Investors who saw the COVID-19 selloff in March as a buying opportunity would have reaped some handy gains over the past few months. But after an unexpectedly bullish June quarter, higher valuations make for a more complex outlook in the second half of the year.

In that environment, Oracle Investments fund manager Luke Winchester reckons mining services is one sector that can still outperform.

He’ll also be watching closely during FY20 reporting season, when companies left more exposed to the crisis will be forced to provide some clarity around earnings and cash-flow.

Looking back on the historic volatility in March and April, Winchester said the focus turned to earnings certainty — small and mid cap stocks that could demonstrate an ability to maintain their business model in a world that got turned on its head.

Stormy weather

Instead of its usual monthly meeting, Winchester said the Oracle investment committee probably had “three or four” ad-hoc gatherings to navigate the height of the crisis.

The result was a period of more active trading, where the Emerging Companies fund he runs reduced its cash holdings from around 20 per cent to 10 per cent.

New additions to the portfolio in that time included infant formula provider Clover Corp (ASX:CLV) and online lotteries business Jumbo Interactive (ASX:JIN).

While the Oracle team aren’t “gold bugs”, Winchester’s fund also built new positions in Ramelius Resources (ASX:RMS) and Red 5 Ltd (ASX:RD5).

Elsewhere, the fund re-upped its positions in some mid-cap tech names including Appen (ASX:APX), Bravura (ASX:BVS) and Dicker Data (ASX:DDR).

“A common theme for us was that you could see tech business that could provide their solutions through the cloud weren’t going to be impacted as heavily,” Winchester said.

“Short term there may be some impacts closing sales, but there were no fundamental problems moving forward with these business over the next few years.”

Next big thing: mining services

Looking ahead, Winchester said the mining services sector may throw up attractive opportunities over the short-to-medium terms, in comparison to other sectors that have already run hard in the COVID rally.

“I think we’re starting to see a strong recovery there, which has sort of lagged other sectors through April and May,” Winchester said.

He cited the example of mid-cap player Mineral Resources (ASX:MIN), which has been “on fire” over the past few weeks.

“There’s some cyclicality to that sector, but over the next year or so it looks like an interesting space for earnings certainty and growth.”

“It’s not the mining boom by any means, but when miners are recognising higher production and profits, it typically flows through comes to mining services”

“Even commodities you’d expect to be more linked to global growth like copper and nickel have rallied hard. I’m not sure how sustainable that part of the commodity space is, but where we’re looking is gold and iron ore I think the outlook is OK in the short-to-medium term,” Winchester said.

Bottom-up approach to investment

A unique feature of the post-COVID rally is that it’s resulted in a pronounced divergence between stocks and the economy.

Australia is a good example, where the ASX has climbed by more than 30 per cent amid what will no doubt be a steep recession.

But Winchester emphasised that from an emerging companies perspective, the investment approach always starts with the merits of individual companies rather than the broader economic outlook.

“Anyone who says they ignore the macro side completely, I don’t think’s telling the truth. You have to incorporate it at some point,” he said.

“But we generally don’t look at it from a top topdown point of view, it starts with a bottoms-up analysis of the individual company.”

Webjet (ASX:WEB) is a good example — from a bottoms-up point of view they’d tick a lot of boxes, but then we overlay what the macro environment looks like for these businesses and it’s a lot more uncertain.”

Dilution factor

Throughout the pandemic Australia’s equity capital markets have remained particularly liquid, with many companies taking advantage of the disruption to raise extra capital.

But Winchester observed that investors should also be aware that for some companies that tapped investors over the past few months, the “longer term capital structure of these businesses has totally changed”.

As a travel-exposed company, he noted that Webjet completed a $275m capital raising in early April, at the cost of diluting its shares on issue by a ratio of almost two-to-one.

“Even if earnings recover to pre-COVID levels, that dilution means the return on capital is completely different,” he said.

“For some of these businesses you’ve gone from a return of equity of 20 per cent, it’ll now be sub-10 (per cent). As an investor and not a speculator, that’s a different investment than what you had previously.”

“So those sectors that are more exposed are one’s we are a bit wary of. Without that extra certainty around them we’re just finding better places to put capital at the moment.”