My two cents – Finding value using the PEG ratio

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Going forward we will seek to provide readers with an educational article on various ratios, strategies and concepts that we use to select stocks. As with any strategy, using one measure alone will never be the only determinant of successful performance, however, we believe when combined they can provide some deep insights into the value of any business. The first ratio we will look at is the PEG or Price Earnings to Growth ratio.

The calculation for the PEG ratio is quite simple:
Price earnings ratio of a company
Growth rate of earnings

So, what does this measure tell us? It has become evident in the current times of low interest rates and quantitative easing that almost every business is trading on a higher P/E multiple, whether they are growing earnings or not. However, the reason we invest into sharemarkets is to gain the benefits of the future earnings, dividends and growth in both of these in the future. The PEG ratio aims to measure companies on this basis. What information do we use to determine the PEG ratio? This is a very good question; you can calculate both a forward and trailing PEG ratio based on historical earnings growth results or consensus earnings growth forecasts. Both can be extremely useful, however, it is important to keep in mind that the PEG ratio can be less valuable if you utilize historical results when a company is evolving. On the other hand, consensus forecasts for earnings tend to be optimistic, hence it is usually better to use a range for the EPS growth and PEG figure which includes a discount to expectations. How to use the PEG ratio As a general rule, the lower the PEG ratio the more the stock could be undervalued given its potential or delivered earnings growth. If a company has a PEG over 1, and the company doesn’t grow it’s earnings at a faster rate than expected in the future, you would expect the share price to fall as a result. Theory suggests that the PEG ratio for every stock should be 1, which represents the equilibrium of market value and anticipated earnings growth; however, we know this is never the case.

A PEG ratio of greater than one suggests that the market is expecting earnings growth will be higher than consensus estimates, or alternatively that the stock may be overvalued due to the high demand for their shares (Tesla perhaps?). On the other hand, a stock with a PEG ratio of less than 1 suggests the market is underestimating growth and the stock may be undervalued. That or consensus estimates are set too low, or are too difficult to come by in the case of smaller companies. We like the PEG ratio as it makes fundamental financial analysis more comparable across industries and sectors. EPS growth is the denominator of the equation, putting every company on a similar footing. One of the big opportunities for keen investors is to scour through financial statements of smaller companies or more importantly those not covered by the entire range of investment analysts to determine their PEG ratios when no one else is looking. This can assist in finding strong growth companies trading at substantial discounts; a recipe for success. The one major drawback of the calculation is the lack of consideration of the income side of the equation, which is obviously important in Australia. This can be improved by adding the dividend yield to the EPS growth amount to ensure the total shareholder return is included. Some interesting PEG’s for 2018

  • Myer Holdings Ltd – 0.3x
  • Ramsay Healthcare – 2.0x
  • Amazon – 5.87x
  • Facebook – 1.35x

 

3 stocks from the herd – BHP, MPL, CWN

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In this section we provide readers with three stocks that have attracted the interest of the broking community or the ‘herd’. Broker recommendations tend to be biased and highly optimistic. We try and breakdown these barriers and give our own honest opinion. It is important to keep in mind that technical analysis is only one part of the investment process and any recommendations do not give consideration to the underlying fundamentals of each business.

BHP Billiton Broker View: Citibank has downgraded BHP Billiton from Buy to Neutral, cutting their price target to $25.50. The broker has lowered their spot iron ore price forecasts to US$62 and US$50 from US$70 and US$54 for 2017-18 respectively. The coking coal forecast has also fallen US$170 down to US$160 as has Brent Crude, down to US$54 a barrel from US$60 for 2018.

Unconventional View: We disagree with Citibank; we think BHP Billiton should be a sell. The outlook for BHP’s three core commodities is as difficult as ever with pressure on both the demand and supply side continuing to increase. We believe any recovery in BHP, on the back of recent iron price improvements is likely to be short term and the company remains highly cyclical. Whilst there is a chance that their August report is received positively, as free cash flow improves, the recent announcement from Rio Tinto that iron ore shipments are likely to fall at the bottom of their predicted range does not bode well. It is becoming evident to us that the incremental demand for steel is slowing as Chinese fiscal spending is cut and poor performing state-owned enterprises forced to clean up their businesses. This impacts both coking coal and iron ore in the medium term. China has always been the incremental buyer of iron ore hence any slowdown in the growth in demand will impact heavily on BHP. In addition, the threat of sustained higher prices remains to the downside as more supply will come on line with lower breakeven costs in light of technological improvements. BHP also faces pressure in the oil market, which represent close to a third of revenue looking forward. The oil market looks as difficult as ever, with any strength in prices hit by increased US shale production or higher supply from the Middle East. We do not believe the sharemarket is factoring in a structural weakening in commodity prices which is most certainly on the cards.

BHP had a massive run on the back of the iron ore price recovering. However we can see that 2017 has proved challenging with a pullback to the long term trend line. Based on recent history it looks like BHP belongs around the $22 a share price, however will be driven mostly by commodity prices.

Medibank Private Broker View: Goldman Sachs has downgraded Medibank to Sell from Neutral citing two worrying trends; being weaker system policyholder growth and declining health insurance participation from the younger generation. They struggle to understand how current margins and profitability are maintained as pressure on premiums grows and less people sign up.

Unconventional View: We agree with Goldman Sachs in this instance. Just yesterday my Medibank Private premium was deducted, the cost was $360 for the month, or around $4,320. Yes, that is for full cover including emergency and obstetrics; but my first thought was do I really need this cover? Not only is there a substantial amount of out of pocket expenses likely in most cases, but does it really provide that much benefit? I’m probably one of the more conservative in the young generation so I guarantee you the cash strapped YOLO, avocado eating Gen Y’s will be leaving in droves; relying on the Parent Bank to save them from any sort of injury or issue in the future. The wave of disruption is coming for the health insurance sector and policyholders are getting smarter. The Gen Y’s now understand that their high premiums and lack of claims are funding the less profitable older generations. This is why various insurance pooling apps are popping up across the world.We are seeing massive pressure in the retail sector in Australia, with Myer this week announcing an earnings downgrade. We see Medibank also being caught up in this trend as policy holders face difficult spending decisions. As interest rates increase they will need to pull back on non-necessities, like shopping at department stores and eating out, as well as their health insurance. Why pay the premiums if you can just rely on the public system? There is a substantial amount of pressure on the growing premiums in the private health insurance sector, which are approved by the Government, and seemingly only a limited supply of new customers. Whilst Medibank is the largest in Australia, that does not mean it has any pricing power. As Goldman Sachs suggests, the average policy holder growth is just 1%, and with more young people opting out the profile of their policyholders is getting older and quickly. We find it difficult to see any way that Medibank can even sustain margins at current levels if premium increases are cut as anticipated in the future. On this basis, there is likely to be some substantial regulatory change in the years ahead, which may not be good for investors.  MPL is expected to deliver a solid 2017 profit of around $435m, however, the strong pre-IPO growth is likely to have stalled meaning a re-rating is on the cards.

The Medibank chart looks good on first glance. The stock has obeyed its long term trend line from way back when it floated. However overall in terms of price action we are still making lower high’s on the chart. The current pullback to the long-term trend line may present a good opportunity for those who are wishing to buy.

Crown Limited Broker View: Ord Minnett has upgraded Crown to a Buy (from Hold), elevated on the basis of more cost savings from lower operational expenditure, reduced gearing and a better outlook for Crownbet.

Unconventional View: We disagree with Ord’s, we think CWN remains a hold as there is simply too much uncertainty on the horizon. The company has only just escaped from its difficult Macau ventures and whilst staff have been released from prison in China, there is no doubt this will have longer lasting impacts. Analysts had been pricing in the probability that Crown is successful in gaining one of the long sought after Japanese casino licenses. There is talk that the extra-curricular activities in the China may have harmed their application. CWN is facing renewed competition in Australia from Star Entertainment Group as well as from other Asian centre who are aggressively pursuing the high value VIP market. Whilst management seem to have made a sound decision in exiting Macau and using the proceeds to pay down debt, they also have a substantial amount of further capital expenditure on the horizon; in both the Sydney and Melbourne hotel developments. The company has also shelved its disastrous Las Vegas expansion and the IPO of its separate property assets as they attempt to focus on their core Australian businesses. Crownbet appears to be growing strongly, so much so that rumours are circulating of a joint takeover bid for Tatts Group’s wagering and lotteries business. We aren’t speculator, we are investors so will not fall into such talk. There is increasing risk of further regulation around sports betting following the recent changes and more competition continues to enter the industry. Whilst the company’s two Perth and Melbourne assets control monopoly positions for table gaming and VIP’s the electronic gaming machines which make up closer to 30% of revenue are available across the country. It is difficult to see Crown Perth’s revenue not taking a hit from the mining sector and economic slowdown in the west. We also have an eye to the slowing retail sector amid increasing interest rates and property stress and the implications this will have on both spending and gaming.

Crown is at a huge inflection point on the chart. The ascending wedge indicates price is getting squeezed. The stock has had a large bullish run and we wouldn’t be jumping on this moving train. We would like to see some consolidation before entering as a buyer.

Gold as a Global Currency

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Since the turn of the century, the gold price has performed incredibly well, rising from below AUD $500 to AUD $1,645 per ounce. This performance has led to a huge rise in physical gold demand across the Western world, including in Australia. Demand has also exploded in Asia, where high rates of income growth and high savings rates have fuelled demand for the precious metal. The chart below, produced by the World Gold Council in early June 2017, helps put the impressive performance of gold into context, comparing it to a range of asset classes including stocks, bonds and commodities, over 10 years, 20 years, and since 1971, when the price of gold became free floating. As you can see, the yellow metal has more than held its own over the past 46 years, outperforming cash and bonds, and more or less matching the return delivered by equity markets.

Despite the strong performance, most investors do not own physical gold in their portfolio. This is true of institutional investors as well, with many unsure how they should characterize the precious metal, as it does not neatly fit the profile of a traditional growth investment like shares, nor a traditional defensive investment like bonds. The fact that gold doesn’t behave at all like a traditional commodity (as the 10 year performance in the above chart demonstrates) also causes confusion for some. In this article, we’ll explain why gold should be thought of as global currency, the uses of gold for Australian investors, and the benefits that it brings to a portfolio, including protection against rising inflation and market downturns.

Gold as a global currency Gold has been used as a currency for millennia, as the following chart, which comes a World Bank report highlights.

Despite its history, today, many investors struggle to see gold as a currency. At first glance, we can understand why that it is. After all, we don’t use it to buy goods and services on a daily basis anymore. It’s also actually physically mined and refined, unlike the actual currency we use, which is either printed on paper and or created by a computer entry. Physical gold is also used in industry (including in dentistry and in medical) whilst it is also worn in jewellery, with close to 50% of all the gold that has ever been mined in bracelets, necklaces and the like. Nevertheless, gold remains a monetary asset and a global currency today. The best way of realizing this is by looking at the foreign exchange reserves of major central banks around the world today.As a collective, central banks own more than 32,000 tonnes of physical gold, which is roughly 18% of all the gold that has ever been mined in human history. They clearly see it as an important asset, with developed market central banks (in Europe, the United States etc.) holding on average close to 20% of their foreign exchange reserves in gold. Central banks have been net buyers of gold since the GFC hit, with purchases that have averaged over 450 tonnes per annum in the last several years. This can be seen clearly in the chart below, which looks at annual net purchases from 2005 onward.

The Bank for International Settlements also see gold as a monetary asset, stating in their 2013 report that “gold is to be dealt with as a foreign exchange position”, whilst further evidence of its ongoing monetary status is found when one looks at the formation of the European Central Bank (ECB). When the ECB was formed back in 1998, central banks from the Euro area all transferred foreign reserve assets to the new institution, which totalled approximately 40 billion Euro. Some 15% of the 40 billion Euro that was transferred was physical gold. By 2016, the ECB held over 25% of its reserves in physical gold.

Uses of Gold for an Australian Investor Gold is a highly relevant investment for prudent Australian investors today, which offers a number of benefits for those looking to first preserve, as well as build wealth. The two primary benefits of holding gold are that it has historically provided excellent protection against inflation, and it is a simple and transparent hedge against market downturns. We will look at both of these in turn detail.

Protection against inflation As gold has held its value across the millennia, it has a well-deserved reputation as a protector of wealth whenever inflation threatens to seriously reduce the value of the paper money we are paid and save in. We saw a great example of this in the 1970s when inflation averaged over 10% per annum. Most assets fell in real terms during that decade, but gold was an exception, rising by an average of 37% in AUD terms across that 10-year period. One of the neater ways to visualize the ability of gold to protect purchasing power an even longer time frame is by looking at the number of beers an ounce of gold can purchase, which is seen in the chart below.   Paper money on the other hand is designed to lose money over time, with it being part of the RBAs mandate to generate inflation. Investors are typically compensated for that inflation to some degree via the interest they receive on the money they keep in the bank. But today, with rates at record lows, they earn next to nothing, causing them to look for alternatives. Gold is likely to be one of the alternatives they look at, for in Australia, from the end of 1970 to the end of 2016, there have been 22 years where ‘real’ interest rates were 2% or less, like they are now. The gold price rose in 19 of those 22 years, with an annual average gain of over 20%. Given gold has proved itself to be a superior long-term savings currency than Australian dollars, is generally more tax efficient, and that at present;

 

  • The rate of interest one earns leaving money in a bank is near all-time lows today, and likely to stay that way for years
  • Inflation may well head higher in coming years
  • That gold tends to do very well when rates are so low

It’s no surprise that every day, more and more investors are choosing to switch some of their savings out of their bank, and into gold.

Hedge against market downturns The second main benefit that gold offers Australian investors is that it is uncorrelated to financial markets, which provides diversification benefits when constructing a portfolio. Indeed gold has historically been the most effective hedge against market downturns, when traditional assets like shares fall in value. To help visualize this, it is worth looking at the following table, which highlights the worst 5 calendar years for the stock market from the 1970s until the end of 2016. The table also shows the returns for traditional defensive assets, like bonds and cash, as well as gold.

Asset Class Performance in Worst 5 Years for Stocks

Source: ABC Bullion, Global Financial Data As you can see, in the years where the stock market performs worst, with average declines of close to 25%, gold has been the highest performer, recording an average gain of almost 40%. It’s not just those five years either, with the gold price increasing by an average of 16% in all of the years that equity markets have declined since the 1970s. This highlights clearly how gold can help bring much needed balance to an investors’ portfolio. In this sense, gold acts like an insurance policy for your overall portfolio, and it pays off best when it is needed most, as any good insurance policy should do. Over the next several years, we think Australian investors will be well rewarded by keeping that insurance policy in their portfolio, as there remains a litany of risks that the global economy will have to navigate. Global debt levels have continued to climb uninterrupted, both in dollar terms, and even more importantly, as a percentage of output, or GDP, affecting both developed and emerging markets, with the latter being the primary drivers of growth in the past few years. Monetary policy also remains incredibly loose around the world, despite the focus on the Federal Reserve, and the few rate hikes they’ve pushed through in recent months. As it stands today, there have been some 700 interest rate cuts since the GFC, with some 90% of the industrialized world still anchored by zero or even negative real rates. As per our earlier section on gold and its ability to protect from inflation, those negative real rates will likely be a primary driver of gold demand, and prices, in the coming years.Finally, expensive financial markets are likely to drive further demand for gold in the coming years, as it will be seen as a sensible holding in an environment where risk assets like shares likely fail to maintain the strong returns they’ve delivered in the past. Whilst others may disagree with this perspective on risk assets, it would seem to closely reflect the view of Simon Doyle, who is the Head of Fixed Income & Multi-Assets from Schroders. Doyle recently stated that; “Current valuations across most assets tell us that future returns will be low and the risk of a significant correction is high.” Doyle’s comments in effect echo research from other well respected commentators, including BCA Research, who see a portfolio of financial assets alone delivering returns of just 2% per annum from 2016-2026, whilst Jeremy Grantham of GMO is even more bearish, projecting negative real returns in most markets over the next seven years. The combination of low real rates plus the potential for sub-standard returns and higher risk in traditional assets in the years ahead will continue to drive prudent investors wishing to hedge and protect their portfolio toward a physical gold allocation in their portfolio today.

3 stocks from the herd – FLT, XRO, SUN

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In this section we provide readers with three stocks that have attracted the interest of the broking community or the ‘herd’. Broker recommendations tend to be biased and highly optimistic. We try and breakdown these barriers and give our own honest opinion. It is important to keep in mind that technical analysis is only one part of the investment process and any recommendations do not give consideration to the underlying fundamentals of each business.

Flight Centre (FLT) – Current Price $43.57 – Issued atrading update this week. It expects 2017 fiscal year guidance to achieve an underlying profit between $325m-$330m for the 12 months to June 30 after achieving record full year sales and solid second half profit growth. Underlying 2H PBT is expected to surpass the PCP’s result by 2.5%-4.9%, leading to an underlying full year PBT. FLT has also announced a separate deal to acquire – Olympus Tours, a leading Mexico-based destination management company (DMC) and Bespoke Hospitality Management Asia (BHMA), an emerging Thailand-based regional operator of design and lifestyle leisure hotels.

Broker View: Macquarie (UNDERPERFORM $28.70) – The broker acknowledges the profit guidance upgrade but still maintains the view that there will be continued softness in airfares in FY18 and medium term margin decline coupled with valuation pressure. It suggests the risks are now skewed to the downside.

Unconventional View: We disagree with Macquarie. This guidance update is a complete turnaround. After 5 consecutive profit downgrades, FLT looks to be getting its house in order. Not only do they expect higher earnings but they announced two separate acquisitions. FLT has snuggled up with Airbnb and inked a deal to gain more corporate customers with Airbnb hosts across Australia. The deal means customer booking stay through FLT’s corporate brands, including Corporate Traveller and Campus Travel but will have access to Airbnb for Business. FLT’s corporate clients will now have access to more than three million listings worldwide, an unrivalled accommodation pool. The relationship makes perfect sense. It allows travellers to charge stays to their company directly rather than go through their own Airbnb account. It’s a win for both companies. FLT now expects an underlying profit of $325m-$330m. That will be the figure to watch at its next results. We think FLT will hit this mark especially with its recent acquisition. There is upside potential from here on in. Corporate travel is expected to boom for the foreseeable future. FLT has now broken out on the upside and out of its downtrend. That’s a bullish buy indicator. We advise buying on this break out.

Xero (XRO) – Current Price $24.44 – Xero is a New Zealand-based software company that develops cloud-based accounting software for small and medium-sized businesses. Its products are based on the software as a service (SaaS) model and sold by subscription, based on the type and number of company entities managed by the subscriber. Its main rival is MYOB. Shares have rallied this week after the company announced its net loss had shrunk to NZ$69.1m from NZ$82.5m a year earlier. The company said it now has 1,035,000 subscribers, after adding 318,000 over the past year.

Broker View: Citi (BUY $) – The broker has changed its view on Xero. It now longer is expecting a decline in subscriber numbers from FY21 and has lowered their margin projections. Buy / High risk rating kept.

Unconventional View: We agree with Citi. Whilst the StockOmeter ranks XRO quite poorly it’s only because the company isn’t making money. But when has a company not making money ever stopped its share price from rising? I.e. Spapchat. As a result its PE, ROE and Dividend Yield are all Null or negative – which results in a poor ranking. So the StockOmeter is largely irrelevant at this point. So let’s ignore it. This story isn’t a fundamental one. We’ve like XRO for quite some time, but the stock has been trading largely sideways and has been overlooked by brokers because it still is at a loss. But now, we think the company turned the corner and is very close to booking a profit. The New Zealand company posted a Net loss of NZ$69.1m from NZ$82.5m last year. While it is still a loss, it’s a huge improvement and makes us even more confident that it’s heading towards profitability. We think this is something investors should really be looking at. As the market starts to realise and take into account that XRO will be profitable in a few years, more and more brokers will start to jump on board and the share price will start to move higher. Now Citi have jumped on board and it won’t take long for the rest. The other big tick was that XRO pushed past the 1.04 million paying subscribers mark compared with 862,000 at the end of September. XRO is really kicking goalsand moving customers onto its platform in leaps and bounds. On the chart, XRO has broken out on the upside of what looked like a pennant flag. This bullish break out looks to have formed a new short term uptrend. For the moment the uptrend has stalled a little, but we think it will continue. Investors should look to buy at these levels.

Suncorp (SUN) – Current Price $14.65 – Is one of Australia’s largest insurers. Its services are based in QLD which includes retail and business banking, general insurance, life insurance, superannuation and investment products in Australia and New Zealand. SUN has following five core businesses: Personal Insurance, CommercialInsurance, Vero New Zealand, Suncorp Bank and Suncorp Life. The company’s brands include: AAMI, GIO, Bingle, APIA, Shannons, CIL Insurance, Asteron Life, and Vero.

Broker View: UBS (BUY $15.50) – The broker has quite a positive view on Suncorp. It has made minor changes to its FY17 forecasts and prefects Suncorp over the other domestic general insurers given the improving domestic rate cycle.

Unconventional View: We agree with UBS. The last time we wrote about Suncorp was back in March when Tropical Cyclone Debbie hit the North Queensland coast. If history is anything to go by, when cyclone Yasi hit in 2011 both QBE and SUN nose-dived afterwards but soon recovered there-after. So for that reason we advised clients to stay out of SUN just in-case of any adverse damage claims. The impact of cyclone Debbie is now long gone and SUN is blistering through. SUN is well capitalised and with cyclone season now over, it should be smooth sailing. SUN says it has finalised over half the claims lodged by its customers for Debbie which left a an overall insurance bill of over $1 billion. Of the 18,921 claims received by Suncorp, 9,845 have  been finalised, including 7,777 full or partial cash settlements. The company’s costs associated with Debbie and the impact of claims received will be included in its full year financial results, to be released on August 3. It is also set to expand its NZ operations via the takeover bid for Tower Limited via its subsidiary Vero. Tower has entered a scheme of implementation with SUN to acquire shares at $1.40. SUN will inherit NZ$750m worth of gross written premiums and the New Zealand life insurance market is considered a lucrative asset. On the StockOmeter, SUN stacks up quite well. The reading comes in at 63 which is a buy. Whist the stock is not cheap on a PE of 18.47x, its ROE and EPS are rising. That’s a good sign. On the chart the stock has recently broken out on the upside. Investors should be buying at these levels, the stock is making higher highs and rising with bullish momentum.  We advise buying into the lead up to results.

 

Why it’s important to look deeper

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On the 4th of July, just four days after the end of the financial year, Australian Super was the first group to break ranks and announce bumper returns. Headlines throughout the media showed returns on their ‘balanced’ fund were up over 12.4% for the financial year. It is always seeing how quickly a company with over 2 million members can calculate and publish returns when they are strong; compared to say last year when they were 4.54%.

As an inquisitive person, I’m always keen to look deeper into what were the drivers of the returns and how they were delivered byAustralian Super. Unfortunately, this has been incredibly difficult to do with the opaque reporting of the industry fund in recent years. It is however, improving. There is no doubt that readers, DIY investors or those with financial advisers see this return and try to compare it to their own. Yet, this is fraught with danger and will generally provide very little value; it’s more likely to cause regret for those who haven’t performed as well. The first question we ask when these announcements come out is how much risk or market exposure have the managers taken to achieve this spectacular return? In our experience, these returns have generally been achieved by taking more risk but in some cases, it has been due to sound asset allocation strategies. In this year’s case, it is definitely the former.  One quick look at the asset allocation of the ‘balanced’ option offered by Australian Super shows the portfolio manager held just 17.9% of their portfolio in the truly low risk assets of cash, credit and fixed interest. Therefore, the remaining 82.1% was held in higher risk assets, like shares, property and infrastructure. In our view, an asset allocation of 80% to risky assets isn’t really ‘true to label’ for a ‘balanced approach’ which would suggest say a 50/50 allocation. Now, we understand that Australian Super may allocate assets like infrastructure and property as low risk assets; however, experience would tell us this isn’t prudent, given the outlook for interest rates. If rates were to rise sustainable across the globe, which most experts are predicting, this would result in the mass downward revaluation of property, utility and infrastructure type assets; not what you want from a low risk asset right? In our experience, most balanced investors, or at least those seeking both income and some level of capital stability hold asset allocations closer to 40% to cash and fixed interest and 60% to higher risk assets like property and shares. Therefore, comparing one of these portfolios to Australian Super’s Balanced Fund is like comparing a dog to a racehorse; they are completing different animals. You can be excused for thinking you had drastically underperformed the market. So where can we find a truly comparable benchmark? We think it’s best to use one of the major research houses, who don’t manage their own capital and simply provide their views on the market. One of the largest independent research companies in the world, Morningstar, regularly publishes a series of ‘Multisector’ benchmarks for investors; from conservative to balanced and all the way to aggressive. Interestingly, their aggressive option, which has a similar asset allocation to Australian Super’s ‘Balanced’ option, also returned around the same level; at 11.60% for the year. The asset allocations and relevant performance data for each are as follows:

As I am sure you will see from the table above, there is quite a difference in returns, based on the level of risk in an allocation. In our next quarterly UWJ issue we will provide some discussion around why it’s important and how to actually track your return so it is comparable with the benchmarks.

Antipodes Global Fund

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The Antipodes Global Fund is an unconstrained, long-short global share fund. The fund seeks to generate absolute returns in excess of its benchmark, MSCI All Country World Index, by adopting a pragmatic value approach to selecting investments. The management team identify investment opportunities in terms of broad global thematics or ‘clusters’, be they societal, sectoral or country specific.

Investment Philosophy

Antipodes was founded in 1 July 2015 by the Portfolio Manager and CIO, Jacob Mitchell. Jacob was previously the deputy CIO to Kerr Neilson at Platinum Asset Management, where he spent 14 of his 22 years of investment experience. Whilst Antipodes is a relatively new manager, Jacob and his team, which included 6 other ex-Platinum staff, have an exceptional track record. During his previous tenure, he was able to achieve excess returns of 5.7% per annum over the benchmark in the Platinum Unhedged Fund and 9.9% in the Platinum Japan Fund, over the last 7 years. Jacob is supported by Graham Hay (23 years’ experience) and Andrew Baud (15 years). Staff own 76% of Antipodes with the remainder held by Pinnacle Investments, their administration and marketing partner. The manager charges a fee of 1.20% (1.10% for the listed investment company) plus 15% of outperformance above the benchmark and the long-short strategy has grown to total assets under management of $2.7bn in just two years of operation. The Antipodes Fund implements a fundamental value focus to stock analysis and operate in a niche within global markets; being the identification of underappreciated companies in the midst of structural change opportunities. Their view is that markets have a tendency for ‘irrational extrapolation’, or pricing in the current circumstances in perpetuity, which presents opportunities on both the long and short side through patient, fundamental-based research. The fund is high conviction, expected to hold between 30 and 60 individual companies, has a focus on capital preservation, achieved through stringent risk management measures and the requirement for a ’margin of safety’ in all investments. They also take an active approach to managing currency, understanding that obvious under and overvaluations can be used to boost returns over the long-term.

The short-term performance has been strong adding 18.7% for the 12 months to 31 May, exceeding the benchmark by 4.3%; this was achieved with a net exposure of just 58% to markets. The fund will typically carry a net equity exposure of between 50-100% meaning it will be less correlated to the market than a long-only strategy. The fund’s strong short-term performance has come from its alternative approach to analyzing investments that includes a focus on the many ways in which each investment can win. This can include changes in legislation or regulation which open opportunities, an improving product demand cycle, macroeconomic changes, management and the competitive dynamics of the underlying industry. The fund strategy is currently focused around investing into ‘incumbents’ who are entering the recovery phase after a period of disruption and difficulty and on the other hand disruptors who are at the inflection point of growth. They also assess broad thematic themes occurring in major markets across Asia, Europe and the US, including consumer, management and societal trends.

Reasoning

We believe the opportunities available offshore are more attractive than those in Australia at the present time. We have been impressed with the track record and approach of the Antipodes management team during our various meetings and we believe their value-oriented strategy will complement well with the more growth focus of the other holdings in your portfolio. The Antipodes team have a great deal of experience investing throughout Asia, including China, India, Hong Kong, Japan and Korea, which results in a natural bias of this fund towards the East. The importance of Asia is continuing to grow as the centre of financial markets gravitates towards China. We believe Antipodes is the Australian manager best placed to provide outsized returns from this transition and that this will provide substantial diversification against the more US and European focused managers in your portfolio. The value-based approach implemented by Antipodes may be prone to underperforming in the short-term, as momentum or growth strategies are popular, but their focus on avoiding overpaying for profitability and growth and looking for cheaper more eclectic growth opportunities bodes well over the long-term. Antipodes build portfolios differently to most competitors, where they assess companies based on their influences and operations not simply by the sector in which they operate in. At present, they believe that US domestic companies and global developed market defensives (like infrastructure and utilities) are expensive compared to their trend and therefore ripe for a correction. They believe that European, Japanese and Korean domestic sectors are comparatively more attractive and offer a greater margin of safety. The portfolio is currently tilted towards Asia with 22% invested into Developed Asia, 18% in Developing Asia, 25% in Western Europe and 22% in the US. The major holdings at present are Hyundai Motor Co., Baidu, Samsung and Gilead Sciences; which offer a diversity of sectoral exposures.

3 stocks from the herd – BAL, NXT, NHF

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In this section we provide readers with three stocks that have attracted the interest of the broking community or the ‘herd’. Broker recommendations tend to be biased and highly optimistic. We try and breakdown these barriers and give our own honest opinion. It is important to keep in mind that technical analysis is only one part of the investment process and any recommendations do not give consideration to the underlying fundamentals of each business. Bellamy’s (BAL) – Current Price $6.74 – Bellamy’s (BAL) – Shares have been placed in suspension following the suspension of Camperdown Powder CNCA Licence by the China authorities. This is a suspension of Camperdown’s CNCA licence not a cancellation. Bellamy’s are working with Australian trade officials and channel partners to understand the reasons behind the suspension. The suspension does not impact the sale of the Company’s organic baby and toddler formula products, which are currently manufactured by Fonterra and Tatura Milk (Bega) under their respective CNCA licences. BAL does not intend to can its products at the Camperdown facility until H2 2018.

Broker View: Citi (SELL $5.12) – The Citi analysts have downgraded the stock to sell. This follows on from the announcement of the $28.5m acquisition of the Camperdown cannery andnews from Chinese authorities the Camperdown license had been suspended. Bellamy’s cannot catch a break these days.

Unconventional View: We agree with Citi. Although the downgrade is a little too late. We got it wrong too. The stock is already in suspension. But we agree with their commentary. Bellamy’s is in a world of pain and simply can’t catch a break. It says that the suspension does not impact the sale of the Company’s organic baby and toddler formula products nor will it be used to can products until the 2H. That doesn’t matter as we’ve seen before, when investor confidence is shot people dump and run. This is exactly what will happen once shares come back online, investors will dump and run. The short term mood is expected to turn sour. In the AFR this week, there are reports that BAL may have to offer retail shareholders who participated in its recent $60.4m capital raising the ability to hand back shares due to the timing of a key licence suspension in China. BAL raised $45.5m to fund the 90% stake in Camperdown and raised another $27.5m to pay Fonterra to reset key production contracts. The purchase of the Camperdown facility settled last week, just three days before its licence was suspended. Whilst the suspension of the licence has not been cancelled it was all because of a third-party complainant that was sent to Chinese authorities based on historical records and quality issues at Camperdown. It may well be, that these issues are cleared up and the licence is allowed. No one knows. Either way, investors are nervous or many will want to sell out regardless of the outcome. The big lesson here, is the abrupt and sudden impact China can have on Bellamy’s without warning. It’s happened before, it can happen again. It almost seems Bellamy’s has been tainted with the Chinese. Morgans says in the worst case the licence issue would impact sales to China, but not until fiscal 2019. We think the risk is now to the downside. If you hold BAL shares and the announcement is negative, get out on the open.

 

NextDC  (NXT) – Current Price $4.40 – Remember that thing called the ‘cloud’? NextDC is where the cloud lives. Cloud is basically a slang word for storing and assessing data programs over the internet instead of your computer’s hard drive. NXT is a Data-Centre-as-a-Service provider offering a range of services to corporate, government and IT services companies. Last year I attended a tour of NXT’s Melbourne Data centre (M1). The building is more secure than Tullmarine Airport. It’s bombproof, bullet proof, nuclear proof and water proof. There are over 160 cameras that constantly monitor the building. Consequentially the security and reliability of data centres and their information is a tip top priority for organisations. Its data centres are designed to address the market’s growing need for energy-efficient, independent data centers in which organisations can host their critical IT infrastructure, and also to address the growth of cloud computing. The M1 centre uses massive solar panels which generate enough electricity to power 88 Homes and will significantly reduce NEXTDC’s running costs in terms of energy.

Broker View: Morgans (ADD $5.01) – NXT has completed its third issue of unsecured bonds valued at $300m at 6.625%. These funds will be used to pay off existing notes and fund further growth.

Unconventional View: We agree with Morgans. In-fact the stock has a rare 10 broker Buy/Add recommendations. It’s scored 10 out of 10 which makes it one of the most favoured stocks going around. NXT is in a prime position to leverage from a growing tech sector. So you really can’t go wrong buying it. On fundamentals the stock stacks up. Sure it trades on quite a large PE of 58x, but its ROE has finally gone positive. Which means after years of loss making the company is finally turning a profit from its high capex data centre rollout. Debt to equity is ok. NXT grows via the opening of new data centres and through recurring revenue from its current clients. The downside is that data centres are very cost intensive. They aren’t cheap. From its humble beginnings and shaky start, NXT has done a great job. The company continues to raise a combination of debt and equity to increase investment in land and the development of new infrastructure in Melbourne (the most profitable site) and Brisbane. It recently secured a site for a Melbourne M2 and Brisbane B2 data centre. Some might ask why you would invest in such horrible fundamental numbers? NextDC is a long term put in your back cupboard capital growth story. The company has spent big bucks on building these Fort Knox data centres. The capital outlay is huge and the earnings is little and slow. The company is slowly but surely turning a profit. With the relentless demand for data set to explode in the coming years, NXT will continue to expand and benefit from this thematic. All in all, the company is in the right space. On the chart, NXT is looking a bit toppy having rallied quite hard. We advise those wanting to buy to wait for the stock to dip a little. Overall though the stock is in uptrend.

Nib Holdings (NHF) – Current Price $ – Is an Australian health insurer company providing health and medical insurance to over one million Australian residents, New Zealand residents and international visitors and students. NHF operates in four divisions which are private health insurance, life insurance, travel insurance and related health care activities. NHF’s strategy is to provide innovative, low cost health insurance products. This week NHF was informed by ACCC that it intends to institute proceedings in the Federal Court against NHF’s Australian residents health fund primarily in relation to an alleged failure in August 2015 to communicate to customers limited changes made to its MediGap Scheme. MediGap is a scheme in which doctors and other in-hospital medical providers can elect to receive a higher level of fee reimbursement subject to there being no “out of pocket” expense for the patient. NHF rejects the position being taken by the ACCC and believes it has acted lawfully and ethically.

Broker View: Citi (SELL $5.01) – Have updated their models following mark-to-market to adjust for the likely impact of increased hospital utilisation and a recovery ancillary claims. Even though the analysts anticipate FY17 will be better than NHF’s guidance, the broker thinks Fit won’t happen in FY18. Citi also think the share price is above their valuation and hence the sell.

Unconventional View: We disagree with Citi. With premiums rising higher than inflation and health costs going up, health insurers such as NHF are in prime position to capitalise. As Australia’s population rises and grows older, it will place a greater stress on the Government to cater for everyone on the public healthcare system. This means the private sector needs to step up and take some of the burden off the Government. NIB is one of Australia’s leading private health insurersthat could easily step up. It has been experiencing phenomenal growth especially with the government prompting people to get health coverage or pay higher taxes. In Feb the insurer lifted 1H profit by a whopping 65% to $71.1m and is expected to continue rising its premiums and banking higher profits. NHF has earmarked a 2.1% increase in policyholders in the six months to December 31. The thing is NHF’s premium increases above inflation reflect not just the cost of healthcare services but also the growing rate that people use those healthcare services due to an ageing population. On fundamentals NHF scores really well on the StockOmeter returning a 81. Its PE isn’t neither cheap nor expensive. Its ROE is high and rising from 25% to 28%. Its dividend is skinny but ok. EPS is rising and trend is great. On the chart the stock is in a solid uptrend and rising with bullish momentum. We advise investors to buy at these levels.