After two years of shocking underperformance, ASX small-cap shares made a stunning comeback towards the end of 2023.
"Despite the negativity that pervaded most of last year, the small cap market ultimately managed to deliver solid returns in 2023," said IML analysts in a blog post.
"A rally late in the year saw the ASX Small Ordinaries up +7.8% for the calendar year, with the Small Industrials up +11.4%."
Notwithstanding the recent run upwards, the IML team believes small caps are still playing catch-up.
"Small cap valuations remain attractive compared to large caps with superior earnings growth forecasts," read the memo.
"On an individual stock level there remain plenty of quality small cap industrials trading at attractive valuations."
Here are three stocks in particular they're loving right now:
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Reliability of transport contracts
Kelsian Group Ltd (ASX: KLS) is a transport provider that operates in Australia and various other countries.
The IML team likes how much of its revenue is consistent and reliable.
"The Australian, Singapore and UK operations are underpinned by long-term government contracts.
"Effectively the earnings under these contracts are inflation-protected, providing a defensive earnings stream with growth coming from new bus routes and generating efficiencies."
In the US, Kelsian's clientele is the private sector, but those earnings are also reliable with "no patronage risk borne by the company".
"With the revenue significantly contracted, recent tender wins in Sydney and the initial contribution of All Aboard America, Kelsian is well placed to deliver solid earnings growth in FY24.
"Further upside in FY25 is possible from further public bus contract wins in Australia and the UK, as well as bolt-on acquisitions in the USA."
The Kelsian share price has rocketed more than 21% since early October, but the IML team reckons it still has legs.
"Kelsian's valuation is conservative in our view, on 15 times FY25 earnings and a [dividend] yield of 4%."
Reliability of an ageing population
Pathology services provider Australian Clinical Labs Ltd (ASX: ACL) had a busy time testing Australians during the COVID-19 pandemic, but since then the stock has been going sideways.
The demographic trends reassure IML analysts of its future though.
"Australia's ageing population ensures ongoing growth in testing volumes, as older people are more likely to have health issues requiring regular monitoring.
"The number of conditions able to be assessed by pathology testing continues to grow, also underpinning growth in volumes."
In the short-term, business has been slower because of "doctor shortages and cost of living pressures".
"History indicates that these growth rates are likely to return to trend over time."
ACL doesn't have much debt and is in a position to make acquisitions. An attempt to merge with Healius Ltd (ASX: HLS) last year was aborted due to a poor business update on the other side.
"The synergies from such a merger are significant, making a future transaction an attractive opportunity, subject to [regulatory] approval.
"Trading on only 13.5 times FY25 earnings and a yield of over 5%, we believe ACL is attractively priced."
Reliability of outsourcing
SG Fleet Group Ltd (ASX: SGF) is the dominant player in Australia in the fleet management industry, and also operates in the UK and New Zealand.
The business has benefitted from two trends, according to IML analysts.
"The company is effectively an asset manager of large corporate fleets and has benefitted from the gradual outsourcing of fleet management services across government and corporate.
"SG Fleet also operates a novated fleet-leasing operation in Australia, which is benefitting from recent government initiatives to promote electric vehicle (EV) take-up in Australia."
Its contracts are multi-year with a strong history of renewal.
The shortage in new cars arising from the pandemic and subsequent rise in trade-in values dented SG Fleet's earnings.
"These factors have overshadowed recent results, creating noise in the results and hence creating uncertainty for investors, weighing on the share price."
The downside, however, is now "excessively" priced in, the IML team added.
"SG Fleet is very attractively priced, trading on under 10 times FY25 earnings and a dividend yield of over 7%."
