Milford Dynamic (AU) (ETL6978AU) Report & Performance

The Fund returned 3.3% for the month, shy of the S&P/ASX Small Ordinaries which achieved a return of 3.6%. Overall, we were pleased that our stock picking kept us within reach, despite a far less risky portfolio.

Performance was led by Beach Energy (+19.6%) – a recent addition to the Fund. Beach is exposed to global oil markets, along with the Australian and NZ domestic gas market. Project award momentum in Monadelphous Group (+16.2%) continued in July. We’re anticipating further construction contracts in lithium and rare earths to be announced by year end. Australian Ethical Investment (+23.2%) continued its stellar run.

Detractors included our preferred lithium miner IGO (-9.2%) following an operational result, and Kelsian (-4.5%) on no major news.

Equity markets celebrated weaker inflation numbers in July. Current data coupled with robust growth is a goldilocks scenario for equity markets. We remain more circumspect, aware that equity markets tend to extrapolate the present. We continue to believe the path to a soft landing in Australia is narrow. We have long been of the view that as the economy weakens, we will rotate back into quality growth companies at attractive valuations. We have selectively started this process given our elevated cash position, however only in moderate size to date.

The Fund returned 1.7%, ahead of the S&P/ASX Small Ordinaries which made a return of 0.1% this month.

Performance was led by KFC restaurant owner Collins Foods (+17.0%) which delivered a better-than-expected earnings result. Europe operations surprised to the upside, while Australian margins appear to have bottomed. Australasian terminal provider Smartpay (+10.0%) continued its recent momentum. Diversified data centre company Macquarie Telecom (+14.8%) rallied following a trading update and equity raise.

Detractors included fuel retailer Viva Energy (-5.0%) which suffered a minor setback at its Geelong Refinery during a maintenance turnaround, and Neuren Pharmaceuticals (-11.5%) on no news.

It is becoming clear that Australia is in a two-speed economy. On one hand, the older asset-rich generation is booming from high interest rates underpinning increased spend on categories like travel and restaurants. The younger demographic, in contrast, is suffering a cost-of-living squeeze. High household debt and leverage to variable interest rates creates more risk around their consumer balance sheets. We have long been of the view that as the economy weakens, we will rotate back into quality growth companies at attractive valuations. We have selectively started this process given our elevated cash position, however only in moderate size to date.

The Fund returned 3.6% in April, ahead of the S&P/ASX Small Ordinaries which rallied 2.9%. Performance was led by Australia/New Zealand terminal provider Smartpay which rallied 25.0% following a quarterly and strategic update. Smartpay continues to gain market share and rapidly grow annuity revenues. Global patent attorney IPH rallied 9.7% following the conclusion of a cyber incident announced in March. The incident was handled well by management, with marginal delayed revenue and a minor one-off expense. Leading automotive marketplace Carsales continues to perform well (+7.4%) reflecting confidence in its international growth prospects. Detractors included youth apparel retailer Universal Store (-7.7%). We’re entering a critical phase in the Australian economy where the lagged impact from 10x consecutive rate rises will begin to drag on consumer balance sheets. While we remain defensively positioned, we have long been of the view that as the economy slows, we will rotate back into quality growth companies at attractive valuations. We have selectively started this process given our elevated cash position, however only in moderate size to date.

The Fund returned -0.9% for the month, ahead of the S&P/ASX Small Ordinaries which declined 3.7%. The resource sector lagged, giving up much of China’s reopening enthusiasm which was seen in January. Reporting season was the focus over the month, with nearly all portfolio companies announcing financial results. While the market delivered twice as many downgrades as upgrades, we fortunately navigated the month well and managed to largely evade the typical reporting season bombs.

Performance was led by ‘out of home’ advertising (e.g. billboards) company oOh!Media (+10.8%). oOh!Media has continued its recovery from depressed Covid levels and industry data suggests the outdoor category is tracking ahead of pre-Covid levels reflecting peoples’ improved mobility. While out of home advertising is not immune to a cyclical downturn, it should be more resilient. Integrated energy company Origin Energy (+10.4%) rallied following a revised takeover bid of $8.90 (down from $9) from the bidding consortium. While it is a small price cut to previous expectations, it was a positive step towards consummating the deal.

The stock is currently trading at a 10%discount to this price which we feel will narrow as regulatory uncertainties moderate. Seven Group (+8.0%) – the owner of multiple businesses including the Caterpillar dealership Westrac in Western Australia and New South Wales, Australia’s largest equipment hire business Coates Hire, Boral, and a stake in Beach Energy –delivered a strong earnings result.

The diversified conglomerate provides leverage to demand for domestic resources and the infrastructure capex cycle which we suspect will be a multi-year journey. Mining service provider Monadelphous (-13.7%) lagged following a delay in capex spend into FY24, while gold miner Silver Lake (-22.7%) disappointed after a weaker than expected half.

While 2022 was a weak year for Australian small cap equities, markets have generally held up well in the second half of the year. The Dynamic Small Companies Fund returned -2.6% for the month, ahead of the S&P/ASX Small Ordinaries which fell 3.7%.

We were pleased to pass our three-year performance anniversary for the Fund, having delivered a 24.5% cumulative return since inception in October 2019 against the benchmark return of 5.0%. The underlying Dynamic strategy, since inception more than nine years ago, has returned 10.7% p.a. against the benchmark return of 5.6% p.a. Gold was one of the few sectors which collectively made a positive contribution for the month. Evolution Mining (+10.8%), and Northern Star (+2.9%) were two portfolio companies that performed well reflecting heightened uncertainty from macro-economic and geopolitical pressures. While our gold exposure has been a source of frustration over 2022, we remain constructive in the near term as safe-haven demand builds.

Pharmaceutical distributor EBOS Group (+8.1%) continued its strong form . It has rallied over 20% for the quarter following its annual investor day and inclusion in the MSCI Mid Cap index which has driven technical buying. While we continue to like its strong position in the Australian pharmaceutical distribution industry, we have taken profits over the past few months. Smartpay’s (+7.5%) momentum continued following the release of its first half results last month which showed very strong revenue and earnings growth. Smartpay is a small terminal operator growing rapidly in a large addressable market. Laggards included independent investment platform Netwealth (-12.0%) and sleep apnoea global leader ResMed (-7.4%). We consider both high quality companies trading at reasonable valuations and able to grow earnings through the economic cycle. We remain conservatively positioned from a Fund perspective as we enter the new year. We believe the economy will likely slow at an increasing rate over 2023.

While the property market has responded quickly to the RBA’s monetary tightening, the impact on the broader economy will take longer. As this equity weakness continues, we will look to establish longer term buy and hold opportunities in quality businesses at attractive valuations. We have selectively started this process given our elevated cash position, however only in moderate size.

Global equity markets were buoyant in November, as risk sentiment improved on the back of softer inflation leading to the assumption of lower central bank interest rates. The Dynamic Small Companies Fund returned 3.2% for the month, behind the S&P/ASX Small Ordinaries which rallied 4.9%. The index was led by Small Resources which rocketed on prospects of China reopening. Performance was led by Origin Energy (+41.1%) following the bid from Brookfield Asset Management. The indicative proposal was attractive and represented a 55% premium to the last trading share price.

The stock is currently trading at a discount to this price, but we feel this should narrow in time as regulatory uncertainties moderate. SmartPay (+25.9%) was a notable performer following the release of its first half results which showed very strong revenue and earnings growth. SmartPay is a small terminal operator growing rapidly in a large addressable market. With competitor Tyro under takeover, we feel any market movements will create a significant opportunity for share gains from more nimble operators like SmartPay. Carsales (+12.4%) provided a positive trading update indicating it had already achieved the cost synergies from its recent acquisition, and that dealer acquisition was continuing.

Performance by the recently acquired Trader Interactive business was encouraging, with further revenue opportunities planned in 2023. We view Carsales as a relative defensive technology position. While many other technology companies have been beneficiaries of the Covid environment, it’s more nuanced for Carsales and the Covid hangover will be much more minimal.