“Be as overweight Australia as possible” – Auscap's mid-caps set to outperform

“That’s certainly been the right way over the last 100 years, with the Australian market delivering the best returns of any developed market, at around 12% a year, and I see no reason for that to change and if anything, we’re in a better position now than we have been.” 

He cites Australia’s natural resource advantage, that should position Australia well for the green energy transition, relatively strong population growth over the medium term, Australia’s proximity to the high growth and rapidly developing Asian economies, and the democratic and rules based political system including the protection of property rights as reasons to expect Australia will continue to provide one of the best investing environments in the world.  

He believes that at the moment Australia is on a different glide path for a number of reasons. These reasons include our lower wage growth of about 2.3% and core inflation of 2.6%, which aren’t far away from the Reserve Bank of Australia’s target ranges.

What and when to buy?

Carleton believes now is the time to buy. Auscap was holding a little over 10% cash earlier in 2022 but has since redeployed the majority of this post the recent selloff. The Auscap portfolio currently holds around 39 companies, around three-quarters of which are founder-led. Some of the stocks his team has been either adding to the portfolio or increasing their holdings include:

Macquarie Group (ASX: MQG)

Lauding the financial group’s track record, Carleton ranks the company alongside the best of its global peers for its diversified geographical exposures and “exceptional returns on invested capital.”

Held by the fund almost since inception, MQG has delivered consistently strong earnings per share growth – something Carleton is confident will continue.

Mineral Resources (ASX: MIN)

Another long-held stock, the mining company is the world’s fifth-largest lithium producer, a business Carleton described as “the excitement engine for Mineral Resources going forward.” He cites Albermarle estimates that lithium demand will be 8 times higher than it is today at the end of this decade.

MIN’s other two business units produce iron ore – of which it is Australia’s 5^th largest producer – and provide mining services to some of the world’s biggest companies including crushing, processing and open pit mining. The latter is another highlight for Carleton and his team, its high regard in the global industry being reflected in its unusually long contract durations. And while iron ore currently provides good upside because of elevated commodity prices, this business only comprises around 5% of the total value Auscap sees in the group.

Nick Scali Limited (ASX: NCK)

“This is probably my favourite company right now,” says Carleton, referring to the furniture retailer’s 10-year average return on equity of more than 50%.

He acknowledges concerns from some corners of the market that sales volume growth is a short-term phenomenon spurred mainly by pandemic lockdowns, but highlights record sales in the last two months of 2021, which continued into January, “and we think this is likely to continue.” More importantly, the business has many company specific drivers of growth in revenue and earnings over the medium term, including the opportunity to nearly double the company’s store foot print, margin expansion opportunities within the recently acquired Plush business, and a continued push into the ecommerce channel at very attractive margins.

HomeCo Daily Needs REIT (ASX: HDN)

This listed commercial property firm owns 51 homemaker centres around Australia, whose tenant mixes are dominated by either ASX-listed firms or large international brands.

The forecast dividend yield of 6.6% and fixed rent escalations built into the majority of tenant leases that average 3.6% “provide a very attractive base return, even before we consider anything else,” Carleton said. “We think there is a long runway of above-market rent increases over time.”

Another sweetener includes the REIT’s site coverage of just 38% - which means 62% of the land it owns remains ripe for further development.

With a development pipeline of $500 million, we expect them to be working on between five and 10 projects per year to develop some of that surplus land for the next decade and beyond.”

“These will be incremental to an already very attractive total return of around 11%”