TRANSCRIPT 🔗
00:00:03
Sean Aylmer: Welcome to the Fear and Greed business interview. I'm Sean Aylmer. A good one for investors today, we often talk to Wilson Asset Management about their listed investment companies. Today I want to focus on small caps and where the team at WAM see the opportunities. Remember, this is general information only. You should seek professional advice before making investment decisions. Tobias Yao is portfolio manager across four of Wilson Asset Management, WAM's LICs, that's WAM Capital, WAM Microcap, WAM Research, and WAM Active. Tobias, welcome to Fear and Greed.
00:00:33
Tobias Yao: Good day, Sean. Thanks for having me.
00:00:35
Sean Aylmer: So WAM, Wilson Asset Management, is known as a small cap investor and always has been, but it's been a pretty tough time for small cap investors, hasn't it? Why is that the case?
00:00:47
Tobias Yao: Yeah. Look, it's been a rollercoaster ride for sure for equities and particularly small caps over the last few years. If you cast your mind back to 2018 and '19, if I remember correctly, that was the trade war period between China and the US. Then we've had COVID in 2020 and 2021, which caused significant disruptions, but also for tech companies and growth companies was an extremely strong period, given rates and the liquidity in the system. But to your question, the reason why it's been challenging over the last 18 months is due to the market impacts of the war in the Ukraine, and at the same time the largest interest rate hiking cycle in over 30 years. When there is great uncertainty and particularly risk of a recession, the market gravitates towards larger cap companies because they're more diversified, more liquid and safer in an environment that's highly uncertain. And in Australia, particularly, banks, on the back of higher rates and lower levels of bad debt and resources, on the back of the China reopening story, also did well. So you're right over this period of uncertainty, small caps definitely fell out of favour.
00:01:58
Sean Aylmer: Okay. That is across the board, all fund managers has experienced that. Now, where we stand today and we're getting towards the end of the interest rate hiking cycle, if that's such a phrase as that, what's the outlook for small caps now then?
00:02:13
Tobias Yao: Yeah. So as a team we're very bullish, the small cap companies. In the market, we think a lot of them have come off quite substantially and we've spent a lot of time finding ideas in the small cap space that we believe could be strong outperformers in the next two to three years. So particularly in some of the tech names that has been sold off aggressively over the last two years. And then, more recently, we've started to look at some of the consumer discretionary names, knowing the demand is falling off, but you typically have to be 9 to 12 months ahead of that. So those are just two areas that we're looking at right now.
00:02:52
Sean Aylmer: We'll get into some specifics in a moment, but I just want to... so consumer discretionary is an interesting one. You would think as an economy slows then their earnings, at least in the short term, won't be as good as you might think. But then you just said 9 to 12 months. So I presume you're kind of looking beyond earnings in the next 6 to 12 months. You're actually looking beyond that. Is that why you're interested in consumer discretionary?
00:03:16
Tobias Yao: Yeah, sure. And so if we look at the consumer discretionary space, in the small cap space, it could probably separate it into travel, automotive and just general retailing. And so the travel guys have done exceptionally well. There's revenge spending in terms of holidays, everyone's gone to Europe. And auto's done really well due to this pent-up demand and the supply not being able to meet up to demand. So we've invested in those two sort of buckets quite extensively over the last two years. I guess my point is, at some point money should flow back into retail, which to your point, it should be a pretty tough period over the next six months. But then you almost have to be a little bit ahead of the market, investing in those names. And then probably have to allow the share price to go down before it goes up. 'Cause if things turn, then everyone would be wanting to invest in retail and it would be very difficult to then therefore buy those names at a significant discounts to their intrinsic value.
00:04:20
Sean Aylmer: Stay with me, Tobias, we'll be back in a minute.
00:04:28
Sean Aylmer: I'm speaking Tobias Yao, portfolio manager for WAM Capital, WAM Microcap, WAM Research and WAM Active.
Okay. So can you give us a name that you like in that discretionary retail area? And we just hasten to add to listeners, this isn't professional advice, get your own advice before making any investment decisions. But who do you like, Tobias Yao from Wilson Asset Management?
00:04:51
Tobias Yao: Yeah. Look, this one is in retail, but I would say it's a little bit different. The company's called Temple & Webster, so they are a dominant e-commerce platform. They sell furniture and homewares. Now we love management. They've done an exceptional job growing the business, since I think around 2016 is when they entered the business. Our view is that online penetration in their space will continue to go up in the long term. And these guys are pure online players, as I was saying before. And large players with scale should do really well as a result. In the short term, the flexibility of their model, to pivot towards
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value customers and continue to drive growth when their peers are struggling, means they will be even stronger coming out of this period of uncertainty. And finally, on the cost side, they've been talking about this a little bit recently, but they're trying to implement a few AI initiatives within the business and we believe that the incremental cost savings going into the marketing budget to drive growth will be funded by some of the efficiency gains from these AI initiatives. And the best thing is they have, I think, around a hundred million dollars of net cash in the bank, which gives them that extra optionality and the safety net.
00:06:06
Sean Aylmer: Okay. So let's moving on to the tech space because you mentioned the tech space a moment ago. What is your view on the small cap tech stocks at the moment? And particularly, again, you talked about AI and I don't know if there's a bubble, but there's certainly lots of enthusiasm for AI stocks. Think of Nvidia in the US, but what's your take particularly on small cap tech stocks?
00:06:27
Tobias Yao: Yeah, so we do like tech because we believe if you get the core right you can generate a lot of performance. One of the things I think over the last 18 months that we're very mindful of as a team is not to be too bearish because this gave us the headspace to look for investment ideas. And I think you can always generate performance in every market, you just have to look a little bit harder. Over the last, I'll say 18 months until recently or until probably the last three months, we've generally stayed away from the loss making tech names, but we've invested in the really high quality tech names like ProMedica, Carsales, which is a platform as well, which has done really well for us. However, more recently we've started to look at, I guess, some of the high beta names that's on the verge of breaking even. And we're therefore eliminating the capital raising risk, which usually sees a re-rating in the share price and gives you that initial margin of safety. So someone like Megaport, to your point, exposed to AI, new CEO, great initiatives by the board and the management team, is a great example. But we're still trying to stay very selective and effectively continue to stick to our process, which is identifying catalysts that could re-rate the share price of these businesses. In this case, the catalyst could be getting to the break-even point sooner than expected.
00:07:48
Sean Aylmer: We haven't really spoken about the WAM process, but you're famed for it. And the idea is that, just explain it to us, you're looking for not just valuation. There's more to it than that.
00:08:00
Tobias Yao: Yes. So our process is pretty straightforward and we've been consistent with sticking to this process since the inception of the fund. We're looking for undervalued growth companies, catalysts to re- rate the share price of these businesses over the next 3, 6, 9, 12, 18 months. And these catalysts could be earnings upgrades, typically, or an EPS accretive acquisition. More recently, a cost out program or a capital management initiative, such as a buyback or special dividend, worked really well over the last two years. So we spend all of our time as bottom- up stock pickers meeting with management, suppliers, customers and traveling both domestically and overseas to try to find these great ideas. And then we need to identify the catalysts before we would invest in a business.
00:08:55
Sean Aylmer: Okay. And the catalyst could be balance sheet related, it could be legislation, it could be... I'm just trying to get my head around what a catalyst is.
00:09:03
Tobias Yao: It could be anything that we believe is upside to the market expectation for the business that is not currently captured in the share price, in our view.
00:09:13
Sean Aylmer: Okay. Tobias, you've given us a couple of ideas. How about a third one?
00:09:17
Tobias Yao: Yeah. So I mean another company we like is a company called MMA Offshore. It's the old Mermaid Marine. Now it provides support vessels to offshore oil and gas and wind power projects. Again, the management team is exceptional. Having inherited a business in a very bad shape all those years ago with a lot of debt. And slowly turning the business around to now be in the best position to benefit from this, the activities in the oil and gas and the wind power space.
The biggest debate in the market right now is whether the supply of vessels will come online to meet the demand and hence reduce the overall profit of the industry. And our view is that if you're ordering a new vessel now, it'll take you over 30 months to get it delivered. And a lot of issues around financing and shipyard availability. So it's going to take a long time for new vessels to come online. And idle vessels, it costs a lot of money to reactivate those vessels in the current environment. So vessel operators like Mermaid should benefit from increasing rates as the demand is really coming through now. And so that will continue to stay elevated.
So over the next few years, I think, ideally what the company can do is to transition the business, which they've done a great job already, and rebalance their revenue to be more exposed to win power projects. These are less cyclical in our view, demands a high valuation.
00:10:45
Sean Aylmer: Tobias, thank you for talking to Fear and Greed.
00:10:47
Tobias Yao: Thank you very much for having me.
00:10:49
Sean Aylmer: That was Tobias Yao, portfolio manager for WAM Capital, WAM Microcap, WAM Research, and WAM Active. This is the Fear and Greed business interview. Remember, this is general information only and you should seek professional advice before making any investment decisions. Join us every morning for the full episode of Fear and Greed, Australia's best business podcast. I'm Sean Aylmer. Enjoy your day.