Reporting season wrap up for the Australian small cap sector

So reviewing the calendar year so far and the recent reporting season, the key trend really has been this shift in market leadership that we’ve seen. This rotation under the surface out of some of the winners from last year in technology, software, consumer financials, into some of the more value areas of the market like commodities, materials, energy. And that’s played out quite well for our emerging companies fund. We’ve done a lot of repositioning in the portfolio. I think over the past year, we have seen a breakdown in valuation discipline. It’s been a bit of a growth bubble. Some of these companies reach very high valuations, that sort of price to perfection scenario, high valuation multiples, quite optimistic earnings expectations. You couldn’t really squeeze that much more. And we’ve seen this shift into these more value areas. What we’ve seen as well is a lot of concerns around AI.

It’s developing very quickly, evolves very rapidly, and that has the market questioning the barriers to entry or the competitive moats around some of these technologies, some of these software companies that could be under threat. And that’s causing quite a bit of turmoil in that part of the market. And again, given the repositioning that we’ve done in the portfolio, our portfolio’s played out quite well during this period. I think if we look at the backdrop for the material space in particular, we still remain very positive. And I think looking through the reporting season, it really just confirmed the thesis for us. Looking at the supply demand dynamics from a demand point of view, we’ve got a number of data points over the past month that the structurally growing demand that we’re seeing for a number of commodities really continues to play out. We saw a lot of these tech companies that are really transitioning from sort of this capital light to capital intensive business model announced quite significant CapEx plans for data centers.

That’s all very positive for a number of commodities, these critical minerals that will go into the data center build out. And we’re positioned quite well for that. You look at some of these minerals like lithium, rare earths, copper, aluminum, the energy that’s going to be required to power these data centers. We’re really seeing a structural uplift in the demand outlook for these commodities. We’re living in a very interesting world as well. A lot of geopolitical conflicts. The defense industry is getting a lot of investment. That’s positive for a number of commodities. And also this whole focus on self-sufficiency, deglobalization. Again, it’s raising the focus on commodities as being really a strategic allocation. You’ve got to make sure you’ve got that self-sufficiency in supply chain. So demand outlook looks very encouraging and we just continue to see that thesis play out. I think on the supply side as well, I think the market has been underestimating the replacement cost of a number of commodity producers.

We’ve seen a lot of inflation in this post- COVID environment, and its cost of developing new mines is likely to be much higher than the market really anticipates. And that really brings back the focus on existing producers with sunk assets, generating strong cash flows that have already put that investment into the ground. So we continue to like some of these commodity producers. We like some of these existing producers that were transitioning into production, position low down the cost curve, generating strong cash flows, in safe jurisdictions, management teams that are good allocators of capital. And across our portfolio, we have a number of commodities very diversified across lithium, rare earth, coal, uranium, copper, coal. So it’s quite diversified across a range of commodities. I think of some other highlights from reporting season as well, where some of these companies that provide equipment into the mining industry.

We’ve got a number of companies exposed to that. We’re seeing a real uplift in exploration activity. After some difficult years, and we look at companies like Index, a real standout result from the reporting season, very strong revenue growth, very strong EBITDA coming through. This is a company that provides specialized drilling equipment and technology to the mining industry, and we see them at the start of a multi-year recovery as we start seeing more investment come into the mining industry. Another one, Chrisos as well. Again, specialized technology for the mining industry for gold in particular, gold testing equipment. They’re really disrupting the industry, a global player. They reported very strong revenue growth, EBITDA growth. And again, we see them at the start of a multi-year growth story. So overall, when we look at the outlook for small caps and the market in general, we continue to like some of these more capital intensive businesses.

Over the last decade, it’s really been about investment in intangibles, software companies, technology, and some of these capital intensive businesses have been starved of capital. That’s really laying the seeds of the recovery that we’re seeing across multiple commodities. So the outlook looks really interesting and we continue to have key overweights there. But what we are seeing more in recent months is this sell off in growth, and that’s likely to present some opportunities. We’re seeing a lot of concerns around AI. We’re seeing a lot of us sort of indiscriminate sell off in lots of quality business models in the technology space, in financials consumer, and that’s likely to present opportunities. So although we have this overweight in some of these commodity producers, we’re actively hunting around for some of these quality names that could be being indiscriminately sold off and we’re certainly remaining opportunistic to some new opportunities to deploy capital into at this point in the cycle.