Hear from Sam Twidale, Portfolio Manager for the DNR Capital Australian Emerging Companies Fund as he discusses our three key take aways from the recent reporting season.
So looking at the reporting season in the small cap sector, there are really three key takeaways for us. Firstly, our performance and recovery of many heavily shorted names in the consumer discretionary sector, the ongoing opportunities we’re seeing in the tech space from disruption. And lastly, our performance of quality through the month. So exploring those in a bit more detail. Really the standout performance was that the rebounds in a lot of the consumer discretionary holdings. That’s an area we’ve been adding to in our emerging companies fund. It’s been a core overweight. We’ve seen some great opportunities to buy some good quality businesses where the market’s got some short-term concerns around the outlook. Obviously there been lots of concerns around short-term consumer spending, the impact of higher rates. And for us, when we look at the reporting season, Lovisa was really a standout performer for us, shares increased very strongly.
That’s a name we’ve been adding to over the last 12 months, and I think the result really sort of put to bed some concerns there that the market had sales more resilient than the market was expecting. And also the margins came in better than expected, showing very good cost control, strong cashflow, strong balance sheet, and really brought the focus back onto the store rollout potential that the companies has turning into a really global retailer with over 850 stores. Another standout performer was ARB, four-wheel drive accessories retailer. Again, that business is really benefiting from its strong market leadership that the company has now sales better than expected, a very strong order backlog. And again, the margin came in better than expected, very good cost control, good pricing power, and the company’s really benefiting from that fixed cost leverage, benefiting from the economies of scale and the efficiencies that they’re getting.
So I think both of those companies, strong stand out performers in the consumer discretionary space for us, they both have a great long-term outlook. They’re reinvesting at a high return on invested capital and that puts them in a good position. Long-term. Another key takeaway was the out performance of the tech space as well. We’re seeing a lot of interest in this sector. We’re seeing what’s happening overseas with the impact of AI and there’s some great companies here for investors to get exposure to with a lot of disruption happening, a lot of structural change, many industries benefiting from a lot of this disruptive technology. And for us in our emerging companies fund, orate was one of the standout performers for us. That company’s really disrupting the professional AV industry, helping them convert from analog to digital based signals over networks. And that company really is consolidating that market leadership position that they have. And the result really highlighted that. And that company has now over nearly 7 million devices out in the field, there’s an opportunity to leverage that install base with a software opportunity on top. And we think that puts them in a really strong position. So that’s a company we continue to really like.
And lastly, I think the other key was the outperformance of quality. And this is something we’ve been talking about for quite some time in small caps because there is a huge dispersion in quality across a small cap index. And this is really evident through the reporting season where there were many companies that did struggle, whether it was because of poor cost management, pricing power starting to fade. Many companies have done some speculative acquisitions when interest rates were low. Some of those are failing to deliver on high expectations. Many companies with leverage balance sheets struggling with high interest costs now with rates higher. So I think it just highlights the importance of focusing on quality businesses. And when we look at our emerging companies funds and how we are positioning, I think you need to be really selective in the small cap market currently. Really focus on those good quality businesses we believe are mispriced. And when we look at the positioning currently where we see those quality businesses, it’s mainly across the consumer discretionary and tech sector. They’re some of the key overweights in our fund. And we continue to like these businesses, which have a long runway for growth. They’re reinvesting a high return on invested capital, and we think that puts them in an attractive position, long-term, to deliver that capital growth for investors.
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