Prime Value’s Richard Ivers shares the small-cap names he’d hold for the long-term and what investors are missing in this space.
The typical wisdom when it comes to buy-and-hold stocks is to look for quality, stable non-cyclical sectors and strong balance sheets. Not typically viewed as the domain of small-cap investments. Certainly not the realm of media, aged care or real estate companies. Particularly when you factor the challenges such sectors have had in recent years.
But it is exactly in these spaces that Richard Ivers, Portfolio Manager of the Emerging Opportunities Fund at Prime Value, has located his three small-cap companies to hold for the next five years.
He believes that the investor fear of small-caps comes down to a misunderstanding about the risk levels.
“They do have higher risk than large caps, but there’s also a bunch of really high-quality businesses that generate earnings growth through the cycle, year after year,” Ivers says.
In some ways, Ivers’ stock selection takes a contrarian approach to it – but it’s always backed by the fundamentals. He selects those companies that he believes have sufficient quality and balance sheets to be long-term buys for his portfolio.
In this edition of Expert Insights, Ivers shares his top three small-caps to hold, why risk doesn’t need to scare off small-cap investors and the potential for this real estate company to continue to thrive despite rising interest rates and falling house prices.
What’s the biggest thing you think investors are missing when it comes to small-caps?
I think there’s great returns to be had without taking big risks.
A lot of people think that small caps are a really high risk place to invest and they do have higher risk than large caps, but there’s also a bunch of really high-quality businesses that generate earnings growth through the cycle, year after year. Structurally growing businesses that we think provide a really attractive risk return profile. So you can get good compounding returns without taking on big risk.
If you generate a return in small caps in the order of say 15% per annum, then you’ll be one of the best performing small cap funds in Australia. You don’t have to try and swing for the fences and double your money on every stock you hold in a short period of time.
You can just generate good, consistent returns and have a relatively high return profile with a relatively low risk profile. That’s the sweet spot that we invest in.
The largest allocations in the Emerging Opportunities Fund are industrials and financials. Why do you typically find more opportunities in these sectors?
In small caps, the sector can a bit misleading at times. In the large caps it’s more relevant because you have companies like banks. In financials, we’ll have a bunch of very different uncorrelated businesses that are all classified as financials. To give you some examples, we hold an insurance broker called AUB Group (ASX: AUB). That’s classified as a financial. We also hold EQT Holdings (ASX: EQT), a trustee business, which is not correlated at all with insurance broking. NIB Holdings (ASX: NHF), a health insurer is also a financial. There’s a lot of different types of business models with very different drivers and uncorrelated returns, but classified as financial.
I think it’s a bit of a quirk in the sector classifications in the terms of our large weighting. In financials, our weightings move around based on the stocks that we hold.
We’re stock pickers. We don’t invest in sectors. We invest in stocks and the returns and risk profile potential from those specific stocks.
If you could only pick three companies to invest in for the next five years, which companies would you choose?
I really love this question because that’s the way we think about investing. We think about long-term investing, not short-term trading. I’ll give you a few examples of the stocks that, that we hold.
1. News Corporation (ASX: NWS)
NewsCorp is one that I think is a great stock you could hold for multiple years. It has a bunch of really, really high quality assets. For example, realestate.com (REA Group (ASX: REA)), DOW Jones, which owns the Wall Street Journal in the US, move.com which is the equivalent to Domain Holdings (ASX: DHG) here in Australia. It’s a portal for real estate listings in the US. It’s the second largest player over there, which recently is rumoured to have a bid of about US$3 billion, which is equivalent to $7m in Australia when NewsCorp is trading at around $30. It’s big and we don’t think that’s in the stock price at all.
A lot of people complain about NewsCorp. The main pushback we get is that it’s cheap and I think that’s broadly recognised, but it’s always been cheap. And so people say, well, it will stay cheap.
We take a longer term view and say, well, the businesses within that business are structurally growing high quality businesses that will increase in value over time. At some point in future, you may get a potential balloon payment where the value that is realised from the sum of the parts in that business.
Rupert Murdoch is, is the head of that business. He’s 91 years old. He still seems to have a lot of energy, but he won’t be around forever. When that point happens, it could potentially crystallise the value of that business. We’re happy to wait and know that the business is growing in value over time. But then you could get a big payment at some point when the value of is realised from the sum of the parts. So that’s one example.
2. Regis Healthcare (ASX: REG)
Another example that we like at the moment is one that’s a bit contrarian. It’s a business called Regis Healthcare. It’s in the aged care space, which is an area that’s had trouble with industry funding from the government in recent years. We think that the industry is at the bottom of the cycle in terms of government funding.
If you look at the businesses in terms of the price per bed that you are paying at the moment, you’re paying about $90,000 per bed for Regis at the moment. The replacement value for a bed in the aged care space is about $135,000 or thereabouts if you include the RADS payments that they receive. You’re buying a business below replacement cost.
The lack of funding in the industry the last few years means that supply has been very weak coming into the industry, but demand is growing through an ageing population and we’re potentially at the bottom of the industry funding cycle from the federal government, which is looking to increase funding as well.
If you look out multiple years, I think it’s highly like that funding will improve and the earnings growth and returns on that business will improve. So it’s a bit of a contrarian one.
3. Domain Holdings (ASX: DHG)
Another one that we like that is also a bit contrarian is Domain, which is the second largest real estate portal here in Australia behind REA Group (ASX: REA).
That stock has halved in the last 12 months from $6 down to about $3 as the number of houses being for sale or or listing on their website has been declining and slowing. That bad news is well known by the market and we take the view that the listing numbers are potentially at a cyclical low.
With the stock having halved, there’s a great opportunity to buy a very high quality business with structural growth. It has very strong pricing power with little incremental cost as the prices go up.
So you get strong earnings growth and potential margin expansion. It’s margins are about half the level of its largest peer REA Group. It’s also a fantastic funnel for consumers to purchase houses. It’s becoming increasingly valuable for the likes of mortgages. We saw last week, ANZ (ASX: ANZ) took a an equity stake in View, which holds the business realestateview.com au. This highlights the value that we think of in these funnels in terms of the whole value chain of property transactions. Very rarely do people go into branches these days to purchase mortgages. The value of a portal, which is the beginning of the purchase process, is a very, very valuable asset.
We’re happy to take a contrarian view on Domain. We’ve built a small position in the last couple of months and we take a view that holding this business for a long period of time with the price of at moment half of what it was 12 months ago, is a fantastic opportunity to buy a high quality business at a very attractive price.
Are you concerned about the impact of rising interest rates and falling house prices on a company like Domain?
It’s a good point. The reason that listings or or houses advertised on the website at the moment are low is because house prices have been weak. The number of listings has already fallen quite significantly on both REA Group and Domain and it could remain soft for some time. If you look out for a long period of time, like you, we think at some point, listings will increase. Even in a scenario where house prices fall significantly, you could get more distressed listings coming on at the moment. People are seeing the house prices are falling and are holding back and they’re not putting listings on the website. There’s a bit of a Mexican standoff with listings. If you look at the long term cycle of listings, they are about 10% above the long-term low in listings.
When you look at it from that perspective, they’re already at a relatively low point and potentially don’t have too much further to go down.
We think all of that is in the price and well known by investors. Domain updated the market in December last year and downgraded earnings because of that. That’s when we became more attracted to the stock. The stock fell on the back of it and a lot of the bad news was priced into the stock.
One of Australia’s most trusted managed funds
Founded in 1998, Prime Value was established to meet a growing demand by investors for a privately owned managed fund that would exclusively manage investments on their behalf and not be driven by typical institutional shareholder demands. Click here to find out more.
Source: https://www.livewiremarkets.com/wires/three-asx-small-caps-to-hold-for-the-next-five-years
To invest in the Prime Value Emerging Opportunities Fund please contact our Client Services Team at info@primevalue.com.au and 61 3 9098 8088