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Emma Fisher on picking companies not trends or themes

Emma Fisher is Portfolio Manager at Airlie Funds Management, the Australian equity manager within the Magellan Group. For a podcast version of this interview, see Wealth of Experience, Season 1, Edition 5.

 

GH: Your style is more to pick companies rather than themes but are there any big market trends or themes that you're backing at the moment.

EF: The short answer is no, as you say, we’re really bottom-up stock pickers, but it's probably worth exploring why we don't try to pick trends. The simple answer is because I don't think we'd be good at it. I don't really back myself to identify thematics early, and by the time they're obvious when you turn to a certain trend, they tend to be overvalued for their near-term prospects. So that's why we’ve always shied away from it.

Another thing is, typically with trend investing you're talking about forecasting demand and I've always found forecasting demand difficult. I prefer to concentrate on supply because it's easier. Typically, you've only got so many players in an industry and you know the supply years in advance and it is supply coming online that tends to drive pricing in an industry. The obvious example is the miners in the supercycle when prices were high. All the supply was coming online, you could see it coming from space. It crushed pricing in the industry and it took years to absorb that supply.

Even with a business like CSL, one of the reasons why that's been such a phenomenal investment over the last few decades is because on the supply side of that industry, there are three players. There are unlikely to be many more because the barriers to entry are so high. And those three players have been rational about expanding supply to meet demand. We don’t back ourselves to pick trends because you risk thinking the same way as everyone else and it can be difficult to make money that way.

GH: Your fund doesn't have what you might call a dominant style, you don't argue for example for value over growth. But do you think that as a consequence, in the market we've had over the last few years where growth has run so strongly, that you distrust the very high P/E stocks, the really big growth stories?

EF: Yes but distrust is probably not the word I'd use. Jealousy is probably a better word. I’m a bit jealous of the things that we missed not going in early enough and riding the rerate in earnings. I think that broadly the market is pretty efficient and usually the businesses that are on very high multiples actually do have very good prospects. It's just that if you're wrong on a business on a very high multiple, it's a long way down, and a long time from when the growth investors start selling a stock to when the value investors start buying. A recent example is a business like A2 Milk: very well loved on a very high multiple, runs into some issues, and it's been a long way down from $20 to $6.

We talk about multiples, price to earnings multiples for example, but it's a shorthand way of comparing different businesses in different industries. You must be aware of its limitations, and it tells you nothing about the prospects of the business. It does tell you something about what the expectations are but it doesn't tell you whether or not those expectations are going to be right. If you look at a business like Afterpay, which we've never owned, people have been calling it crazily overvalued at a $2 billion valuation and a $10 billion valuation and now it's going to be taken over at a $39 billion valuation. So there's no shortcut for doing the work. You have to get into an industry, get into the business, try to understand it and then try to figure out what it's worth, rather than having a fixed mindset that high P/E is bad, high valuation is bad, because I think that can lead you astray.

GH: We talk about the reopening trade as we come out of COVID, although we haven't yet really reopened. Do you think that some sectors have been left behind while the market has been focusing on that?

EF: Yes. When you are searching for stocks to give an exposure in your portfolio, it can lead you astray and into a section of the market that's probably overvalued in the short term. I remember last year in November, we were getting all this efficacy data on Pfizer and Moderna and the markets were rallying because it was so good. I was getting brokers sending me emails with lists of reopening stocks, here are the ones that we suggest you buy. It was everyone crowding into the same ideas.

It was looking silly in terms of valuation for a business like Qantas. We've owned Qantas for a number of years, unfortunately rode it all the way down, then rode the recovery backup. So, when it got to about $5.50 in January or February this year, you might say, well, the share price was $7 pre-COVID so it has further to go. But while COVID is not the death knell of the business, we know that it's not been a good thing for airlines, the valuation really got ahead of itself. So we sold that ‘reopening trade’.

I think the segment of the market that had really been left behind at that time was retail especially bricks and mortar retail. You would never have predicted in March last year that retail was going to be one of the best-performing beneficiaries, but these businesses had phenomenal numbers, they generated a ton of cash in the 12 months. We're all in lockdown and spending money to get the dopamine hit of the postman come over. Retail is a business model that doesn't actually have very high cash needs, which means the balance sheets of these businesses are great, and they're probably going to pay that back out to shareholders.

We were able to pick up cheaply businesses like Nick Scali at $9, which is growing its store rollout by 40% over the next few years. So even if there's an elevated COVID element to their earnings right now, we think that they can absorb that with store growth rollout. Businesses like Premier Investments, with Solomon Lew one of the best retailers in Australia, and Wesfarmers as well. You know Wesfarmers was never hugely sold off or hugely cheap but Bunnings, Kmart and Officeworks is a suite of the best retailers in Australia. So the exposure you want is to these really good businesses that aren't a reopening trade. That's where we've been seeing value.

GH: Let’s focus on some stocks that have done well for you recently, such as Mineral Resources, Reece and PWR?

EF: The question is where to from here. PWR is a Gold Coast-based owner-managed business, and the guy that runs it was a mechanic who many decades ago decided he could make the best radiators in the world. And now he supplies every Formula One team with their cooling systems. It's quite incredible. I think it's a brilliant business that has further to run. Reece probably looks stretched on near-term valuation metrics on 44 times next year's earnings. They're Australia's largest plumbing wholesaler and they bought a plumbing wholesale business in the US three years ago and the market was pretty skeptical. But they've actually done a really good job. It's such a huge market In the US but it could trade sideways for a while.

Mineral Resources, I still feel like this business could still double although it's up about fivefold in the last 18 months and I know iron ore prices are falling. But in the next five years in iron ore, they want to get to 90 million tonnes. At that point, they'll be producing half of what Fortescue does and Fortescue is a $70 billion market cap company versus Mineral Resources at $11 billion. So leaving aside price, the iron ore volume expansion story alone is offering considerable upside.

GH: Is there a company that the market is completely under estimating, one that you can't understand why the market is missing?

EF: I can think of a few stocks that haven’t worked in the way that I would have hoped. But one thing the market is potentially underestimating is the wave of cash that is coming back to shareholders over the next 12 months. It's quite unusual to see the economic strength that we've seen across the board like it was for the last 12 months. Usually, you've got one part of the economy letting the side down whether it's banks or the mining or industrial businesses or the Aussie consumer, but everything has been firing.

So, all these businesses are sitting on piles of cash. Over the last six months there's been an unwillingness to pay that out to shareholders because of the uncertainty of COVID. And now that we've got vaccines that we know work and we can see the finishing line in sight. Maybe not this reporting season because we're now locked down again and maybe another excuse to hold the cash, but over the next 12 months, I'm expecting a lot of that cash to be paid out to shareholders.

And not only does that support the market because a lot of people just reinvest those dividends but it's a good thing. The market has looked pretty expensive in an absolute sense for a number of years, but in a relative sense, relative to a cash rate of 0.1%, the fact that the Australian market is yielding 3.5% in dividends is very attractive compared to what you can get with your cash. So that relative argument actually makes equities look fair value when looking at it through a different lens.


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GH: A couple of questions about your own business. What does being part of the Magellan Group bring to an Australian equity manager?

EF: John Sevior founded Airlie about a decade ago. He'd been working at Perpetual but he wanted to run his own business, but he found after a number of years that more and more of his time was being taken up by non-investment hats that he had to wear – compliance, risk, legal, all the stuff that is increasing in our industry. And it was a real impost on our time as a small business. Magellan brings world class capabilities to the non-investment side, so we let them wear all of those hats and we just focus on investing which is what we love doing.

And the other angle is the Airlie Australian Share Fund which has now been running for three years. Prior to that, we were an institutional-only business since 2012. We run over $9 billion of money for institutional clients, but the Airlie Australian Share Fund is a retail offering. And in order to access the retail market, you need the distribution and marketing that Magellan brings to the table. That would have been quite difficult for us to do on our own.

GH: And Magellan also allows investors to access funds in both listed and unlisted form.

EF: Exactly, and that cannot be underestimated. My friends and family who invest in the Fund all own the listed version. It's just so much easier. You can buy and sell it like any other share. The previous element of a premium or discount that came with a listed investment company was unfair either to existing investors or future investors, depending if it's at a premium or a discount. The single unit structure means you're basically entering at NTA.

GH: Yes, it's been a fantastic development. Final question. Are you tired of answering questions about inflation when nobody knows the answer?

EF: You've worded that perfectly, that question encapsulates exactly how I feel about the matter. The short answer is yes, I think everyone's tired about talking about inflation. I understand why the debate’s happening, because the markets are only attractively priced in a relative sense, so the debate is around if that cash is right or wrong. If the cash rate is wrong, then the market valuation is wrong. But I think it's unknowable.

As an investor, you need to separate your stock-picking skills from your honest assessment of yourself as a macro investor. I think I'm a good stock picker. I've got enough of evidence of that but I have no evidence of whether or not I'm a good macro investor. Probably not. So you've got to make sure that you're not taking big macro swings with your portfolio because if you get them wrong and it is a different skill set, it can really overshadow the power of your stock picking. So we try to make sure that we're not positioning our portfolio in a way that is strongly positioned for this inflation narrative, because we don't know the answer. So I am sort of sick of inflation because it's this year's narrative. Next year it will be a different narrative.

 

Graham Hand is Managing Editor of Firstlinks. Emma Fisher is Portfolio Manager at Airlie Funds Management, the Australian equity manager within Magellan Asset Management, a sponsor of Firstlinks. This article is for general information purposes only, not investment advice.

For more articles and papers from Magellan, please click here. This is an edited transcript of the original recording which can be heard on the podcast version at ‘Wealth of Experience’, Season 1, Episode 5.

 

3 Comments
Dennis
August 23, 2021

I like the honesty Emma displays by not trying to predict the unpredictable. You know what you are getting with Airlie & more particularly what you are not getting. The former being stock picking expertise & the later trends.

Warren Bird
August 19, 2021

I like Emma's terminology about how ''it's a long way to fall'' if a high multiple stock runs into some issues that undermine the optimistic expectations that are built into the multiple.

That's a neat way of saying what I've said from time to time, that P/E is less important as a valuation measure than it is as a risk measure. It's conceptually and mathematically similar to the duration of a bond, capturing the time period over which the cash flows from the asset will repay the current purchase price. A high P/E is telling you that the stock is a long duration stock. The equity market is overall a longer duration - higher risk - asset class than bonds, and within that there are very high P/E companies that are higher risk still.

Risk doesn't automatically mean loss. High P/E stocks can indeed perform, as Emma points out, so long as they continue to do what the market has factored into their price. However, the high P/E is telling you that even small shifts in either the earnings growth expectations or the discount rate you apply will have a large impact on the price. As Emma said, there's a long way to fall!

Jack
August 19, 2021

Good to hear Emma is tired of talking about inflation as I'm also over it, and generally, the banging on about macro this and macro that dates as quickly as the next announcement from the Fed. Does Apple or Google or Amazon care about the timing of tapering? I can't imagine Jeff Bezos listing to an economist each morning, he has (had) a business to run.

 

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