Podcast: Small-cap update – March quarter 2024

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For our second podcast instalment, join IML Senior Portfolio Manager Simon Conn and Jason Guthrie, Head of Wholesale Distribution at Natixis Investment Managers to discuss how the small-mid cap funds performed during Q1 and why Simon believes many of holdings are still under valued.

Lightly edited transcript below

Jason Guthrie: Hello and welcome to Navigating the Noise, a podcast by Natixis Investment Managers Australia. Where we bring you insights from our global collective of experts to help you make better investment decisions.

I’m Jason Guthrie, Head of Wholesale Distribution, and today I’m joined by Simon Conn from IML. Now Simon is one of the senior investment team members. He’s been with IML for over 25 years and manages a number of the small and mid-cap strategies across the firm. We spent some time together seeing clients and as always, he’s full of great insights.

He knows his companies back to front and I’m sure you’ll hear that today. Now the agenda will include a market update for the quarter, how the funds have performed, some of the more recent opportunities in the portfolios and the outlook from here. Please enjoy the conversation. Simon, welcome to the podcast.

Simon Conn: Thanks Jason. Thanks for having me.

Jason: Hard to believe it’s been over three weeks since we were seeing some clients together out on the road. We’re obviously now through that first full quarter and small and mid-caps seem to have continued their strong run that we saw in the last quarter of 2023. What were the main things that really stood out Simon, for you and the team, over that quarter?

Simon: Well, clearly the key story of the quarter was the reporting season. Which I think Jason showed companies are well positioned and delivering good outcomes, good margins. And even though the top lines aren’t growing strongly, still generating good cash and able to grow in a pretty difficult environment, cost wise. The economy overall is okay.

The other thing obviously has been just the fervent of activity in mergers and acquisitions. Seen a lot of activity through the quarter, a lot of companies getting taken over. One of our companies, QUANTM, was on the receiving end of two takeover bids over the quarter. Also small and mid-cap companies are acquisitive and raising capital to make acquisitions.

Jason: Yeah, I’d love to touch on some of those, the other M&A and potential other takeovers in the portfolio. I think it’s a really obviously a dominant theme that’s played out over the last couple of years. You’ve had a number of businesses in the portfolio that have just been trading sideways, but great businesses growing their earnings. Now we’re seeing a lot of interest from offshore PE, et cetera. What about the funds? How did they perform Simon against benchmark over the quarter?

Simon: Yeah, no, we had a very strong quarter. Again, Jason, really following on from strong calendar year 23. The first quarter started very strongly with the [small-mid cap] funds up over 9%, so that’s pleasing. Pleasingly also Jason, coming from a range of holdings, it wasn’t just one or two stocks. It was a range of performances from companies like Sigma, QUANTM, SG, Fleet, Cooper Energy, Codan, Regis, Bega Cheese, all performed strongly over the quarter.

Jason: And anything that maybe went against the team, it sounds like you had a number of very strong companies. Anything that you’ve had to sell during the quarter or maybe taken the opportunity to top up?

Simon: Yeah, look, I think there’s always pluses and minuses in the portfolio. A couple of disappointing or softer results you should say were TPG and Kelsian. Obviously Kelsian’s results didn’t quite hit the mark in terms of what the market was looking for. A couple of soft points in the result and that sort of stock pulled back quite heavily, which we thought was unjustified and we used that opportunity to buy more.

The other one was TPG Telecom, which as followers of IML know, we like the infrastructure-like earnings of the telcos. Mobile phones are effectively the infrastructure of the new generation and we like TPG in the small-mid caps. It had disappointing guidance going forward, which was put out at the result, which saw the stock pull back. But we still think the stock’s very well positioned and fundamentally believe that mobile pricing tends to continue to justify the investments that we’re seeing all three major players make in the sector.

Jason: Okay. So no doubt about it. We’ve had a couple of very strong quarters for your team and small and mid-caps in general. I guess looking beneath the surface, are there any wholesale changes in your overall positioning? Any sectors in particular you’re looking at or is it all about the underlying positions and companies?

Simon: I think Jason, at the end of the day we’re bottom-up stock pickers, so we’re looking for good-quality companies trading at the right prices. From a sector perspective, we haven’t really changed our views. We are obviously fairly cautious generally on the resource sector and continue to look for good quality industrials that can really hold their margins and grow their margins, generate cash in what I think will becoming a slower-growth environment going forward.

Clearly the focus is on, costs are an issue for many companies with wages growing quite a bit and energy costs going up – insurance and the like. I think the focus has to be on companies that can sustain and hopefully grow their margins going forward and generate good cash, pay dividend or maybe even can make an acquisition or two to deliver some growth to the business.

Jason: I guess a second part to that question out there, speaking with clients, we’ve had this really strong rally. Is there still opportunities in this space? Is there that relative value opportunity between large caps? Everyone’s been tracking obviously what’s happening offshore with the Magnificent Seven, but is now a good time and are you still finding these underlying businesses trading on reasonable valuations?

Simon: Yeah, Jase, I think we’re out visiting companies all the time and there still just remains good value in the market. Clearly, as we’ve talked about on the road, many companies have delivered good performance, but there are still companies that we can find that look cheap and we’re happy to accumulate them and you still obviously get opportunities like we did with Kelsian at the results season, where it pulled back and we were able to top up on that one.

Also, I think that people need to realise that the starting point late last year was just so beaten up and so cheap where you saw QUANTM, for instance, trading on a PE of five or six times. So, even though it’s being taken over at $1.85, that’s probably twice the level it was six months ago. Takeover is only happening at a PE of 14, which is hardly nosebleed territory.

The starting point was so depressed and that’s the one we’ve seen with SG Fleet for instance, the stock, again that’s rallied since the end of the quarter. It’s only just now trading just over 10 times (PE). Before it was trading at big discounts and has re-rated significantly and still we think represents very good value for what is the market leader in fleet leasing and novated leasing in the country.

Jason: With the M&A obviously you’ve got some cash coming through, you’ve got some great existing holdings you’re able to build on. Has there been anything new over the last couple of months that you’ve added that maybe some of the clients haven’t heard of before?

Simon: Not saying any new names I’m willing to share today. But we’re always on the opportunity, looking for good-quality businesses to add on the right time. Obviously things like IDX (Integral Diagnostics), which we added to over the quarter and ACL [Australian Clinical Labs]. That’s the sector we still very much like, the healthcare sector.

We’re still yet to see GP attendances recover to what was pre-COVID levels. I think both those businesses will get that tailwind from time. At the moment I think both are looking out of favor. ACL significant discount to Sonic with a good balance sheet and with Healius in a world of pain; I think that sort of could present opportunity at some point in time. They’re stocks we think still look cheap and we’re happy to top up on those. As I mentioned, Kelsian was another one we were happy to top up through the quarter.

Jason: Lastly, Simon, inflation, I have to ask. It remains top of mind for many of our investors and really the general community. We’ve started to see some offshore central banks cut and it appears there may be more on the horizon. How do you see this playing out here in Australia and how does the team think about this in positioning the funds into the future?

Simon: Yeah, look, I think Jason, fundamentally the Australian economy is in pretty good shape. We don’t see the need for interest rate cuts to happen and certainly inflation I think in Australia remains fairly sticky at this 3 to 4% level. Our cash rate at 4.35 is not necessarily restrictive. I think to talk about rate cuts in Australia is actually premature. Clearly, we’ve had the Swiss flag one rate cut and the European economy, I think fundamentally looks softer and inflation better controlled. But domestically, I think our inflation interest rate setting doesn’t speak to interest rate cuts in the near term.

Jason: Well thank you Simon. As always, it’s been an absolute pleasure. We appreciate your thoughts and congrats again to the team on delivering such great outcomes to investors. Thank you to everyone listening in today. Please don’t forget to provide your feedback and tune in again very soon to hear from our global collective of experts.

This podcast has been prepared and distributed by Natixis Investment Managers Australia Proprietary Limited, ABN 60 088 786 289, AFSL 246830 and includes information provided by third parties, including Investors Mutual Limited (“IML”) AFSL 229988, the responsible entity and investment manager for the IML Funds.

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