Nick Guidera’s four small cap ideas for staying ahead of the herd

Animal Spirits are a key ingredient for small-cap investors. Unfortunately, these spirits have been in deep hibernation for many years. However, 2024 saw the early stages of a small-cap revival. The S&P/ASX Small Ordinaries Index delivered a total return of 8.36% in 2024, slightly lower than the S&P/ASX 200 index, which returned 11.44% for the year.

Why is sentiment improving? According to Eley Griffiths Group's Nick Guidera, two contributing factors are a more stable macroeconomic environment and investor caution about highly concentrated markets.

Guidera believes the market has been crowding into defensive growth names due to concerns about a murky macro backdrop and geopolitical uncertainty.

"I think in the last 18 months to 24 months ... there was a lot of concentration in defensive growth names. The market was concerned about the macro backdrop and what was happening geopolitically. And people weren't willing to look at broadening their portfolio into a whole bunch of new ideas."

With the US presidential race settled and confidence growing in the prospect of interest rate cuts, investors are increasingly in the mood to deploy capital into new ideas.

"If you look at the last six months alone, there has been at least $15 billion of capital raised, non-IPO capital, so just secondary capital and most of those deals have done pretty well. Up until the end of October, the last time I looked at those stats, the average deal price was up 15% from the placement price. That, to me, suggests that people want to put new capital to work."

Guidera is bullish on the outlook for 2025 and believes a bull market in small-caps that started in late 2023 can continue in the year ahead. The prospect of lower interest rates is a key contributor to this view, as is the reality that investors are less anxious about a number of the big geopolitical uncertainties that plagued markets in 2024.

Guidera also notes the recent strong performance of large-cap shares such as CBA and argues that many investors have been happily and rightly benefitting from the run. However, should growth in large-cap stocks stall, it could provide another tailwind for smaller companies.

"There's a lot of large-cap guys who haven't sold their CBA and started kicking the tyres outside that ASX100 because you haven't been paid to do that."

"When you see those large-cap guys coming into smalls, that's when you know this small-cap rally can continue for some time."

As part of Livewire's 2025 Outlook Series, we asked Guidera to share his views on the prospects for small caps, as well as a selection of his top ideas for growth, a breakout sector, a contrarian play, and his one stock to own in 2025. A summary of his ideas is below, and the full responses are in the video at the top of this wire.

Growth pick: Paragon Care (ASX: PGC)

Nick Guidera: So, I've got a bit of an unusual one. There's been a lot of attention on Sigma (ASX: SIG) in the last 12 months. I think it's up yesterday, 174% year-to-date, and that's largely on the backdoor listing of Chemist Warehouse, which has had a lot of attention.

The ACCC has now given that it’s blessing, so that's going ahead. But realistically, that stock is probably going to be an ASX 100 stock in the not too distant future. So, for small cap investors, if you haven't been on that trade in the last six or nine months, you're looking for what's next and that's largely what we do.

So what we've found in the last six months is a company by the name of Paragon Care. Now, Paragon Care has been listed for a number of years, but in June 2024, they merged with CH2. Very similar, not a backdoor listing per se, but CH2 is a much larger company than Paragon Care, to the point that they now have more than $3 billion worth of revenue as a result of that merger.

What's interesting about CH2, it's a very similar business to what Sigma and EBOS were before Chemist Warehouse, they're big in wholesale pharmacy distribution. CH2 is also really big in hospital distribution.

This 85-year-old business was bought out by management in 2015 - a management buyout, two gentlemen, the chairman and CEO of the business at the time. They vended that into Paragon Care and are now the CEO and chairman of Paragon Care going forward. What you've got now is a large wholesale distributor. You've also got a manufacturer and you've got a supplier into majority of the hospitals.

What we like about it though, why we think it's really interesting is you've got really strong structural growth markets like hospital and pharmacy and the like, that are growing mid-single to high-single digits year in, year out as the ageing population plays out. At the same time, you've got a nice merger of two businesses with a huge amount of synergies.

They've identified $5 million for FY '25 and another $12 million in FY '26. In addition to that, you've got huge alignment. The three guys, the founder of Paragon Care, plus the two founders of CH2, own over 60% of the stock.

So you've got some really good ingredients there that suggest that this business, once they deliver on the synergies and they can start to do some of the cross-selling opportunities, that these guys that have delivered some pretty impressive earnings at CH2 when it was an unlisted company, to where it is today, we've got the confidence that that can continue.

Breakout industry: Non-bank financials

Stock: Australian Financial Group (ASX: AFG)

Nick Guidera: I think it's non-bank financials and the reason why I think that's really interesting is because interest rate cuts are on the horizon.

Typically in a rate cut environment, you will see the bank's funding mix change and the funding disparity that you've seen where the banks have had a bit of an advantage in a higher interest rate environment. Plus you've had facilities in place from the Reserve Bank that have allowed cheaper credit that has now come to an end. A lot of these non-bank financials have been competing with one hand behind their back.

We particularly like those exposed to the mortgage market because in a lower interest rate environment you should see improved housing affordability. You should see improved housing turnover. And the stock we like in that space is AFG.

AFG is a mortgage aggregator, that is its DNA. It provides services to a bunch of mortgage brokers. And those are part of their network. There's 3,800 mortgage brokers within their network as part of that. They don't own direct shares in these mortgage brokers, but what they do, is they provide access to technology to compliance. They provide things like BrokerEngine, which allows you to fill out your information when you're submitting your mortgage to the broker. It provides connectivity to all the banks and access to all those products. And as the banks are shutting down branches and more people looking for advice when it comes to their mortgage, they're turning to a broker to do that. Brokers are taking share and we expect that to continue in the years ahead.

But probably the most interesting thing about AFG, they've also got a securities business. So, not only are they going to benefit from an increase in turnover of mortgages and household formation, they'll also benefit by their products ultimately being in the consideration set. They've got a $4 billion loan book. They haven't had a whole bunch of losses. I think they've had none in the last 12 to 18 months, but I think they're pretty well positioned.

Contrarian idea: Myer (ASX:MYR)

Nick Guidera: There's probably not many people that have spent much time in Myer in the last six months, but I've been there twice.

The secret sauce that Myer probably has is 7 million Myer One customers which have those little black and white cards that, 15 or 20 years ago, your mum and dad might've had one in their wallet.

They still exist, and I think on last count, there's more than 4.5 million that are active. That loyalty is pretty amazing for a store that's potentially lost its way in terms of what does it sell and what it stands for.

The other secret ingredient that Myer has is a new executive chairperson, who is Olivia Wirth. She was one of the architects behind one of the most successful loyalty programmes at Qantas in the last decade. She's coming here with that loyalty background to put a fresh set of eyes on how they can transform those really loyal customer base into buying more from Myer while also looking at productivity improvements and opportunities.

The third leg in the story is that they've recently announced a deal to acquire a number of private label brands off Premier Investments (ASX: PMV). Now their brands like JJs, Just Jeans, Dotti, for example, and Jacqui E. With that acquisition, Myer has indicated that there will be potentially $30 million in synergies in the first instance, but it's going to become a pretty big business. $4 billion worth of revenue and maybe $150 million of EBIT. We think that there's a lot of opportunities for Olivia, assuming the merger goes ahead and is approved, to look at the smarts that are within Premier and potentially introduce that to some of the brands that are sitting within Myer itself.

One stock for 2025: Infratil (ASX: IFT)

Nick Guidera: It's a Kiwi stock, would you believe it? But it's dual listed. So it's listed in the ASX as well. It's not as well known as many would think despite all the attention on data centres and AI. The stock's Infratil; it's a global infrastructure investor and where they're spending their money, digital infrastructure, healthcare and renewables. Now if you put those three themes on the list of Livewire readers themes for the next three years, they're up there.

And these guys have got exposure to it and probably the most interesting asset that they have is they've got 48% of one of the largest data centre operators in Australia known as CDC. This data centre has been an incredible asset. It's continued to grow. It's got over 400 megawatts of contracts that are currently in negotiations and likely to be rolled out over the next four to five years. That's just one asset.

They've also got a large renewables business in the US known as Long Road with a large solar portfolio. On the cashflow front, they also own the number two telco in New Zealand that generates a heap of cash and helps fund these growth investments that they've got in infrastructure and renewables as they continue to plough capital into it.

Disclosure: The author’s SMSF own units funds managed by the Eley Griffiths Group