Small companies: Invest in the blue chips of the future

Without further delay, let's welcome our first speaker tonight, Mr. Daniel Stein, Senior Investment Analyst from OC Funds Management.

The OC Premium Small Companies Fund is a managed fund that invests in small to mid-cap Australian listed companies.

The fund aims to outperform the S&P ASX Small Ordinary Accumulation Index by 3 to 5% per annum over a rolling five-year period after fees.

Daniel is a senior investment analyst responsible for financial modeling and researching small and micro-cap companies with a strong focus on identifying value creation opportunities.

He previously worked at Adler Asset Management, Wilson HTM, and Azure Capital.

Daniel's topic is Micro-Cap Companies Invest in the Mid-Cap Companies of the Future.

Welcome, Daniel.

Thanks, Angelina.

Thanks for that great introduction.

I know that you've got a great agenda full of really exciting and interesting fund managers.

I have a long track record that I follow, so it'd be great to actually listen to some of the fund managers you've got coming up presenting.

My name is Dan Stein.

As I mentioned, I'm part of OC funds management.

And today I'd like to take you through a bit about OC, why invest in micro caps and how positioned in this current environment.

So just in terms of OC, we're a smaller micro cap specialist fund manager based in Melbourne, Victoria.

We look after two main strategies being small and micro cap Aussie equities.

We've got a team of five really experienced investment professionals.

And it might not seem like it, but I've been investing in small micro caps at OC for over six years.

Often I get, you know, questions and some people feel surprised because you know,

I've had been in meetings with a CFO who asked me to get him a coffee and also pick up his dry cleaning because he thought he was the intern.

But I've actually been investing in small micro caps alongside his team for over six years.

And the guys we've got in the team are very experienced, very stable, and have very deep relationships in the small and micro cap space, which is extremely important.

Moving along, just to bring up that slide, moving along, OC

Our micro cap fund invests in micro cap companies which have a market cap below 500 mil in market cap.

And we're really focusing on companies that we can understand.

And what that means is typically, we won't invest in single mine, single commodity mining or energy stocks, we don't do early stage biotechs.

And typically we avoid really early stage companies.

We are star neutral.

So we do invest in both growth and value companies.

I know you've got some really good growth managers coming up, such as ECP.

And yes, we really do like investing in good growth stories, but we do have a balance of also companies that have more conservative valuations that do pay dividend and may trade on less than 15 times PE.

So moving along, why smaller micro caps?

Look, this is a really interesting part of the market.

We're really passionate about finding these small microcap companies at an earlier stage, and that do have a longer period of time where they can compound earnings at 10 to 20% per annum.

And so for us, this is really important in terms of generating that outperformance by finding these companies that do have the potential to keep growing strongly over a longer period of time.

Often as well, you'll find when these companies are a bit early stage,

you do find the company's founders are still actively involved in the day-to-day management.

And what this means is that they have a bit of a more entrepreneurial kind of way of managing the company.

And you also get a lot of founders and managers that do own equity.

And this is really important as they own the same equity that we own.

And we really think that alignment is a really big reason why

you can generate better returns and growth in microcap companies.

Furthermore, you'll find that as these companies are typically a little bit more illiquid, and there's less coverage by brokers, and that means that you can find companies that have probably a better risk return in terms of a better valuation for their growth profile due to this less or lower research coverage.

You can see that

you know, this is true of companies that, you know, started off as micro-cap such as Afterpay, then became a small-cap company, then became a large-cap company.

And I don't see, because we've got both micro-cap and small-cap, we can follow these companies that might go from pre-IPO to IPO-ing as a micro-cap and then graduating into a small-cap and then a mid-cap.

And that is the appeal of having both a micro-cap and a small-cap fund together.

Moving onto the next slide,

You know, this is sort of culminated in a strong long term track record of investing at OC Microcap.

We've got a longer term track record of strong performance.

You'll note that this year we did beat our benchmark, which is the emerging companies index.

This is a slightly different index to our portfolio.

As I mentioned, we don't really invest in single mine, single commodity stocks, but they do definitely feature in the emerging companies index.

And this was also pronounced in FY22, which was a tougher year for smaller microcap companies.

And the reason is typically because when the market anticipates a tougher economic cycle, the market will rotate out of smaller microcap stocks, which are a little bit more liquid and a little bit more exposed to macroeconomic conditions as they're less diversified and have been around for a shorter period of time.

And as companies, as investors move back into small caps and large and more liquid stocks, typically the smaller end underperforms.

And you can see that in the next slide, slide nine.

And this actually looks at data that's come out of the US and this is really data from the Russell 200 small cap index.

And you can see that the Russell underperforms going into recession

As the market rotates back to larger cap companies, which is illustrated by the S&P 500.

So going into a recession, larger cap stocks will outperform smaller cap stocks.

And then when the recession actually starts, smaller cap stocks start to outperform.

And this has been true for the last the last

I think it was eight recessions that have been documented, six recessions in this amount of data that's just come out of William Blair.

So this data doesn't actually exist for Australia because there hasn't been that many recessions in the previous 20 years.

So small caps should outperform large cap stocks typically as we enter a recession.

And this is really the opportunity for small and micro cap stocks.

And if it was true of small cap stocks in the US, it was definitely pronounced in micro caps as we found in FY22

liquidity definitely tightened up in the micro cap end as the market rotated out of micro caps and back into the safe behaviour of more liquid large caps.

And so how are we positioned in this environment?

In a slowing economic environment, we're definitely focusing on companies that have high quality resilient earning streams that can grow in despite of a slower environment.

And we're also focused on companies that have pricing power because

As costs are inflating through wages and rents, we do see that margins can potentially get squeezed.

So companies that are able to increase prices with their customers will definitely be able to generate better earnings and more resilient earnings growth.

And we think these companies which have more resilient earnings growth will be scarce in that environment and therefore will attract more premium valuations.

So moving into our approach, as I mentioned,

Those are the sort of companies we're focused on that do have, you know, resilient earnings, but also reasonable valuations.

And in terms of the stocks we've added, we've added Aussie Broadband, Crysos, SmartPay into our micro cap portfolio.

I can talk to those in a little bit more detail, but ultimately we're really trying to find companies that have high degrees of earning certainty that can keep growing.

So Aspen Group is an example of that.

This is a business which is half a holiday park and half a residential rental business.

Rents are currently going up 10% in their portfolio, so you can kind of see that that pricing power is coming through and buttressing earnings.

We're also increasing our exposure to companies with pricing power.

As I mentioned, some examples are Monash IVF, which is a fertility business, and they're definitely increasing prices.

and Pro Biotech, which is a manufacturer that is also able to get price rises through their large farmer customer base.

So we do have a reasonable amount of cash on hand in case the market sells off.

And we can buy some of these attractive stocks at a better valuation.

And we're also very focused on balance sheet currently.

So this is a key example of some of the stocks we've added to the portfolio.

I've talked to them broadly, but just given the

time constraints, we can talk to them in the Q&A perhaps.

But overall, that's OC Microcap and how we're really focused on the space.

If you have any other questions, please feel free to contact Client Services at Copia or drop us a line.

I'm more than happy to take any questions.

Thank you.

Thank you, Daniel.

It's a great presentation.

We got some questions for you.

Can you give us some examples of your funds current small or micro cap stocks exposure?

Yeah, it's great.

Great question.

We are definitely focused on, as I mentioned, still finding companies that can grow despite a tougher economic environment.

And one key example might be SmartPay.

So SmartPay is a company which provides card terminal,

to small businesses and you might have come across SmartPay as you've gone to buy a coffee at your local cafe.

SmartPay has actually been really successful in the last year at growing customers.

So they've grown their customer base by over 60% in the last 12 months.

And when you find companies that are growing this quickly, it's often the most important question is to work out why.

And so when I went to the local coffee shop in

the food court down the road, I asked the merchant, why do you have a SmartPay terminal?

Why do you like it?

And the answer was that this merchant at the coffee shop used to pay CBA $2,000 a month to rent a terminal, but today pays nothing using a SmartPay terminal and didn't require any capital at all.

$2,000 a month is a lot of money, particularly for a small business.

It can be $24,000 a year.

That's a lot of money which can go into

generating additional growth through investing in your business or paying off your mortgage.

The reason is because Smart Charge is the business model which SmartPay is using, and they're effectively increasing the surcharge that goes through to the customers of the cafe.

That is paying for the terminal rental fees, merchant service fee, and effectively SmartPay's revenue.

So given this zero cost EFTPOS solution makes a lot of sense, can save these SMEs a lot of money.

They are winning customers very quickly away from the big four banks in Australia.

Another example might be Viva Leisure, which is a less sort of, you know, a company that trades on a lower multiple than SmartPay is still growing.

And this is a gym operator, which operates both a corporate owned network plus a franchisee owned network.

And Viva Leisure has found that they're still getting gym memberships, new people joining gyms, I went to the gym today at 6am, it was still really busy.

And customers are still valuing their health.

Even though you know, the gym might cost $16 a week, we're finding that in an environment where discretionary retailers have noticed a just, you know, a large drop off in sales through

April, May, June, FIFA Leisure is still actively growing their gym members.

So this is a company which is still growing, but is trading on nine times PE, and is sort of more of a value at the value end of our portfolio.

So there are two examples of companies that we still like and we still supporting in our micro cap fund.

Yeah, got a few questions for you, but in the interest of time, I might just squeeze in one more question.

What is the hardest part of researching valuing a small company that may have very limited business track record and does not have a lot of publicly available broker research about it?

Yeah, I think the quiddity and actually getting access to companies management teams is a really key element that

is really fundamental to investing in microcap funds and microcap sort of companies.

An example might be Pro Biotech.

So this is a contract manufacturer of over-the-counter pharmaceuticals.

So they manufacture Benadryl and other cold and flu medicines for large pharma companies such as Johnson & Johnson.

And it's not a very liquid company without a lot of broke coverage.

So to actually understand these businesses, which is fundamental to investing in microcap businesses, you do have to reach out and go and see these companies face to face and build relationships the old fashioned way, which is really going out and seeing companies.

So we have a visitation program of going and seeing, you know,

over a thousand companies, over a thousand meetings per annum.

So that's really important in investing in microcap companies.

Hmm, makes sense.

Well, old school can be good school, right?

Well, thank you, Daniel.

Great to see you and all the best.

Fantastic.

Thanks, Angelina.

Thanks for your time.