Spytech, IPOs and Christmas shopping: the small-caps to watch in the reopening

Wilson Asset Management

Wilson Asset Management

As we start to come out the other side of COVID – setting Omicron to one side, with fingers crossed, for a moment – you'll have noticed that much of the positive talk about recovery has been qualified by creeping concerns about supply, labour and rising interest rates and the negative implications for the current market cycle.

Still, there have been a few areas where the positivity is undiluted, with small and micro caps sustaining a surprise rebound during the Pandemic, often offering added room for growth compared to their large-cap counterparts.

This is especially the case, says Oscar Oberg, for the Australian small-cap scene:

The difference this time is because Australia is coming out of coronavirus lockdowns and economies are rebounding, there is very strong demand. There is a lot of savings from consumers and you also have a very positive environment for consumer sentiment. 

In this video, the investment team at Wilson Asset Management argue their favourite small- and micro-cap stocks picks ahead of the reopening and the biggest opportunities going forward.

Discussion Points:

  1.  The rise of inflation and other market dynamics
  2. Singling out the tech, resources, telecomm and resource sectors

Edited Transcript

Olivia Harris: In this segment of WAM Vault I am joined by Will, Cooper, Oscar, Tobias, Shaun and Sam. Oscar, we will start with you. We are seeing a lot of dynamics at play in the market right now. There is higher inflation and talk about rising interest rates. What is your outlook for small-caps?

Oscar Oberg: It is a really tough market to call right now and it is probably one of the hardest markets we have had for some time. I think it is largely because, as you said, just inflation everywhere. Whenever we meet a company, whether it be commodity prices, freight or labour, every company is talking about inflation right now and generally when you have rising inflation and rising interest rates, that is a negative for the share market. The difference this time is because Australia is coming out of coronavirus lockdowns and economies are rebounding, there is very strong demand. There is a lot of savings from consumers and you also have a very positive environment for consumer sentiment. So we are watching it very closely but for the most part, given we like to invest in companies in the small-cap market exposed to the Australian economy, we are very positive on the environment for small-caps going forward.

Olivia Harris: Sam, I want to flip to you. One thing Oscar mentioned was that higher interest rates can be negative for equities. In regards to the technology sector, are you seeing any room for opportunity there?

Sam Koch: Definitely. Higher interest rates typically are negative for the technology sector, however we think it is actually slightly more nuanced than that. 

When we spoke to many fund managers and most brokers and companies, everyone is talking about the prospect of higher inflation and that naturally leads to increased rates. There is a general expectation out there that rates are going to rise. While some might take a view that they are not going to touch the sector from a macroeconomic perspective, we have been doing our homework and identifying individual companies that we think will outperform in the current environment.

Key categories that we are looking at the moment is technology companies that are benefiting from the reopening. More members on Life360’s (ASX: 360) platform are going to engage as we reopen and similarly for hotel software provider SiteMinder (ASX: SDR), a recent company that has undergone an initial public offering (IPO). The second key category is those companies that have pricing power. As increased inflation comes through, that can impact costs. We are gravitating towards those companies that can raise rates, raise prices, maintain margins and increase margins over time, such as Carsales.com (ASX: CAR) and PEXA (ASX: PXA).

Tobias Yao: As Sam mentioned, one of our larger technology positions is a company called Life360. Life360 has a family location sharing app which effectively allows parents to track the whereabouts of their kids, usually teenagers. It is a little bit like big brother, but it does give the parents some peace of mind. One of the initial catalysts for us to buy Life360 was on the back of the appointment of Randi Zuckerberg, sister to Mark Zuckerberg and also one of the early Facebook employees. Given her profile and the amount of opportunities that come across her desk, we thought it was a huge vote of confidence that she decided to choose Life360.

Having delved further into the business model, we realised that despite having over 30 million active customer users, the user engagement levels are really high. In fact the users love the utility and love the product. That is very important for a premium model like Life360 because it is not only just about growing users, it is about monetising that user base in driving revenue growth. Chris, the CEO and Co-Founder is very impressive, both strategically and also from a marketing perspective as he has created one of the most viral internet campaigns. And finally, the valuation is actually undemanding relative to many of its international peers, so we believe the share price still has material upside, driven by continued top line growth as well as multiple expansion on the back of people getting more comfortable with the long-term growth story.

Olivia Harris: Oscar, are you seeing a positive environment in the initial public offering in the acquisition space at the moment?

Oscar Oberg: Yes we are. We are seeing plenty of deals at the moment. For the most part they have actually been pretty good. We have participated in SiteMinder (ASX: SDR), Judo Bank (ASX: JDO) and Vulcan Energy (ASX: VUL) and also a micro-cap company called Step One (ASX: STP). They have all performed very, very strongly and we expect more deals to close out the year. It has been a busy backend for this calendar year and we do expect more.

Olivia Harris: Shaun, could you maybe give us an example of a recent IPO you participated in?

Shaun Weick: Sure. Step One is a recent IPO that we quite like. That business was founded by the current CEO Greg Taylor. Today it is servicing the Australian market as well as the UK, and also an emerging operation within the US. It is essentially a retailer of men’s underwear and we see significant growth opportunities for this business going forward as they expand into other categories including women’s and sports and then there is the geographic expansion coming down the road. If you look at the growth trajectory of the UK business it is materially exceeding the Australian business at similar stages of its lifecycle. Going forward we think that is a great vote of confidence and provides the blueprint for the US business. Management have significant skin the game, retaining 66% of the shares post the IPO. We think there is strong alignment there with shareholders and see a really good runway for this one medium-term.

Oscar Oberg: Like all companies we wanted to test the product. I actually did the first meeting and Shaun wasn’t in the meeting. I thought I would get him some underpants to send him up to Coffs Harbour.

Shaun Weick: And I can say with a strong vote of confidence, I am wearing them right now, and they are extremely comfortable. So get out there and get yourself a pair.

Olivia Harris: Tobias, one think you have spoken about in the past is the pre-IPO space. Can you talk us through that a little bit and the opportunities that you are seeing there at the moment?

Tobias Yao: Sure. The pre-IPO opportunities are typically companies with the aspiration to list in 12 to 24 months, but just need a little bit more capital to get them there. It is attractive to investors like us because of three things. Firstly, it allows us to buy a stake at a reasonable valuation, typically using a convertible bond structure so it limits our downside. Secondly, these companies are typically very high growth, so our bet is that the growth can continue over the next three to five years. Finally, it gives us a bit of time to familiarise ourselves with the industry, with the company and the management team, so we can build the conviction to bid harder into the IPO process. There are lot of pre-IPO opportunities in the market. Most of them are in the technology space given that is where the growth is. Some of the notable ones in our portfolio includes Iris Energy, which is going to be listed very soon, Xpansiv, which is a carbon trading platform, and also one of our new names is Packform, a business-to-business packaging solution in the United States.

Olivia Harris: Shaun, could you give us an example of a pre-IPO opportunity that you participated in and continue to hold?

Shaun Weick: Tobias forgot my favourite one which is Camplify (ASX: CHL). Camplify is essentially the Airbnb of recreational vehicles (RVs) and campervans. The business was founded here in Australia and has since expanded into New Zealand more recently via acquisition to now become the number one player through SHAREaCAMPER. It also has operations over in the UK and Spain. Going forward for this one we see a really strong growth trajectory, particularly as we move into the second quarter and thankfully we all get out there and take some holidays for the first time in probably two years. It is seeing bookings across the platform completely filled out for the next three to four months. We are expecting a strong quarter coming up and we think this business has very bright opportunities ahead for it.

Olivia Harris: Shaun, sticking with you. We want to talk about some individual sectors now. The retail space has obviously been impacted by supply chain issues and coronavirus lockdowns. Are you seeing any opportunities there?

Shaun Weick: We actually think in the retail space the best opportunities are within those that have been impacted by the coronavirus. These are the ones that have either leverage through a store base that will benefit from demand coming back into stores reopening, or they have a product that will benefit from reopening. 

Some of the examples of opportunities that we really like there are the moment are Accent Group (ASX: AX1). We are also holding some Lovisa (ASX: LOV) at the moment which is a fast-fashion jewellery retailer. Universal Store (ASX: UNI) is another one we quite like in that space too. City Chic (ASX: CCX) as well, which is a plus-size women’s retailer. We think there are still good opportunities in the retail space.

Olivia Harris: Sam, there has been a lot of excitement around telecommunications. Are you seeing any opportunities there? Are you playing that in maybe the WAM Microcap (ASX: WMI) Portfolio?

Sam Koch: The sector has been on a tear recently. We believe investors are actually attracted to the organic and inorganic growth profiles within the sector at the moment and we are playing it through three different ways. The first is rapid organic expansion into new markets with companies like Tuas (ASX: TUA) and MNF Group (ASX: MNF). The second is inorganic opportunities. These are companies that are rolling up the fragmented space, such as Swoop (ASX: SWP) and Aussie Broadband (ASX: ABB). Finally, we are playing a turnaround in Superloop (ASX: SLC). Superloop is an interesting one. It has been backed by Bevan Slattery who is a doyen in the telecommunications sector for sure. Effectively it has sold two of its underperforming assets in Hong Kong and Singapore at a 30% premium to the book value, and is going to reinvest those proceeds in a way that we think is quite shareholder friendly, through capital management or accretive acquisitions.

Olivia Harris: Cooper, traditionally WAM Microcap and WAM Capital (ASX: WAM) have avoided the resources space. Are you seeing any opportunities there given such a positive environment?

Cooper Rogers: I wouldn’t like to say we have avoided the resource space but we have typically played to our strength and invested in that sector through resources sector derivatives, and we still do. We still own companies like Imdex (ASX: IMD), DDH1 (ASX: DDH) and ALS (ASX: ALQ) and they give us exposure to drilling and exploration and we also own Monadelphous (ASX: MND) and Austin Engineering (ASX: ANG) which are engineering companies with earnings derived from the resource sector. That is how we traditionally play in that space.

As you can see there are six of us, a little bit more bandwidth in the team. Thommo and I love resources so we have gone out increasing our direct exposure. Companies still have to fit in with the WAM Capital investment process. They have to be undervalued growth companies with upcoming positive catalysts, for example, copper players like New World Resources (ASX: NWC) and Eagle Mountain (ASX: EM2), as well as a pure play oil producer Karoon (ASX: KAR).

Oscar Oberg: Cooper is very modest but he actually won the award for the best stock in the WAM Microcap portfolio last year which was Chalice Mining (ASX: CHN).

Olivia Harris: Yeah right. Go Cooper.

Cooper Rogers: There you go.

Shaun Weick: Might win it this year too with some of the uranium names.

Cooper Rogers: Oh yeah.

Olivia Harris: Will, green energy investment has attracted a lot of attention over the last year. Are we engaging in that thematic at all?

Will Thompson: Yeah definitely. Lots has been written about it and we saw Biden’s Infrastructure Bill over the last week, which is all green energy focussed. We focus on high quality companies with a quality management team and quality projects. Mincor Resources (ASX: MCR) is an example of that, a nickel miner. Its downstream partner is BHP (ASX: BHP). It is partners with Tesla (NASDAQ: TSLA). We think there is upside in the valuation and upcoming catalysts because it could probably significantly increase its production quite easily. Then on the uranium space, Boss Energy (ASX: BOE) resources is a really good company and we like their management.

Olivia Harris: Tobias, what would be your most successful non-consensus holding over the last 12 months?

Tobias Yao: It would have to be Tuas Limited, or TPG Singapore, which is a disruptive mobile service provider in Singapore. TPG Singapore was spun out of the merger between TPG Telecom (ASX: TPG) and Vodafone and it was founded by David Teoh, one of the most astute and successful businessmen around. After listing, TPG Singapore’s share price went through a prolonged period of weakness given there were a lot of unnatural shareholders that got out. In fact, we would argue that the market forgot about the stock, given at one stage it was trading at a 40% discount to its net tangible asset (NTA) backing. That is when we started buying shares. As a newly listed business there was not a lot of publicly available information, so we had to do a lot of proprietary research, speaking to Singaporean experts or competitors and trying to triangulate the various data sources online, and what we realised is that there were two things that we believe will drive the share price over the coming years. 

Firstly, in Singapore there is a huge proportion of the market of migrant workers and the TPG mobile plans are typically 80% cheaper than all other plans. We think that will resonate well with this large cohort of customers. Secondly, with a lot of phones in Singapore having dual sims – so two sim cards within the same phone – it means TPG can continue to disrupt and grow market share without the incumbents realising that they are losing market share from TPG. 

As a result, the company announced very good results at the most recent announcement showing that it tripled its customer base and the share price went up 150%, as it went from a discount to NTA story to a growth company. We still think the business can grow over the coming years. But that would have to be one of our best non-consensus calls.

Olivia Harris: Oscar, is there a message that you would like to leave the shareholders?

Oscar Oberg: It has been a tough 18 months. It feels a lot longer since coronavirus started and just like everyone, it has been tough for the team. We have done an incredible job working from home and on countless amount of Zoom calls, and as you have seen today we have a great team and a wide array of experience. I am very positive in terms of how we are performing and obviously for shareholders and I would also like to say thank you to all the shareholders for their support. Really appreciate it.

Olivia Harris: Thanks very much guys. It has been great to chat.

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Wilson Asset Management

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