Sam Twidale, Portfolio Manager for the DNR Capital Australian Emerging Companies Fund spoke to AusBiz recently to discuss mining, IPOs and where their focus is for small caps.


Speaker 1: Welcome back. You are watching The Open here on AusBiz. Well, let’s move to the small cap space now. And our next guest says he’s overweight mining and underweight IPOs. To explain Sam Twidale joining us from DNR Capital from Brisbane. Sam it’s great to see you there. Thanks for joining us once again on the program. Long mining, pretty good spot to be over the past 12 months. What’s the bullish thesis moving forward?

Sam Twidale: Hi guys. So we’re overweight mining in our small cap, in our emerging companies fund. We have been for some time. I think there’s obviously lots of discussion at the moment. Are we at the start of a new supercycle? Well, I think you have to be sort of more selective depending on the commodity that you’re looking at, but certainly we see the outlook just looking at the sort of supply demand from fundamentals as the most positive they have done for some time. I think firstly, if we just look simply at the supply side, it’s been very interesting sort of contrasting versus the last sort of supercycle. The mining companies really have prioritized returns back to shareholders after some of the sort of bad decisions that were made during the last cycle. So it’s been a sort continual fall in mining investment now for a number of years since it sort of peaked back into 2012.

So that really means that there’s not much really supply being added at this point. So we’re sort at the coming out of the trough in the mining investment cycle. And then if you look at on the demand side, I think that is really where it gets quite interesting. Obviously, if we sort look broadly at the key drivers of commodity demand, I think a lot of the fiscal spending coming through is obviously helping infrastructure spend, the construction activities picking up. But for us, when we sort of think about commodity supercycles, what really drives that elevated demand growth for a number of years? I think the whole decarbonization thematic is a bit of a game changer, definitely for the whole commodity space. And we certainly see a number of years of very strong demand growth ahead for certain commodities.

I think we look at that in a bit of detail. Certainly the whole transition away from fossil fuels towards renewables is really gaining pace. I think if we look offshore, 90% of utility spend now is in renewables, in solar, on wind, and that certainly… That direction I think is going to continue going forward. But it’s also the whole electric vehicle thematic. You’re obviously getting a lot of attention currently and all the auto companies really sort of scrambling all over each other, trying to announce their plans, shifting away from the combustion engine, moving the R&D dollars away from that, sort of killing that off really over the next decade and shifting towards the electric vehicle. And industry forecast really are sort all over the place over the next 10 years, but we are going to really see an acceleration towards that. And no, that’s very positive for some of the commodities, the lithiums, the rare earths, the base metals, and there’s going to be substantial supply that’s going to be needed and that’s going to need high prices to incentivize that supply.

Speaker 3: Yeah, that’s right, Sam, I guess we’ve had the beginning and the death of the supercycle called within a matter of months, but I think you are correct. It’s a shift. Not all commodities move the same because everyone is quick to say that coal and oil and that will all roll over at some stage to be taken over by lithium, et cetera. So it’s the transition. So are your small cap preferences? Are they the last of the old resources or the beginning of the new resources? What’s your preferred play?

Sam Twidale: Yeah, we have sort of a spread of opportunities. And certainly I think if we look at some of the commodities that will certainly benefit. Lithium, nickel, the rare earths. The interesting part about the small cap space in Australia is you can get some great exposure to some of these companies. There’s some good quality small cap mining companies that are generating strong cash flow. Good mine life, strong balance sheets. And we’re certainly invested in some of those ones that we like. And I think firstly, if we look at the lithium space company we like, or a copper rate, that’s got a really sort of low cost asset, long mine life, will generate strong cash flow over a long period of time and going through an interesting merger opportunity with galaxy that really increases its scale, allows it to diversify across multiple minds. And that sort of increases the quality of the business.

We think IGO as well, leading producer of nickel acquiring a really high quality lithium asset as well in Western Australia and Lynas Rare Earths as well. One of the leading rare earth producers outside of China, very long mine life, very strategic asset, producing a core commodity that goes into the magnets in electric vehicles and where we see very strong demand growth. So we’re definitely in some of those newer metals that we think will benefit, but no, there’s other areas that will still look attractive. And I think something like iron ore, there’s obviously lots of concern around the very elevated iron ore price and the risk of a correction, but we still like a company like Champion iron ore.

That really high quality business is quite misunderstood based in Canada. Now this produces a very high grade iron ore, 66% grade. And that’s interesting within this whole sort of focus on decarbonization as well because all steel isn’t created equal for using high quality iron ore that produces less emissions when you’re producing it. And Champion iron ore is very well placed for that transition. Their production’s doubling over the next 12 months. And it’s on a very high valuation, very, very high free cash flow yield, current iron ore prices. But even if iron ore prices halve, it’s still going to be on more than double digit free cashflow yield over the next 12 months. So we see a sort of spread of opportunities across the commodity space.

Speaker 1: Still potential cash machine there for those iron ore miners. Let’s go and talk IPOs. Now there’s been some really good ones that have got underway, particularly in the mining space, but a lot of tech and a lot of eCommerce names that have gone public recently have really flopped badly. What do you put that down to? And would you go and touch that space at the moment?

Sam Twidale: Yeah, look, I think it’s a bit telling in terms of what we’ve seen in the market and a very wide valuation dispersion. Some of these secular growth stocks reached very high valuations, very high growth expectations in forecasts, and that’s where you’ve needed to be really careful. You’ve had to really scrutinize some of these businesses and of late in the process, we have seen a number of IPOs come to the market where sellers have been trying to take advantage of those very elevated valuations. A company like Newark has obviously got a lot of attention in that sort of data intelligence space, came at a time when there’s a lot of excitement around tech data intelligence, came on a very high valuation, multiple and sort of highlights the fact that you have to scrutinize these businesses very carefully. Do your due diligence. There was a few concerns were raised when we did the work on that business.

We didn’t participate in the IPO. We came on a very high valuation and obviously there’s been a lot of shareholder value that has been destroyed since then. We’ve seen another one recently Keypath Education in the software space that’s come into pressure. So I think generally with IPOs, the risks are sort of stacked against the buyer. Certainly that’s what we’ve been seeing more recently, the sort of information as symmetry. The seller has a lot more information. And I think generally the whole concept of an IPO discount for that information symmetry has been lost and the value hasn’t really been there for us. So I think you have to be really careful with some of these opportunities. That’s not to say that we don’t look at them all. I mean, IPO should be the birthplace of some of the great small cap ideas. And you want to always look at some of these opportunities, but you do need to scrutinize them very carefully, especially given some of the high valuations that many have come out on recently.

Speaker 3: Certainly food for thought. And as we like to say here in AusBiz, do your homework before looking at that opportunity. Thank you so much, Sam, DNR Capital in Brisbane.

Sam Twidale: Thank you.