Round Table – 2022

Periodically, we contribute to Richard Hemming’s Under The Radar Report where a selection of fund managers crystal ball gaze for the year ahead. Below are our responses to the questions posed for 2022. The excellent site can be found here: https://www.undertheradarreport.com.au/

1. What are two big themes that you see dominating 2022?

Two interesting themes that we see playing out in 2022 are supply chain onshoring, and ESG reporting and compliance.

Supply Chain Onshoring: With COVID impacting supply chains and geopolitical concerns, corporates and governments are looking to bring more critical manufacturing and services on-shore. In our portfolio, we are already seeing local pharmaceutical manufacturer Probiotec (PBP) capture market share with $15m of new contracts in FY22 that have been on-shored, as global clients look to localise manufacturing in Australia. PBP expects this trend in onshoring of contract wins to continue over the next 3 years.

ESG reporting and compliance: The governance required by boards to meet compliance requirements is increasing exponentially as issues such climate change risk, cyber-security, modern slavery and data protection must be reported on.

Ansarada (AND) provide software to boards to manage their increasing board compliance as well as tendering and deals. We see AND as well placed to grow their revenues in this growing market. We also expect weather data provider Aeeris (AER) to be another ESG reporting beneficiary. Last year, they developed a Climate Risk Assessment Tool specifically designed for corporate boards to be able to report on their climate risks using their proprietary data sets and tools.

2. What have been your best performers in 2021 and why? Do you still own them?

We had a broad range of strong contributors to our 2021 returns. Two of our better performers were both long term positions in our portfolio, Janison Education (JAN) and Joyce Corporation (JYC). 2021 saw our patience rewarded in these names.

We have owned JAN since it IPO’d in 2017 when we were initially impressed by the quality of its online exam offering, which, at the time, was being used to enable NAPLAN exams to be held online. Since then, JAN has expanded its global customer base which has driven strong growth, with the company articulating a pathway to $100m revenue. During 2021 the market has rewarded JAN for its impressive execution, high quality product and genuine global opportunity. We continue to hold.

We also have owned JYC for a number of years, and despite it paying a good dividend and achieving consistent growth, it had been ignored by the market for some time. However in 2021, on the back of reporting some pleasing FY21 results, and market appreciation of the potential for continued growth (particularly as its Kitchen Connection business rolls out across Australia), the share price has rallied strongly. Again, we continue to own.

3. What have been your biggest losers in 2021 and why? Do you still own them?

One of our weakest performers was Corum (COO). COO provides software services to pharmacies, and is a turnaround play that was recapitalised in 2020. While the business has stabilised after several years of losing market share, organic revenue growth and margin expansion is taking longer than expected while the executive team has been rebuilt. With a strong balance sheet, and signs of momentum picking up, we continue to hold and expect a stronger 2022.

4. Do you invest in mining related companies? Which ones and why?

While hard to sometimes find quality, we never discount mining-related companies as there are some interesting businesses in the sector. Below we highlight a couple.

• Laserbond (LBL). The company provides surface engineering services and products to increase the life of mining and industrial equipment. We like it because it has genuine IP that it is now selling around the world at high margins. The business also has the opportunity to expand its services business to WA and QLD through acquisition.
• Swick Mining Services (SWK). Mining services companies don’t often attract high multiples, but SWK, a drilling contractor, was dirt cheap with hidden value in the Orexplore technology asset prior to the merger proposal from peer DDH. While SWK has rerated on the takeover, we still see value if DDH can extract synergies from the merger. Another offer from an international peer cannot be discounted either.

5. What are the disruptive trends that you are investing for in 2022? What stocks best reflect those trends? 

Digital disruption continues to be an ongoing trend as lagging sectors such as HR and education migrate their manual processes to digital.

One that we think is positively disrupting the HR sector is Xref (XF1). They are digitising the reference checking process with cloud-based software replacing traditional phone calls, thus reducing HR costs and producing better outcomes. XF1 had previously had to work hard to convince HR departments to convert to digitisation, now it is just a matter of convincing them that Xref is the right product.

Another more HR niche provider is Schrole Group (SCL). It provides a job marketplace for international schoolteachers. Previously, schools and teachers would meet in recruitment events around the world. Schrole is leveraging their large teacher and school database bringing these events online using their Schrole Connect Plus product.

In the education sector, Janison Education (JAN) is bringing assessment on-line. Driven by its early wins like NAPLAN exams, JAN are bringing exams on-line around the world. And in the tutoring space, Kip McGrath Education (KME) is enabling the move from face-to-face to online tutoring, making tutoring accessible to a much larger number of children.

6. Which sector are you most exposed to and why? Which stocks do you own in that sector?

Our largest sector exposure is the financials. With the big banks standing back from business lines such as SME lending, wealth, and even riskier mortgages, there have been plenty of opportunities for Australian companies to fill the gap.

In the wealth sector, wealth services companies like Sequoia Financial (SEQ) and Diverger (DVL) have been able to grow as banks exit the advisor industry and smaller companies struggle under the burden of regulation that was bought on by the Royal Commission. Micro investing platform Raiz (RZI) has captured the attention of millennial investors with over $1B invested in their app.

In the lending space, we own Earlypay (EPY), a business lender, that has been focused on Invoice Finance and rapid digital approval processes. FSA Group (FSA) is providing lending to the self-employed with mortgages and car loans that fall outside the banks tight lending criteria. We also own mortgage broker and lender, Yellow Brick Road (YBR), which is driving their growth through lending to a similar cohort.

Finally in payments, we own payments terminal provider Smartpay (SMP). Its terminal offering is quickly taking market share as the banks fail to innovate and provide products that suit small business needs.

7. Have you been buying recovery stocks and if so, which ones?

Not explicitly, and not at this point. We think, for the most part, those companies impacted by COVID are already pricing in a recovery. We suspect the recovery will take longer than most investors expect, and the recovery will be uneven as habits have changed. That said, we’ve been buying Smartpay (SMP) recently and many might consider that a recovery stock. But we’re buying it for its business economics, favourable market dynamics, well-considered strategy, excellent execution to date, and tremendous potential over the many years ahead.

8. Do you have any exposure to travel in your portfolio? Which stocks?

Our biggest exposure to tourism is via PTB Group (PTB). PTB provides small plane engine maintenance services to a variety of industries including the tourism industry. Its largest customer is an airline in the Maldives, where PTB earns revenue on the number of hours flown and which was heavily impacted over the COVID period. However, PTB managed through this period profitability and are now seeing that headwind turn into a tailwind as the Maldives is experiencing inbound tourism at levels greater than 2019.

9. What proportion of stocks in your portfolio pay consistent dividends? Which smaller stocks you own are most likely to increase dividends in 2022?

From a portfolio management perspective, we like to maintain a healthy balance between value orientated stocks with strong near term earnings, and growth opportunities that generally have longer dated earnings. Reflecting this, six out of our ten largest positions have paid dividends for many years. Among our larger holdings, we have seen the likes of Sequoia (SEQ), PTB Group (PTB) and Earlypay (EPY) all provide FY22 guidance suggesting large earnings uplifts for the coming year. We would expect that their dividends will increase in FY22 in line with their forecast EPS increase.

10. What contrarian bets have you made in the past two years, and have they paid off?

Labour hire company People Infrastructure (PPE) was a company we knew well, having bought into its IPO at $1. Its share price performed well post its listing, increasing to over $3, and we exited our position. In the depths of COVID it fell back to $1, with the market concerned about the impact of COVID on a low margin staffing company with debt on its balance sheet. Trading on a mid single digit PE multiple at the time, we bought back in, and PPE has subsequently rebounded above its previous highs.

11. In your portfolios, are there any particular catalysts that cause you to quickly take action, either buying or selling.

Our investment universe is dynamic, fast moving and generally under-researched. There are often events that can significantly ‘move the dial’ of the earnings profile of a small company. We are always on the lookout for such opportunities that can fundamentally step-change the valuation of a company. These could be a material earnings upgrade, a significant contract win or the realisation of a previously under-appreciated non-core asset.

12. What are three of your biggest positions and why?

Our larger positions include:

o Sequoia (SEQ) is a diversified wealth management firm with strong industry tailwinds (as discussed above) in a strong upgrade cycle as it sees positive momentum across all its operating divisions. At its recent AGM, it advised that its FY22 forecast EBITDA is on track to increase by more than 15%. At last year’s AGM, SEQ guided for a 25% lift in EBITDA, but after three profit upgrades during the year, actually delivered a 138% increase. We would expect SEQ to comfortably exceed this year’s AGM guidance, and to deliver a minimum 30% EBITDA uplift for the year. On our forecast numbers, SEQ trades on a single digit NPATA multiple with $15m of surplus cash.

o Pure Profile (PPL) sells data and insights to over 700 global clients but until recently had been struggling with high debt and low profitability. After a comprehensive balance sheet restructuring in 2020, and the appointment of a refreshed management team, PPL returned to growth and profit in FY21. Growth in new markets (particularly in Europe) and existing customer activity has seen a strong start in FY22, and we believe its current valuation remains undemanding.

o PTB Group (PTB) has, over the years, proven to be excellent operators of its core Australian business, refining its unique power by the hour business model at its Brisbane workshop. PTB now has the opportunity to replicate the success it has experienced in Australia in the much larger US market. We are starting to see this progress in the US be reflected in recent results and believe it provides a strong growth runway for the company over the next several years. On a below market multiple, we believe PTB continues to represent an attractive combination of value and growth.