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Speaker 1: Welcome to the Fear and Greed Business Interview. I'm sure

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Speaker 1: and alam. According to many analysts and investors, twenty twenty

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Speaker 1: four was supposed to be the year of the small

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Speaker 1: cap mind you, twenty twenty three was as well. But

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Speaker 1: here we are in September and small caps are still

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Speaker 1: broadly underperforming, with our largest companies, the banks in particular,

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Speaker 1: the standout performers on the local bours. I wanted to

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Speaker 1: take a look at what it means for investors and

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Speaker 1: whether there are some opportunities now out there in the

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Speaker 1: small cap space. Andrew Perros is the co portfolio manager

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Speaker 1: of the Osville Microcap and Small Cap funds. Osbille Investment

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Speaker 1: Management is an Australian investment manager with more than sixteen

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Speaker 1: point six billion dollars in active Australian and global equity investments. Andrew,

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Speaker 1: welcome to Fear and Greed.

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Speaker 2: Hello Sean, thank you for having me.

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Speaker 1: I want to talk about the future, but before we

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Speaker 1: get there, let's just like your take on the reporting

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Speaker 1: season that we've just had finished a couple of weeks ago.

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Speaker 1: What did you make of it?

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Speaker 3: Well, reporting season is a great time for us here

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Speaker 3: at Osbille as a small cap investor. We're very much

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Speaker 3: bottom up and fundamental stock pickers, and what better time

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Speaker 3: to prove out that process than reporting season where we

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Speaker 3: get to see the company's reports and effectively get our

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Speaker 3: report card to see if we have been picking those

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Speaker 3: companies which are in upgrade mode and clearly avoiding the

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Speaker 3: bombs that are in downgrade mode.

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Speaker 2: You know, it has been in.

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Speaker 3: The past a very lucrative time for alpha generation from

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Speaker 3: our perspective. That said, the August reporting season that just

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Speaker 3: passed was actually quite challenging, probably one of the more

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Speaker 3: challenging reporting seasons we've had in a very long time,

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Speaker 3: and that is mainly because number one, there are a

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Speaker 3: lot of bombs throughout reporting season, but more specifically in

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Speaker 3: aggregate industrial stocks throughout reporting season downgraded their numbers by

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Speaker 3: approximately eight percent, whereas in the past we normally see

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Speaker 3: downgrades of one to two percent. So, as I said,

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Speaker 3: there were plenty of land mines out there very tricky.

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Speaker 3: Eighteen stocks were up ten percent or more on the

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Speaker 3: day of their result, but perhaps more importantly, there were

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Speaker 3: thirty five stocks which were down more than ten percent.

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Speaker 3: And then maybe just taking that one step further, there

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Speaker 3: were seven stocks which totally bombed out down more than

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Speaker 3: twenty percent. So you know the likes of Ordinate John's, Ling, Tabcorp, Kelsey,

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Speaker 3: and pter Br Holdings, just to name a few.

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Speaker 1: Okay, was there a theme about why there was an

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Speaker 1: underperformance in the industrials. Was it a cost story? Was

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Speaker 1: it a revenue story? Or there wasn't anything broad enough

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Speaker 1: to put it in those sorts of terms.

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Speaker 3: No, nothing specifically, but you know, the downgrades or the

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Speaker 3: weakness was across the entire spectrum of the P and L.

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Speaker 3: We did see some softness at the top line. There

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Speaker 3: were a lot of cost pressures. I mean, there's been

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Speaker 3: talk of inflation being a lot stickier than anticipated, so

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Speaker 3: costs were slightly elevated, which flowed through down to the

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Speaker 3: end pat line.

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Speaker 1: Okay, so let's look at you were talking small caps

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Speaker 1: and micro caps. So actually, maybe I'm better for you

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Speaker 1: to define what a small cap is in Osmull's world

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Speaker 1: and what a micro cap is, and then I really

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Speaker 1: want to get into why they have underperformed for so long.

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Speaker 3: Yeah, what we see is small caps as a company

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Speaker 3: that fits within the small Ordinaries index. I also co

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Speaker 3: manage the Osbooe Microcap Fund and it's more of an

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Speaker 3: ASEX two hundred microcap fund, but we really target those

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Speaker 3: stocks in the AX three hundred to two hundred. We

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Speaker 3: call that the sweet spot and the emerging companies that

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Speaker 3: may eventually progress into the ASX two hundred.

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Speaker 1: Right, So that's the micro cap and the small caps

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Speaker 1: are more than sort of one hundred and two hundred

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Speaker 1: or even correct two. Okay, So why have small caps

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Speaker 1: underperformed for the past couple of years, particularly given valuations,

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Speaker 1: because you know, elsip's large caps on a historical basis,

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Speaker 1: they look cheap.

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Speaker 3: Well, a lot of us small cap managers have really

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Speaker 3: been calling this the year of small caps, and Sean

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Speaker 3: it is a great question that you're asking, because we

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Speaker 3: do get asked that quite a lot. From the outset,

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Speaker 3: I will say that there are still many opportunities or

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Speaker 3: huge opportunities in the small cap market and significant alpha

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Speaker 3: to be generated if you look hard enough and if

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Speaker 3: you work hard enough to find those But I guess

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Speaker 3: you know your broad question around small caps under performance

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Speaker 3: is more in the context of relative to large caps.

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Speaker 3: So if I use round numbers, the small ordinary index

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Speaker 3: is down one percent this calendar to date.

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Speaker 2: Large caps are actually up six percent this calendar year

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Speaker 2: to date.

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Speaker 3: But if we take a step back and look under

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Speaker 3: the hood, you know, there's a vastly different story to

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Speaker 3: be told, you know. And if I was to segment

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Speaker 3: the small cap market into two buckets, resources and industrials,

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Speaker 3: the small cap resource market has actually been quite weak,

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Speaker 3: So small cap resources down twelve percent this calendar year

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Speaker 3: to date, whereas small cap industrials are up six percent,

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Speaker 3: which is more or akin to the performance that we've

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Speaker 3: seen in large caps. But I guess when we're comparing

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Speaker 3: the two on a relative basis, it's good to understand

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Speaker 3: what's driving the performance in large caps as well. And

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Speaker 3: you did call that out Sean from the outset that

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Speaker 3: it really is a story around banks in large caps.

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Speaker 2: You know.

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Speaker 3: I was looking at the large cap bank index more recently.

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Speaker 3: That's up twenty seven percent this calendar year to date,

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Speaker 3: which is quite unbelievable. I had to double take when

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Speaker 3: I saw that Commonwealth Bank, for example, up twenty five percent,

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Speaker 3: or about twenty five percent this calendar year to date,

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Speaker 3: Westpac upper whopping forty percent. Now those numbers are quite

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Speaker 3: unheard of. You very rarely, if ever, see that kind

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Speaker 3: of performance in the Aussie bank market.

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Speaker 2: But I guess you know.

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Speaker 3: What I'm trying to say here is that you know

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Speaker 3: the opportunities are there, you've just got to go hunting

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Speaker 3: for them.

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Speaker 1: Stay with me, Andrew, We'll be back in a minute.

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Speaker 1: I'm speaking to Andrew Perrol, Co, portfolio manager of the

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Speaker 1: Osville Microcap and Small Cap Funds. Okay, Andrew, so we

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Speaker 1: might just park resources at the moment because how much

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Speaker 1: of that is based on commodity prices? Industrial though, So

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Speaker 1: in your small cap index, what are some of the

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Speaker 1: industrial I mean, name a couple of industrial companies were

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Speaker 1: maybe their consumer discretionary retailers, that sort of thing which

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Speaker 1: you like at the moment.

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Speaker 3: Yeah, it was probably worth calling out, you know, some

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Speaker 3: of our larger positions in the portfolio. Roughly our top

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Speaker 3: ten stocks account for half the portfolio. The top twenty

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Speaker 3: account for about seventy percent of the portfolio. So we

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Speaker 3: do run a very concentrated portfolio, averaging you know, anywhere

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Speaker 3: between thirty five and forty stocks. But some of the

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Speaker 3: key names in the portfolio, the key contributors Life three

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Speaker 3: sixty a stock, which is up one hundred and twenty

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Speaker 3: percent this calendar year, to date, Guzman and Gomez. A

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Speaker 3: recent addition into the portfolio Coden, a.

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Speaker 2: Company which we're familiar with.

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Speaker 3: We did own in the past, and we have revisited

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Speaker 3: that name and has been a strong contributor.

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Speaker 2: Pinnacle Promedicus.

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Speaker 3: Unfortunately we had to recently exit the Promedicus position now

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Speaker 3: that it's firmly in the ASX one hundred, so out

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Speaker 3: of index.

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Speaker 1: Disappointing, but it's kind of a good reason to have

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Speaker 1: to get out of here.

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Speaker 3: Yeah. We never like to see our favorite children flee

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Speaker 3: the nest, but unfortunately that's the reality of life. Zip

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Speaker 3: again a relatively new position in the fund. Unlightened wonder

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Speaker 3: Rock solid key contributor to this year's performance as well.

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Speaker 1: You mentioned Pinnacle then, and you said you were in it,

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Speaker 1: then got out and then came back in Codin. Yeah,

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Speaker 1: that was Coden. Sorry, So in that particular instance, in

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Speaker 1: Caden's kind of communications metal detection, correct mining tech company. Yeah,

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Speaker 1: how hard is it to get out? And in mentally,

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Speaker 1: I mean it's not physically hard to do that, but

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Speaker 1: if you've got a company, it's almost you know, it's

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Speaker 1: easy to buy, hard to sell, I suppose, how overcome that?

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Speaker 3: Yeah, we're very unomotive with the way we think about stocks.

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Speaker 3: We have a process which we follow. The Osvielle process

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Speaker 3: is tried and tested over many years. There was a

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Speaker 3: period of time when code and didn't fit within the

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Speaker 3: Osvielle process, but it has come back on the radar.

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Speaker 3: And look for us, they're just numbers on a screen.

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Speaker 3: If the numbers add up, then you know, we'll certainly

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Speaker 3: revisit it. If they don't, we will exit a position.

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Speaker 1: And so that process just give us a very thumbnail

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Speaker 1: sketch of that.

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Speaker 2: So we look for quality.

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Speaker 3: I mean quality is one of the key characteristics we

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Speaker 3: look for in stocks. And when we think about quality,

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Speaker 3: we think about, you know, a quality management team, a

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Speaker 3: management team that has skin in the game. We look

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Speaker 3: for assessible earning, so a company that we can model

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Speaker 3: out build a full P and L cash flow balance sheet.

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Speaker 3: We want to assess the earnings and subsequently value those

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Speaker 3: earnings or those cash streams. We look for capital light

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Speaker 3: businesses generating a high return on invested capital. But perhaps

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Speaker 3: most importantly in small caps, we're looking for those that

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Speaker 3: have undergeared balance sheets, a very low net debt to

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Speaker 3: EBITDA ratio, it's critical in small caps. We've seen so

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Speaker 3: many instances where small cap companies have been caught on

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Speaker 3: the wrong side of having or carrying too much debt

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Speaker 3: at the wrong time in a cycle.

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Speaker 1: Okay, you named a bunch of companies there, any through

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Speaker 1: one or two of those that you are particularly can

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Speaker 1: or there in your portfolio, are the ones outside your

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Speaker 1: portfolio that you're looking at, or any of those that

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Speaker 1: you mentioned that you're particularly keen on.

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Speaker 2: Yeah.

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Speaker 3: Zip is a relatively new position in the portfolio and

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Speaker 3: something that we're quite constructive on. We initiated a position

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Speaker 3: at around a dollar fifty two when the company raised

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Speaker 3: capital to pay down some expensive debt, and that was

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Speaker 3: a highly accreative transaction. The cost of equity clearly much

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Speaker 3: cheaper than the cost of debt. So it's been a

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Speaker 3: great investment so far, up fifty percent or thereabouts since

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Speaker 3: that initial investment. But you know, ZIP clear number two

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Speaker 3: by now pay later business in the A and Z market,

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Speaker 3: a very strong position in North America. The company has

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Speaker 3: been transformed under the stewardship of a very exceptional CEO,

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Speaker 3: Cynthia Scott. She's quite outstanding and has been instrumental in

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Speaker 3: turning the business around from the period where free money

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Speaker 3: was readily available and they were targeting growth at any cost,

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Speaker 3: and now it's more a function of profitable growth and

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Speaker 3: sustainable growth. And you know, despite tightening the metrics within

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Speaker 3: the business, on our numbers, we can see a scenario

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Speaker 3: where the top line is growing anywhere between twenty five

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Speaker 3: and thirty percent over the next couple of years, and

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Speaker 3: you're getting EBITDA growth of eighty to ninety percent, so

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Speaker 3: firmly within an upgrade cycle, and at least on our numbers,

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Speaker 3: we think they're going to beat consensus markets FORCAS.

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Speaker 2: So that's why we like it.

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Speaker 1: Fantastic. Andrew, thank you for talking to Fear and Green.

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Speaker 2: Thank you for having me, Sean. It's been a pleasure

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Speaker 2: that was.

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Speaker 1: Andrew Peris, co portfolio manager of the Osville Microcap and

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Speaker 1: Small Cap Funds. This is the Fear and Greed Business Interview.

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Speaker 1: Remember this is general information only, and you should seek

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Speaker 1: professional advice before making investment decisions. Join us every morning

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Speaker 1: for the full episode of Fear and Greed. Daily business

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Speaker 1: news for people who make their own decisions. I'm Sean Elmer,

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Speaker 1: Johnny Day