There are many sensible reasons for investing in Australian small caps. For example: Access to earlier-stage, higher-growth businesses; a broader range of sector opportunities to pick from; an ability to more easily back future trends. As always, the golden rule with small companies is to leave it to the professionals. Whilst the rewards are potentially high, so too are the risks, especially for investors with short investment horizons. Using a small companies fund can provide a more sensible and measured exposure to small caps in both a professionally managed and risk constrained manner.
4 quality technology businesses
If one is looking to back some very strong future trends, Next DC has merit. As time goes on we will all consume ever-larger volumes of data on our mobile devices. Additionally most business software is moving to "software-as-a-service" (SaaS), delivered over the internet. This all translates to significant growth in demand for cloud based (a.k.a data centre) storage and processing. Next DC has the largest footprint of vendor-neutral data centres in Australia. With strong recurring revenues, high returns on capital, and further capacity being added to its network we expect to see strong share price growth in the years ahead.
Technology One is another beneficiary of the SaaS revolution. It is a leading provider of SaaS based enterprise (ERP) software to the mid/large corporate and government sector. The founder (executive Chairman) retains a large shareholding. This company has quite a unique track record of consistent earnings growth in the technology sector spanning almost 20 years of life as a listed company.
WiseTech Global also has a very large founder/CEO shareholder. In this case he owns more than 50%. Unlike TechOne, WiseTech is newer to the ASX having only listed in 2016. Nevertheless it has an equally long track record of strong profitable growth as a private company before listing. WiseTech's SaaS ERP software is a key enabler to the global freight forwarding and logistics industry (think "Amazon" driven volume growth).
Both Technology One and Wisetech Global have strong management teams, deliver high returns on capital and have balance sheets with no debt (net cash).
Aconex is our fund's third SaaS software holding, although a smaller position due to its earlier stage lifecycle (only recently becoming profitable). They provide customers with a collaboration based SaaS software for use in the construction and infrastructure industry.
All three SaaS software businesses are either regional (TechOne) or global leaders (WiseTech & Aconex) in their chosen field. The still-early stage of SaaS adoption by corporates should deliver this trio many years of good growth (subject to good management execution).
2 pre-revenue medical device companies
Another field of technology that Australia has historically done well in is medical devices (think Resmed and Cochlear, both of which started as small caps). Whilst generally of higher risk again, this space also offers some promising small cap opportunities. Two names with some merit are AirXpanders (a "better mousetrap" tissue expander for use in post-mastectomy breast reconstruction) and Impedimed (a bioimpedence device used to measure body mass/fluid composition which is a precursor to many serious disease conditions).
Both companies are very early stage and mostly "pre-revenue" so are commensurately much higher risk. We do forecast considerable revenues for this duo within our six year forecast period. Both have very large addressable markets and offer the promise of strong growth over many years.
So how to assess fair value for stocks in this sector? Technology stocks are generally high growth. For this reason they often trade on high price to earnings (PE) multiples. PEs will only look ahead 1–2 years. They won't capture any significant growth potential beyond two years.
A valuation based on cashflows that are forecast over a more reasonable (but not too long) period of say 5–6 years is a better compromise. To be sure, we expect the company share prices to see much more volatility than their underlying business over those six years. As fund managers it is our job to either trim or add to our core positions as market prices oscillate around our view of fundamental value. For part time investors this may be harder to do.
Contribute by Victor Gomes, Portfolio Manager
Disclosure: All the abovementioned companies are owned by the UBS Australian Small Companies Fund. © UBS Group AG 2017. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved
Disclaimer: Nothing in this document is to be taken as specific financial product advice. We have not taken into account any individual investor’s investment objectives, tax and financial situation or particular needs. Any opinions expressed in this document are subject to change without notice. Investors should seek professional advice before investing. UBS managed funds are issued by UBS Asset Management (Australia) Ltd (ABN 31 003 146 290) (AFS Licence 222605). Performance figures are net of ongoing fees and expenses. The benchmark does not incur these costs. The performance figures quoted are historical, calculated using end of month redemption prices, and assume the reinvestment of all distributions and do not allow for the effects of income tax or inflation. Performance has been prepared in accordance with 2015 GIPS standards. Performance can be volatile and past performance and fund ratings are not reliable indicators of future performance. Up to date performance can be obtained by contacting UBS Asset Management or by visiting our website.