'Forgotten gem': 2 mid-cap ASX shares this fundie loves

When interest rates are rising steeply, cash flow is paramount. Here's a pair of stocks that are self-sufficient this way.

| More on:
Two boys in business suits holding handfuls of money

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

In volatile times such as 2022, cash flow is king.

Rising interest rates means borrowing money becomes more expensive. So, naturally, if you can generate capital from within the business, it makes for a smoother path ahead.

Spheria Opportunities Fund portfolio manager Marcus Burns told a conference recently that his fund seeks mid- and small-cap ASX shares that precisely fit this bill.

"We do believe balance sheets are really important."

The era of near-zero interest rates encouraged a grow-at-all-costs mentality that produced many false idols.

"For a period of time no one really cared about debt because it was so cheap," he said.

"And all the pundits tell [businesses] to invest heavily, gear up the business… That's great in theory until you have to raise money, because [now] debt's risen in terms of cost."

As examples, Burns presented two of his fund's holdings that he has high hopes for.

Usually expensive market leader selling for cheap right now

Online real estate classifieds site provider REA Group Limited (ASX: REA) is one that Burns admitted he's bought and sold in the past, and has recently rebought.

The portfolio manager pointed out REA's "very good history" of cash flow management.

"Something like 96% cash flow conversion, which is extremely strong," he said.

"Everyone knows the business is a market leader. The only negative about the stock is that it does get expensive occasionally."

The share price has cooled off 27% year-to-date.

"We've added it back into the portfolio at a decent weight."

Burns is not the only fan of REA shares.

"Combined with its strong pricing power and new acquisitions and revenue streams, the company has been tipped to continue growing at a solid rate for many years to come by the team at Goldman Sachs," reported The Motley Fool's James Mickleboro last week.

"In light of this, the broker currently has a buy rating and $164.00 price target on REA's shares."

That's an upside in excess of 30% from the current level.

REA Group is due to report its preliminary numbers on Friday.

Showed tremendous resilience through the pandemic

Burns' team bought into jewellery retailer Michael Hill International Ltd (ASX: MHJ) after a change in management.

"CEO Daniel Bracken came across about two years ago and he's executed an incredible internal turnaround," said Burns.

"Loyalty programs, putting much more online, got rid of high-low pricing… which has given a big fillip to the revenue growth."

And of course, Michael Hill's cash flow has been exceptional in recent times.

"Their cash flow conversion is very strong, particularly in [financial year] 2021 when massive amounts of free cash were generated by the management team, despite the fact that 23 or 24 of the trading days were closed," said Burns.

"So they weren't a COVID beneficiary at all… so it traded very well during that period."

The Michael Hill share price has dropped about 28% so far this year, but Burns feels like "the forgotten gem" is well set for future growth.

"Balance sheet's net cash of to the tune of almost $100 million, trades at about 4 times EBIT," said Burns.

"So even though we're going through a potential consumer downturn, and people are worried about spending, [the shares are] still trading on extremely low levels despite the fact that [the business is] trading very strongly."

Michael Hill is scheduled to report its preliminary numbers on 22 August.

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended REA Group Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Investing Strategies

A mature-aged couple high-five each other as they celebrate a financial win and early retirement
Dividend Investing

5 top ASX dividend shares to buy right now

Analysts think income investors should be loading up on these shares.

Read more »

Two adults and a child look happy as they walk through airport with child sitting on suitcase.
Dividend Investing

Will Qantas shares pay a dividend in 2024?

Will the dividends return this year? Let's find out.

Read more »

A woman sits at her computer with her chin resting on her hand as she contemplates her next potential investment.
Dividend Investing

2 market-leading ASX dividend stocks to buy in April

Analysts have put buy ratings on these market-leaders.

Read more »

Father in the ocean with his daughters, symbolising passive income.
Dividend Investing

I'd spend $8k on these ASX 200 shares today to target a $6,102 annual passive income

I believe these ASX 200 shares will continue rewarding passive income investors for years to come.

Read more »

Man holding Australian dollar notes, symbolising dividends.
ETFs

Want the latest dividend from the Vanguard Australia Shares ETF (VAS)? Here's what you have to do

If you want to bag the latest VAS dividend, here's what you need to do.

Read more »

A smiling businessman in the city looks at his phone and punches the air in celebration of good news.
Dividend Investing

Investing for passive income? Keep any eye out for that boosted Telstra dividend today!

If you own Telstra shares, keep an eye out for that juicy dividend payout today.

Read more »

Couple at an airport waiting for their flight.
Cheap Shares

Is Qantas a bargain ASX 200 stock today?

Analysts at Goldman Sachs think the Flying Kangaroo could be dirt cheap.

Read more »

Person holding a blue chip.
Blue Chip Shares

2 ASX blue-chip shares I'd buy with $3,000 right now

These are large businesses with compelling futures.

Read more »