Regal’s Phil King expects one sector to stand tall as cost pressures rise

Regal Funds Management CIO Phil King alluded to the ongoing battle for Liontown Resources (ASX: LTR), during an investor webinar last week. In a wide-ranging discussion, King discussed global macroeconomics, his outlook for markets and sectors, and how his funds are currently positioned.

Liontown on Friday saw major lithium producer Albemarle (NYSE: ALB) withdraw a $6.6 billion takeover bid, prompting further activity from LTR’s major shareholder Gina Rinehart.

“More recently we’ve seen a lot of activity focused on resources, with takeovers announced for stocks like Oz Minerals (ASX: OZL), Newcrest (ASX: NCM), Liontown, and Origin (ASX: ORG). Not all of these have been successful but we’ve seen a lot of activity in mining and we think this will continue,” he said.

King, CIO of Regal, believes corporate activity in the Australian market is likely to remain muted for the foreseeable future, with the exception of the resources space, and expects this will remain the case in the short to medium term.

King remains bullish on resources

The sector that has long been favoured by King remains an area of focus: “And in fact, I think I will get more bullish over the next few years,” he said.

“Once we get through economic weakness in the next year or two, I think that’s the time to increase active exposures to the sector to the maximum that we’re comfortable with,” King said.

He remains as positive as ever on companies in Energy, Uranium, Copper and critical minerals industries. Iron ore is the one area of the sector on which he remains cautious, anticipating the bursting of the Chinese property bubble could weigh on prices in the years ahead.

King's preferred markets

The Regal CIO discussed some of the global markets he regards as most appealing currently, explaining why the broader US market isn’t one of them.

“People are being very negative on equities and so are forced to cover when they don’t go down. Once this buying stops, it might pull the rug out,” he said.

“I’m not predicting a crash but I certainly think it’s a time to be cautious about equities.”

Pointing to the US as a prominent example, King believes investors are currently not being adequately rewarded for the risk they’re taking to invest in stocks given current levels of volatility.

“Both in Asia and in Europe, where bond yields haven’t gone up to the same extent and PEs are a lot lower, with equity risk premiums a lot more attractive than we’re seeing in the US,” King says.

Equity risk premia by country

Source: Regal, Bloomberg, as of October 2023

In line with this, Regal’s Global Long-Short Strategy has pivoted away from the US and tilted further towards Europe.

Regal’s Asian Long-Short strategy is currently seeking out opportunities in markets such as Japan.

Is a bubble inflating?

King discussed the large market shifts driven more recently by the technology sector, particularly in the US, where the so-called “magnificent 7” have seen the S&P 500 retrace most of its losses since last April.

“We’ve seen some outperformance among Australia’s top 10 stocks but it’s less apparent because they aren’t quite as “magnificent” as those in the US. So, the outperformance and overvaluation isn’t so obvious,” he said.

For King, any bubble in the US equity valuations is concentrated within big tech, with the sector’s seven largest firms currently trading on an average PE of around 28-times.

“But if you back them out of the S&P 500, the rest of the market trades on 16 times, well down on where it was a few years ago. That’s where we’re seeing the best opportunities [in the US],” he said.

King also alluded to what he believes is a potential bubble many are less aware of: “The bubble we’re seeing in passive investing, which has driven some of this outperformance of large US stocks, has also impacted the Aussie market”.

What’s King most excited about?

Turning his focus to Australia, King noted the recent reporting season in Australia was one of the most volatile in recent history, many stock prices moving up or down more than 10% during the month of August. This was driven largely by the macro scenario of higher interest rates and inflation, “with many analysts having more trouble than previously in trying to predict earnings.”

But he singled out ASX Industrials among the most resilient sector locally, where companies have seen the most success in passing their increased costs through to customers and continuing to achieve strong earnings growth.

King suggested the advantage of companies within this sector will continue to increase, tipping that the next 12 months will see the interest expense for Australian corporates rise to double that of the prior one or two years.

Where are the small-cap opportunities?

In terms of company size, small caps remain King’s preferred part of the market cap spectrum. Coming back to his earlier point about passive investor dollars inflating stock prices among the mega-cap and large-cap stocks, he regards small-caps as a beneficiary of this phenomenon.

His happiest hunting ground currently is among those listed companies whose market caps remain just outside indices such as the ASX 200 in Australia or the S&P 500 in the US.

King explained that companies with a market cap of between $500 million and $1 billion have been his funds’ “sweet spot” in recent years. Some of the names he singles out are:

Life360 (ASX: 360)

The US location-based services and technology company has been a holding inside Regal for several years, having first been bought within the Emerging Companies Fund when it was a pre-IPO company.

Source: Market Index

Cettire (ASX: CTT)

“Which reminds me a bit of Life360, it’s shown a lot of potential in recent years but has started delivering within the last 12 months or more,” King said.

“We think it’s got a long runway ahead and could become a global leader,” King said, suggesting it may soon join the ASX 300 and even the ASX 200 in 2024.

Source: Market Index

Jessica Farr-Jones, portfolio manager of the Regal Emerging Companies Fund, named a few unlisted companies she's also watching closely. She said the fund is currently more focused on listed markets than on private markets, given IPO activity remains so sluggish. But some of the companies she singles out as watching most closely for movement once the IPO window opens include:

• Enlitic: A provider of medical technology company that has been a holding in the Regal fund since 2019.

• Moxico Resources: A Zambian copper explorer considering a 2024 IPO.

• AGI Global Logistics: A global software business and owner of legal services firm Link Legal.

This article was first published for Livewire Markets.