For most investors, 2022 was a tough year. For CY2022, the Australian Small Ords was down -18.40%, the S&P500 was down -19.40%, and the Nasdaq was down -33.10%. Our Australian All Caps fund did not fare better as we, in particular, experienced tough stock-specific declines, particularly due to de-rating multiples in small caps. However, investing is a long game and the law of mean reversion will likely come to the forefront again in 2023.
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For over 100 years markets have always risen to new highs after pulling back: the global march of progress means that, over time, investing in businesses is the best way to compound wealth despite short-term volatility and frequent downturns.

It is worth noting that both on a historical and fundamental basis, 2023 is shaping up to be a strong year for equity markets. Historically after such market downturns as last year, it is rare to see another consecutive year of large losses. In addition, if the US enters a recession this year as expected, markets tend to rally when recessions are announced as investors anticipate an earnings recovery. Finally, China reopening post its zero COVID policy, will be a strong tailwind for the Australian and global economy.

We know our investment process works. Our long-term results annualise as double-digit returns and we expect mean reversion to occur here too. We do not extrapolate one year of under or overperformance as to what we can do, but the average of many years. On that basis, we’re excited for the year to come.

Looking at our portfolio allocations, it’s important to stick to our principles and continue to invest in growing companies that have strong balance sheets to withstand a downturn and any cyclical businesses that may recover quickly in time.

We must remember that the strongest gains in markets tend to happen right after markets bottom, and since there’s no one there to ring the bell, timing the markets is impossible. This is why we remain invested and will outperform when markets recover.

We are now firmly of the view that the worst of this cycle is behind us and although markets may continue to be volatile in early 2023, we expect an overall strong performance during the year. As of writing, some of this optimism is already showing in the portfolio’s performance.

​​Here are three holdings we believe are set to rise in the coming twelve months.

Retail Food Group is a food services and brand franchisor. This investment is a special situation where a new management team are in turnaround mode. Since 2017, Retail Food Group has been shrouded in controversy and out of favour. Explosive allegations were made regarding the company’s dealings with franchisees following an investigation conducted by The Sydney Morning Herald. At the time, it was alleged that Retail Food Group failed to provide adequate financial information for the stores being sold to franchisees for those that operated stores such as Michel’s Patisserie, Donut King, and Brumby’s.

Understandably, the market reacted very negatively to the situation and floored the Retail Food Group share price down a crippling 98% within two years. Skip to now and the Australian Competition and Consumer Commission (ACCC) has completed its investigation and the company is moving ahead with a new management team.

Retail Food Group is well-positioned to grow earnings from multiple internal growth initiatives, as well as being better placed to attract new franchisees and commercial partners, which was previously impacted by the shadow of the ACCC investigation.

The results are beginning to show with profits this year expected to grow up to 35% to $29 million in operating earnings (EBITDA). During the past month, the company delivered good news with an agreed settlement with ASIC for previous misconduct. The outcome of circa $10 million was favourably below market expectations. Going forward we see Retail Food Group beginning dividend payments and resuming its store network growth. Additionally, Retail Food Group currently trades at a multiple half that of its peers, positioning the stock to re-rate if management continues to restore growth and goodwill.

After slower merger and acquisition (M&A) activity in 2022, stabilising market conditions this year will provide the right environment for these kinds of situations to kick off again. Additionally, with small cap valuations getting hammered in the past twelve months, some lucrative opportunities have risen for the right suitors.

Mayfield Education is a Victorian-based childcare provider with 28 centres. In 2021 the company acquired its competitor Genius Education for cash and script, making Genius its largest holder (35%). Then, during 2022 these acquired 14 Genius centres underperformed relative to the original Mayfield centres, the central reason for earnings to miss expectations and for any earnout payment to be cancelled.

Recently, Genius surprisingly made a takeover offer of Mayfield for $1.28 per share of the stock it doesn’t already own. The offer was quickly superseded by Busy Bees Early Learning bidding $1.35 per share. Busy Bees previously acquired Think Education (ASX: TNK) in 2021 in what ended up being a contested takeover battle.

The highest bid from Busy Bees only values Mayfield stock at approximately 11 x price-to-earnings (PE). The offer precedes what we expect to be an earnings recovery and doesn’t reflect the positive outlook for the company. We are sitting tight and waiting for the corporate activity to play out.
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Another holding within the sector is G8 Education, one of the largest childcare companies in Australia. The company released a positive trading update in December, with operating earnings (EBIT) of $71 million and net-profit-after-tax (NPAT) of $41 million. Year-on-year core occupancy improved to 77.3%. Management has also shown discipline with better cost control and managing labour shortages to achieve cost savings which mitigate inflationary pressures.

The balance sheet is also in a solid position with net debt at 1.2x operating earnings and, so far, $32 million has been spent on a share buyback initiative.

We see 2023 as a positive year for the childcare sector with both favourable government policies and improvement in occupancy levels as the COVID impact completely wears off. We also expect staff shortages to ease as the international visa backlog unwinds. Overall we see the sector re-rating on the back of improved earnings and dividends. With Mayfield on the verge of being acquired, we see G8 Education as an attractive alternative exposure to the sector.

Disclaimer: Retail Food Group (ASX: RFG), Mayfield Education (ASX: MFD), and G8 Education (ASX: GEM) are currently held in the TAMIM Fund: Australia All Cap portfolio.