15 Feb 2023
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January was an interesting month in global markets as investors took confidence from data signaling slowing inflation in various regions. Central bankers were at pains to state there is still a long way to go, but the data held more sway than the commentary and most developed markets pushed higher, led by a strong 11% charge from the tech-heavy NASDAQ Index in the US.
The majority of Australian indices were up between 5% to 7%, including the ASX200, All Ords and Small Ords. Frustratingly the microcap end of the market continues to suffer from liquidity issues and remains volatile.
The Cyan C3G Fund enjoyed some good returns early in the month, but these were given back at the end of the month, partly driven by poorly received quarterly cashflow statements (4C reports) from a couple of our investments which are discussed below. The Fund ended the month in slightly negative territory with a return of -0.7%.
Month in Review
The performance of the portfolio was again a true representation of the volatility within the micro-small cap market, with 8 positions trading up, 4 unchanged for the month and 11 falling. The most material moves were seen in the investments listed below:
- Raiz Invest (RZI) +28.7% (Fintech): Raiz appears to be receiving some credit for the strategic change being driven in the business, as evidenced in the release of its much-improved quarterly cashflow statement and renewed growth in active domestic customers. We believe this momentum should continue as further costs are removed and more clarity is produced on the direction of the company’s Asian expansion. The next positive catalyst should be the upcoming interim result later this month.
- Mighty Craft (MCL) +19.4% (Boutique Liquor): The quarterly business update illustrated the strong rebound in this business as it fully emerges from prior Covid-impacted results. The jewel-in-the-crown asset in Better Beer continues to grow at a remarkable rate and must surely be on the radar of some of the larger alcohol business. We believe MCL is cheap on a sum-of-the-parts basis and look forward to some of the inherent value being released over the next 12 months.
- Big River Industries (BRI) +17.4% (Building products): No announcements were made in January, so it appears BRI enjoyed some buying on the back of market strength and its very appealing fundamentals with a single digit price earnings ratio and fully franked yield over 5%.
- Playside (PLY) -17.2% (Game development): We endured a disappointing end to the month with Playside. We have backed this company since listing at the end of 2020 but were frustrated by some of the commentary in the quarterly cashflow statement including the discontinuation of several original IP titles. Whilst this does make good sense strategically, it was poorly communicated and left the market with questions about the company’s ability to successfully execute its original IP strategy. It’s the first misstep the company has made since listing, and it was treated harshly. We have spent more time with management and are comfortable that the future remains very bright particularly given its leading client base including Activision Blizzard (NASDAQ: ATVI) and Meta (NASDAQ: META) combined with a strong balance sheet including net cash of $30m.
- BirdDog (BDT) – 6.5% (Tech hardware and equipment): BirdDog develops, manufactures, and sells video technology solutions. The quarterly cashflow statement illustrated that the company has faced headwinds in the US and European markets and has fallen short of our expectations on delivery of its growth strategy. We are hopeful that the coming months see a material improvement as new products are released, and supply and demand dynamics normalise. Like Playside, the company has the benefit of an extremely strong balance sheet with almost $20m in net cash.
Other detractors from performance that pushed us into slightly negative territory for the month were PureProfile (PPL -8.7%), Field Solutions Group (FSG -13.0%) and Readcloud (RCL -12.0%). Low volume selling in illiquid markets were the main drivers for these movements.
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Media
Graeme Carson presented a Webinar for Reach Markets, where he discusses the Fund, the investment philosophy, the process, and some key stock picks. See the link attached for a full replay.
https://reachmarkets.com.au/the-insider-meet-the-fund-manager-graeme-carson/
Reach markets also released an article about Cyan prior to the event.
Portfolio manager shows faith and patience in small caps
Outlook
As stated in previous monthly reports, Cyan looks to invest in companies in their growth lifecycle phase, as illustrated in the chart below.
The portfolio, at any given time, has a mix of companies at various stages of their lifecycle. The chart below illustrates that we break the portfolio up into 3 main categories of cash and cash generative, growth and emerging. We then weight the investments accordingly.
The current portfolio composition is:
- Cash and cash generative ~40%
- Growth ~40%
- Emerging ~20%
It has been the “Growth” and “Emerging” investments that have been hurting performance of late. This is the part of the market that has underperformed the most and continues to face challenges with liquidity due to lack of both institutional and retail participation in the sector. Any selling seems to have material negative impact on stock prices, but it has created an environment where there are obvious value opportunities. For instance: Birddog (BDT) which has a current market capitalization of $30m and yet holds $20m in inventory AND $20m in cash on it balance sheet.
In our opinion, this is the part of the market that provides the most potential upside in the recovery. We don’t know exactly when the recovery will come, but we believe the statement we made in our monthly report in September last year still rings true:
“We believe the most-likely first positive catalyst for a stock market recovery will be a line of sight as to when the interest rate hike cycle will end. Most central banks in developed economies are rapidly and aggressively raising rates. Stock markets hate this. We don’t know if this monetary policy strategy will curb inflation as hoped, but an end to this cycle could provide a clear positive catalyst for a shift in sentiment for equities.”
As mentioned at the beginning of the report, the NASDAQ has had a strong run, and is in fact ~20% above its December lows. That tells us there is an appetite for growth investments when investors see inflation peaking and interest rate hikes potentially coming to an end.
Some of the more recent data, including stubbornly strong inflation and wages growth, has contradicted this so there is still a way to go, but the market will always lead the economic rebound and we believe the hardest hit part of the market (micro and small caps ex resources) has the most upside over time.
Patience is always tested at times such as these but, each time in history, the market has improved, and disciplined investing has been rewarded accordingly.
As always if you would like more information about any aspect of your investment, please contact us directly.
Dean Fergie & Graeme Carson