Ask a Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part one of this edition, we're joined by Adam Lund, analyst, head of trading & co-founder of Spheria Asset Management.
The Motley Fool: What sets the Spheria Australian Smaller Companies Fund and Spheria Australian Microcap Fund apart from the competition?
Adam Lund: The small and microcap sector is filled with hype and investor exuberance, which is usually concentrated around aspirational companies that tell a good story.
Our approach to investing in smaller companies is to invest in fundamentals, not narratives. This alone helps set us apart from the small and microcap crowd.
MF: So, how do you go about that?
AL: To summarise our core investment process, we have a strong focus on risk management and seek to purchase securities where the present value of future free cash flows can be reasonably ascertained and the stock is trading at discount to its intrinsic value.
Additionally, it's worth mentioning the small and microcap space is under-researched and has little broker coverage. So, there are phenomenal opportunities for the few investors applying disciplined fundamental analysis to build exposure to great smaller companies well before the wider market catches on.
MF: What were some of your top-performing ASX shares in 2022?
AL: We added The a2 Milk Co Ltd (ASX: A2M) back into our portfolio in 2021. We hadn't held it for a few years. However, we'd owned it as far back as 2014 when it was a relatively unknown company. So, our team knows the business well.
We thought it was being irrationally priced by the market, and the re-rate we anticipated came as new management returned the business to growth, cleaned up the inventory position and steadied the strategy of the business.
Additionally, a buy-back was activated, providing good share price support. And renewed interest came as FDA approval allowed A2 to import infant formula into the US, and China's reopening saw further expectations of growth.
A2 is a high-quality growth business, and even after the recent rally, it still remains somewhat overlooked by the market. The turnaround driven by CEO David Bortolussi, who stepped into the business in 2021, is well underway.
The company has an enviable position in the imported infant formula market in China, with a high margin and highly differentiated product. It's a strong cash-generative business, capex-light and has multiple potential longer-term growth drivers.
A2 has significant cash on its balance sheet, with over $780 million of net cash. And it trades at only around 2.5 times enterprise value (EV) to sales and some 18 times enterprise value to earnings before interest and taxes (EBIT).
MF: What other ASX shares have stood out for you?
AL: The second stock that's been a good performer for us over the past year is Monadelphous Group Ltd (ASX: MND). This is a high-class engineering group that provides construction, maintenance and industrial services to resources, energy, and infrastructure industries.
With commodity spot prices firming up, the capex cycle finding a new gear, and labour markets loosening, investors have woken up to MND, and the company has delivered stellar returns to patient long-term shareholders.
The valuation is much fuller today than it was in early 2022 when this business was trading on an undemanding EV/EBIT multiple of 10 times, with a net cash balance sheet and a strong track record of returns.
MF: And what's your outlook for Monadelphous shares for 2023?
AL: We think MND has great further upside potential as it continues to benefit from an extended CAPEX cycle and a strong and growing pipeline of work.
The business was under pressure with the WA border closures limiting the access of interstate and offshore workers, which drove labour cost inflation while restricting project commitments. But this will now hopefully be history.
MF: After a volatile 2022, what's your outlook for the market in 2023?
AL: We are in a complex and extremely challenging economic environment, but the volatility in the market is creating opportunities aplenty for active long-term investors that have a focus on valuations, strong cash flows and balance sheet risk.
On the flipside, it is a particularly troublesome environment for passive investors, who allocate their capital to index funds, which indiscriminately invest with no consideration for fundamentals or risk management.
It is our view that we are closer to the top of the rate hike cycle than the bottom and given the market tends to overreact both ways, we expect the volatility to persist, which will continue to create opportunities to buy good quality businesses at reasonable prices.
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Be sure to tune in tomorrow for part two of our fund manager interview series with Adam Lund.
(You can find out more about Spheria Asset Management's fund offerings here.)
