2 unloved sectors of the market that are providing big opportunities

NovaPort Portfolio Managers, Sinclair Currie and Tim Binsted, delve into the August reporting season. They discuss the latest trends, surprises, and market insights, with a particular focus on the resilience of the Australian consumer.

Transcript

Sinéad Rafferty: Welcome to the latest Novaport Narratives podcast. I’m your host, Sinead Rafferty. Today’s discussion centers on August’s reporting season, and in particular, the resilience of the Australian consumer. I’m joined by Novaport Capital Portfolio Managers Sinclair Currie and Tim Binsted. Can you give us a bit of an insight, first of all, of your overall impressions from reporting season and what kind of scorecard would you give?

Sinclair Currie: Sure. We weren’t expecting fireworks coming out of this reporting season. We think the market and management had in general done a pretty good job of setting expectations about right. So in general, where we were looking was towards the outlook statements and what they might contain and how the market might react. We’d give a pretty high score. If we’re going to call it out of 10, we’d say seven or eight. It was a pretty pleasing reporting season in the main to our mind, in terms of the sorts of results that were reported.

Wouldn’t say things bashed it out of the park massively, but things were pretty much close to where we would’ve anticipated. And quite frankly, the outlook statements, they were cautious. They usually are cautious, but given the environment we are in, possibly could have been a little bit more cautious. So we’re pleasantly surprised with the outlook statements and the market probably reacted.

I think the biggest surprise to us was the market was possibly a little bit more eager to react positively to some… particularly those consumer discretionary names. Some of the outlooks they gave, we thought there’d be a little bit of caution by the market, but they sort of took those statements as a really positive sign. So in all, it was a pretty good reporting season despite the fact that the market came back, et cetera, during the period with some results largely in line with expectations. And we think there’s some good signs of optimism and I guess the market’s listening to what management are saying.

Sinead Rafferty: So can you share, maybe, Tim, some of the stories that kind of surprised you in terms of some of the names in the portfolio?

Tim Binsted: Yeah, yeah, sure. And to Sinclair’s point around those retailers and the consumer to your opening comment, Sinead, we had the market sell off all these names into reporting season. You’ve always got to remember, where are stocks trading relative to market expectations? And a couple of stocks that performed quite well, including a couple of holdings, Nick Scali (ASX: NCK) and Breville Group (ASX: BRG), two retailers that are not at the lower end of the market, they’re higher quality retailers, well-run with good market positions and better control over their pricing than others have, even though they’re discretionary products.

And some thematics, like for example, the global taking of coffee share towards espresso from… so filtering other coffees in markets around the world for Breville and for Nick Scali just not priced appropriately to its earnings potential. So they both performed well despite the fact that the shift was actually a bit softer than it was in the previous period, so expectations always matter relative to the outcomes.

I guess another one that was pretty positive would be something like Boral (ASX: BLD), that’s the big construction materials business, talking about change in pricing dynamics. And there’s been a few others who followed suit and that’s been very positive for the industry to claw back better returns after a period of hypercompetition that’s put a lot of pressure on returns on capital. So that’s been a standout as well from the season.

Sinclair Currie: And one of the things we noticed in the microcap space was really interesting, to Tim’s point, was Wagner’s Group (ASX: WGN), which I think… Tim, you had a close look at that result and I think the market was really surprised by it.

Tim Binsted: Yeah, … again, to this point of a change of pricing dynamic, that one performed really well. It had been under pressure with costs rising heavily against it within this inflationary period that’s been well-publicized and the stock had a really tough first half result. And that was one where if you looked at the change in competitive dynamics with, for example Boral, the market leader, getting more robust on pricing, you could see that the headwinds of rising costs were starting to recede and the tailwind of better pricing and less aggressive competition for market share was going to turn margins around the other direction.

So the market had become too negative and focused on, I guess, the previous 12 months and we were looking to the next 12 months and it’s proven we’ve got that one right and it’s really reacted well. So that was a standout for that part of the market.

Sinclair Currie: And I think the market was also pretty impressed with the results from Regis Healthcare (ASX: REG), which is another sector, aged care, we’ve been following for a while. has obviously been taken out, but I think what Regis’s result highlighted was the fact that occupancy has gone from a headwind to a real tailwind to earnings and they’re really getting on top of some of the change that’s required in terms of care minutes, et cetera, by adapting their care models and are quite positive about their ability to, I guess, deliver under the new funding and care regime that’s ahead, which I think really the market was quite positively surprised by their confidence coming out of this result.

Sinead Rafferty: Do you think that’s set to continue given the demographics and the other tailwinds that are in place for that part of the market?

Sinclair Currie: Absolutely. In aged care, one of the highlights that both management teams of the listed operators pointed out was, you really are at a bit of inflection point now where those baby boomers, the older ones, are starting to get very close to 80 years old, which is where that point of need for their services really kicks in.

Sinead Rafferty: And what about, was there any announcements that led you to change your view on a particular company?

Sinclair Currie: I guess there was one, the salary packaging sector. We actually took the opportunity to pick up a position in salary packaging through Fleet Partners, not because they actually announced they didn’t have a result, but some of their competitors did, McMillan, Shakespeare and SG Fleet. And it highlighted just the tailwinds that really coming out of a change, which has been to the fringe benefits tax regime on electric vehicles, battery electric and hybrid vehicles. And I’m just constantly amazed how few people are still aware of the huge, I guess, tax concessions that are available to salary packaging and EV at this point in time. But as that awareness grows, it’s certainly leading to a lot more inquiry and volumes for these operators, fleet partners, McMillan’s (ASX: MMS) and SG Fleet (ASX: SGF). We chose to pick up some Fleet Partners because it was a little bit outside of the reporting cycle, so the share price hadn’t responded. So we saw a little bit of an opportunity there.

Sinead Rafferty: And what about the outlook more broadly for the small companies part of the market, what are you seeing? And bring it back to the theme of the day in terms of the Australian consumer?

Tim Binsted: Yeah, I’ll say from a high level, the discount for small caps relative to large caps is still quite wide. And as we’ve just been discussing, the earnings outlook for some of these stocks is actually relatively robust. So lower valuations relative to other opportunities in the Australian market, plus earnings that in some cases can be more robust than maybe the market’s pricing. So there’s definitely attractive opportunities in the small cap market. We don’t take that macro lens in how we invest. We tend to look at idiosyncratic opportunities from the bottom up. So there are opportunities there. For example, in the building and construction market, we think there’s going to be a shallower downturn in the cycle. The home builder raised to get your lot started created a huge demand for new freestanding homes. There’s a big backlog to work through, which will support earnings probably for the next 12 months or so.

There will be a bit of a dip from the peak in terms of volumes and margins, but we think it’s not going to be as sharp as maybe the market is estimating. So some of these stocks are quite attractive valuations relative to those what should be better outlooks. And as we’ve seen with migration coming in, house prices defying the doom and gloom predictions, it should be a better place for those companies.

Sinclair Currie: Yeah, I mean, I think from our perspective, one of the things which has opened up an opportunity at the moment in small caps is there has been a vacuum of liquidity to the sector. As large players have said they don’t want to invest in smaller liquid stocks. That’s created fantastic opportunities. A lot of really fantastic growth names de-rated substantially through that period and we were able to take a look at investments which previously just were too rich, valued too rich, things like Audinate (ASX: AD8) or Netwealth (ASX: NWL) where we’ve really managed to find some good opportunities.

So I think for us, that sort of liquidity cycle, we’re at a point which is pretty opportunistic for investors in small caps, but to Tim’s point, within small caps, it’s always about trying to find those names, those really interesting differentiated businesses, which aren’t necessarily just exposed to the broader economy, but have got something, a beating heart behind them, which is independent of what’s going on between interest rates and housing or whatever that is.

Tim Binsted: Or where the market may have just thrown it out and isn’t looking properly like Wagner’s Group. That’s the beauty of looking at those smaller market caps is that sometimes, other people aren’t looking and there lies the opportunity for us to spot something that others don’t see.

(VIEW LINK)

(VIEW LINK)