6 emerging plays as the index hits record highs

The December quarter was among the busiest and most eventful periods I can recall in recent times. The period in review concludes a year of extraordinary occurrences, both in the market and the real world. 

Domestically, November was declared the S&P/ASX All Ordinaries strongest month on record, rallying 10.2%. The AGM season delivered broadly in line with expectations although several consumer discretionary names saw adverse share price reactions to upbeat guidance, an indicator that markets had likely gotten ahead of themselves. Investors seemed largely comfortable that economic momentum would underwrite any earnings tail off from JobKeeper winding back from September 30.

The S&P/ASX 200 Index is on track for a test of 7200, the old market high. The ASX100 is also poised for something similar. Mid cap names went to new highs in December and appear well bid at this time. 

The Small Ordinaries Index is constructive too but has more work to do, starting with a convincing and sustained clearance of the March 2020 high of 3100. This should usher in a swift move to 3505 and ultimately a test of 4177 - the historic high of 2007. Breadth remains snug, with 70% of the benchmark above the investment line. It will not be surprising to learn that the Small Resources Index is set to push topside having worked through a seven-year base. 

It is exciting to report that the old highs for the Emerging Companies Index are within reach. My September update described price action for these names as ‘blue-flame bullish’. Apt at the time, and this most probably remains the case. 

On the back of this good news, we have made the following changes to our portfolios.

6 additions to our portfolio

We returned to the Credit Corp (ASX: CCP) register in October, having quit the name in March as the global pandemic began. There was little doubt as to management’s ability to traverse the unfolding crisis, but how would their clientele fare? With limited visibility, CCP pre-emptively raised $120m in late April, ensuring the balance sheet had $500m to deploy when pricing for debt ledgers met their requisite 16-18% ROE. The earnings outlook for CCP became clearer as the pandemic unfolded, so to its competitive position. The question is now timing; when will pricing be attractive enough for CCP to deploy its arsenal? The recent $160m acquisition of Collection House’s local debt ledger book for 80c in the dollar is evidence the process has commenced.

EGG added Pilbara Minerals (ASX: PLS) to both portfolios in November. PLS in our minds is the ‘bellwether’ EV sentiment stock in our market, being a large scale Australian spodumene producer sitting towards the upper end of the global lithium cost curve. During the 2016-2017 bull run, PLS was an explorer transitioning through the development phase. By the time it was funded and into production, the cycle had turned and the operation has essentially been bleeding cash ever since. Whilst it became clearer throughout the latter half of CY20 that the demand equation for anythingƒ EV-related was inflecting higher, PLS was already on a path to cash flow breakeven, irrespective of if /when the spodumene price started to move (which it has, albeit only marginally to date). Throughput and recoveries were improving, unit costs were falling and interest costs had more than halved. With the cash bleed subsiding, the funded proposal to acquire neighbouring producer, Altura (as lithium prices evidently had bottomed) proved to be the turning point for the stock.

After a long absence, Virtus (ASX: VRT) returned to the portfolio. The combination of Covid-19 government income support, a change of family priorities and restricted travel options, has resulted in the IVF sector enjoying a surge of interest from couples keen to start a family. At their AGM, VRT referenced strong volume growth across key markets, with premium cycle growth ahead of the market in Q1. Despite H2 volume trends being tipped to moderate, the fixed cost nature of the business means that improved volumes will result in strong incremental margins. We believe the fertility sector will be a continuing beneficiary of a buoyant consumer.

A modest holding was established in Playside Studio’s (ASX: PLY) during and immediately after the company’s IPO. PLY is one of Australia’s biggest independent game developers with both self-published games and those developed in collaboration with all of Hollywood’s major studios. The global gaming industry in all its guises was valued at US$160bn in 2020 and is forecast to grow at ~10.5% pa over the next 2 years. Little wonder it has been one of Wall Street’s most keenly sought industries. The founders have deep industry credentials and remain well aligned with incoming investors.

Sovereign Cloud (ASX: SOV) was added to the portfolio during the quarter. Cyberattacks through 2020 have reinforced the importance of data sovereignty and to date, Enterprise has led the migration to the cloud. Government has a significant migration ahead of it, with one of the main issues relating to data being stored on infrastructure owned or operated by a foreign entity or physically housed offshore. SOV is a secure, scalable and domestically domiciled Australian Infrastructure-as-a-Service provider solely focusing on the Australian Government, especially the defence forces and critical national industry communities. Management are best-of-breed with chairman Cathie Reid recently being appointed to the Government’s new advisory committee on cybersecurity. SOV is well-positioned for significant demand growth from government and critical industries in the years to come.

Aussie Broadband (ASX: ABB) joined the portfolio recently. ABB is Australia’s fifth-largest provider of nbn™ (NBN) services, connecting more than 250,000 Residential and Business customers. Aussie Broadband’s competitively-priced NBN bundles have proven popular with consumers with the group enjoying a solid share of ADSL-NBN conversions over the past 4 years. Founded by Phillip Britt, a 24yr telco industry veteran, the opportunity to participate in the future growth of the business was hard to pass up.

2 exits from our portfolio

Our Fineos (ASX: FCL) shareholding was sold despite us being attracted to the groups medium to long term prospects. The multipronged runway for growth, be it through the retirement of legacy platforms in the Life, Accident & Health insurance market, implementing new modules/capabilities, carrier consolidation and transitioning to a SaaS revenue model, we believe to be enduring. There are some headwinds to overcome. First, delays to new implementations (services) may yet result in slowing SaaS revenue growth into outer years. Second, the recent Limelight acquisition has underperformed initial expectations.

Finally, currency headwinds (Euro strength relative to USD) ~10% in this current half will stymie reported growth figures. All of these issues we believe are surmountable, but with the backdrop of rising bond yields also looming (= potential for higher discount rates), we opted for a better re-entry point at a later date.

Bega Cheese (ASX: BGA) was quit from portfolios during the period in response to a changed investment thesis. Eley Griffiths Group believed that the worst of the group's earnings volatility (largely via acquisitions) was behind them and that a cost-out and right-sizing of the business currently underway would generate improved returns for the group. Further, the balance sheet would be bolstered by the likely sale of the Vegemite site in Port Melbourne as well as the rationalizing of several milk processing sites. Improving global milk/cheese prices and a commercial milk supply with dairy farmers would provide a bullish backdrop. Blurring the script, the group launched a $534m bid for Lion Dairy and Drinks, an exacting purchase we preferred they not entertain.

Outlook going forward

As the bull market in stocks marches on, it is increasingly commonplace to observe a lessening in respect for capital. In the US, door to door food delivery company, Door Dash (NYSE: DASH), listed with a market cap of US$60bn. AirBnB (NASDAQ: ABNB) debuted at double its offer price. The median price/sales ratio for a US IPO is 24x. 

Nosebleed stuff? Perhaps not when you consider the 2000 dotcom market saw this ratio at 50x.

This, by the way, is an all too familiar feature of stock markets that are replete with funding, have a new and enthusiastic audience and are positioned late in their cycle.

Covid-19 and its variants and the distribution of vaccines remain the wild card influences on how the economic story plays in 2021. Additionally, February's local reporting season will be delivered with a backdrop of buoyant consumer sentiment, a firm resources market and improving property and construction pulse. Customarily it provides a window for professional investors to reset earnings expectations and this frequently brings on outsized volatility in share prices but it is reassuring that the pre-season confessions have not been problematic. 

At some point, the advancing US 10-year note yield will begin to trouble the market. Tactical asset allocations to equities are reportedly únder the gun’ between 1.3%-1.5%. Whilst equity risk premiums remain at elevated levels (US ~6% and Australia ~7.8%) investors continue to be in the privileged position of being paid to not fight the tape and remain long equities.

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Eley Griffiths Group is a specialist at focusing on small and emerging companies in Australia. Their investment process and team have delivered consistent outperformance through all market conditions for 15 years.

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