Small and mid-caps leveraged to the Australian economic rebound

When considering how well Australia has managed its response to the coronavirus pandemic relative to other countries, Oscar Oberg and Tobias Yao find it difficult to not be bullish on the equity market.

“Tobias and I have seen hundreds of companies in the last two or three months, and we have been across Australia, and it really is a very positive and buoyant picture for corporate Australia going forward.” – Oberg

That being said, the Portfolio Managers believe a change in thinking is required to capitalise on opportunities in the micro, small and mid-cap markets. Whereas they were bullish on retail, automotive, and agriculture six months ago, Oberg and Yao see better upside in cyclical and cheaper sectors including financials, mining, travel, and notably, traditional media.

“Coming out of coronavirus, we believe companies will have to spend aggressively to try to re-establish their brand presence in the market.” – Yao

In this stock-rich discussion, the managers of WAM Capital, WAM Microcap, WAM Research, and WAM Active talk about their recent marathon of company visits and nominate 15 Australian companies with prospects for sizzling gains.

Discussion points

• Reasons to be bullish on equities
• Why investors are in for a golden period in small caps
• The sectors and 15 stocks Oberg and Yao are upbeat on

This video is part of the WAM Vault series filmed in June 2021. Click here to access interviews covering Aussie large caps, global equities, and alternative assets.

Transcript

James Marlay: Hello and welcome to the latest instalment of WAM Vault. My name is James Marlay. I am your host. Today I am joined by Oscar Oberg and Tobias Yao, who are the Portfolio Managers of Wilson Asset Management’s micro and small-cap strategies. Oscar, I’m going to start with you. I understand you are bullish on the outlook for the Australian economy. Could you give me an insight into what is driving that optimism?

Oscar Oberg: Given how well Australia has managed coronavirus, and what we are seeing with low interest rates and record house prices, it is really hard not to be bullish on the Australian economy at the moment. Tobias and I have seen hundreds of companies in the last two or three months, and we have been across Australia, and it really is a very positive and buoyant picture for corporate Australia going forward. One of the best examples, I caught up with a non-bank lender, one of the largest in Australia, just yesterday in Melbourne, and they were saying that the number of problem or impaired loans that they have on their book is actually lower today than what it was before coronavirus. So it just shows you how strong the Australian economy is right now.

James Marlay: So with that positive backdrop, what sectors do you think are set to outperform?

Oscar Oberg: We’ve certainly played the transition from growth to value and we did that as soon as the announcement of the Pfizer vaccine occurred back in November. We have positioned the portfolio in sectors such as diversified financials, and some others, what we call ‘beaten up’ sectors, the most impacted sectors and companies from coronavirus, such as aged care, construction services and building materials. We see a really buoyant outlook for these companies, particularly for earnings growth over the next two or three years.

James Marlay: Small caps have had a really strong period. What is your outlook for the smalls?

Oscar Oberg: Very bullish James. We still are. I think it is a great period for small cap investing, probably one of the best we have seen. It is great for our investment process as well, and that is largely because around 40% to 50% of the small-cap companies that we look at are exposed to the economy in some way. Now, we have shifted our thinking. When we talked six months ago, we were very bullish on retail, automotive and agriculture. We have shifted to more cyclical and cheaper sectors such as financials and mining services, and we do think these sectors will outperform over the medium-term.

James Marlay: In terms of that small space, do you have a tilt for size? Is it smalls, or midcap and is there a sweet spot there?

Oscar Oberg: The strategy really has not changed since last year. We wanted to stay in more liquid companies and bigger companies. I think the average size of the companies that we invest in WAM Capital (ASX: WAM) is around $3 billion. We could probably sell around 80% of the portfolio if we wanted to in five or six days, and we are staying liquid. It is a very volatile market. It changes every week. It changes every day. It goes from growth to value. So we are happy staying liquid as it is still an uncertain market. Who knows, we might have an outbreak of coronavirus, touch wood. But at the moment we are happy with how we are positioned like that.

James Marlay: The re-opening trade has been one that people have been really focused on. Sectors like housing, travel, media are in the spotlight. It would be great to go through a few of those sectors. Oscar, I will kick it off with you. Your view on housing?

Oscar Oberg: Very bullish housing. Sam, who is an Equity Analyst in our team, did some great work when the Home Builder Scheme got announced just over a year ago. It was about $100 billion and effectively that is the equivalent of 12 months of new housing construction in Australia. So it is just massive. The building materials have been a good space for us. We still hold and have big holdings in Fletcher Building (ASX: FBU), Adelaide Brighton (ASX: ABC) and Reliance Worldwide (ASX: RWC). We also have those financial companies exposed to the housing market, like Genworth (ASX: GMA) or Australian Finance Group (ASX: AFG).

James Marlay: Now, the travel space. We are all still waiting to find out if we can go offshore, but domestically travel has been really strong. How are you thinking about that particular part of the market?

Oscar Oberg: We are really bullish travel and we have been adding to our positions. It does actually feel like sentiment to the travel industry right now is the lowest since the vaccine was announced in November. I think that is because we have been slow in Australia to roll out the vaccine. But people have forgotten, before coronavirus hit, using Flight Centre (ASX: FLT) as an example, over 50% of its earnings came from the US and Europe and we are about to go into the European and US summer. There have been a lot of quotes from tourism companies globally and the best one we saw was Hilton, who said bookings in the US were up 10% compared to the pre-coronavirus period going into the summer. So we do see high levels of pent-up demand and we do expect once we get back to normality, all of that money that has gone into the retail sector will come back into the tourism sector.

James Marlay: Tobias the other sector we’re going to have a chat about was media. What are your views on the space? It has had a bit of a revival and a renaissance.

Tobias Yao: We definitely near bullish the traditional media sector. We have holdings in Seven West Media (ASX: SWM), which is the old Channel Seven, oOh! Media (ASX: OML), which is a large outdoor media company, and also Here, There & Everywhere (ASX: HT1) which is the old Australian radio network. Coming out of coronavirus, we believe companies will have to spend aggressively to try to re-establish their brand presence in the market, and if you add the addition of advertising spend that is going to go into the next federal election, in our view that over the next 12 months it is going to be a very buoyant advertising market and that is going to directly benefit the three players I mentioned earlier. The other common thread between all of these players is they all have their firm specific catalysts. So for Seven West Media, it is about divesting and deleveraging. For oOh! Media, it is about rolling out a cost out programme under the new CEO. And for Here, There & Everywhere, it is about crystalising the value of the minority stake in a high quality software business.

James Marlay: Oscar, last time we caught up we talked about agriculture and it was a part of the market that you were pretty bullish on. Could you give me an update on your view across that sector?

Oscar Oberg: We are still positive, James, but we have shifted our focus in terms of the companies that we quite like at the moment. So GrainCorp (ASX: GNC) and Elders (ASX: ELD) are still in the portfolio but they are at a lower weight and that is largely because we think the conditions we are seeing seasonally across Australia are as good as people have ever seen it. We have transitioned more into some of the agricultural stocks exposed to a re-opening style of trade. And United Malt Group (ASX: UMG) is an example of that. It is one of the larges malt processors globally and it is exposed to effectively a re-opening of restaurants and pubs in the United States. We think it is going to go well. And also Select Harvest (ASX: SHV), which has been a business that has been impacted by very low almond prices for some time. There is a drought in California – California is the biggest producer of almonds, so we do see the potential that almond price starts to lift over the next few years. So it is an early call but we quite like that one.

James Marlay: Now Tobias, it is hard to pick through the market and find those stocks that may not be grabbing the attention. Have you got a few ideas of stocks or ideas that you think are being a bit overlooked at the moment?

Tobias Yao: Yes I have three ideas, all of which we have gone substantial in recently. The first company is Virtus Health (ASX: VRT). It is actually the leading in vitro fertilisation (IVF) clinic group in Australia. We bought the stock around a year ago on the recovery trade, but our current investment thesis is premised on the new CEO’s ability to find new revenue streams. So this is in precision fertility, in genetics testing and in also digitisation services that they can use for companies overseas. It is trading on 14 times price to earnings ratio so we think a lot of this additional optionality has not been priced in to the current share price.

The other company is Ardent Leisure (ASX: ALG). It owns Main Event in the US, which is like Dave & Buster’s and family entertainment centres. It also has a theme parks division here in Australia. Now the US recovery is actually going really well on the back of strong government support for the consumers and much more relaxed coronavirus restrictions that are currently in place. Our view is that at the current share price, you are not paying anything for the theme parks division which is over a $100 million on the balance sheet. So the risk-reward trade off for this one is really appealing for us.

The final company is Lynch Group (ASX: LGL). It is a recent initial public offering. But it is actually a business that has been around for decades and it is the number one floral supplier in Australia. We think this is a value company, a growth company priced on a value multiple, and the market currently under appreciates the medium-term growth drivers for this business. So it is on 11 times P/E. We think there will be earning upgrades and perhaps a couple of organic merger and acquisition opportunities over time.

James Marlay: Oscar it has been a really bright spot in the market, the small caps. What message would you give to investors about the opportunity in the micro and small-cap part of the market going forward?

Oscar Oberg: There is a lot of commentary because markets up a lot since this time last year and people are saying, “oh the market is too expensive, the market is too expensive”. Now we would agree with that with certain pockets of the market, and certainly what we have seen with technology companies, healthcare, biotech, they are expensive, no doubt about it. But on the other side of the spectrum, a lot of cheap companies out there and you have just got to find them.

A good example is Seven West Media (ASX: SWM) which we own in WAM Capital and WAM Microcap. That is trading on a price to earnings multiple ratio of three and a half times earning right now. It is less than half of what Channel Nine trades on. It is a company that is sitting right in our wheelhouse and it is a company we like to invest in. So we are seeing plenty of opportunities. We are seeing plenty of companies with catalysts. And so for that reason, we are very bullish small caps and microcaps going forward.

James Marlay: Oscar, Tobias, great to catch up. Thanks for your time today.

Tobias Yao: Thank you.

Oscar Oberg: Thanks James.