Buffett’s favourite metric is return on equity, or ROE, which gives investors a
measure of how well a company’s management team is using its equity to generate
CSL is a classic example of a company with a high ROE, and this has been instrumental to its long-term success. Using Bloomberg data, we screened the market to shortlist five midcap stocks that have had an ROE above 15% for each of the last three years.
In this episode of Buy Hold Sell, Jeremy Hook from TMS Capital runs these five names past Jelena Stevanovic from Platypus and James Miller from Firetrail Investments to see if this filter may have picked out the next crop of CSLs.
Jeremy Hook: Welcome to Buy Hold Sell. I’m Jeremy Hook from TMS Capital. With me today on the panel is Jelena Stevanovic from Platypus and James Miller from Firetrail. There are some terrific mid-cap companies in the Australian market, but ones we want to focus on today, for this session, is the ones that return a very good return on equity, something above 15%, three years in a row, in the last three years. And we thank Bloomberg data for that.
We’re going to look firstly at QANTAS. Jelena, what do you think? Buy, hold, sell?
Jelena Stevanovic: It’s a hold for me. Look, QANTAS is operating in a better environment than where it exited second half of last year in terms of fuel costs as well as its international portfolio, but it is trading at a two-times premium to its listed PE. So at this level it’s a hold.
Jeremy Hook: Okay, a hold for you Jelena. James, QANTAS, taking off, buy, hold, sell?
James Miller:QANTAS is a buy. There are two crown jewels in that business. It’s got a frequent flyer business, which is attached to 35% of all credit card transactions in Australia, that’s growing at double digits. And then you’ve got a domestic franchise, which has had five years of industry rationality, so QANTAS is undervalued.
Jeremy Hook: Okay, good one. Medibank Private, since it listed, it hasn’t received much of the rave reviews of a lot of stocks. It’s done pretty well. Buy, hold, sell?
James Miller: Hold on that one. It’s a great asset. It’s about 25% of health insurance members in Australia, and I think that will look attractive to an acquirer at some stage, but right now you’re paying about 21 times PE for not much earnings growth. It’s a hold.
Jeremy Hook: Yeah, they’re losing members and no real earnings growth at the moment, but a good basic business. Buy, hold, sell, Jelena?
Jelena Stevanovic: It’s a sell for me. It’s to your point, trading at a top end of its PE range and EPS growth profile is flat at best. Capping health insurance premium increases is still front of mind on political agenda. All that in mind, hard to see earnings growth.
Jeremy Hook: Okay. And Nick Scali has been a really good stock for a long time, but just last month, a profit warning. Buy, hold, sell?
Jelena Stevanovic: Look, sell for me, despite recent derating. The trading update provided by the company was significantly worse than a lot of its listed peers. It should benefit from improving domestic housing market. However, really, really downbeat trading update. Cannot not question company execution at this point.
Jeremy Hook: Interesting. James, it did bounce after being sold off pretty aggressively. Buy, hold, sell on Nick Scali?
James Miller: It’s a hold for us, and that’s really around timing. It is going to be a great beneficiary of this house price and house transaction lag, but that’s probably six months away.
Jeremy Hook: Yeah. Okay. Now, A2 Milk, since its result in August has gone sour. It’s gone down by $12 now. Is that a buy, hold, sell?
James Miller: It’s a great company and we’ve owned it in the past, but right now, it’s a sell. And the reason for that is that the China infant formula market has got competition heating up, and it has high costs as well in terms of serving the channels there too. So short-term earnings pressure, but medium term, it’s a good company.
Jeremy Hook: Okay. Jelena, A2 Milk, is that to your liking?
Jelena Stevanovic: Look, it’s the hold for me. There’s no doubt the low hanging fruit in the China infant formula market has been picked, and the company needs to invest in various marketing initiatives to grow further, but the US opportunities are immature, and it’s a huge potential. The company has a strong track record of executing. There’s no reason to believe they won’t be able to replicate success in the US market.
Jeremy Hook: Another one going very well in the US as Credit Corp. It’s almost doubled this year. Buy, hold, sell?
Jelena Stevanovic:Sell, purely on valuation. To your point, they have excellent track record of delivering earnings growth, have proven themselves to have good risk management and pricing strategy, but on a valuation, it’s a sell.
Jeremy Hook: Okay. James, do you agree? Is it too expensive? Buy, hold, sell?
James Miller: It’s a hold, and the main reason is valuation. It’s been growing at a great rate because it’s been buying these debt ledgers up to grow earnings, but when cash flow is severely lagged from where earnings are, we struggle with valuation.
Jeremy Hook: So we’ve given you five terrific stocks to look. But James and Jelena quite rightly don’t think all of them are buys at the moment.
In 2017, WeWork’s CEO said, somewhat emblematically: “Our valuation and size today are much more based on our energy and spirituality than on a multiple of revenue”. Then in 2019, public markets chopped their spirituality-based valuation to ribbons before the IPO spectacularly imploded. More locally, Latitude Financial’s massive second tilt at listing didn’t pass muster either.
Between shoots of Buy Hold Sell last week, we took the chance to ask Jelena Stevanovic from Platypus and James Miller from Firetrail Investments for their view of these events and to ask what it takes to ‘forecast the dream’ correctly with IPOs.
And when we asked for one ASX listing they could back,
notably, both managers picked the same stock, a SaaS business servicing the
lion’s share of a huge and established sector. Watch or read for their
Jeremy Hook: Welcome to Buy, Hold, Sell. My name’s Jeremy Hook from TMS Capital. Joining me on the panel today is James Miller from Firetrail, Jelena Stevanovic from Platypus. We’re looking at IPOs today, Initial Public Offerings. Typically, they excite the market but not all are as simple as they seem.
Recently, WeWork in the US and Latitude Financial here, as well as PropertyGuru, just recently all been canned. So, what’s it saying about IPOs generally, and does it mean, James, going to you first that we’re getting a bit late in the cycle and floats are getting a bit ratty?
James Miller: Well, I think it’s both the cycle and the markets right now. So, if
you look at equity markets around the world, valuation multiples are right up
there compared to history, which is a natural function of our lower risk-free
rates around the world.
But, if you look at
these companies that are coming to market, they’re saying it’s a great
opportunity. I want to get that multiple, but you’ve got to show us that you’ve
got a sustainable path to earnings, or path to cash flow, so we can actually
value you. So, that quality really hasn’t been there recently.
The second thing I’ll
point out is that there’s a big difference between IPO sell down and IPO
raising for growth capital, as well, and growth capital, we much prefer that
Jeremy Hook: Okay, excellent. Jelena, do you agree, or is there something specific
about these ones, or do we read more into the whole thing?
Jelena Stevanovic: Look, as a general sign, we think that this is a signal that the markets
are still functioning rationally and that’s a positive thing. I mean, generally
speaking, aggressively-priced IPOs are often cited as a sign that the looming
bear market is ahead of us. The fact that we’re not seeing excessive equity
issuances either through aggressive capital raise to fund silly M&A, or
very highly-valued IPOs getaway is a positive sign for equity market outlook,
in my opinion.
In particular, I mean Latitude, as one that you called out, that was a difficult IPO. The company attempted to list a couple of times, at least, and through that process we, as investors, got to see historical financial targets that would have been prospectus targets in earlier attempts and we also got to see that those targets were missed, had it not been for some material one-off adjustments. All of that made it difficult for that IPO to get away.
Jeremy Hook: Just staying with you there on the issue of valuation, so WeWork started with a valuation of 47 billion. I think, when it was last canned, it got about 10 Billion. Does this now say something about valuations in equity markets overall?
Jelena Stevanovic: Look, I think the fact that valuations still matter is a positive
sign. We’re not seeing that exuberance in the equities market. That’s typically
a good sign. It’s a sign that we might be late cycle, but not hitting into bear
market just yet.
Jeremy Hook: Yeah. Great. James, just coming back to your point, and then,
looking at valuations, is there something you’re looking at differently in an
IPO to the stocks that are listed currently.
James Miller: Ah, no, not at all. Valuations have always mattered and earnings
have always mattered, as well. Where, I think, a bit more focus has come on
recently is, we want to see those earnings in a company whether they’re
loss-making now and will make money in the future. We want to be able to
So, a company like WeWork, in private hands it might have convinced its investors that it was changing the way we work and making these great co-working spaces. But, when it came to equity markets, we were going to look at a company that was losing $1 billion a year. More than that. $50 billion of lease liabilities. And, to be honest, it could be relatively easily replicated by competitors.
So, that scrutiny,
when you come to public markets-
Jeremy Hook: Different level of scrutiny, isn’t it?
James Miller: It’s still there.
Jeremy Hook: Yeah, good. Scrutiny of the Australian attempted float of Latitude Financial. Do you think we can read anything into the state of the Australian consumer from that failure to get away?
James Miller: Talking about the consumer is a broad term because there’s bright
spots, and then, there’s weaker spots, as well. And, one thing I like to like
to look at is new car sales. It’s been 16 consecutive months, year-on-year
declines in new car sales, so that, by itself, says things aren’t that great,
but you break up their data, luxury car sales are actually going all right,
close to flat in recent months, so you can’t make a broad brushed assumption
about anything there.
There are two things
that I think will probably happen though that are pretty clear. Firstly, Sydney
and Melbourne property prices. We’ve seen this before. Property prices go up,
more houses are listed, more houses are transacted, and then, people buy more
things to go inside of those houses. So, furniture, electrical goods, JB Hi-Fi,
Harvey Norman, they will be beneficiaries there.
Jeremy Hook: And car sales are backward-looking and the property sales are giving
us more confidence.
James Miller: Yeah. That’s one way to think about it there.
Jeremy Hook: Can you read in something broader in the macro sense here, Jelena?
Jelena Stevanovic: Look, I’ll come back to my original comment on Latitude. I think that that particular business had difficulty with the equity market, in particular, having tried to list multiple times. I wouldn’t necessarily extrapolate across the consumer sector.
I agree on the fact
that domestic housing looks like it has bottomed, and a number of stocks
exposed to that theme should benefit, with a lag, but should benefit over time.
On Latitude, again, I just think given that it’s essentially a consumer finance business, the proposed valuation metrics were simply too high for that nature of that business.
Jeremy Hook: And, did they try to spin the market to have the buy now, pay later,
add on icing on the top of the cake, when the cake was maybe a big problem?
Jelena Stevanovic: That was the unproven part of the business. That’s a new venture,
and to your point, as a listed investor, you want to see a little bit of track
record, something to hang onto to be able to forecast the dream.
Jeremy Hook: Okay. Now, talking about dreams. IPO, the average investor likes
them. Have you found one in the last 12 months that you liked and invested?
Jelena Stevanovic: Yeah. So, in last 12 months we have participated in Fineos Corporation Holdings. It’s a software as a service provider to the insurance sector, in particular, health, accident, and life insurance. The company was started in 1993. Initially, in its first phase of its life, it focused on claims management software as a service.
In more recent times
they have broadened that product portfolio to include things like billing,
absence management, policy, et cetera. So, going forward, forecasting the
dream, we think the company can grow earnings through either selling more
modules to existing customers, through adding new customers, through going into
Jeremy Hook: Okay. That’s great. James, have you got a special for the viewers from
the last twelve months?
James Miller: I do. And, there’s some rationality in equity markets because we like
Fineos as well.
Jeremy Hook: Wow. There you go.
James Miller: This is a company that’s an exciting company, but it’s in a really
Jelena Stevanovic: Correct.
James Miller: It provides core system insurance software to companies that are really running on largely legacy systems, some that are over 20 years old. So, Fineos can come in there, provide its cloud-based software. It’s got a great management team. The founder has been around for years and years. It’s worth about $800 million as a market cap, and we think it’s got great growth potential.
Jeremy Hook: Okay. So, when you are looking at IPOs, founder-led businesses coming to market for the right reasons, maybe buy from governments or receivers, but be wary of private equity.
There is a special cluster of industrial mid-caps on the ASX
that are perennial crowd-pleasers, stocks that under-promise and over-deliver
every reporting season, forever in an upgrade cycle.
In contrast, the broader market has seen earnings forecasts
trending lower as slower growth and lower sentiment take their toll. So,
against this backdrop, the continuous upgrades of the crowd-pleasers stand out
like a sore thumb. They do come with a price tag, of course, and they always
have… yet their share prices keep on rising.
In this episode of Buy Hold Sell Jelena Stevanovic from Platypus and James Miller from Firetrail Investments pass their verdict on three of these crowd-pleasers and each share a stock that they believe could surprise the market with an upgrade.
Jeremy Hook: Welcome to Buy Hold. Sell. I’m Jeremy Hook from TMS Capital. With me on the panel today is James Miller from Firetrail and Jelena Stevanovic from Platypus.
What we’re looking at today: in an environment where
earnings post reporting, and for the last few years have basically been going
down in the industrial side of the market, are those companies that are bucking
the trend with earnings going up. We want to examine those and find out what
our panellists think.
Starting with James. Aristocrat, buy, hold, sell?
Jeremy Hook: Okay. Jelena, can the earnings growth catch up with that price now?
Jelena Stevanovic: Look, I think it’s a buy. It’s a buy for me at this level. The multiple is not stretched, still. The land based business has a strong track record growing share and earnings. The digital business does need to be repositioned, so the earnings growth there might be patchy but the opportunity is still large.
Jeremy Hook: Okay. Now one that’s been a phenomenon. Everybody knows it, it’s one of the biggest now. CSL hit $250. Buy, hold, sell?
Jelena Stevanovic: Hold at these levels. Only in valuation, but it is a great business. Outstanding health franchise. The lowest cost producer in the market, the only one that’s been investing into growing its capacity so that can actually service the growing market. A great franchise but hold at this multiple.
Jeremy Hook: The market loves earnings growth but sometimes can pay too much, James. CSL, buy, hold, sell?
James Miller: CSL is a buy, and the reason is it takes five years to build out a whole blood plasma collection centre. CSL is building three times as many as anyone else and the market’s already tight. So despite the valuation multiple, we see a pretty good runway of growth.
Jeremy Hook: Okay. Fisher & Paykel Healthcare have probably surprised a lot of people. What do you think now, buy. hold, sell?
James Miller: It’s a hold for us. The reason being on that stock is that it’s more skewed towards sleep apnea masks rather than the generators. And we think in the US of the next few years there could be some pricing pressure on masks, which is around 85% of their revenue in that division.
Jeremy Hook: Jelena, do you share concerns about FPH? Buy, hold, sell?
Jelena Stevanovic: A hold for me as well. Another great health franchise, the company has a true differentiated proposition in the hospital segment. I do agree with the risks in the RSA part of the business. The hold is purely on valuation, again has traded through its long-term PE range. So great franchise, but a hold.
Jeremy Hook: What about a special of yours where there’s either very good earnings growth in a lacklustre market for earnings or a real surprise the market doesn’t know about?
Jelena Stevanovic: Oh, look, I like Goodman Group. It’s an industrial real estate company, invests in locations the company identifies as cores are being highly urbanised, exposed to strong e-commerce strengths and in high barriers to entry markets where land availability is poor. All those trends will support earnings profile of that company for a long time. It has a highly incentivised workforce through a share-based remuneration scheme that aligns interests of shareholders with the entire workforce. And unlike most companies in that space, it’s a capital-light model because most of the development activity happens not on their own balance sheet, but within the partnership structure.
The only risk in the short term to call out is that the
chunk of the portfolio sits in the Hong Kong geography and given recent
political risks that may be a little bit of a problem.
Jeremy Hook: Goodman Group. Thanks for that, Jelena. What about you James, what’s the team and yourself found out that there as a really good earnings growth story?
James Miller:Downer is a business that’s very well positioned. It’s a company that develops and then operates urban infrastructure. It’s trading on a multiple below the market multiple, and as earnings growth, above the market earnings growth. Not only that, if there is any fiscal stimulus directed towards infrastructure then they’re going to be a key beneficiary of that. So cheap valuation, earnings upside. It’s a buy for us.
Jeremy Hook: Excellent. Share prices will always in the long-term follow earnings growth. Keep your eye out for Goodman Group and Downer.
The Firetrail Australian High Conviction Fund has been awarded a ‘Bronze’ Morningstar Analyst Rating.
Firetrail’s flagship strategy was one of only two new strategies to receive a medal rating from Morningstar in their 2019 Australian Equities Large Cap Review.
In its report, Morningstar states that the “Firetrail Australian High Conviction is a solid option for investors seeking a high conviction manager…”
Patrick Hodgens, Managing Director at Firetrail and Co-Lead Portfolio Manager for the strategy said that the “Bronze’ rating from Morningstar is an important endorsement for the Firetrail team and their high conviction approach to investing.
“We are very pleased to be able to offer our investment capabilities to investors that utilise Morningstar research. It is an important milestone for Firetrail, allowing a broader range of investors to access to our high conviction investing approach”, Hodgens explained.
The Firetrail Australia High Conviction strategy is co-led by experienced investors’ Patrick Hodgens, Blake Henricks and James Miller. “All three [portfolio managers] have worked together for over a decade and have delivered strong relative returns over their respective tenures”. We are confident the team can deliver outperformance over teh full cycle…”, Morningstar notes.
Prior to launching Firetrail in March 2018, the three portfolio managers ran the Macquarie High Conviction Fund, which delivered 10.6% per annum (after fees) to invetsors since inception in 2005, until they departed Macquarie in November 2017.
Firetrail Investments Pty Limited ABN 98 622 377 913 (‘Firetrail’), Corporate Authorised Representative (No. 1261372) of Pinnacle Investment Management Limited ABN 66 109 659 109 AFSL 322140.
Any opinions or forecasts reflect the judgment and assumptions of Firetrail and its representatives on the basis of information at the date of publication and may later change without notice. Any projections contained in this article are estimates only and may not be realised in the future. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This communication is for general information only. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice relevant to their particular circumstances, needs and investment objectives. Past performance is not a reliable indicator of future performance.
Firetrail believes the information contained in this communication is reliable, however its accuracy, reliability or completeness is not guaranteed and persons relying on this information do so at their own risk. Subject to any liability which cannot be excluded under the relevant laws, Firetrail disclaims all liability to any person relying on the information contained in this communication in respect of any loss or damage (including consequential loss or damage), however caused, which may be suffered or arise directly or indirectly in respect of such information.
Sydney, 19 February 2019: Firetrail Investments Pty Limited (Firetrail) today announced that its Firetrail Absolute Return Fund has received the coveted “Highly Recommended” rating from Zenith Investment Partners (Zenith). Highly Recommended is the highest possible Zenith rating.
Patrick Hodgens, Managing Director at Firetrail, said the “Highly Recommended” rating from Zenith shows their high regard for Firetrail’s experienced team and deep fundamental research approach.
In its report, Zenith mentions it holds the investment team in high regard and are comforted by the strong growth of the business, which has provided an increasingly stable environment for the team. Zenith remarks that the investment team’s fundamental approach to shorting, based on earnings risk and catalysts, rather than valuation, is intuitive and prudent, as stocks perceived to be “expensive” can continue to rise, driven by market sentiment.
“Share prices follow earnings. The key to identifying candidates for our short portfolio is to focus on earnings and identify opportunities where a company is at risk of missing market expectations. There are over 150 earnings downgrades per year in the Australian market, so the opportunity to add value from shorting is material” Hodgens explains.
Zenith notes Firetrail’s market-neutral investment style is well-suited to investors who are looking for an alternative source of returns, independent of movements in the underlying share market.
“The portfolio is constructed to ensure it is market-neutral. That is, the returns are uncorrelated to the performance of the share market. We are looking to deliver returns in excess of the RBA Cash Rate over the medium to long-term, irrespective of the performance of equity markets”, Hodgens said.
The Firetrail Absolute Return Fund employs the same investment approach as the Macquarie Pure Alpha Fund which was managed by the same investment team until October 2017 and which returned 20.4% above the RBA Cash Rate since strategy inception in July 2015 (after fees).
The Zenith Investment Partners (“Zenith”) Australian Financial Services License No. 226872 rating (WHT5134AU assigned February 2019) referred to in this document is limited to “General Advice” (s766B Corporations Act 2001) for Wholesale clients only. This advice has been prepared without taking into account the objectives, financial situation or needs of any individual and is subject to change at any time without prior notice. It is not a specific recommendation to purchase, sell or hold the relevant product(s). Investors should seek independent financial advice before making an investment decision and should consider the appropriateness of this advice in light of their own objectives, financial situation and needs. Investors should obtain a copy of, and consider the PDS or offer document before making any decision and refer to the full Zenith Product Assessment available on the Zenith website. Past performance is not an indication of future performance. Zenith usually charges the product issuer, fund manager or related party to conduct Product Assessments. Full details regarding Zenith’s methodology, ratings definitions and regulatory compliance are available on our Product Assessments and at https://www.zenithpartners.com.au/regulatory-guidelines-funds-research