MoneyTalks: Are these 3 ASX stocks equipped to pounce on rapid change?
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Money Talks is Stockhead’s regular recap of the ASX stocks and sectors that fund managers and analysts are watching and think could be a bargain for investors.
Today we hear from Chadd Knights, co-founder of Duro Capital.
Duro Capital focuses on the small and microcap ASX sector, is sector-agnostic and takes a longer term horizon view. Knights says a key focus of his firm is ASX stocks with small market shares in large markets where there is rapid change.
“The fund management industry has a strong focus on looking out 1-2 years and applying a multiple of earnings or sales to value a business,” he told Stockhead.
“While that’s fair game for more stable, mature companies, applying the methodology to companies experiencing rapid change typically won’t capture the long term earnings potential of these companies.
“Our view is that smaller companies with good customer value propositions and an entrepreneurial flair are well positioned to capitalise on end markets typically dominated by large incumbents.”
Knights gave Stockhead three ASX stocks facing massive opportunities in their respective markets (facing rapid change) but have only just scratched the surface.
Australian Ethical is an ESG-focused fund manager, with both managed funds and superannuation funds.
While this company has been around for a while, since 1986, it has particularly gained in the last couple of years as ethical investing has surged.
“We feel AEF is well positioned to capitalise on this shift towards ESG investing which we believe is structural – it’s not a fad in our opinion,” Knights said.
“AEF have a long runway for growth, they only have a small market share and [are] in a growing market too.
“To put this into context at 31 December 2020, AEF had about $5.1 billion in funds under management and that was up from $4.1 billion just six months prior to that.
But with the domestic superannuation asset base at $2.9 trillion ($2.2 trillion without SMSFs), AEF still has only about 0.2 per cent of the market.
“With such a long runway for growth, outstanding management team and capital flowing into ESG investing, we believe significant upside remains,” Knights explains.
And if you still think ethical investing is just a fad driven by millennials, Knights says this is increasingly becoming a reason to pay attention to, rather than ignore it.
“In five years or so they [millennials] are projected to earn most of the disposable income globally – so they’re the ones that are going to be determining who wins and loses,” he said.
Smartpay is an EFTPOS terminal provider across Australia and New Zealand – two unique markets for the company.
Knights explains Smartpay’s New Zealand business is mature and a cash cow. But Australia is where the company’s potential for growth lies and again it only has a small share of the market at this stage.
“As of 31 December 2020, they had about 5,800 terminals in Australia and when you compare it to their addressable market of 250,000 it’s a market share of 2.3 per cent – so once again a small share of a large market,” he said.
“Our view is that the value proposition to customers is clear and transparent.
“With a SmartPay terminal as long as you process at least $10,000 in credit cards transactions per month and implement a feature they have called SmartCharge which essentially passes the merchant fees onto consumers, the merchant pays nothing for the terminal.”
Meanwhile the major banks’ charge the merchants directly and have both a fixed and variable element to their charges.
Smartpay now has an Annual Recurring Revenue (ARR) of $24 million in Australia alone.
“This implies the Australian business is only trading on five-and-a-half times the current ARR – and it’s important to point out this ARR actually grew by 75 per cent in Q3 FY21 compared to QF FY20,” Knights said.
“So putting that all together we see significant upside as they continue to grow their terminal count and the NZ business provides a bit of a safety net in that it generates significant cash flow.”
Adairs is an retailer specialising in homewares and it is transitioning online. It has two businesses, Mokka and Adairs, that are both vertically integrated.
Omni-channel retailers have been a beneficiary of COVID-19 but Knights thinks investors still underestimate the extent.
“Adairs operates in a large market – the total addressable market is $11.4 billion in Australia alone and if you compare it to their FY20 revenue of $389 million, that implies a market share of 3.4 per cent,” he said.
Prior to COVID, ecommerce penetration among the homewares category was slow in Australia, at 5 per cent in 2019 compared compared to 15 per cent and 17 per cent for the US and UK.
Knights believes that COVID-19 will be the catalyst for that gap to converge.
“If this occurs – if we move towards that 15-20 per cent online penetration – that translates into about $1.1-$1.7 billion in revenue that should shift from bricks and mortar to online,” he said.
“Our view is Adairs is well positioned to benefit from this shift which in our view comes at the cost of in-store revenue.
“[The] key to Adairs continuing to take market share rests on continued store closures and downsizing by competitors which is a trend that started prior to COVID-19 but we believe will accelerate over the coming months and years.”
Adairs has already seen positive signs. In the first five weeks of store closures from late March, the company’s sales more than tripled compared to the prior corresponding period and about 30 per cent came from new customers.
It estimated that for the first half of FY21, it made $240 million and earnings of $64 million – more than the entire FY20 figure.
“We take a view that Adairs are well positioned to take advantage of billions of dollars moving which more than offset short term concerns,” Knights says.
“We remain pretty excited and we expect ecommece to demand about $2 billion annually in revenue in Australia alone and Adairs to grow its online revenue.”
The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead.
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