Spheria Asset Management Wins at the 2018 FundSource Awards

We are pleased to announce that the Spheria Australian Smaller Companies Fund has taken out the Australia Equity Sector award at the FundSource Awards 2018.

The event, held in Auckland, New Zealand, on 29 August 2018, drew a strong turnout of fund managers from New Zealand and Australia. FundSource presented 14 awards in total. Funds must pass rigorous qualitative and quantitative screening as part of the selection process, before being analysed on a performance based approach. Overseas based funds needed to demonstrate a strong commitment to the New Zealand market.

See the full list of winners at: https://www.fundsource.co.nz/fundsource-awards/2018-fundsource-awards/

fundsource_photo
From Left to right: Darren Howlin (Chief Judge, FundSource), Glen van Echten (Head of FundSource), David Batty (Pinnacle).

Spheria Emerging Companies (ASX:SEC) Annual Results

July 2018 | Market Commentary

 

 

Overview

A lot of people know which are the good horses but the odds adjust such that the proceeds from wagering on those horses theoretically even out. In both cases the message is clear – valuation matters and it is possible to pay too much for a great business. In the short run many things drive share prices. It seems to us that earnings and price momentum have been the two dominant short term (voting) themes. This is hardly the stuff of weighing machines and is prone to dramatic sentiment change when the current investment climate abates and longer term drivers take over.

So how do you use the “weighing machine” to invest? We hold the view that investing in the stock market cannot be considered in isolation and needs to be considered against the back drop of all asset classes. Investors can freely switch between equities, cash, bonds, property and other alternatives. As such, the only way to properly compare all asset classes is from the cash flows derived from investing in each. There is a long history of the world’s best investors supporting this notion and it is the only one we are aware of that sifts out the rolodex of shorter term “voting machines” out there. If you think about your own business you don’t measure the number of likes, clicks or barrels of oil equivalent in the ground to determine how profitable it is – you measure how much cash you have generated in the bank at the end of the year. We use the same simple and repeatable method to evaluate shares in the smaller companies space to sift and sort the universe in order to try to find the best relative and absolute investments. Cash flows not only have the benefit of being measurable but they also enable companies to fund their own growth and avoid the use of external funding which is useful during times of market stress.

Given the strong run the market has had over the past year it would seem logical that some areas of the market might offer less compelling value – certainly than they did a year ago. We see two areas in particular which warrant caution – the larger end of the smaller companies index and wannabe disruptors. The larger end of the small companies index comprises many rapidly growing fintech type investments. The valuations of these companies would stretch any weighing machine type valuations to breaking point. Secondly, the smaller end comprising what is probably best referred to as the ‘wannabe disruptors’. These wannabe disruptors usually have a few things in common – little to no revenue, are rapidly growing (off a minute base), lose money, don’t generate cashflow and they usually have a hyperbolic sounding company name. We ran a screen on the number of stocks which fit this criterion and it peaked in January of this year at 56 companies (according to a Bloomberg screen of stocks with market caps greater than $100m and revenues less than $2m). This number has since declined to 42. Suffice to say we do not own any of these companies in the Fund.

Key Contributors

During the month we had strong contributions from Technology One (TNE.ASX, +16%), Nufarm (NUF.ASX – not held, -19%),Mortgage Choice (MOC.ASX, +11%), Evolution Mining (EVN.ASX – not held, -21%) and Isentia (ISD.ASX, +12%). TNE typifies the style of business we like to own. Over its 19-year history as a listed company TNE has converted 96% of its EBITA (Earnings Before Interest, Tax and Amortisation) into free cash flows. The business has a strong net cash balance sheet and despite paying a healthy dividend also manages to grow organically by 10-15% pa. TNE had declined quite substantially after their first half results. Although the company had communicated that they were up against a tough comparator the market sold the shares down aggressively. We viewed the sell off as a misunderstanding and substantially increased the position in the Fund. Not only did we think there was substantial value in the shares as they sold off, but we also view the business model as becoming higher quality through time. TNE is migrating their client base onto a SAAS (software as a service) platform and changing the way they bill their customers. Around 25% of their client base is now on a SAAS hosted platform. As the company continues to migrate customers onto this platform, the amount of recurring revenue continues to grow. We expect this to increase from around50% of total revenues today to closer to 75% within a few years.

There were also strong contributions from we had strong contributions from Supply Networks (SNL.ASX, +18%), Gage Roads Brewing Co (GRB.ASX, +16%) and Isentia (ISD.ASX, +12%). SNL is the leading aftermarket supplier of truck parts to the independent truck mechanic trade in Australia and New Zealand. SNL has a long history of organic rollout which has meant that its return on capital is high and the balance sheet has remained virtually ungeared throughout its roll out. SNL upgraded its previous guidance from both a sales and earnings perspective. GRB is a boutique brewer based in Perth which is undergoing a shift from producing private label beer for Woolies to its own eponymous brands. This shift sees a pronounced improvement in margins and growth rates over the next few years. During July they announced a strong fourth quarter from both a sales and cash flow perspective.

Detractors

Detractors included Class Ltd (CL1.ASX, -8.3%), Afterpay (APT.ASX – not held, +51.6%) and Specialty Fashion (SFH.ASX, -8%). APT warrants some comment although the Fund is restricted from owning it given the market cap >$3bn versus the limit of A$500m. APT came onto the scene two short years ago and offers consumers a novel lay-by facility in the form of four equal payment instalments over two months for relatively small purchases ($100 – $1500). APT have signed up many retailers in Australia and grown sales very quickly over the past two years – a credit to the founders’ entrepreneurialism and vision. Whilst the business is growing fast it is highly capital consumptive and reliant on third party debt funders in order to grow its business. APT also has a relatively short trading history and thus investors have little idea of how bad debts will look over a credit cycle and what a stabilised competitive environment looks like. It has been for these reasons we feel the business does not fit with our investment process, which has cost us relatively dearly versus the Benchmark.

APT warrants some comment given our underweight position. APT came onto the scene two short years ago and offers consumers a novel lay-by facility in the form of four equal payment instalments over two months for relatively small purchases ($100 – $1500). APT have signed up many retailers in Australia and grown sales very quickly over the past two years – a credit to the founders’ entrepreneurialism and vision. Whilst the business is growing fast it is highly capital consumptive and reliant on third party debt funders in order to grow its business. APT also has a relatively short trading history and thus investors have little idea of how bad debts will look over a credit cycle and what a stabilised competitive environment looks like. It has been for these reasons we feel the business does not fit with our investment process, which has cost us relatively dearly versus the Benchmark.

Other detractors included Sigma Healthcare (SIG.ASX, -40%) and Reliance Worldwide (RWC.ASX – not held, +11%). SIG declined almost 40% over the month as they lost a major client in the form of Chemist Warehouse and had a weak trading update. Chemist Warehouse represented close to 40% of SIG’s wholesale volumes and after protracted negotiations decided to change suppliers to EBOS. This was both a surprise and a disappointment to the market and the apparent pricing regime taken on by EBOS seems sub-economic considering the short-term contractual nature of the supply agreement. SIG will receive a substantial amount of working capital release (i.e. cash) as compensation at the end of its current agreement but nevertheless will be required to reduce costs and/or lift volumes to hold earnings to their new guidance. There is likely to be positive fallout for SIG given many EBOS pharmacists view Chemist Warehouse as the enemy. Given SIG was a relatively small position for the Fund before the update and valuation risk has lessened (i.e. exchanging cash for earnings) we have substantially increased the Fund’s weighting to SIG.

In Conclusion

In spite of some pockets in our universe being highly valued we are still able to find good investment ideas that meet our process fundamentals. Markets are cyclical and sentiment – whilst powerful – is transitory over the long term. We believe our process positions us well for when markets inevitably return to the weighing machine (cash flow) valuations.

June 2018 | Market Commentary

 

 

 

In Summary

This month, The Australian Microcap Fund, Smaller Companies Fund and Opportunities Fund increased in June (+0.3%, +0.2%, +0.6% respectively),  which resulted in underperformance (-0.7%, -0.8%, -1.1% respectively)  versus the Benchmark.

Looking at the Benchmark, we note the bottom five performers as measured by % price movement after reinvestment of dividends were: – Retail Food Group (RFG.ASX, -85%), Blue Sky Alternative Investments (BLA.ASX, -80%), CSG (CSV.ASX, -69%), Beadell Resources (BDR.ASX, -69%) and iSentia Group (ISD.ASX, -65%). The only one the Fund owned being ISD. The others generally having poor cash flow dynamics and, in some instances, parlous balance sheets. It’s difficult to envisage how these companies survive given that equation, albeit if history is any guide there could be a lot of money made in one, possibly two of these names. Specialty Fashion Group (SFH.ASX) resuscitation from a near death experience being a recent case in point. Whitehaven Coal (WHC.ASX) being another example from a couple of years ago.

iSentia Group (ISD.ASX)

In respect of ISD, we underestimated the level of price erosion in the media monitoring industry instigated by Meltwater – a private company founded in Norway. Its focus is online and social media, but it also monitors traditional media. It is an efficient technology led player that has taken an estimated 15% (measured by revenue) of the Australian media monitoring market. We believe most of its clients are small and tend to churn but it makes relatively good money. As we understand, it has approximately $20m of revenue and a margin of around 30%. ISD on the other hand is skewed to mid-large clients and has approximately $90m of revenue and a margin of 25%. We could be wrong, but we believe a new industry copyright agreement could be blessing in disguise for ISD, if as we understand there is a harmonisation of costs across participants. Currently ISD is paying about $16m per annum for its copyright licence, given it is around 4x the size of Meltwater you would reasonably guess that Meltwater should be paying around $4m in copyright fees. As we understand this is not the case and Meltwater is paying a fraction of that. Any significant increase in copyright licence fees for Meltwater will mean it needs to lift end prices substantially to maintain current profitability. However, there is some risk that the Copyright Agency Limited (CAL) increases licencing costs across all users. In the case of ISD there may be a lag before it can recover the cost increase. Recovery may also be difficult if Meltwater sidesteps a copyright increase or decides to maintain its price discount to win share at the expense of margin. As is often the case in the sharemarket money is made when uncertainty is at an extreme and you feel most uncomfortable.

Top Performers

The top five performers in the Benchmark as measured by % price movement after reinvestment of dividends were: – Beach Energy (BPT.ASX, +214%), A2 Milk Company (A2M.ASX, + 180%), Altium (ALU.ASX, +166%), Sino Gas & Energy Holdings (SEH.ASX, +162%) and MG Unit Trust (MGC.ASX, + 143%). We missed BPT, A2M and ALU due to valuation. Of these companies only two had a market cap less than $500m, being SEH and MGC. The other two companies did not have the cash flow dynamics as dictated by our process with MGC having a very weak balance sheet to boot. MGC was effectively taken over by Saputo during the year which saw the share price rally significantly from a very distressed level. SEH was also subject to takeover from Lone Star, a private equity firm.

Class (CL1.ASX)

Recently, we have had a lot of enquiry about our investment in Class (CL1.ASX). As is often the case when share prices are falling and you go against the grain, you tend to receive the most inbounds. Funnily enough Cabcharge (CAB.ASX) was in the same boat only a few months ago when it was plumbing lows around $1.60, with the CAB share price rally to $2.50 those concerns have been alleviated for now. We view CL1 as one of the few true growth propositions in the Australian market, whilst growth has slowed we note it is still adding over 20k accounts on an annualised basis (we include Class Portfolio as we believe these are nearly as valuable as SMSF accounts). Relative to a base of 160k this still equates to organic growth of +14%. This despite the main competitor (BGL) heavily promoting its cloud (BGL 360) offering by providing a 12-month fee holiday to its desktop users when they switch. A clever move really given two-thirds of CL1’s account wins in 2017 came from BGL desktop according to an independent survey conducted by Investment Trends. We assume this has led to a flood of previous desktop users moving to BGL 360 thus reducing CL1’s growth in recent quarters. This begs the question as to how long BGL can sustain the fee discounts/holiday. With no publicly available financial information we can only go off comments from BGL management that revenue is somewhere between $16m to $22m. Given CL1 has a cost base around $20m and a narrower business, we wonder how long the discounting by BGL can last. Regardless, CL1 is in a strong position to grow, just probably not at the past rates given it now has 27% of the SMSF market.

We believe there are two reasons to remain optimistic on the growth outlook:

1) In the long term we believe Class Portfolio could be disruptive in the non-super platform space as dealer groups increasingly access financial products directly and rebate any savings derived through group buying power to clients.

2) In the short-medium term we do not believe AMP is a natural owner of SuperMate, which is a competing Cloud SMSF software provider with 7% market share (>40k accounts) which is sub-scale. Given BGL has over 40% market share we believe it would struggle to achieve ACCC clearance to acquire SuperMate, which makes CL1 the obvious buyer. Assuming average revenue per account is $100 pa, SuperMate would be generating about $4m in revenue. This additional revenue would come at very little incremental cost to CL1 and hence would be accretive to valuation. For AMP it eliminates a non-core business that is likely loss-making. The only sticking point to the deal being who buys the front-end administration business, Super Concepts, from AMP. This would represent about one-quarter of the accounts on SuperMate based on our estimates.

Final Thoughts

At 30 June 2018, the Fund’s cash levels were higher than usual to fund a significant distribution to unit holders. The high cash levels do not reflect our view on opportunity set, in fact we have found several new companies to invest in recently that tick our investment process requirements.

Webinar: M&A targets for Australian small caps

CommSec Executive Series


CommSec’s Tom Piotrowski speaks with Spheria Emerging Companies Ltd (SEC) Portfolio Manager, Marcus Burns about the performance of SEC’s portfolio, the team’s investment process and his views on the tech sector in the small cap space.

May 2018 | Market Commentary

Overview

The recent Fund outperformance is a pleasing result given the style of market we have been investing in. Anything technology related or with the whiff of ‘disruption’ about it has been on a tear with little regard to the value of the underlying cash flows. Our process is anchored to core metrics like cash flows and balance sheets which we believe are the only things that will remain in vogue over the long term when momentum loses its lustre.

Key Contributors

During May the Funds had notable contributions from Seven West Media (SWM.ASX, +47%), Blackmores (BKL.ASX, +29%), Cabcharge (CAB.ASX, +14%) and Sirtex Medical (SRX.ASX, +4%). SWM.ASX rose sharply over May as the market started to reward the company for its cost saving program (an incremental $70m in FY 19, albeit some of these cost savings included revenue from the Winter Olympics and the Commonwealth Games) and the potential for merger synergies in a media consolidation scenario. We remain of the view that there is substantial value to be unlocked in the Australian media landscape as players merge to rationalise production and media content costs.

We have written before about CAB which we still think is attractively valued. CAB has gone through a challenging time on two fronts namely: changes in State regulations which have reduced the rate at which they can charge for electronic payments in taxis and secondly the rise of ride sharing apps (viz Uber, Taxify and Ola). Ironically, necessity can be the mother of invention and CAB has been able to use the change in industry structure to improve how their business is structured and performs. Taxi operating costs for drivers will decrease over time as the high cost of taxi license plates decline (now minimal in Victoria) and CTP insurance costs fall due to recent regulatory changes. Deregulation of the Victorian market has led to significant increase in licences being issued allowing drivers flexibility as to when they work, leading to strong market growth as there are more taxis on the road at peak times. Technology changes also mean CAB has developed a competitive booking app (improving the customer experience) and reducing despatch times. . Lastly, it is expected the personal transport market will continue to evolve with taxis and ride sharing co-existing to service a growing market as many people do away with the second car and in some cases do not own a car. There remain challenges for CAB from the monopolistic past in particular the service quality and standards that can still evoke negative reaction. The management team however, is making ground on this front by tackling these issues rather than living in denial – with previous management having had the benefit of regulatory protection.

Detractors

The Fund saw detractions to performance from Reliance Worldwide (not owned) (RCW.ASX, +25%), Monadelphous (MND.ASX, 10%) and Wisetech (not owned) (WTC.ASX, + 46%). RWC made a very large acquisition during May and rose strongly on the news. MND has pulled back on the view that their FY 19 year could see some topline pressure as they transition from Oil and Gas work back to Iron Ore capital projects. The Iron Ore miners have enjoyed several years of record production with limited capital reinvestment and there is some catch up to capital investment required to keep their asset base at current production levels. We view MND as well placed to win significant mining construction work that will position It for strong earnings growth over FY20 and FY21 despite the potential for a reduction in revenues in the short term.

In Summary

The microcap space is looking attractive particularly on a relative basis to the smaller company universe. Whilst some of the larger smaller companies continue to re-rate on little more than what appears to be momentum, there is a compelling opportunity in the microcap names that have been left behind or de-rated.

Additionally, the smaller end of the Benchmark and stocks outside the narrow and hyper popular Fintech space appear to offer much more compelling investment opportunities to our minds. The investment process dictates to look at cash flows and use these to value and measure relative investments. Whilst we are aware of the short term power of momentum in the investment universe there is no warning bell when this thematic reverses.

April 2018 | Market Commentary

 

 

 

Overview

It feels like the market has moved into a new phase with a flurry of takeover activity in recent months. The Spheria Australian Smaller Companies and the Opportunities Fund benefitted from holdings in Sirtex Medical (SRX.ASX), Healthscope (HSO.ASX) and HT & E (HT1.ASX) that have attracted corporate interest.

Australian Microcap Fund

The Spheria Australian Microcap Fund was down 0.8% in April versus the S&P/ASX Small Ordinaries Accumulation Index which was up 2.8%, equating to underperformance of 3.5% for the month. Over one-year the fund is up 15.3% after fees versus the benchmark up18.4%.

The underperformance in April was primarily due to stocks in the benchmark that we could not own due to size including Metcash (MTS.ASX), Beach Petroleum (BPT.ASX) and Worley (WOR.ASX). As a reminder the Fund is limited to owning companies below A$500m in market capitalisation which restricts it to listed companies currently outside the top 280 (in ascending order).

Interestingly from an attribution perspective, the Fund owned only two stocks out of the five largest negative contributors for the fund in April, being Vita Group (VTG.ASX) and Ridley (RIC.ASX). The negative contributions being relatively small as they were down only 10% and 13% respectively over the month.

In contrast the Fund owned four out of the top five positive contributors for the month being Mount Gibson (MGX.ASX), Adairs (ADH.ASX), Gage Road Brewing (GRB.ASX) and Horizon Oil (HZN.ASX). The only top five contributor the Fund did not own was Blue Sky (BLA.ASX), which the Fund has never owned.

It has been a strange few months in the small cap space and even more peculiar at the microcap end of the market. The S&P ASX Emerging Companies index declined 3.5% in the quarter ending 30th April 2018 while the S&P ASX Small Ordinaries Accumulation Index (the Benchmark) rallied 0.4%. The mismatch between our microcap strategy universe and the Benchmark index makes it very difficult to keep pace. Clearly, the larger companies in the Benchmark have significantly outperformed the micro end.

A surprising aspect to this underperformance has been de-ratings of microcap stocks unrelated to earnings revisions. The Fund has not been immune from this effect with three key holdings in particular worth commenting on:

  • Vita Group (VTG.ASX) – fell a further 11% in April bringing the fall in the quarter to 39% despite upgrading earnings in January. We think to a large degree this reflected its diversification strategy that involves a move into cosmetic clinics. We view this as a potential medium to long term positive given the similarity in selling methods and the fragmented nature of the industry they have entered. We note Laser Clinics Australia was reported to have sold for $650m last year. Whilst its core business is laser hair removal, it has grown the business into the adjacent cosmetic procedure space which has delivered significant value.
  • Class (CL1.ASX) – fell a further 3.4% in April bringing the fall in the quarter to 23% as the market de-rated it on competitor comments. We understand the competitor BGL, the incumbent desktop provider has less than half CL1’s revenue and yet has a greater headcount (BGL’s = 120 vs CL1’s 100). Based on these crude figures (there is very little publicly available information) it would appear BGL is at a financial disadvantage versus CL1. Clearly this may change if it continues to gain traction with its cloud product – BGL360. Nonetheless a two-player market is still a very supportive backdrop, especially given the third player Super Concepts looks tenuous at best with single digit market share and an unnatural owner in AMP.
  • Isentia (ISD.ASX) – fell a further 4.2% in April bringing the fall in the quarter to 42% which represents an enormous de-rating given it reiterated guidance at the half year result. We note the company generates sound levels of free cash flow and is the number one player in the Australian media monitoring market with a strong foothold in Asian markets. The issue for ISD is legacy pricing and an aggressive technology driven competitor, Meltwater Australia (Meltwater), which has much sharper pricing that is leading to industry price erosion with ISD the biggest player being most exposed. Positively it appears ISD is maintaining market share at the top end of town (i.e. medium to large clients) where the bulk of the profits are made. The potential circuit breaker in respect of pricing being Copyright Agency (CAL) negotiations which should render a more even playing field on copyright costs, thus potentially reducing Meltwaters cost advantage and reducing their discounting. In the meantime, ISD has a significant cost out campaign led by the CFO who we rate highly.

We believe all three positions will be strong positive contributors in the long term given industry dynamics, free cash flow generation and valuation appeal.

Australian Smaller Companies and Opportunities Fund

Post month end, SRX entered a trading halt on the last trading day before a shareholder meeting to approve the proposed takeover by Varian Systems at $28 per share. Given our view that SRX could be worth significantly more than Varian’s bid (hence why we had retained the majority of the Fund’s holding), we were not overly surprised by the entry of an interloper. In saying that we were shocked by the timing of the eleventh-hour gazumping. The new suitor is CDH Investments, a Chinese private equity group that manages US$20bn in funds. The market is heavily discounting the conditional approach, probably due to the belated timing more than anything else. While conscious of the risk of non-completion, we wonder why a suitor would liberally spend money on advice and legal costs at this late stage unless it was legitimately interested in acquiring the asset. Therefore, we believe there is a decent probability CDH Investment’s approach converts into a formal takeover offer. At a 20% premium to Varian’s offer this would be a significant positive for our performance given our large weighting in SRX.

The Fund has been a long-term shareholder in HT1 attracted by its highly cash generative radio assets (ARN) and its strong position in the outdoor media sector via ownership of Adshel. It has been a relatively poor performer after overpaying for the 50% shareholding in Adshel it did not own, and the ensuing loss of the Yarra Trams street furniture contract to competitor JCDecaux. That all changed recently with ARN returning to growth and Ooh!Media (OML.ASX) making an unsolicited approach for Adshel. We believe this is a compelling acquisition for OML as street furniture completes its portfolio of outdoor media assets which should provide a unique fully integrated proposition to sell to advertising agencies. Clearly, the issue for OML is that ARN is not a natural fit. This wrinkle is not insurmountable, however, with large media players and private equity the obvious candidates to take on ARN in any carve-up of HT1 alongside OML. Generally, a breakup of a listed company is a complex transaction given the entanglement of assets and liabilities. So, this process could be long and drawn out. In the meantime, the business appears to be trending well and is trading at a discount to our fundamental valuation.

Given our long-term horizon, we are finding significant opportunity in the market despite its recent ascendency. We feel the derate in pricing of certain companies to be in some instances overly harsh and difficult to rationalise. We do not expect everything in our portfolio to rise in unison, with sell-offs and de-rates providing us opportunities to build into companies where issues might prove temporary.

March 2018 | Market Commentary

 

 

 

Overview

March was a challenging month for stock markets. We gain no schadenfreude from this observation other than some sense that our more cautious view seems to be vindicated. These declines occurred although global economies are humming along nicely with growth and unemployment rates not seen for many years. The stock market however is a forecasting machine and attempts to build in expectations of future earnings not spot reflections of global economies. Charlie Munger once opined that the market was like the pari-mutuel system at the racetrack. Everyone goes there, bets and the odds change based on what’s bet. Stocks that are popular get bid up and their valuations rise incorporating investors views on its likely prospects. The questions to ask therefore before investing are twofold – is the business a good one (business analysis) and is this a good investment (valuation). It seems to us that in good times the second doesn’t get asked very often and the market has focused exclusively on what seems like a good business. Valuations have been a secondary issue if they have been considered at all.

As investors have accepted more risk, valuations in popular stocks have become – at least to our eyes – stretched. A secondary consequence of this risk seeking behaviour has been investors’ willingness to buy a good “stock story” – a business that shows great promise even if it has no proven business model let alone any cash flow. We recently ran a screen across the smaller companies universe for stocks with market capitalisations over $100m which earned less than $2m in revenue and found that to be at a cyclical high of 51 stocks. Whilst some early stage businesses may eventually prove to be long term winners, it strikes us that there is a lot of money out there willing to bet on them becoming successful. In order for a company to be worth $100m it would have be sustainably earning at least $10m of Earnings Before Interest and Tax (EBIT) p.a. Most of these companies however have been founded within the last few years and are struggling to produce sales revenue of $10m let alone an EBIT of $10m.

Contributors and Detractors

Positive contributors included Tower NZ (TWR.NZE) which rose 20% after Bain Capital agreed to buy a 20% holding in the company, Horizon Oil (HZN.ASX) which rose 13%, NZX (NZX.NZE) which increased 7%, Sirtex Medical (SRX,ASX); which was flat in a down market) and Reece (REH.ASX) which rose 7%.

Detractors from performance included Class Ltd which declined 18% without any specific news flow, Vita Group (VTG.ASX) which was down 18%, Mortgage Choice (MOC.ASX) which declined 24% on the back of the Hayne Royal Commission into the banking sector, and Seven West Media (SWM.ASX) which declined 14%.

Our strong preference is to buy and hold well run, cash generative companies for the medium term. These type of companies form ‘core’ holdings and comprise at least 75% of the portfolios. One important holding meeting this criteria for us is Reece Ltd – Australia’s largest plumbing supply business. Reece is founder/ owner controlled and run, highly cash generative and continues to grow revenues between 7-10% each year. Reece employs minimal use of balance sheet gearing (although it does have leases) and earns an impressive ROIC of 27%. This high return is in spite of its relatively high ownership of property which is unusual amongst retailers.

In Summary

We continue to see good value in the portfolio of companies the Fund owns and believe that solid valuation support coupled with lowly geared balance sheets and good cash flow generation will see long term outperformance. Market volatility will offer up opportunities to prepared minds – to paraphrase Louis Pasteur. Our aim is to be prepared and to that end we constantly update models and company information in order to be able to make the most informed decisions as opportunities knock.

Webinar: Benefits of allocating to small caps

x

COMING SOON

This fund will launch by 1 July 2016.
To register your interest, contact us on

1300 010 311 view fund information