In this week’s video insight I joined Montgomery’s head of distribution Scott Phillips to discuss two stocks we currently hold in the Montgomery Small Companies Fund including insurance broking, underwriting agency and risk management businesses AUB Group (ASX:AUB) and lithium producer Allkem (ASX:AKE). AUB Group falls into the category of stable compounders, those businesses with defensive growth characteristics. And we think Allkem is very attractive in the lithium sector.

Transcript

Scott Phillips:

Welcome to this video Insight. I’m Scott Phillips from Montgomery, and with me today I have Gary Rollo, Co-portfolio Manager for the Montgomery Small Companies Fund. Welcome, Gary.

Gary Rollo:

Thanks, Scott.

Scott Phillips:

Look, I thought I’d take us on a bit of a journey today on a couple of stocks, looking at the Fund’s top 10 holdings at the moment and trying to get some thoughts on some key positions, given there’s been a lot happening in the market. AUB Group (ASX:AUB) is one of the largest holdings in the Fund. Can you talk me through what’s going on with that business? You did buy it. It looks like, after a transaction occurred, when there was a pullback in the share price, it’s run strongly. How do you see this stock playing out and what sort of role does it play in the portfolio?

Gary Rollo:

Yeah, that one, Austbrokers is the company, it’s one of what we call stable compounders. So really the attributes we’re looking for there are defensive growth characteristics with some, what we call latent optionality that gets us paid for holding that stock. So in the case of Austbrokers, we got involved because we saw three things. We saw the potential for robust revenue growth and we thought the transaction would produce scale that would lift margins, and we saw a valuation regime that didn’t make sense. I think this story will take a couple of years to play out as the full benefits of the acquisition come through and that valuation gap narrows and that’s why it’s still in the portfolio because there’s still some more to go. So that’s a big picture of what it’s doing.

Scott Phillips:

And I know you’ve described stocks before, that are playing particular roles. Is this a good example of a stable compounder that’s growing above market trend?

Gary Rollo:

That’s exactly right. And not all the stocks can be superstar rock stars. What we’re looking for, this part of the portfolio to do, is steadily beat the market and then when some valuation angle crystallizes, we get a significant uplift, and I think with this case, with Austbrokers, that’s the thing that’s going to play out.

Scott Phillips:

Okay. Gary, moving along now to one of the hottest sectors in the market is  electric vehicles (EV) and lithium, and going through our top 10, as I said, when I looked at the As we can go to Allkem. Big merger been announced, what’s your take on it and where to from here?

Gary Rollo:

So set the scene, I think, with Allkem (ASX:AKE). Allkem, as you said, it’s a lithium producer and there is a proposed merger of equals with a company called Livent in the U.S., another lithium producer, and that sector is consolidating. We think Allkem is a very attractive asset in the sector. I guess the real thing we need to look at with this transaction proposal, as with any merger, is who gets what? So that’s where we’re at with this one.

Scott Phillips:

So Gary, who decides who gets what in the merger?

Gary Rollo:

Fair question. So the proposal that’s been put in front of shareholders is for Allkem to get 56 per cent of the business and Livent shareholders, 44 per cent. And really, to assess whether or not there’s value in that transaction, as an Allkem shareholder, what you’ve got to do is look at, is that right and fair, I suppose. But when we consider that Allkem delivers something like two-thirds of the production capacity, if we look at the ore bodies, the ore body sizes are more than twice the size of what Livent is bringing to the table. That’s not really reflected in the valuation allocation about who gets what. So I think there’s going to be a lot of work that needs to be done by the Allkem board to explain why this transaction is actually fair and reasonable. Otherwise, this is a consolidating sector, someone else could come in and take this value.

Scott Phillips:

Okay, so for the moment you’re holding onto your position and looking at how this plays out.

Gary Rollo:

For sure. Allkem, we think it’s an attractive asset. This sector is consolidating. There are plenty of big mining companies that don’t have lithium in their portfolio, that if they were looking to do so, Allkem would be a perfect candidate for that. So I think there’s time to work out if you’re going to get paid the right value or another scenario will play out.

Scott Phillips:

All right, so that’s Allkem and AUB, two key positions in the Montgomery Small Companies Fund. That’s all we’ve got time for today. Remember to follow us on Facebook and Twitter.

Gary, we’ll talk to our audience soon.

The Montgomery Small Companies Fund own shares in Allkem and AUB Group. This video was prepared 18 May 2023 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade these companies you should seek financial