The five most provocative investment ideas from top fund managers the Sohn Hearts & Minds conference.
Stock: Transurban
Investor: John Pearce, Unisuper
If history is any guide, the world could be “closer to the start of the yield trade than the end of it,” he says, admitting it is a non-consensus view.
“I personally can’t go past a tollroad operator, Transurban,” Mr Pearce proposed. The super fund is the largest investor in Transurban.
“You all know the company because you’ve all been customers whether you like it or not. Here we have a company that’s paying a yield of 5 per cent, it’s not promising it’s paying a yield of over 5 per cent. It’s got long-term concessions and monopoly assets.”
“You can construct a case based on very conservative assumptions that sees Transurban’s yield go to 7 per cent in five years’ time,” he forecasts. The yield curve implies that rates will be 3.1 per cent in 2021. “That is your frame of reference,” he adds.
He urged investors to “look through the noise”. Under $10 a share, he believes investors are not at risk of paying too much for the stock.
“What if I’m wrong about inflation? What if it rears its ugly head well Transurban can just increase its tolls.”
Stock: BIM (Turkey)
Investor: Leah Zell, Lizard
One of the strongest business models she has discovered lies in Turkey’s grocery sector.
“I can imagine what you’re thinking grocery retail is not sexy, it’s slow growing, it’s highly competitive and it’s low tech. So why am I excited about this idea? Let’s start with stellar metrics.” Last year BIM earned 46 per cent return on capital and 41 per cent return on equity.
BlackRock’s Beaumont thinks the market is valuing Fairfax’s print assets at negative $400 million, “we think this is irrational and based on emotion rather than facts”. Daniel Munoz
The balance sheet is net cash. BIM sells a limited range of basic goods and aims to be the price leader in the market place. It may sell one type of sugar and three grinds of coffee.
BIM doesn’t use budgets, it doesn’t use market research, and it doesn’t advertise. Ms Zell reveals that the company has links to Aldi: it was started with the help of a former Aldi executive. Importantly, 60 per cent of the Turkish grocery market is still “unorganised”.
The remaining 40 per cent is highly fragmented and the top five players combined control “only 18 per cent of the pie”.
Gross margins at BIM average about 16 per cent and operating margins average 4 per cent “so if you do the math, all-in operating expenses for this company run around 12 per cent of revenues”.
“There are very few retailers of any sort anywhere in the world that can run their business this lean,” Ms Zell insists. The stock trades at around 20 times forecast earnings.
Stock: Armidale Investment Corporation
Investor: Geoff Wilson, Wilson Asset Management
Mr Wilson picked a small cap financial services company, a stock which he believes could be ahead 50 per cent within 12 months.
Armidale is an asset finance broker which Wilson says is a $42 billion industry.
“It’s growing at 10 per cent plus per annum. These guys have made some recent acquisitions and they will benefit as the industry consolidates.”
The stock meets Mr Wilson’s criteria to find well-run companies with good earnings growth, which is the main driver of share price performance.
Earnings per share are expected to grow at 25 per cent-plus each year over the next two years and will lower the price to earnings ratio to under 10 times.
“It’s an investment company moving to an operation company so the market will revalue it,” he says.
The asset finance brokerage industry is similar to the mortgage brokerage industry which has grown substantially over the last 10 years.
“I believe the share price will be 50 per cent higher but from an investment perspective it’s [a] five-to-10 year view.”
Mr Wilson is cautious about the market and held a 42 per cent cash balance, above his average of 34 per cent.
“We have always managed the money with a focus on not losing money, the default is hold cash so if I don’t believe we can make money we will sit in cash.”
Stock: Chorus (New Zealand)
Investor: Patrick Hodgens, Macquarie
Macquarie’s high conviction fund manager pitched what he says is the one stock you have to own, and the cheapest yield stock in the market – ASX-listed Chorus Ltd.
The New Zealand-based telecom firm has been ploughing capital into building a ultra-fast broadband network which forced it to suspend its dividend for five years.
But by 2020, he expects capital expenditure to fall to $245 million from $600 million today. This will result in free cashflow rising from negative $30 million to $245 million.
That will push the free cash flow yield to 16.5 per cent, which works out to be an 11 per cent dividend yield at the current price.
“What excites us is we can buy it for half its intrinsic value,” he says.
A future yielder, Hodgens says, must offer sustainable cash flows that can be converted into dividends within two to three years. To find them he looks for conservative boards with a strong dividend.
Hodgens says that of the 200 stocks his fund tracks, 94 have yield potential, 17 are future yielders and they have invested in four stocks.
By chasing dividend stocks, investors would have outperformed the market by 36 per cent over five years. But though yield stocks appear exhausted, he believes the yield trade is an enduring thematic.
Hodgens said Chorus was his top pick over other high conviction ideas such as Qantas and BlueScope.
Stock: Fairfax Media
Investor: Madeleine Beaumont, BlackRock
Fairfax’s estimated $2.2 billion Domain asset “is a business that has grown sales by an average of 33 per cent over the past three years,” and has substantial pricing power.
Domain is the number two player in the $1.2 billion-and-growing Australian real estate advertising market.
“We believe that the trend to the mobile and well-informed consumer is only just beginning and that companies who are winning in mobile will be the winners of the future.”
It is still relatively cheap to advertise on Domain compared with other forms of advertising but “this is just phase one”.
“The second leg of growth in Domain will be driven by using that data to penetrate deeper into the value chain for real estate services,” the fund manager said.
The “very hot” property market has been a headwind for the business, Ms Beaumont says, estimating a 23-year low in Australian housing turnover.
The number one player in the market, the $7 billion REA Group, commanded a $3 billion-plus valuation when it had a similar level of profit as Domain is forecast to achieve this year. “Domain is overlooked as an asset because it is owned by Fairfax,” Ms Beaumont said.
“What really excited us from an investment perspective is you can actually buy the whole of Fairfax Media for less than the value of Domain. Why?”
The perception that its print business is “dead”. In fact, according to the fund manager, the print business is in structural decline but generating positive cashflow.
BlackRock thinks the market is valuing the print assets at negative $400 million, “we think this is irrational and based on emotion rather than facts”.
Further, Stan, its streaming video on demand joint venture, is valued at zero by the market.