Amid ongoing global uncertainties and elevated interest rates, many investors remain cautious about Australia’s smaller companies. These businesses, often technology start-ups or explorers, typically face headwinds from higher borrowing costs impacting profit margins and growth funding. However, Luke Laretive, portfolio manager of Seneca’s Australian small companies fund, argues that current market conditions present a generational buying opportunity, especially following recent cooler-than-expected inflation data.
Laretive asserts that the pain for the small-cap segment has largely been absorbed by earlier Reserve Bank of Australia interest rate hikes, leaving many ASX-listed small stocks deeply discounted. He highlights a significant valuation disparity: the S&P/ASX 50 Index trades at roughly 22 times earnings with less than 5 per cent earnings growth, while the ASX Small Ordinaries Index sits at 16 times earnings, offering 23 per cent earnings growth. This gap is expected to narrow once the market anticipates the RBA has concluded its rate-rising cycle, historically leading small caps to trade at a premium due to faster earnings growth.
Seneca Financial Solutions is a financial services firm managing various investment platforms. Its Australian small companies fund specialises in identifying and investing in smaller ASX-listed businesses. The fund, which manages $30 million, has delivered a 20.60 per cent annual return since its October 2023 inception, outperforming the S&P/ASX Small Ordinaries Index by 9 per cent annually after fees. A key strategy for the fund involves identifying potential takeover targets, a theme that has significantly contributed to its strong performance.
Laretive points to recent successes in marine services provider MMA Offshore and mineral explorers, including the newest addition, Queensland-based Maronan Metals, which recently received a $22 million investment from Kinterra Capital. This investment could signal a full takeover bid, a common catalyst for share price premiums. Broader M&A activity across the ASX, amounting to $US76.1 billion this year, further underscores the potential for value unlocking in the small-cap sector, which Laretive believes is being undervalued by the ‘certainty premium’ driven by passive investment flows into larger companies.
