Transcription of Finance News Network Interview with Fairview Equity Partners Executive Director and Portfolio Manager, Leigh Cronin
Lelde Smits: Hello I’m Lelde Smits for the Finance News Network and joining me today from Emerging Companies Fund Manager, Fairview Equity Partners is Executive Director and Portfolio Manager, Leigh Cronin. Leigh welcome to FNN.
Leigh Cronin: Thank you.
Lelde Smits: Firstly, could you give us a backdrop of the small to midcap section of the market?
Leigh Cronin: Well it’s been a really interesting start to the year. The year started quite positively with some more positive signs out of Europe with respect to austerity measures. We saw an easing of concerns about a potential hard landing in China. We also saw another, better than expected, reporting season out of the US. Now in Australia, the reporting season was broadly in line, we’re coming from some pretty attractive evaluations and the Small Ords benchmark rose by about 15 per cent during the March quarter. Now unfortunately we’ve seen some of those macro concerns resurface, so we’ve given a bit of that back over the last couple of weeks.
From our perspective, we’re not macro or thematic investors, we’re very much bottom up stock pickers. So this is a backdrop that we need to be aware of, but we’re really out there looking for the stock specific opportunities.
Lelde Smits: So what’s your assessment of the small to midcap section of the market?
Leigh Cronin: Where we currently stand is the Small Ords is trading around 10 times prospective earnings, which relative to long term averages of around 14 times, suggests that there’s some value on the table. But it is a time to be selective; the broader economy is not really providing a lot of joy for the more cyclical or consumer facing segments of the market. So it is a time to be stock specific, it’s not a time to be picking broader thematics and sectors. It really is a time to be finding those less well known opportunities in the market at the moment.
Lelde Smits: And what should potential investors know about the small to midcap section of the market, when looking to invest in your Fund?
Leigh Cronin: Well there’re a few factors we tend to cite to potential investors, when they’re looking to allocate a portion of their portfolio to the smaller companies space. Firstly we tend to allay any misconceptions around investing in this space. This is certainly not about investing in a speculative way in penny dreadfuls, or in early stage exploration plays. We invest in 50 companies ranging in size from around $70 million to $2 billion in size, they’re established business models, well managed and they’re readily valued. Secondly, we emphasise that this really is an under researched, less intensively researched part of the market. So that brings with it, a lot more opportunities for finding inefficiently priced or undiscovered companies.
We also talk about the fact that this is the part of the market where companies are typically, at earlier stages of their growth or maturity. Or they’ve got growth opportunities available to them that can see material shifts in the value of those businesses, so that brings with it the opportunity for more significant share price appreciation. And finally, this is a part of the market where the companies tend to be less diverse or more focused. And that means we can get the exact exposure that we’re looking for, without the less attractive businesses that sometimes sit alongside the larger more conglomerate style of businesses in the market.
Lelde Smits: In the past when we’ve spoken to Fairview, we’ve heard your investment case is based on investing in stocks and sticking with them, unless of course, the investment case changes. What do you look for initially to ensure stocks don’t need to be removed at a loss from your portfolio?
Leigh Cronin: Well there’re four broad areas we tend to think about when we look to include a stock in our portfolio. Firstly we look at the extent of our insight – why do we think that stock is mispriced, or what do we know that the market doesn’t know? Secondly we do considerable work around the qualitative aspects of the business, looking at the industry structure and the key drivers, the quality of management and the balance sheet structure. Thirdly, we want to make sure we’ve got sufficient valuation upside and that involves testing the key drivers and sensitivities, and making sure that the risk return parameters are appropriate.
And finally, we spend considerable time understanding the risks. And whether that be risks around the business model, risks around the earnings estimates or even risks around liquidity - around entering and exiting a stock, is very important consideration.
Lelde Smits: And what does this process involve and what do you gain the most from it?
Leigh Cronin: As I mentioned, this is a less intensively researched part of the market. So our own proprietary research plays a key part and insight is the key to our investment case. And we would argue that the best way to gain that insight, which is really in the form of knowledge or understanding, is through an intensive and ongoing company visitation program. So we visit around 10 companies per week, be they the companies themselves, suppliers, customers or competitors.
Lelde Smits: And Leigh, could you give an example where this process has resulted in stocks being added to your portfolio?
Leigh Cronin: Sure. G8 Education (ASX:GEM) is a recent inclusion in the portfolio, a childcare business. We’re really attracted to the industry dynamics of the childcare industry, both the socio-demographic trends, the government support. It’s a very fragmented industry, so it’s right for consolidation. Investors are really reluctant to re-enter this space post the ABC Learning (ASX:ABS) debacle, which we think is very company specific – more about the debt burden and the offshore expansion. And this is also a company that’s not particularly well covered by the market. So when we look at it, we’ve got insight, we’ve got valuation support, we understand the qualitative characteristics of the business and we believe we’ve done a sufficient assessment on the risk profile.
Lelde Smits: Looking closer at your Emerging Companies Fund. What did the Fund return in the last quarter and how does that compare to your benchmark?
Leigh Cronin: Well over the three months to the end of April, the Fund returned to investors on a net basis after fees, 10 per cent and that was around four per cent stronger than the Small Ordinaries benchmark. In the three and a half years since we incepted the Fund, the Fund has returned 19 per cent per annum to investors, which is around 12 per cent stronger than the Small Ordinaries benchmark. And that makes us one of the strongest small company’s funds in the market.
Lelde Smits: So which stocks contributed and which detracted?
Leigh Cronin: On the positive side, Auscenco (ASX:AAX), Breville Group (ASX:BRG), Red Fork Energy (ASX:RFE) and Super Retail Group (ASX:SUL) were the stronger performers during that quarter. On the negative side, Saracen (ASX:SAR) which is a gold stock, Challenger Group (ASX:CGF) and Atlas Iron (ASX:AGO) detracted from our performance.
Lelde Smits: And are you still holding these stocks?
Leigh Cronin: We continue to hold the stronger performers. In terms of the negative detractors, the uncertainties with respect to some of the grade control issues for Saracen, which caused it to downgrade its production expectations and raise its costs, were sufficient for us to exit that stock. And also the result for Challenger over that quarter was sufficient to see us exit that stock as well.
Lelde Smits: And what about new positions, were any added following the recent earning season?
Leigh Cronin: Well three stocks that have made it into the portfolio since the February reporting season are G8 Education (ASX:GEM), which I’ve touched on and also Cardno (ASX:CDD) and Virgin Australia (ASX:VAH).
Lelde Smits: And what is your largest position and do you limit the size of positions?
Leigh Cronin: Well the size of the positions within our Fund is limited to a five per cent active weight, and we’ve got 50 stocks in the portfolio at the moment. So that suggests that the average weight is actually quite a bit less than that. And really we’re looking for a broad range of contributors, not trying to get one or two stocks spectacularly right. The largest stock at the moment is Regis Resources (ASX:RRL) which is a gold stock. This year it’s expected to produce 100,000 ounces of gold. Over the next couple of years with some new projects coming on board, that should rise to in excess of 400,000 ounces, at a cost of less than $600 an ounce. So that’s going to produce some very strong cash flows for a number of years.
Lelde Smits: Finally Leigh, as owners and investors in your Fund, how do you handle differences of opinion with respect to stock selection and managing the portfolio?
Leigh Cronin: Our investment process is quite deliberately very collaborative. Between the three of us, we’ve got in excess of 50 years of experience. And we think the best way to leverage that experience and that background is through a more collaborative model. We’ve been involved in structures before where there’s single person decision making, or where investors are left to look at particular sectors or stocks. And we’re not convinced that’s the most robust model, so we adopt a more collaborative approach.
In terms of how we deal with differences of opinion, we actually encourage it, as long as it’s informed discussion or opinion. I touched on before, that for us it’s all about conviction in those four factors I mentioned – insight, valuation upside, qualitative characteristics and risks. And after informed discussion, if we still get differences of opinion, then by definition our conviction is lower than what it would be if we were all 100 per cent in agreement. So our position size would be lower, but we don’t require 100 per cent unanimous decisions.
Lelde Smits: Leigh Cronin, thanks for shedding some light on your process.
Leigh Cronin: Thank you.