The unloved sector at an inflection point

Glenn Freeman

Livewire Markets

The standout sector for the folks at Eley Griffiths isn’t sexy. In fact, it has been somewhat demonised as the decarbonisation train has blasted across markets in recent years. But EGG founder Ben Griffiths and his fellow portfolio managers are perhaps more bullish on commodities and resources than anything else right now.

Griffiths and co explained why during a recent webinar, pointing to some macro themes the style-agnostic (they’re not one-eyed on either Growth or Value) small-cap fund manager believes provide huge support to strong consumption trends.

"We think we’re at an inflection point there and see significant upside to investing in resources over the next year or two.” - David Allingham

Key takeaways

  • US productivity growth despite high unemployment
  • Inflation will be lower for longer
  • The most exciting Aussie small caps for this year and next
  • Four of EGG’s highest-conviction holdings
EGG places itself firmly in the “lower for longer” camp regarding its views on future inflation and interest rates. But while Griffiths’ team expects inflation to be transitory, “our view is it will be around for longer than most people think," portfolio manager David Allingham said.

US GDP surpassed its pre-COVID peak in March this year, but the number of jobs that have come back after the company closures and lockdowns of the last 18 months remains well below the pre-pandemic figure.

“Yet it’s producing more goods and services than ever, which really talks to the productivity boost that the economy has seen. This has been driven by investment in technology by American corporates,” said Allingham.

“From here, the jobs recovery will be a grind, which will be a struggle for the economy meaning rates should stay lower for longer.

The other big theme is the high savings rate that Allingham believes will sustain consumption. “We’ve seen a savings rate explode to higher levels than we saw in the GFC. The stimulus in response to the pandemic has gone into deposit accounts, which we see as a powder keg to really drive consumption, particularly in the consumption-based economies of the developed world,” he said.

On the macro-environment closer to home, Allingham and the EGG team dismiss concerns about the sustainability of Australia’s economic health, maintaining their bullish stance.

“We believe there’s going to be a significant wealth effect to drive the Australian economy as we move into 2022 and 2023,” he said.

Allingham reserved his most emphatic macro view for last, indicating EGG is "absolutely convinced" the resources bear market has bottomed. Harking back to the early 2000s, he recalled when commodity and resource companies were generating enormous returns.

“That has been absolutely dead for a decade but we think we’re at an inflection point there and see significant upside to investing in resources over the next year or two,” Allingham said.

Delving into the stocks, portfolio manager Nick Guidera reflected said he regards the ASX 200 as slightly more negative than it has been in the year so far.

But the Small Ords has stayed relatively stable, and impressive returns have continued from a few key sectors including communications services, real estate and particularly financials.

“Analysts are starting to bake in the impact of lockdowns and the higher earnings base that a number of companies are starting to cycle. One of the drivers of those negative earnings revisions is that a number of companies have signalled reinvestment, a theme I noticed a lot during reporting season,” Guidera said.

For example, Temple & Webster (ASX: TPW) last month flagged margins would stay flat while it reinvests in the areas of technology, artificial intelligence and delivery services. “They’ve outperformed during COVID and want to take some of those winnings and set the business up for long-term growth.

“On the other hand, retailers have struggled with how to invest these record profitability gains of FY21,” he said.

Home appliance company Breville (ASX: BRG) is one example of this alongside e-commerce company Kogan (ASX: KGN).

The most exciting stocks post-reporting season

Among the holdings Guidera and Allingham are most excited about for the rest of this year and into 2022, they nominated these companies.

  • Oilfield services company DDH 1 (ASX: DDH). The share price of $1.24 as of midday Wednesday is only slightly above its IPO price of $1.10. “It’s got everything going for it, with rig numbers and utilisation improving on the back of strong demand, we think there’s significant upside for this name.
  • The Reject Shop (ASX: TRS) There was no further insight provided on the discount retailer. But EGG has held the stock since at least last September - which is when Ben Griffiths did some undercover research.
  • Tyro Payments (ASX: TYR) “The company is at the forefront of the reopening trade that we’re going to see coming into Christmas,” said Allingham. Noting that retail and hospitality comprise around 80% of its transaction values, he believes the reopening will provide a huge tailwind for the payments company. 

Regarding Tyro, Allingham said: “It’s trading on a 30% valuation discount versus its opening price after its IPO, and it’s recently signed a very strategic deal with Bendigo…it’s going to be a very strong reopening beneficiary.”

“From $4 today, we think Tyro could comfortably trade beyond $5 as we move into the next year," he said.

EGG’s highest-conviction stock picks

Allingham described Carsales.com (ASX: CAR) as “the underperformer of the online classifieds space in Australia versus REA and Seek,” despite delivering compound growth of around 7%.

“It’s steady and has been a consistent performer, but if you look at what’s driving underlying profit growth, the mix of revenue is changing, with offshore revenue having grown from 11% to 24% of the group total.

“We think this is the inflection point for an acceleration of group-level earnings per share growth,” Allingham said.

“It will benefit structurally from what COVID has done, with people embracing the buying of cars online, as we’ve seen with Autotrader in the UK.”

From Carsales.com’s current price of just below $25 a share at midday Wednesday, he expects it will trade beyond $30 soon.

Allingham also flagged Karoon Energy (ASX: KAR), an oil exploration and production company with primary concessions in Brazil. Key positives for Karoon include the firm’s recent management overhaul and anticipation it will more than double production over the next two years.

And despite operating in a somewhat troubled sector regarding the environmental considerations around fossil fuels and decarbonisation, Allingham is also encouraged by management’s clearly articulated plans on the ESG front.

From EGG’s Emerging Companies fund, Guidera highlighted the following pair of stocks:

DGL Group (ASX: DGL). The chemical manufacturing company is one of the few recent IPOs Guidera’s fund has participated in, having bought into only 14 of the 90 IPOs in this part of the market over the last 12 months. Key attributes he singles out include the company’s founder-led management team, highly specialised business field with high barriers to entry and the upside of further acquisitions.

Serko (ASX: SKO) - Guidera described this reservations software company as “a technology play on the travel recovery.” Providing booking systems for corporate travellers globally, Serko recently inked a large deal with the business travel arm of Booking.com. “They’ve already activated 200,000 businesses that will use their platform going forward, with a potential $100 million revenue opportunity if they’re successful over the next couple of years,” he said.

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2 contributors mentioned

Glenn Freeman
Content Editor
Livewire Markets

Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...

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