Small caps: What the present says about the future

Nick Guidera

Eley Griffiths Group

Small and micro cap companies have largely finished reporting their full year results to the market. Online retail and consumer facing Fin Tech firms have been market leaders while the REIT sector has understandably struggled. The travel industry is shaping up as a major beneficiary of a turnaround as markets start to price in opportunities beyond COVID.

We believe that money is made in small caps by doing the work, backing the right management, the right business, getting in early and seeing the journey out. Reporting season gives us the opportunity get an update on that journey and see how the business is performing.

In this interview I explore the best performing industries, those with huge rebound potential and the pertinent themes emerging from this reporting season. With investors looking to bank profits as outlooks shift beyond JobKeeper and stimulus, I highlight the firms in the best position to flourish.

Recorded Friday 28 August

Edited transcript

Sectors reporting particularly strongly

Consumer Discretionary would be the standout sector particularly retail and travel related names surprised the market to the upside.

Online retailers continued their top-line strength into August on the unfortunate second lockdown in Victoria, but with such explosive growth in revenue, a lot of this is starting to drop through to the EBITDA line, despite aggressive investment to support the ongoing structural growth opportunity. Temple & Webster, which is a name where we backed management early was a key example here.

Traditional retail also surprised to the upside on the improvement in profitability, despite the COVID Challenges. Reduced rents, restructured labour forces, Job Keeper & strong LFL in the last 2 months of the financial year have given good quality retailers such as Nick Scali & Adairs confidence in new store growth to support the omni-channel offering.

Fin Tech was also a standout this reporting season. Good quality management teams, with significant market opportunities, continue to be rewarded by the market for ongoing delivery. Netwealth a core holding in the EGG Portfolio, delivered a great result, despite the market volatility, low interest rates and a sizeable step up in investment.

Industries that are feeling the pain and potential turnaround opportunities

 A key disappointment this reporting season has been the REIT sector. Not surprisingly as retailers have threatened store closures and rent abatements have been abundant, the market is beginning to price in the likelihood of future vacancy rates in specialist retail. Shopping centre owners are facing the likelihood of a significant decline in the value of shopping centre assets.

Energy stocks, particularly coal and conventional oil and gas plays have struggled this reporting season. Burdened with debt acquired on the premise of a different commodity price outlook, coal companies such as Whitehaven Coal are struggling with bottom of the cycle pricing, while gas plays such as Cooper Energy are recording large impairments ($108mil before tax), as a result of lower price assumptions for un-contracted gas in Victoria.

As for turnarounds, the travel industry looks primed at this juncture for the most upside in the very near term. For many travel companies FY20 is a year they would rather forget, but initial signs suggest the desire to travel remains resilient, and cost bases have been reset particularly in the agencies for a significant rebound.

Key Themes & Trends

The discrimination in tech I think stands out as one of the key trends this reporting season. As the tech blow-off continues in the US market driven by a small concentration of large tech stocks, Australian tech companies have had plenty of underlying support from offshore leads. The fly in the ointment has been some of these tech stocks locally have had to release results which have struggled to meet lofty market expectations.

Tech companies with a large proportion of revenue weighted towards enterprise software sales have struggled. Potential clients have already seen significant disruption to their businesses through the pandemic, meaning large scale IT projects where whole of businesses are being re-platformed have been deferred. Bravura Solutions, Rhipe’s Dynamic Business and Elmo Software have struggled this reporting season as FY21 outlooks have confirmed the ability to sell new enterprise software is harder.

Conversely consumer facing tech names, those exposed to data consumption or with the ability to install remotely have thrived, as the Working From Home revolution has changed the way both businesses and consumers purchase and utilise tech.

Headline fatigue has been another key theme this reporting season. With so many companies providing disclosure prior to the release of formal results, including LFL sales comps and monthly trading updates, the lack of new news-flow, or the reluctance for companies to provide a guide for FY21, has been taken negatively by the market. In most instances many of these names are still up nicely for the FYTD, however investors are banking profits as the outlook beyond the end of JobKeeper and the ability to cycle the strong 2H, look challenging.

The other notable theme would be cash-burners losing less cash have been rewarded. Industries that have been severely impacted by COVID and had been forecast to record significant losses, who have managed to stem the losses and generate better end of year cash balances have seen a significant re-rate by the market. Corporate Travel & Vista Group stand out as two companies where the market is beginning to price what the future of these businesses look like, beyond the pandemic.

Company outlooks that offer hope for the future

In terms of companies that have given me hope:

Resimac – a major home lender with 21% growth in origination in the year, flagged repayment deferrals from those suffering hardships have reduced significantly.

Integral Diagnostics – a radiology play flagged 18% growth in volumes in New Zealand and a return to growth across all their portfolio outside of Victoria in July.

Peet Group – a large property & land developer flagged sales growth of 43% in FY20 driven by strong recoveries in the West Australian & Queensland.

Aventus Group – a leading large format retail centre owner flagged foot traffic had increased to 9% above pre-COVID levels in the past 3 months (excluding Victoria) across the portfolio.

Finally payments company Tyro flagged new applications for in store terminals are back to similar levels pre-COVID.

While the previous 4 months have seen a focus on costs for many companies to maintain profitability or stem losses, its encouraging to see companies not wasting a good crisis and investing in the future.

Natural Beauty play and owner of the Sukin Brand BWX flagged significant investment in new capacity to drive productivity in the production of skin care. Similarly FIFO airline and a long term EGG Holding Alliance Aviation saw the opportunity to acquire a new fleet of Embraer Aircraft to replace its existing fleet as they end their useful life, at bargain basement prices.

Finally its great to see an early backed EGG name Megaport continue to go from strength to strength despite the pandemic, signing a new global partnership with CISCO in the exciting growth area of SD-WAN.

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Nick Guidera
Porfolio Manager
Eley Griffiths Group

Nick joined Eley Griffiths in September 2016 after 6 years at the global equity research house CLSA, in both analytical and research sales roles in the US & Australia. Prior to financial markets Nick spent 4 years as a practicing lawyer.

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