(upbeat music) - 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 your host, Jason Guthrie, head of Wholesale, and today we've got a couple of special reporting season episodes where we're joined by the investment team at IML. I mentioned the last episode, I've been in the Sydney office earlier this week, and there's been a bunch of management teams rolling through the IML doors there. So today is a timely update to run through some of the key themes and how the companies are performing in the IML portfolios. In this episode, we're joined by IML's small cap senior portfolio manager, Simon Cotton. Welcome, Simon, always great to have you back on the podcast. - Thanks, Jason, thanks for having me again. - Now, I understand a lot of the smaller companies in Australia still yet to report, a little bit later than the large cap guys we caught up with earlier. So it is a bit early to cover the whole market in certain sectors, but how are you seeing things so far? And in particular, what are some of the key themes and messages coming from the reports and some of the management teams you have spoken to today? - Yeah, I'm going to have to say, Jason, initially, you know, most of the results have been sort of, I think, much better, or better than feared. I think Australian corporates are still in pretty good health, to be frank. Obviously, a lot of concern was around the consumer coming into reporting season. And we've seen, I think, you know, through the results today that the consumers managed to trade through a pretty difficult period in terms of high cost to living. And there's been some relief coming through with cost to goods sold from the retailers and that today, you know, top lines have been actually quite reasonable, sort of better than feared. And I think the highlights for me has been gross margin performance across the board. And, you know, operating cash flows have been very strong. So we've seen some companies being able to print good cash flows and reduce their balance sheet positions, being able to reduce their debt, which is, you know, flying back into the buyback and better dividend outlooks, I think. - So certainly seems a bit of a similar story to what the large cap guys are seeing. And it does feel and sound like the economy is performing pretty well, despite the stubborn and persistent inflation in a high rate environment we're in. And if we turn to the performance of the small cap funds, how are things going there? It's always best going through the actual individual companies. So it would be great to touch on some of the more specific names and the results that you've seen. - Yeah, thanks, Jason. Look at obviously small cap markets, much more varied in terms of sector exploration than the large cap guys, but, you know, we've seen some, you know, some solid results. You know, one particular automotive, which was previously known as GUD, they've just renamed themselves, but really in line with what I was saying before, you know, sort of sales growth of about four or five percent. The company was able to hold their cogs and actually grow their gross margins. And that business has grown a really strong cash flow. So on top of the asset sale of Davy, they did during the half, they've managed to reduce their gearing down net debt to the data once point six times. So you remember a couple of years ago that this company geared up to buy company called Auto Pacific Group to expand their portfolio into the four-wheel drive accessories market. And that business, whilst it's still below the investment case, has been able to grow, honestly, it's seen increased car suppliers coming back into the country. So stocks on 12 times yields four percent. Really good management team. They've set the balance sheet up now, I think, for small bolt-on acquisitions. And ARB continues to show that that category is very resilient. It continues to run high gross margins. And we think the business can continue to generate, you know, reasonable earnings growth and pay a good yield going forward. And at 12 times, you know, we think it looks really, really attractively priced. So for ours, that's one, the much cheaper version of four-wheel drive after market accessories than ARB, which trades in a much higher multiple. So the name change, what was that? Do you know why that happened? That's really just reflects the changing nature of the business. GUDY was a bit of a mini conglomerate. And Davy was their last sort of non-automative related asset. And a couple of years ago, they had a reset of the strategy and decided to focus on the automotive aftermarket and repair market. Right, what else is jumping out of you? Bansal, that's a stock we know very well. You know, we've owned that in the past. And it's a stock that we think made a really significant acquisition in Kimberley Clark in healthcare sector earlier this calendar year. They raised capital at $22.45. And we participated in the raise and bought more stock following that capital raising. Stock's just under $30 today. So it's been a good performer for us. Really good management team and who seemed really invigorated. This was a business that really got knocked around in COVID. You'll remember one of the businesses whenever I was buying what they call PP&E or gloves and protective equipment. It had a booming result and then got left with the hangover as a lot of stock was in the inventory channels in their customers and distributors. So it's taken a long time for that inventory to wash through the system. But the second half result shows in the healthcare division that the do storeings ended. And so that's now the, now things are starting to normalise which means that their second half result was better. And I think the outlook for their healthcare business into 25 is much better. And you add to that the Kimberley Clark business. And that was their nearest competitor in that hand protection and body protection market. You know, I think, you know, stocks sort of had a good run but it's still on 18 times next year which is not overly expensive for a business we think can continue to grow. And the company that generally tends to generate much more cash on the earnings. And they're in the middle of a CapEx cycle by the end of 25 that will have completed a big India manufacturing facility. And then CapEx will decline and cash flow generation will improve. And we think with the synergies coming through from Kimberley Clark that sets them up for a very good couple of years. - Certainly a little bit different. I think they reported today's at Hanson. Hanson technologies. - Absolutely. Yeah. So what's happening is a real electrification of the grid and people are talking about virtual power stations, people linking solar on their roof with gas backup or hydro. So really a lot of the energy companies are now building virtual grids and having to real-time trade electrons as the electricity price moves and the source of energy generation moves with the grids becoming increasingly integrated. But interesting, I went to the AgL lunch and they talked about this sort of three leading software platforms globally. I'll put this obviously in the UK in Australia which is aligned with Origin. There's a colluser out of Japan which Origin are now bringing in Australia. And the third one is a company called PowerCloud. Now PowerCloud has a large market position in Germany and it's a business that Hanson applied about 12 months ago. Now PowerCloud got into some trouble and expanded to rapidly under private equity ownership and the vendor of that business, the private equity firm looked to an exit and the company was losing money at the time. And so the Hanson team as they've done many times have bought a business they're really going to strip back to the core and focus on their core expertise. Importantly, Hanson already operate in Germany. They've got a leading telco services software platform. So Hanson is a very, it's a global business in terms of software billing and procurement software. It's said really they run the billing engines for a lot of electricity companies around the world. And it sort of flies below the radar but it's been a very successful business growing through acquisitions of mature technology businesses. But the result today was, you know, I think, you know, a solid result and taken well because, you know, the core cashier of the day was up 11%. They're able to grow their top line six to 8%. And a lot of the businesses Hanson have had in the past have been quite mature. But I think PowerCloud and some other acquisitions they've made seem to have repositioned the business back into more of our growth markets. And we think there's just a huge opportunity in PowerCloud given the low penetration of renewables today in Germany but the big pipeline that the German government has in terms of rolling out, you know, renewables into that market and a lot of the market hasn't adopted the technology platforms. And the other factor in players hit the SAP are pulling out of the sector. So they're not investing in the next generation of technology required to run these virtual power grids. And that positions PowerCloud very well in the German market, we believe, to generate good growth. So it's, you know, found a lead. Andrew Hanson's run the business for a long period of time and going back many years, we owned it below a dollar and it was a good performer for us for many years. And so we've sort of tipped our way back in the water over the last six months with the stock coming back. Look, it's very reasonably priced. And we think, you know, it's quite well positioned. It's got a very, very cash-rich balance sheet. So not much debt at all, which sets the balance sheet up to fund further acquisitions going forward. So, you know, we want to be really like and yeah, I think on any weakness, we'd be happy to add to that position as well. Sounds like a cracking business, so. Yeah, look, I really appreciate it. Yeah, we think. Positive and interesting companies there. Anything that hasn't gone to plan? Anything you want to highlight? Yeah, obviously people are aware that Ampol's one that's it's been a really big holding in the fund one that sort of ran earlier in the year and we've achieved that weight back, but you know, it's still a large-ish holding in the fund. And their result was earlier this week was a bit disappointing. The disappointing really came around the more cyclical parts of their business. People obviously are aware that they're one of two refiners in the country. So they run a few refiring up in Queensland. And they also have a trading business, which is really about hedging their requirements into Australia and they managed to make a margin on that. But what we've witnessed over the last six months is that refining margins have been pretty benign. And there's also actually perversely, despite all the middle issues in the Middle East, the trading margins have been quite soft because there's been not much dislocation in the market. So both those businesses had soft results. The core fuel and infrastructure distribution, the convenience retail business, their new acquisition of Z energy in New Zealand, all those core businesses that are more annuity-like all performed very solidly, despite the headwinds of a tough consumer environment. But their more cyclical businesses are refining and trading head software outcomes. And so the result was held back by that. They also announced the result that capex would be higher for the next 12 to 18 months with some shuts in the refinery and an upgrades the low self-fulfill requirements. So they flagged higher capex, which means that the dividend will be lower over the next 12 to 18 months. We're meeting with them next couple of days, so we obviously have got a size there. But in our estimates, it's still on about a 5% fully frank to you, whilst, you know, assuming that these two more volatile and extreme to stay depressed for a while. So it's still an attractive yield, but obviously not as high potentially as we expect. But you're given the volatility with seeing in geopolitical environment. And you know, we know that markets can always be volatile as we witnessed at the beginning of this month. You know, I wouldn't bet against them it's been seeing some volatility and those earning streams recovery at some point in the next six to 12 months. So, you know, 12 and a half times, yield to five, looks very cheaply priced and one that we've been adding to our weakness. - And I guess, Simon, just more broadly, we are seeing more interest and increased demand from investors potentially looking to rotate some capital into smalls. Are you still seeing that gap, that dispersion between large and small cap valuations in the Aussie market? - Yeah, look, I think, you know, things like Hanson and Ampol are motive. You know, these are 12, 13 times PEs. They're not that expensive. And what we have witnessed is that, you know, that flash crash we had at the beginning of this month where we saw a massive correction in the markets, small caps got sold off very heavily. And I think if you look at the small boards, it fell back to a level where it was trading maybe late January, early February. The ASX 200, the border market really only gave up a couple of months of gains. So, you know, unfortunately, we gave up quite a bit of the gains there and the market really means quite bifurcated at the small cap end. So, we're seeing big price moves by a lot of small, a lot of growthy stocks by PE stocks that are re-rating. And yeah, there's still a lot of good value in this sector of the market. And what's coming through and reporting, Susan, is the, you know, this position in Australia is actually not too bad. Unemployment remains low. The consumer has, you know, at the high end of being, you know, those people who are retired, dipping into their savings, they're getting positive returns on their turn to positives and the like. And the government continues to put a lot of money into the economy. The tax cuts come through. So, you know, there's a bit of stimulus there. And, you know, the economy, it's chugging along, okay, Jason. I think I think nearly as bad as people might have feared. - Fantastic. All right, we might wrap it up there. Thanks again, Simon. Always great to have you on the podcast. I know things are really starting to heat up there for the team on the small cap side. So, we appreciate you jumping on to provide a quick update to our clients. Thank you, of course, to our listeners. If you enjoyed the episode, please click follow on your podcast platform and tune in again very soon to hear more from our global collective of experts. 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