Buy Hold Sell: 5 undervalued small caps with big growth prospects

Australia's GDP growth has been on a steady decline for a while now. While the economy was still growing at a rate of 0.5% in the fourth quarter of 2022, that pace has slowed markedly from the 3.7% print seen in 2021. 

The December quarter of 2022 was the fifth consecutive period of economic growth, but it was also the smallest uplift of that period. That's likely because consumers are increasingly burning through their savings as cost pressures and interest rates remain elevated.

So where can investors find growth in a low or even no-growth world? 

In this episode, Livewire's Chris Conway was joined by Yarra Capital Management's Katie Hudson and Prime Value's Mike Younger for their analysis of three small-cap stocks with big growth runways ahead of them. 

Plus, they each also name a high-conviction portfolio position with what they believe to be the best growth prospects over the year to come. 

Note: This episode was filmed on Wednesday 5 April 2023. You can watch the video, listen to the podcast, or read an edited transcript below. 

Edited Transcript 

First up today, we have EQT Holdings. Its funds under management, revenues, and net profits all increased in the first half. Katie, starting with you, is it a buy, hold or sell?

EQT Holdings (ASX: EQT)

Katie Hudson (BUY): It's a buy for us. We like Equity Trustees. We think they've got a really great platform, and a really strong, resilient earning stream. The corporate trust business is growing. They've done a great acquisition with IOOF's AET business. We think the synergies from a capital release and a cost perspective will be higher than people are expecting. We think they have an opportunity to sell their UK business, which while unprofitable, we think will release value. Then over time, that platform should be capable of growing leverage to markets and they should get really good operating leverage. Great balance sheet, good management, and one we like.

Mike Younger (BUY): It's a buy for all the reasons Katie has said. I think she stole my script. The one thing I would add is that over the last few years, notwithstanding this fantastic growth outlook, is that the company's EPS growth is likely to rise about 50% in the next two years. You've seen PE derating in the last few years such that it's trading at a market multiple for a business that is well above market quality.

Domain Holdings Australia (ASX: DHG)

Mike Younger (BUY): For us, Domain is also a buy. It might sound contrarian with house prices falling, but if we zoom out a bit, the actual listings volumes this year are probably going to be within 5% of 15-year lows. So while it could get worse, it's probably not going to get much worse. At the same time, Domain and its main competitor, realestate.com, are putting up their prices, which is cushioning the earnings impact. So it's another stock that we think has 50% earnings per share upside in the next couple of years.

Katie Hudson (BUY): It's a buy for us. This is the sort of opportunity we love to buy, these long-term structural growth companies. Essentially, they're a digital media company transferring value from print and other sources of marketing to online digital platforms. And as Mike highlighted, last year we had listing volumes above historical levels because we were coming out of COVID. This year, they're well below. Through that disruption, the share price has fallen and that feels like a really good opportunity that we're taking advantage of.

Australian Clinical Labs (ASX: ACL)

Katie Hudson (BUY): It's a buy for us as well. We really like the pathology sector. In fact, the whole diagnostic sector at the moment has had a lot of disruption. Coming out of COVID, there's been problems with access to health services. Volumes have been artificially lowered as a consequence, and we think those volumes will resume their normal growth trend over time. The COVID revenues have now largely fallen out of their P&L, so we've got a firm base as to how they look going forward. And that diagnostic sector, particularly pathology and radiology, we think is trading at multiples below private market multiples, which is unusual. Typically, public markets trade at a higher level. We've got an unusual situation here where private markets are trading at a higher level, and if they don't recover, we think they'll get taken over.

Mike Younger (HOLD): It's a hold for us. Management appears to have done a fantastic job of managing that COVID testing winddown and the valuation looks quite reasonable. The thing that keeps us on the sidelines is the audaciousness of ACL making a bid for a company three times its size (Healius, ASX: HLS), particularly one that's got a chequered financial history.