Round Table – 2023

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 2023. The excellent site can be found here: https://www.undertheradarreport.com.au/

2023 Round Table Questions

1. Disruption: What are the disruptive trends or themes that you are investing for in 2023? What stocks best reflect those trends?

Very much like 2022, we believe ESG trends will increasingly influence boardroom thinking, and provide opportunities for companies that are solving problems in the space. Companies that we hold that will likely benefit from this include:

• Aeeris (AER), a provider of weather forecasts, alerts and climate risk reporting, helps businesses manage and report on their climate risks. For example, insurance companies use AER data to understand the risks of providing house insurance to properties subject to cyclone threats, or alert affected customers before a hailstorm hits. AER’s new Climatic Product will allow businesses to understand their climate risks across their assets.
• Energy One Limited (EOL) provides energy trading software and services to energy generators and traders across Europe and Australia. While EOL has a successful operating business today, the bluesky opportunity for the years ahead come as new wind/solar/battery entrants move into the industry. These smaller generators will look to outsource the energy trading management as it is not economic to manage it themselves.
• Advanced Braking Technology (ABV) provides aftermarket braking solutions predominantly to underground mining vehicles. Mining customers use their braking solution because it is safer in the harsh underground environment. Additionally, because the brake is fully enclosed, there is also no toxic brake dust. Increasingly, we expect miners with an ESG focus to look to ABV to protect their staff.
• Laserbond (LBL) provides surface engineering services and products to increase the life of mining and industrial equipment. This proprietary technology extends the life of products, reduces downtime, and lowers the overall cost for their customers.
• DDH1 (DDH) is the largest provider of drilling services to miners in Australia. The acquisition of Swick Mining Services, in early 2022, significantly enhanced their capability to build their own underground rigs. DDH has been prototyping electric rigs and are nearing production readiness. These electric rigs are expected to reduce power usage by 50% and helping clients meet ESG targets.

2. Best performers: What have been your best performers in 2022 and why? Do you still own them?

Our best performer, from a portfolio contribution perspective, was aircraft engine maintenance provider PTB Group (PTB), which started the year at ~$1.00, and received a takeover bid from a US competitor in August at $1.62. The bid was successful and PTB has now delisted after 16 years on the ASX. The timing of the takeover was unfortunate in our view, as the company was beginning to make strong progress growing its North American business, which was a large market opportunity for PTB.

We have also benefitted during the second half of the year from other takeover activity in holdings, including Proptech (PTG) and Nearmap (NEA).

Outside of takeover bids, better performers included cold storage medical logistics company Cryosite, which had a strong year of growth and reinstated its dividend, and education providers Acadamies Australasia (AKG), and EDU Holdings (EDU).

3. Biggest losers: What have been your biggest losers in 2022 and why? Do you still own them?

One of our biggest losers during 2022 has been family law group AFL. AFL had a strong 2021 profit and cash flow result: Covid lockdowns during 2021 improved productivity as staff weren’t taking holidays or changing jobs. However, in 2022, these Covid related tailwinds turned into headwinds as staff took the opportunity to change jobs/careers and catch up on missed holidays, impacting productivity and revenue. A messy failed transaction and board and management movements further dented confidence towards the stock. We still hold AFL given it continues to build out its national legal practice with revenues of $20m, relative to an enterprise value of $10m.

Some smaller illiquid software names such as Corum (COO) suffered large falls during the year. With an enterprise value now of slightly more than $10m, we continue to hold COO on the basis of significant upside potential from its low current valuation.

4. Dividends: What proportion of stocks in your portfolio pay consistent dividends? Which smaller stocks you own are most likely to increase dividends in 2023?

Approximately 40% of the names in our portfolio pay dividends. We are supportive of our small company holdings paying dividends to shareholders as 1) it provides credibility to the investment thesis 2) paying dividends encourages financial discipline from management & 3) dividend paying stocks generally attract a wider investor base. One of our positions, Prime Financial Group (PFG) has recently confirmed a forecast 30% increase in its full year dividend for 2023, placing PFG on a 7% dividend yield. Other portfolio holdings on strong (7%+) yields include Shriro (SHM), EarlyPay (EPY) and DDH1 (DDH). Among other dividend payers, we are looking for strong increases in dividends in 2023 from Kip McGrath (KME) and Laserbond (LBL).

5. Against the trend: What contrarian bets have you made in the past two years and how have they gone?

2022 saw technology companies out of favour as interest rates rose and sentiment against technology names turned very bearish. We have not seen this much carnage since the dot-com crash. We bought or added to various technology positions in the face of this sentiment change, including Elmo (ELO) and Proptech Group (PTG) near their lows. In both cases, management were communicating a growing profit trajectory and both companies have subsequently received takeover offers.

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

Being bottom-up investors, sector exposure is more a function of opportunities we find. However, we are conscious of aggregate exposure and weight our positions and exposures accordingly.

Given the quantum of companies in the software space, we have found a number of compelling growth companies with global opportunities. Some names in our portfolios include:

• Gentrack (GTK), a software provider to utilities and airports with clients scattered around the world.
• Knosys (KNO), a provider of Knowledge management, Intranet, and Library software with clients across the US, Europe, and Australia.
• Ansarada (AND), a provider of Virtual Data Room and Governance software with clients in Europe and Australia.

We also have exposure to the Wealth Management space where we see compelling valuations combined with consolidation opportunities that have the potential to create much larger businesses with increased operating leverage. Names in our portfolios include:

• Sequoia (SEQ) & Diverger (SEQ). These two business service Accountants and Financial Advisors. Along with other listed players including Centrepoint Alliance, WT Financial, and Countplus, we see a lot of value that could be created with consolidation. In the meantime, SEQ and DVR are growing, capital light businesses that pay dividends.
• Prime Financial Group (PFG). PFG is a combined Financial Advice and Accounting group that is looking to cross-sell and extend service offering with a clear path to being a much larger business in the medium term.

7. Technology: Have you been buying technology stocks and if so, which ones?

Having failed to find opportunities in the IPO space during much of 2021 and 2022, we cornerstoned the recent ASX listing of SOCO (SOC). SOC provide Microsoft consultancy with a focus on the Eastern Seaboard. Started in 2013 by five founders, the business has grown on the back of cloud adoption and digital transformation with 66% of FY22 revenue coming from Federal, State, or Local government. Employee retention during FY22 was 98% which is incredible in the IT environment. SOC also enjoys enduring relationships with their clients with 70% of revenue coming from retained clients.  Pleasingly, the founders see plenty of growth ahead and are not selling down their holdings at the IPO.

8. Mining & Energy: Do you invest in mining and energy related companies? Which ones and why?

We look to get exposure to mining and energy via mining service companies. As mentioned above, we are attracted to companies that can drive ESG outcomes and/or improve profitability for the miners. We think ABV, DDH, and LBL provide great solutions in this space.

9. Buying and selling: Do you have any advice for our subscribers? Are there any particular catalysts that cause you to quickly take action, either buying or selling.

We are long term focused investors, with several of our positions held since the inception of DMX in 2015. We typically hold illiquid positions that are often difficult to quickly trade in and out of. So our buying and selling decisions are generally made within this framework: we would look to buy stocks that we are comfortable to hold for several years given strong medium-term upside potential, and sell stocks when our long-term thesis is broken or if valuations become excessive.

10. Stocks: What are five of your biggest positions that you haven’t yet mentioned and why?

Payment terminal provider, Smartpay (SMP), is one of the fastest growing companies in our portfolio as payment surcharging (the SMP model) is becoming increasingly accepted. SMP’s strategy is to target bank customers that have historically been provided low levels of service and are easily displaced. Importantly, SMP estimates it has only penetrated 5% of their Australian TAM, so there is plenty of room for profitable growth.

Pureprofile (PPL) sells data and insights to over 700 global clients but previously 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. Management have since invested for growth with offices in new geographies while still remaining profitable.  In the medium term we expect to see expanding margins as the company gains scale.

Cryosite (CTE) is primarily a logistics provider for clinical trials where drugs must be kept in temperature controlled conditions, but is increasingly expanding their services to pharma companies outside the clinical trials space. The business is attractive as it has a relatively flat fixed cost base and high barriers to entry through regulation and customer relationships. There is also a hidden asset as their legacy cord-blood customers move to yearly subscriptions.

Credit Clear (CCR) is at the forefront of bringing technology and digital solutions to the debt collections industry offering a hybrid collection service offering (digital supported by traditional). The industry is only just beginning to digitise and CCR is getting superior results to traditional phone communication with a younger generation. CCR also have a significant head start with years of data that it uses to determine the best time, language, and method to engage with overdue creditors.

Global tuition provider Kip McGrath (KME) was enjoying strong growth prior to the COVID lockdowns, but earning momentum was lost during 2020 through 2022. This is set to reverse as COVID headwinds unwind, investment in technology moderates, and its corporate centre strategy moves to profitability. KME is a family-run business, and as such, has a long-term focus with management that is committed to strong capital allocation and delivering positive outcomes for the children they help.