Sam Twindale

Momentum continues to build in the small-cap sector, with recent performance and reporting season results pointing to renewed investor confidence and attractive opportunities across several sectors, according to DNR Capital Portfolio Manager Sam Twidale.

“The standout story in recent months has been the strength of small caps,” said Twidale. “We’ve seen some excellent bottom-up opportunities emerging, with the Small Ordinaries Index up over 8%, significantly outperforming the large-cap index.”

Twidale noted that investor focus is returning to the small-cap space, with structural growth companies delivering particularly strong results.

“Businesses like Zip and Life360 have been standout performers. Zip has shown continued strength, particularly in the US market, where buy-now-pay-later penetration remains relatively low compared to Australia. The company is growing profitably, supported by a strong balance sheet and disciplined management,” he said.

“Life360 has also continued its strong momentum, growing revenue by over 35%. The company is building an entrenched position in the family tracking and location-sharing market, demonstrating both strong revenue and earnings growth with a long runway ahead.”

Twidale noted the resilience of consumer-facing businesses as one of the key takeaways from the latest reporting season.

“There was a lot of concern heading into reporting season about how consumer companies would fare given macroeconomic headwinds,” he said. “However, what we saw was much greater resilience than expected. Many businesses continue to perform solidly despite the broader economic uncertainty.”

While gold has dominated headlines, Twidale pointed out that several industrial commodities are now presenting value opportunities after an extended downturn.

“We’ve been through a challenging bear market in commodities like lithium, coal, and iron ore,” he said. “Lithium prices, for example, are down around 90% from their peak. But we’re now seeing signs that we’re near the bottom of the cycle.”

“Demand for lithium remains strong with electric vehicle growth remaining strong and stationary storage demand increasing. With prices so low that many producers are loss-making, supply discipline is beginning to emerge, particularly in China. That sets the stage for potential recovery.”

DNR Capital has been repositioning its portfolios to take advantage of these dynamics.

“We’ve been active in recent months, building positions in quality, low-cost, long-life mining producers,” said Twidale. “We’re now overweight the mining sector, which supported our performance through the recent month.”

“Overall, the small-cap space remains full of opportunity. There’s volatility, yes, but also strong potential for alpha generation. We continue to favour quality businesses across technology, financials, consumer, and now selectively within mining.”

“The underperformance gap between small and large caps is beginning to close, and as we move beyond current reporting season, we expect continued interest and momentum in this space.”

DNR Capital Australian Emerging Companies Fund offers investors exposure to a concentrated portfolio of high quality, small cap Australian listed equities. In 2024 the Fund received a “Highly Recommended” rating from Lonsec Research and a “Highly Recommended” rating from Zenith Investment Partners.

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“The manager’s track record has delivered impressive relative performance outcomes since the Fund’s inception [in August 2018] along with the portfolio management team’s co-tenure and stability has led to increased conviction in the capability,” Lonsec said in its report.

The Fund is managed by Portfolio Managers Sam Twidale and Mark Sedawie, and in its report, Lonsec said the pair are dedicated to small cap research and contribute their insights to the broader investment team.

“We are extremely pleased to receive this upgrade. Lonsec has recognised the skills of our team and our bottom-up stock selection process which focusses on quality companies at attractive valuations,” Portfolio Manager, Sam Twidale said.

Lonsec listed the Fund’s high-conviction, concentrated approach (the Fund invests in 20 to 45 companies) as one of its key strengths, along with a boutique investment culture and a highly regarded and well-structured investment process.

“The manager demonstrated a strong engagement program and a structured approach. Engagements are tracked clearly with clear objectives set and outcomes tracked,” the Lonsec report found.

The DNR Capital Australian Emerging Companies Fund is also the recipient of a ‘Highly Recommended’ rating by Zenith.

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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.

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The prestigious annual awards, hosted by Zenith Investment Partners, celebrates excellence in investment management across various asset classes and strategies. Recognised as a benchmark for the industry, the awards aim to uphold the highest standards in funds management, ultimately benefiting investors.

Launched in 2018, the DNR Capital Australian Emerging Companies Fund1 provides investors with access to a concentrated, long-term portfolio of high-quality, small-cap Australian listed equities. It has posted an annualised return of 13.01% since its inception in August 2018, outperforming the S&P/ASX Small Ordinaries Total Return Index by 9.62%2.

“We are honoured to be recognised by Zenith as a leading investment manager in this space. The small-cap sector is known for its inefficiencies, offering significant opportunities to add value through our rigorous, bottom-up investment approach,” said Sam Twidale, Portfolio Manager at DNR Capital.

“Our team applies DNR Capital’s disciplined investment philosophy to identify high-quality small-cap companies. We define quality as companies with strong earnings, a superior industry position, robust balance sheets, excellent management and ESG risk assessment. This, combined with a thorough valuation analysis, allows us to take advantage of market inefficiencies,” Twidale added.

The DNR Capital Australian Emerging Companies Fund has been awarded a ‘Highly Recommended’ rating by Zenith.

The winners of the 2024 awards will be announced on 18 October by Zenith Investment Partners.

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The Fund, managed by DNR Capital offers investors a relatively concentrated, exposure to quality Australian smaller companies. It has posted an annualised return of 11.23% since its inception in August 2018, outperforming the S&P/ASX Small Ordinaries Total Return Index by 8.08%^[2].

This rating also reflects Zenith’s “high regard for DNR Capital’s robust investment process, which aims to identify high-quality companies trading at attractive valuations.”

Furthermore, Zenith believes the Fund is a highly attractive investment option within the Australian smaller companies peer group and believes the Fund is well placed to deliver upon its investment objectives.

The report highlights the robust security selection process adopted by DNR Capital and says “Zenith seeks to identify Funds that can outperform in over 50% of months in all market conditions, as we believe this represents consistency of manager skill. In addition, we view a strategy’s ability to produce stronger upside capture ratios relative to downside capture ratios as an attractive feature.

“The Fund has achieved both outcomes since inception. It has displayed greater consistency of outperformance in rising markets relative to declining markets. The Fund’s tracking error has remained significantly higher than its peers, which is consistent with DNR Capital’s concentrated and benchmark-unaware approach.”

Zenith acknowledges that both Sam Twidale and Mark Sedawie, who have joint responsibility for the Fund, are capable investors with complementary backgrounds and skill sets.

DNR Capital Australian Emerging Companies Fund Portfolio Manager, Sam Twidale says “We are pleased to retain this high rating from Zenith.

“We continue to focus on positioning the portfolio in quality businesses with attractive valuation upside. Key overweight positions are across the Consumer Discretionary, Technology and Financials sectors. Of particular focus are management teams reinvesting cash flows at high returns on incremental capital, and where the runway for organic growth remains substantial.

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Notes:
[1] DNR Capital Australian Emerging Companies Fund, ARSN 627 783 957. APIR PIM4357AU
[2] Performance is net of fees as of 31 January 2024. Past performance is not indicative of future performance.

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Sam Twidale

DNR Capital, a leading Australian equities investment manager, says now is the time for investors to be positive on opportunities in the Australian small caps space.

Sam Twidale, portfolio manager of the DNR Capital Australian Emerging Companies Fund, says “We are changing our view of the sector and moving from a defensive bias to embracing more positive positions in this segment of the market.

“If we look at the economic backdrop over the last 18 months, small caps significantly underperformed compared to large caps.”

But now valuations are pulling back, and a significant number of high quality companies are being de-rated, notes Twidale.

“But we still need to be selective. Investors need to look closely at what’s under the surface of the market as there are still some areas of overvaluation and speculative activity. Defensive companies still have high valuations as investors pour into that sector to manage recessionary risks and concerns around slowing economic growth.

“However, it is the earnings’ downgrades which is the main catalyst for us to turn more positive. Those downgrades are now coming through.

“As valuations pull back there are new opportunities to buy companies on much more realistic valuations and more conservative earnings expectations. This is quite a change from the price for perfection scenario 18 months ago,” says Twidale.

“Fear and uncertainty around high quality businesses is causing dislocations between price and value. And for us, this shows up as a concern around the economy, especially impacting the consumer discretionary sector. That’s now our largest overweight. It’s a more contrarian positioning but I think investors will be rewarded taking a longer term view for many stocks in this sector,” says Twidale.

“We have been investing in Breville and Lovisa, two high quality companies, in recent months. They are leaders in their industries and generate high returns. These companies are well managed with strong balance sheets to get through a bit of a trickier period in the short term. They’re not out of the woods yet. However, we think they will emerge on the other side of this cycle in a really strong position. This presents the opportunity for long-term investors.

“On the other hand, we have been actively reducing our exposure to the mining sector. That’s been a key overweight for us for several years now. But I think conditions have changed and we are not seeing the contrarian opportunities and the mispricings that we saw several years ago.”

Twidale adds “Across the Emerging Companies Fund, we are back in some of the companies that we sold out of several years ago, and see de-rated quality opportunities in consumer discretionary, financials, industrials, and tech sectors. We have a concentrated portfolio of some great businesses where valuations have really pulled back.

“For investors willing to look through short term uncertainty, the small cap sector is now presenting great opportunities to take advantage of.”

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Zenith says DNR Capital has a “robust investment process” based on the premise that markets are inefficient and short-term in focus, giving rise to opportunities to outperform over the medium to long term. “Since DNR Capital’s investment philosophy and process have been applied to the smaller companies segment of the market, impressive results have been delivered.”

The Fund offers investors a relatively concentrated exposure to Australian smaller companies, with 20 to 45 stocks. DNR Capital aims to hold a portfolio of attractively priced companies that exhibit high quality characteristics, such as earnings strength, superior industry position, sound balance sheet, strong management and low ESG risk.

The Fund^[1] has posted returns of 13.32%p.a.^[2] since its inception in August 2018, outperforming the S&P/ASX Small Ordinaries Total Return Index by 9.93%p.a.

Over the 12 months to the end of January 2023, the Fund returned 5.65%2, compared with a 4.44% fall in the benchmark.

DNR Capital Portfolio Manager, Sam Twidale says “Although the short-term outlook remains uncertain as central banks hike interest rates, we believe that more attractive opportunities are starting to emerge in Australian small caps.

“Valuations have adjusted significantly lower over the past year, providing a more compelling entry point for investors. Earnings forecasts are also being revised to more realistic levels, with profitability under pressure from lower revenue and higher costs.

“For long-term focused investors, we believe this presents the opportunity to start buying high quality business models on rebased valuations and earnings. Our focus has been on companies which have the resilience to get through a weaker period for the economy, and where the long-term outlook remains very promising”.

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[1] DNR Capital Australian Emerging Companies Fund, ARSN 627 783 957. APIR PIM4357AU
[2] Performance is net of fees as of 31 January 2023. Past performance is not indicative of future performance.

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Twidale, who manages the DNR Capital Australian Emerging Companies Fund, says the inflation story has shifted from a view that inflationary pressures are transitory to a longer-term theme, and the shift in equity market leadership could have further to run.

“Greater inflationary pressure has been evident during just about all our recent discussions with various companies’ management teams. This is due to supply chain challenges, higher commodity prices, increased energy costs associated with the transition to renewables, higher property costs and ongoing labour constraints.

“Some normalisation can be expected as the impact of the pandemic recedes, but many of these issues also appear more structural in nature and may not be resolved quickly.”

Twidale says DNR Capital has been reducing the exposure to the more expensive areas of the market in the DNR Capital Australian Emerging Companies Fund.

“This shift has been in favour of the cheaper sectors of the market, including Resources, Energy and attractively priced defensives. We finished 2021 with the forward price/earnings (PE) multiple of the stocks in the portfolio at one of the lowest levels since the inception of the strategy four years ago. The forward PE multiple is 17 times currently, compared with close to 30 times a year ago.”

He believes the shift in market leadership could have further to run. “Many of the main beneficiaries from the long period of low inflation and low interest rates could find it difficult to repeat this period of outperformance. Many growth stocks were simply priced for perfection.”

“This compared with many of the more value and cyclical related sectors, where earnings expectations appear more on the conservative side and offer a margin of safety in their valuation.”

A top performing stock so far this year is commodity producer Champion Iron. The company is trading on a PE of less than six times and has a net cash balance sheet. Champion Iron is one of the Fund’s key Resource sector positions, along with Iluka Resources, IGO, Lynas Rare Earths and Deterra Royalties.

Other stocks in the portfolio that have quality business models with defensive characteristics include intellectual property services group IPH and financial services software company Iress.

High quality industry leaders with strong pricing power in the portfolio include student placement provider IDP Education and appliance manufacturer Breville Group.

The Fund returned 34.87% in 2021, compared with a return of 16.90% for the S&P/ASX Small Ordinaries Accumulation Index. Since the Fund was launched in August 2018 it has returned an average of 18.89% p.a., while the index has returned 8.99%, an outperformance of 9.90% p.a.

Twidale says: “As we look ahead to the 2022 calendar year, our outlook for the market and the positioning in our DNR Capital Australian Emerging Companies Fund remains unchanged. We continue to look for strong bottom-up investment opportunities, in quality companies trading on attractive valuations.”

“We expect that market leadership going forward could come from a narrower selection of companies, which will require a more concentrated and benchmark agnostic approach to managing the Fund.”

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Lonsec says the DNR Capital Australian Emerging Companies Fund provides investors with access to DNR Capital’s highly regarded bottom-up stock selection approach, with a focus on quality companies trading at attractive valuations.

Lonsec notes the broader team and process have been able to generate considerable alpha versus the large cap benchmark during their tenure. While the process is less established in small caps, Lonsec believes it is reasonable that the team can achieve similar alpha potential in small cap equities through the application of its ‘quality’ approach.

According to the Fund’s latest performance report, it produced a return of 59.06% over 12 months 31 July2, compared with a return of 32.30% for the S&P/ASX Small Ordinaries Accumulation Index over the same period.

Since inception in August 2018, the Fund has returned an average of 19.42% a year^[2], compared with 8.57% a year for the index.

DNR Capital takes a concentrated approach, with the portfolio holding 20 to 45 stocks. Management of the Fund is led by Sam Twidale, who joined DNR Capital from Schroders in 2017. Lonsec says his global investment experience is a benefit in the management of the Fund.

DNR Capital’s stock research has a strong focus on identifying high quality companies. Stocks must pass an initial series of quantitative screens designed to narrow the investment universe. This approved list of companies is then subject to detailed qualitative analysis based on industry positioning, earnings strength, balance sheet strength, company management and ESG factors.

Lonsec believes this approach provides a disciplined and highly repeatable process which allows the manager to quantify a ‘quality score’ for each company.

Lonsec rates DNR Capital’s ESG policy, which involves integration within the investment process, as “above peers”.

“There is clear evidence of ESG integration within the research elements of the investment process. There is one resource within the team who is designated as ESG champion and serves to maintain the integrity of the ESG output that feeds into the process.”

Sam Twidale, Portfolio Manager for the DNR Capital Australian Emerging Companies Fund adds: “We will continue to back quality small cap companies because we believe they can successfully reinvest capital and achieve pricing power that allows them to grow above inflation. Additionally, these companies have strong balance sheets that allow them to ride out cycles, along with providing strategic optionality.”

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[1] DNR Capital Australian Emerging Companies Fund, ARSN 627 783 957.
[2] Performance is net of fees as at 31 July 2021. Past performance is not an indicator of future performance.

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The Fund has posted returns^[2] of 18.22%p.a. since its inception in August 2018, outperforming the S&P/ASX Small Ordinaries Accumulation Index by 9.65%p.a.

The Fund offers investors a concentrated exposure to Australian small companies. The Fund’s investment process takes a long-term approach, identifying high quality small cap companies trading at attractive valuations. Sam Twidale and Mark Sedawie are the Portfolio Managers for the Fund, which consists of between 20 and 45 of their highest conviction ideas.

Robert White, CEO of DNR Capital adds: “We are very pleased to see this Fund added to these leading platforms, increasing its availability for financial advisers. We are now in a position to provide access to the Fund on nine different wrap platforms.

“We are seeing strong interest in this Fund and are encouraged by the support from consultants, advisers and investment platforms. DNR Capital has generated a consistent track record of outperformance in large caps over the last 18 years, and the performance of this Fund since launching has validated our reason for entering the small cap space.”

Sam Twidale, Portfolio Manager for the DNR Capital Australian Emerging Companies Fund says: “We back quality small cap companies because we believe they can successfully reinvest capital and achieve pricing power that allows them to grow above inflation.

“Additionally, these companies have strong balance sheets that allow them to ride out cycles, along with providing strategic optionality.

“We believe the Australian small cap sector is a particularly inefficient part of the market, providing significant opportunities to add value from applying a consistent and proven investment process. We believe our quality discipline is proving to be more relevant to this part of the market, especially as investors focus on the prospect of a strong recovery from the coronavirus pandemic combined with significant pent-up demand and rebound of the global economy over coming quarters,” notes Twidale.

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[1] DNR Capital Australian Emerging Companies Fund, ARSN 627 783 957.
[2] Performance is net of fees as at 30 June 2021.

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