• Small and microcaps have sold off this year amid adverse market conditions
  • Perpetual fund managers however see lots of opportunities in this space
  • Stockhead reached out to Perpetual PMs, James Rutledge and Alex Patten

 

Over the last 12 to 18 months, a lot of micro and small cap names have been sold off quite aggressively amid a backdrop of higher rates, inflation and cautiousness.

Some investors have moved on to different parts of the market, or even to cash altogether as liquidity becomes a major focus.

But while many head for the exits, fund managers at Perpetual believe this is a good time to find oversold, high quality microcaps.

“The small cap index has lagged the large cap index in the last 12 to 18 months,” said Alex Patten who’s managing a circa $120m microcap fund at Perpetual.

“And if you look at the emerging companies index, which is made up of even smaller companies, that’s performed even worse,” he told Stockhead.

Patten believes there’s plenty of oversold stocks out there, adding that the price/earnings (PE) multiple of his fund is currently sitting at 9.5x, which is the cheapest it’s ever been.

But while opportunities are aplenty, Patten advised that investors should be more selective.

“I think it’s a good time to be investing in the microcap space, but investors will do better to focus on those profitable ones generating cash.”

(Note that Perpetual defines microcaps as those with free float of less than $300 million).

Patten explained that his fund has a more conservative style and approach compared to other microcaps funds.

“We’re a little bit different than probably most other microcap funds out there, and will only invest in those which are already profitable,” said Patten.

“For example in the mining space, we do invest there but it’s difficult for us to find companies that are established and generating positive cash flow.

“The same goes with tech and biotech space. We’re not really looking at companies at the R&D and pre-revenue phase, so they don’t really pass our filters.

“Instead, we’re looking mainly at industrials which have solid, stable businesses that are generating cash.”

 

3 recommended stocks from Perpetual

Perpetual likes these 3 industrial stocks, which currently make up a part of its holdings.

 

Capral (ASX:CAA)

Capral is Australia’s largest extruder and distributor of aluminium products. The company has a strategic national footprint of warehouses and distribution centres providing customers national service.

Capral also offers a range of aluminium systems for the built environment and industrial applications.

“About half their business is exposed to the residential property market, while the other half is exposed to commercial and industrial uses,” explained James Rutledge, also a portfolio manager at Perpetual.

“It’s a cyclical business that has changed quite materially over the last number of years.”

Rutledge explained that the company has done a lot of cost-out in its manufacturing facility in Brisbane, improving things such as process automation to soften the impact from the weak residential backdrop.

Although the residential property market will likely become tougher through the course of calendar 2024, Rutledge believes the starting point in terms of valuations looks quite attractive for the stock.

“It’s trading around 5x P/E at the moment, and they have about $40 million of net cash on the balance sheet. They also pay a very high fully franked dividend of about 8%.

“They will trade better through this environment over the next 12 to 18 months than they have in the past, given all the restructuring they’ve done through the last down cycle.

“So we believe there’s still pretty significant upside, given where the stock trades relative to other building materials at the larger end of the market.”

 

Motorcycle Holdings (ASX:MTO)

MTO is a motorcycle dealership and accessories group with 48 franchises operated from 31 dealership and 8 retail accessory locations in Queensland, NSW, Victoria and ACT.

The dealerships are engaged in the sale of new and used motorcycles, accessories, parts, finance, insurance as well as service and repair.

“They’ve had a tougher last couple of years with volumes coming off, but it looks like volumes of motorcycle sales have bottomed, and have now started to go up,” said Patten.

The stock is currently trading at 6-7x earnings, and pays a double digit dividend yield.

“They also have a founder who’s still very involved, so this is one of those great opportunities that we’re seeing at the moment in the microcap space with really cheap valuations.”

 

Gentrack Group (ASX:GTK)

Gentrack is involved in the design and development of specialist software solutions for energy utilities, water companies and airports mainly in Australia and New Zealand.

According to Patten, the business has made a turnaround from 3-4 years ago where they were under-invested in product development and had a few acquisitions that didn’t go well.

“But in the last couple of years, they’ve had a new management team that’s come in and started investing in product development,” says Patten.

“They also did some good partnerships with Salesforce to improve the quality of the product, and started to grow the business quite nicely over the last couple of years.”

Patten says the stock is attractively priced relative to its strong organic growth profile.

“There were some interesting management incentives that were just signed off by shareholders the other day, where the management team will get paid a lot of money if they can deliver some pretty aggressive EPS growth target.

“The incentives are also directly linked to the share price being materially higher over coming years.”

 

Share prices today:

 

 

The views, information, or opinions expressed in the interview in this article are solely those of the interviewees and do not represent the views of Stockhead.

Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.

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