By Oscar Oberg
New Zealand’s equity market is extremely cheap and is offering value to investors.
Since mid-2022 the team and I have said that the small-cap companies in Australia were undervalued and primed to outperform once the macroeconomic environment settled. Pleasingly, since December 2023 we have seen valuations of small-cap companies rerate while some sectors approached overvaluation. Over the past 12 months the team has been looking at sectors and markets which are undervalued and yet to rebound in this current environment. One such market we think is extremely cheap and is offering value to investors is the New Zealand equity market.
In late 2021, New Zealand was one of the first countries in the developed world to aggressively hike interest rates in response to rising inflation. Since then the Reserve Bank of New Zealand (RBNZ) has raised the cash rate by 525 basis points, much higher than the 425 basis points raised by the Reserve Bank of Australia (RBA). At that time, we had a very small exposure to New Zealand within our investment portfolio and we saw this as an opportunity given the simple thesis that, if New Zealand is the first country to raise interest rates, then surely, they would be the first country to cut rates.
Over the last 12 months we have been adding to our New Zealand-based small and micro-cap company exposure within WAM Capital (ASX: WAM) and WAM Microcap (ASX: WMI) that fit our investment process, to the extent where New Zealand companies now represents approximately 10% of our investment portfolio, the highest exposure to the market we have ever had. Despite valuations in New Zealand companies looked extremely cheap compared to Australia, our investment thesis had proved to be too early to realise returns with the New Zealand market continuing to underperform. In fact, the New Zealand equity market has underperformed its Australian counterpart by 19% since its lows in June 2022. We believe this is due to sticky inflation in labour and logistics such as freight, uncertainty around the election in October 2023 and a more hawkish central bank.
Despite this, our recent trip to New Zealand – our third in nine months – suggests that this underperformance may be coming to an end and that the New Zealand market is poised for a recovery. Labour and logistics inflation is starting to fall and most companies we met with suggested that employing staff had become much easier in the last few months. This was confirmed by the RBNZ last Thursday which stated that inflation was normalising, and that demand was slowing, highlighted by the 0.3% decline in the economy for the December 2023 quarter, suggesting New Zealand was in a technical recession. Following this trip, we are confident that the New Zealand market can recover strongly as interest rates are set to drop, benefitting small and micro-cap companies that are looking cheap.
The New Zealand Stock Exchange (NZX: NZX) is one company we think is poised to rerate. The business is trading at a price to earnings multiple of 20 times, a 25% discount to the Australian Stock Exchange (ASX: ASX). A return to average market trading and volumes would boost earnings by 20% on our estimates but we think the hidden gem in the business is the Wealth Technologies division which investors are not paying for at the moment. This business lost money in 2023 as the company chose to prioritise investment but is now swinging into a profit. Over the medium-to-long term we think this business can deliver NZD10 million of earnings before interest, tax, depreciation and amortisation (EBITDA) (approximately 25% increase for the company) and with Australian peers HUB24 (ASX: HUB) and Netwealth (ASX: NWL) trading on large valuations, we think this can generate a rerating of the New Zealand Stock Exchange share price.
Similar to New Zealand Stock Exchange, we believe integrated media company NZME (NZX: NZM) is undervalued with its ‘hidden’ business in OneRoof, the number three property portal in New Zealand. This business is growing steadily as property listing volumes in New Zealand are increasing and is benefitting from continued investment over the last few years. January and February saw digital revenue growth which were greater than 80%. NZME is trading on a CY24 price to earnings multiple of 9 times which suggests to us that investors are not paying for OneRoof. Remaining on the property theme, we think Summerset Group Holdings (NZX: SUM) is poised to benefit from a stronger New Zealand property market, rising settlements and a reduction in gearing. The company has an excellent management team and is currently trading at a slight premium to its book value despite the ten-year premium being close to double its book value.
We are also positive on steel distributors Vulcan Steel (NZX: VSL) and Steel & Tube Holdings (NZX: STU). We are interested in Vulcan Steel because it reminds us of Harvey Norman (ASX: HVN) where last year we saw its short-term earnings estimates being downgraded. However its share price continued to rise, suggesting investors were willing to look through short-term weakness. Vulcan Steel has an excellent management team and has diversified its business through the downturn with its entry into aluminium. Steel & Tube Holdings is smaller than Vulcan Steel but is trading on a 45% discount to Vulcan Steel despite performing well with its new management team and having NZD26 million of net cash. We think both businesses will see their valuations rerate in time.
Finally, Tourism Holdings (NZX: THL) provided a net profit guidance of NZD100 million in the 2026 financial year following the three year integration of its acquired business Apollo Tourism & Leisure. Assuming the company is successful, Tourism Holdings is currently trading on a price to earnings valuation of 7 times which compares to its ten-year average prior to COVID of 12 times.
In summary, we believe the macroeconomic environment is becoming favourable in New Zealand and that small and micro-cap companies are set to have a very strong period and close the valuation gap with Australia.