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Quarterly Report March 2022


Chief Investment Officer Letter

A dose of reality - the medicine growth stocks need

It was a decidedly downbeat mood at this year’s Roth Conference in California.

With the sun shining and with meetings scheduled in person for the first time in three years, you might have expected smiles and laughter. But for most CEOs in attendance, a bit of sunshine and socialising did little to offset the declines in their companies’ share prices over the past year. After all, it’s been a brutal year for many of Roth’s clients—typically smaller, rapidly growing companies for whom it’s not uncommon to be down 70% or more from their 52-week highs.

When Forager’s Gareth Brown asked one business’s CEO what he thought about an acquisition that his company made this time last year, he responded, “I paid $200 million for it and the market cap of my entire company is now less than that. How do you think I’m feeling?”

We tried to cheer a few of them up. They might be worth hundreds of millions of dollars less than they thought they were, but at least now we are more interested in their businesses. The 2021 Conference, in comparison, was three long nights for the Forager team, sitting in one Zoom meeting after another talking to interesting companies with absurdly high share prices.

It’s not just lower share prices in 2022 that have us feeling more enthusiastic, though. Most CEOs aren’t just aware of their share prices—they use them as cues to make decisions. The current environment is bringing a much-needed dose of reality back into that process.

Less destructive acquisitions

Gareth’s CEO wasn’t the only one to make an overpriced acquisition.

We sold our investment in his company soon after it was announced. But there are others. Inflated market prices for listed companies are often used as justification for value-destructive acquisitions. Gan, Whole Earth Brands and Neogames have been guilty in the International Shares Fund, while iSelect is a perfect example in the Australian Shares Fund.

With share prices in the gutter, fewer CEOs are discussing acquisitions at all, and those who are seem far more sensible about the prices they’re willing to pay. That can only be a good thing.

Less profligate spending

Rampant investor enthusiasm for these businesses has also created an abundance of cash with which to “accelerate” growth plans. With more money, the theory went, companies could hire more developers, spend more on marketing, and what would have taken 10 years could be achieved in five.

While it’s impossible to know what the alternate reality would be, the main acceleration seems to have been in developer wages and customer acquisition costs. That’s certainly been true for Forager investments like Adore Beauty and Twitter. Google was doing very well out of all that marketing spend, but newly capital-constrained managers might find that the spend can be throttled without too much diminution in growth.

Value will become clearer

What makes a business good value has changed over time. And if Forager’s research and valuation process has taught us anything, it’s that we sometimes need to look beyond our own backyard—down Tech Avenue, for example—for new opportunities that hold potential.

Navigating through this unfamiliar territory has made for a bumpy ride. It begs the question: will these loss-making companies ever make a profit—and if so, how much?

I’ll set the non-revenue generators to one side for the moment. Bizarrely, the share prices of the likes of Audio Pixels haven’t fallen as much as their revenue-generating comrades. All the businesses we are looking at have real revenue and the qualities investors were overly excited about 12 months ago remain.

They are growing rapidly thanks to dramatic changes in the way businesses deal with customers, staff and shareholders alike. It is all shifting online and, while COVID-related lockdowns might have brought forward a few years of growth, many of these businesses still have a decade of transition ahead of them. Many do have high levels of recurring revenue and have become deeply entrenched in their clients’ businesses. This makes them relatively resilient to economic downturns and more predictable than most—at the revenue line, at least.

However, the big remaining unknown is just how profitable they will ultimately become. We know software businesses in particular can be highly profitable. Adobe generates pre-tax profit margins of more than 35%. Microsoft, Alphabet and Meta are all absurdly profitable businesses. Even the ASX’s Hansen Technologies— which generates operating margins of 25%—shows that lesserquality software businesses can generate wonderful margins if you decide to run them for cashflow.

But very few software companies are going to mimic Adobe. There’s a monstrous valuation difference. So far, most of these smaller companies have shown they can grow the cost line at least as fast as their revenues.

The year for proof

Countless companies at the conference said they’ve been getting the message loud and clear: it’s time to show investors some proof that their business can be highly profitable. We heard the same thing time and again through the Australian reporting season, too. From Whispir to Bigtincan and Adobe copycat Nitro, CEOs are telling us that this is the year for proof.

With investors no longer rewarding growth at any cost, most businesses are now focused on showing that they can increase their margins, at the very least reach profitability in the short term, and show investors that they can grow their revenue much faster than their expenses.

We’re clearly not going to know what the ultimate profitability will look like for these still-immature businesses. But by the time the 2023 Roth Conference rolls around, we will have a much better idea of which companies are on the right trajectory. And for those that succeed, they may also be much happier about their share prices.

No reprieve from volatility in 2022

It’s been a crazy few years for financial markets and frankly, even we—generally welcoming of volatility—would not have complained about a year of reprieve.

Russia is one of the largest suppliers of oil and gas, and Russia and Ukraine combined grow almost 30% of the world’s exported wheat. Commodity prices have skyrocketed on supply risks and inflationary pressures were concerning even prior to the war’s influence on prices. The last thing the western world’s debt-burdened economies need is higher interest rates. Neither governments nor consumers can afford dramatic increases in their financing costs. Yet what we want and what we get are often poles apart.

All of this has investors on edge. Stock prices have been extremely volatile, mostly to the downside (with commodities being the exception). And smaller companies have been punished far more than their larger counterparts. After all, larger companies are generally better equipped to navigate difficult environments than small companies.

Forager’s relatively concentrated portfolios of mostly small companies have seen substantial share price falls in 2022. The unit price for the Forager International Shares Fund has fallen 19% in the three months to 31 March 2022 and the Australian Fund’s distribution-adjusted price has fallen 12% over the same period. While it seems we have swapped some of the 2021 financial year’s extraordinarily high returns for volatility this year, we invest in concentrated portfolios of small stocks because of the long-term excess returns that will generate.

The current bout of pessimism for such companies shows exactly why the returns can be so large. Yes, there is plenty to worry about, and we have reduced some exposure to discretionary consumer spending and economically sensitive sectors in both portfolios. But many share price reactions have been extreme and indiscriminate, no matter whose backyard you’re looking at.

Economic cycles come and go and good businesses add to their competitive advantages in difficult times. Even businesses that you would expect to be robust against economic changes have experienced share price falls of more than 50%. Many of these companies would be highly attractive investments if interest rates were 6% or more. In short, most investment cases remain intact and lower prices simply make for higher future returns. Again, it’s a long-term view.

New Forager investors might find unit price falls disconcerting. My only advice is to welcome them and, if that proves difficult, to not look too often. Because this year is going to be another challenging one for all. But while the risks are meaningful, so are the rewards on offer. Best to let us do the stressing.

Steve Johnson

Forager Australian Shares Fund

Forager Australian Shares Fund
Forager Australian Shares Fund

With reporting season wrapped up in the quarter, few companies disclosed any meaningful news. But the macroeconomic situation is changing faster than expected, showing threats to the spending power of Australians.

The Forager Australian Shares Fund rose by 2.9% last month, trailing the 6.9% return of the All Ordinaries Accumulation Index. As was the case last month, the performance of the index was driven by resource companies, which rose by 10%.

After reporting earnings in February, few companies disclosed any meaningful news this month. There was no let-up in the flood of macroeconomic news though. The ramifications of the war in Ukraine continue to be felt. Inflation is rising in many parts of the economy. And interest rates are set to soar.

The macroeconomic situation has changed faster than many expected, and there are some serious threats to the spending power of Australian consumers. At the end of December the oil price was $75 per barrel. It is now $100 per barrel, leading average petrol prices to be well over $2 per litre and up more than 30% during the quarter. The availability and cost of labour alongside the increase in other commodity prices have also played a part in rising inflation, increasing the cost of living for Australians.

This being an election year, the government had some money to spend to relieve consumer pain. In the budget delivered last month the government halved the fuel excise for six months, increased the low-and-middle-income tax offset this year and handed out cash. This totalled $8.6 billion or about 0.6% of household disposable income. That tax offset is set to end this financial year though, despite the government initially thinking about another extension. This will sap about the same amount from consumer pockets starting in July.

But the other shoe is still to drop

Interest rate expectations have risen sharply over the last quarter such that by mid-2023, Australia could be seeing cash rates of 3% from the current historical low of near zero. This would see the standard variable rates of the cheapest major banks move to nearly 6% from 3% today. On the average $800,000 new mortgage in NSW, that would be an extra $16,000 of after-tax dollars to be funded from consumer pockets for the length of the loan. The banks have already adjusted the interest rate on fixed-rate mortgages for new borrowers, with Westpac hiking nine times in the last six months.

Add to that the consumer hunger for long-overdue holidays, and many companies exposed to consumption on large-ticket items and domestic goods could suffer. Lower house prices, dragged down by higher interest rates, are unlikely to make consumers feel good about spending up. Already, household spending estimates show furnishings and household equipment spending is down 5% on the prior year in January but remains 9% higher than pre-pandemic levels. The next big purchase is much more likely to be an overseas holiday than a new sofa.

Less than 5% of the Fund is invested in consumer-oriented businesses most affected by these pressures, with a further 3% invested in fintech lenders. In these companies we see stockspecific factors overcoming macro risks.

More of the Fund is invested in higher-growth technology stocks. And while they had taken a battering over the quarter, the month of March offered some reprieve for the likes of Whispir (WSP) and Nitro (NTO). The opportunity in smaller Australian technology stocks, relative to other parts of the market and relative to their large-cap brethren, remains.

Small-cap tech stocks are down twice as much as large-cap tech stocks since the zenith in the middle of last year, and trade at a fraction of the valuation for similar levels of growth. A basket of the largest and best-known Australian tech stocks is down 25% from the peak in 2021. The basket of less well-known, smaller tech stocks has more than halved.

With little to no profits for these groups, we can compare them on an enterprise value to revenue multiple. On that metric, the large-cap basket trades at 19 times revenue. The small-caps trade at just 3.4 times. Both groups are due to grow revenue 20% to 25%. Both have high-quality, sticky revenue.

And both are due to see revenue outgrow costs. So despite the tech malaise we have been seeing over the last nine months, large-cap tech business valuations have not really come down to earth. The valuations of smaller tech companies have come down with a hard thump.

Fund statistics

Forager International Shares Fund

Forager International Shares Fund
Forager International Shares Fund

Stock markets have fallen sharply over the past quarter, and the Fund assesses the underlying companies that were underwhelming, on target and looking good.

Stock markets have fallen sharply. The Russell 2000 Index of small US companies, measured in Australian Dollars, fell 2.1% over the month of March and 10.2% over the March quarter. Despite also owning some larger stocks, the Forager International Shares Fund performed worse than that. You can put most of that down to unforced errors.

March was an important month for the Fund, with many of its investments reporting their 2021 results and 2022 outlook. It was a chance to collect evidence and reappraise. Had the operating performance justified Fund valuations, or was the market pessimism correct? The hope was for emphatic wins, but the result was a mixed bag.


Sweetener company Whole Earth Brands (NASDAQ:FREE) fell sharply after releasing its results. Like companies everywhere, Whole Earth is being impacted by both supply chain constraints and cost inflation. While we believe the company will be able to raise its selling prices over time, there is a lag that’s hurting it today. The Fund had been trimming this position since mid- 2021 in response to disappointing free cash flow generation and concerns about acquisitions. The trimming has continued.

While the 2022 outlook for both sales and adjusted earnings before interest, tax, depreciation and amortisation (or EBITDA) was underwhelming, its valuation suggests there’s a lot of upside if management can right the ship.

Online gambling giant Flutter Entertainment (LSE:FLTR) was another landmine. The industry is awaiting a governmental review of UK regulation, with a particular focus on problem gambling. Flutter isn’t waiting—it’s proactively reducing its reliance on larger punters. These changes lopped 8-10% off fourth-quarter UK revenue and more again off profit. It is comforting that large competitors like Entain (LSE:ENT) are reporting stronger UK results, having not taken any proactive measures. If the review turns out to be a non-event, Flutter can selectively unwind changes to regather share and profit. If there are changes, Flutter is better placed than anyone.

Russian and Ukrainian exposure was another area of focus for the business, where it generated £60 million of contribution margin in 2021. It’s not particularly meaningful for Flutter, and exposure to that part of the world was set to decline anyway. In comparison, Australian operations are doing very well. And its US business FanDuel is growing even faster than anticipated and leads the market by several lengths. Management is guiding US operations to reach profitability by late 2023 and the hope is that FanDuel will generate immense amounts of free cash thereafter.

Online real estate agent Fathom Holdings (NASDAQ:FTHM) produced $95.5 million in revenue in Q4 2021, up 79% on the same period 12 months ago. That number blitzed most broker forecasts but was in line with our expectations. Fathom trades around breakeven profitability today, which is not unusual for a business that is reinvesting and growing at breakneck speeds. However, the big concern is its 2022 outlook. While management has guided for revenue growth of around 30%, the view is that the business can—and should—grow faster than that. If it doesn’t, it needs profitability to scale up quicker.

On target

Fashion retailer Hallenstein Glasson Holdings (NZSE:HLG) released interim results that were in line with last month’s trading update. Sales of NZ$170.6 million were down 6.2%— impacted by pandemic-related store closures in both key markets. However, online sales are doing well—rising almost 30% and providing one-third of total sales.

Its net profit of NZ$11.9 million was 40% lower than last year, impacted by higher operating costs and lower revenue. Other challenges, like COVID outbreaks and short-term production shutdowns in some of its manufacturing facilities, have also weighed on results. However, the company has deftly navigated the issues of the past two years and is likely to continue doing so. It remains cash-generative and has declared an interim dividend of 18 cents per share.

There were no big surprises in the fourth-quarter results of business services provider APi Group (NYSE:APG), as the company pre-released in February. However, sales of US$1.1 billion, up 27%, came in above market expectations. Unsurprisingly, supply chain issues and cost inflation continued to weigh on margins. Revenue guidance of US$6.3-6.5 billion in 2022 implies 6-7% organic revenue growth. A US$250 million share buyback was announced soon after results were released—not insignificant versus APi’s US$4.9 billion market capitalisation.

Janus International (NYSE:JBI) manufactures doors and accesscontrol systems for the self-storage industry. It’s also been a beneficiary of increased use of internet-enabled access expanding its market. As market leader (by a substantial margin), it has cost advantages over its competitors. That, of course, is a relative advantage. It’s suffering less from increased raw material, labour and logistics costs. Cost-containment measures and passing on higher costs to customers should help in 2022, with a management outlook for revenue growth of 14% and adjusted EBITDA of 15.5%.

Looking Good

The Fund has owned “healthy” energy drinks business Celsius Holdings (NASDAQ:CELH) before and it’s in the portfolio again today. This is a business that needs to grow rapidly to justify its US$4.4 billion market capitalisation. But grow it has. Fourth-quarter sales were up 192%. On Amazon in the US, Celsius commands a 20.2% market share and is rapidly closing in on the market leader.

Unfortunately the company hasn’t professionalised at the same rapid rate. This quarter, Celsius failed to lodge its accounts on time. There was a stock-based compensation expense for $12 million that hadn’t previously been properly accounted for. Not its first indiscretion but it was rectified soon after. Celsius changed its auditor last year, which Forager had been strongly pushing for. Hopefully this is helping. It would be good to see Celsius develop high-quality systems and protocols to avoid repeated missteps, even if that means raising some capital today. But these are just growing pains and Celsius is destined to be taken over by one of the drinks giants.

BM Technologies (NYSE:BMTX) hasn’t been mentioned much, despite the Fund being one of this illiquid microcap’s larger shareholders. The digital banking platform provider reported a strong fourth quarter result, with revenue increasing 41% to US$95 million and core earnings of $11 million as the group transitioned to profitability.

Finally, (SWX:LMN), an online travel tech company disguised as a travel company, reported impressive results for the second half of 2021. Cost control led to a small profit despite the emergence of Delta and Omicron and the punishing travel restrictions largely in place through the end of 2021.

This is the year travel returns to normal, with the pandemic and a devastating war so far doing little to dent Europeans’ holiday plans. Bookings recovered rapidly in early January coming out of the Omicron wave and were temporarily slowed at the onset of Russia’s invasion of Ukraine. The trend for bookings currently sits ahead of the same period in 2019, the last “normal” year. This might be a record year and we think it will follow with even bigger results in 2023 and 2024. As with Celsius, we think a takeout by a larger competitor is the end game.

Fund statistics