Where Forager is hunting in 2024 (including 8 stocks and one unloved sector)

Forager's CIO Steve Johnson reflected on 2023 as a fascinating year for investors, bookended with an impressive rally in November and December, during an investor webinar on Wednesday. One of the early points was around the impressive 26.9% return delivered by the Forager Global Shares Fund for the year – a performance that is even more remarkable given that around 75% of investors this time last year were predicting a hard landing and recession in the US – a figure that has since declined to around 20%.

“Markets have always been focused on the short term but are more than ever focused on directional movements rather than the absolute valuation,” said Johnson.

“There’s been a big recovery in small-cap stocks over the past six weeks, and it seems investors were just waiting for signs that interest rates were at least going stop rising. And they’re now pricing in several rate cuts for 2024 in both Australia and the US.”

In this context, Johnson regards inflation data as trending far more positively now than in recent months. He also highlights that prices in several important areas of the market are substantially lower in year-on-year terms, which are dragging headline performance figures down.

“We’re going to see dramatically lower inflation numbers through 2024,” says Johnson.

Looking at some of the ways Forager’s global fund performed, portfolio manager Harvey Migotti and Johnson noted that many of the small-cap holdings in the fund achieved more “appropriate” valuations.

The portfolio also saw some broader-based performance improvements.

“Some of these stocks that we’ve now held for three, four and five years were putting on some good returns, particularly later in the year,” Johnson said.

Migotti also referred to the strong performance of Quality stocks, both in Australia and abroad, in the past 12 to 18 months, “as investors retrenched into more defensive businesses.”

Some of these held in Forager portfolios include:

• APi Group (NYSE: APG),
• Installed Building Products (NYSE: IBP), and
• Ferguson Plc (NYSE: FERG).

Johnson emphasised the weaker environment for small caps also enabled the fund to buy into some companies they had been considering for a while.

MTU Aero Engines (DB: MTX)

A German-listed provider of engines for short-haul commercial aircraft, the firm was knocked by some problems stemming from faulty parts provided by one of its suppliers. As a revenue-sharing partner, MTX is required to pay compensation to the airlines involved, which will affect earnings negatively between now and 2026.

While a short-term negative for the company, Johnson and Migotti believe the investor selloff was over-done, and have taken the opportunity to buy into the position.

Clean Harbors (NYSE: CLH)

Another new addition to the portfolio, Clean Harbors is North America’s largest re-refiner and recycler of used oil, parts-cleaning and related environmental services to the commercial, industrial, and automotive industries.

The company is also at the centre of many environmental changes being driven by the US government and other big stakeholders, benefiting from high infrastructure spending.

Having grown its top-line revenue by 15% since 2000, primarily through acquisitions, Forager is confident the firm will achieve its ambitious targets over the next few years.

Australian equities

Turning to Forager’s Australian Shares Fund, Johnson spoke about the importance of the upcoming half-yearly corporate reporting season.

“We’re also now seeing results start to be reflected in share prices so it’s going to be important. And while this small-cap performance has been going on, most of the businesses we own have been growing their value over time, without this being reflected in their share prices.

“As long as that dynamic is at play, time is your friend. The value of the business grows and when people eventually come to realise it, you want it to be higher than it was at the start of that period of underperformance.”

RPMGlobal (ASX: RUL)

The fund’s largest holding, RPMGlobal provides software mining software. Johnson expects the firm to deliver $20 million of EBITDA this year, which he regards as a “good proxy for its earnings, it doesn’t have much capex.”

A sector flying under the radar

Johnson also discussed a couple of the firm’s holdings in the travel and tourism sector, an area of the market he believes has been underplayed by investors in the wake of the pandemic.

“I’ve been really surprised about tourism stocks, not just here in Australia but globally. There’s a lot of pessimism,” he said.

Johnson and Migotti describe the dynamic as one where investors “buy the rumour but sell the fact,” in buying the stocks during the downturn and selling out at the first sign of upside.

“The thing that people are missing is that we are still 12 to 13% below the 2019 levels of international arrivals,” Johnson said.

“I still think that if the airlines can continue to get more capacity into the market, there’s still plenty of demand for the number of people to recover. We will be seeing revenue numbers that are well above where they were in 2019.”

Viva Leisure (ASX: VVA)

This firm is an owner-led business that operates low-cost gyms, with 160 locations across NSW, ACT, Victoria, Queensland, and Western Australia.

“Our timing on this has been reasonably good, buying shares at close to the bottom…but it is really good to see the business growing and returning to profitability after COVID and reinvesting a good chunk of that into growth,” he said.

Johnson noted the firm was trading on a price-to-earnings multiple of 30 to 40 times a couple of years ago, but now trades at a P/E of between 11 and 12.

Experience Co (ASX: EXP)

An adventure tourism and leisure business, EXP operates primarily on the eastern seaboard of Australia.

“It hit a three-year high on the day Australian borders reopened and has done nothing but decline since the number of international arrivals increased over time,” Johnson said.

“This business is yet to prove its profitability…it’s going to be an important half-year result for them – and more importantly an important FY2025, when we think this business should be earning something like $30 million to 40 million of cash flow relative to a couple-hundred million of market cap currently.”

Johnson noted the dramatic improvement in the macro environment was yet to be reflected in EXP’s share price, “but we should see signs of that this coming February and certainly by the end of 2024.”

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