Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 422

Five stocks that have worked well in our portfolios

In a crazy 12 months for markets, it became clear to us that what was a logical and compelling macro view one moment could fundamentally change a few months later. While we cannot completely divorce our macro view from bottom-up stock picking, we resisted the temptation to make investment decisions based substantially on our macro view. 

Picking macro trends is incredibly difficult and if FY21 taught us anything, it is to keep an open mind. We cannot change the past, but we can learn from it. The core of our investment decisions will remain our fundamental bottom-up stock picking.

Here are five stock ideas which have worked well for us.

Eagers Automotive (ASX:APE)

We spend a lot of time looking at cyclical companies. We are not afraid to own companies exposed to a cycle. The opportunity generally arises in the stock market at the low end of a cycle when earnings momentum is negative. This is often met with a weak share price as momentum investors, passive funds and quant funds tend to sell when a company downgrades short-term earnings. The opposite also happens. When there is an up-cycle, earnings momentum is positive and this is usually combined with a strong share price and positive analyst recommendations. This is despite the mid-cycle valuation not really changing.

APE is a good example of this. In February and March 2020 there were on average four buy recommendations despite the share price languishing between $3/share and $4/share. Currently with the share price over $15/share the number of buy recommendations from sell side analysts has doubled to eight.

The important formula is to make sure you own the best managed company in the space, which has a strong balance sheet to take advantage of bargains at the lower end of the cycle - either through mergers and acquisitions or strategic investments. Going into COVID, the auto retailers were already going through recessionary conditions. There had been more than two years of negative industry new car sales and regulatory changes made it more difficult to generate commission from finance products.

In the middle of this, APE took advantage of its strong balance sheet and excellent management team to buy its biggest competitor AHG. We like this sort of move at the low end of a cycle, however, it is easier said than done. During the middle of COVID, APE fell below $3.00/share in March 2020. For our sins, we continued to buy all the way down. We got comfort from the strength in the management team, the strength of the balance sheet and the experience of the board. We felt that mid-cycle earnings for APE would be around $0.60/share conservatively, and hence we thought we were getting a good price at $3-$4/share.

The stock rallied hard over FY21 and finished the year at over $15/share. While we were happy that we kept our nerve when everything was looking bad and everyone was selling the stock, we also got a bit lucky. For a variety of reasons, there is a global shortage of microchips which are essential for new car manufacturing currently. This has stifled supply of new cars. At the same time, change in consumer behaviour has seen a big spike in demand for cars. This has resulted not only in car volumes bouncing back (something we thought would naturally occur as the cycle turned) but margins are at record highs (something we didn’t predict). 

Iluka Resources (ASX:ILU)

The summary of our investment view was that we liked the supply side set up for both the zircon and high-grade chloride feedstock markets and that if demand were to start to rebound, the market would tighten up and pricing would follow. We also thought that there was optional upside with the company’s rare earths opportunity in its tailings deposit in Eneabba.

Since the beginning of November, the Iluka share price has rallied 73% and has been a large contributor to our performance. Already in 2021, contrary to market expectations, we are seeing this tightness lead to price increases. We expect the zircon market to remain in a structural deficit over the next few years and view the price increases as sustainable. The other major part of Iluka’s revenue stream is from titanium feedstocks (used to make pigment) and this market has also tightened significantly. 

On the project side, we feel the market is only beginning to recognise the potential of Iluka’s Rare Earth assets. The major advancement during 1H21 was a letter from the Federal Government for funding support (non-recourse loan) for the construction of a REE refinery in Australia by Iluka as part of the Strategic Mineral Policy. Despite the very strong share price performance over the past ~6 months, we remain positive on the outlook for the business and continue to hold a significant position in the fund.

Boral Ltd (ASX:BLD)

During March 2020, BLD’s share price fell from $4.50/share to a low of $1.80/share. The stock had been weak heading into this period due to underwhelming performance in the US business and a slowing cycle being compounded by increasing competition in the core Australian market. As markets fell materially on the initial COVID panic, the market became concerned about BLD’s balance sheet and the ability to withstand a long period of subdued operating conditions.

BLD’s NTA at the time was $2.10/share and we accumulated a decent position in the fund around this level. Our view was that even considering the COVID related uncertainty, the business was worth materially more than NTA and had significant optionality within its portfolio of assets. Our view was that the Australian business had sustainably delivered returns on funds employed of ~14% over the last decade and thus deserved to trade at a material premium to NTA. We see the Australian construction materials business as high quality with hard to replicate assets including its quarry base.

We also noted the investment the company had made in Australian quarries in recent years ($380m) which had yet to generate full returns. We felt the US business was also worth materially more than its NTA value. In terms of the balance sheet risk, we felt that the market was too focussed on the leverage ratio of the business in an environment where the earnings were depressed and overlooked the optionality the business had on the asset side of the balance sheet. In particular, BLD has a number of surplus property assets in Australia that we felt could have been sold to strengthen the balance sheet without impacting the earnings power of the business. Given this relative comfort and the view that the business was materially undervalued on a mid-cycle view and verse NTA, we continued buying on the weakness.

Over the last financial year, the optionality we saw within the BLD portfolio has played out. BLD sold its 50% share in the plasterboard JV for US$1.015b or 15x FY20 EBITDA. It has also sold its US building products business for US$2.15b and is currently exploring a sale of its North American Fly Ash business which could release another $US1b.

Post this sale, BLD will no longer have any operations in the US and will be left with just its Australian construction materials business which is the #1 in the Australian market. Seven Group (ASX:SVW) launched an off-market takeover for BLD at $7.40/share after initially buying a 10% position at $3.11/share in June last year. In our view, at this price the assets of the business are fairly valued and thus we have sold the position to SVW at $7.40/share.

Woolworths (ASX:WOW)

Woolworths has been a great investment for us over the last five or so years. We started buying it in mid-to-late 2016 and have been holders to varying levels since that time. Our initial interest was aroused as the share price waned in light of the over-earning, complacent core supermarket business making an ill-fated venture into the hardware market through Masters, made possible by a weak management team and Board. The core grocery business still retained much that was good, but its high margins were not only unsustainable, they had also attracted competition from the likes of Aldi and Costco.

From our perspective, that changed with Board refreshment and appointment of the current management team. We looked favourably on the overall operating assets, balance sheet and turnaround strategy of the company. Initial strategic steps included selling out of Masters, replacing store roll out with upgrades to the existing supermarket store network and sacrificing short term margins for longer term sustainable growth. More generally, Woolworths under this new (current) leadership took short, medium- and long-term strategic decisions centred around resetting itself as a genuine value proposition to customers. This meant becoming increasingly sustainable and defendable over time through sound behavioural practices and solid investment across all aspects of business. Investment has been very substantial over the past five years and while never 100% without hitch, Woolworths is increasingly effective in presenting the most compelling customer offer in the marketplace.

Woolworths is now beginning to grow its overall and already market-leading food market share. Woolworths has a 50%+ market share in the online grocery market in Australia despite having only 37% market share in the traditional land-based grocery market.

We believe that as far as loyalty, digital, data, supply chain and store footprint, Woolworths is materially ahead of any of its national competitors. Just the Australian Woolworths food business has almost 13m active loyalty customers, 12.5m weekly visits to its app or online and almost $4bn annual online sales (growing up 92% in H1 21). The numbers are mindblowing.

The most interesting aspects for me are the customer loyalty and further aligned activities possible for Woolworths within a growing ecosystem of interconnected goods and services. Potentially future developments and innovation will further fortress the Woolworths core food operations with adjacent earnings and unlock the value that is inherent within this enormous customer database. Extensive infrastructure built out over time including important consumer protections, embedded behavioural practices and management accountability added to now incrementally growing scale is expected to offer increased leverage and earnings growth into the future.

While this was the picture over several years, Woolworths was a detractor from relative performance over FY21 generating a return of 18.5%. That is a good annual return, however was a drag on relative performance given the market was up just under 30%.

Despite underperforming in FY21, the stock has performed strongly already in FY22 following the spin-off of the Endeavour Drinks division. While the share price may have gotten ahead of itself in the short term, we believe Woolworths has a good growth outlook which should be able to deliver earnings no matter what the macro environment supported by a stellar balance sheet.

Underweight (avoiding) CSL

As a value manager, generating alpha from being maximum underweight a company like CSL Limited (ASX:CSL) when it underperforms should be a given. No value manager can look at you with a straight face and tell you that buying a specialist pharmaceutical company at 40x+ P/E (double its overseas equivalent companies) is a value investment.

We have been maximum underweight CSL as we are value managers and no matter what way we look at the valuation, we have and continue to believe that CSL is overvalued. Generating alpha from not owning CSL when it underperforms is pleasing given the alpha which it has detracted on the way up, however, this should be a given and hence we don’t take credit for that. As a fundamental value manager where we think we can add value is avoiding some stocks which cosmetically look cheap but are in fact value traps.

The fund was short or did not own AGL, AMP, Aurizon, Coles, Lend Lease, Cimic, Amcor, IAG and QBE for most of this year. These are all traditional value-style companies and all underperformed the market materially. We spent a lot of time analysing these companies and, for one reason or another, felt that while cosmetically cheap a lot of them were value traps. 

 

Anthony Aboud is a Portfolio Manager at Perpetual Investments, a sponsor of Firstlinks. This article contains general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. Stock charts are provided by Morningstar.

For more articles and papers from Perpetual, please click here. For information on the Perpetual funds that may invest in the stocks mentioned, click the following links:

 

RELATED ARTICLES

Invest in Australian value stocks before it is too late

Hide and seek: the FX impact on global equity investments

Winners and losers in sharemarkets, 2017/18

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

Let's make this clear again ... franking credits are fair

Critics of franking credits are missing the main point. The taxable income of shareholders/taxpayers must also include the company tax previously paid to the ATO before the dividend was distributed. It is fair.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Latest Updates

Investment strategies

Joe Hockey on the big investment influences on Australia

Former Treasurer Joe Hockey became Australia's Ambassador to the US and he now runs an office in Washington, giving him a unique perspective on geopolitical issues. They have never been so important for investors.

Investment strategies

The tipping point for investing in decarbonisation

Throughout time, transformative technology has changed the course of human history, but it is easy to be lulled into believing new technology will also transform investment returns. Where's the tipping point?

Exchange traded products

The options to gain equity exposure with less risk

Equity investing pays off over long terms but comes with risks in the short term that many people cannot tolerate, especially retirees preserving capital. There are ways to invest in stocks with little downside.

Exchange traded products

8 ways LIC bonus options can benefit investors

Bonus options issued by Listed Investment Companies (LICs) deliver many advantages but there is a potential dilutionary impact if options are exercised well below the share price. This must be factored in.

Retirement

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Investment strategies

Three demographic themes shaping investments for the future

Focussing on companies that will benefit from slow moving, long duration and highly predictable demographic trends can help investors predict future opportunities. Three main themes stand out.

Fixed interest

It's not high return/risk equities versus low return/risk bonds

High-yield bonds carry more risk than investment grade but they offer higher income returns. An allocation to high-yield bonds in a portfolio - alongside equities and other bonds – is worth considering.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.