This week we take a look at one of our top performing investments from the last year, a stock we wrote about on multiple occasions. This week we would like to explain our investment journey; why we backed the company then, our entry and exit prices and ultimately what changed our mind in January and February this year that caused us sell the stock.
Authors: Ron Shamgar
Redbubble (RBL.ASX) is an e-commerce marketplace that connects consumers with artists globally. The business model is one we like; it enables shoppers to choose from many different designs and product categories and get it printed on demand. This business model is favourable as it carries no inventory risk and the company receives the purchase payment upfront while paying artists and fulfillers after.
In mid-2020 we took a position in RBL at around the $3.00 mark. As we articulated last year on many occasions, businesses that facilitated and enabled consumers to shop online during lockdowns and restrictions were amongst our so called “Covid Winners”.
Source: Yahoo Finance
Unlike many of its peers, RBL was cashed up and profitable. It also operated on a global scale which meant it wasn’t limited by its addressable market like some of its land constrained peers, Kogan (KGN.ASX) and Temple & Webster (TPW.ASX).
During 1H2021, RBL reported strong sales growth and profitability was on track to hit $60m of EBITDA by 1H. Cashflows were strong with cash balances ballooning to over $100m. RBL was not only benefitting from consumer demand for online shopping, but also from reduced marketing costs and higher gross margins in (temporarily high demand) products like face masks.
We understood from day one that RBL would likely struggle to maintain elevated sales growth in 2H2021 and beyond. We did however believe that, due to the global nature of its business, RBL could maintain growth and profitability, albeit at a lower level. We also expected management to begin paying dividends to investors. Our valuation over 1H2021 increased to $7.00 based on consensus estimates. We also had a bullish best-case scenario valuation of $10.00 had RBL achieved our estimate of $100m EBITDA in FY21.
During January 2021 the stock exceeded our valuation of $7.00 and we sold down substantially to secure profits for our investors. We maintained a small position going into the Q2 update.
There are many sayings in investing, but one that never fails is that “good news travels fast”.
The market (and us), were expecting very strong sales and EBITDA figures for Q2 and there was an expectation that management would update the market by late January. As the news never came, we became concerned and reduced our holding even further at $7.00+ as the risk/reward trade off was no longer balanced.
RBL reported Q2 results during its half year result in late February and although sales were as expected, gross margins were significantly below expectations as competition increased. We exited our holding above $6.00 on the day. Overall, RBL was one of our top performing stocks in 2020.
Last week, RBL provided a Q3 update to investors and laid out a new strategy for investors under the reign of recently appointed CEO Michael J. Ilczynski. As we no longer owned the stock, we looked on with interest from the sidelines.
Unfortunately for investors, the update was disappointing as sales growth slowed down and profitability completely disappeared as margins were heavily impacted by discounting and increased marketing spend. To make matters worse, the new CEO laid out a strategy of reinvestment and lower profits for the next two years to drive top line growth.
The ultimate reward for investors is a $1.25bn sales target beyond 2024 and EBITDA margins of 10-15%. Essentially, or in other words, the company now needs to spend more on marketing to stay competitive and relevant. Investors were not impressed and sent the stock to $4.00.
So, does RBL now present a buying opportunity
At this stage we don’t believe so. There are serious headwinds for the company for the remainder of CY2021. These short term hurdles include cycling the elevated sales from the lockdowns from April to December last year and a persistently stronger AUD, which has appreciated 17% against the USD (RBL’s main sales currency).
To make matters worse, RBL was added to the ASX200 index just three days before the disappointing update. It is now likely that RBL will be removed from the index on the next rebalance, adding more artificial selling pressure to the share price.
Overall, we did well out of RBL and we may re-enter the stock at some point in the future. Experience has taught us that there is no immediate rush to do so, and we will want to see a material discount to our updated valuation of $4.50, based on consensus forecasts for the next two years.
As promised, this week we continue to look through some of the key highlights, and my notes, on the top end of the market. The securities this week are NAB and ANZ.
National Australia Bank (NAB.ASX
NAB has started off in stellar fashion this year with the key highlights for the first quarter being an increase in cash earnings by 47% over the preceding average, to $1.65bn. The caveat here being that revenue grew only slightly above 1% (though the headline might show otherwise (i.e. -3%), this was a result of MtM losses in markets and treasury income). The cash earnings were driven primarily by a decline in bad and doubtful debts (BDD) to the tune of 98% to $15m and the business continued to see a substantive decline in loan deferrals with home loan deferrals declining to $2bn and $1bn for business loans.
The business has been helped along by Australia’s ever-buoyant property market as well as a favourable policy environment with initiatives like the first home loan deposit scheme. Management has continued to increase asset quality as reflected by the fall in credit impairment charges and existing deferrals better than the previous year’s guidance. The bank continues to remain well capitalised at 11.7% (CET1), slightly higher than the previous 11.6%. Management has continued to demonstrate a desire to keep up with the times, introducing the first interest free credit card in an effort to keep up with BNPL. Though we don’t see this as substantive, in a similar manner to CBA’s own program, it allows for customer retention and should increase overall profitability per customer.
On the matter of the bottom line, management has continued to deliver on its cost cutting measures with expenses falling 1% in 2H2020 and guidance of a further limitation of 0-2% on expense growth going forward. That said, NIM’s have continued to disappoint slightly, being similar to CBA in reporting a decline.
Red Flags & Risks: Although the market has seemingly forgotten, remediation costs (or them being higher than expected) could continue to plague the business dispite the sale of the MLC business. In addition, much relies on management successfully executing on expense management and strategic initiatives with uncertainty around the commercial lending book.
My Expectations: We remain consistent in our expectation of NIMs to stabilise at 1.55% over the coming eighteen months. On one aspect, we were pleasantly surprised. That aspect is the continued focus on cost reduction by management. Predicated on the others following suit, if NAB moves its online savings deposits more in line with the RBA cash rate then this should add another 3-5bps to their NIMs.
Dividend Yield: Expected yield of 3.7% (assuming a share price of $26.9 AUD).
ANZ Banking Group (ANZ.ASX)
Going straight to the numbers, NIMs were surprisingly up, up to 1.63% (an increase of 5bps vs. 2H20), though still a laggard among their competitors. This is a great sign to us, especially given the environment surrounding the sector as whole. This was driven primarily by lower funding costs and, most important of all, revenue grew by a stellar 4%. This number excludes the markets division which was our biggest concern through much of last year and remains the big question mark. What has been pleasing to see, however, was that the group reported higher margins on the institutional asset (custodian services, capital raisings, trade finance etc) business.
From a cash profit perspective, the results came in at a stellar $1.62bn while expenses came in flat, showcasing continued discipline when it comes to the balance sheet and operations. The group remains well capitalised and CET1 came in at 11.7%, comparable to NAB. More importantly, 98% of its home loan deferrals pre-covid have returned to payment with restructuring accounting for 1% and transferals to hardship accounting for another 1%. Within the business loan segment, the numbers stand at 90% of deferrals returning to payment with a further 7% restructured with 3% transferred to hardship. Looking at asset quality, the bad debt benefit remained at $150m. We remain of the view that ANZ’s comparatively more diversified balance-sheet and their remaining institutional business somewhat de-risks the business.
Red Flags & Risks: The NIMs are by far the biggest concern when it comes to ANZ and, while management’s improvement in this aspect is to be applauded, they remain substantially lower than their peers. We had previously predicted that the commercial business might get messy and this has turned out to be rather prescient, though it has been much better than expected.
My Expectations: We had previously expected NIMs to stay flat but the business has proven me wrong and now has momentum behind it. We now expect ANZ’s NIMs to play catchup to their peers over the coming quarters.
Dividend Yield: 3.4% expected yield, based on a share price of $29.10 AUD.
Author: Sid Ruttala
An update to my takeaways from six months ago:
Leanest and meanest of the lot: CBA (no change)Cheapest of the lot: Westpac
Previously: NAB. WBC now has momentum behind it.
The laggard of the lot: NAB
Previously: WBC. NAB has continued to deliver as a business, more to do with the fact that Westpac surprised on the upside and is no longer as comparatively cheap.
This week we return to our Top Twenty series. Six months since our last review, we look to provide an update on the companies. This week, Commonwealth Bank and Westpac. Read on!
Again, a disclaimer before reading further, this is the just first part of my notes on the top twenty securities by market capitalisation. Please also note, this does not necessarily mean that we currently hold any of them, especially given our domestic equities mandates are broadly ASX ex20.
Author: Sid Ruttala
Context
Perhaps one of the most important characteristics of successful investing (in my view) is the ability to accept when you may have gotten something wrong, figure out why and learn. When it comes to the Australian banks, it is one area that I got wrong. For many of you that may be familiar with my previous writings, you may know that I have consistently had a broadly bearish view on the sector given the monetary policy and regulatory environment not only post-covid but pre-covid with the conclusion of the Royal Commission. Much of my previous thesis was predicated upon declining NIM’s (Net Interest Margins) as well as, the (in)ability of the RBA to maintain a positive cash rate.
On both counts the markets have defied expectations. Not only did Lowe maintain the stance of not taking rates negative bound or even 0 as his counterparts globally were so willing to do, the banks have been adept in ascertaining and taking advantage of lower funding costs. This, combined with the Term Funding Facility, has meant that firstly the sector was provided a tailwind of 5bps on the deposit front (which should move further should term deposit rates move downward toward the headline cash rate of 0.1%) and the TFF which added another 4bps.
All this combined with a more than buoyant property market has seen stellar growth in the loan books and has stabilized the Big 4 respective PPOP (pre-provisioning operating profit). On top of this, kudos to the management teams for ensuring that over 80% of the total mortgage book remains variable (de-risking the portfolio). On top of this, the better than expected pickup in economic activity in the broader market, furthered in no small part by the fiscal largesse, has ensured that much of the mortgage deferrals, which were the major issue during much of last year, have been improving considerably. And thankfully, the public with its rather short memory has put the findings of the Royal Commission behind it (thankfully for shareholders that is).
Commonwealth Bank of Australia (CBA.ASX)
Despite management commentary being on the conservative side and provisioning sitting 1.8bn above its scenario modelling, CBA has continued to deliver. Unchanged PPOP, lower bad debts and increased payout ratio (a boon for the dividend starved investor) were the main highlights. Numbers wise, 1H21 cash earnings of $3.886bn, net interest income came in at $9.371bn compared to $9.26bn in the previous half. More importantly costs have been kept in check with the biggest highlight being the strong capital position, standing at 12.6% (this has beat my expectations slightly given that even with the sale of non-core assets I expected 12.5%).
Nevertheless, while the results have surprised me on the upside, the statutory NPAT of $4.877bn AUD (a decline of 20.8%) does show the toll that Covid has placed on the business.
Red Flags & Risks: NIMs continued to fall from 2.04% to 2.01% (above the expectations of 1.8%-2.0% that I gave last year). This will, in my view, stabilise. However, the competitive nature of the mortgage market in this nation will offer considerable headwinds going forward with the potential for downward mortgage repricing. The current valuation also ignores the impact of lower rates and is already focusing on dividend yield.
My Expectations: Cash NPAT will remain broadly flat but the payout ratio should increase in order to catch up. The firm’s recent foray into BNPL, though still in its infancy, shows that management is looking to keep abreast of changes in the economy. The offering of lower charging (1.4% vs. APT’s 3.8%) is unlikely to be enough to eat away at APT’s market share substantially though. What it is likely to do however is further increase customer retention and increase the profitability per customer by offering more holistic services. Its ability to ascertain better credit data gives it a unique advantage over its competitors (though if NAB’s Klarna is anything to go by, this will not be substantive).
Dividend Yield: 4.09% (assuming share price at $88 AUD and a 68% payout ratio – in absolute terms $3.60 AUD per share).
Westpac Banking Corp (WBC.ASX)
This was perhaps one of the bigger surprises of the year so far given WBC’s penchant to be the perennial laggard. Not only were 1Q21 revenues 100bps higher than the previous quarterly, it has been a story of turnaround in every single notable metric. This includes expenses down by 2%, CET1 up by 74bps from the previous quarter (though substantially lower than CBA) and bad debts benefit of $501m. Numbers-wise, statutory net profit was $1.7bn and cash earnings were $1.97bn, up 54%.
While the bank remains substantially less well capitalised when compared to CBA, what has been quite interesting for me was the fact that NIMs stood at 2.06%, not only is this higher than CBA but it is an increase of 3bps from the previous half. It showcased a clear turnaround story in the making for me.
Red Flags & Risks: Much of the recovery is predicated on continued housing growth and continued momentum in the cost cutting measures. The bank is also unique in its concentration of exposure to the NSW housing market compared to the loan books of their competitors.
My Expectations: This is one firm that I have done a complete 180 on in terms of my expectations. Not only did the NIMs improve, as opposed to my forecast last year of 1.6-1.75%, but management has continued to deliver on its cost cutting measures and de-risking its balance sheet. The bad and doubtful debts (BDD) has also continued to see substantial improvements. All round, this is a management story and Peter King has proven me wrong. Apparently appointing insiders in times of upheaval isn’t all that bad after all.
Dividend Yield: Expected yield of 7% (assuming a share price of $24 AUD and a payout ratio in line with 2019).
I remain of the conviction that management are likely to be incentivised to play catch up this year. This remains a better bet then CBA in my view from a dividend perspective.
Next week, NAB and ANZ!
Disclaimer: CBA and WBC are currently held in the TAMIM Australia Equity Income portfolio.
In a previous article, we gave a rationalisation for why, despite seemingly irrational valuations, we remain overweight equities here at TAMIM. This week we continue to explore this but with a caveat, that is the potential for inflation and the reasons why it might pay to be more discerning in your asset allocation. And what are some of the businesses we have invested in to take advantage?
Author: Sid Ruttala
We remain in an environment where leverage continues to grow at a considerable pace. This was perhaps best illustrated by the Archegos fiasco which showcased that, despite the GFC and the regulations that followed, risk was transferred from one area (i.e. namely the banking sector into the shadow banking and non-financial sector). This, combined with a whole generation off new investors seemingly driven by FOMO, should give us pause to take a step back and take time out to think.
Context
Despite the rhetoric coming out off most central banks across the planet (including Stateside), who continue to maintain a view that any inflation is rather transitory and normalisation of policy is unlikely, we would like to take a contrarian approach. No, its not the “this time it is different” line that is a surefire way to pain but rather understanding what has been happening. For the investors amongst you who have lived through the last great recession, you are probably aware off the doomsday-sayers who, at the time, predicted runaway hyperinflation when non-conventional policy was first implemented. But where the so-called pundits got it wrong was, I believe, a fundamental misunderstanding of the way and manner in which QE actually works. So, let us begin with that.
QE is simply put a mechanism by which the central bank effectively buys longer duration assets in return for liquidity into the financial system. For those off you not quite aware of how the financial plumbing works, please refer to my previous article where I did my best to explain in simple terms how the central banking system works and how cash rates are set in practice, you may be in for a surprise (I did get one particular call about the cash rate being taken to zero wrong though).
While QE does increase money supply in theory, it is not in the way in which you’re thinking. When you deposit cash with say ANZ or CBA, the bank is required to pay you interest. The bank has two options in this instance, the first is to lend against said deposit or alternatively buy interest bearing securities, say treasuries for example, which are still considered risk-free, and pay the differential in that. The problem occurs when commercial banks choose the second option and accumulate treasuries since the central bank will effectively swap them again in return for liquidity. And so, the cycle continues and money accumulates within the financial system as opposed to being seen as credit growth in the real economy. This is the reason credit growth across the EU and Japan has been stagnant through much of the last decade, as shown was shown by the first negative mortgages underwritten in Denmark a few years ago.
Unfortunately, what is required in this instance is the continued expansion of deposits despite the low rates. Although money supply seems to grow on face value it is in fact trapped in the financial system, the ultimate liquidity trap that also creates deflationary pressures. Ironically, Australia has avoided this scenario in many ways given the uniqueness and centrality of the property market to our psyche. We arguably created the ultimate “too big to fail” asset bubble, but it got the liquidity out of the commercial banking system.
So, what has this got to do with equities and what we are talking about here? For one thing, this context has also created some rather unforeseen headaches. Ironically, in their fixation to avoid inflation at all costs, the design of QE has created another problem: asset price inflation. More particularly, the lack of return in risk free assets has in many ways pushed liquidity into riskier asset classes. This is perhaps the reason why Credit Suisse and Nomura, both institutions that are domiciled in jurisdictions which have seen this happen, were so willing to take outsized bets on a single entity in Archegos (apart from the magnitude of the counterparty risk not showing up on the balance sheet). The lending, apart from showing up in the real economy, has shown up in margin lending and swaps to date. The below graphs shows margin debt-to-GDP. In Australia’s case this has shown up in household debt-GDP (more important metric given the centrality of property).
Source: thefelderreport.com
So Where to Next?
The case till now sounds as though I am arguing against equities but here is the kicker. It was covid and the related selloff that has made me rather more bullish. Not for the reason you’re thinking, Personally, I’ve never believed in the V-shaped recovery and I don’t kid myself into believing that the world fits such idealised textbook models but rather my argument is predicated on what liquidity is doing and inflation is likely to do. Remember that the central part of my argument is that QE ended up trapping liquidity in the financial system, it did so because there was no mechanism for MS (Money Supply) to enter the real economy which is why we didn’t see core CPI pick up. What happens however when, because of say a pandemic, governments start to enter the spree?
A spree that, given current electoral and geopolitical imperatives, is unlikely to see financed by tax increases (at least on an income tax basis)? When direct stimulus, whether through infrastructure or legislation, puts upward pressure on wages? All this at a time when the biggest deflationary catalyst of the past century (not innovation), China, not only moves up the wage curve but is flexing its geopolitical and economic muscle? So, “we have a localisation of supply chains, increasing share of labor in GDP and liquidity that enters mainstream, including a lot of the new generation of leaders asking for a “bailout” of “mainstreet”. If these aspects aren’t inflationary, one must really ask what is.
Combine this with loose monetary policy, remember central banks (aside from ensuring the stability of the financial system) are also their respective nations’ bankers and (increasingly) primary lenders, and we might have a rather changed investment environment. Why does this make me bullish on equities? Simple, show me a better option to preserve wealth.
How to Invest
Across most of our portfolios we have pivoted away from growth and toward a reflation trade. The high growth stocks that we have become used to might not have it in them to 1) substantiate their valuations; and 2) to continue their trajectory in the face of increased government intervention. The liquidity will continue to grow (there is not much of a choice for the central banks) but it will flow in different directions.
The likely uncertainty around corporate tax (not income, corporate), anti-trust, increasing share of labor in profits and government scrutiny will probably impact the top-end of the market disproportionately, which may just answer the question as to why Mr Bezos was so forthcoming in arguing for a higher tax rate. What looks particularly attractive, even from a valuation perspective, are the so-called old-world industries – sectors like Energy, Real Estate, Consumer Discretionary and Infrastructure – which should not only benefit from the tailwinds of increased consumer demand but are a tried and tested way to hedge inflation. Additionally, they are usually a great way to generate consistent dividend yields. Having said all that, here are a few Energy companies we own.
Exxon Mobil (XOM.NYSE)
With a dividend yield of about 6.3% and P/E of x10.3 Exxon not only looks cheap but, given my conviction on a continued rebound in oil prices through the rest of the year along with supply constraints across US shale production, this is one stock that should be on the radar of any dividend hunter with substantial upside as the company continues to prove its emissions and green credentials (essential for institutional flows with the continued rise of ESG).
Enbridge (ENB.NYSE)
For those of you unaware of the company, Enbridge owns and operates the largest footprint of crude oil and liquid hydrocarbon systems in North America. It has been caught up with some recent political grandstanding with the Governor of Michigan seeking to decommission Line 5, which crisscrosses the Great Lakes, despite Enbridge’s exceptional track-record in safety (it has been operating it since 1953). However, given the support it has received from Trudeau in stating that the issue was non-negotiable we think it is somewhat de-risked, even with the change in the US’ administration. The dividend yield stands at a stellar 6.3% and, perhaps more importantly, a growth rate of 7% for the past ten years (we expect this to continue).
TC Energy (TRP.TSE)
This one’s mainstay is a humungous natural gas pipeline network that now extends to over about 93,000km and transports close to 27% of North America’s LNG demand. It also accounts for 20% of Western Canada’s exports. More importantly, TC Energy has a dividend yield of 7% and a growth rate in the high single digits (9.34% p.a. over the last 5 years).
Disclaimer: All three stocks are held in TAMIM portfolios.
In general, the market and investors like companies that make acquisitions. Acquisitions that add scale and capabilities and are done at attractive valuations can be very accretive to a company. There are some companies that are definitely more acquisitive than others. Whether a company makes a large or small deal, some acquisitions can be more strategically beneficial and transformational than others. With this in mind, we discuss three companies we own that made very strategic deals last week.
Authors: Ron Shamgar
EML Payments (EML.ASX) announced the acquisition of Sentenial and its subsidiary Nuapay for $110m plus a $60m earn out. The deal, funded by partial cash and debt, is not huge in size for EML but significant and transformative as it enables EML to enter the fast-growing open banking sector. Open banking is taking over the payments world; driven by regulatory changes and customer demand. It allows customers and merchants to make instantaneous account to account payments, thereby reducing costs to merchants and fraud. For consumers it is a more convenient way to pay than using a card.
Since open banking is bypassing the card scheme operators like Visa and MasterCard, these payment giants are concerned as some estimates predict that 30% of all future payment revenues will go to the open banking sector. Visa, for example, agreed to acquire leading open banking fintech Plaid in early 2020 for $5.3bn, double their then most recent private valuation. The acquisition was blocked by the competition regulators in January this year. Just three months later Plaid is now valued at $13bn.
Source: EML company filings
For EML, the Sentenial deal adds a key growth vertical that will help them not only disrupt and stay relevant in the payment world, but also add $23m in EBITDA three years from now. We estimate that Sentenial alone adds over $2 per share of value to EML and our valuation increases to over $8.00 as a result. EML is currently a holding in our Australia All Cap portfolio.
Spirit Technology Solutions (ST1.ASX) acquired telco business Nexgen for $50m last week. The deal adds $36m of revenues and $7.5m of EBITDA. More importantly, 80% of revenues are recurring and are contracted for an average of 4.5 years. The combined group will double its SME customer base to 10,000. We see the deal as transformative for ST1 not just because it adds scale and profit. Nexgen brings with it a sales team of 100+ personnel that can now cross sell ST1’s other services to its wide and freshly expanded customer base, offering products for cyber security and data. Following the deal we now estimate ST1 is has run rate revenue of $150m and approximately $20m of EITDA. Our valuation is 55 cents. ST1 is currently a holding in our Australia All Cap portfolio.
Source: ST1 company filings
SG Fleet (SGF.ASX) announced the acquisition of one of its largest competitors in Australia, Leaseplan. The deal is transformative as it creates a fleet management and car leasing group with 250,000 vehicles under management. Management is estimating $20m worth of cost synergies over the first three years which in turn will be 20% cash EPS accretive for shareholders. The deal will see the combined group become by far the largest player in the local Australian and New Zealand market, managing approximately double the number of vehicles of to their nearest competitor.
Source: SGF company filings
By adding Leaseplan, SGF improves its recurring revenue profile to 70% of group sales. We believe this will command a higher valuation multiple from investors over time. We value SGF at $3.50 and we own the stock in the Small Cap Income portfolio.
Source: SGF company filings
Disclaimer: All three stocks are held in TAMIM portfolios.
EML Payments (EML.ASX) announced the acquisition of Sentenial and its subsidiary Nuapay for $110m plus a $60m earn out. The deal, funded by partial cash and debt, is not huge in size for EML but significant and transformative as it enables EML to enter the fast-growing open banking sector. Open banking is taking over the payments world; driven by regulatory changes and customer demand. It allows customers and merchants to make instantaneous account to account payments, thereby reducing costs to merchants and fraud. For consumers it is a more convenient way to pay than using a card.
