Although — or maybe because — small-cap ASX shares were absolutely hammered in 2022, some experts are tipping a roaring comeback in 2023.
IML portfolio managers Simon Conn and Marc Whittaker are certainly in this camp and specifically like the look of small-cap industrials.
The fund managers told clients on an IML blog post that the greatly reduced valuations for these stocks now factor in "a lot of negative news" already.
"Small industrials are trading at their biggest discount for over a decade," read the blog.
"Small industrials and large industrials have tracked each other quite closely for much of the past 10 years. However, over the past year a significant value gap has opened between the two indexes."
If you're wondering which ASX shares would be the best to buy right now to take advantage of this small-cap revival, the IML team thankfully named three:
'Astutely led' with a bank of assets
The IML fundies reckon Bega Cheese Ltd (ASX: BGA) did not have a chance to show its full potential in the 2022 financial year because of a string of one-off hurdles.
"Shanghai shutdowns negatively impacted its June 2022 result by over $40 million. Then as operations were returning to normal Bega witnessed a rapid increase in costs, particularly the price it pays farmers for milk," read the memo.
"However, at its recent AGM, Bega confirmed that it had finished implementing these price increases and its profit for the 2nd half of FY2023 should be back to the level it anticipated when it bought Lion Dairy and Drinks [in January 2021]."
Looking ahead to financial year 2024, Conn and Whittaker love the outlook for Bega because of three factors: competitive advantage, balance sheet, and management quality.
"Bega has a significant asset base on its balance sheet, including land & buildings worth circa $400 million," read the blog.
"Bega has been astutely led by the current chairman for a significant time, who has overseen the company grow from a small dairy company with one operating site on the South Coast of NSW to today being one of Australia's leading food and dairy companies."
The Bega share price has declined more than 21% over the past year, but has spiked up 27.5% since early November.
'Well-recognised brands' at a cheap valuation
GUD Holdings Limited (ASX: GUD) is primarily a vehicle parts and accessories provider.
According to Conn and Whittaker, its oldest business is the automotive aftermarket, distributing products like Ryco filters and DBA brakes.
"This division is relatively defensive given the wear and tear nature of demand for its products, and generates significant cash — however it has limited growth potential," they said.
"GUD has made a series of acquisitions over recent years in order to diversify its earnings. This makes it more resilient, while providing a potential growth driver for earnings."
Similar to Bega, GUD has had its share of troubles with supply disruptions and cost inflation.
But its growth potential, pricing power, and cheap valuation have the IML fund managers licking their lips.
"At current levels, GUD is very attractively priced at under 10 times FY2023 earnings with earnings that should grow into FY2024 as supply chains normalise and recently won contracts with major Australian car companies are fulfilled," read the blog post.
"GUD has had good success in the past in raising prices to mitigate cost increases, given its portfolio of well-recognised brands in the aftermarket and focus on wear and tear parts for the trade, where range and service are valued."
COVID cash well invested
Pathology services provider Australian Clinical Labs Ltd (ASX: ACL) saw earnings grow strongly during the COVID-19 pandemic.
The company used that cash, according to Conn and Whittaker, to pay off its debts, leaving it in a strong financial position for post-pandemic growth.
Like Bega Cheese, the IML team reckons ACL displays excellent competitive advantage.
"ACL has invested significantly in its national laboratory footprint, which allows it to flex its costs up and down as volumes fluctuate," read the blog post.
"This unified national laboratory system enables it to process samples in any laboratory around the country, so maximising the efficiency of its fixed-cost, laboratory network."
The pair also love ACL's growing earnings and management team.
"The recent acquisition of Medlab is a significant development for the company as this provides ACL with a presence in the Queensland market for the first time, meaning it is now able to offer a national footprint to customers and tender for national contracts," said the IML experts.
"It is [now] one of only three national pathology providers."
There is no doubt ACL shares are now heavily discounted. It has dropped more than 43.5% over the past 12 months.
