Small-caps and mid-caps riding global growth

Australian small and mid-cap companies are perhaps not the first port of call in an investors mind when considering avenues to gain exposure to international growth opportunities. Yet the sector at present offers investors a multitude of companies with leveraged exposure to the growth in offshore markets, a function that is becoming increasingly prevalent in our own portfolios.

Currently more than half of the entire earnings of the combined 45 companies held across the Ophir portfolios are generated from offshore. In the High Conviction Fund alone, the core investment thesis behind each of the top five portfolio positions at present all come from an expectation of increased earnings contribution from an offshore business unit or opportunity.

It’s important to note this increased exposure to businesses with international earnings isn’t the result of a strategic top-down call to deliberately overweight our portfolio into overseas earners. Rather than being by design, it is simply an outcome of an overall investment process that seeks to identify businesses that are demonstrating an ability to sustainably deliver above market earnings per share growth. In the current low-growth domestic environment, it is increasingly businesses that are growing into offshore markets that are invariably having an easier time in delivering that growth.

This increased weighting is also simply a function of the fact that many Australian emerging companies have taken it upon themselves to acquire or establish international operations in their own right, given the lack of available opportunities locally. When we talk with investors about the current portfolio positioning toward more overseas earners, many are surprised to learn that a number of fairly well-known Australian businesses now generate such substantial proportions of their earnings from offshore.
 

Webjet

Portfolio holding Webjet (WEB), for example, is most immediately recognised as the direct-toconsumer travel agent used by Australians to purchase flights and accommodation packages online. While this ‘Mainstream’ business line still presently accounts for ~60% of the Group’s total earnings, the business in recent years has moved fairly aggressively into a new business line that supplies wholesale hotel rooms to travel agencies globally. Through the acquisition of a number of larger players across Europe, the Middle East and Asia, the ‘WebBeds’ business line has subsequently grown to be the second largest B2B player globally, supplying agencies across 64 countries with hotel rooms in 170 nations. This is a fairly notable effort given the business only first ventured into B2B in 2013 with the acquisition of Middle Eastern player Lots of Hotels.

For investors, this means the underlying earnings leverage shifts away from Australian consumers’ propensity to spend on holidays and more toward the global structural trend of increased travel from the emerging middle class. While total transaction volume (TTV) in the traditional Australian online business grew at a still respectable +15% for FY17, the international B2B businesses under the WebBed’s umbrella are seeing multiples of that. Lots of Hotels, for example, saw year on year TTV growth out of its Asian source markets of +301%.

Premier Investments

The Smiggle business inside the Premier Investments (PMV) group is another international expansion story hidden inside a fairly iconic Australian retailer that we have highlighted in previous notes. While the FY17 Full Year results released this month highlighted a relatively flat sales performance out of the company’s heritage Australian-facing brands (Just Jeans, Jay Jays, Portmans, dotti and Jacqui-E), the Smiggle business delivered an incredibly strong +28.8% sales growth on FY16. With the addition of 58 Smiggle stores globally, the brand is moving away from a fairly lacklustre Australian consumer environment and instead now looks well positioned to benefit from the continued recovery across the UK (102 stores at end FY17) and continental Europe. While Australian retail sales data in August slumped to its lowest level in seven years, it was pleasing to see the UK retail data released in the same month reach three year highs. The UK now makes up Smiggle’s largest market for sales, with the retailer on track to open an additional 30-40 stores in the region through FY18.

With an increasing overweight to businesses with overseas earnings at present, it does demand more of the investment team in terms of travel to visit and analyse company operations on the ground. While the air miles have increased of late, we have found that the increased level of international travel (and the interactions we have with businesses, both listed and unlisted) continues to bring a more global perspective to the portfolio and has proved of benefit when understanding the growth opportunities ahead for local businesses earlier in their growth path.