This week we visit our second category within the mobility thematic, that is autonomy. A topic that is arguably more important than the general electrification of transport, we arrive at three key considerations for those wishing to take advantage of the thematic.
Think for a moment about the impact of this autonomy theme, not only within the automobile segment but the broader economy. The questions that spring to my mind include the impact on automotive sales, especially in densely populated geographies such as China? The economic impact in nations such as India where driving as a profession makes up the primary income source for over 150m people? On the flip side, the ultimate nirvana of fully autonomous vehicles (connected) should also reduce road accidents and fatalities. This is one topic that has clear benefits and will potentially lead to large dislocations in the overall economy.
Autonomy and shared mobility, which we refer to as ACES (Automated, Connected and Shared Vehicles), has already had a tremendous impact upon the border economy. Just think of the more well-known Uber and Lyft IPO’s and, in emerging markets, companies such as Ola. The way I try to contextualise this trend is to think about the evolution from the simple mobile phone to the smartphone, trends that are mutually reinforcing. Where the hardware (in this case the Electric Vehicle) is evolved into the fully autonomous vehicle (in this case software that enables connectivity in the same way as the iOS or Android systems make up the vast majority of the underlying interface that enables the features of the smartphone). As of today, the market for automotive software has been silently growing at about 7% annual CAGR with the market expected to grow to over $469bn USD by 2030 (Source: McKinsey). This is the first thing that the discerning investor should be aware off, the overall automotive market (characterised by end-user sales) is, in contrast, expected to grow at 3% p.a. over the next decade (assuming current trends are not changed). Simply put, the best opportunities do not necessarily lie in access to final producers or downstream so to speak, but rather in the components that make it up. As if that were not enough, it is more than likely that we will see the same creative destruction trends that we saw in other markets. Think about it in the same way that Apple revolutionised the smartphone market and now the market share of Nokia today.
Within automotive software, as is the case with any new industries, there is significant divergence and segment-level variation. We have yet to see a centralised software or a player take the lead within the space. My view is that, unlike the automotive industry in general, the software itself might just be a winner takes all market (with the caveat being that it will be hard to judge who the leader might be), just as Google took close to the entirety of the search market and Windows (Apple’s iOS nonwithstanding) with the PC market. This is a place where the watch and wait approach might be best with a diversified pool of bets in the portfolio. Some listed companies within the space include, Keysight Technologies Inc (KEYS.NYSE), Thermo Fisher Scientific (TMO.NYSE), Materialise (MTLS.NYSE) and Silicon Laboratories Inc (SLAB.NASDAQ). Existing incumbents such as Microsoft, SAP, Autodesk, Dessault and Oracle are also making headways in building out divisions.
Aside from software, we will continue to see advances made with regards to sensors. One can reasonably expect to reach double digit growth in this market as incumbents scramble to perfect the segment. These include shared mobility players and the more traditional auto manufacturers. Looking more in-depth, the backbone for the technologies can be categorised into two segments, ECUs (Electronic Control Units) and DCUs (Domain Control Units), which underpin VxV (Vehicle to Vehicle communication). The relevant leaders within these segments currently include Nvidia (NVDA.NASDAQ) and QualComm (QCOM.NASDAQ). We expect that high-voltage harnesses within ECU to increase whilst the converse is true for lower voltage (i.e. EV vehicles).
That said, major players have already made certain headways including Volkswagen, which plans to adopt a unified automotive architecture, and BMW, introducing a central communication services and service-oriented architecture (SOA) providing a certain level of scalability. To date, the issues remain the security of the underlying software, the efficiency and efficacy of VxV communication and circuit level complexity. Rather than going into detail that might very well bore, think of it like the problems associated with making an iOS system communicate with Windows. The alternative could be open source and a centralised system with regulators effectively operating as the middle-man. For the more impatient investors, the companies that currently dominate the DCU market are Visteon (VC.NASDAQ), Continental AG (CON.ETR), Bosch (a private company other than their Indian operations) and Aptiv PLC (APTV.NYSE). The upcoming contenders include Chinese player, Huawei (not publicly listed), Desay (part of Huizhou Desay SV Automotive Co Ltd, 002920.SHE), Shenzhen Hangsheng Electronics (HSAE is also not public) and Neusoft (600718.SHA).
What is perhaps interesting about the incumbent players vs. the upcoming players is the geographic segmentation and it adds a secondary consideration for the discerning investor. The first group are domiciled in the EU and US whilst the second are all domiciled in China. This is where we must consider geo-politics, as the Huawei situation has undoubtedly shown with regards to 5G, there will be lines drawn that makes the supply chain and investing a little more complex (and perhaps more profitable for the same discerning investors) since companies are not necessarily competing on a global landscape but within particular spheres of influence.
If regulatory responses were to go toward preferential treatment for certain players, this will almost certainly create scenarios of greater economic profit than would otherwise be the case in a truly competitive environment (in economics this is termed economic rent-seeking). It might very well be the case that it would be better to diversify portfolios across not only market-leading companies but also geographies with the added advantage that risk is mitigated somewhat by ensuring a base-level of profitability (i.e. even if the company is not necessarily best-of-breed globally, they may be profitable purely based on jurisdiction).
To conclude, recognise the following:
1) There is a developing and evolving ecosystem of companies within the broader AV thematic;
2) The industry is still in its infancy and, if the past is anything to go by, then the winners are not so easily discernible, hence it is best to diversify at this stage;
3) Find market-leaders but with the caveat that it might be best to also diversify geographically since the macro political situation warrants and creates a scenario whereby the winners are not necessarily best of breed. For the older generation or the historians amongst you, think back to the creation of keiretsu firms in Japan (which now encapsulate the likes of Toyota and Mitsubishi) or chaebol firms in South Korea (think companies like Samsung, Hyundai and LG) which eventually became best of breed by economic rent-seeking, thus enabling the profits to be reinvested and allowing them to move up the value supply chain. Or, going back even further, American protectionism and policies that created the industrial giants of the late 19th and early 20th centuries. To put it even more simply, take the example of aeroplane manufacturers and ask yourself the following question: If I were to invest in aeroplane manufacturers, would it be more reasonable to choose Boeing or Airbus? Personally, I would spread the investment either equally or proportionally based on market share and it would help me mitigate the risk of regulatory intervention or tit-for-tat scenarios based on the vagaries of politics. Assuming of course that all I care about is a return on my investment and not normative questions.
This week we revisit the property market, specifically the potential/future for commercial office space. We are in the process of offering our most recent buy in the Adelaide CBD and throughout the process we have consistently received questions around the prudence and rationale behind taking exposure to the space. In particular, within the broader context of increased tendencies toward work-from-home and falling demand. So, we thought we would address that question rather briefly and why we feel that this question, though warranted, may in fact be somewhat overdone.
Author: Sid Ruttala
Before proceeding further, we will put a disclaimer in saying that when it comes to property we have a tendency toward the Buffet school of thought in saying that economics and broader trends are nice to have but, when it comes down to the actual investment, has very little sway in the decision making. A good company is a good company, a good property is a good property. Almost always, the viability and return of a property investment comes down to the price at which you buy and, secondly, the way in which you manage said asset (this second aspect often determining capital growth).
This is perhaps the reason why TAMIM has historically gravitated or been attracted to so called industries in decline. Retail for one. Starting with our community shopping centre in Elermore Vale, our Fairfield Heights asset anchored by Woolworths or the more recent large format retail addition in Rutherford. Just listening to the headlines would’ve turned most investors off looking at these particular assets but it is precisely this tendency which enabled us to buy at what we feel are reasonable (if not) strong yields. If one cared to drill down into the details and past the headlines, it may have been rather evident that perhaps staple stores such as your local Woolies may still have a place. Or that consumers may still rely on physically inspecting big-ticket purchases such as home and contents (i.e. Rutherford) and this may still lead to higher foot traffic. This is all to say that we can’t simply rule out the entirety of a sector (i.e. retail) based on a broad trend, there are good assets out there for those with the patience and expertise to find them. Buy smart and manage well.
Similarly, when it comes to commercial offices, we feel that there are dislocations becoming increasingly evident.
Commercial Office Space
Let us begin by saying this, the headlines are right. Covid-19 has been momentous for the commercial office market in Australia (and globally). We do in fact agree that we will continue to see dislocations in the market and longer term declines in the demand for office space. Most office staff shifted to working from home during the early days of pandemic (and associated lockdowns) with the event acting as a broad catalyst in moving toward work-from-home or flexible working arrangements. There have been some, especially in technology like Atlassian, which have gone even further in effectively letting 100% of the workforce go to a flexible work-from-home arrangement. Currently, occupancy rates across Australia remain at 10-30% below pre-pandemic levels.
A recent survey by the RBA, for example, found that a majority of firms were looking to reduce floor space by around 25% and make increased use of hybrid solutions. All this might suggest that I’m arguing against exposure to commercial office space but here is where the nuance comes in. Let’s actually look at the previous statements and untangle it a bit. The key word is hybrid, that is businesses were by no means looking to get rid of physical presence but operate through a combination of work from home and office. By extension, the question then becomes whether there is excess supply. Secondly, what are the types of businesses looking to make these arrangements? For some greater detail, have a look at the chart below which shows the proportion of businesses with work from home arrangements broken down by size. The fact of the matter is, large enterprises have by far the highest proportion of remote working arrangements. This occurs for a plethora of reasons but it usually comes down to capacity constraints. Think then about what type of spaces are used by large enterprises (generally owner occupied, think Westpac or CBA) versus medium to small (rented).
Source: RBA
So herein lies point number one, there will be substantial differences in the impact of the changing dynamics, contingent on the profile of the properties in question.
Arriving at our second point and declines in office space demand. There will certainly be particular industries that are more amenable to a remote working dynamic than others. Tech being one example that comes to mind, but what about others? Say, for example, financial services or legal services? Based on our own interactions and primary research, we remain of the view that this may not be quite so simple. Clients, for example, still require physical interaction (I highly doubt any of our investors would be quite comfortable knowing that there is no physical presence or address) or industries which still require training, a point that was recently relayed to us by one in the legal profession. This has broader implications and that is in the nature of employment in relevant cities. Most technology businesses in Australia, for illustration, have their headquarters in Sydney or Melbourne. Moreover, the nature of the labour market in these two cities suggests to us that this is where the greatest amount of dislocation may eventuate. The graph below shows the vacancy and occupancy rates across Australia’s major metropolitan areas. The outlier appears to be Canberra, which has seen consistent declines even despite the pandemic. Why? The proportion of the labour force employed in government (one area not so amenable to remote working).
Source: RBA
Looking at the second chart, showing occupancy rates in comparison to pre-pandemic, what becomes immediately evident is that Melbourne and Sydney remain outliers. This is what arguably matters more for pricing. First, a slower recovery indicates excess supply and bargaining power remaining with the tenant as opposed to the landlord (whereas a better implies the opposite). An excess supply may indicate that there are deals to be had aplenty but, given the nature of the property markets in Melbourne and Sydney, the higher vacancy rates may not be baked into the selling price. The dislocations and real opportunities are likely to come outside of these two cities. Looking at Adelaide, we see some consistent momentum behind it towards pre-pandemic levels of occupancy yet lower in absolute terms which, all things equal, should provide some attractive pricing for buyers.
This may seem like a post-hoc justification but the rationale remains solid.
So, with that, let’s recap. Firstly, yes, commercial office space is a segment facing some long-term headwinds but this is precisely what creates the opportunities for the discerning investor. Especially so in a property market that seems excessive to say the least. Two factors that remain important are location and nature of the tenancy profile. Office spaces that are suitable for flexible working, priced more economically (catering specifically toward SMEs, not for profits, government and quasi-government and services) are likely to sustain themselves over a longer period of time. This doesn’t sit well with the investor who potentially equates larger or higher profile tenants with lower risk, however it is precisely that profile which lowers the bargaining power of the landlord and makes themselves amenable to look toward remote working. Assuming that the market continues on this trajectory and we see declining supply (we will start to see it eventually), we use the same logic in looking at this market as we did with the energy markets.
Digging deeper, we believe that a greater degree of “value add” will need to be provided by property owners to fit into the changing profile of the rental landscape. Physical offices, for example, could adopt creative propositions such as green spaces, exercise rooms and specific attributes, such as natural light, could play a greater role in the value of assets. Similarly, we also see the nature of the landlord-tenant relationship changing; aside from bargaining power, a more nuanced approach to rental contracts (including those that reflect uncertainty around end usage) will increasingly become a factor aside from compression of WALEs (increase in break points). As with anything, these changes cannot be written off by the investor as risks but potential opportunities. A compressed WALE also gives the owner some flexibility in being more active in order to potentially increase rents through more aggressive campaigns than would otherwise be the case. Similarly, a multi-tenant approach, if done properly, could certainly provide for some lift in overall rental yields.
To conclude, we shall say this: be careful what fixation on a theme or headline may cause you to miss! In fact, a bear market arguably presents the best opportunities. In this case market pessimism to a particular sector or category can also be an incredible investment opportunity. After all, going back to our first point, the best investments usually come down to simply the price an asset was bought at.
Once again, buy smart and manage well.
Sidenotes
Some may think that the comparison above when it comes to the major metropolitans may not be fair given the variance and degree of lockdowns and policy implementation. The point here is that, even taking this into consideration, we are not seeing the fall in occupancy which is not necessarily being reflected in the asking price for sales.
And! We have a policy announcement from the RBA. Surprise, surprise! The cash rate stays put at 0.10% with an abandonment of yield curve control (interesting times ahead for the traders). This implies that the central bank will let the long end of the yield curve rise while using the short end to maintain its target till 2023-2024. Somehow we continue to be of the opinion that rates will remain compressed for longer (except only targeting the short end). If you follow that train of thought (and this is in no way advice), every time there are jitters about rates going up (we’re quite sure the pundits will point to the long end) just buy! Balance of probabilities, they’re not. We neither have a Volcker nor the demographics to stomach it.
This week we’re looking at a small cap retail stock that is offering investors a concentrated bet on the reopening theme. In 2020 we saw a huge shift in sentiment towards stocks that were benefiting from a covid-19 environment. Companies such as Pushpay (PPH.ASX) and Redbubble (RBL.ASX), we bought both heading into the pandemic, were huge beneficiaries. Heading into Christmas, the covid winners and now the covid losers and retail stocks are starting to grab more attention. With Australia exiting lockdowns there is a lot of pent up demand for retail spending, what we like to call revenge spending.
The stock in question is the specialist jewelry retailer Michael Hill.
Michael Hill (MHJ.ASX)
MHJ has slipped under the radar in the FY21 reporting season; they saw revenues increase 13% despite 10,447 lost store trading days as a result of Government mandated lockdowns and some permanent store closures. Their Canadian segment has done very well since reopening in June/July and we see the same happening in their Australian and New Zealand segments which are showing a lot of upside.
Source: Company filings
Digital Expansion
MHJ has been shifting the company toward a more digital footprint. Their digital sales increased by 53.4% and management expects to see digital sales accounting for north of 10% of total sales within the next few years. MHJ are also expanding through digital marketplaces, now offering their products through The Iconic, one of Australia’s largest digital marketplaces. We expect to see MHJ find similar partners in Canada and New Zealand.
Source: Company filings
Loyalty Program
Michael Hill launched their loyalty program, Brilliance, and within eighteen months memberships have already grown to over 800,000. The program is clearly resonating with customers and is aiming to deliver increased frequency, larger baskets, and higher margins. The program will provide MHJ with valuable data and insights which should help increase personalisation and enable the use of artificial intelligence to deliver further growth in the business.
Source: Compay filings
Valuation + Outlook
To value MHJ we are going to look at their assets and then their earnings power. After paying down debt, MHJ is now in a significant net cash position of $72m. To be conservative, and taking into account the required working capital for the business (i.e. cash for the registers), we will use a reduced net cash figure of $65m. MHJ recently conducted a strategic review of their Canadian in-house customer credit book. The asset is held for sale and is considered probable and expected to be completed within a year, the sale of the customer finance book should bring in around $13m. MHJ is also currently sitting on inventory of around $170m, if we add the $13m of assets held for sale then we get a net cash figure of $78m. This puts MHJ at an enterprise value of approximately $310m, giving MHJ an EV/EBIT of 4.3x. MHJ’s strong balance sheet gives us a huge margin of safety if things weren’t to go as expected, an important consideration we take into account in our investment process.
Authors: Ron Shamgar
Looking to MHJ’s earnings power, we see MHJ starting to pick up up tailwinds on the back of a great FY21 result. They recently gave an FY22 Q1 update which saw same store sales up 15.5%, up from the corresponding quarter last year. Margins continue to rise on the back of their digital expansion and their additional omni-channel offerings – including Ship-from-store, Click & Reserve and Virtual Selling – all of which are higher margin channels. MHJ lost over 10,000 total trading days in FY21 and, while they lost 7,400 days in the September quarter heading out of lockdowns and into the Christmas spending season in Australia and New Zealand, they should see a surge in spending for retail across the board which should drive MHJ’s sales. There is a lot of pent up demand for consumer spending and we have already seen how it positively affected sales in Canada upon reopening. Management recently noting that “our Canadian business has been flying, delivering impressive sales and margin growth every week.” The play here isn’t like most retail store strategies, which is typically to open up new stores and expand their physical presence. The strategy here is to increase digital sales through marketplaces like The Iconic, thus driving margins and opening up their products to new customers. MHJ has also done a terrific job at growing their loyalty program to over 800k members in less than eighteen months; this will be essential to leverage their digital capabilities.
If MHJ sees the demand that we expect upon reopening and heading into Christmas, they should see $50m+ NPAT for FY22 which will put them at less than 8x earnings. All while paying a cool 4.5% dividend yield. If MHJ were to rerate to 10x FY22 earnings then this would put them at a share price of around $1.30.
MHJ is one of our favourite stocks to take advantage of the reopening theme
Last week we looked at energy markets and made the case that the recent price action was a result of broader policy failures in speeding up the transition towards a net-zero world. This week we look at the green energy market to understand the incentives, opportunities and outcomes going forward. The irony may be that our bullish case for medium term oil prices may in fact perversely create a tailwind for the broader sector, despite what this may imply for growth prospects and inflation.
Author: Sid Ruttala
Before delving further, a disclaimer. We are by no stretch of the imagination experts on the actual technology required for the changes currently taking place. What we can do however is look at it through the lens of investors and to understand where the opportunities may arise and weed out the noise from reality.
A quick summary of the progress to date
The decade between 2011-2022 has been momentous for the renewables sector with annual net renewable additions to capacity (i.e. that is new capacity accounting for retiring older assets and accounting for depreciation) increasing from circa. 120 GW (gigawatts) to a record 280 GW in 2020, which saw a phenomenal 45% increase in capacity from the previous year despite Covid and the related headaches. 2022 looks set to continue building on these gains with current trends indicating that the sector (predominantly wind and solar) accounts for 90% of the increase in global capacity.
Off these overall numbers though, there are nevertheless some caveats. The growth over the last decade, despite the headlines that the EU and US continue to make, has primarily been a Chinese story with Vietnam being a surprise addition to the mix. China alone, for example, accounted for close to 80% of the increase in overall additions in CY2019 and CY2020; the longer term trend has averaged around 40% of global growth. Before proceeding further, it may be prudent to understand why this has been the case and what the incentives were that created said environment.
Utilities and the energy sector generally is a story of high capex and is intrinsically a regulated beast. Globally, much of the windfall for continued investments was created by the FIT or feed-in tariff mechanism, designed to offer compensation and help finance renewable energy investments. Typically this results in a difference in tariff awarded to wind power, for example, or PV sources as opposed to traditional fossil fuels. Its implementation may vary to a great degree however and can lead to substantial price differences seen by the end user. In the US it has primarily relied on legislation introduced during the Carter years, with the Public Utilities Regulatory Policies Act (or PURPA) and more recently through generous tax rebates. In the EU, led predominantly by Germany, the relevant legislation included mandated percentages of the energy mix by source. The difference in policy incentives (theoretically at least) would result in a slightly different burden in terms of cost. A mandate would inevitably lead to costs being passed on to the consumer in terms of higher utility bills while tax incentives and/or effective tariff differentials would see governments bear the burden.
With that in mind let’s return to China. The way in which this has been implemented, in classic CCP style, was a top down approach where the national target set by Beijing would effectively feed down to the provincial governments which then created different incentives in what was effectively a race to build capacity. This typically came in the form of direct subsidies/generous loan schemes. The national solar tariff was issued at about US$0.15 per kWh and various other policies created a conducive environment for the development of onshore wind power plants as well as helping struggling operators (through targeted subsidies). The tariffs for wind power, for example, were set at close to a 30% premium when compared to coal.
By this point, we hope that you are starting to get the point that policy environment and government intervention has a great degree of impact on the fortunes of the energy mix and, by extension, the returns of investors. So, why has China been an exceptional case? Here is were we bring in a few opinions. Firstly, we would argue that the question for China has not been about climate or its impact but rather the structure of the domestic economy. For one, think about the percentage of the PRC’s GDP that is made up of the industrial sector (including manufacturing), it currently stands at 30.8% compared to the US’s 10.8%. Think then about energy usage in said economy. Given industrial production, and manufacturing in particular, creates a greater need for stable supply, especially for the government in keeping unemployment low. A similar argument can be made for why Germany may have taken a greater initiative in the area in comparison to the rest of the Eurozone (i.e. manufacturing accounting for 17.82% of GDP, an outlier for a developed economy).
Moreover, China (along with much of Asia) stands as an outlier in terms of local sources of supply; their short term economic fortunes often decided not on government or domestic demand but rather on the price of global energy. In addition, this is a geopolitical issue for many countries, energy independence being a key issue around the world. Here, think of things like Russia’s influence over Europe’s supply. For China, it’s about the Malacca dilemma in reference to the Belt and Road Initiative, referring to the fact that 80% of PRC’s supply comes through the Straits of Malacca, making for some rather interesting implications on the national security front.
We see similar implications for India. Headway has been made in recent years starting under the previous Congress government in 2010 and catalysed by the Modi government who have pushed towards building out PV capacity in conjunction with the broader “make in India” policy. In fact, if it hadn’t been for the rather bi-polar response to Covid, India should have seen an additional 50% capacity added during the CY 2020-2021 period. Construction delays and grid-issues leading instead to a 50% decline over the period. We should however, assuming no further mishaps or outright bungling, see it hit all time highs soon enough.
This brings us to the next question. Does this imply that developed nations or services oriented economies don’t have an incentive? Especially given that we are likely to see a decline in Chinese growth over the coming years as government incentives are gradually phased out and the rollercoaster that has been recent energy markets settles with the onset of winter. Beijing has in fact ordered the re-opening of coal mines and created a medium term imperative to open up fossil fuels based solutions (which, unfortunately, remain vastly cheaper).
The question of incentives in developed nations – and future growth?
We would suggest that much of the slowdown in China will be mitigated and even overcome by greater demand in the developed world, led by the EU and US. However, the road will be much longer and rather messier because of an arguably more complex political environment characterised by periods of inertia (ah, the vagaries of democracy). Think for a moment about the much touted Green New Deal and the fact that it’s more ambitious aspects may need to be curtailed due to gridlock. Senator Manchin of West Virginia, a vital so-called Democratic moderate, has been the most vocal opponent (the fact that he made his fortune in coal may contribute) but any transition will firstly lead to higher costs (which can either be borne by government and indirectly by consumers or directly by them). The fact that key battleground states, including Biden’s own Pennsylvania, have a significant (and vocal!) portion of their employment in traditional fossil fuels based industries does not help, unless these industries have direct help with the transition period.
The case is similar in the EU which arguably has the most cohesive policy of the Western world. Given the recent spike in energy prices, led in no small part by continued grandstanding from Moscow, is a tell-tale sign that shorter term political considerations may put a dent on the more optimistic expectations. We have previously argued that it was a great failure of policy not to take these considerations into the calculus.
Nevertheless, we do see a longer term trend here. Perhaps not as immediate and with some uncertainty around growth prospects (which matters more for the investor who constantly looks at their securities). For one thing, it offers a great opportunity to create immediate employment and could also have the added benefit of bringing back some manufacturing.
Aside from this, we see the opportunity in these economies as perhaps having greater long term potential. The flipside of democratic governments is also the ability to have free enterprise which does have the added benefit of increasing commercial viability. Think for a moment about the Levelized Cost of Energy (LOCE) for solar and wind, which has fallen close to 90% and 70% respectively, and where the technology that enabled this has come about. Ultimately, as previously alluded to, the cost will determine the viability of these technologies. The biggest hurdles remain things like seasonality, weather and transmission congestion (the ability to circumvent gridlock during peak demand). These issues were rather unfortunately summed up by our own Minister Angus Taylor, who suggested that solar does not work during the night. What we hope he was getting at was the lack of commercially viable storage technology. I remain an optimist and hope that a cabinet minister (and one who looks after Energy) would have the intellectual capacity to see that.
The key to cracking the code on this will remain storage capacity. Lithium-ion batteries, while they continue to fall down the cost curve, remain (at least in the shorter term) ineffective in the deployment on a utility-level scale (too expensive). Under some estimates, we would have to see a reduction in about 80% with tech that can increase lifespan and decrease dissipation. Again, the problem remains peak demand. Without this, even increased capacity build out makes for a rather messy scenario with peak demand leading to overextension while per unit cost during off-peak continues to fall. An alternative through the transition may be a hybrid grid, where peak demand would be complemented by fossil-fuel generation. However, there is a little problem with this idea. Given that there would be very little appetite for the private sector to make the numbers work even in smaller markets, it would require government funding. The question may be what would happen in the advent of a technological breakthrough in storage given the pace of innovation currently taking place? That level of uncertainty and constant flux is also perhaps the reason why there is very little appetite for traditional generators, the potential risk of what are termed stranded assets.
So, the growth prospects are there but how do we benefit?
For those that read last week’s article, it may seem that we do not believe in renewables or the transition occurring. This is simply not the case. The previous contention was the lack of policy initiative to take dislocations and the adverse impacts into consideration. As an investor it pays to be aware of some of the nuances that are underlying the sector. For example, how does Senator Manchin in the US throwing a spanner in the works of the more ambitious proposals impact a renewables sector, and PV companies priced to perfection, impact your returns in the short run?
Similarly, how does direct policy intervention incentivised by political considerations impact a rare-earths manufacturer like Lynas? We’ve previously talked about their DoD funding to start manufacturing in Texas. Even for those that aren’t particularly interested in the space, how does a lack of capital investment in more traditional fossil fuels based approaches impact the price of those commodities which still remain vital to the economy not only in terms of growth but inflation? Assuming inflation and a more aggressive monetary policy stance, what might that do to my own portfolio with say an allocation to Alphabet or Microsoft (Hint: the discount rate changes and so does their valuation). However, we’ve also written about the broader supply chain in terms of Mineral Resources, Pilbara and broader commodities including copper?
This week we are writing about a pair of financial services companies that are growing, have tailwinds and are trading at what we believe to be bargain prices. In the wake of the 2019 Royal Commission we have seen huge changes in the Australian financial services industry. There has been a structural shift away from banks by consumers, igniting the fintech scene in Australia. Non-bank lenders have also been beneficiaries but we feel it is a sector that has been overlooked by investors and offers some quality businesses that are growing their loan books at attractive margins.
Money3 (MNY.ASX)
Money3 Corporation Limited is involved in the delivery of secured automotive loans as well as secured and unsecured personal loans. The secured automotive loans relate to the purchase of a vehicle with the vehicle as security for the loan. MNY currently has a loan book of $600m, having grown considerably over the past few years.
Funding Facility
Authors: Ron Shamgar
MNY recently executed a transformational $250m funding deal with Credit Suisse. The deal will both lower their cost of capital and allow them to expand into new car financing; given the higher value of new cars this should accelerate their loan book growth. The new facility will increase margins and allow MNY to pursue their growth strategy in the auto finance market.
Acquisitions
MNY has also been active when it comes to M&A activity. They acquired New Zealand company Go Car Finance in 2019, giving them a presence in the NZ auto finance market. Go Car now has a loan book of AU$158m, increasing over 300% since MNY acquired them. Their NZ presence opens up the opportunity for MNY to grow their loan book above $1bn and, with the cheap funding behind them, MNY should continue to scale this segment. More recently, they took over Automotive Financial Services (AFS) who have a $52m loan book and are projected to do around $2.5m NPAT in FY22.
Source: MNY company filings
Valuation + Outlook
MNY has been a post covid winner and, with second hand car prices at highs, they are benefiting from increased value of their loans. MNY has a clear path to grow their loan book on the back of their new loan facility, which will see them expand their new car lending, and the Go Car Finance acquisition ,which has given them a position in the NZ market. There have been issues with vehicle supply shortage, slowing loan origination, but that will normalise as the world returns to normal. MNY has been able to acquire struggling competitors that don’t have the same access to funding that Money3 has. We can see MNY achieving a loan book of $1bn by FY24. We estimate that this will yield approximately $80m in NPAT which would put MNY on a forward PE multiple of around 8x, all while they continue to distribute strong dividends. We can see MNY being worth double their current share price if they achieve that $80m of NPAT by FY24.
Last week we saw Money3’s peers Plenti (PLT.ASX) and MoneyMe (MME.ASX) provide strong updates and they have both seen good growth in loan originations. We expect MNY to do the same, their upcoming annual general meeting on November 16th could be a catalyst as they provide an update on their outlook for FY22. We expect them to do over $50m of NPAT in FY22 which would put them at a PE of around 14x.
Source: MNY company filings
Resimac Group Limited (RMC.ASX)
Resimac Group is a residential mortgage lender and multi-channel distribution business specialising in Prime and Specialist lending. RMC operates in targeted market segments and asset classes in both Australia and New Zealand. As a non-bank financial institution, they have developed a high quality lending portfolio, loan servicing capability, and funding platform predominantly through organic growth.
Resimac is a quality business that has mostly slipped under the radar. They are attacking a huge market and are achieving huge growth in their loan book with AUM (assets under management) now at $15bn. Resimac are currently investing heavily in their digital capabilities to develop a customer centric organisation that is data-driven, powered by a modern digital platform providing cost-effective, scalable and rapid growth.
Resimac has benefited from the consumer shift away from traditional lenders. In a post-Royal Commission world consumers are better informed and have started to favour alternatives in finance solutions, the recent rise of fintechs is a testament to that. Resimac has a number of competitive advantages over their traditional bank competitors; by offering superior service, systems and approval procedures they have established themselves as one of the biggest non bank lenders in Australia. Simply, Resimac has the quickest loan settlement turnaround time.
Resimac has been diversifying into asset finance under the newly acquired Resimac Asset Finance brand. RMC will look to leverage their existing digital expertise in scaling their asset finance business. Given the growth in their home loan portfolio, the asset finance business should be highly accretive to Resimac’s AUM.
The key drivers of Resimac’s earnings are their AUM and their net interest margin (NIM). Resimac has benefited from a lower cost of funding which has led to a huge increase in earnings. Their funding comes from issuing residential mortgage backed securities (RMBS). The older bonds were issued at a higher rate and, as they mature, the new bonds they will be issuing will be at a lower rate. Their NIM was 207bps in FY21, up from 190 in FY20. Resimac will have very favourable funding costs for FY22. Looking to their AUM, they grew their home loan book by 11% in FY21. If they continue to deliver a superior service, growth in NZ as well as their diversification into asset finance, their earnings power is huge.
Valuation + Outlook
In current market conditions Resimac has seen multiple tailwinds that have accelerated their business. Resimac posted a 37% return on equity in FY21, an almost unheard of result for a company trading at less than 10x earnings. Looking ahead, we see Resimac continuing to benefit from low cost of funding in the short term. Resimac have a tiny portion of the Australian lending market and there is plenty of room to grow AUM in both home loans and asset finance. Resimac should also see their NIM remain above 200bps for HY22. Considering growth in their loan books and a strong NIM, Resmac should be trading at closer to 6x earnings in FY22.
In their most recent presentation, Resimac said they are targeting $8bn in annual settlements by FY24 for the home loan segment. They are also targeting $1bn in annual settlements by FY24 for the asset finance business. These targets would see Resimac achieve strong growth in their originations and, at a PE of less than 8x, there is huge upside for multiple expansion.
Source: RMC company filings
Finding a quality business like Resimac that is trading at less than 8x earnings, paying a dividend and growing their business is hard. Resimac is being overlooked by the market and, at current valuation, Resimac offers huge upside. They are a very profitable company that is attacking a huge addressable market.
Disclaimer: MNY and RMC are both currently held in TAMIM portfolios.
MHJ has slipped under the radar in the FY21 reporting season; they saw revenues increase 13% despite 10,447 lost store trading days as a result of Government mandated lockdowns and some permanent store closures. Their Canadian segment has done very well since reopening in June/July and we see the same happening in their Australian and New Zealand segments which are showing a lot of upside.
