Buy Hold Sell: 4 winning small caps and the worst of FY21

Where else in the world can you find innovative treatments, lithium, candles and jewellery all in the same category? In the small-cap arena of course! 

In the final instalment of Buy Hold Sell's FY21 review, we take a look at some of the pocket rockets within the small end of the market. While the ASX broadly had a commendable year, it was the darlings in the small-cap space that had a cracker. The ASX Small Ords Index was up around 27%, thanks to names like Brainchip and Chalice Mining. 

It was, however, our top-performing small-cap for FY21, discussed by our guests, that rallied the group, up over 1000% (you'll have to watch to find out which stock it is). 

But will FY22 see a similarly spectacular run? That was the question put to Shane Fitzgerald from Monash Investors Limited and Emanuel Datt of Datt Capital. In this episode of Buy Hold Sell, Livewire's James Marlay quizzes our guests on the best and worst-performing small caps of FY21. They'll also provide their outlook for this area of the market for the upcoming 12 months. Plus, our guests will also share two winning stocks for the year ahead. 

Note: This episode was filmed using Zencastr on the 7th of July 2021. You can watch, listen or read an edited transcript below.

Edited Transcript

James Marlay: Hello and welcome to Livewire's Buy Hold Sell, my name is James Marlay and today I'm joined by Shane Fitzgerald from Monash Investors and Emanuel Datt from Datt Capital. And we are back in lockdown. I guess the beauty of that is we can bring our Victorian guests north of the border in a COVID safe environment. Emanuel, great to have some Victorian participation on the show. Today's show, we are doing a bit of a review, or we're doing a series of shows on the best and worst performers from FY21 and our guests today are going to be talking about the small-cap sector of the market, which had a tearaway year. But underneath it all, it's kind of like a little bit of a mad feast underneath. Lots of volatility in small caps, as you would know. 

We might kick things off with some of the really strong performers, I'm going to start with Imugene, market cap, $1.2 billion. Shane, it had a great year, more than doubled - buy, hold, or sell on Imugene?

Imugene (ASX:IMU)

Shane Fitzgerald (SELL): Imugene for us is a sell. It's got a very novel modality it's going down for its solutions, it's drugs. However, it's a very early stage business. Only one of its drugs is in stage two clinical trials, the others are in stage one, even preclinical really. So for that valuation, given there's so much road still ahead of this business, we think it's pretty full at the moment, so we would say it's a sell.

James Marlay: Emanuel, cancer therapies, obviously a huge and very attractive market. Attractive to the directors, that bought some shares a little bit earlier on this year. Are you buying with the directors or are you a hold or a sell?

Emanuel Datt (SELL): I'm a sell as well, James. I think Shane hits the nail on the head when he says that this is an early-stage drug company. And I think investors have to keep in mind that drug development is a risky process. Only about 10% of drugs actually progress all the way through the whole clinical trial phase through to regulatory approval. And I think at over a billion dollars in market cap, it's very expensive for us.

Liontown Resources (ASX:LTR)

James Marlay: Okay, so Imugene had a great year, but a company that had an even better year was Liontown Resources. The stock has been around for a long time. It's led by Tim Goyder who is a veteran of the mining industry over there in WA. They're looking after lithium, $1.4 billion market cap. Emanuel, buy, hold, or sell on Liontown?

Emanuel Datt (SELL): I'd call this one a sell. It's run eight times in the last 12 months. It is now capped at about $1.5 billion. I think the resource itself is quite good, however, it's not really unique and they're not actually going to be producing until about 2024. That's what the company are aiming for. So I think there's a whole suite of lithium assets that are production-ready. Legacy of the last lithium boom back in 2017. So I think that this is far from the only candidate and I think the prices run a little bit ahead of the fundamentals here.

James Marlay: Yeah, that's a sell. Shane, Liontown is tapping into that theme with electric vehicles. There's been a lot of interest in lithium producers, particularly over the last 12 months. They even managed to put ESG on slide three of the latest presentation, which is obviously catching the attention of some investors. Is it a buy, hold, or sell on Liontown for you?

Shane Fitzgerald (HOLD): I to'd-and-fro'd on this one quite a bit, and at the end of the day, I came down on a hold. I acknowledged all the points our colleague just mentioned there about it's a longer stage business and it's a good resource. What I think that's a bit hard to fully value though, is the optionality in this company. It's the fourth biggest resource of hierarchal lithium in the world. And it's uncontracted. That's not the case anywhere else. It's also coming on stream in 2024 where the so-called gaping supply in lithium is going to be at its peak. So, there is a lot of optionality and there's also the optionality when they're spinning out of their gold and copper assets as well. So, the valuation is certainly up there, but at this point, I think it's still a hold.

Mesoblast (ASX:MSB)

James Marlay: Okay. Now one of the 2020s darlings was Mesoblast. The stock was all the rage when COVID hit the market 12 months ago. They peaked towards the second half of last year and it's been a downhill slide ever since. Shane, buy, hold, or sell on Mesoblast?

Shane Fitzgerald (SELL): Mesoblast is a sell for us. This company has been around for an awfully long time. It has had plenty of false dawns, and we saw a couple of them in the last little while. Back in December, one of their heart failure medications missed one of its primary endpoints. It did okay in one of the others and they're trying to repurpose the drug. But this is the classic story in Mesoblast, it's always something around the corner and it never seems to deliver. So for us, it's a sell.

James Marlay: Emanuel, Mesoblast, it's been around a long time, it's raised a lot of capital, and it's been a bit of a roller coaster ride as Shane described. Are you a buy, hold, or sell on Mesoblast?

Emanuel Datt (SELL): I'm a sell as well, James. So, as Shane pointed out, Mesoblast has been around for a very long time. They first floated in 2004 and haven't yet come out with a commercial product. They do have a big suite of products, so they're towards the mid and tail end of the regulatory approval process, and there's no doubt that they have attracted large pharmaceutical partners. But ultimately, this is a company that consumes a lot of cash with very little outcome so far. So definitely a sell from our side.

Kogan.Com (ASX:KGN)

James Marlay: Next stock, another rough year, Kogan. It was a beneficiary in FY20, had a cracking year with demand brought forward under the COVID circumstances. Hasn't had such a good run in 21. Buy, hold, or sell, Emanuel?

Emanuel Datt (HOLD): Kogan is a hold for us, James. We think that, even though the company had a great run last year, they have experienced some operational teething problems and hiccups this year, but I think overall for the long term, the company will continue to benefit from the tailwind of the transition to online shopping, but also attractive that it's founder run. And Ruslan Kogan has proven to be quite canny and entrepreneurial. So, that's a plus point for us, but it's definitely a hold for us. Not quite in the buy zone yet.

James Marlay: Shane, a wise investor once told me that downturns come in threes, we saw one in April with some indigestion around growth pains. Are you a buy, hold, or sell on Kogan at the moment?

Shane Fitzgerald (BUY): At the moment, I'm going to say buy on this one with a caveat. I want to see the next result, which is not that far away. Kogan's problems in the last 12 months really boiled down to a simple thing, they believed that the step up in their business experience coming out of COVID when everyone was in lockdown and everyone was spending online was the new normal, new base, and they were going to grow from that. So they built the inventory around that assumption, the distribution around that assumption. And then obviously it was a blip basically, and things came back down to earth. They need to cycle out that inventory build that they've had, but I back this management team, they are a very competent management team, they are excellent retailers, and there's an excellent play on e-commerce. We do see long term value there, but as I said, I just want to see the next result and be confident that inventory issues they've been dealing with are resolved.

Fundies' outlook for the new financial year

James Marlay: Okay. Got a couple of micro-stock specific questions on the best and the worst. Had a cracking run in the Small Ords through FY21. We need to now look forward. Shane, are you a bull or a bear on the outlook, particularly with a smaller company end of the market over the next four months?

Shane Fitzgerald: I would say I'm a perpetual bull when it comes to the small-cap market, and it's for a simple reason. Large caps are, by their very definition because they're large, leverage plays on the economy. So they're very dependent on what the economy is doing, up or down. In the small-cap space, what you tend to find is businesses where it's something about the business itself, the execution of a new strategy, a product launch, a geographical rollout story that is the story. So whether or not interest rates are going up or down or GDP growth points are higher or lower is not the thing that's going to drive those stocks. You can always find these businesses. And in any given year, you find plenty of stocks go up a lot and plenty that go down a lot. And that's our happy hunting ground.

James Marlay: Yeah. It's interesting that the four stocks that we just discussed as the best and the worst performers, all had idiosyncratic reasons behind their good or their bad performance over the past 12 months. Emanuel, I'm going to give you the same question just on the small-cap end of the market. Are you a bull or a bear or no animal at all over the next 12 months?

Emanuel Datt: I'm definitely a bull on the small-cap space. And it is because you find a lot of these companies are market neutral in the sense of, a lot of them are experiencing strong organic growth and are run by great entrepreneurial CEOs. So, as they're little, they have a lot more insulation from general market conditions than just large stocks that tend to trade around due to other factors. So, I think that idiosyncratic risk is something that we definitely look for and recognise that there's a lot more opportunity in the small-cap space rather than the large-cap.

James Marlay: Okay. Well, I lobbed four idiosyncratic ideas and for the two of you to give us your views. We've also asked you each to bring along a stock that you think looks good for the next 12 months. Emanuel, I'm going to start with you. Can you pitch us an idea for the next 12 months in that small-cap space, something that's got you excited and give us the theses on it?

Dusk Group (ASX:DSK)

Emanuel Datt: Yeah, absolutely. My pick would be Dusk Group. Dusk is an Australian homewares retailer, best known for its scented candles. And it just recently floated on the ASX in November 2020. It has about 120 physical stores. And somewhat uniquely, since floating, the company have released three consecutive positive earnings upgrades. And it basically demonstrates very strong sales growth, but also importantly, margin expansion, which is basically the holy grail of retail. The company continued to grow towards its long-term goal of 150 stores in Australia. But interestingly, it's also commencing its international expansion with New Zealand first off the rank. So some really interesting things we consider for the company going ahead is that the UK and the US markets have been flagged for future expansion. And I think just the metrics of the company are just absolutely incredible.

Each store turns in about a million bucks of revenue and you can compare that with other great retail chains like Lovisa. That's double Lovisa's revenue per store, basically. And it has strong customer loyalty, it's been growing its customer loyalty program by 50% over the last 12 months. But also the company trades incredibly cheaply for a growth stock. It currently trades at an EBIT multiple of about six times, which is closer to a private market value than a public market value we think. We value the company as it stands at about $6 a share and today it trades for a little under $4. So we think there's quite a bit of upside potential going forward for the stock.

Lovisa (ASX:LOV)

James Marlay: Shane that was Dusk Group from Emanuel, compelling pitch there. Have you got something that can match that up or do better than that for the next 12 months?

Shane Fitzgerald: Well I certainly hope so, it's one of the bigger positions in our portfolio. I'm going to say Lovisa. Lovisa has had a very rocky period during the COVID lockdowns because literally their stores were closed. But we think it's going to be a great reopening trade story. If you think about what's going to happen as the world reopens, there's going to be a lot of celebrations. People who had a birthday and don't normally have a party will probably have a party. And that plays right into their cheap jewellery line offering that they have. So we think you could see some pretty exciting sales growth like to like sales growth coming forward in this business.

Over and above that, the longer-term story on Lovisa has always been the store rollout program they were pursuing offshore. They are very early days in that rollout story. They’ve got circa 500 stores around the world. The end game here is 2000 plus, so it's not going to happen overnight, so it's going to deliver a very solid new store openings year after year after year, and that's going to end up being very solid sales and earnings growth. So we think Lovisa looks pretty good.

James Marlay: Well ladies and gentlemen, that wraps up our small-cap best and worst for FY21 episode. Not a whole lot of love in the best and worst performers from our group, but they did pitch us a couple of compelling small-cap ideas for the year ahead. Emanuel and Shane, thanks for your time. And for all you viewers out there, don't forget to subscribe to Livewire's YouTube channel, we have fresh content going up all the time and you can catch the other best and worst of FY21 episodes there on our YouTube channel. Thanks very much for watching.

What small-cap are you picking for FY22? 

Emanuel picked Dusk Group and Shane is backing Lovisa, but we would love to know what you think. Let us know your small-cap pick for the new financial year in the comments section below. 

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