Top small cap ideas
It is always interesting chatting about the big macroeconomic forces impacting and influencing corporate profits, property prices and job prospects. But our main game is investing. And investing in smaller companies not only offers the opportunity to benefit from company ownership, there’s the potential bonus of rapid growth, long-term growth or both.
Some years ago, Charlie Munger, one half of the Berkshire Hathaway powerhouse, singled out small caps as a rational and valid investment thematic in its own right.
With that mind, and with the market preoccupied with whether it should be fearful or nonchalant about the inflation threat, I thought today might be a good day to consider some of the Montgomery Small Companies Fund’s key holdings, some of which are enjoying structural growth; growth that is not dependent on ideal macroeconomic conditions.
Brisbane based Megaport (ASX: MP1, market capitalisation of $2.8 billion) is one such structural grower. Megaport’s products enable over 2,100 customers – some of the largest players in the world to connect their networks in a flexible and cost-efficient real time manner to Cloud Service providers. Megaport brings access to ecosystems of service providers in over 740 datacentres worldwide, meaning you can pretty much connect to anything you want via Megaport (hence the name). Not bad for a company founded as recently as 2013, MP1 is headquartered in Fortitude Valley, Australia.
We believe MP1 has a large growth opportunity in front of it, including from new products, an example being the recently launched Megaport Virtual Edge which is being sold by the salesforce of Cisco, one of the world’s largest suppliers of networking equipment to large corporate enterprises, MP1’s key customer segment. We expect the company to enjoy the tailwinds of rapid growth in cloud computing, which is a lowly penetrated market, offering multi-years of opportunity runway ahead.
The next catalyst should be a quarterly report which we expect in July.
Alliance Airlines (ASX: AQZ, market capitalisation of $700 million) is Australia’s aviation infrastructure company. It provides contract and charter aviation services to the mining, energy, tourism and government sectors both domestically and internationally. Alliance also provides aircraft wet leasing, airport management, aircraft trading, parts sales, engine leasing and engineering services to airlines.
Wet leases are agreements between two airlines, where the lessor agrees to provide an aircraft, crew, maintenance and insurance (ACMI) to the lessee in return for payment on the number of hours the aircraft is operated, irrespective of how many passengers are on the plane or the price they paid for their seat. Wet leases offer the lessee everything needed to begin flights on an almost immediate basis.
Last year Alliance took advantage of slumping global travel, announcing it would spend just A$197 million to acquire 30 Embraer E190 aircraft, lifting the number of planes in in its fleet to 66. These prices are cents on the dollar of the original capital cost of the assets. This is AQZ’s key competitive advantage, great operational on-time performance from the lowest capital cost aircraft in the market.
The acquisition further entrenched management’s reputation for taking advantage of sector cyclicality and enhancing its winning business model. Management lead by MD Scott McMillian are very confident of operational activity today and the success of their planned deployment of the new aircraft.
We believe it is worth in excess of $5.00 per share, up from the current $4.30.
Our final small cap idea today is a copper play. There has been a long-identified dearth of global copper discoveries and projects coming online, with mined grades continuing to fall as the easiest to find and cheapest to mine copper gets accessed and depleted. Future supply growth for copper looks challenged, whilst the future demand, driven by incremental needs from de-carbonising economies looks strong.
In Australia, Aeris stands out. Aeris (ASX: AIS, market capitalisation of $440 million) is a producer (can pay the bills) with exploration optionality in copper and gold. A recent placement raising of $50 million means the company can fund further drilling, with the objective of increasing in the mine life of its QLD Cracow Gold Mine (which it acquired from Evolution Mining) as well as its NSW Tritton Copper Project. The exciting story is this influx of capital has funded increased drilling activity at targets close to existing infrastructure. High copper grades have been found near surface, which could mean higher copper production, longer mine life, and cheaper extraction costs and potentially higher margins in a commodity that looks structurally attractive.
We have been an investor in AIS from three cents per share and assuming continued strong drilling results, we think 30 cents is not out of the realm of possibility.
The Montgomery Small Companies Fund owns shares in Megaport, Alliance Airlines and Aeris Resources Limited. This article was prepared 24 June 2021 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade these companies you should seek financial advice.