Three small cap themes, and how to play them

Michael Steele

Yarra Capital Management

The significant rebound in equity markets from its COVID lows will prompt many investors to ponder their ability to generate suitable risk-adjusted returns in the years ahead. For us, compelling opportunities remain ever-present in the smaller companies market, with many earlier stage companies offering compelling growth opportunities which are less hamstrung by legacy businesses and earnings. Importantly, we continue to see an increase in market inefficiencies driven by the rising prominence of passively invested capital and low sell-side coverage.

To illustrate the prevalence of compelling investment opportunities within the small end of the market as we move into 2022, here are three positive investment themes we currently favour across the resources, technology and e-commerce sectors.

Net-zero: As the world transitions to lower carbon emissions, we will need to undertake potentially the largest ever replacement of capital stock. This large and long-dated super CapEx cycle, ranging from your personal vehicle to the source of your power generation, will cost at least US$55 trillion and will bring increasing demand for commodities over a 10+ year time horizon. Our preferred commodities within this backdrop are lithium and copper: we expect lithium demand will increase by at least 10-times to 2030, supported by accelerating demand for electric vehicles (refer to Chart 1), while copper demand will be driven by renewables generation investment, transmission network expansion and EVs. We see Pilbara Minerals (ASX: PLS) and 29Metals (ASX:29M) as best placed to leverage this attractive demand outlook.

Chart 1 - Projected commodity demand growth to 2030 is significant

Source: UBS

Shift to the cloud: The importance of technology’s role in the global economy has been further highlighted by a rapid shift to working from home once never thought possible. While COVID has accelerated the shift to the cloud, we still see a significant growth runway as businesses chase the large productivity benefits that come from shifting on-premise data storage to multiple cloud products (refer to chart 2). But these productivity benefits require expertise, as the volume of data and complexity of networks continues to increase exponentially as extra cloud products are added. We see Megaport (ASX: MP1), a global leader with an expanding product offering, as particularly well-positioned to benefit from the continued growth in cloud products. 

Chart 2 - Cloud revenue forecasts are compelling - Two-year CAGR of 19% to 2022

Source: Citi Research, Flexera

Outdoor media: we see an attractive opportunity at this point of the cycle, with the media market below its pre-COVID levels, in clear contrast to many other cyclical industries that are materially above sustainable levels (e.g. discretionary retail and housing). Outdoor media provides a broad cyclical exposure across the whole economy and has a positive outlook, with the current starting point below pre-COVID levels (refer to Chart 3) despite economic activity more than recovering.

Chart 3 - Outdoor advertising revenue is below pre-covid levels

Source: Goldman Sachs global investment research

oOH!Media (ASX: OML) is our preferred media exposure which we expect will benefit from a re-opening of the economy and which also has long term growth through an expanding digital product offer and improving audience measurement.

Discover small and mid-cap potential

Australian investors can access the Yarra Australian Smaller Companies Strategy via the UBS Australian Small Companies Fund, a fund that has been managed by Yarra Capital Management since December 2018. 

Michael Steele
C0-Portfolio Manager
Yarra Capital Management

Michael is co-Portfolio Manager of the Firm's Smaller Companies strategy and is responsible for analysing the consumer sector and ex-100 companies within the Australian equities team. Michael previously spent nine years as an investment...

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