Australian quality small caps outperform amid volatile reporting season

Sam Twidale

The recent ASX reporting season highlighted that small caps, in particular, have continued to face challenges in this sluggish economic environment where high interest rates are weighing heavily on many companies. Despite these headwinds, one of the overriding themes of this reporting season has been the outperformance of quality, noted Sam Twidale, portfolio manager at DNR Capital.

“For many small caps the tide has gone out this reporting season,” said Twidale. “We’ve seen the impact of fiscal and monetary support being removed and significant fluctuations in inflation. This environment has made it crucial to identify what the true sustainable level of profitability is for companies moving forward.”

Twidale highlighted that many companies faced significant challenges during the reporting season with some struggling with margin reversion, stretched balance sheets, high interest costs and underperforming acquisitions. “We saw some significant share price reactions to the downside for several companies,” he said.

Despite these challenges, DNR Capital’s Emerging Companies Fund delivered a strong performance, significantly outperforming the index, largely due to its focus on quality.

A standout performer was Breville, a long-held position in the fund. “Breville really showed its strength this season. Despite concerns around consumer resilience in a high interest rate environment, the company’s continued reinvestment into product development and geographic expansion has put it in arguably the strongest position in its history,” Twidale said.

Twidale also pointed to the investment platform market as another area of strong performance. “HUB24 and Netwealth continue to cement their positions as market leaders, taking significant share from legacy incumbents. Their success is driven by economies of scale, reinvestment in their platforms and superior customer service,” he said.

Looking ahead, Twidale sees a compelling opportunity set in the small cap space, despite current challenges. “There is a big dispersion in quality across the market and that really came through in reporting season. Our focus remains on being highly selective and targeting quality businesses in the consumer, financials and tech sectors where we see the potential for attractive long term returns,” he said.