Matt Griffin

The latest reporting season showed some small cap companies are under pressure – including retailers – while others have a rosier outlook, such as gold miners, according to Phillip Hudak and Matt Griffin, co-portfolio managers of the Maple-Brown Abbott Australian Small Companies fund.

They said retailers’ margins might continue to shrink in 2025, even though retail sales are holding up in Australia.

“Margins are under pressure and while retail sales are holding up, retailers are discounting prices to attract consumers who are reluctant to spend as cost-of-living pressures mount, reducing their margins. We have seen this is the case for listed retailers such as Myers and Adairs in the February reporting season,” Mr Hudak said.

“We’ve also seen more small caps downgrade earnings and earning per share (EPS) forecasts than upgrades, so there is some pressure being felt across the share market more broadly,” he said.

Looking ahead into 2025, the banks, which comprise nearly a quarter of the Australian equity market, are unlikely to provide substantial market support in 2025 due to limited earnings growth and full valuations. 

“Interest rate cuts generally aren’t good for bank earnings, and with a mixed set of results from earnings season, this could be a big headwind for the ASX100 over the coming year, given how large the banks are as a percentage of the Australian index. Couple this with insurers who are very well owned by large cap managers, in an environment where the premium rate cycle is turning negative, this could support our thesis of small caps catching up some of the underperformance over recent years,” Mr Griffin said.

In addition, merger and acquisitions (M&A) activity is boosting some small caps, including Domain and Mayne Pharma.  Maple-Brown Abbott expects more M&A activity in 2025, with the lower Australian dollar making local assets cheaper for offshore buyers, and cash heavy private equity groups circling local companies.

“Private equity money is chasing undervalued stocks in the small cap space, and so we are seeing increasing M&A activity,” said Mr Hudak.

“In recent times, Insignia shares have rallied amid an intensifying bidding war between private equity firms CC Capital, Bain Capital and Brookfield and we have also seen takeover bid for Domain, which was a top performer this reporting season, from US giant CoStar,” Mr Hudak said.

“Another example is private equity-backed US pharmaceutical giant Cosette making a takeover bid for Mayne Pharma Group, and we believe that we will see a greater level of corporate activity going forward in 2025,” he said.

Greater M&A activity could also support the gold sector into 2025, with higher gold prices triggering greater activity. In terms of other sectors, the first half of the 2025 calendar year is expected to be mixed given the upcoming Federal election, which must be held by May 2025. 

“We expect cost-of-living measures and fiscal spending to continue which should be supportive for the aged care and childcare sectors,” Mr Hudak said.

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Matt Griffin

The Australia dollar is a key factor that markets have yet to price in and will need to be closely watched this earnings season, according to co-portfolio manager of the Australian Smaller Companies fund at Maple-Brown Abbott, Matt Griffin.

Over the last quarter the Australian dollar is down 9 per cent, around 6c, to the US dollar, which Mr Griffin says is not reflected in consensus numbers for a majority of stocks.

“Sell-side estimates always become a bit stale at the start of the year, as analysts haven’t updated their number for several weeks during the holiday season. As a result, consensus is still using 67-68 cents in a lot of their assumptions.

“For retailers and importers that purchase goods in foreign currency, the readjustment to a lower Australian dollar will take about 6 to 12 months to flow through to cost of goods sold, given currency hedging in place. These companies will need to put through a material price rise to offset the currency impact, but this will be particularly difficult in the current environment given the cost-of-living pressures. It will be something to watch this earning season.

“On the other hand, for companies with offshore operations, such as US tech companies like Pro Medicus (ASX:PME) and Life360 (ASX:360), we would expect to see earnings upgrades in AUD terms as they benefit from the strong US dollar.”

Mr Griffin says Australian gold miners are also likely to benefit from the currency moves.

“The Australian gold price is now over A$4000 per ounce, meaning there is plenty of margin for domestic miners. However even with the rise in gold prices, specific stock selection is essential,” says Mr Griffin.

The depreciation of the Australian dollar will also be a positive for potential mergers and acquisitions from offshore players.

“For a US private equity firm or corporate acquirer, the valuation of companies in Australia is now 10 per cent cheaper than it was last quarter, so we expect more M&A activity this year. A great example of this is the bidding war over Insignia Financial,” says Mr Griffin.

Apart from potential currency headwinds, Mr Griffin says he is relatively downbeat on the retail market.

“The feedback we have so far from retailers is that the top line is holding out. However, having a stable or slightly increased topline hasn’t offset margin factors, which has been driven by discounting over the past several months, coupled with wage and rent rises.

“Overall, we think the market is too optimistic on margins for many retailers this reporting season. We have seen Premier (ASX:PMV) and Myer (ASX:MYR) this month have big earnings downgrades, despite revenue holding up reasonably well. We are expecting some downside margin surprise from some retailers this earnings season, but again it will be down to those stock specific stories,” says Mr Griffin.

The smaller end of the financials sector is where Mr Griffin is optimistic.

“A number of the smaller financial companies have exposure to the US market, where the consumer is in good shape. Any easing of inflation and interest rate cuts should bolster consumer demand for credit, and lower funding costs.

“One of our key picks in this sector is ZIP (ASX:ZIP). With buy-now-pay-later segment still in its early stages in the US compared to Australia, there is potential for earnings upgrade over the course of the year. ZIP is already making good gains in terms of merchants in the US market, and we expect them to grow the number of active customers as well. This, coupled, with the general positive consumer financial health in the US, suggests positive tailwinds for ZIP in the year ahead.

“Judo Financial (ASX:JDO) is another key pick for us in the financials sector this earnings season. It is a challenger bank that is taking on the big four in the business banking segment, and has already hired some of the top business bankers from its competitors. It’s done a great job getting the right mix for loan book growth, credit risk and funding costs,” he says.

“We are expecting hits and misses by sectors this reporting season, but ultimately it will come down to those stock specific stories and how companies are mitigating potential headwinds heading into 2025.”

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Phillip Hudak

The higher gold price has boosted margins for gold miners who likely have further to run, while cost-of-living pressures make retailers more risky investments, according to Phillip Hudak and Matt Griffin, co-portfolio managers of the Maple-Brown Abbott Australian Small Companies fund.

Following the recent earnings season, Mr Hudak says there are good opportunities in select gold companies.

“The gold price has done very well over the past two years, despite rising real bond yields which are normally not good for gold. However the impact of bond yields has been offset by high levels of central bank buying and we see value emerging for gold producers,” he said.

“Those companies that are producing gold right now, such as Perseus and Genesis Minerals, and can take advantage of the “scarcity value”, have outperformed the gold price.  Combined with easing cost inflation, profits have been boosted.

“This contrasts to gold developers, which have underperformed the gold price, as they are seeing higher funding costs, project cost blowouts and delays,” said Mr Hudak.

The US dollar gold price is currently trading near all-time levels at US$2,500/oz, having risen over 20 per cent year-to-date.

“We believe there is still significant upside in select gold companies, especially those companies that are increasing their resource base and have low-cost options to bring gold production on, including Spartan Resources, as well as those developers that have high-quality well-funded projects, such as De Grey Mining,” said Mr Hudak.

Source: Bullion Vault, www.bullionvault.com/gold-news/infographics/olympic-medals-real-gold-silver-bronze-medal-count, MBA, FactSet, 23 August 2024. gold producers include CMM, EMR, GMD, GOR, PRU, RED, RMS, RRL, RSG, WAF and WGX, gold developers include BGL, DEG and PDI.

Greater merger and acquisition (M&A) activity is likely to continue in the gold sector into 2025, with higher gold prices triggering greater activity. With exploration activity still limited, this has led to a depletion of gold reserve, helping to boost margins for producers. Coupled with a lengthening and less certain permitting process for new mines, this is causing producers to pursue a ‘buy over build’ strategy to growth.

“Gold sector M&A activity is heating up, for both global and local small cap gold miners,” Mr Hudak said.

“It is now becoming cheaper to buy gold miners rather than build gold mines. We’ve seen Newmont and Newcrest get together, Goldfields has been active and that has flowed through to Australian small cap gold companies, including Ramelius taking a stake in Spartan, Perseus taking a stake in Predictive Discoveries, and Red 5 and Silverlake Resources merging.

“We believe this M&A activity will continue, particularly at the smaller end of the market.

“We also liked the aged-care sector, which has benefited from increased government funding in areas like wages. On top of that, the government is supplementing growth of labour,” Mr Hudak said.

Matt Griffin, co-portfolio manager of the Australian Small Companies fund, said other companies they like includes storage real estate investment trusts (REITs), with the ageing population and housing turnover driving demand for greater storage.

In contrast, other REITs such as industrial and office have seen valuations decline and are trading at significant discounts to Net Tangible Assets (NTA), especially office and industrial REITs, while gearing levels are rising.

According to Mr Griffin, the market is implying valuations are not at the bottom yet, and earnings growth will be very hard to come by for the majority of small cap REITs in FY25.

“The one bright spot we see is storage, with structural factors driving a more favourable outlook than other REITs, with downsizing, an ageing population and housing turnover driving demand for storage space, and storage REITs have a strong pipeline of growth,” said Mr Griffin.

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Matt Griffin

Boutique investment manager Maple-Brown Abbott believes select Australian small cap gold miners offer attractive valuation and earnings metrics.

Phillip Hudak, co-portfolio manager, Australian small companies at Maple-Brown Abbott, says the Australian small cap gold sector is set to attract increased investor interest given it represents approximately 9 per cent (by market capitalisation) of the S&P/ASX Small Ordinaries Index and has the potential to react positively to the recent increase in gold prices.

Matt Griffin, co-portfolio manager, Australian small companies, adds there is upside potential for companies in the sector that can deliver on production guidance, effectively manage costs and offer significant operating leverage.

“If the gold price remains higher for longer, this has the potential to result in material positive earnings revisions for companies at the smaller end of the Australian gold mining sector,” Mr Griffin said.

The Maple-Brown Abbott small companies team believe some stock valuations look compelling at the current gold spot price and valuations for select producers remain relatively undemanding, particularly in the context of all-time high gold prices.

“Current stock valuations broadly imply gold prices around long-term pricing, which is well below the current spot price. Valuations have held up best for producers with high quality projects, for example Perseus Mining, that continue to deliver production growth, meet cost guidance and build cash reserves,” Mr Hudak said.

The Maple-Brown Abbott small companies team believes Spartan Resources (SPR) is an attractive high-grade, low-cost gold prospect in Western Australia in an increasingly acquisitive local small cap gold market. Genesis Minerals (GMD) is another favoured stock, run by a high quality management team. The company is turning around an underperforming asset base and leveraging other deposits in the Leonora and Laverton regions in Western Australia.

Declining exploration spend and depleting reserves means there is a limited organic growth profile for many gold miners. Given the recent strong gold price and rising producer margins, this promotes merger activity to backfill declining production profiles. In addition, increasing complexity and time taken to permit new projects means it is likely now cheaper and easier to buy versus build.

“We have also seen early-stage explorers continuing to struggle to attract new capital with the number of global junior fund raisings in February 2024 being lower by 33 per cent relative to the previous period last year and the lowest reported since January 2022 which makes them easy targets in the current environment,” Mr Griffin said.

Both the VanEyk Gold Miners and Junior Gold Miners ETFs have materially underperformed the gold price over the past three years, which emphasises how hard delivery from both a production and cost perspective has been. However, select emerging Australian small cap gold developers and producers such as De Grey Mining, Emerald Resources and Genesis Minerals have recently delivered strong returns above the underlying commodity.

“Over the past few years, the smaller end of the Australian gold mining sector has been plagued by higher costs from both a capital and operating perspective given cost inflation pressures and labour constraints, particularly in Western Australia. Our industry channel checks and a review of mining costs across Australian mines point to a stabilisation and even an improvement in mining costs over the past 12 months.

“Our discussions with gold miners indicate labour pressure is easing, validated by the decline in job advertisements in the mining services industry. This has been assisted by the recent closure of nickel and lithium mines given commodity price pressures which is easing mining industry labour constraints,” Mr Hudak said.

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Phillip Hudak

Overall, the February reporting season was generally positive for Australian small caps, with the domestic economy remaining resilient, and many small cap company results beating market expectations, says Phillip Hudak and Matt Griffin, co-portfolio managers of the Maple-Brown Abbott Australian Small Companies Fund.

“There were several positive results, with upwards earnings per share (EPS) revisions triggering share price rises for many small caps, and we note that reactions to company announcements have been more elevated than what we have seen in previous reporting seasons,” said Mr Hudak.

“The consumer discretionary sector was the big surprise given more resilient top line sales relative to previous conservative assumptions. This, combined with easing input costs, has allowed retailers to continue to clear excess inventory without elevated promotional activity. This resulted in better margins, notably for Breville Group, ARB and Adairs,” he said.

Maple-Brown Abbott believes the Australian small cap market is set for a potential significant rebound over the next two years and small caps are likely to outperform larger companies.

“Australian small cap valuation metrics look attractive with forecast earnings upside relative to Australian large caps, given the economy is performing better than previously expected. There are also signs of easing financial conditions; any easing in interest rates by the Reserve Bank of Australia (RBA) would be constructive for small caps,” said Mr Griffin.

“For investors who may have missed the bottom a few months ago, we believe that it is not too late to buy into the sector. We are seeing substantial interest from advisors and investors in small cap stocks, but they are not necessarily increasing their allocations to that interest. We think that eventually allocations will catch up.”

A robust level of mergers and acquisitions activity is likely to continue in 2024, underpinned by the lower Australian dollar and potentially lower interest rates, supporting the performance of the Australian small cap sector, according to fund manager Maple-Brown Abbott.

Following on from a robust reporting season for small cap companies, takeover activity could continue into 2024, following a flurry of corporate activity seen in the backend of the 2023 calendar year.

“We believe merger and acquisitions (M&A) activity will continue this year. The lower Australian dollar and the prospect of lower interest rates going forward are expected to result in a flurry of corporate activity,” said Mr Hudak.

“This reporting season has seen the high level of recent M&A action continue with France’s Cie. de Saint-Gobain bid for CSR, Seven Group’s bid for Boral and most recently Altium, which is being sold to Japanese chipmaker Renesas Electronics and Aussie Broadband’s bid for Superloop. We’re also seeing more M&A activity in the mining sector.

“With the lower Australian dollar, we believe M&A activity will continue to create opportunities in the Australian small cap sector and be far more pronounced than IPO activity which is also expected to ramp up. Many companies, particularly at the smaller end of the market, could see M&A activity as the year continues. Spartan Resources, for example, is a potential takeover candidate and also a key stock pick given our bullish view on gold,” he said.

The portfolio managers said several themes are supporting small-cap companies, including artificial intelligence and clean energy themes.

“Some Australian companies that are benefiting from the huge interest in AI stocks, as evidenced by the surging demand for semiconductor company NVIDIA, include datacentre exposed companies including NEXTDC, Megaport and Macquarie Technology Group. These companies are being caught up in the AI theme and we think this trend is set to continue through 2024,” Mr Hudak said.

“In terms of our portfolio we have invested in medical imaging company Pro Medicus because we think the integration of AI in the radiology imaging area will create significant advances in imaging technology and upside for this company.”

A recent rebound in lithium prices has also boosted lithium miners and other miners linked to clean energy production.

“Following on from the fall in nickel and lithium prices, we have seen a growing number of mine closures in battery materials metals, driven by oversupply and changing battery technologies. Nickel is likely structurally challenged and lithium is highly cyclical,” said Mr Griffin.

“However, we feel the lithium price could be bottoming and in recent days, we have seen the prices of lithium miners rise, which is likely being driven by short covering.  The lower prices have created opportunities with lithium miners, and we are looking at positioning for the next cycle in companies like Patriot Battery Metals.

“We are also seeing opportunities to get into the gold mining space. We’ve seen a recent drop in price of some gold miners which has opened up opportunities. At the same time demand for gold is strong, particularly from central banks. Gold could also benefit from lower interest rates throughout 2024 and we are focussing on companies that continue to deliver production growth, meet cost guidance and build cash reserves such as Genesis Minerals and Persus Mining,” said Mr Griffin.

Maple-Brown Abbott also expects the uranium price to rise, lifting uranium miners. Strengthening fundamentals and increasing urgency to reduce carbon emissions from utilities will increase contracting levels in an environment of supply uncertainty.  Companies that stand to benefit include Boss Energy and Paladin Energy.

The structural shift to electric vehicles (EVs) is also benefiting car dealers and fleet/novated leasing companies. Sales of EVs are rising, and account for approximately 8 per cent of all vehicle sales in the 2023 calendar year. Fleet and novated leasing companies have also been major beneficiaries of recent fringe benefit tax changes, including Smartgroup.

However, rising wage inflation will hold back some companies especially those which are not able to pass on price rises, including some discretionary retailers exposed to younger demographics. As a result, Maple-Brown Abbott is investing in companies with pricing power, such as Technology One and Monash IVF Group.

Separately, buoyant financial markets have seen fund inflows recover for both the platform and fund manager providers. Maple-Brown Abbott has international equity fund manager GQG Partners as a key stock pick.

“Strong inflows, lower management fees compared to competitors and attractive operating margins will likely see this company outperform. GQG is also trading at a discount to global and local fund managers, but it enjoys strong distribution capability supporting strong net inflow performance and new product opportunities,” said Mr Hudak.

However, cost-of-living pressures, including higher mortgage rates and muted wage growth, is impacting companies exposed to younger demographics, including Baby Bunting. Media spending continued to see both a structural and cyclical shift away from television and radio to both digital and out-of-home, Mr Hudak said.

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Matt Griffin

Given our investment philosophy is ‘earnings drive share prices’, we typically don’t buy resources stocks until there is a solid framework around resource/reserves and a scoping or feasibility study, with a pathway to production in the next few years. We typically need to have a positive view on the underlying commodity, although are more focused on what we consider to be internal company drivers that can deliver value that is not priced into the shares. This can include a differentiated view on things like the production and cost profile, mine life extensions or growth projects.

Companies that we deem to have higher risk profiles, such as those building or commissioning projects, with elevated debt levels, or with a higher position on the cost curve, have position sizes adjusted to the lower end of the typical portfolio range to account for these potential risks. For us, a good management team is hugely important in the resources space: proven operators who have a track record of being conservative and focus on shareholder returns (rather than risky growth projects or empire building) generally deliver outsized returns for investors, especially given the volatile nature of commodity markets and mining stocks.

Trends to watch

Raising money has become harder for many smaller, younger mining companies, which we expect will flow through to lower exploration and drilling activity in the coming year. Having said this, good projects can almost always attract funding, and there have been a number of exciting new discoveries in the battery materials space.

Building new projects has been exceptionally hard over the past few years as cost inflation and supply chain issues have seen large capex increases and delays. The vast majority of ASX-listed juniors who have commissioned projects in the past year have required a ‘top up’ equity raise to cover cost overruns and working capital. This has typically been done at a significant discount to the main equity raise price for project financing, meaning investors are less incentivised to own companies during the development period.

The market seems to have forgotten the experience of 2016–2018 in lithium, and just how hard it is to commission new lithium mines. We are again starting to see some of these issues resurface in commissioning, with target recovery levels taking a long time to be met. Investors are also discounting the potential for new extraction technologies such as Direct Lithium Extraction (DLE), which was viewed much more positively a few years ago.

We have observed that there has been a big step up in the implementation and communication of environmental, social and governance (ESG) practices and messaging from junior miners over the past year. Most new projects are being designed with a renewable power component (typically solar) included, and native title engagement is becoming increasingly more important given the lengthy permitting processes.

What sustainability means to us

Sustainability means two things to us.

Business models – It is the sustainability of the business model and earnings stream of a company. This relates to qualitative factors that we research, such as industry structure, competitive positioning, the impact of technological change in an industry, and growth options and cost levers the company has available. Looking at management tenure, track record and alignment is also a big component of this.

ESG – We have a dedicated ESG team that engages with companies and assesses their ESG credentials on a range of metrics. We score companies on both business sustainability and ESG, which feeds into our investment process. Apart from general restrictions on tobacco and controversial weapons, we don’t exclude companies from our investable universe just because they have lower sustainability ratings, however this becomes a trade-off against the return expectation. Companies with lower sustainability ratings require a higher expected return to make it into the fund, and vice versa.

With respect to the resources sector we will consider carbon emissions disclosure and a company’s proposed pathway to reducing emissions, in addition to the social side of ESG – workforce measures such as safety and modern slavery, and the impact of operations on local communities. Governance is always the most important factor in small cap stocks, regardless of sector. We don’t need companies to tick all the boxes on governance, especially at an early stage in their lifecycle, but we believe a strong board with appropriate skills and incentive frameworks are critical factors in future success.

The influence of geopolitics on mining

Politics is becoming increasingly important in the mining space. The Russian invasion of Ukraine saw energy security become a critical issue and political tensions between China and the US has seen the introduction of new legislation such as the Inflation Reduction Act, aimed at securing more supply of critical minerals. Some of these policies have been very positive for the battery materials space, with low-cost government funding and grants being handed out for domestic projects. However, the requirement for downstream processing in some jurisdictions is increasing costs and risks, especially in countries with high-cost labour and a lack of technical expertise in these areas.

The re-routing of global trade routes and supply chains will mean a huge amount of capex will need to be spent over the coming decade in western countries. This will increase security of supply but also lead to higher costs and inflation. We believe long-term price assumptions for many commodities will need to be revised upwards over time to account for this.

We are happy to invest in most mining jurisdictions, and our process around the sustainability of business models applies to this too: less favourable jurisdictions require higher returns to attract our investment. We currently have holdings in a handful of companies with mines in various African countries, with good management becoming a critical factor here, as companies need teams who have experience operating in the region and spend a lot of time on the ground over there. Due to a lack of historic exploration compared to countries such as Australia and Canada, junior companies in Africa can discover very good deposits and bring them to production at a relatively low cost. Interestingly, the majority of cashflow generated by ASX listed junior gold miners over the past three years has been generated by African operations, while the older mines in West Australia have seen increasingly higher costs and production declines.

The prognosis

We believe we will see more mergers and acquisitions in the year ahead, particularly in the junior gold space. The large amount of money in various indices means as companies increase in size and gain index inclusion, they typically trade on a premium given the weight of passive buying that follows. This can become a self-fulfilling cycle as scrip-based acquisitions are then more accretive. In our view, the reduction in capital raising activity will see some juniors under pressure to sell and realise a premium for shareholders, rather than slow exploration and go into hibernation mode. Many major and mid-tier miners are struggling for organic growth options and have relatively good balance sheets, and may cast their eye more towards inorganic opportunities.

As is often the case, most acquisitions make sense on a spreadsheet, but few add value in real life. Cultural alignment and the ability to extract synergies from the operations is crucial to creating shareholder value in the medium-term.

Parting thought

When assessing idiosyncratic opportunities within the ASX small resources cohort we look for many of the same attributes as we do with industrial companies, including strong management teams and positive sustainability characteristics. Key to success is having a deep understanding of the risks involved in the company, understanding where a company is in the earnings cycle as well as the fundamentals driving underlying commodity prices.

By Matt Griffin, co-portfolio manager, Australian Small Companies

The post Mining for growth: navigating the small cap resource sector appeared first on AdviserVoice.

Phillip Hudak

According to Maple-Brown Abbott, Australian small cap companies are well positioned for any downturn given balance sheets are flush with cash and limited debt, the majority of stocks in the benchmark are profitable, and many companies have cost levers that can be pulled.

Co-Portfolio Manager for Australian Small Companies Phillip Hudak said despite economic uncertainty the starting point for the Australian small cap market appears more attractive given the strength of many smaller companies and the recent underperformance relative to other equity asset classes.

“Timing the turnaround in relative performance, however, is extremely difficult, and underperformance can persist for significant periods of time. It is likely a catalyst is needed in the form of easing financial conditions by central banks, an improvement in global macroeconomic data, a peak in interest rates, and/or an improved earnings outlook for smaller companies.

“The Fund is currently defensively positioned, including those companies with genuine pricing power and strong balance sheets. We continue to look to pivot into quality cyclicals and value cyclicals at opportune times,“ he said.

Mr Hudak said a constant theme coming through in most Australian small cap sectors is wage inflation, with the recent 5.75 per cent minimum wage decision – which applies to approximately 20 per cent of the workforce – yet to feed through.

“Australian wage growth has lagged the rest of the world given our more rigid regime, although recent government policies may facilitate greater power for trade unions and employees going forward. As a result, we are also seeing a surge in expectations for annual wage increases under enterprise bargaining agreements to be greater over the next 12 months.

“Rising wages will have a material impact on sectors such as healthcare and retail, where many companies have high labour components as a percentage of sales and minimal pricing power. When assessing these sectors in particular we have a preference for companies with a variable cost base and pricing power. In healthcare, for example, we prefer IVF providers with greater pricing power versus radiology providers which are constrained by the level of indexation.”

Matt Griffin, Co-Portfolio Manager for Australian Small Companies said AGM trading updates could see mixed results for the retail sector, as employment and consumer spending holds up better than expected, but are offset by cost of living pressures.

“In retail, our research and industry contacts indicate that performance is diverging by category. For example, apparel is fairly weak due to over-stocking and competition, while less discretionary goods such as auto parts are holding up relatively well. With foot traffic to many stores falling materially, the coming year will be a chance for the quality retailers to shine, as differentiation around product range, price points and customer service drives better sales results.

“Travel stocks have all materially de-rated over recent months, down around 30 per cent, on the expectation that cost of living pressures and the end of ‘revenge travel’ will most likely see travel spend fall in the next 12 months. Despite travel stocks materially de-rating over recent months, we are relatively positive on the sector for a few reasons. Firstly, leisure travel has proven to be extremely resilient in past downturns – provided people have jobs, they will take leave and travel. Secondly, increased airline capacity and falling airfares will draw more people back to longer haul flights, especially families. And finally, many Asian countries have been slow to recover from COVID lockdowns and this will be a tailwind in 2024.

“Our research suggests that travel has held up well in the first quarter of FY24 and forward bookings are strong, and we may see renewed interest in the sector with trading updates being better than feared,” he said.

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Phillip Hudak

Maple-Brown Abbott Australian Small Companies Co-Portfolio Managers Phillip Hudak and Matt Griffin believe the recent market pull-back makes the Australian small-cap sector increasingly attractive for longer-term investors.

With further recent market weakness, the team believes there is an attractive entry point at both the sector level and for a number of individual stocks.

Mr Hudak stated “Australian small cap companies are well positioned for a downturn: valuation metrics currently look attractive versus large caps, balance sheets are relatively strong with low debt levels, the majority of stocks in the benchmark are profitable, and many companies have cost levers that can be pulled.”

The team believes the poor sentiment for Australian small caps, as the market pays up for liquidity and earnings certainty, is typically a positive contrarian indicator for the asset class.

Mr Griffin stated “Our ‘earnings drive share prices’ philosophy means the team typically focuses on companies that have proven fundamentals and are in the right phase of the earnings cycle. This also means we systematically avoid select parts of the small cap market, namely where companies are ‘selling the dream’ as opposed to delivering growing, reliable earnings over the medium term.”

The team believes the approach of constructing a portfolio of undervalued holdings with idiosyncratic exposures is a reliable form of alpha generation. Since inception of the Maple-Brown Abbott Australian Small Companies Fund (the Fund) this approach has delivered significant outperformance versus the small ordinaries benchmark, with lower volatility than the benchmark.

The Fund has selected exposures to segments of the market experiencing medium term structural growth, including electric vehicles, biotechnology, travel and uranium.

The team believes uranium is a key commodity exposure to be involved in over the medium term. Two key reasons for this belief include growing acceptance of nuclear power as part of the future energy mix and increased term contracting activity, driven in part by increased supply shortages. The Fund’s exposure to the uranium sector is currently through Paladin and Boss Energy, both closely tied to the uranium price.

The Fund is currently underweight retailers but overweight in specific stocks with cyclical and structural tailwinds into the medium term such as travel and technology.

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Phillip Hudak

The impact of higher interest rates and the rising cost of living is yet to take full effect on the Australian sharemarket, meaning there is likely to be further downgrades on earnings expectations for certain sectors and stocks over the next 12 months, according to Phillip Hudak and Matt Griffin Co-Portfolio Managers, Australian Small Companies at Maple-Brown Abbott.

“We think we are early in the downgrade cycle for certain segments of the market.  It follows a pull back in earnings expectations for FY23 during the most recent reporting season,” says Mr Hudak

“The Australian market is at an interesting juncture, with the shift to the new “post-pandemic” normal well underway; however, the end point is still uncertain.

“In particular, the impact of higher interest rates and rising costs is yet to fully play out, and in this context Australia seems to be 6 to 12 months behind the rest of the world.

“The opportunity for investors is to find those companies with structural growth stories and industry tail winds that are well placed to withstand any future downturn, and we believe that active management will be key to this.”

Mr Hudak and Mr Griffin say there five key characteristics they are looking for in companies in the current environment: pricing power to offset cost inflation coming through; earnings certainty that are trading at reasonable valuations; exposure to industry tailwinds and structural growth stories; cost flexibility – in an environment where growth may slow; and mining services.

Mr Griffin says that some companies are struggling to pass on cost rises which has affected their share price. However, this is not consistent across the board and depends on the company and sector.

“We are therefore looking for companies that have pricing power or that are cost leaders.  Companies that can maintain margins and profitably should continue to perform well for investors.”

He pointed to the retail sector as a good example of the importance of active management.

“The retail sector has been holding up well but we believe this reflects the fact that most people still have a good savings buffer and haven’t started to cut spending.  As a result, the impact of the rising cost of living hasn’t yet flowed through.

“The lead up to the Christmas shopping period will therefore be crucial for the retail sector.  Inventory levels look elevated and continue to rise, as a result of concerns about supply chain risk which has led a number of retailers to order well in advance to have stock on hand.

“However purchasing decisions and forecasts may be based on last year’s Christmas sales which were very elevated.  This means there is a big risk if demand slow, as those retailers with a high inventory level will need to discount heavily which will hit margins and profitability.  We’re starting to see this in global markets already.

“As investors, we are therefore focusing on retailers with good cashflow models, very light inventory models, and scalability.”

Mr Hudak added that travel is a sector with industry tail winds.

“Travel – both leisure and corporate – is benefitting from significant tail winds as we exit the pandemic.  Europe and the US are both well advanced on this trajectory, however there is a lag in the recovery in Asia as lockdowns continue indefinitely in China.

“While the sector looks attractive over the next few years, there are risks to the recovery profile.  However, some companies have emerged from the pandemic much stronger than before and are recovering at a faster rate than the broader sector, and we see material upside to these.

“Overall, we see upside potential for those companies that have sustainable business models and strong medium-term earnings trajectories.  This is particularly crucial in the small cap end of the market, which has experienced a significant multiple de-rating so far this calendar year.

“The pullback, triggered by tightening financial conditions, elevated inflation and higher living costs, has been indiscriminate across many stocks which brings stock-picking to the fore,” says Mr Hudak.

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Sophia Rahmani

Maple-Brown Abbott has launched an Australian small companies fund following the appointment of Phillip Hudak and Matt Griffin to the boutique investment manager in April.

The Maple-Brown Abbott Australian Small Companies Fund is primarily invested in undervalued small companies where the investment team has conviction in medium-term earnings delivery and that are supported by sustainable business models. The fund typically holds 30–50 stocks which score well on combined earnings-based valuation and sustainability measures, with the focus on diversification and stock specific risk management. It aims to outperform the S&P/ASX Small Ordinaries (Total Return) Index, after fees, over a five-year period.

CEO and managing director Sophia Rahmani says the fund is based on the expertise, philosophy and investment approach of two experienced Australian small caps investors, who previously managed the AMP Capital Australian Emerging Companies strategy.

“Phillip and Matt have an impressive track record and a compelling earnings-based philosophy integrating a sustainability focus that we believe differentiates the strategy. They also have a proven and repeatable investment process, focused on in-depth fundamental research.

“Judging by the early market feedback, history of the team and capacity limits of small caps strategies, we expect this will be a popular offering for institutional and wholesale clients. The fund further diversifies Maple-Brown Abbott’s offering to investors, and we have seen early interest in a small caps strategy run as a boutique within Maple-Brown Abbott,” Ms Rahmani said.

Mr Hudak says he and co-portfolio manager Matt Griffin have worked diligently with the support of the broader Maple-Brown Abbott team to launch the fund within a relatively short period.

“Matt and I are passionate about finding undervalued Australian small companies with idiosyncratic exposures, and we are excited to be able to do what we love in our new home at Maple-Brown Abbott.

“The new fund is based on our existing strategy and core philosophy that earnings drive share prices rather than on any particular investment style. We consider the valuation and where the company is in the earnings cycle. We believe this combined with our focus on sustainability and avoiding short-term downgrades can deliver consistent returns,” Mr Hudak said.

Mr Griffin added it was an exciting time to be launching an Australian small caps fund given the current opportunities.

“The recent market volatility has presented more attractive entry points for companies with strong medium-term earnings expectations and sustainable business models,” Mr Griffin said.

“As part of the team’s research, we focus on non-consensus and proprietary insights and expect to hold over 1,000 company-related meetings per year, including management meetings, site visits, industry expert panels and ESG meetings. The team is highly aligned to client goals through a competitive remuneration framework and each team member having invested into the strategy.”

In just over 12 months, Maple-Brown Abbott has broadened its offering from three investment strategies – broad-cap Australian value equities, Asia-Pacific equities and global listed infrastructure – to five with global emerging markets and now Australian small companies.

“Being a privately owned boutique investment manager with a long history of strong client alignment and quality investment capabilities means that when we identify solutions that align with our strategy and our clients’ interests, we can add them relatively quickly and efficiently. We believe the launch of our Australian Small Companies Fund is a good example of this,” Ms Rahmani added.

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