If you think big caps are the only defensive stocks, think again. Small caps have led the way to a recovery, proving that they really can be resistant to external shocks. Since March lows, the ASX Small Ordinaries is up ~66% (as of August 20), with no signs of slowing down.

On this episode of Buy Hold Sell, Ben Clark of TMS Capital is joined by Victor Gomes of Eiger Capital to discuss the small-cap stocks that are marching to the beat of their own drum.

The stocks discussed include 1) A technology company that trades at a forward PE of 73x and pays a small dividend, 2) An essential service which is paying a reasonable dividend, and 3) A company flying under the radar. As usual, our guests bring along two stocks that fit the recession-resistant thematic.

Notes: Watch, read or listen to the discussion below. This episode was filmed on 12 August 2020.

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Edited Transcript 

Vishal Teckchandani: Welcome to Buy, Hold, Sell brought to you by Livewire Markets. My name is Vishal Teckchandani. Today, we're going to be talking about small-caps, which are resistant to almost any external shock, whether it's a pandemic, whether it's a new Nickelback album, these stocks will march to the drum of any beat. Joining me on the show today is Ben Clark from TMS and Victor Gomes from Eiger Capital.

Appen (ASX:APX)

Vishal Teckchandani: Victor, let's start off with you. Appen needs no introduction. Buy, hold, sell?

Victor Gomes (Buy): It's a buy for us. We like the business. We like the place it has in that whole ecosystem. There are some major megatrends here that are driving opportunity for Appen. Its customers are in an arms race for AI and machine learning. It's supplying the shovels and the picks, the annotation data labelling, the language relevance. There is customer concentration, we acknowledge that, but the growth profile is so strong over the next five years. We're very supportive of it.

Vishal Teckchandani: Ben, it's only on a forward P/E of 73 times earning. Pays a small dividend when a lot of tech stocks don't, stock prices hold up really well. Buy, hold, sell?

Ben Clark (Hold): It's a hold for me. We've owned the business for a number of years now, and I completely agree with Victor there. The demand for data is going to continue to go exponential. The quality of the data is becoming much more imperative for the bigger clients out there, which will be good for Appen. The Figure Eight acquisition, which had some wobbles in its early days, is now looking really good for them. And it's moving them into site and diversifying the business. For me, though, it's just that the multiple expansion we've seen over the last 12 months is fairly extraordinary. There hasn't been an upgrade really this year from Appen. So for valuation reasons, I'd have it at a hold, but it's a great business otherwise.

Cleanaway Waste (ASX:CWY)

Vishal Teckchandani: Okay. Staying with you, Cleanaway Waste. An essential service, pays a reasonable dividend. Buy hold, sell?

Ben Clark (Buy): I'll be a buy on Cleanaway. Very defensive earnings, I think less than 10% of the earnings come from corporates, which is a big tick at the moment. The management have done a great job vertically integrating the business. They've had some remediation costs that they've had to be wearing over the last few years, which will drop off going forward. So, that's going to drop nicely down to the bottom line. So I think it's a buy.

Vishal Teckchandani: Okay, Victor is this stock in your portfolio, or in your recycling bin? Buy, hold, sell?

Victor Gomes (Hold): It used to be in our portfolio, we have owned it. We don't own it today, even though we can own mid-caps and it's a mid-cap. I agree with Ben. It's very well managed. There's that ballast of the municipal contracts that are just very defensive. It doesn't have the same exposure that the other major player does to commercial, industrial, and to demolition construction. Probably the only thing keeping me out of it is the valuation, it just doesn't have enough growth for me to justify the valuation, and I can't make it stack up on … I forecast the cash flows and the growth just doesn't justify it. So, that's the thing holding me back.

Vishal Teckchandani: Okay, so you're a hold?

Victor Gomes: I'm a hold.

Hub24 (ASX:HUB)

Vishal Teckchandani: The next stock is HUB24, a tech stock that doesn't get a lot of attention. Buy, hold, sell?

Victor Gomes (Hold): Look, I'm a hold, hold to a sell. I think the valuation is the major part there, again. There's some structural tailwinds there. The shift to these new platforms, the legacy platforms have rested on their laurels, they haven't invested in their technology, they've allowed these new guys to come in and steal their share. And HUB has done very well out of it. I think it's priced very finely, and that's the thing that really makes me think long and hard. If it was cheaper, I'd be happy to buy it.

Vishal Teckchandani: What do you reckon Ben? Buy, hold, sell on HUB?

Ben Clark (Hold): Ditto. I'm a hold to a sell. The growth that they've had this year has been extraordinary. There's a huge structural change happening in financial service, and how rapidly that's happening is quite amazing. ClearView are going to be migrating onto their platform this year, so they're going to have another great year this year.

There is a bit of margin pressure in these businesses, there's more competition between Netwealth and HUB and a couple of other players. It's just the valuation, you're paying 50 times for this business. The share price has been very volatile despite how consistent the earnings growth has been. So I think there'll be better times to look at it.

Audinate (ASX:AD8)

Vishal Teckchandani: Okay. It's that time of the episode where our guests reveal their two secret pandemic-resistant stocks. Ben, what have you got for me today?

Ben Clark (Buy): I'm going to go for Audinate, which has just done a raising. This is the globally number one player in digital media networking. So they supply a lot of the hardware and software that is needed for it. They have been hit by COVID, but they raised about $30 million bucks recently, and what they're going to be using those funds for is R&D to develop new products that is going to benefit the COVID environment. So, that's helping their customers deal with employees working remotely, customers buying remotely, online learning. They've got $50-odd million in cash on the balance sheet, their EBITDA positive, great management team, and they're growing eight times faster than their nearest competitor. Truly a great business.

Elders (ASX:ELD)

Vishal Teckchandani: Okay, Victor, what's your pandemic-proof stock that you've brought us today?

Victor Gomes (Buy): Sure, my stock is Elders. We like Elders, we own it in the portfolio. It's obviously an agricultural, rural, and rural services company. You know, it's got a patchy history, but actually the recent history of the company is actually very strong. Management team are very good, they've done a great job. Returns on capital, which is a franchise factor we focus on, is actually very attractive. And the rural sector is really booming. You may have noticed it keeps raining in Sydney and it's raining in a lot of places. So, farmers have a smile on their face, anecdotes about real estate prices in regional, rural areas, very strong. It's got a bit of a tailwind.

COVID hasn't impacted regional areas and farming community, they're isolated by nature. So it's been a bit of a safe haven there, and I think it's got a really good next two, three years at the very least. And the valuation is very attractive.

Vishal Teckchandani: Okay. Well, if you think big-caps are the only stocks that are defensive, think again, because there's plenty of resilient business models in the world of small-caps.

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