Americans have enjoyed their home workout “so much” during the pandemic that they plan to cancel their gym membership.
The demand for at-home workout is reflected in Nautilus’ financials. Q3 2020 was a record quarter for the company with sales growth of 152%. It was also the most profitable quarter with an operating income of $44 million.
The Q3 launch of new products is also likely to support growth in the coming quarters. The company entered Q4 2020 with an order book of $72.8 million, shaping up to be equally strong.
NLS stock touched an all-time-high of $27.80 before correcting to current levels above $17. As growth sustains and cash flow increases, I expect the shares to remain firm. Therefore, fresh exposure can be considered at current levels.
Tattooed Chef (TTCF)
TTCF stock was listed earlier this year through a reverse merger. Plant-based food has been one of the key investment themes in the current year. With Tattooed Chef offering plant-based, organic, non-GMO and protein-rich products, the brand is likely to be in the limelight.
Tattooed Chef is already on a high-growth trajectory. For the first nine months of 2020, the company reported revenue of $108.9 million. Revenue growth was 87% on a year-on-year basis. Further, the company expects to deliver revenue of $222 million in the coming year. Along with robust revenue growth, the company is expecting sustained growth in EBITDA and EBITDA margins.
The pandemic has also increased the demand for healthy food offerings and this is a key growth trigger for Tattooed Chef. The company has also been aggressively expanding its product portfolio. Currently, its menu has 39 SKUs and is expected to increase to 59 in 2021. Recently, the company launched plant-based meat alternatives in its product offering.
Operating cash flow turned positive in the first nine months of the year. If OCF continues to swell, I expect the positive momentum to sustain for TTCF stock. Given the product portfolio and top-line growth momentum, I am bullish.
Antero Resources (AR)
Antero Resources is another interesting name among small-cap stocks in the energy sector. While AR stock has been moving higher, up 32% in the past six months, I believe that there is more juice in the rally in the coming year.
Recently, JP Morgan upgraded the stock to “overweight.” Arun Jayaram believes that the company is “uniquely positioned to take advantage of anticipated declines in U.S. supply for natural gas liquids and robust international demand for liquefied petroleum gases.”
It’s worth noting that for Q3 2020, the company managed to generate free cash flow (before working capital changes) of $88 million. If natural gas prices firm-up in the coming quarters, the FCF could be robust. At a current market capitalization of $1.34 billion, the stock seems undervalued.
As of September 2020, Antero Resources reported total debt of $3.2 billion. The company has an annualized interest expense of $190 million. However, for the current quarter, the company reported adjusted EBITDAX of $272 million. Considering the annualized EBITDAX, the interest coverage ratio comes to 5.7x. Therefore, debt servicing is not a concern.
Overall, I am bullish on the energy sector for the coming year and AR stock is an attractive name among small-cap stocks.
Lifeway Foods (LWAY)
Lifeway Foods currently sports a market cap of just $97 million. LWAY stock has surged by 210% this year, yet I believe that the shares still have upside into 2021.
As an overview, the company is a leading U.S. supplier of kefir and fermented probiotic products. For Q2 2020, the company reported 8% sales growth on a year-on-year basis. Sales growth accelerated to 14% in Q3 2020. If the positive growth momentum sustains, LWAY stock will continue to trend higher in the coming quarters.
One reason to be bullish on the company is the product offering in the time of the pandemic. The company’s drinks have immunity-supporting attributes such as probiotics, vitamin D and protein. With increasing retail visibility and digital growth, the outlook is positive.
Lifeway foods has already been generating positive operating cash flows. With growth sustaining, the company will have higher financial flexibility for product expansion and marketing.
Overall, LWAY stock can be considered for small portfolio exposure. I would not be surprised if the stock doubles from current levels in 2021.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.