Every generation sees certain trends that go beyond the cyclical. Trends that encapsulate a fundamental change to the way things are done. When we say secular growth, we are referring to structural changes taking place in the economy; from e-commerce fundamentally changing the ways in which people shop to QE that has ushered in a decade long growth story in equities, in particular the higher growth names. In this piece we want to put forward a few such trends that are likely to fundamentally shift both the economic and investment landscape over the next ten to twenty years.
Author: Sid Rutalla
Before we proceed further, there are a few things to bear in mind. Secular growth does not mean irrespective of market environment. E-commerce and information technologies did undoubtedly change the way we do business, but that doesn’t necessarily mean buying Microsoft in the 2000 would have been a particularly great investment and remember that markets do create excesses, as pets.com did. Or for the history buffs, the tulip mania of 1637.
So, without further ado, what are the three secular growth stories that we think will fundamentally shift the way our planet (and investment markets) look over the coming decades?
Mobility & The Future of Transportation
For those of you that aren’t aware, this is one area that we feel is about to change and do so at a rapid rate. A technological revolution quite on par with Ford’s mass production during the infancy of automobile commercialisation. In our view, the changes taking place in Mobility can be schematised under four aspects 1) electrification; 2) autonomy; 3) connectivity and 4) shared mobility.
This is the beginning of an ecosystem, enabled and advanced as a matter of policy across most of the developed and developing worlds. While adoption might be at differing stages depending on context, there is a marked incentive for governments across the planet to adopt the technologies and commercialise quickly, especially on the electrification front. Ranging from the more aggressive targets set by regions like the EU, who as a matter of broader climate policy aim to move towards a ban of new combustion engine sales to the more aggressive outright ban of all combustion engines. The case is similar across densely populated South East Asia and the broader APAC region whose population density and energy dependence create an immense desire from governments to adopt more aggressive policies.
Take India as a prime example. The government and policy makers are not only considering a ban of new sales (as is the case in the UK) but rather an outright ban, how this will be implemented in practise is still somewhat of a question mark though. Nevertheless, that nation’s reliance on energy imports (its economic fortunes are arguably dependent upon the price of oil) make it imperative to transition towards more sustainable transportation methods. The case is similar across China, whose battle with pollution across the major cities is well documented. China has become the largest EV market in the world as of last year with government policy supporting and subsidizing the still nascent industry.
Porsche Mission E concept car, 2015
Mobility is also one area that happens to be central to Industry 4.0, an area that will see nations compete as a matter of both economic and national security. Thinking about the autonomy aspect, what do autonomous truck fleets mean for delivery and logistics going forward? Autonomous cars could mean an extra hour of productivity in the day for commuters. The potential benefits of autonomous vehicles are obvious but that’s not to say there aren’t roadblocks. The biggest concern we come across when talking to people about TAMIM’s Global Mobility strategy is the viability of autonomous vehicles, more specifically their general safety at this stage and the “Trolley Problem”. Simply put, what does the car do when forced to choose between protecting the passenger or protecting a pedestrian? The other side of this is the liability problem; who is liable in the event of a collision if no one in the cars were in control? Many people, somewhat understandably, see this as a major issue to the rollout of autonomous vehicles. But, guess what. Waymo, an Alphabet (GOOGL.NASDAQ, owned) subsidiary, operates a commercial self-driving taxi service in Phoenix, Arizona called “Waymo One”. Since the back end of last year it has operated without a safety driver. It’s already here. Waymo is developing its technology for the delivery and logistics side too and has partnerships with a number of vehicle manufacturers to integrate their technology. Here we are talking about the likes of Volvo, Nissan-Renault, Daimler AG, Fiat Chrysler, and Jaguar Land Rover. The name Waymo itself is derived from their mission to find “a new way forward in mobility.” Waymo is just one of many companies making strides in this area (sometimes being backed by the goliath that is Google/Alphabet helps); Drive.ai (an Apple subsidiary) is well underway, the Mercedes-Benz S-Class (W223) launched last year with software ready to be downloaded as soon as laws permit Level 3 ALKS (Automated Lane Keeping Systems) and Tesla maintains that all of its releases are built with the hardware for the highest level of safety (SAE’s Level 5 – essentially meaning a steering wheel is entirely optional). As a side note, the autonomy of a horse was once seen (by some) as a positive over early motor cars. A hundred-odd years later, give or take a decade, we are having the same conversations about fuel, costs, and safety while on the verge of the next leap in transport and mobility.
Winton, January 24, 1903
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Shared mobility is arguably the furthest along of the four aspects we mentioned above. One just needs to look at ride sharing companies like Uber, Lyft, Ola etc. One just needs to extrapolate from where we are now to see the potential opportunities. Do these companies end up running their own autonomous fleets? In a similar fashion to Blockbuster vs streaming companies like Netflix, do these companies die because they are replaced by subscription services offered by automakers? By that we mean it is possible that, in future, you end up having a Daimler subscription and you order a car from their fleet when and if you need the Merc. If this is the case and car ownership plunges, then what happens to auto insurers? This is a nebulous area with plenty to play out and the opportunities for both long and short positions will be extremely interesting to monitor, precisely why our Global Mobility portfolio can take both long and short positions.
If all this is still not enough, below are a few figures that might help make up your mind:
2025, 2026, 2027 – The years in which, Norway, Belgium and Austria respectively are introducing bans on non-electric vehicles with differences across sectors. For example, the scope for Belgium only extends to new company cars.
2030 – The year in which the UK is proposing to ban outright the sale of fossil fuels based automobiles. India has gone further in targeting not only a ban of new vehicles but an outright ban.
2050 – The year at which the EU proposes to achieve a net-zero carbon target. With 2040 being the more aggressive base case in order to meet the targets set in the Paris Climate Agreement.
With the US set to rejoin the Paris agreement, we see a marked incentive for that particular market to phase out fossil fuels based automobiles sooner than later (though we wouldn’t count on an outright ban stateside, maybe a tax on non-EV vehicle sales?).
€5 billion – The amount of direct subsidies offered by Germany alone for auto-manufacturers to go renewable. We will continue to see more incentives within the bloc towards enabling and fast tracking the move towards EV, which remains a key pillar to achieve a net-zero carbon economy.
The largest automotive market in the world, China, is currently undertaking a research timetable for an outright ban.
€20 billion – The amount of penalties that automakers face going into 2021 if they don’t meet new stringent CO2 emission targets.
$2.5 trillion – The minimum value of the new ecosystem of businesses and services that are emerging within the segment by 2030.
$8 – 10 trillion – The overall opportunity set over the next 50 years.
62% – The percentage of automotives that are used as Robo-Taxis in China (think again about traditional automobile sales and private ownership).
$1.1 trillion – The most conservative projection for market revenues generated by mobility services in China
So how do you play this?
As an investor, the best way to describe what is at play here is that it is analogous to the smartphone market in its infancy. Hindsight is an interesting thing for the investor, we would all love to say that we could have predicted Apple’s future market share and success back in the early 2000s. However, in that particular year, the mobile phone market was dominated by Nokia and Blackberry. The key is to understand that in a dynamic industry, perhaps the best way to invest is not to necessarily pick the winner of the final product but to make bets across the entire ecosystem.
After all, Apple did create a trillion dollar ecosystem ranging from semiconductors to third party component manufacturers including the likes of FoxConn, otherwise known as the Taiwanese listed Hon Hai Precision Industry. In a similar manner, mobility and the vehicle market is not only predicated on EVs per se but the software that is key to autonomous driving, the chips that go into the end product, the platform that is required to build out an increasingly autonomous and self-governing transportation network. Some winners that exemplify what we have been investing into are companies such as NXP Semiconductors (NXPI.NASDAQ) and Corning Glass (GLW.NYSE) who also happen to manufacture the gorilla glass that goes into the majority of modern smartphones, including the iPhone. Take a look at what has happened with Lithium prices and the companies that extract it in recent years, electric vehicles need batteries. This also ties in with infrastructure in the form of energy and renewables but, that said, we are a little bearish on lithium as we think the boom is mostly priced in now. You have to think blue jeans to miners in this space, not just Tesla (not currently owned in our Global Mobility strategy).
Within autonomy and sharing, companies include both traditional ridesharing platforms and e-commerce companies such as Just Eat Takeaway are particularly interesting for us. When it comes to autonomy, you will also want to research companies that are involved in things like LiDAR (light detection and ranging), RADAR, IMUs and odometry technology. Across both autonomy and sharing, cyber security will be a critical element and is well worth looking into (in today’s digital world, this is going to apply to all three thematics we are discussing). None of these aspects of mobility operate in a vacuum and we will see increasing M&A activity within the space with some of the more niche players being bought out by larger players. Take MobileEye, for example, which was bought out by Intel (owned) in the largest acquisition in the space to date. Additional firms that look particularly attractive from a listed space include UK based Aptiv, Alphabet, Baidu (for geographic diversification) and GM (owned). Another allocation that looks particularly attractive as the field consolidates is VC, in particular companies with unique ideas that target specific niches and look attractive from a takeover perspective. Many of the companies pioneering these technologies never make it to listing as the Googles and Apples of the world voraciously snap them up. One nation that is at the forefront when it comes to this space is Israel where we have historically been invested and continue to.
In addition to the above, we see an increasing scope for added investment returns by diversifying across geographies given the politically sensitive nature of this particular thematic. In fact investors in companies such VUL.ASX (Vulcan) would’ve seen astronomical returns that are in no small part to do with geographic and EU oriented supply-chains. We will similarly see additional barriers created and re-localization of supply chains which, while pushing upward pressure on manufacturing costs, could also see supply chains and profits protected. The best position for the discerning investor in our view is to bet on both sides. Irrespective of who wins or the future, the medium term should see capital benefiting from economic rent-seeking by portfolio companies.
Regardless of if you are bearish on any one of the four aspects mentioned above, this is a space undergoing a transformational period. That is, if you don’t believe autonomous vehicles are viable, electrification of mobility is already underway and being legislated. This is a space everyone should consider for inclusion in a well rounded portfolio. The roll out of the next generation of automobiles will require an element of adjustment (roads, storage, charging etc) that ties in nicely with our next theme…
Infrastructure
Coming back to the topic of fiscal led growth, we arrive at our next thematic: infrastructure. What covid-19 has brought about (for better or worse) is fiscal deficits and questions of budgetary prudence taking a backseat. Across the planet, governments have continued to add more debt as a percentage of GDP than in the decade following the last crisis (GFC). This is a scenario that was a direct result of the extraordinary measures undertaken as a result of covid and we are not likely to see this reset perhaps as a result of path dependence. A significant aspect of spending going forward will be in critical components such as infrastructure. Indeed, this is one aspect that seems to have some much needed consensus across the aisle in the US and around the world.
Take a look at the below graphic from the American Society of Civil Engineers who, amongst other things, grade the US’ infrastructure every four years. This graphic is a favourite of our own Robert Swift who sees it as a perfect illustration of the thesis underpinning his Infrastructure portfolio and elements of our Global High Conviction strategy.
Source: ASCE
Indeed, under current estimates, the infrastructure deficit over the next decade (if the current pre-covid trajectory was being kept) is set to grow to $15tn USD. That is, there is a differential of 15tn from what is required in order to maintain and keep up with population growth. One of the silver linings of covid, in a perverse manner, has been to make it easier for nations and policy makers to use this period as an excuse to expand budgets and tackle some of these challenges. The proportion of government expenditure (as a percentage of GDP) is likely to continue to grow with a substantial amount going towards direct stimulus.
Looking locally, the below graphic from Infrastructure Partnerships Australia illustrates the opportunity nicely. Notice the sheer scale of the increases in spending; also worth noting is that the totals provided here are for spending from 2020-21 to 2023-24, not even the 10+ year timeframe we are looking at with these thematics. Take a look (see here) at the projects included in the Federal Government’s land transport infrastructure program ($110bn over the next ten years).
Source: IPA
Within this space, there will be certain nuances though. Whereas developed countries might see greater emphasis upon upgrading the telecommunications and ailing road infrastructure (both sorely needed in Australia), we will see increased emphasis placed upon rail and energy storage (there’s those batteries again) in developing markets across Asia and Africa. A key aspect of our own exposure comes from companies like Verizon (VZ.NYSE, telecommunications), China Water Affairs (0855.HKG) and China Lesso (02128.HKG, a PVC pipe manufacturer). The obvious play on this thematic is companies that will be getting the construction work but we feel this a bit of a trap, this places entirely too much reliance on winning contracts for our liking. Much the same with picking the ultimate finished product winners of the mobility segment, you’re far better placing diversified bets across the entire space, up and down the supply chain.
Similarly, we also make the call that infrastructure is likely to play a greater role in global geopolitics. We have already seen increasingly ambitious projects by China such as the One Belt and One Road (OBOR) plan. OBOR has a considerable amount of its reason for existence rooted firstly in managing the de-industrialisation process that is likely to take place as its China’s populace continues to age and move up the wage curve (i.e. older industries are likely to transition towards South East Asia in search of lower labor costs) and secondly to extend Chinese influence outwards in order to maintain its own economic and protein supply chains. Take the case of energy. As the largest importer of oil, China faces what has been termed the ‘Malacca Dilemma’ which essentially refers to the fact that over 80% of her energy imports pass through the Straits of Malacca and, should instability occur in the region by a state or non-state actor, it could effectively paralyse the Chinese economy. A key rationale behind ambitious projects such as CPEC (China-Pakistan Economic Corridor) is to safeguard China’s strategic interests for imports from EMEA (Europe, the Middle East and Africa). By the way, these strategic imperatives have a large part in explaining the increasingly aggressive stances taken in the South China Sea. For the investors, one must also remember that this creates immense opportunities to profit, including exposure via Chinese infrastructure companies such as China Merchant Port Holdings (0144.KKG), China Railway Group (0390.HKG & 601390.SHA) and the inputs that go into it. For the Australian investors (iron ore or copper anyone?) companies such as BHP and Rio, we feel, have continued potential in what could be a multi-decade commodities boom.
On the other side, we are likely to see a counteraction to this by Western competitors. The Trans-Pacific Partnership was supposed to be a counterpoint to China’s plans before the Trump Administration pulled the US out. A significant aspect of the TPP was to build out energy infrastructure. We are likely to see increased cooperation from the US, as they seek to re-engage, and from a freshly independent UK (i.e. they need to find alternative trade partners following Brexit). Renewables are also likely to play a greater role in energy infrastructure and a changing energy mix is likely to be a priority role under the Biden administration. Closer to home, and regardless of the current government’s attitude, we are starting to see the established player pivot to this reality. Just this month Andrew “Twiggy” Forrest, founder and chairman of iron ore miner Fortescue Metals Group (FMG.ASX), brought Fortescue’s net-zero emissions target to 2030, a reduction of ten years and twenty years ahead of other larger miners. Part of this project is exploring the use of green hydrogen instead of coal in producing steel. Fortescue plans to develop green electricity, hydrogen and ammonia projects through subsidiary Fortescue Future Industries, chaired in Australia by Malcolm Turnbull. Australia itself, which has (in)famously refused to commit to zero emissions targets, is investing $300 million into hydrogen.
Across Asia, we have also seen China and India take great pains to implement policies pushing green infrastructure. For TAMIM, we still remain underweight India due to issues around access and equity market valuations, companies like L&T (LT.NSE) nevertheless look particularly attractive for those who are interested. Similarly stateside look to companies, even utilities (another favourite of Robert Swift), that are actively moving towards a greener energy mix such as Nextera Energy (NEE.NYSE, owned). For greater geographic exposure, research Canadian listed Brookfield Infrastructure (BIP.UN.TSX & BIP.NYSE), though the company has been trading at a considerable premium. For more growth exposure, Enphase Energy (ENPH.NASDAQ), which designs and manufactures software-driven solar energy solutions, may be worth looking into.
Domestically, our strategy has been to avoid top end players such as Transurban or Telstra but rather to focus upon niches such as Uniti Wireless (UWL.ASX, owned) which we consider to be a more credible alternative to the government run NBN. Tangentially, you also want to think about other players in the digital/data/IT infrastructure space. Our own Ron Shamgar likes Spirit Technology Solutions (ST1.ASX, owned) as a modern IT services and telco provider mostly to SMEs and corporate/government clients. Interestingly, ST1 entered the cyber security space at the tail end of 2020 via a pair of acquisitions (remember, cyber security will be critical for most industries going forward). Empired (EPD.ASX, owned) is another IT services company Ron currently favours. For utilities, we prefer the likes of Origin (ORG.ASX, owned) over AGL (AGL.ASX) despite the relatively cheaper valuation when it comes to AGL, the legacy coal business being a headache from a valuation perspective as much of institutional flows are diverted to renewables (which has the added problem off adding upward pressure on the cost of capital).
Digital Banking & Payment
This is one theme that we are quite sure many people would have an immense amount of fatigue hearing about so we’ll keep it relatively brief. Nevertheless, it remains an area that will likely see continued growth. New payment methods, such as BNPL, have managed to generate phenomenal profits for Australian investors over the last half-decade. Luckily for us, Australia has been used as a guinea pig of sorts for these products before they are rolled out to the rest of the world. But where to next?
The world continues to move away from traditional cash and even the use of credit cards in payments transactions. New and creative solutions such as EML’s (EML.ASX, owned) VAN (Virtual Account Numbers) will continue to take market share from more traditional players. Along with niche providers, such as SMP (SMP.ASX, owned), that offer the more traditional terminals will offer significant growth potential to investors domestically. SMP recently caught a break with competitor Tyro’s (TYR.ASX) EFTPOS terminals experiencing major issues, also underscoring the importance of the infrastructure and technology underpinning these processes.
On a global level, we think BNPL remains very much in its infancy (remember Australia’s guinea pig status here). Sezzle (SZL.ASX, previously owned) remains our favourite when it comes to the US and Paypal is likely to make some headway given its recent entry into the market. Its ownership of p2p payments app Venmo and Honey Science give that particular business an edge in reaching to audiences that wouldn’t otherwise be reached. Square (SQ.NYSE), also a payment terminal provider, remains a service provider to federal stimulus payments (a decent business that we feel will likely continue to grow over the coming years, somehow we doubt this is the last set of stimulus measures we will see). Its cash app combines a digital wallet and enables p2p and b2b transactions.
The most obvious risk in this space is regulation. Regulation is usually lagging and done post hoc, the segment is entering this phase. This type of thing will dictate the future prospects of the segment but you can rest assured, there will be winners coming out of this and, with global expansion or takeovers, there could be plenty of profit yet to be made for investors. For even greater growth exposure, continue to watch the Chinese regulatory approach with regards to Alibaba (owned) (the stake in Ant Financial makes it a rather attractive prospect). Ant Financial, by the way, also has investments in Paytm, India’s second largest payments provider after PayPal. There will likely be certain markets that don’t even let things like BNPL take hold, here we are thinking the likes of India, but that is the draconian end of regulation.
It would be remiss of us not to at least mention the crypto space when talking about digital banking and payments undergoing change. That is only to say that there is definitely something happening there and it appears to be here to stay. Whether it is one of the established tokens or the technology/concepts underpinning them, there is a potentially transformational element sitting in amongst the noise somewhere. While big institutions are beginning to allocate to things like BTC, regulation is once again a big risk over the next few years. It remains a big question mark for us but definitely interesting to watch.
Conclusion
Ultimately, these three themes should see secular growth over the next ten to twenty years. Regardless of where we are at in the economic cycle, the changes happening in the mobility space will be going ahead. The beauty of this theme is that there are enough aspects under the mobility umbrella that it will see growth regardless of the issues currently facing any one of electrification, autonomy, connectivity and ride sharing. And that’s the pessimistic view. Optimistically, you only have to consider the tailwinds currently in place thanks to government legislation to see the upside. The infrastructure theme is primed because we are currently sitting in a perfect storm; a trifecta of “developing” nations still building out theirs, “developed” nations updating theirs and massive stimulus due to a global crisis accelerating everyone’s timeline. The digital banking and payments theme is probably the furthest along in terms of its development and as such we are currently looking closely at imminent changes to regulations, it is a space that has massive potential opportunities when it comes to global expansion and takeovers but much will be dependent on that.
Interestingly, you may also have noticed a few common considerations across all of these themes. First, the risk of regulation and policy. This will happen. The next generation of cars will be regulated and legislated, infrastructure policy around the world will vary with the geopolitical situation and the payments space is always being regulated to catch up with the latest innovation, BNPL is up next. On the positive side, there will be certain plays one can make that sit across all of these and cyber security comes to mind. No one wants their electric and/or autonomous car hacked and in someone else’s control, infrastructure includes massive amounts of telecommunication and data and cyber security has always been at the fore when it comes to banking and payments.
Ron Shamgar takes stock after yet another busy reporting season, looks at his portfolio and gives us three brief highlights from the recent results.
Author Ron Shamgar
Reporting season wrapped up on Friday and for us it was mostly a positive set of results. It was worth noting that a feature was companies significantly cutting their overheads and finding more efficient ways to do business in light of covid restrictions. As a result, first half profitability and cash flows were strong and this translated to higher dividend payments which will flow to investors in the next few weeks. Currency was another feature where importers, like retailers, are benefiting from higher gross margins whereas offshore earners are seeing some headwinds.
For our portfolio, there were three highlights in particular from these results:
EML Payments (EML.ASX) results were in line with analyst expectations and probably disappointed the short sellers betting against the company. Cash flows were incredibly strong and they have $136m to deploy on acquisitions. EML showed investors the diversity and resilience in the business and that it is no longer reliant on gift card sales in shopping malls. The biggest surprise was the pipeline of new business, growing to over 400 programs.
Management quantified win rates of 40%, which is $8bn of new deals every year and should be replicable for the next few years. That is a huge runway of growth on the current $20bn of debit volume they will process this year. Finally, EML is in line to win government stimulus disbursements programs. If announced to the market, this could take the share price closer to our valuation of $6.50 this year.
Resimac (RMC.ASX) is a leading mortgage originator in Australia, delivering an excellent result that the market, in our view, misunderstood. They are currently investing heavily in their digital capabilities and are fully expensing the spend this year. This is why profit after tax wasn’t at the top end of guidance and probably why some investors were disappointed.
For perspective, net profit after tax grew 90% to $51m and full year guidance is $105m net profit after tax. What investors are missing is that guidance doesn’t include any covid provision write back. Something which their competitor, Liberty Financial Group, already wrote back in their half year results. We believe there is an upgrade coming later this half and our valuation is $3.50
Earlypay (EPY.ASX) is an invoice financing and equipment funding business that has reported their first result as a true fintech. Unlike others in the sector, EPY is actually making real profits and paying dividends to investors. In December, 56% of new business came from their online portal Skipper, which they acquired last year. Already, in January and February, more than 76% of new business is coming from this online channel. Online on-boarding takes two days, compared to the previous system taking two weeks.
We believe that when government stimulus begins to taper off in March, many businesses will require further working capital and think that Earlypay will continue to benefit and continue to grow this year as they pick up some of the slack. We are currently forecasting FY22 net profit after tax of $14m and we value the stock at 70 cents. There is always a possibility that Scottish Pacific or Consolidated Operations Group (COG.ASX) or another player in the finance industry will make a takeover bid for Earlypay.
Disclaimer: EML, RMC and EPY are all currently held in TAMIM portfolios.
This week we thought it would be valuable to highlight Ron Shamgar’s recent monthly report. Ron has delivered a stellar return for our investors over the last couple of years, managing the portfolio through the covid crisis with aplomb.
Author: Ron Shamgar
During the month of February the ASX300 was up +1.48% while the Small Ords was up +1.55%.
The TAMIM Fund: Australia All Cap portfolio continued its strong outperformance for 2021 and finished the month up +4.30% net of all fees.
Calendar year to date, the portfolio is up +10.44% net of fees. The strategy has now delivered +20.37% p.a. since inception. More recently, the portfolio has returned +39.73% p.a. over the last two years.
February was a busy period as companies reported their half year results. In most cases, due to covid disruptions, many companies have regularly updated investors on their financial performance. Therefore, the devil was in the detail, so to speak.
One key feature of this reporting season and the first half of FY21 generally, was the way companies adapted their businesses to the new covid environment. In most cases cash flows were quite strong as management teams focused on working capital and cutting costs. This resulted in increased dividend payments which will flow on to investors from March.
Covid has forced companies to operate more efficiently and invest in digital capabilities in order to manage a remote workforce. We see these efficiencies remaining in the future even with the full reopening of economies and easing of restrictions.
Overall, our holdings delivered strong results. We added some new positions and cut some underperforming ones where we have lost confidence in management. We are seeing a lot of new opportunities and value emerging in many companies that should benefit from a post-covid world.
Finally, the biggest topic of discussion and concern for investors this month was long term bond yields increasing due to expectations of inflation. Generally speaking, higher yields lead to lower valuations of growth stocks as investors use this metric to value these businesses future cash flows. We have somewhat anticipated this shift and have recently moved away from some of the “Covid Winners” we have previously discussed and into companies that should benefit from the reopening trade in a post-covid world. We remain focused on the fundamentals of the businesses we own rather than macroeconomic noise. We see that alone, as the ultimate recipe for long term performance.
Uniti Group (UWL.ASX) delivered a pre-released result with 1H21 a revenue run rate of $200m and EBITDA of $116m while free cash flows are estimated at $72m. More importantly, approximately $100m of EBITDA will be generated by the high quality and long term wholesale and fibre division.
Source: UWL company highlights
We keep comparing UWL to a higher quality and higher growth mini version of the NBN. As such, we believe the company should be valued as a core infrastructure asset rather than a generic telco. In addition, management highlighted that over the next five years EBITDA should double to $200m purely by executing on the contracted future pipeline of fibre connections. Investors are slowly catching on to the upside and growth story in UWL and the stock has slowly re-rated towards our near term valuation of $2.50.
Empired Group (EPD.ASX) delivered a stellar result with revenues up 7% to $90m, EBITDA up 107% to $16.2m and NPAT of $7.7m. Operating cash flows were strong at $17.5m and the company is in a net cash position of $6m. A 1.5 cent interim dividend was also declared for the first time in six years. EPD is a beneficiary of the digital transformation undertaken by large corporates and government agencies. In addition, there is less competition from offshore IT services providers due to border closures.
Source: EPD company filings
EPD expects strong Business Applications growth to further strengthen in 2H21 with an outstanding pipeline of material contract opportunities. We see EPD delivering approximately $32m EBITDA in FY22. This translates to $15m NPAT and makes EPD look cheap at 8x PE and EV/EBITDA of 3.5x. Our valuation is $1.00.
Cardno (CDD.ASX) is a professional infrastructure and environmental services consultancy. 1H revenues were down 11% to $434m while underlying EBITDA was up 10% to $25m and NPATA was $14.m. We expect full year EPS to be in the range of 6-7 cents which makes the stock look incredibly cheap at the current price of 47 cents. Our entry was 33 cents. CDD’s strong balance sheet and cash flows allowed the company to buyback 10% of shares on issue during the half. Accordingly, management declared a 1.5 cent franked dividend.
Source: CDD company filings
We see CDD as a beneficiary of the reopening trade in the post-covid world. Management also provided an upgraded guidance of EBITDA range of $45-50m (a 10% upgrade). We believe CDD is a potential takeover target if the shares remain undervalued. We value the stock at about 70 cents.
Dusk (DSK.ASX) results came in at the top end of their guidance as, like many retailers, DSK benefitted from covid consumer demand for home fragrances and decor. Sales were up 49%, online sales up 120%, and EBIT of $28.3m (excluding JobKeeper) which was up 194%. DSK also has a net cash balance of $35m. An interim dividend of 15 cents was declared. Pleasingly, management also provided a trading update for the first six weeks of 2H with sales up 55%.
Source: DSK company filings
DSK opened six new stores during the half with the store network now up to 118. Another four new stores and the refurbishment of thirty-six legacy stores is also planned for this year. Longer term, we believe DSK will have to show investors that the company can expand beyond Australia and NZ and into other markets in order to receive a higher valuation compared to peers like Lovisa (LOV.ASX). We took some profits above $3.00 as we have almost doubled our investment since our entry at around the $1.60 mark.
This week we would like to take a look at Greensill Capital and its spectacular fall from grace. Its fall, preceded by another yet bigger collapse in the form of German payment processor Wirecard, has raised many questions around the ability of regulators to keep up with changes in modern finance and left the German regulator in a shambolic situation.
Author: Sid Ruttala
A Bit of Background
So, how does a company that just two years ago had raised $961m at a lofty valuation of $6bn AUD from SoftBank and was talking up an IPO at a humble valuation of $7bn AUD (according to industry insiders) just a month ago, collapse almost overnight? What that might suggest about valuations and the IPO market in its current form may be an article in its own right but for now let’s look at what happened.
Firstly, let’s begin with what Greensill actually does. Simply put, the business, despite its later diversified revenue streams including conventional banking services and bonds (on debt it has purchased) to outside investors, operates in the world of supply-chain finance as its bread and butter. Think about it as BNPL for a supply chain. Essentially it is factoring in reverse, whereby a buyer uses a bank or financial institution to finance a suppliers invoice. Because the invoice gets immediately sold, the supplier gets immediate cash whilst the buyer has more time to pay off the cash. In this entire transaction there are three parties involved, the buyer, the supplier and the mediating financial institution (cue Greensill).
Simple, right? However, for the financial institution, there are even more hurdles. A company like Greensill needs two further things, access to immediate capital (a line of credit) to pay the suppliers on behalf of the buyers and, from a risk perspective, an ability to adequately insure the possibility of non-payment by the buyers. On face value this seems simple enough. However, problems can arise when any one of these pieces fails to work.
So, what happened?
The problem began around eight months ago, when Greensill found itself in a situation whereby the insurers, IAG (IAG.ASX) in this case, were unwilling to insure or renew around $4.6bn AUD in policies. With that first major problem, the dominos began to fall. Without insurance, there was no way that banks or financial institutions, in this instance Credit Suisse and GAM Holdings, were going to extend liquidity in order for them to make the requisite payments to their suppliers. The business model effectively falling to pieces as soon as this occurred.
There was some last minute flurry when Greensill sought an injunction in order to stop IAG from ceasing coverage. Unfortunately for Greensill, it was not until the last minute (they had found out about IAG looking to cease coverage in September 2020) that they sought to do so and the Justice cited this issue as the reason for denying the firm. Shortly following this Credit Suisse froze close to $10bn AUD in funds.
What went wrong?
This begs the question, why did IAG actually suspend coverage? What went so wrong? The answer lies not in the Greensill business model itself but around how it handled its risk and we’re quite sure that this is what IAG realised rather slowly. The big red flag for investors, including Softbank, should have come from the fact that when the firm sought a change in auditors due to increased complexity, two of the Big Four accounting firms (and the smaller BDO) all declined the business.
But let’s look at the risk and Greensill’s management of it or lack thereof, a somewhat understandable scenario given the founder and CEO’s propensity for risk-taking and making bold moves. So bold in fact that, despite the firm’s claim of over $163bn in financing and north of 10m customers, by far the biggest and most lucrative client was a single entity, GFG Alliance (the group owned by Sanjeev Gupta). This group owes close to $7.3bn AUD. Not only had the firm engaged in traditional supply-chain finance but they had made loans which were then repackaged, securitised and sold back to GAM Greensill Supply Chain Finance Fund (which has now been closed for subscriptions and redemptions).
Mr Gupta, of course, has conveniently indicated that repayments would be frozen and had previously indicated that GFG itself would file for bankruptcy should Greensill stop providing it with working capital loans. A relationship that had turned particularly toxic and was predicated much upon the personal relationship between the heads of both groups.
As if the concentration and reliance on one client wasn’t enough, it seems that, on the other end of the spectrum, IAG through its subsidiary BCC was the only substantial insurer. So, the firm in its entirety relied on one client and one insurer to make or break its business. A situation that helped it when it grew rapidly. The GFG and Greensill alliance, though now seemingly toxic, was mutually reinforcing (on the way down too it seems). On the positive for GFG, the loans from Greensill were unsecured.
For the shareholders of IAG? Despite the beating it took at the time of writing, the company has apparently managed to sell off its exposure. The subsidiary, BCC (the entity writing contracts to cover Greensill bonds), actually sold a chunk to Tokio Marine Management, itself owned by three companies all linked to the Mitsubishi UFJ Financial Group (MUFJ) keiretsu. IAG sold its 50% of BCC to Tokio on 9 April 2019 and the deal effectively wiped out any exposure to trade credit insurance. The timing was coincidental, of course. This author would like to know how Mitsubishi feels about this particular coincidence.
Where to Next?
Call me a cynic, but I for one have a feeling that it wasn’t an accident that the working capital issue was left to the last minute. Much of the recent mess may have been avoided with a timely IPO at a requisite valuation and enough of a liquidity injection. No one would have been the wiser. But for now, Apollo Global Management, the private equity firm with enough brains to see a good deal, are probably going to come out on top. They are likely to buy out the business for a tidy $127m, minus the headache of the Gupta loans of course. Remember, this is a business that still made close to $35m AUD in 2019 (that’s net profit) and, if you take out the biggest headache (GFG) and reinsure it with some capital on top, that may just be a decent deal (if done well, one might say, the deal of a lifetime).
As for the Honourable Lex Greensill CBE (oh yes, he’s that too)? The golden boy from Bundaberg might’ve fallen from grace along with his eponymous firm but, somehow, I doubt this will be the last we will see of him. For the moment, the now former rich lister might file for insolvency and be protected under safe harbour laws for whatever is left of his business (after Apollo is finished with its cannibalisation).
For us mere mortals though, it shows us some useful lessons when assessing a business. Always look to the downside, after all, it only took IAG pulling its support and a $7bn business went to 0 almost overnight.
Robert Swift takes a look at what happened in February in markets and touches on some of the adjustments made within his portfolio. This is an excerpt from Robert’s Global High Conviction report for February 2021.
Author: Robert Swift
We are at a very interesting juncture in capital markets. Equity markets have moved a long way up from the short term Covid induced nadir about a year ago. Profit taking always happens at some point and halfway through this February was that moment. Global Equity markets still rose c.2.5% in US$ terms. By way of comparison the Global Government Bond Index declined c.1% as long rates rose and the yield curve steepened.
It is still our view that for investors certain equities remain a better option than cash which yields nothing and government bonds which are fast becoming a return free risk as opposed to a risk free return. However, we want to make clear again that we are at a defining moment in capital markets and policy making.
Market participants have been told clearly and repeatedly by central banks, that there is no reason to raise interest rates. So much is clear but what is NOT clear is what the intentions are towards the longer end of the yield curve – an area which typically central bankers have left to market participants to set the price and yield. The defining moment is here because so much QE and now potentially another large fiscal programme (=8% of US GDP) has created a significant back up in the price of the 10 year US note. The SHAPE of the yield curve is steepening since investors rightly fear continued abuse of the fiat money system and continued inflation well over 2% (in some areas it is already here); and it is this and not the level of short rates that the equity market is now correctly focusing upon. What will the Fed do (they will say they are not concerned) about this?
So we will briefly make the following observations
Steeper yield curves presage stronger nominal GDP and a shift in equity styles whereby Value will do better than Growth
The time value of money with a steeper yield curve, means that it now matters WHEN profits and dividends are paid to investors. The longer you wait, the less value
Central banks will have to shortly decide whether to let this rise continue or to intervene. At some point, quite soon actually, the SHAPE of the US yield curve will be the same as it was in May 2013 when we had a big ‘taper tantrum’.
IF they decide to intervene to prevent this taper tantrum, then we will ponder how and how much AND whether they will return us to the 1950s when we had centrally directed capital allocation to buy government debt issuance. Do not rule this out. Much as the 1950s financial repression was necessitated by financing two wars, we have had a similar ‘war on Covid and have debt levels typically associated with wars.
At some point continued expansion of the Fed balance sheet will itself call into question the value of fiat money.
If they decide to return us somewhat to capitalism, and let the long end find a natural level given inflation expectations, then the long term benefits will be pleasing BUT SOME companies and bonds will not make it through. The cost of refinancing will be too high. Do not invest in loss making or companies whose multiples are stratospheric. (Scott McNealy’s words from 2001 should come to mind)
This dilemma has been handed to Jay Powell by his predecessors. This has been about 25 years in the making and asymmetrical monetary policy (always cut more than you sometimes raise) and now fiscal incontinence make for a heady combination and typically mean inflation.
Much like managing a forest – small frequent fires (recessions) are a lot better than letting the detritus build up and then having a MONSTROUS blaze (depression). Sadly we have had the latter over the last 25 years; and it has essentially been ‘monetary policy for rich people’.
There is hope! A recent but somewhat unnoticed comment came from the New York Fed President, John Williams, when he said that a higher minimum wage would work best to support the economy AND that there is some evidence that low interest rates can move asset prices disproportionately held by wealthy households. It’s a start.
Significant price changes in the month occurred in Industrials, Basic Materials and Energy companies. Valero, one of the world’s most sophisticated refining complexes, rose almost 40% in February as the market reappraised the need for non-renewable energy sources and downstream products. In Texas there was a complete blackout caused by unusually cold weather, raising the obvious point that renewables should be a piece of the generating capacity, but not all of it, and that natural gas is both clean and easily stored and transported. Texas, needless to say, has a number of peculiarities about its power system but a need for better and more investment in USA infrastructure is clear.
On March 3rd (US time) the American Society of Civil Engineers, releases its quadrennial report on the state of USA Infrastructure. Last time, in 2017, the grade was D+. Surprisingly, it went up and there will be a lot more interested readers this time.
Source: American Society of Civil Engineers
Source: American Society of Civil Engineers
Other significant company developments were Sony’s results (beat and raise) Quest Diagnostics (beat and raise) and Discovery A shares where the share price rose 25% as they announced strong subscriber growth for their streaming service. Over the last 1 2 and 3 years at the time of writing, Discovery A shares have outperformed those of Netflix.
We sold Nexon in Japan and reinvested in Kurita Water. We sold Legal & General in the UK and reinvested in Euronext the French based European exchanges owner operator. We took large profits in Hong Kong Exchanges where the share price had run up on the basis of the exchange receiving an infinite number of mainland China listings, no longer welcome via ADR in the USA. It is a large opportunity for HK in a region where other exchanges are lamentably short of large and quality companies, but everything and more is in the price. We reinvested into China Construction Bank H shares which are on a wide discount to the A shares and the Chinese financial system appears to be pulling back from wilder excesses. Some companies are allowed to default to the detriment of executives and bond holders. If only the USA was quite so enlightened.
In the medium term, infrastructure companies in the US especially will be subject to news flow surrounding the Green Energy Policy and thus volatile, but their revenue bases are stable and dividend yields attractive. The return of National Industrial Policy (also a nudge upward for inflation) will make logistics, storage and transport companies attractive – globally. Industrial companies likewise. Asia including Japan remains financially, economically and now geopolitically strong, and so is a favoured area.
