Looking for growth outside the ASX100
Small caps have outperformed blue chips this year. Here’s some opportunities outside the ASX100.
Morningstar Market Strategist Lochlan Holloway recently authored a report “The Most Hated Rally Takes a Healthy Breather”. The report highlights the recent hiccup in markets following a significant run led by AI. The sell off has blunted this year’s bullish run on the ASX200, now returning a meagre 4% year to date.
Aussie Blue Chips have led the downward trend. Macquarie, Commonwealth Bank and Wesfarmers have all seen share price declines of 10% or more in the past month.
Halloway notes that global equities have looked stretched, especially in Australia where we have enjoyed the AI run without any fundamental driver. Blue chip valuations are falling back to reality while small caps have generally outperformed.
Small cap shares returned 18% YTD (XSO index) compared to a 3.3% return for ASX100 (XTO index). The key for investors when looking outside the 100 largest companies in Australia as represented by the ASX100 index is avoiding low quality companies with dried up earnings. Picking high quality businesses in the small-mid cap sector provides a runway for share price growth. Let’s have a closer look at 3 of the 11 shares identified in the report that reside outside the ASX100 and meet certain ‘quality’ metrics.
Pexa (ASX:PXA)
- Fair Value Estimate: $20 (28% discount at 2 December)
- Rating: ★★★★
- Moat: Wide
Pexa is a property settlement exchange that dominates a monopoly in Australia. The electronic platform allows lawyers, conveyancers and financial institutions to streamline the process of buying, selling or refinancing a property. Wide adoption of Pexa’s platform was led primarily through the co-ownership by the Australian banks and state governments.
With its Australian market almost fully saturated, a key growth driver will be the expansion into the UK in 2026. According to our analyst, the market seems to have ascribed no value to the UK expansion given the difficulty of breaking into such a sizeable market. However, ongoing risk of failure in the UK is within manageable territory and holds significant upside if successful.
The network effects of early adoption have created substantial benefits for Pexa whose platform experiences a pull effect across the ecosystem. This dominance is why Morningstar assigns a wide moat rating for the Australian business. Pexa has 90% market share of total transactions in the Australian property market while Pexa’s main digital competitor, Sympli, has less than 1% of total transactions. Pexa enjoys the benefits of high switching costs and low sensitivity to price increases which increases with inflation.
Bapcor (ASX:BAP)
- Fair Value Estimate: $5 (53% discount at 2 December)
- Rating: ★★★★★
- Moat: Narrow
Bapcor is a leading provider of automotive parts primarily in Australia, New Zealand and Thailand. The company operates across several brands you may be familiar with including Autobarn, Midas and Burson Auto Parts. The share price has fallen 51% this year following a slump in net profits caused by both operational and financial challenges. Poor integration of acquisitions has led to increased complexity and neglect of the core business. As the CEO Angus Mckay put it, the company is dealing with – “the sins of [Bapcor’s] past”.
The company is currently undertaking a simplification of the business structure and focusing on cost reductions. Management is also focusing on investments that drive competitive advantages in the trade network which is Bapcor’s largest segment.
The trade segment which includes distribution of automotive parts to mechanics and workshops, is where Bapcor lead the market with 27% market share in Australia. Stickier customer bases in the professional network mean better pricing power, which drives greater returns at the bottom line.
The recent sell off has pushed Bapcor into materially undervalued territory compared to fair value. Our analysts forecast profitability improvements and revenue growth compounded by the company’s strategic ‘turnaround’ - albeit an uphill battle from here. The fall in share price has also pushed the current yield up to 6% fully franked.
Spark New Zealand (ASX:SPK)
- Fair Value Estimate: $3.30 (39% discount at 2 December)
- Rating: ★★★★★
- Moat: Narrow
Spark NZ is the largest player in the telecom sector in New Zealand. Similar to how Telstra operates in Australia, Spark provides mobile and broadband plans to both residents and travellers of New Zealand. The company generates revenue in three core segments being: mobile, fixed line and IT products & services. Spark’s moat is derived from its mobile business which generates around 60% of earnings. The mobile division is benefited from the company’s superior network scale which is important when considering the dispersion of the population across New Zealand.
Spark competes with two privately owned companies being Vodafone/One NZ and 2degrees. The relative threat of another competitor entering the ring is low due to the upfront costs associated with establishing a network at scale.
The share price has struggled over the past year, down 25% year to date. The main reason is weaker earnings as Spark deals with challenging economic conditions in New Zealand as well as underperforming segments such as the IT division. Despite this, our analyst see a stable long term outlook for the company and opportunities for the business to reignite earnings growth.
The key focus from management is driving growth through the mobile segment. In addition, the company aims to extract further operational efficiencies from simplifying the business structure. The company has a strong balance sheet which underpins a solid dividend payout policy. The reduction of the share price has pushed the yield higher, now at 11% (no franking). This yield is expected to normalise to 6-7% over the medium term.
Wrap up
With small cap shares currently outperforming blue chips, it may be time to reevaluate the heavy concentration at the top end of the market. As highlighted by Lochlan, picking smaller cap companies comes with greater risks. To avoid businesses with dried up earnings and no runway for growth, we pin our focus on quality companies. The three companies discussed today are examples outside the ASX100 with moats and a potential runway for future earnings growth.
