The Australian small-cap that could become the next CSL

A little over six months ago, Monash Investors’ Shane Fitzgerald tipped small caps to outperform in 2024, after a lacklustre period. Since then, the ASX Small Ordinaries index has pulled ahead of the ASX 200, as high valuations in larger companies have driven a rotation by investors.

The Small Ords is up 15% since October, versus 11% for the ASX 200. In Australia at least, this coincides with the national conversation shifting toward the first interest rate cuts as opposed to further hiking from the central bank.

“Investors’ willingness to go down the risk curve is heightened because now that inflation is tamed, the large caps go back to being their boring old selves,” says Fitzgerald, co-founder and director of Monash Investors.

“Now, we're in an environment where quality growth will do well – and you can find a lot more quality growth in the small-cap space than in large caps,” he says.

In the following, Fitzgerald explains why and discusses how his team finds opportunities. He also explores several companies the team is backing – including one he suggests could be the next CSL.

Please note: The information in this wire is not, nor is it intended to be, a set of recommendations. Please do your own research and seek advice from a professional before making any investment decisions.

Is there more upside ahead for ASX small caps?

“I think there's still plenty of upside and that’s going to be driven by earnings growth. We’ve probably seen most of the multiple expansion part of it, that blanket multiple growth with no earnings associated with it,” Fitzgerald says.

He notes we’ve seen strong share price “re-rates” from many companies in this space, pointing to Life360 (ASX: 360) as one example.

“In these sorts of names, that multiple expansion has probably run its course. Now they need to execute on their ambitions to deliver next-level growth, and they can certainly do that,” Fitzgerald says.

He comes back to his earlier comments about the shift in macro sentiment in Australia.

“This is an environment where the underlying performance of companies can come to the fore and as always, the challenge for investment managers across the board and investors in the market is identifying those companies that are going to do well.”

How is Monash positioned now?

In the Monash Investors Small Companies Fund, Fitzgerald and his team focus primarily on companies outside the ASX 100. They can also hold up to 20% in large caps, in cases where they see opportunities that aren’t available within smaller companies. This weighting currently sits at 14%, which is spread across the following three names.

Pilbara Minerals (ASX: PLS)

This is Monash’s preferred play for an anticipated recovery in the lithium price. Fitzgerald regards the curtailment of production among some larger miners as evidence this has overshot on the downside. He notes that Pilbara’s key asset ranks among the larger lithium deposits, and it is one of the world’s lower-cost producers, “with a great management team and a lot of growth options in downstream areas.”

It also has fewer of the risks associated with small-cap companies in the space, which are often challenged by capital raises and ongoing mine construction activity.

QBE Insurance Group (ASX: QBE) 

Fitzgerald says this company is in the portfolio “because we want exposure to the global insurance industry and there's nothing in ASX small caps that provides this.”

Technology One (ASX: TNE) 

The technology service company is held because it is a high-quality growth stock, explains Fitzgerald.

How do you identify the most attractive opportunities?

“We focus on companies where we can identify some sort of step change in the prospects for the business,” says Fitzgerald.

This comes in many different forms, including:

• Store rollouts,
• New product launches,
• Capacity expansions,
• Geographic expansions, and
• Regulatory changes.

“The key is to identify these situations and then determine if the management team is capable of executing,” Fitzgerald says. He nominates his team’s extensive bottom-up research as the most important part of its investment process.

Telix Pharmaceuticals (ASX: TLX)

Alongside QBE, as discussed above, Fitzgerald last August named Telix as a firm with double-digit earnings growth ahead.

“One of the stars of our portfolio. We've held it since inception,” says Fitzgerald, having bought into the cancer treatment company at 20 cents. The biopharmaceutical company last closed at $13.65.

At Telix’s latest Q1 earnings update on Wednesday, management reported 19% quarter-on-quarter growth in revenue.

“They’re delivering near $450 million revenue at the moment and also have a renal imaging product and a brain cancer product coming to market,” says Fitzgerald.

“It's developing into a premier global radiopharmaceutical company…I see this as going on to become the next CSL in Australia.”

Impedimed (ASX: IPD)

The medical device firm is another company Fitzgerald discussed last August. He notes that since then, a dispute played out between some disgruntled shareholders and the previous Board. This led to management departures and a new board.
"All of this needs to settle down and get back to a focus on the opportunity in the US lymphoedema market," Fitzgerald says.

“But I stand by the underlying technology itself, which has been the best in class. I still think it has potential, once the new board and management get back to running the business,” he says.

Decarbonisation beneficiaries

Fitzgerald also discusses two mining services companies benefiting from the multi-decade energy transition and global decarbonisation efforts.

Austin Engineering (ASX: ANG)

This niche mining services company manufactures lightweight trays and buckets for mining equipment.

“Coupled with the fact their spare mining trays are now best in class, they’re also gaining market share,” Fitzgerald says.

“When you put that together with the solid management team and the outsourcing they’ve done to source parts offshore, we’re seeing margin expansion come through as well.”

Southern Cross Electrical Engineering (ASX: SXE)

An electrical services contractor, SXE has recently finished fitting out Sydney’s Martin Place Metro and is working on the Western Sydney Airport.

“And in the last few days, they've signed up an additional contract with NextDC,” Fitzgerald says.

“It looks like the right time in the cycle for these businesses…there's a big tailwind as we move into decarbonisation and the electrification that is going to come from that.”