Leading fund managers have gathered in Melbourne’s Hamer Hall for the third Australian Sohn Hearts and Minds investment leaders conference. Here are their best ideas:
Blake Henricks, Firetrail Investments: Nufarm
Why buy Nufarm? Industry consolidation and Omega 3. Nufarm has become undervalued because of the Australian drought and their distribution of a specific weed killer commonly used in crops. The company has had two stumbles, but Mr Henricks believes it presents great value at today’s prices. The industry is now more consolidated than the Australian banking market. That means Nufarm can take organic market share as competitors are distracted doing M&A, in short, Nufarm is a beneficiary of industry consolidation.
Nufarm has a technology which earns nothing today but is worth $1 billion according to Firetrail. Humans rely on small fish as a source of Omega 3, growing around 6 per cent per annum. Henricks expects no increase in ocean based supply of Omega 3 because of over-fishing. But it can now be grown from plant-based canola and Nufarm can take 20 per cent market share of that supply gap.
Most of the regulatory approvals have come through, and it is trading on less than seven times EV to EBITDA today because the market has over-reacted to the drought and glyphosate concerns. One of the great strategies is to buy in drought and sell in rain, Mr Henricks said. He strongly believes Nufarm is well placed around all reasonable scenarios related to glyphosate outcomes. Valuation of $10.40.
Emma Goodsell, Airlie Funds Management: Reece
In May, Ms Goodsell says she woke up to the ten most terrifying words on Australian investor can read – equity raise to fund large offshore acquisition from private equity. “I had visions of half eaten Bunning sausages lying on the floor in the UK rain,” she said, in reference to Bunnings’ doomed purchase of UK home improvement chain Homebase.
But she says there is sound logic to Reece Ltd’s $1.9 billion purchase of wholesale plumbing chain MORSCO. One of the reasons is that Reece is a owner-managed company – a subset that has delivered twice the returns to shareholders compared to the broader index.
The Wilson family, which still has a substantial stake in the $6 billion company, have managed to handily outperform their main rival Tradelink. Over the past 20-years, Reece’s sales are are up 6 times and profits are up 18 times, while Tradelink has traded flat.
“They have maintained fantastic returns by investing in the business,” Goodsell said. She says increased margins and store roll outs in the United States can add up to $4 to its current $10.77 share price.
Nick Griffin, Munro Partners: Amazon
Mr Griffin says Amazon may have been the second company to hit a $US1 trillion valuation, but he expects it to be the first to hit $US2 trillion.
“That’s a fairly bull market statement,” he told the conference, but while the fund has owned the e-commerce and world’s largest cloud computing stock for years, it is still its best stock idea.
Griffin says the big problem for investors has always been Amazon’s valuation. But he says its valuation has been relatively stable around 20 times earnings before interest tax depreciation and amortisation (EBITDA), which is just a 40 per cent premium to a standard consumer company.
He also questions the commonly held view that the stock is overvalued because it doesn’t make any money: he points out Amazon hasn’t undertaken a capital raising since it listed, and is able to entirely fund its growth.
Griffin says Amazon sits at the start of two “growth runways” and notes it has about a 10 per cent share in two rapidly growing sectors: cloud computing and e-commerce. “Amazon’s growth is being driven by two structural trends and they are both in the their infancy,” he said.
He noted that Amazon has 109 data centres around the world, and 50 per cent share of the public cloud market. As well as growing its market share, Griffin expects Amazon will grow its margins, noting that it only generate 5 per cent margins in its e-commerce division at the moment.
Griffin predicts Amazon’s EBITDA is growing to go more than three fold in next seven years, and ascribing a 17.5 times multiple he forecasts it will have a $US2.3 billion enterprise value by 2025.
Scott Bessent, Key Square: macro views
Three forces driving macro investing: Bessent won the crowd over by saying if you could be long any asset in the world he would be long Melbourne. His presentation, ‘the divorce, the disruptors and the divergence’, was macro in theme.
The former professor said when the candidacy of Donald Trump was announced, he was sure of a Trump victory – “The hardest part of macro investing is distinguishing between what you want to happen and what’s likely to happen”. The divorce refers to China and US relations, a theme which will drive 2019 and maybe the next decade.
As it is, he tells anyone who comes into his office with a European idea to “get the hell out”. But the new government in Italy is a wake-up call, he says. The bull case for Europe relies on cracking open fiscal spending, as Europe is the only place not doing a fiscal spend. In the US, “we have blown the doors off”.
The divergence refers to the “orange swan” a rare creature who likes to hiss, has good instincts and many characteristics of a black or white swan. President Trump has also however overseen a drop in regulation, creating a perception the government is on the side of business. The White House is trying to entice the Democrats into an infrastructure program.
“An alternative outcome is the Democrats become a confidence killer in the economy.”
Trying to assess the Australian dollar, he starts with, ‘where is the currency relative to its long run real exchange rate, its purchasing power?’ “Aussie dollar is not cheap, not expensive now”. He spends a lot of time on plumbing, meaning the financial sector and economy – GDP has remained remarkably resilient, he said. “This is the first time in my career that US rates have been higher than Australian rates,” the 56 year old said.
Finally, “when you’re sure, do twice as much.”
Tim Carleton, Auscap Asset Management: JB Hi-Fi
“How do we get comfortable buying a retailer, even a high quality retailer like JB Hi-Fi when it’s facing these issues?” the fund manager began, referring to house prices and Amazon. He is long JB Hi-Fi, taking the other side of sizeable shorts against the stock.
Mr Carleton says fears about the rise of Amazon and falling prices make JB Hi-Fi, the retailer that is the most shorted stock on the market, a screaming bargain. The retailer is well run, highly cash generative and most importantly cheap at 11 times forward earnings.
JB Hi-Fi was pitched as a short idea at the 2017 conference by Regal’s Phil King, partly because he anticipated Amazon would disrupt its bricks and mortar model. But Carleton says the retailer is out-competing Amazon on headphones, games and latptops and is attracting more eyeballs to its website.
He also strongly believes that the strength of the Australian economy is being understated. The correction in house prices has been triggered by a tightening of credit – “a sensible long term objective.”
“We are forgetting about a number of economic positives – household wealth is at all-time highs and a 20 per cent drop in house prices would only take us back to 2016 levels.
Crucially, Australia’s population growth is healthy and there is still positive inflation – which provides a positive medium-term forecast for retail sales. “We are in a technology super cycle and this is the company that is going to sell us our gadgets we are going to need for the next twenty years.”
Kok Hoi Wong, APS Asset Management: Venustech (002439:CH)
China’s dominant cyber security firm Venustech is Kok Hoi Wong’s pick, and he says it’s better than just a strong growth stock: it’s also recession proof and undervalued.
The fund first got interested in the sector after the Edward Snowden affair, and since 2014, has visited Venustech 15 times and talked to the company more than 50 times. Venustech is the largest cyber security company in China, with an 8 per cent market share.
At a broad level, APS argues the Chinese are massively under-invested in cyber security, noting cyber security capital expenditure to IT was just 1 per cent, compared to 6 per cent in the US.
The fund is also impressed with the talent at Venustech, with about 30 per cent of 4000 staff having doctorates or masters degrees, including the founder. Venustech has a broad customer base, it services 80 per cent of government institutions, banks and 60 per cent of the top 500 Chinese companies. As well as taking market share, another source of growing earnings is the SME sector, where the adoption of cyber security is only 35 per cent compared to 80 per cent in the US, and winning contracts for cities.
“This is a strong buy… paradoxically, the more Sino-US relations worsen the higher the earnings visibility of this company,” he says.
The valuation is compelling at 23 times next year’s earnings.
“While some people speak of building walls, China built one 2000 years ago… today China is building a new wall in cyber space, a wall you can’t see and touch, but very possibly profit from.”
APS, which manages more than $US2 billion mainly for institutional investors, was founded in Singapore in 1995 and was among the first foreign investors in China. At Sohn’s Hong Kong conference in May, the stock pick was going short JD.Com, on the basis of an overhyped share price and a CEO that made “reckless and silly” acquisitions.
“There’s almost no prospect of JD making any profits for the next few years… yet the stock is still selling at five time NAV. Why so many institutional investors still hold the stock is very puzzling to me.”
Steven Glass, Pengana: Kar Auction Services (KAR:NYSE)
Kar is mainly an auctioneer for commercial customers in North America. Its Adesa unit is an auctioneer of whole vehicles with 30 per cent market share, and the two largest players have 70 per cent share in that market. Another business, IAA, has 40 per cent market share and handles the the category of salvage vehicles. Kar operates in essentially duopoly markets and is a major player in all. That being so, it will spin-off IAA in 2019.
Finally, its AFC unit supplies car financing: “this business is not as risky as you might think,” the fund manager says. To give you a sense, AFC was profitable in 2008 and 2009, so “don’t let this business distract you from Kar,” Mr Glass urged.
“I love network effects,” he continued, and “Kar clearly has network effects.” Namely scale, owing to the need to operate numerous large facilities to provide vehicle repair services and inspections. “The key message is Kar has sustainable competitive advantages.” Its market multiple is just 18 times earnings, and 6 per cent free cashflow yield.
However, there are two structural bear arguments: vehicles are becoming safer, and there will be a decline in vehicle ownership owing to car sharing services. The problem with this argument is miles driven is actually the key driver of Kar’s volumes.
More to come