Rudi’s View: Woodside, REA, QBE, Appen & Megaport

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Sep 08 2022

In this week's Weekly Insights:

-August Reports: Closing Remarks
-Conviction Calls
-Research To Download

By Rudi Filapek-Vandyck, Editor

August Reports: Closing Remarks

The key attraction for investing in small and micro cap companies is the ability to generate oversized gains when things fall into place at the right time.

But just about every reporting season shows the opposite holds equally true and this time around the true stinkers from the August reporting season are called PPK Group ((PPK)), Redbubble ((RBL)) and Appen ((APX)).

In particular the erosion in the share price of "innovative technology investor" PPK Group looks genuinely gut-wrenching since the share price peaked above $21 in July last year. In August, the stock lost an additional -40%, pulling it closer to $1.52.

The thesis that when market dynamics toughen up, smaller cap stocks become relatively more vulnerable doesn't need such extreme examples to prove its validity. One look into the finer details of the FNArena Corporate Results Monitor can be just as revealing, and affirmative.

At face value, the inclusion of 344 corporate results released in August has generated 30.8% better-than-forecast results while 26.7% disappointed and 42.4% simply fell in line with guidance and/or expectations. The numbers look decisively better when we zoom in on respectively the ASX50 and ASX200.

Of the 44 companies of the ASX50 that reported in August only 20% (9 companies) were marked down as a "miss" with 29.5% (13 companies) surprising to the upside. For the 161 companies of the ASX200 the numbers don't look fundamentally different: 23.6% disappointed (38 companies) against 32.5% (52 companies) that delivered a better-than-expected performance without also issuing negative guidance for the year ahead.

These statistics reveal that when it comes to "disappointments", the percentage of negative market updates is noticeably higher for small cap companies that are outside of the ASX200. Apart from PPK Group, the list of small caps delivering big disappointments in August includes the likes of Kina Securities ((KSL)), Polynovo ((PNV)), Service Stream ((SSM)), SiteMinder ((SDR)), Southern Cross Media ((SXL)), and Veem ((VEE)).

Admittedly, the outsized punishments have been matched by significant gains for the likes of Nearmap ((NEA)), Tyro Payments ((TYR)) and Lovisa Holdings ((LOV)).

One of the key reasons as to why smaller companies are more vulnerable is the lack of a genuine moat or pricing power, while a relatively minor headwind can cause major problems when the company is only small-sized.

But one of the key observations from the August results is equally deserving to be highlighted: as a population, we had been all too eager to return back to old habits from the moment covid-restrictions and lockdowns became a thing of the past.

The demise in 2022 of former high flyers such as Booktopia Group ((BKG)) and Redbubble is equally evidence that, as a community of analysts, investors and speculators, we had been too eager to accept that covid had pulled some of the megatrends into irreversible acceleration.

As it turned out, those megatrends including working from home and spending online simply went through an artificial growth-spurt; one that was quick to deflate from the moment the valve was released.

There is no stopping these trends, of course, and they will most likely continue for many years yet to come. But many of the companies that were previously riding on the coat tails of megatrend market enthusiasm might now be facing a tough twelve months ahead.

And that's on top of this year's new market-led requirement that companies not profitable or cash flow positive establish and communicate a plausible pathway to break-even.

Given the many question marks and uncertainties ahead, it should be no surprise investors are, on average, not in a mindset of giving such small cap companies the benefit of the doubt before anything concrete shows up in financial numbers.

While cheap-looking share prices can always attract the interest from a corporate suitor, as has happened for Nearmap, Nitro Software and Link Administration ((LNK)), in the absence of a take-over, investors might have to be patient for longer before share prices in companies such as Aussie Broadband ((ABB)), Fineos Corp ((FCL)), Life360 ((360)) and Megaport will see sustainable momentum return.

And given so many worries about how ongoing tightening by the US Federal Reserve, and the RBA here in Australia, will deflate the housing market, and how that will impact on household spending, and exactly when, it seems very likely the same patience might have to be tapped into for ASX-listed consumer and housing-related companies.

Comparing the August stats with prior years, the final balance is far from fantastic, in particular the relatively high percentage of "misses", but also the -2.95% adjustment in average individual target price.

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