We’re seeing the most opportunities in small and mid-caps since 2020

From the middle of 2023, over 800,000 Australian households with fixed-rate home loans written at rock-bottom interest rates began switching to much higher variable rates. This, combined with rising inflation and decelerating consumer sentiment, heralded a painful period for consumer discretionary stocks in sectors such as retail, automotive, building materials, media and tourism, which make up approximately 20% of the S&P/ASX Small Ordinaries Accumulation Index.

While cognisant of a deterioration in the economic environment, our team saw this period as an exciting opportunity to invest in the consumer discretionary sector, despite analysts aggressively cutting their forecasts in the 2024, 2025 and even the 2026 financial year. 

Using our investment process, we have compared analysts’ future earnings projections for several companies, based on the latest half-year, versus the pre-COVID 2019 period. In some cases, we've seen analysts predicting future profit (on a per store basis) to be lower between 2024 and 2026 than before COVID, with examples including: 

• Beacon Lighting (ASX: BLX), 
• Nick Scali (ASX: NCK), 
• Lovisa (ASX: LOV) and 
• Premier Investments (ASX: PMV).

For these reasons, we saw the potential that these companies could go through an earnings upcycle despite a tough economic environment given our view that analyst forecasts had been cut too hard.

During the recent February reporting season, company results in the consumer discretionary sector have proven that analyst earnings expectations have been too pessimistic. Several examples include the following companies, which all reported positively: 

• JB Hi-Fi (ASX: JBH), 
• Harvey Norman (ASX: HVN), and 
• Lovisa. 

Within the e-commerce sector, companies that have performed well over the period include Cettire (ASX: CTT) and Temple & Webster (ASX: TPW), which have fully cycled over the impact of the COVID period and are now reporting stronger-than-expected growth. 

As we look forward, we continue to see catalysts for earnings upgrades in the consumer discretionary sector in the year ahead. 

We are backing companies that are supported by strong balance sheets and capable management teams with valuations continuing to look attractive.

ASX mid- and small-cap opportunities

We also favour companies that are taking the opportunity to prudently grow through mergers and acquisitions (M&A). Companies such as Kelsian (ASX: KLS) and Aussie Broadband (ASX: ABB) have used this challenging period to make accretive acquisitions to diversify and benefit their business through synergies over the medium to long term. 

We expect to see more M&A activity in the small-to-mid cap sector, given a more stable inflation outlook, and are encouraging the companies we own within our portfolio to use their strong balance sheets to make EPS-accretive acquisitions.

In the past six months, we have also seen a number of smaller companies being taken over including:

• Adbri (ASX: ABC), 
• Link Administration Holdings (ASX: LNK), 
• Pacific Smiles Group (ASX: PSQ) and 
• Ansarada Group (ASX: AND). 

With valuations in some small to mid-cap sectors at attractive levels in sectors such as financials and healthcare, we see the likelihood of additional takeover activity. This could also be a catalyst for several sectors to achieve a rerating

It feels like the macroeconomic uncertainty of the post-COVID period is now behind us, leaving investors a clear path for individual stock selection. In this environment, we see more small-to-mid-cap opportunities than we've seen since 2020, all while pursuing our disciplined stock selection and investment process.

April 2024 Shareholder Presentations

You are invited to enjoy lunch in the company of our investment team and engage in insightful discussions at our Shareholder Presentations in April 2024. We encourage you to secure your spot and register. Please feel free to invite friends and family who share an interest in equity markets, alternative assets and social impact.