The ASX micro-cap sector could be set to benefit from changing conditions, argue Perpetual portfolio managers Alex Patten and James Rutledge.
- Micro-caps used to new norm
- Earnings, corporate activity increasing
- Learn more about the Perpetual Smaller Companies Fund
Opportunities are emerging in the Aussie micro-cap sector after a challenging 18 months, argue Alex Patten and James Rutledge, who co-manage Perpetual’s Smaller Companies and Pure Microcap funds.
“A lot of these businesses are very exposed to the real economy – retailers, industrial companies, building materials, service companies,” Patten explains.
“The rate rises we've seen over the last couple of years has put a lot of pressure on those sorts of businesses. GDP per capita has been negative for some time now, and consumer confidence is well below pre COVID levels.”
Destocking amplified the downturn, Rutledge adds.
Tide turning for micro-caps
But the tide may be turning.
During the latest ASX reporting season, many microcap companies indicated they had adapted to the new interest rate environment Patten points out.
And consumer confidence is starting to pick up.
“It feels like we're bouncing along the bottom now," Rutledge says. “Over the last nine months, the environment hasn’t gotten any worse and that’s what we heard during the August reporting season. Companies have adapted to the new normal.”
Rutledge points out that markets are forward looking, and expectations are building for a rate cut, or at least no more rate hikes.
“That’s a reason why we are seeing signs of life in this part of the market,” he says.
Pick-up in corporate activity
Patten highlights other encouraging signs, such as a pickup in merger-and-acquisition activity in the microcap space.
“There’s been three or four bids in the micro-cap space recently and that will help the sector,” he says.
“Earnings are starting to inflect upwards, and that’s reflected in some of the outlook commentary we’ve seen recently.
“When you look at this part of the market, not only are earnings towards what we think are cyclical lows, but valuation multiples are also depressed versus history,” Patten says.
“So, there’s an opportunity for these stocks to both re-rate and show strong growth in earnings. A lot of them can trade a lot higher and still look relatively attractive.
“Also, more companies than usual are undertaking share buybacks which reflects that they have strong balance sheets and also see opportunity in where their share prices are at the moment,” Patten says.
Residential, Qld and WA among the picks
“Residential exposure is starting to look interesting again, as are stocks exposed to Queensland and Western Australia,” Rutledge says.
Patten cautions that the micro-cap end of the ASX is relatively illiquid.
“It only takes on incremental buyer to come in and decide they want to own the stock, and that can move a price quite significantly. And it’s the same on the downside.”
Ruttledge concludes: “There has been such a long period of underperformance for microcaps over the last couple of years that the setup is quite attractive.”
About Perpetual’s Australian small cap equities team
The Perpetual Smaller Companies Fund aims to provide long-term capital growth and income by investing in companies outside the S&P/ASX 50 Index (when first acquired).
The portfolio leverages the growth potential of smaller and emerging companies through a proprietary stock selection process.
Perpetual is a pioneer in Australian quality and value investing, with a heritage dating back to 1886.
We have a track record of contributing value through “active ownership” and deep research.
Find out more about Perpetual’s Smaller Companies Fund
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