Thursday 11 November 2021
NAOS Small Cap Opportunities Company Limited advises that its Annual General Meeting (AGM) will be held at 12.00 pm (AEDT) on Thursday 11 November 2021 as a virtual meeting.
Further details relating to the AGM will be advised in the Notice of Meeting to be sent to all shareholders and released to the ASX immediately after dispatch.
In accordance with the ASX Listing Rules, valid nominations for the position of Director are required to be lodged at the registered office of the Company no later than 5.00 pm (AEST) on 16 September 2021.
Tuesday 26 October 2021
Please add the NAOS Q1 FY22 quarterly webinar to your calendar, when the investment team will provide an update on our Listed Investment Companies (LICs). The discussion will include an insight into our investment philosophy and process, notable market events, and an analysis of some of the core investments and potential catalysts.
We hope you will be able to join us.
* Investment Portfolio Performance is post all operating expenses, before fees, interest, taxes and capital raising costs. Performance has not been grossed up for franking credits received by shareholders. Inception date is 1 December 2017. Returns compounded for periods greater than 12 months.
“The strong investment performance has been reflected in the Company’s share price, allowing the Company’s Total Shareholder Return (TSR), which measures the change in the share price and dividends paid over the financial year, to return +132.6%.”
Dear fellow shareholders,
On behalf of the Board, it is with pleasure I present the NAOS Small Cap Opportunities Company Limited Annual Report for the financial year ended 30 June 2021. I would like to thank all shareholders for your continued support and welcome the 597 new shareholders who joined the Company during the 2021 financial year.
Although the initial onset of the COVID-19 pandemic presented challenges to the Company in FY20, I am pleased to report that for the financial year ending 30 June 2021, the Company achieved a record after-tax profit of $51.5 million (FY20: after-tax profit $1.4 million). The Board has declared a fully franked final quarterly dividend of 1.25 cents per share, bringing FY21 fully franked dividends to 5.0 cents per share, which represents a 25% increase on the prior year. This represents a net dividend yield of 5.1% based on the 30 June 2021 share price. Since its inception in December 2017, the Company has now declared an aggregate 18.50 cents per share of fully franked dividends.
The Company will continue to focus on delivering a growing stream of quarterly dividends, franked to the maximum extent possible, whilst maintaining an adequate profit reserve balance to enable the Company to pay dividends when it is more difficult to generate significant performance. The profit reserve balance at year end was $32.79 million or 21.4 cents per share.
The NSC Investment Portfolio returned a record financial year return of +58.40%, significantly outperforming the benchmark S&P/ASX Small Ordinaries Accumulation Index (XSOAI), which delivered a return of +33.23% in an exceptionally strong year for domestic equities.
The pre-tax Net Tangible Asset (NTA) backing per share of the Company increased from $0.68 to $1.10 over the financial year, with positive performance of the investment portfolio increasing NTA per share by 47.7 cents over the year. During the year, 4.75 cents per share was paid to shareholders in fully franked dividends, and management fees and interest expense on borrowings decreased the NTA by 1.21 cents per share and 0.85 cents per share respectively. The share buyback was also a positive contributor to the Company’s NTA, adding 0.71 cents per share.
The strong investment performance has been reflected in the Company’s share price, allowing the Company’s Total Shareholder Return (TSR), which measures the change in the share price and dividends paid over the financial year, to return +132.6%. This measure does not include the benefit of franking credits received by shareholders. The TSR for the year is reflective of both the strong investment performance and the significant reduction in the share price discount to NTA over the course of the year. The NSC share price closed the financial year at $0.98, having ended FY20 at $0.45 cents.
The Board remains committed to managing the capital base of the Company in a manner to maximise shareholder returns including:
In May 2021, the Board of NSC announced a 1-for-3 issue of bonus options to eligible shareholders. A total of 51.44 million bonus options were issued with an exercise price of $1.02 per option. The Board believes that the issue of bonus options is a measured way to allow the Company to grow over the next three years without placing undue pressure on the short-term performance and dividend reserves of the Company. The options are listed on the ASX under the code ASX: NSCOA with an exercise price of $1.02 and expiry date of 28 June 2024.
The Company maintained a focus on a high standard of marketing and communications so that all current and prospective shareholders have a clear understanding of the NAOS offering. Quarterly investor webinars are delivered to all shareholders along with regular email shareholder updates, which are sent to all current and prospective shareholders on the database, which totals over 11,000 subscribers.
While equity markets may remain vulnerable to short-term corrections, it is the opinion of the Board that the disciplined NAOS investment philosophy will continue to generate strong performance for shareholders over the medium term. The Board continues to have a strong alignment with its shareholders, increasing cumulative holdings during the year to 2.29 million shares.
On behalf of the Board of Directors, I would like to congratulate the Investment Manager for its strong FY21 investment performance and thank them for their dedication throughout the year.
19 August 2021
Dear fellow shareholders,
The NSC Investment Portfolio recorded its strongest year since inception in 2017, returning +58.40% for the financial year ended 30 June 2021 and, pleasingly, significantly outperforming the benchmark S&P/ASX Small Ordinaries Accumulation Index (XSOAI), which returned +33.23% in one of the strongest financial years on record for domestic equities.
I strongly believe that 12 months ago very few investors would have made even the slightest suggestion that the ASX-200 Index would post 11 months of gains in the financial year, with only September 2020 producing the single negative monthly return. I am a firm believer that no matter what edge any successful investor may believe they possess, at certain stages they will simply be the beneficiary of good fortune. In my opinion, FY21 was one of those years when the wind was at many investors’ backs. Even so, I firmly believe that the patience we have shown as an investment team and remaining true to our investment philosophy, have played the most critical part in delivering the strong performance over FY21.
Today, we live in a world where interest rates have never been lower. Across the globe, central banks have flooded markets with liquidity through numerous initiatives, and federal governments have resorted to fiscal stimulus initiatives to drive investment over the short and medium term. This has been very apparent in Australia.
This backdrop has created an excellent environment for asset prices, which includes listed companies. The nuance to the above is that the type of company that the market perceives to benefit over the long term has shifted. As such, we have seen a sharp rebound in valuations for businesses that for the prior 3–4 years have generally been overlooked by many investors. Industries in which these businesses operate include financials, building materials, consumer discretionary and construction/engineering services to name a few.
All NAOS portfolios were a beneficiary to some degree of the events mentioned above in FY21. In saying that, I am a firm believer in the NAOS investment philosophy of investing with a long-term focus in industrial type businesses that:
FY21 may well have been the year when the BRI strategy achieved the scale and momentum that it has desperately needed since listing some four years ago. There were three key events that occurred over the course of FY21 that assisted in driving the total return to over +55% for the financial year.
The first of these events was BRI’s successful application for the NSW Government Bushfire Recovery Grant. This grant was established due to the devastating bushfires in the 2019/20 summer period. As a result of this grant, BRI will receive $10 million to assist in the consolidation of its two manufacturing facilities into one facility at its Grafton operations. We believe BRI will emerge from this process as a more capital-efficient and predictable business. As a result of this manufacturing consolidation, the working capital unwind could prove to be significant. Subsequent to the relocation, BRI should receive additional proceeds from the sale of its Wagga Wagga land holding. Once this process has completed in FY23, we believe that the total improvement in the cash position of the business could be greater than $16 million.
The second key event for BRI was the completion of its largest acquisition to date – Timberwood, for an enterprise value of $24 million. Timberwood is a distributor of premium-grade timber panelling products and will provide BRI with much-needed scale within its core distribution segment. In addition, Timberwood distributes premium-quality, higher margin products that can now also be sold through BRI’s wider distribution network. This acquisition highlights the large-scale opportunity for BRI to continue to grow its trade-focused distribution network as it operates within a highly fragmented industry and one that has a high level of baby-boomer ownership, with limited succession options.
The third key event has been the stimulus programs introduced by federal and state governments over the past 6–18 months, which have generally been very beneficial for the wider housing sector. We believe this will lead to sustained demand for building products associated with the building of new homes and the alterations of existing homes. We also believe that in the longer term, this heightened activity will flow through to large infrastructure projects (which we are already seeing), as well as multi-residential projects. An uptick in both of these market segments would also be beneficial for BRI and its growing national network.
After many years of persistence, refining its strategy and adapting to the ever-changing finance industry, the COG management team has begun delivering on a strategy that works for its customer base as well as its shareholders. For FY21, we believe COG should deliver a group NPATA of approximately $20 million, compared to just over $9 million in the previous year.
More importantly, the quality and composition of the earnings has changed significantly for the better. We now view COG more like an insurance broker-type business as opposed to a typical finance business. The earnings generated from COG’s broker operations accounted for >70% of the group’s earnings and importantly, the balance of earnings, which are derived from lending, is generally via Westlawn Finance. Westlawn is run via a capital-light model, meaning it does not rely on COG’s own balance sheet funds but on capital raised via the debenture program.
In the past year we have also seen digital online powerhouse REA Group (ASX: REA) successfully take over Mortgage Choice (ASX: MOC), which was Australia’s largest mortgage broker network. We think this highlights the strategic value in building large-scale distribution networks within the financial services industry. While this is difficult to do, COG has been able to achieve this.
Looking forward, we expect COG to take advantage of its existing customer relationships and look to offer more essential products, such as business insurance and equipment/vehicle insurance. In theory, if you can provide critical financial arrangements for assets that allow your customers to operate their businesses, then the same should apply for the insurance of these assets, which can be completed at the same time as the financing. If COG can execute on this insurance opportunity, we believe the potential could be more than double that of the existing finance broking business and also provide a more recurring nature to its earnings profile.
Since the inception of the NSC Investment Portfolio, BSA has always showed potential. However, due to internal and external factors, this potential has either not been realised or it continues to be deferred until the following financial year. Unsurprisingly, FY21 was no different; however, as we exit FY21 and move into FY22, the potential for BSA does look more promising.
To the management team’s credit, it did secure a new contract with the National Broadband Network (NBN). Under this contract, BSA has managed to secure the largest percentage of market share in what could be a long-duration and large-value contract. Following this success, BSA also secured a significant contract with Telstra Corporation (ASX: TLS), which also has potential to be of long duration and reasonably significant from a revenue standpoint.
It is our understanding that a significant majority of the executive team has changed under the new leadership of CEO Tim Harris, whom we hold in high regard. It will be imperative that BSA finally proves to the market that it can grow organically and achieve a respectable margin. Furthermore, BSA will need to be more cognisant of inorganic growth opportunities that would not only diversify the revenue base, but also bring scale that the business desperately needs to offset the fixed-cost nature of its corporate overhead, as well as further driving margin growth and potentially, further innovation.
Since the inception of the NSC Investment Portfolio, MNF has been a core investment and at times the largest investment in the portfolio. Over the course of the latter part of FY21, we made the decision to significantly reduce our holding due to a number of factors that we felt did not fit with our investment philosophy, including the following:
MNF remains a very high-quality business with an excellent customer base and global growth potential. With a share price that has largely been flat over the last approximately four years, in our view the level of investment that MNF has made has not generated a sufficient return. The fifth year may well be the year that this changes and we hope it does, as MNF has the potential to be a market leader over time.
Technology-type companies have been some of the best-performing companies since COVID-19 as many of them have been the benefactors of the expedited transition to a more digital world. With the recent rotation out of higher growth, technology-type investments into more value-type investments, NSC has invested into a new core investment in what we believe to be a value-type software company called Gentrack Group Ltd (ASX: GTK).
GTK is a technology services provider to utilities and airport operators and was established in the 1980s when New Zealand deregulated its power markets. Today GTK has approximately 50 core customers across three main geographies: New Zealand, Australia and the UK, who are supported by over 300 internal engineering staff at GTK.
More recently GTK has undergone significant change, with a completely new executive team from the CEO down, as well as a new chair. From an earnings standpoint the business has also experienced a significant amount of change, in part due to internal execution issues as well as external issues such as regulation change in the UK for utilities providers, which has affected some of their customer base.
The reasons we are attracted to the GTK business are relatively simple. It is a business we have followed for over five years as it has a high-quality customer base. Over 75% of its revenue base is recurring in nature and, in theory, is growing. Many of the new executive team have worked together previously and have a good track record in running technology-focused businesses that solve the problems of very large organisations through innovative solutions.
Under the new team, GTK has reintroduced a move to fully expensing all research and development spend, which we view very favourably, the cash-flow generation has largely been sound, and its balance sheet stands in a healthy net cash position.
As is the case with a majority of our long-term investments, this particular investment will likely not be a smooth ride and does carry a degree of risk. Even so, we believe the risk is more than outweighed by the potential return. The returns will come if management can continue to grow the sticky revenue base, consistently grow margins, and reinvest the subsequent increased free cash flows into further improving its software, as well as inorganic opportunities that fit the strategy. If this can be achieved, the valuation multiple uplift applied to GTK could potentially be significant.
It is impossible to provide an accurate prediction as to how a portfolio of investments will perform over a 12-month period. Even so, I believe it is important to provide a general outlook to our fellow shareholders detailing our level of comfort with the current NSC investments, their potential, and any catalysts that may occur in FY22.
We believe that the current portfolio has a significant amount of unrealised value and the current trajectory for a clear majority of these businesses is where it needs to be. Some are benefiting from strong short- to medium-term industry trends, e.g. Big River Industries (ASX: BRI) and COG Financial Services (ASX: COG), while others, e.g. BSA Limited (ASX: BSA), need to capitalise on potential opportunities and increase their scale in a realistic timeframe, both organically and via acquisitions.
For NSC, there could be numerous catalysts that may have a material effect on the portfolio return in FY22. The key and most realistic catalysts in our view would include Over The Wire Holdings (ASX: OTW) achieving an organic growth rate of 10–15% at the revenue line with stable to growing EBITDA margins, and Big River Industries (ASX: BRI) capitalising on the industry tailwinds as well as sourcing another logical acquisition comparable to that of Timberwood. In addition, if COG Financial Services (ASX: COG) can provide greater transparency around the potential of the group to grow its insurance broking earnings and the current trajectory of this earnings stream, this would, in our view, command a higher valuation multiple.
FY21 was an excellent year from a pure return point of view, but we are under no illusions and believe that you are only as good as your next year’s returns. We believe the NSC Investment Portfolio has a compelling balance between risk management (protection against permanent capital loss) and long-term returns, despite its highly concentrated portfolio.
As always, the entire team at NAOS would like to thank all our fellow shareholders for continuing to be shareholders in NSC and we also welcome all new shareholders who joined the register in FY21.
If you have any queries, do not hesitate to speak directly with me or any member of the team.
We look forward to continuing to provide you with regular updates throughout FY22.
Managing Director and Chief Investment Officer
NAOS Asset Management Limited
“Some NSC investments are benefiting from strong short- to medium-term industry trends, e.g. Big River Industries (ASX: BRI) and COG Financial Services (ASX: COG), while others, e.g. BSA Limited (ASX: BSA), need to capitalise on potential opportunities and increase their scale in a realistic timeframe, both organically and via acquisitions.”
Rather than follow the crowd, we prefer to pave the way with innovation and provide a better outcome for our stakeholders. We have a disciplined investment process and do not get caught up in the hype and noise of the market.
At NAOS we focus on providing genuine long-term, concentrated exposure to emerging Australian industrial companies – and we strive to be the best at this.
At NAOS, we are honest and transparent. We continue to exist due to the earned trust of our shareholders.
Each NAOS employee has been specifically chosen for their unique ability, proven experience and willingness to learn. At NAOS, we have created an inclusive work culture and one that supports all our employees.
As NAOS Directors and employees, we have a significant interest in NAOS’ investment strategies. This means we are invested alongside our shareholders, creating a strong alignment of interests. In addition, NAOS Asset Management Limited is majority owned by employees and Directors.
We believe in investing in businesses where the earnings today are not a fair reflection of what the same business may earn over the longer term. Prior to investing in a business, we ask ourselves: do we want to own this business forever?
We are responsible for investing our fellow shareholders’ funds and we do not take this responsibility lightly. NAOS seeks to always act responsibly and diligently in all matters – from our investment choices through to our shareholder communications.
NAOS employees strive to make NAOS a success by taking ownership of their tasks and responsibilities. Most employees are also owners of NAOS.
As a company, we have committed to the Pledge 1% global movement; that is, to pledge 1% of our revenue, time and knowledge to movements and missions that matter. We want to make a difference and aim to contribute to economic, social and environmental change.
We believe in investing in businesses where the earnings today are not a fair reflection of what the same business will earn over the longer term. Ultimately, this earnings growth can be driven by many factors including revenue growth, margin growth, cost cutting, acquisitions and even share buybacks. The end result is earnings growth over a long-term investment horizon, even if the business was perceived to be a value-type business at the time of the initial investment.
Excessive diversification, or holding too many investments, may be detrimental to overall portfolio performance. We believe it is better to approach each investment decision with conviction. In our view, to balance risk and performance most favourably, the ideal number of quality companies in each portfolio would generally be 0 to 20.
As investors who are willing to maintain perspective by taking a patient and disciplined approach, we believe we will be rewarded over the long term. If our investment thesis holds true, we persist. Many of our core investments have been held for three or more years, where management execution has been consistent and the value proposition is still apparent.
We believe in backing people who are proven and aligned with their shareholders. One of the most fundamental factors consistent across the majority of company success stories in our investment universe is a high-quality, proven management team with ‘skin in the game’. NAOS Directors and employees are significant holders of shares on issue across our strategies, so the interests of our shareholders are well aligned with our own.
This means we are not forced holders of stocks with large index weightings that we are not convinced are attractive investment propositions. We actively manage each investment to ensure the best outcome for our shareholders and only invest in companies that we believe will provide excellent, sustainable long-term returns.
With the big four banks making up a large proportion of total domestic equity holdings for the SMSF investor group, many Australian investors are at risk of being overexposed to one sector and may be missing out on opportunities to invest in quality companies in industries such as media, advertising, agriculture or building materials. Australian listed industrial companies outside the ASX 50 are our core focus and we believe the LICs we manage provide pure access to these companies, which may be lesser known by the broader investment community.
We believe in taking advantage of inefficient markets. The perceived risk associated with low liquidity (or difficulty buying or selling large positions) combined with investor short-termism presents an opportunity to act based purely on the long-term value proposition where the majority may lose patience and move on. Illiquidity is often caused by aligned founders or management having significant holdings in a company. NAOS benefits from a closed-end LIC structure, which means we do not suffer ‘redemption risk’ and we can focus on finding quality, undervalued businesses regardless of their liquidity profile.
As an investment manager, NAOS recognises and accepts its duty to act responsibly and in the best interests of shareholders. We believe that a high standard of business conduct and a responsible approach to environmental, social and governance (ESG) factors is associated with a sustainable business model over the longer term that benefits not only shareholders but also the broader economy. NAOS is a signatory to the UN-supported Principles for Responsible Investment (PRI) and is guided by these principles in incorporating ESG into its investment practices.
NAOS are not activist investors; due to our investment approach it is common for NAOS to establish a substantial shareholding in a company with a long-term (5 years+) investment horizon.
This approach allows us to supportively engage with the boards and/or management teams of our portfolio holdings.
Examples of constructive engagement where the NAOS investment team look to add value:
Eureka Group is a rental village operator providing affordable living for independent seniors.
Eureka Group completed the NAOS ESG questionnaire during FY21.
The following examples were provided by Eureka Group.
“Eureka’s focus is on creating sustainable communities. The Board is developing an investing and environmental sustainability strategy to guide the Group over the next few years to deliver on its broader economic, environmental and social goals.”
(Excerpt from the Eureka Group FY20 Annual Report)
“As an outdoor adventure and tourism company, the Group is committed to protecting and minimising the impact on the environment, promoting environmental best practice operations and to achieving maximum sustainability.”
(Excerpt from Experience Co.’s Corporate Governance Statement)
EXP is an adventure tourism company.
Experience Co. completed the NAOS ESG questionnaire during FY21.
The following examples were provided by Experience Co.
A formal governance statement is in place and is adhered to.
Sebastian is a Director of NAOS Emerging Opportunities Company Limited (ASX: NCC), NAOS Small Cap Opportunities Company Limited (ASX: NSC), NAOS Ex-50 Opportunities Company Limited (ASX: NAC) and has held the positions of Chief Investment Officer (CIO) and Managing Director of NAOS Asset Management Limited, the Investment Manager, since 2010. Sebastian is the CIO across all investment strategies.
Sebastian holds a Master of Applied Finance (MAppFin) majoring in investment management as well as a Bachelor of Commerce majoring in finance and international business, a Graduate Diploma in Management from the Australian Graduate School of Management (AGSM) and a Diploma in Financial Services.
Robert joined NAOS in September 2009 as an investment analyst. Robert has been a portfolio manager since November 2014 and is currently Portfolio Manager across all NAOS LICs: NAOS Emerging Opportunities Company Limited (ASX: NCC), NAOS Small Cap Opportunities Company Limited (ASX: NSC) and NAOS Ex-50 Opportunities Company Limited (ASX: NAC).
Robert holds a Bachelor of Business from the University of Technology, Sydney. Robert also holds a Master of Applied Finance from the Financial Services Institute of Australasia/Kaplan.
Brendan joined NAOS in July 2021 as a Portfolio Manager. Brendan has over 19 years’ finance, accounting and M&A experience. Most recently Brendan had a 15-year career with ASX-listed marketing services business Enero Group Limited in finance roles and ultimately as CFO and Company Secretary for a 9-year period. Prior to that, Brendan spent four years at KPMG.
Brendan is a chartered accountant and holds a Bachelor of Business Administration and a Bachelor of Commerce from Macquarie University.
Jared joined NAOS in April 2021 as a Senior Investment Analyst. Jared has over 14 years’ financial services experience. Most recently Jared was an investment analyst at Contact Asset Management and prior to that spent nine years at Colonial First State.
Jared holds a Bachelor of Commerce majoring in accounting and finance, from the University of Notre Dame, Sydney, and is a CFA Charterholder.
Julie joined NAOS in November 2012 as Compliance Officer and in January 2021, commenced the role of ESG Officer.
Prior to joining NAOS, Julie worked within the compliance and performance teams at BZW Investment Management, Commonwealth Bank, Colonial First State and QBE.
Julie holds a Bachelor of Business majoring in finance and economics from the University of Technology, Sydney, and she also holds a Graduate Diploma in Applied Finance and Investment from the Securities Institute of Australia.
Richard joined NAOS in October 2015 as Chief Financial and Operating Officer. Richard has over 14 years’ financial services experience in the UK and Australia, beginning his career in London with Deloitte & Touche before relocating to Sydney in 2013.
Richard holds a BA (Hons) in Business Management from the University of Sheffield, is a fully qualified Chartered Accountant and is a member of the Governance Institute of Australia.
Rajiv is Head of Legal and Compliance at NAOS and holds a Bachelor of Laws (First Class Honours), a Bachelor of Business (accounting major) and a Graduate Diploma in Legal Practice from the University of Technology, Sydney.
Rajiv has over 11 years’ experience, having most recently held senior legal roles at Custom Fleet, part of Element Fleet Management Group (TSX: EFN) and Magellan Financial Group (ASX: MFG). He has also previously worked at law firms Johnson Winter & Slattery and Clayton Utz.
Rajiv is a member of the Law Society of New South Wales, an Associate of the Governance Institute of Australia and is admitted to the Supreme Court of New South Wales and the High Court of Australia.
Angela joined NAOS in May 2020 in the capacity of Marketing and Communications Manager.
Prior to joining NAOS, Angela held marketing roles for companies in both Australia and the UK, including SAI Global, American Express, Citibank, and Arete Marketing.
Angela holds a Bachelor of Communications majoring in advertising and marketing from the University of Canberra.
To be caretakers of the next generation we must actively support positive change. Supporting our commitment to ESG issues, NAOS Asset Management (the management company) donates 1% of recurring revenue to the community and the environment.
The Board of NAOS Small Cap Opportunities Company Limited is committed to achieving and demonstrating the highest standards of corporate governance. As such, the Company has adopted what it believes to be appropriate corporate governance policies and practices having regard to its size and the nature of its activities.
The Board has adopted the ASX Corporate Governance Principles and Recommendations, which are complemented by the Company’s core principles of honesty and integrity. The corporate governance policies and practices adopted by the Board are outlined in the Corporate Governance Section.