By Oscar Oberg

Since the initial public offering in June 2017, the WAM Microcap (ASX: WMI) investment portfolio has outperformed for six consecutive financial years despite heightened levels of volatility, demonstrating the strength of the proven Wilson Asset Management investment process and the stock picking ability of the investment team. The investment team has identified many opportunities and believes we are entering a similar period to 2020 and 2021 where micro-cap companies outperformed strongly. Last week, we announced a share purchase plan (SPP) and placement to take advantage of this environment.

When WAM Microcap last raised capital in August 2020 it was following the COVID pandemic where micro-cap companies had lagged the recovery in large and small cap companies that had performed strongly following the low in the market in April 2020. We see a similar period emerging in 2024 with an improved macroeconomic environment contributing to improving investor sentiment towards micro-cap companies.

The micro-cap landscape

Looking deeper at the investment landscape, we have invested in compelling micro-cap companies across a variety of sectors that are currently trading at depressed valuations when compared to their larger listed peers. Microcaps have lagged the broader market since the 2022 sell off, and interestingly, the Emerging Companies Index, which is a proxy for micro-cap companies, has underperformed the S&P/ASX Small Ordinaries Accumulation Index by 6.5% since 1 July 2023. With central banks globally indicating that interest rate rises have come to an end, we believe the tide is now set to turn in favor of micro-cap companies.

The opportunity in valuation disparities 

There is a high valuation disparity between micro-cap companies and their larger listed peers, near the highest levels we have seen since 2020. One example is Embark Early Education (ASX: EVO), a key player in the childcare sector and a company that WAM Microcap is a substantial shareholder in. Embark Early Education is currently trading on a price-to-earnings (P/E) multiple of 7.5 times earnings. This is in stark contrast to its largest peer, G8 Education (ASX: GEM) which trades at approximately 12 times earnings, representing a 40% discount. Similarly, the New Zealand Stock Exchange (NZX: NZX), a holding within the investment portfolio, is trading at a 25% valuation discount to the Australian Stock Exchange (ASX: ASX) despite having a stronger growth profile.

Increasing takeover activity 

As at 31 March 2024, the WAM Microcap investment portfolio has outperformed the S&P/ASX Small Ordinaries Accumulation Index by 5.9%* in the financial year to date. A large proportion of this outperformance can be attributed to takeover activity which we believe is a reflection of the depressed level of valuations we are seeing in the micro-cap sector at present.

We have seen six meaningful takeover bids targeting our investee companies so far this year, which is more than we have seen in our time at Wilson Asset Management for the first nine months of a financial year. Companies that have contributed to our investment portfolio outperformance in the financial year to date include Genex Power (ASX: GNX), Ansarada Group (ASX: AND), Healthia (ASX: HLA), Superloop (ASX: SLC), Mermaid Marine now MMA Offshore (ASX: MRM) and Symbio Holdings (ASX: SYM). With valuations low in the micro-cap space compared to larger companies, we expect takeovers to continue over the medium term.

Equity capital markets activity 

We have a positive outlook for corporate activity and believe that the number of deals such as initial public offerings and capital raisings will gain momentum throughout 2024 into 2025. In the four years from FY18 to FY21, the WAM Microcap team participated in 91 deals on average each year. From FY22 to FY24 this has dropped 65% to an average of 32 deals each year. With the macroeconomic environment settling, interesting opportunities are emerging, particularly for initial public offerings, where we believe valuations will be attractive.

The WAM Microcap investment team is excited about the prospects for micro-cap companies in the year ahead. We remain committed to our proven investment process as we find the most compelling opportunities in the market.

*Investment portfolio performance is before expenses, fees and taxes to compare to the relevant index which is also before expenses, fees and taxes