Small caps are cheap – The companies Oscar Oberg is watching (hint: one is a pre-IPO)

If I had a dollar for every time I’ve been told lately that stocks are cheap but now isn’t the time to buy – especially for technology firms…I’d probably have about 10 bucks. But you know what I mean.

I heard it again yesterday while dialling into a webinar hosted by the stock pickers who manage some of the money at Wilson Asset Management. The team - including lead portfolio manager Oscar Oberg, senior analyst Tobias Yao, and analyst Sam Koch discussed Aussie small caps more specifically, and not just technology. The trio work across a handful of the fund manager's listed investment companies:

• WAM Capital,
• WAM Active,
• WAM Microcap, and 
• WAM Research.

One theme they covered - which is another that I've heard repeatedly, is the decoupling of company fundamentals (earnings, balance sheet, cash flow) in favour of kneejerk macro sentiment (war is breaking out so let’s panic sell; and why are my feet so wet here in Sydney?). Stock prices are under pressure but the re-ratings are based mostly on sentiment instead of the metrics that really matter.

For example, in the recently concluded half-year corporate reporting season, of the 63 companies in WAM’s portfolio that posted results, 38 beat expectations. But only 13 saw their share prices higher at the end of February than they were at the beginning.

“And I’m sure they’re all lower again by now, despite their strong results,” Oberg said.

See? It doesn’t make sense in the normal scheme of things. And that’s the point: these times are highly abnormal.

• Russia’s beating down on Ukraine (our thoughts go out to the people of Kyiv and other Ukrainian cities);
• Climate-led events – floods, this time, but remember those fires a while back? These have hit Australia’s east (and north, and west) hard;
• It’s almost time to pay for all that monetary stimulus that pulled the world through COVID, as inflation ratchets up and central banks start hiking interest rates in response (though the war may dampen the fiscal response a little).

What does all this have to do with small-cap stocks?

As usually happens when tough times hit, small caps have been hammered during the calamitous start we’ve had to 2022. The ASX Small Ords is down about 11% year to date, versus a fall of about 6.5% on the ASX 200.

When you strip out the technology sector, small-cap valuations are at decade lows. But Oberg believes the selloff is grossly overdone, that earnings remain robust in quality companies, and the overall sector performance should pick up nicely when some certainty returns (wouldn’t that be nice?).

And without labouring the point, inflation: in response, as mentioned above, rates are lifting. Before Russia picked a fight with Ukraine and everyone else, the tightening of central bank policy was really only showing up in technology to any meaningful degree. It’s now hitting all sectors.

From the earlier consensus view of six US rate hikes this year and another two or three in 2023, there’s now more of a question mark – for this year, anyway.

“I’m not sure we’ll see six this year, which would be good for small caps,” Oberg said.

The stocks WAM’s watching

In agriculture, one of WAM analyst Sam Koch’s highest conviction pics is Ridley (ASX: RIC), one of Australia’s largest animal stock feed producers. Astute work from the company’s management team in de-risking the company and cutting costs has lifted margins and boosted shareholder returns.

Despite the raft of improvements, the company is trading at the highest discount ever, at 12.5 times versus its historical average of 15 times.

Telecommunications company Tuas Limited (ASX: TUA) – A Singaporean telco founded by TPG Telecom (now merged with Vodafone) founder David Teoh. As a founder-led business – a company characteristic common across much of WAM’s portfolio holdings – it ticks that box, especially given Teoh’s pedigree. “We think the market is underestimating the potential revenue growth,” said Tobias Yao, portfolio manager of the WAM Capital, WAM Microcap and WAM Active listed investment companies.

Automotive fleet leasing and novated leasing company SG Fleet (ASX: SGF) – A holding selected by Shaun Weick (who’s unfortunately down with COVID currently. We hope he gets well soon.) Lead portfolio manager Oberg says the firm’s performance was suppressed by a lack of new cars coming into Australia over the last couple of years. As Omicron recedes and businesses reopen, management recently upgraded earnings by more than 30%. But the share price is still below pre-COVID levels, trading at $2.45 at Thursday’s market open versus $2.55 in December 2019. Trading on a PE of 8 times earnings – SGF’s nearest competitor Smart Group is on 14 times: “We think those valuations will converge and believe the share price is worth around $3.50,” Oberg says.

Property developer and construction firm Maas Group (ASX: MGH) – Another founder-led business, is vertically integrated, producing building materials supplies. With a large pipeline of construction in regional Australia, across civil infrastructure and residential, – benefiting from huge regional pop growth. A key attribute is its ownership of strategic tracts of land that should benefit from regional Australian population growth.

With a recent reported earnings outlook of between $120 million and 150 million, the stock now trades at around $4.50. “We think that’s covers just the properties the company owns on its balance sheet, so you’re getting the operating business for free, so we think it can double over the next two to three years,” Oberg says.

On a sector basis, Oberg and crew also call out other names across Retail, Agriculture and Industrial.

Accent Group (ASX: AX1), a retailer of footwear and sportswear highly leveraged to people going out and jewellery retailer Lovisa Holdings (ASX: LOV) – “If the tide shifts, their share prices will rebound quicker than many of their peers,” Oberg says. He suggests the key is to differentiate between COVID beneficiaries and others, also singling out the likes of furniture retailers and homewares company Temple & Webster (ASX: TPW)

In agriculture, the Nufarm (ASX: NUF) and Graincorp (ASX: GNC) have done well but are largely understood and are widely held. Almond grower Select Harvests (ASX: SHV) is another sector exposure WAM likes. The firm is trading near its net tangible asset value, “But we see a re-rate from here, driven by normalising supply chains,” Oberg says.

And finally, the pre-IPO company, Xpansiv, is a carbon credit trading platform, held by WAM Microcap and WAM Capital, whose share price has, in the words of Oberg, “gone ballistic.” It could hit the boards of the ASX as soon as the next few months, having completed a successful $100 million capital raise in September.

To find out more about why WAM loves the company, watch the full recording of the webinar here. You’ll also find a few more stock picks and hear the audience Q&A.

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