TOL - 16th Sep, 2023
Chris Prunty's 5 top stock picks for growth
Plus, he shares what he has recently heard at the coalface during reporting season that has him concerned.
Unlike us punters, fund managers get a front-row seat to CEOs and CFOs during reporting season. This is a chance for the professionals to ask tough questions of their portfolio companies, in the hope they gain an edge that the rest of their peers may have missed.
This reporting season, the topic du jour was artificial intelligence. But a more serious call out was the lack of hiring intentions for the future.
That's according to Chris Prunty, a portfolio manager and co-founder of QVG Capital - an Australian small- to mid-cap manager with high conviction and long/short strategies.
"Our portfolio is very biased towards growth companies, so you would expect those businesses to be hiring to support that growth," he explains.
"But I've never had more companies, either portfolio companies or just ones that are on our radar, tell me that their hiring intentions for this financial year are zero or close to zero."
Prunty believes this could suggest that the RBA's rate hikes are finally bleeding through to the employment market. With this in mind, he argues that we could have seen the end of the central bank's rate hiking cycle. But he's not betting the house on it.
"Our approach, irrespective of rates, is to go for organic growers, and in a tougher rate scenario or in an easing scenario, that organic growth will be the driver of returns," Prunty says.
In this interview, Prunty points to five stocks that fit the bill and provides a deep dive into the most impressive (and most disappointing) results from the August reporting season.
Note: This interview was recorded on Wednesday 6 September 2023. You can watch the video or read an edited transcript below.
Edited Transcript
Ally Selby: Hello and welcome to Livewire Markets. I'm Ally Selby, and today we're very lucky to be joined by QVG Capital's Chris Prunty for a look into how he's positioned on the back of reporting season as well, as where he is finding the most opportunity within small caps today. Thank you so much for joining us today, Chris.
We've obviously seen liquidity dry up in smaller microcaps over the last two years. We've just come off the back of the August reporting season. Given that you really explore within that smaller micro-cap arena, how was reporting season for you?
Chris Prunty: Well, it was volatile. Lots of stocks moved up or down 10% on the day of their results, and that really tested your conviction in what you owned. Fortunately for us, we had more go-ups than blow-ups, and as volatile as reporting season was, it was a lot of fun. We love getting in front of companies and seeing their results. It's like having two grand finals a year for us.
Ally Selby: Have you made any changes to the portfolio on the back of those results?
Chris Prunty: There are two types of changes you make in reporting seasons. There are the natural portfolio moves you make around adding and taking away positions as their prospective returns increase or decrease - that's just the normal course of business. The second type is more the "oh shit" moments where a result comes out and you fundamentally change your perception of the company off the back of it and then you have to move more aggressively. The good news for us this reporting season is we didn't have any "oh shit" moments. It was more the natural trading activity as you readjust your views around future returns based on new information.
Two standout results (that can be sustained going forward)
Ally Selby: I definitely had an "oh shit" moment with one of my portfolio companies, so I'm quite jealous there. For you, what was the standout result from your portfolio?
Chris Prunty: From the stocks we own, there are probably two I'd call out, Johns Lyng (ASX: JLG) and Aussie Broadband (ASX: ABB). The similarities were their results came in line or ahead of expectations, cash flows were very strong, which meant the balance sheets look good, and the outlooks were in line or ahead of the market's expectations. And we feel like both companies have guided conservatively, so there's the prospect for upgrades throughout the year. So those were the two I'd speak to.
Ally Selby: Do you feel like those results will be sustainable over the next few years?
Chris Prunty: That's the other point. Johns Lyng and Aussie Broadband are both more or less economically insensitive. So irrespective of what happens in the wider economy, we think those results will be sustained. And they're both founder-led companies, which we also like.
A company that surprised to the downside
Ally Selby: I know you said you had no "oh shit" moments, but were there any companies that surprised you to the downside?
Chris Prunty: Yes. Data#3 (ASX: DTL) was down 20% in a day off its result, so that was a potential "oh shit" moment. But the nature of the business, the balance sheet, and the cash flows were all quite strong, and subsequently, the stock reversed most of that 20% fall. So it was only temporary.
Ally Selby: Okay. What are you seeing at the coalface? Obviously, you get to speak to CEOs every day, but particularly during reporting season, what were they saying?
What Chris is hearing at the coalface: No one is hiring
Chris Prunty: Well, they were getting asked a lot of questions on AI. We didn't ask that question. I think it's too early to really know what that means. The call-out I'd have, a more serious one, would be around hiring intentions.
Our portfolio is very biased towards growth companies, so you would expect those businesses to be hiring to support that growth. But I've never had more companies, either portfolio companies or just ones that are on our radar, tell me that their hiring intentions for this financial year are zero or close to zero.
So I think that's a really important call out for what unemployment looks like through the rest of the financial year, and perhaps signals that what the RBA is trying to do is working. We know employment is a lagging indicator, so that's something that was a call-out for us.
Ally Selby: Let's dive a little bit deeper into that. What could that mean for the interest rate cycle going forward?
Chris Prunty: Well, if it plays out as expected, then it means rates have peaked. I think the uncertainty around rates is that the services component of inflation has been relatively sticky. We know the goods side of it has come down, but the major feed through to services inflation is labour costs, and obviously minimum wages have gone up quite materially, so that's still going to feed through. But perhaps we could see some dampening within those middle-income and higher-income workers.
Where to invest with this in mind
Ally Selby: Where are you seeing the most opportunity today? Given that we might see unemployment rates rise, where are you seeing the most growth opportunity?
Chris Prunty: Well, if that scenario plays out, then you really want to look for businesses that have an internal driver to their organic growth - so something they're doing that's unique to them - or they're selling into an end market that's above GDP growth.
If you tilt your portfolio towards more economically sensitive or cyclical companies, then you'll probably do poorly in that scenario. So we have a very growth-biased portfolio [right now].
Ally Selby: Do you want to take us through some examples?
Chris Prunty: Our top five holdings are Johns Ling (ASX: JLG) and Aussie Broadband (ASX: ABB), which I spoke about before. HUB24 (ASX: HUB) is a big holding, Lovisa (ASX: LOV), and Life360 (ASX: 360).
They're all quite different companies, but the commonality is they're all well above market growers, with high incremental returns on capital, and great balance sheets.
Often, those companies will look expensive to other managers, but we think the organic growth in those businesses justifies a premium valuation. So we have a heavy tilt towards strong organic growers at the top of our portfolio.
Ally Selby: Obviously, there's been this almost crazy dispersion in returns within the small end of the market. What do you think needs to happen for both small and micro caps to rebound as a group?Chris Prunty: Well, we've certainly been a victim of that the last couple of years. Smalls have underperformed their large-cap peers by 20% over the last 18 to 24 months, and even over the last 12 it's been about a 10% underperformance. So we would love for that to reverse.
What has to happen for that to reverse? It's probably going to be flow-driven, so if interest rates peak, that will give investors more confidence that we've seen the valuation trough. And then it becomes very much about earnings for specific companies.
That's where most small-cap fund managers should do well. Typically, as a cohort, we're good at picking earnings for our companies. But I think it's got to be flow driven and I think it probably takes a bit of momentum to come back into the market that will give people confidence to re-look at that disparity between large caps and small caps.
Chris Prunty: Well, we certainly hope so, but we're not betting the portfolio on that. Our approach, irrespective of rates, is to go for organic growers, and in a tougher rate scenario or in an easing scenario, that organic growth will be the driver of returns.
Ally Selby: Okay. Well, I really enjoyed this chat today. Thank you so much for your time, Chris. If you enjoyed that too, don't forget to subscribe to Livewire's YouTube channel. We're adding so much great content just like this every single week.Find out more via QVG's upcoming investor webinar
If you're interested in hearing more from the QVG Capital team please register for our upcoming invest webinar to be held on Tuesday September 19.
The webinar will cover the recent reporting season, QVG's portfolio positioning and the outlook for our funds.
Register Here
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Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian Group, Your Money, Sky Business and Sky News.
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Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...
Expertise
Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...
Expertise
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