Thank you to everyone who participated in Wednesday’s Investor Optimism Webinar. The Q&A ran a bit long and unfortunately we were unable to answer every question live. We’ve now responded by email to every unanswered query that came with an attached email address. We republish them below for the benefit of a wider audience.
For those who asked anonymously, we’re obviously unable to email you an answer but you’ll find a response below. We hope it finds you.
Question: Is the World in a similar place now to Japan’s 2 decade stagnation given world financial metrics?
Steve: Yes, I think there is a serious risk of the world turning Japanese and we are contemplating it when constructing our portfolios. I’ve written a couple of blogs related to the topic over the past few years.
First, debt is dangerous in a deflationary world. People think it’s costing them nothing because nominal rates are low but if the value of your asset deflates every year, debt will kill you.
Second, the best investments in Japan have been unlevered yield paying stocks. Probably no surprise but, particularly in Europe, there are still quite a few of these opportunities around. The Euro index yields 3.7%, the highest it has been in a long time.
I hope those couple of thoughts help. No doubt history won’t repeat exactly, but the Japan experience is certainly worth thinking about.
Question: Do you have a top down cash setting (eg if macro risks start to look worse/immediate), or is the cash weight purely an outcome from building the portfolio bottom up?
Gareth: Our cash weightings are definitely a function of the bottom up processes of finding new ideas and the speed of existing ideas reaching full value, rather than a top down view.
Of course, we try our best to consider top down risks within each investment we make, so it’s sort of a second derivative consideration. Cash normally drifts up as valuations become stretched (more profit taking, fewer new ideas) and drifts down as bargains become more prevalent. But it’s organic rather than to a plan.
Question: Does Motorpoint offer vehicle trade ins and if so what do they do with that stock?
Gareth: Yes they do, it’s a normal and essential part of the business. About 2/3rds of buyers bring a trade in into the deal, or ‘part exchange’ as they refer to them in the UK. As you may have been hinting at, because Motorpoint is focused on the near new category (< 2 years old), most of these trade ins are unsuitable to be sold on the Motorpoint retail lots. The company runs its own wholesale disposal group (Auction4Cars), which only registered motor traders can buy at (not a huge hurdle, Auction4cars have about 6,000 business customers). So Motorpoint can sell much of its unwanted stock, for example to dealerships specialising in older stock, and both seller and buyer do better than if it was traded through traditional (expensive) wholesale channels like BCA Marketplace.
Motorpoint does preparation work to maximise the sale value of these cars. This has historically been done at the backend of each of their retail sites. But they’re currently undergoing a transformation to centralise a lot of this prep work, both to improve prep and to free up space at retail sites to sell more near new cars. It’s a part of the bull case for the stock – the early financial indicators are very good.
This trade in resale business is profitable for Motorpoint but lower margin than retail used car sales (gross margin estimated 5% versus ~7.5% group average), at least in part because there’s limited associated margin from financing etc. It makes up about 15% of company sales by value (and I’d guess a little more than 1/3 by volume)
Question: Forager is now the largest shareholder in MSL solutions. Just wondering how active forager is being in this business model. A venture to the middle east office was quite confusing from the company.
Jeffrey: We have for some time been critical of the misleading reporting and ineffectiveness of the prior management team. You’ll note that in the past year, three MSL Solutions directors have resigned, Tony Toohey was appointed Executive Chairman, Patrick Howard was appointed CEO and David Marshall was appointed CFO/COO. This is a position we’re continuing to monitor closely and we engage with the board and management team on a fairly regular basis.
Question: How do you like the new iselect ad tv? Is is brilliant or does it jar? Do they need Enero?
Alex: The new iSelect ads are a lot better than the campaign they had early 2018 which led to the disastrous downgrade (and allowed us to buy stock). iSelect isn’t working with Enero but they did change agencies and appointed a new chief marketing officer. It’s an important part of their business – the ratio of marketing spend to revenue (which they now disclose in their presentations) is something we look at closely.
Question: What type of time frame are you looking at to turn a profit in your what seems multiple investments in the transport theme both locally and internationally and would the time frames be different.
Gareth: Generally, all our stock purchases are made with a long term perspective. And if the company is growing and becoming more valuable with each passing year, we’re unstressed if that discount doesn’t close quickly (deep value, cigar butt type investments are a different matter). So we buy with the long term in mind, but of course we might sell it sooner if the discount closes quickly or if it becomes obvious we made a mistake or if we find even better ideas elsewhere.
Our auto related investments are no different. We’ve made good money out of some of them already – Auto Trader and Motorpoint in the international fund, and carsales.com.au locally. Linamar and Lear will take longer. I think we’ll know if we’ve made a mistake or not within 2-3 years.
Question: View on Copper?
Harvey: We don’t have a strong view on the near term fundamentals for copper and it will be heavily dependant on the China/US trade war and overall economic activity trends. I don’t think that our mid/long term view is different from the consensus one out there, i.e. trends are positive given increasing demand for electronics and so forth.
That said, we do like some of the mining equipment supplier names that are heavily geared towards copper production and have one on our watchlist (Epiroc, which spun out of Atlas Copco last year). It’s a high quality razor/razorblades-type model. Unfortunately the share price has had a strong run this year, we’ll look closer at the 80-85 SEK level.
Question: How do you guys think about ESG? Does it form any part of your decision making process?
Gareth: Steve promises to write a blog on this matter in the near future explaining our thoughts in more detail. We’ve long said we don’t use an ethical filter and are prepared to invest in pretty much anything that the law allows to be listed. But the realities are more nuanced. ESG is becoming more and more important from a risk perspective, and we absolutely consider it in this regard. So while nothing is stopping us buying tobacco and coal mines from an ethical perspective, we’re very cautious about it because these businesses face immense risks from a changing world.
Question: Hi, I’m just wondering if the thesis is still holding on NZME? It’s been quite some time since entering the position and just wondering on the progression
Alex: We continue to be shareholders in NZME. It has been a tough advertising environment in New Zealand and the structural decline in the print business has continued. But there were a few positives from their recent results. Radio grew for the first time in quite a while and subscription and classifieds revenue started to contribute (for now these are very small). The oneroof classifieds business especially can become a valuable part of the business as it challenges the dominance of trademe in property listings. Longer term the dominance of the NZ Herald should see higher revenue from online subscriptions and online advertising helping to offset print revenue decline.
Question: What do you think of a stock like Afterpay and how come you missed out?
Gareth: Stocks that go up 10x in a few years are rare beasts. Most of us miss most of them and I don’t lose a wink of sleep over it. It’s not our core type of investment. That said, the explosive growth in Afterpay has been fascinating and we’re not an uninterested party. Our international fund is the third largest shareholder in ThinkSmart in the UK, which started Clearpay a few years ago. Thinksmart sold 90% of Clearpay to Afterpay last year to become the vehicle for the latter’s growth in UK and Europe. It’s growing like a weed. Thinksmart retained 6.5% of Clearpay and we hope to profit handsomely from it. Growth stocks are no anathema to us, we just don’t like paying up for them. Look out for more in the November report out any day now.
Question: The world’s distaste for fossil fuels as a source of energy is accelerating. Are you still comfortable with your oil exposure given this?
Gareth: In the international fund at least, our exposure to oil has come down quite dramatically recently. That’s more a function of the opportunities we’re finding elsewhere than a direct view on the outlook for oil.
We’re cognizant of the risk. The way the oil market has operated the past five years really appears to be coming from a supply shock (glut caused by shale) than a demand drought. The world is having no problem finding ways to burn a little more oil each year, although we recognise the lower prices might encourage that demand. I don’t rule out an abrupt change in the future but we’re not seeing it so far.
Question: Outside of the trade war, the Chinese economy is showing escalating signs of stress (bond defaults by SOE’s, liquidity issues with small and medium banks particularly in the Shenzhen province). How are the respective portfolio’s positioned in this regard?
Harvey: We have relatively limited direct exposure to the Chinese economy, with the exception of Oriental Watch, Yum China and HopeFluent. There is also some indirect exposure through international names such as IPG Photonics. Our overall exposure to the country (direct and indirect) is approximately 6-7% of our total portfolio.
Needless to say, we are monitoring the situation and leading indicators there pretty closely. The November manufacturing data actually surprised to the upside, suggesting that (at least over the near term) the government’s monetary push has been able to increase demand and animal spirits to a small degree.
Question: What’s your take on China, in current environment, de-leveraging, trade tensions, slowing but still relatively high growth, Xi’s big plan for global dominance in 2025, etc. Would you go hunting there for opportunities? Any emerging thesis?
Harvey: Note that we have relatively limited direct exposure to the Chinese economy, with the exception of Oriental Watch, Yum China and HopeFluent. There is also some indirect exposure through international names such as IPG Photonics. Our overall exposure to the country (direct and indirect) is approximately 6-7% of our total portfolio.
Needless to say, we are monitoring the situation and leading indicators there pretty closely. The November manufacturing data actually surprised to the upside, suggesting that (at least over the near term) the government’s monetary push has been able to increase demand and animal spirits to a small degree. The Li-Keqiang Index, which tracks bank lending, rail freight, electricity consumption etc has also recovered from the lows.
We are not China bulls per se, we just feel that there are some China exposed names that got slaughtered recently due to the troubles in HK, trade war, pause in capex / automation investment etc. that remain solid structural growth stories over the mid-term (IPG Photonics) or have some sort of asset backed upside (i.e. Oriental Watch). We do see an opportunity in various Chinese Internet / technology names (where we are kicking the tires on a few ideas) and the “westernisation” of the Chinese consumer as well, hence our position in Yum China (that owns KFC and Pizza Hut).
P.S. Did you know that Coffee consumption in China is less than four cups per year. In the US, it is 300!
Question: Thoughts on the AUD?
Steve: Just quickly on the AUD, my guess is today’s level is roughly right. It’s very simplistic but I base my view on how expensive things are here relative to other places I visit on my travels and that has historically been fairly useful. At these levels, most places I go are expensive again.
Australia should be quite competitive at 67-68 and with strong demand still for commodities I don’t think it needs to fall dramatically further. That doesn’t mean it won’t, but if it falls back to 50 something we will probably be looking to implement more AUD hedging into the International Fund.
Harvey: We quite like the Nintendo business but feel it is fairly valued at current levels. We would certainly look closer if the stock trades down from here but how the company plans to follow up to their successful Switch product is a question mark. Our favourite video gaming position at the moment is Sony, which continues to trade at a significant discount to its underlying sum of the parts value.
Question: With the UK Auto Trader do they have much debt helping the good ROE?
Gareth: If anything, Auto Trader is undergeared, although I have absolutely no qualms with that and would run it that way myself. It has net debt of around £300m and could entirely repay that debt with about 18 months of free cash flow. Its operating profit covers its annual interest bill more than 30 times over. I’m not at all worried about debt and the incredibly high return on equity is a function of business economics rather than leverage in this case.
Question: Thanks for these seminars they are a fantastic way to stay in touch. I just looked up a quote from Peter Lynch given the low cash weighting “I’m always fully invested. It’s always a great feeling to be caught with your pants up” – so for myself, I would rather see money invested rather than sitting idle. With stocks that do ‘run’ such as Blancco – do you think that selling it down (similar to Enero in the Aust fund) is the best approach? I do understand it is most likely the best approach for risk aversion for the fund, but is it the best approach for absolute gains? There is another quote from Warren Buffett “Selling your winners and holding your losers is like cutting the flowers and watering the weeds”. Is it better to just let them run over 5/10/15 years?
Gareth: Thanks for the feedback. The when to sell question is a constant battle, something we’re always thinking and talking about. We’ve gotten better at letting them run, but we do also have to keep portfolio risk at front of mind. Our Blancco position would be well over 15% of the fund by now if we hadn’t trimmed. I don’t have a clear answer, just know it’s a question we’re always asking ourselves.
Question: What themes to you see value in stocks for 2020?
Steve: I wasn’t 100% sure whether you meant value as a theme or what themes we thought were good value.
In any case, my record at picking the next 12 months is spotty to say the least! I think there is great value in the UK, and with any sort of Brexit/political resolution over the next few days, 2020 should be a good year for that market.
And like we talked about yesterday, I still think there is good value in some cyclical businesses. If we’re right about that, tech and defensive sectors could struggle.
Either way, we’re focussed on the next 5 years and think the opportunity set is reasonably good as we sit here today.
Question: Can you speak to ‘fishing where the fish are’? I’m not sure that the Australian and English markets, where you seem to be fishing, are the most undervalued, unloved markets.
Gareth: Oh don’t leave me hanging! Where else shall we fish? We’re always open to different waters. That said, I disagree re the UK. It’s been stand out cheap for a developed market the past few years. And while I would have said 6 months ago that our track record is patchy, that’s turned pretty sharply in recent months. We have been finding good businesses there at less than 10 times earnings. We’ll see.
Question: In the international fund how do you decide what regions to invest in?
Gareth: Where we invest is really decided by three factors:
Our own knowledge and skills
We’ve been longer Europe and the UK because we’ve found cheaper stocks there than in the US, for example, because of things like the Euro crisis and Brexit. More recently, though, we’ve added positions in the US and Asia because of the addition of Paul Quah and Harvey Migotti to the team, bringing a different set of experiences and skills to our group.
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