For investment fund 1851 Capital, there’s growth to be found in telecommunications and healthcare as markets emerge from the COVID-19 pandemic.

And as FY21 draws to a close, Stockhead caught up with portfolio manager Martin Hickson to discuss the outlook for ASX small caps.

Hickson works alongside 1851’s chief investment officer Chris Stott, where they run a small cap portfolio comprising 30-80 stocks.

The pair joined forces in September 2019, after working together at Wilson Asset Management (WAM) for almost 10 years.

After WAM’s funds under management (FUM) grew from around $300m to more than $3bn, their goal was to establish a nimbler fund.

“The bigger you get, the harder it is for the fund to outperform,” Hickson says.

“So we started with $80m FUM and we’re about to reach $300m. At that point we’ll put out a final call to investors before soft-closing, so we can restrict size and stay at a level that allows us to continue delivering alpha.”

1851 Capital — investment strategy

In terms of its investment approach, Hickson outlined that 1851 steers clear of resources (“we’re not geologists”) and biotech (“we’re not doctors either, and it’s difficult to assess clinical trial results that often have a binary outcome”).

That leaves an investment universe of around 650 companies. And a key priority of the fund’s investment thesis is tied to earnings growth.

“We don’t like revenue multiple stocks or ‘concept’ stocks – companies that are losing money and will probably continue doing so,” Hickson said.

“If you look at the metrics of our portfolio, it currently has a P/E ratio of 19 times against the index ratio of 21. So it’s 10% cheaper, but has around 4x the earnings growth.”

In that context, Hickson provided details on the two largest holdings in the 1851 portfolio.

Uniti Wireless (ASX:UWL)

UWL is the largest holding at 1851 Capital, comprising around 5% of the fund.

Effectively Uniti operates as a “competitor to the national broadband network (NBN)”, Hickson said.

That means for each new property development in Australia’s major growth corridors, Uniti competes for deals with developers where it lays the fibre that allows tenants to access the internet.

It then sells access to those networks to consumer-facing internet service providers.

“I look it at it like a toll road – they’ve got an asset base that’s going to generate recurring revenues over a 30-40 year time horizon. But the up-front capital costs are low because the developer is paying to build it,” Hickson says.

“So it’s a high-quality business, where we think the multiple can re-rate to trade closer to an infrastructure business.”

He cited the quality of the management team, naming director (and M2 Group founder) Vaughan Bowen and CEO Michael Simmons as two standouts.

Both worked at M2 Group before it merged into Vocus in a $3.75bn deal, and Simmons brings around 30 years of experience in the telco sector, including a previous stint at TPG.

Hickson also thinks Uniti can generate earnings growth “ahead of what the consensus is”.

And over the medium term, he said the listed telco sector has the potential for some more takeover activity.

“If you look at Uniti’s bid for OptiComm last year, there was a large super fund involved in that process and then you had the Vocus takeover by Macquarie earlier this year,” Hickson said.

“So I think as Uniti continues to prove out their business model, they could also become a takeover target themselves down the line.”

Capitol Health (ASX:CAJ)

The second largest holding in the 1851 Capital portfolio, CAJ is a medical imaging company that runs a national network of radiology clinics.

Again, Hickson focuses on the quality of management – this time highlighting Capitol Health CEO Justin Walter who took over the reins about 18 months ago.

“We think he’s done a great turnaround job there, taking costs out of the business while the clinic network has concurrently gone through a period of decent revenue growth,” Hickson said.

He added that CAJ should benefit from a key regulatory development with the re-introduction of Medicare indexation.

For the last five years or so, prices per scan have been capped but the Australian government recently reintroduced indexation measures that will allow imaging providers to pass through annual price increases.

Along with the turnaround story, Hickson said CAJ also has a “very strong balance sheet with low debt, which gives them the option to deploy those funds and make accretive acquisitions”.

But like Uniti, Hickson thinks CAJ could itself become an acquisition target over time.

The company currently trades at an enterprise value (EV) / EBITDA multiple of 8.5, while its biggest listed peer — Integral Diagnostics Ltd (ASX:IDX) — trades at around 11x, Hickson said.

“There’s also unlisted companies in the radiology space being acquired at multiples of up to 13x.”

“So it’s trading at a significant discount and we think given how the new CEO has turned the company around, over time it could become an acquisition target for one of the other larger players,” he said.

Rates outlook

Lastly, Hickson provided his views on the economic outlook in the wake of some market jitters this week tied to the US rates outlook.

Monday’s selloff followed news that the US Fed will bring forward its timeline to hike interest rates – from 2024 to as early as 2022.

In Australia, “the bond market is starting to price the first rate hike at the back end of 2022, and I think that will happen,” Hickson said.

So yes, rate rises are now on the cards. But “the reason central banks are doing that is because economies are performing a lot better than expected”, he said.

“We speak to more than 500 companies a year and speaking to a lot of small caps in recent months, it’s quite clear the Australian economy is performing extremely well,” Hickson said.

So in that sense, he’s “not too concerned about rates going up over the next couple of years”.

“In one sense it’s a positive that monetary policy will start to normalise, and we’ll exit this ultra-loose environment that we’ve been through in the pandemic,” Hickson said.