Small caps ‘poised for rebound’ into 2025

Australia’s small cap market is set for a potentially significant rebound over the next two years, with smaller Aussie businesses set to outperform big cap stocks, according to analysts from boutique Aussie investment firm Maple-Brown Abbott.

After a promising start to 2024, most surprisingly in the consumer discretionary sector, the investment firm has forecast continued strong earnings for Australian small caps relative to local large caps, with Maple-Brown Abbott predicting that increased M&A activity and innovations in AI and clean tech likely to propel growth into 2025.

Co-portfolio managers for the investment firm’s Australian Small Companies Fund, Phillip Hudak and Matt Griffin, observed that the economy is “performing better than expected”, with early signs of an interest rate drop boding well for small cap companies.

The analysts note that while investors may have missed the market bottom out last year, it is still “not too late to buy into the sector”.

“We are seeing substantial interest from advisors and investors in small cap stocks, but they are not necessarily increasing their allocations to that interest. We think that eventually allocations will catch up.”

M&A activity to continue into 2024

Maintaining the “flurry” of merger and acquisition activity at the end of the 2023 calendar year, the analysts forecast continuing M&A dealing in the small caps sector into 2024, “underpinned by the lower Australian dollar and potentially lower interest rates”.

Maple Brown Abbott cited acquisitions of local construction product producers CSR and Boral, and the sale of automation software developer Altium, as well as growing M&A activity in the mining sector.

“With the lower Australian dollar, we believe M&A activity will continue to create opportunities in the Australian small cap sector and be far more pronounced than IPO activity which is also expected to ramp up,” Griffin said.

“Many companies, particularly at the smaller end of the market, could see M&A activity as the year continues. Spartan Resources, for example, is a potential takeover candidate and also a key stock pick given our bullish view on gold,” he added.

AI and clean energy drive small cap growth; metals producers poised for rebound

Innovation in artificial intelligence and clean energy technologies are driving increasing interest in small cap companies, many of which are key suppliers to bigtechs and the ‘Magnificent Seven’.

The analysts, for instance, noted increasing interest in data centre-exposed companies, including NEXTDC, Megaport and Macquarie Technology Group Australian, which are benefitting from the “huge interest in AI stocks”.

“These companies are being caught up in the AI theme and we think this trend is set to continue through 2024,” Hudak said.

Maple-Brown Abbott said it has invested in medical imaging company Pro Medicus, noting its integration of AI in the radiology imaging area.

This, it said, would “create significant advances in imaging technology and upside for this company.”

A protracted downturn in metals stocks (notably nickel and lithium) may have bottomed out, with the analysts forecasting a potential rebound for battery materials metals driven by increase clean energy production.

“We feel the lithium price could be bottoming and in recent days, we have seen the prices of lithium miners rise, which is likely being driven by short covering.  The lower prices have created opportunities with lithium miners, and we are looking at positioning for the next cycle in companies like Patriot Battery Metals,” Griffin said.

Maple-Brown Abbott is also eyeing opportunities in the gold mining space.

“We’ve seen a recent drop in price of some gold miners which has opened up opportunities. At the same time demand for gold is strong, particularly from central banks.

Gold could also benefit from lower interest rates throughout 2024 and we are focussing on companies that continue to deliver production growth, meet cost guidance and build cash reserves such as Genesis Minerals and Persus Mining,” Griffin said.

Maple-Brown Abbott also expects the uranium price to rise, providing a lift to uranium miners, driven by increased “urgency to reduce carbon emissions from utilities” and to patch deficiencies in the energy market. The investment firm singled out Boss Energy and Paladin Energy as key beneficiaries of the uranium surge.

The structural shift to electric vehicles (EVs) is also benefiting car dealers and fleet/novated leasing companies, which are also major beneficiaries of recent fringe benefit tax changes.

However, the pair note, “rising wage inflation will hold back some companies especially those which are not able to pass on price rises, including some discretionary retailers exposed to younger demographics.”

“As a result, Maple-Brown Abbott is investing in companies with pricing power, such as Technology One and Monash IVF Group.”