The rotation into value continues to gather pace, with the US ten-year yield creeping closer to 2.5% ahead of this week’s Fed rate decision. So tune in as we ask Vince Pezzullo from Perpetual Equity Investment Company, and John Murray from Perennial Value Management: ‘Is it a good time to buy value, and where do we find it in this market’. As John tells us: ‘since the GFC it’s been a really difficult time for value, but that cycle is just starting to turn’. Stock selection remains as important as ever, and as Matthew Kidman summarises: “We might just be heading into a golden era for value stocks, but you just have to make sure you pick the right ones”. In this thematic discussion, John and Vince talk about some of the sectors and stocks they think look attractive on a value basis. Click below to watch the video and the full transcript.
Matthew Kidman: Welcome to Buy Hold Sell. My name is Mathew Kidman and today we're going to talk about value. Is there actual value in the market? Joining me is Vince Pezzullo from Perpetual and John Murray from Perennial. Welcome gentlemen. John, I'll start with you. Value: Is it a good time in the market to explore value at the moment?
John Murray: Well, thanks Matt and hello to everyone. It's always a good time to buy value, Matt. But I mean that sincerely. Good value and perhaps we'll talk a bit about this over the next few minutes, but it's all about buying good companies that aren't overpriced. If you want to add value to your portfolio over the longer term, that intuitively to me makes sense. So it's always a good time to buy value. The only other point I would make, if you look at the macro trends over the last few years, going back over five or six years essentially since the GFC, it's been a really difficult time for value, just as a general observation. Global value managers have had a tough time. That cycle's just starting to turn and value managers generally, both here and globally, their performance has started to turn up a little bit.
Matthew Kidman: So I'm gonna say, yes, it is a good time for value. Vince do you agree with that?
Vince Pezzullo: Absolutely. As a value manager you can always find pockets of value in the market. You have to look harder sometimes in the market cycle and sometimes it's a bit easier to find. Usually when it's a bit easier to find it's quite a lonely time to be investing because, as John mentioned, the last five years it's been pretty much thematically driven, yield driven, growth … and companies that make things that go bang in the night, etc. they've been ignored. Some traditional old sectors like resources or materials and steel manufacturing. They've been ignored completely.
Matthew Kidman: Lets go down that path. Where do we find value in this market and how do we avoid the value trap?
Vince Pezzullo: Where we're seeing value there are some forgotten stocks in the market at this point, where we're seeing some fundamentals start to turn up, but the market's sort of ignoring them because they've been out of favour for a while. We're known for our pretty large investment in Woolworths. It's a bit contrarian. We still like, we think the fundamentals have already turned, we like Graincorp. Not just for the cyclical aspects of it but we like what the CEO is doing, Mark Palmquist, he's doing a lot on lowering the cost base there and we like Clydesdale as well. For us to avoid the value trap, we always look at the balance sheet first. You’ve got to have a good balance sheet because in value investing, it can be, as I said before, lonely and you have to have quite a bit of patience. You need some protection from the market sometimes. Having a good balance sheet is the way to protect yourself.
Matthew Kidman: Okay John. Vince has given us companies from all different sectors. Is there a sector or is it like that: you got to pick the individual stock to find value in this market? If so, what are they?
John Murray: I think it's a bit of both Matt. I'd actually agree with Vince on all three of those stocks. We've got some commonality in our portfolios, but that probably wouldn't surprise because we're sort of both value investors in many ways. Just to add the picture, I think resources look really interesting.
Matthew Kidman: Had a good run in the last six or so months.
John Murray: They have had a good run but I think the really interesting thing about the resources is if the spot prices stay anywhere near where they are now, and they've come up a long way since earlier this calendar year. If they stay anywhere near where they are, whether you look at a BHP, or a South32 or Rio, the free cash flow generation is going to be unbelievable. It's going to be much stronger, ironically, at the bottom of the cycle now than what it was at the top of the cycle. Remember earlier this year Matt that the big companies, specifically Rio and BHP, they committed to payout ratios between fifty and sixty percent broadly. If their earnings go way up, as we think they could well do over the next year or so, their dividends are going to go way up as well in terms of payout, just rising cash flow. I think there's still some value in resources stocks.
Matthew Kidman: Let's go to the other side of the Australian barbell and the banks. Four big banks. Big part of the index. Are they value at the moment?
John Murray: I think they're okay Matt. I think they're okay. The way I look at the banks is very simplistic. The four of them are broadly the same. There's been references to the big four banks as being, well perhaps more so the likes of CBA and Westpac has been really large building societies. Their focus has just been on housing . There's two bookends for the banks. The first one is a big recession. Lots of bad debts on the back of lots of job losses. That's dire for the banks. The best-case scenario is strong credit growth, big profits for the banks, fast rising dividends and so forth. I think where we are at the moment is somewhere in the middle. On that basis, the banks, I think they look okay. I think there is a lot better value elsewhere. We both talked about a few stocks a couple of minutes ago. The running yields if you gross them up at the moment are round about nine percent. It's probably a place in the portfolio but I don't think they're outstanding value at these levels.
Matthew Kidman: Okay. Vince, John defined the value as good companies at the right price. Do you agree with that or are we talking about companies that are bombed out, that are at extreme evaluations that you call value?
Vince Pezzullo: I have to agree with John again. I hate to do this again but we're always looking for quality. Again, I mentioned the balance sheet before, but you'd be amazed at what the market can do to high quality companies. They will throw them out the door pretty quickly for a little bit of a misstep. It's as simple as buying stocks which are highly cyclical and we're at the bottom of the business cycle. We believe in mean reversion. At some point, like a Boral or BlueScope, those things, eventually they will rerate, you’ve just got to get your timing right. That's why it's important with the cyclicals, that you find an entry point where you think it's close to the bottom of the cycle. You're never going to pick the bottom, at all of the cycle. You just have to get a decent average price through the bottom.
Matthew Kidman: We've had a golden era around growth and as you said, bond proxies. Are we at the beginning of a golden era for value?
Vince Pezzullo: I would have to agree wholeheartedly with that given that's our business. I think so. I think it's going to be a lot more stock specific. You're going to have to have a portfolio of idiosyncratic risks. A lot of stocks, you're buying stocks, not because of the theme, overarching theme, I need to find an income. You're buying a company. You're trying to find a cash flow stream, and in particular one that the company can grow the dividend. That's sort of my ... I may be contrary to John on the banks. I think he's right. They're okay. I think they're going to struggle to grow their dividends from here. They're got very high pay out ratios based globally, on global comparables and there's not a lot of credit growth left in the market, unless corporates really start borrowing a lot but that's a confidence issue. I think the banks are going to struggle to grow here, their dividends.
Matthew Kidman: We might be just heading into a golden era for value-based stocks. You've just got to make sure you pick the right ones out of the hat.