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Looking for the long-term ‘reopening beneficiaries’

As the COVID recovery gathers momentum, it is interesting to consider which sectors and companies are benefiting from the short-term boost of temporary stimulus measures and which present long-term opportunities as global growth recovers.

We have identified three themes that frame our thinking about the long-term prospects of Australian small cap stocks: adding to high quality industry leaders; long-term “reopening beneficiaries”; and value opportunities in the resources sector.

What lies ahead over the next year or two will be different to the post-GFC environment, which was characterised by fiscal austerity and a relatively fast withdrawal of supportive monetary policy.

  • Policy support remains highly accommodative, with low interest rates and increased fiscal spending set to continue until we see clear evidence of self-sustaining recovery and a rise in inflation.

    Overall, we believe this has positive implications for equities, particularly in the emerging companies market.

    With considerable uncertainty around the macro-economic environment due to the pandemic, the market has favoured many of the secular growth stories, given their relative immunity to the economic outlook.

    However, following their strong outperformance over the past year, we now see a less favourable risk-reward profile for these opportunities. We are cautious where valuations have significantly re-rated and earnings expectations have been reset higher.

    Opportunities where companies are more sensitive to an improving growth outlook, especially in the value and cyclical areas of the market, include sectors such as materials, financials and consumer cyclicals.

    Resources companies look particularly attractive, given their strong free cash flow and the positive outlook for commodity prices. Our focus is on established producers generating strong cash flows and positioned low on the cost curve with net cash balance sheets.

    Examples include IGO Ltd, a mining company whose strategy is to align its business with the structural shift to energy storage; mineral sands miner Iluka Resources; and rare earths miner Lynas Corporation.

    “Reopening beneficiaries” should benefit from pent-up demand for in-person activities, such as shopping in physical stores, overseas university education and corporate travel.

    Reopening beneficiaries that may make long-term gains include Corporate Travel Management, jewellery retailer Lovisa Holdings and international education company IDP Education.

    IDP Education is well positioned to take market share in its core markets of Australia, United Kingdom and Canada. Near-term pressures remain as Australia’s borders remain closed but the UK and Canada are open to international students, where some of the student flows have been redirected.

    High quality industry leaders with good long-term prospects include financial software company Iress, automotive accessories supplier ARB Corporation, and online lottery retailer Jumbo Interactive.

    Despite our current preference for value and cyclical stocks over re-rated growth stocks, we retain a positive view of a select number of growth focused companies. Typically, these are industry leaders with positive long-term outlooks and include ARB Corporation and Temple & Webster.

    Investors should keep their eye on the fundamentals. Strong balance sheets are essential while we are still in a period of uncertainty. Return on invested capital should be high.

    Other characteristics we like include a high proportion of revenues generated outside Australia, giving exposure to larger markets; and significant ownership of the company by founders or management, which makes for good alignment of interest with shareholders.

    Sam Twidale is the Portfolio Manager for the DNR Capital Australian Emerging Companies Fund.

    Ends

    IMPORTANT NOTE: The information relating to DNR Capital has been prepared by DNR Capital Pty Ltd, AFS Representative – 294844 of DNR AFSL Pty Ltd ABN 39 118 946 400, AFSL 301658. Whilst DNR Capital has used its best endeavours to ensure the information within this document is accurate it cannot be relied upon in any way and you must make your own enquiries concerning the accuracy of the information within. The information in this document has been prepared for general purposes and does not take into account your particular investment objectives, financial situation or needs, nor does it constitute investment advice. Before making any financial investment decisions you should obtain legal and taxation advice appropriate to your particular needs. DNR Capital will not be responsible or liable to anyone who acts or relies upon anything contained in, or omitted from, this document. Past performance is not indicative of future performance.

    Sam Twidale




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