Five key stocks in our Small Companies Fund
The Montgomery Small Companies Fund is diversified across the spectrum of growth. It includes stable compounders, tactical opportunities and structural winners. In the following wire, I set out our key holdings in each of these categories.
But first, let me explain the categories.
Stable compounders, whose earnings are expected to grow by between five and ten per cent per annum, offer defensive growth characteristics and are intended to provide investors with some protection as companies in this category are in stable industries, they tend to be market leaders and are generating, or will generate, solid cash flows.
Tactical opportunities offer 10 to 20% earnings growth. These firms might offer opportunities through industry catalysts, a company taking market share, or as we saw during and after COVID’s impact on a number of Australian industries, companies moving from being perceived as survivors to thriving.
Finally, structural winners might be part of a global megatrend, have long runways for growth, are disruptive and or market share takers with a long-term total addressable market that is theirs to lose. Their earnings are anticipated to grow by at least 15% per annum.
Tactical opportunity: Alliance Airlines (ASX:AQZ)
In addition to its own regional airline operations, Alliance Airlines wet leases planes to the big operators. Under a wet leasing arrangement, Alliance supplies the aircraft as well as crew, maintenance, and insurance while the customer pays by hours operated, pays for fuel, and covers airport fees, duties and taxes.
Alliance is a beneficiary of the reopening of domestic travel and specifically Virgin recommencing and scaling operations. We think the company enjoys the benefit of one of the best management teams in Australian small caps. Low unit capital cost assets, a low cost base and plenty of spare capacity means an estimated 40 per cent EBITDA uplift is not implausible.
As Virgin recommences operations it will need planes, AQZ have these and the cost structure to make money, along with a solid balance sheet.
Most recently Qantas announced it will aim for a greater share of the Australian domestic market with the help of Alliance under a three-year deal. Qantas will wet lease at least three of Alliance’s recently acquired Embraer 190 jets, and possibly as many as 14.
As a demonstration of Alliance’s status in the domestic market, Qantas noted: “The ability to switch on extra capacity with Alliance will help us make the most of opportunities in a highly competitive environment and having the right aircraft on the right route helps us deliver the schedule and network that customers want.”
Structural winner: Macquarie Telecom (ASX:MAQ)
Recent share price weakness reflects the fact this company is still evolving and also the market’s perception it is or was exclusively a COVID winner. Experience tells us the patient will be rewarded. Our valuation estimate is currently circa $70. Revenue from first stage deals will help the company fully fund its second stage.
The separation by the company of its Cloud Services/Government (CSG) and Data Centres (DC) into discrete divisions helps to emphasise the revenue and earnings growth of CSG. But DC revenue and earnings is what we see as the crown jewels. The wholesale customer at IC3 East is expected to commission its contracted capacity next financial year and billings, and therefore earnings from it, will emerge the year after.
Stable compounder: Uniti Wireless (ASX:UWL)
Uniti offers a bunch of internet services and arguably the most important is the installation of fibre networks on, and connection to, broadacre developments sites, Multi Dwelling Unit (MDU) developments and brownfields. Following its acquisition strategy, Uniti has effectively become the only competitor to the NBN. When it’s done, the company claims it will have built and own a fully funded fibre network covering a great swathe of western Sydney.
With the acquisition phase of its strategy now complete, Uniti will focus on integration, growth and building capability. In other words, it is now pivoting to organic growth. On that front, the company’s biggest MDU customer is Meriton however Stockland and Mirvac represent a third of the market, and Uniti’s commercial flexibility and deployment speed may yet convince them to sign up.
Importantly, the relatively low level of penetration into existing ‘brownfields’ also extends the company’s potential growth runway, while at the same time, the ‘visibility’ of its earnings and cashflows is improving.
One can also imagine a vast network of connected homes could be an important strategic asset for another telco or a great cash flow generator for a pension fund looking for a reliable income stream. But of course, that’s pure speculation at this stage.
In the meantime, the company knows how many buildings are connected and will be connected, and consequently the business is delivering sustained organic growth in annuity revenue. Only 10.5 per cent of second half FY21 revenue will be of the ‘one-off’ variety.
Structural winner: City Chic (ASX: CCX)
The combination of a winning formula and a demonstrated ability to execute is being transferred to overseas opportunities with large addressable markets. At the same time, clothing and accessories should see a surge in sales as economies, especially the US, the UK and Australia, reopen permitting consumers to dress up and go out.
In the Northern Hemisphere City Chic has experienced very strong double digit active customer growth of over 55 per cent to over 800,000 customers. This growth sets the company up well to cross-sell City Chic and Avenue products.
Importantly from a marginal cost of delivery perspective, its online penetration has also surged from 53 per cent to 73 per cent just in the last twelve months. Strong growth and higher margins are usually a recipe for PE expansion.
Tactical opportunity: Corporate Travel Management (ASX:CTD)
A "COVID recovery" beneficiary CTD should benefit from a slew of good news regarding the vaccine-fuelled reopening of the global economy and especially travel. The good reopening news includes, the US TSA (Transport Security Administration) reporting the highest number of passengers screened for travel since COVID19. AMC Entertainment’s CEO observing the business has pivoted from “survival” to directing a surge in movie going with 90 per cent of cinemas open, and American Airlines CEO noting, according to Bloomberg, “our last three weeks have been the best three weeks since the pandemic hit.”
Meanwhile US dine-in and hotel occupancy are near the highest levels in 12 months, Disneyland in California reopened on April 30 and US hospitalisations are falling at an accelerating rate, reaching near pandemic lows.
The pace of reopening suggests the US could lead the world on business and leisure travel this year and CTD’s US exposures positions it potentially ideally.
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Roger Montgomery founded Montgomery Investment Management, www.montinvest.com in 2010. Roger brings more than two decades of investment, financial market experience and knowledge. Roger also authored the best-selling investment book, Value.able.