While the past year has seen stock price corrections across the electric vehicle (EV) sector, 2023 looks to be a transition year for the underlying businesses themselves. EVs are going mainstream as manufacturers across the globe are ramping up production. For the keen growth investor, the sector is made up of more than just manufacturers: microchips, artificial intelligence and autonomous vehicle systems can also be considered part of the EV industry.
The last twelve months continued to see growth for the EV market, not only in key markets, but also in the rest of the world, including Australia, New Zealand and South Korea. EVs made up 10% of all new cars sold globally in 2022. Europe and China are leading the way, with fully electric vehicles accounting for 11% and 19% of all new vehicles sold, respectively.
With stock prices down and sales continuing to rise, let’s take a look at some key players that investors could consider in 2023.
Tesla: still fascinating the world
Source: Electrek.com
Even after a fast share price recovery to start 2023, Tesla stock is still down almost 33% over the past 12 months. The company is out to prove it remains the EV industry leader and is making moves to swallow up more market share.
Tesla’s latest earnings report capped off a tremendous year, posting record profits and cash flow, despite numerous challenges from global supply chain kinks, to shutdowns at its Shanghai production facility due to rampant COVID-19 cases in China, to CEO Elon Musk’s high profile takeover of Twitter.
In the Q4 2022, Tesla recorded year-over-year revenue growth of 37% to US$24.3 billion, translating to net income of US$3.7 billion. Whilst free cash flow for the quarter declined against the corresponding period in 2021, this was mainly due to a step-up in inventory between the third and fourth quarter of 2022. The US$7.6 billion of free cash flow for full-year 2022 represented a 51% jump from 2021, in which Tesla generated just over US$5 billion in free cash flow.
It’s clear that Tesla’s operating performance is strengthening. Maybe not as much as some analysts and investors hoped, but that’s why the shares have become less egregiously priced. Some feared Tesla’s recent vehicle price cuts across its sales regions indicated a drop in demand that signals a slowing business. But investors should look at results, and not just what prior expectations from analysts have been.
According to Musk during the company’s earnings call, demand continues to outstrip the supply, and Tesla is focused on ramping up volume while decreasing manufacturing costs.
Musk said:
“Thus far in January, we’ve seen the strongest orders year-to-date than ever in our history. We currently are seeing orders at almost twice the rate of production.”
The company’s strategy is to attempt to hold market share and deliver high volumes of vehicles. Even as its margins slide somewhat, Tesla will have those customers and potentially be able to upgrade those units with higher-margin automation in the future. It’s still a long-term growth story to be played out over many years to come.
Nio: China’s answer to Tesla
Source: Nio.com
Chinese electric car maker Nio (NYSE: NIO) was one of the hardest-hit EV stocks in 2022. The company has been publicly traded since 2018 and is not shy about battling Tesla for market share in the biggest global markets.
Similar to Tesla, the company is more than a simple car manufacturer. The company designs and manufactures premium EVs with a focus on battery technology, connectivity, and autonomous driving. It also offers EV charging solutions and other services, including insurance, maintenance, roadside assistance, and an enhanced data package.
Nio has built its customer base partially by offering its Chinese customers more than just smart EVs. Its SUV and sedan models are sold with an option to use a subscription for swapping drained batteries for fresh ones in just minutes (Batteries as a Service, or BaaS). The strategy lowers the initial cost to customers and differentiates Nio from its competitors. It also has aimed to build a loyal following with Nio Houses and other gathering spaces many Chinese consumers have embraced.
The company is now building out that model across Europe. To date, Nio has more than 35 service centers in the EU along with several Nio Houses, battery swap stations, and other charging infrastructure.
In lieu of these exciting concepts, Nio continues to be a loss making company. Nio recently reported a quarterly record of 40,052 units delivered, generating revenue worth US$2.3 billion but this growth is yet to translate to a profitable bottom line.
Gross margin compression and a muted outlook for the next 6 months attracted several analyst downgrades. However, investors wouldn’t want to write off the stock just yet.
Nio is transitioning its EV models to a second-generation technology platform, NT2.0. This means that the company was busy selling down older inventory in the last quarter and reportedly also offered incentives to customers, which added to its costs. Additionally, Nio is still preparing its manufacturing lines to produce the new models, which is a major reason why it sees lower production and fewer deliveries in the first quarter.
Nvidia: on the way up
Source: Nvidia.com
Only a decade ago, Nvidia (NASDAQ: NVDA) had a solid albeit unspectacular business,
making best-in-class semiconductors for PC and console gaming. But calling Nvidia just a graphics chip maker would be like calling Tesla just a car company. Sure, it’s an accurate description, but it doesn’t really do the business justice.The software Nvidia engineers developed to render light and physics for game graphics became the foundation for a new computing model based on artificial intelligence. Nvidia made the AI platform open source to entice academics and developers to buy-in. The strategy was a huge success, moving Nvidia hardware beyond gaming into super computers and data centers.
While data chip centres and gaming contribute the majority of company revenue, Nvidia’s researchers have built algorithmic models capable of solving complex problems, like autonomous vehicles. CEO Jensen Huang unveiled an autonomous vehicle (AV) computer in 2017 that was no bigger than a lunchbox but still capable of processing 320 trillion instructions per second, enough horsepower to process data from real time sensor streams, and then push everything up to the cloud for further analysis.
Fast forward to today and the technology has resulted in hundreds of development partnerships. Today Nvidia has engineers working on AV technology with Volkswagen, Audi, Toyota, Hyundai, Volvo and Mercedes-Benz.
Even in the wake of a strong rebound in recent months, shares in Nvidia remain well below their all-time high. Nvidia’s chips have a plethora of potential uses in things like metaverse technology, AI, and autonomous vehicles. Revenue from the professional visualisation and automotive segments grew by 65% and 86%, respectively, year over year in the latest quarter
Nvidia is a hardware company that made the transition to AI software. It is an opportunity to invest in the “picks and shovels” of the new automotive economy as its software/hardware solutions become the brains of many of the world’s best brands.
Australia’s big four banks recently released their financial results for the first half of the 2023 financial year (second half of the 2022 calendar year). While the share prices of ANZ, NAB and Westpac are largely unchanged from a few years ago (and CBA has shown a healthy increase), operationally it’s been a tumultuous period given the effects of the pandemic and dramatic changes in the housing market.
Overall, the banks’ profits were significantly higher than the prior corresponding period (the first half of FY22), mostly due to lower impairment charges (the banks took ‘provisions’ for expected loan losses during the early part of the pandemic, and because the economy has recovered more quickly and strongly than expected, they were able to reverse most of these provisions in later periods). Banking is a cyclical business though, and banks generally ‘over-earn’ in good economic times (their profits are higher than their average earnings through the economic cycle) and ‘under-earn’ in a weaker economy (profits are lower than their cycle average). The recent healthy profits are therefore a bit ‘old news,’ and the outlook for future earnings doesn’t look quite so rosy for the nation’s big four.
Early Warning Signs
One of the most startling revelations came from Westpac, the nation’s second-biggest mortgage lender, which detailed that approximately half (45% or $212 billion) of its $471 billion in housing loans are “at risk of exceeding risk buffers.” This means that customers haven’t been assessed as able to repay their loans at mortgage rates that are expected to occur in the near future. This is partly because the previous 7% minimum “floor” mortgage rate was removed as a requirement early in the pandemic when the Reserve Bank of Australia (RBA) slashed the cash rate to a record low 0.1 per cent. With a generous 3-year ‘term funding scheme’ that meant the banks could lend at low rates and still be profitable, and a buffer that was only required to be 3% above the bank’s mortgage rate, a lot of borrowers were assessed based on rates much lower than 7%. Now though, with the overnight cash rate (OCR) already at 3.35%, many borrowers will have to make repayments that are higher than the maximum that was assumed on their loan applications.
Lowe-r for Longer, no Longer
Although the RBA has increased the OCR at 9 consecutive meetings (the fastest pace in history), Governor Phillip Lowe sees further increases as necessary over the coming months (officially dispelling his pseudonym ‘Lowe-r for longer’). This is the RBA’s attempt to reduce the highest inflation the country has experienced since 1990, which clocked in at 7.8% for the full year 2022. While there are some indications inflation may be easing (the unemployment rate rose slightly in January to 3.7%, for example), this does not appear to be dissuading the RBA. Market expectations are now for 3 further increases in the coming months, taking the OCR to an 11-year high of 4.1%.
This is particularly concerning for borrowers facing a so-called “mortgage cliff,” where their mortgage rates will switch from low fixed rates signed during the pandemic to the substantially higher variable rates of today. These homeowners could be facing a jump from around 2% that they’ve paid for the past 2-3 years to a minimum of 5% (with repayments increasing a staggering $1,800 a month for the average mortgage holder compared to May 2022 when the RBA first began its hiking cycle). This will impact around $96 billion and $92 billion in loans, respectively, at Australia’s two biggest mortgage lenders, CBA and Westpac, over the next year or so.
Westpac CEO Peter King called these interest rate rises a “blunt tool” for reducing inflation, and warned that if the OCR reaches 4%, many borrowers would need either a pay rise or to cut their spending to afford the repayments. CBA chief Matt Comyn already sees signs that households are drawing on their savings buffers, which were built up during the earlier stages of the pandemic.
It’s the Economy, Stupid
The combination of decades-high inflation and rapidly rising interest rates is having a devastating impact on consumer sentiment, which according to Westpac, recently fell back into “deep pessimism.” The Westpac-Melbourne Institute Consumer Sentiment Index tumbled 6.9 per cent in February to 78.5 – a near-record low result (while above the pandemic low of 75.6 in April 2020, it is incredibly below the Global Financial Crisis recording of 79). The survey showed particularly low readings for the nation’s views on family finances, the near-term outlook for the economy, and whether now is a good time for purchasing a major household item. In fact, ‘family finances versus a year ago’ was the lowest reading since the depths of the early 1990s “recession we had to have,” while the recording for consumers with a mortgage was the one of the lowest since the survey began, in the mid-1970s. Companies are already beginning to see the impacts, with retailers like JB Hi-Fi (ASX:JBH) and gambling provider Tabcorp (ASX:TAH) indicating softer trading periods ahead as inflation and higher interest rates take their effect on discretionary spending. Both the RBA and the federal Treasury also expect the economy to “slow considerably this year”, with Treasurer Jim Chalmers expecting a “very difficult time for Australians.”
One Step Forward, Two Steps Back?
Bank stocks generally benefit from a higher/rising interest rate environment, particularly those banks like CBA with such strong deposit franchises. This is because they’re typically able to raise loan rates faster than the rates paid on deposits (much to the ire of the public), as well as how many deposits don’t generate any interest (think of the balance in your main transaction account). It’s easy for this benefit to be more than offset by an economic slowdown though, as loan growth slows and loan losses rise.
Time to Broaden Your Horizons?
For those wanting to maintain their exposure to financial companies, it might be worth taking a more global perspective. In the United States, market leaders Bank of America (NYSE: BAC) and JPMorganChase (NYSE: JPM) have only approximately 10% market share in a much larger market (providing significant opportunity for future growth), benefit more from rising interest rates (they have more commercial lending and mortgages in the U.S. are typically fixed for 30 years), and have much lower leverage (assets/equity) than the Australian banks. They also trade at only 1.6x and 1.9x Tangible Book Value (TBV), respectively, significantly below Australia’s market leader CBA at 2.6x TBV (NAB 1.7x, WBC 1.3x, ANZ 1.2x). In the U.K., leading franchises Lloyds Banking Group (1.0x TBV) and NatWest (1.1x TBV) have finally recovered from the dramatic bailouts of the GFC, and are attractively valued relative to the Australian banks given their strong profitability (as measured by high returns on tangible equity).
Don’t Bank on a Rosy Future
There’s no doubt that the big four Australian banks are solid businesses with a long history of profitability and healthy dividends. That gives them widespread appeal to ASX-focused investors, particularly with the benefit of franking credits (a 30% tax credit on dividends for Australian taxpayers, even if they don’t typically pay any income tax). Excluding CBA, however, the big banks have delivered very modest returns (by equity standards) over the past 5, 10 and 15 year periods. What’s more, the mortgage market has become increasingly competitive, particularly from Macquarie Group (ASX: MQG), and the economic outlook looks to be one of the most challenging in the past 30 years. The combination of high house prices, significant homeowner debt, high inflation, and a rapidly rising interest rate environment could limit the return outlook for years to come.
Australian small-cap shares aren’t normally household names and don’t get the same media attention as the big banks and miners that dominate the ASX 200.
However, keen investors can find opportunities in these smaller companies for better returns than blue-chip regulars like BHP (ASX: BHP) and Commonwealth Bank (ASX: CBA).
With reporting season in full swing, we take a look at two holdings from within our diversified TAMIM Fund: Small Cap Income that are maintaining positive guidance for the remainder of 2023.
Helloworld Travel Ltd (ASX: HLO)
Source: Helloworld.com
Helloworld Travel’s share price rebound accelerated this week. After falling in 2022, Helloworld stock has gained 74% since the start of 2023 while the All Ords has risen 6%.
Helloworld Travel is a leading Australian & New Zealand travel distribution company, comprising retail travel networks, corporate travel management services, destination management services (inbound), air ticket consolidation, wholesale travel services, and online operations.
The company released 1H23 results on Monday, detailing three times more transaction volume than the prior comparable period (pcp).
Here are the highlights from the company’s results:
$1.2 billion of total transaction volume (TTV) – up 209% on the pcp
$73 million total revenue from continuing operations – a 151% leap on pcp
$13 million of operating earnings (EBITDA) – rebound from a close to $8 million loss
Net profit after tax (NPAT) of $1.6 million – a flip from a $15.2 million loss from pcp
A strong balance sheet with $83.8 million of cash and no debt.
2 cent per share fully franked interim dividend declared
Travel is back
The entire travel sector has been riding a post-COVID boom, with demand and prices riding high. Visit any airport and you realise how much Australians want to travel, despite the impacts of interest rate rises and inflation.
The demand is surging across Helloworld Travel’s international operations too, with $178 million of TTV from New Zealanders – up 359% while Fijian operations also saw over 22 times more TTV last half.
The company said demand for the services of its network agents has continued to outstrip agent availability.
Helloworld chair Garry Hounsell commented on the results and outlook, writing:
“[TTV growth] reflects the strong demand from the travelling public, domestic and international borders returning to normal, Helloworld’s strong product offering, and the incredible efforts of our agency networks to service their customer base.
Booking volumes are expected to continue to increase as prices normalise and capacity returns with airlines and tour operators continuing to onboard further resources to meet demand.”
As a result of the strong first-half figures, Helloworld has upgraded its earnings (EBITDA) guidance to between $28 million and $32 million for the 2023 financial year.
PeopleIn (ASX: PPE)
Source: Peoplein.com
TAMIM fund manager Ron Shamgar currently thinks highly of PeopleIn because of Australia’s historically low unemployment rate, its reaffirmed FY23 earnings guidance, and relatively low valuation.
The company released 1H23 results on 17 February, highlight by record __ and a strong outlook.
Here are the key takeaways:
$597.3 million in revenue, up 89% on the pcp
$13.8 million of net income, a 223% jump from pcp
Profit margin up to 2.3%, bettering the pcp margin by a further 1%
Earnings per share (EPS) of $0.14, up from $0.045 in 1H22
PeopleIn is in the business of sourcing staff for its clientele, primarily temp staffing through the use of contractors. These include appointing supplementary nurses, labour hire, IT contractors and some niche areas including a focus on the PALM scheme and indigenous placement programs.
The company stands to benefit from positive operating conditions including, continued acute shortage of labour and strong market opportunity. PeopleIn’s share price fell just over 30% in 2022 and has seen choppy trading in 2023 despite the positive results and outlook.
This has led management to conduct a strategic review with the following rationale:
“The PeopleIN Board considers that the recent share price performance does not reflect the record financial results for FY22 or the fundamental strength of the business and has therefore decided to undertake a strategic review to evaluate options available to maximise shareholder value.”
“We are pleased to announce a record result, which was driven by strong organic growth across our core businesses and favourable industry tailwinds, including record low unemployment.
Based on the operating results for the first half and the mid-range forecast for economic conditions to continue, PeopleIN expects this strong momentum to continue into the second half of the financial year.”
With all analyst coverage signalling PeopleIn to be a buy to strong buy, a multiple of only nine times FY23’s estimated earnings and a potential grossed-up dividend yield of 7%, the market might be overlooking the upside potential of this small-cap company.
We continue sticking to the insurance thematic this week by looking at the other giant in the Australian market: IAG. We will continue using the same template as last week in assessing this business and its reports. The simple/straightforward equation: Profit = Earned Premium + Investment Income – Incurred Loss – Underwriting Expense.
Earned Premium
We’ve previously written about IAG and how it seems to have a parallel story to its competitor Suncorp. For one, this business also saw a transition in senior management with the retirement of its long-standing CEO Peter Hammer, who was replaced by the group’s CFO yet again. There is a common thread where margins are tight, CFOs tend to get preference. Nevertheless, let’s look at the results for the year, top-line growth again being our biggest issue previously.
On this front, the business has performed reasonably well, with gross written premium (GWP) for Home growing 13% while motor performed at a reasonable 8%. NZ added another 9% to growth on local currency terms. These numbers align with its counterpart Suncorp which saw higher numbers across motor and NZ. What was interesting for us was not this top-line number but how much of this accounted for premium increases vs. underlying customer growth. On this count, IAG does not compare particularly well with Suncorp, with the higher amount of its GWP growth driven primarily by rate inflation instead of member growth. However, the group has indicated quite ambitious targets for the coming year.
So on the first part of the equation, the business gets a manageable pass.
Investment Income
Again this is one aspect where the tailwind has been apparent for the business. The business now has an AUD $12 billion investment portfolio with a gain of AUD $80 million in technical reserves driven by higher yields and narrowing credit spreads. With the Fed and RBA likely to continue on their trajectory, we will probably see this increasingly grow. The yield on these funds is circa. 3.7%. Regarding shareholder funds, around 23% of the portfolio is weighted toward growth though there has been substantial derisking following exits from hedge funds.
On this front, as compared to Suncorp, the firm’s investment mix leaves much to be said, given that the total yield remains lower by 140 bps (though a like-for-like comparison is a little on the creative side, given the substantial differences in the underlying business). Again, assuming the status quo in central bank policy, we should continue to see the increase in yields.
We rate the company as a pass on the second part of the equation.
Incurred Loss
Just a refresher, the definition of incurred loss is the total benefits paid to policyholders during the current year plus changes to loss reserves from the previous year. Here it is perhaps appropriate to break this definition down into two components. The first is the benefits paid, which, more often than not, has a lot more to do with external events outside of the firm’s control and the loss of reserves (which indicates the extent or certainty to which the firm forecast future loss).
Like Suncorp, the business continues to battle the weather, with NZ floods taking away and putting pressure on margins. 1H ’23 perils have come in around AUD $70 million above estimate, and inflation is significantly impacting claims, especially in the motor segment. While IAG has a broader geographic segmentation than Suncorp, the La Nina weather cycle has still significantly impacted overall losses.
This brings us to the second part of the definition, which is the firm’s ability to adequately forecast and manage its risk profile (hence reserves). Despite the lack of geographic concentration in the same manner as Suncorp, the firm’s actuaries still have much to answer for, given the lacklustre performance in forecasting the increasing frequency of climate-induced perils. This is not the exception to the rule but rather becoming more habitual. On this front, the firm could certainly have done a better job.
We still give the firm a moderately good rating on the third part of the equation, not for any reason to do with its risk management practices but purely based on its greater geographic diversification. Also, its lack of legacy issues makes it a pure-play insurance provider (Suncorp has been operating the bank in addition).
Underwriting Expense
This brings us to the final part of the equation, and similar to Suncorp, with an Ex-CFO in charge, we should expect some reasonable performance. We were however disappointed that while expenses have declined by about 9.9%, additional outlays were required in what was categorised as the cost to transform expenditure, increasing 41.9%. For those unfamiliar, IAG has been (in)famous for legacy issues, including failed IT systems, provisions hits and charges. We would still have liked to see a greater decrease in the absolute number. We become rather cynical when businesses use words or synonyms like ‘transformation’, ‘strategic’ or words of that nature, especially when the business is being run by an accountant (i.e. new categories are not a particularly good look).
On the insurance trading ratio (standing at 10.7%), the business also fails in comparison to Suncorp, though again, it may not be fair given its quota-sharing agreement with Berkshire, to whom it will give away the lion’s share. That is, the firm effectively gives away close to AUD $3 Billion of its AUD $3.5 Billion in premium income for a 32.5% quota share. This does significantly derisks the firm as a tradeoff.
Still, overall, we give the business a fail.
Overall Outlook & Growth
The business stands to benefit from the broader tailwinds associated with a rising interest rate environment and premium escalation. That said, we think the business could do a lot better when it comes to a like-for-like comparison with its competitor Suncorp. As a pure-play insurer that had significantly derisked (especially in quota sharing), one could understand why it may have struggled. We don’t recognise preventable issues such as prudent allocation of reserves, a more conservative allocation of its investment portfolio and, quite simply put, a basic understanding of modern IT systems.
Would we still buy it?
From a pure valuation perspective, we still think it’s a reasonable allocation especially given that the insurance market remains a duopoly and the fact that it has a good geographic diversification. An average business at a great price is the best way to put it. We see the possibility of a price target or significant upside of 20% from where it is trading today ($5.80).
Disclaimer: ASX.IAG is currently held in TAMIM portfolios.
