One of the most striking responses in Oberg’s last interview concerned investor sentiment: “I’ve never seen the market more one-sided in that any company exposed to the economy is so hated,” he said. he declared.
Wilson Asset Management’s Senior Portfolio Manager spoke with Livewire’s David Thornton in the latest episode of The Rules of Investing.
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Oscar Oberg’s Bear Market Guide to Oversold Small Caps
Oberg takes the lead WAM Capital (ASX:WAM), which invests in growth-oriented Australian small and mid caps. He also directs the WAM Search (ASX:WAA), and Microcap WAM (ASX:WMI) listed investment companies which respectively invest in undervalued small and mid caps and promising companies in the smallest segment of the market.
In addition to his comment above on the current depth of negative investor sentiment, Oberg also pointed out that all stocks that are resource-related or that are dubbed inflation beneficiaries are on bid.
He suggested we’ve seen the greatest investor interest in energy, commodities and banking for around a quarter of a century – contrasting with some of the historically high capital outflows seen in other parts of the market. .
WAM’s favorite commodity play has traditionally been through mining services, a sub-sector that has seen tough times over the past couple of years. Some of WAM Capital’s holdings in this area include:
- Construction and mining company NRW Holdings (ASX:NRW)
- Earthmoving equipment and mining services company Emeco Holdings (ASX:EHL)
- Media, mining and construction conglomerate Seven Group Holdings (ASX:SVW)
- Testing, Inspection and Certification Company and ALS Ltd (ASX:ALQ)
- Mining equipment and services company Imdex (ASX:IMD)
The sector has also suffered from current labor shortages, “but we believe the contracting environment will improve as staff shortages and cost inflation are factored into these contracts,” Oberg said. .
Given that the small resources segment has outperformed small industries by about 40% this year, Oberg said his team faced a dilemma choosing to stay focused on the latter.
“We’re going to have to work through some uncertainty, but we think those with strong management and healthy balance sheets will come out on top and we’re very optimistic about the future,” he said.
“Mining services and the outsourcing industry as a whole could have a very good year next year.”
He notes that most of the companies above are trading at single-digit PE multiples and have healthy balance sheets. This is a key element of WAM’s stock selection approach, which is also based on company research with:
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Strong profit growth
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Quality management teams
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Good prospects for revaluation over time.
A two-step stock selection process
This last point is guided by what WAM calls a “catalyst”. In scientific terms, a catalyst is a substance that speeds up a chemical reaction. In the context of investing, they refer to an event such as an increase in profits, a divestiture, or a capital management initiative such as a share buyback.
It’s part of The WAM approach which combines:
- Long-term research and
- An active assessment of market-driven catalysts.
Take a longer-term view
In the first of these cases, Oberg and his team take a three- to five-year view of potential portfolio inclusions. As an example, it refers to the fuel distribution and refining company, Viva Energy (ASX: VEA), which ranks among WAM Capital’s top performers of the year so far. VEA’s stock price has gained around 40% in 2022 so far, closing at just under $3 on Friday, from around $2.20 in mid-January.
Oberg refers to VEA’s management team as one of the highest quality management teams he has encountered.
And he has long considered the company not earning enough, in part because of the strain on domestic fuel refining operations in recent years. But meanwhile, two other Australian refiners left the market, leaving only Viva and its competitor Ampol.
“And since the Russian-Ukrainian war, we’ve seen records in refining margins,” Oberg said.
From an NPAT loss of $100m in 2021, he thinks VEA could be on track to make a profit of between $700m and $800m in 2022. This has seen the share price rise above $3, against 2 dollars at the beginning of the year.
A bright future for a financial company in difficulty?
AMP Ltd (ASX: AMP) is highlighted as a selection of stocks that ticked the boxes for WAM’s market-focused research component. The reputation of the 173-year-old financial institution has been badly tarnished by the findings of the 2018 banking royal commission and the resulting management problems. This has seen its share price drop around 80% over this period, currently trading at around $1.10.
What is the catalyst for buying the company, which currently ranks as WAM Capital’s largest position? Oberg bought the stock in September or October last year following management’s decision to divest AMP Capital. And he sees another significant buyout or capital management initiative coming.
Oberg explained that most companies must pass these two barriers before being added to a WAM portfolio, although there are exceptions. A great example here is After-paymentwhich WAM Capital bought in the 2016 IPO and reaped the rewards as the BNPL juggernaut continued to beat earnings expectations: “It ended up being a cracker for us,” Oberg said.
He points out that these companies are still screened through an equally rigorous process, but given APT’s high valuation at the time, this did not fit WAM’s long-term research methodology.
What buy signal does Oberg watch?
He thinks the fast approaching August reporting season will be interesting.
“There will definitely be some downgrades…but we think the market priced that in,” Oberg said.
“And short interest in equities is likely at record highs, and in our view, it won’t take much for valuations of these companies to rise. There will certainly be opportunities out of the reporting season. .
The outlook for Australian small and mid caps
Oberg recognizes the headwinds related to costs, inefficiencies and staffing shortages that companies still face.
“And everyone has priced in a recession, but we really think stock prices have moved way ahead of where their earnings are going. We don’t think the earnings cuts will be as dramatic as the market thinks,” he said. Oberg.
More than 50% of WAM Capital’s portfolio of companies have more cash or property than debt on their balance sheets, giving Oberg confidence. “We think our portfolio is in much better shape to fight a recession than it was at the start of the GFC or maybe even the start of COVID,” he said.
And he considers current small cap prices to be about the cheapest since 2001. “Valuations are great, we just have to get through this period for the next six months.
On the broader macroeconomic front, Oberg expects Australia’s cash rate to peak at around 4% by the middle of next year. It also looks through this period with anticipation rates that will be back in the more “normal” level of 2% to 3% by the middle of 2024.
“It’s the uncertainty about where rates will go right now that scares everyone. It will get more difficult over the next few months, it just depends on when inflation projections start to come down,” he said.
Stocks that look good in today’s market
Among some of the companies he monitors are those that aren’t too exposed to consumers, but have been hit hard over the past couple of years.
Examples include:
- Nursery operator G8 Education (ASX:GEM)
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Brewer United Malt (ASX: UMG)
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Almond producer Select Crops (ASX: SHV)
And in the field of health, he likes:
- Medical diagnostic office Capitol Health (ASX:CAJ)
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Optometrist, podiatrist and physiotherapist Healthia Ltd (ASX:HLA)
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Pharmacy network Sigma Healthcare (ASX: SIG).
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