On Wednesday 26 August, two mid-cap companies made announcements – grocery wholesaler Metcash held its annual general meeting, while financial technology company Zip Co announced its full year results, which included news of a deal with eBay Australia. Despite reporting very upbeat results, Metcash’s share price barely moved, while Zip was rewarded on the announcement of its new deal with Zip’s share price soaring 27%. What’s going on?
Metcash – a very positive result, but barely a reaction…
In the case of Metcash, we have over recent months increased our holding significantly in this wholesaler to retail brands such as IGA, Cellarbrations, and Mitre 10. Metcash competes through its affiliate IGA network with Woolworths, Coles and Aldi in groceries in a sector that we understand is ‘aggressive but rational’. In liquor, IBA is the number 2 player behind Woolworths, but ahead of Coles. In hardware, Mitre 10 competes directly with Bunnings, with both chains currently benefitting greatly from the extra spend on renovations as many people working from home take the opportunity to fix up their homes and gardens.
Our confidence in Metcash’s prospects strengthened in recent months when after significant research we undertook including various channel checks and talking to many independent retailers, it became apparent to us that Metcash was not only growing its sales, helped by the increase in grocery and hardware sales during the pandemic, but that the IGA network had also picked up substantial market share from the major supermarket chains as the company benefitted from new localised shopping trends by consumers across all its businesses.
On our estimates for the company, we calculate that Metcash should report a net PROFIT after tax of slightly over AUD200 million for FY2021. As a result of all this and given that Metcash was trading on a P/E of around 14 times earnings and a 4% dividend yield (while also experiencing good growth), we have been a fairly large buyer across our funds in recent months, as we believed the company offered great value given the strength in its underlying businesses. Through our thorough research process, we also learnt that the IGA network had made significant progress in reinvesting in its stores and reducing its prices to be more competitive with Woolworths and Coles.
So when Metcash announced at its AGM on Wednesday 26 August that food sales were up 15% and liquor sales were up 11% and that its hardware sales were up 19%, we were delighted and felt vindicated by our positioning in the portfolios.
These sales numbers were well above our estimates and market expectations. However, Metcash’s resulting 2% share price rise on the day underwhelmed us, as the focus of investors seemed to be on more ‘exciting’ sectors in the market as opposed to real companies with real earnings.
Zip – a poster boy of the current momentum-driven frenzy
On the other side of the spectrum, where momentum-driven activity is approaching a state of frenzy, financial technology company Zip announced its results – a LOSS before tax of AUD45 million. But what really caught the eye was a deal with eBay Australia to offer credit options to small- and medium-sized businesses. As a result of a fairly innocuous announcement, Zip’s share price hit a record high of AUD9.95 on the announcement and finished the day 27.58% higher, adding close to AUD billion in value as the company’s share price closed on Wednesday at AUD9.65, to value the company at over AUD3.7 billion. (This compares to Metcash’s current valuation of AUD3 billion.)
At the end of the day we were asking ourselves the question – does it really make sense when a relatively minor deal from a loss-making company can justify a near one billion-dollar increase in its market-cap, while a double-digit sales increase from a well-established profitable company such as Metcash barely makes any impact on its share price?
Such is the frenzy in the ‘buy now pay later’ (BNPL) sector – or in the case of the companies themselves, should that be ‘buy now, profit later’? – that FlexiGroup has opportunistically announced that it is changing its name to ‘humm’, raising substantial capital and moving its business model to being another fully-fledged BNPL company.
The market is currently a combination of exuberance and extreme valuations in a number of sectors – particularly technology, where stocks like Afterpay are up 10-fold in five months – and where there is muted disinterest in many other sectors (mainly the ones made up of companies that actually make profits and pay dividends!). The enthusiasm for “anything tech”-related has driven the sector – which in Australia contains mainly unproven and loss-making companies – to what in our opinion are massively overvalued levels. Many market participants are seizing on short-term announcements, extrapolating these well out into the future, making no provision for wider economic or regulatory changes, and driving up the prices to huge valuations for some of the most speculative stocks on the sharemarket.
Meanwhile, good-quality companies like Metcash, with proven solid earnings, a healthy 4% dividend yield and a reliable history of paying good dividends, and trading on a reasonable 14 times earnings, languish virtually unnoticed.
The market is not currently rewarding companies which are going in the right direction as we head into an economic downturn and which are proving that they are able to maintain their earnings, profits and dividends.
This point in the cycle is reminiscent of other speculative cycles through which IML has invested over its 22-year history. The most emotional – and therefore least rational – decision-making body is the crowd. Successful long-term investment therefore requires rigorous analysis, disciplined behaviour and a steely determination to persevere with a tried and tested investing process, irrespective of bubble-like activity and headline-grabbing noise from some other sectors.
We know that when the market exhibits such extreme traits, that change is in the offing. At some point – and particularly given the more challenging broader economic and business environment – the market will begin to recognise and reward companies with robust business models and genuine earnings, and lose interest in companies which may possibly become profitable at some stage a long, long way down the track. At that point, the market will return to recognising the value of companies with a competitive advantage, which are the number one or two player in their industry, which are run by high quality management teams and which have recurring revenues which are underpinned by a strong balance sheet – and at some stage the share prices of these companies will benefit greatly as a result.
With central banks talking about keeping interest rates low for the foreseeable future, and with economic growth prospects moving forward far from clear, our portfolios remain heavily-skewed to well-established companies like Metcash, Coles, Amcor, Aurizon, Telstra, and Orica. These are companies which based on our research can continue to generate good cashflows and dividends for shareholders in the years ahead, and which are run by very capable, experienced and proven management teams. We also continue to keep the faith with companies currently affected by the COVID-19 shutdowns, such as Crown and SkyCity Entertainment, but which have strong, long-dated licences which will help these companies generate significant returns for shareholders in coming years as restrictions ease.
There’s no doubt that certain sectors and stocks have entered bubble territory, driven by a wave of liquidity and momentum investing. What causes all this to end and when is anyone’s guess, but in the past, such speculative frenzies have ended without warning, and normally in a very dramatic fashion as many investors look to exit many of these positions at the same time.
This thought piece was co-written by Daniel Moore and myself.
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The advices from `value investors' are all good. The problem is that if you follow them, you are not going to make money. I know they are predicating another tech wreck. But this time it's different!. It's the new economy mate!
I think there's a bit of emotional charge nowadays in this discussion (noting a couple of recent similarly passionate interviews with Platinum's Andrew Clifford in defence of value investing) ... at the end, it all comes to facts and numbers. There's a nice chart to keep an eye on - https://www.msci.com/factor-index-scorecard If / when the trend snaps and the colours change decisively, it will show. Probably it is still the case for not "if" but "when", but it might be that "when" to a point becomes a matter of survival for some strategies / mandates already... On a completely unrelated note, and more of a theoretical discussion: is Metcash more a value or a quality stock? If it does great, under which banner will it be?
This time is different is one of my favorites! New or old economy, the most important thing is which one makes money. Zombies are thriving recently thanks to the governments.
Thanks Anton, a good reality check...your other commentators to date unfortunately seem to be in the busboy category. You deserve a wider audience than that...although some people never learn do they?
Great read Anton,thanks for your rational view based on real experience in the market .Interesting to read the comments as well ,particularly when it comes to not making money on a stock with real profits and dividends .
The problem with this sort of analysis is that it appears to simply be a dogmatic approach to a particular style of investing rather than a genuinely analytical approach. Anton, you've been a devout Value investor through all market conditions and espoused the same approach at all times and relying on the virtue of patience and time to deliver solid results. This has led to underperformance of your fund over the last 7 years while the cycle has been against you. Granted, historically a quant version of value investing has shown to deliver a performance benefit over the long term, albeit as a risk factor that provides leverage. Value has been a higher risk approach that has experienced greater volatility and larger drawdowns than the broader market. I question whether a more qualitative value approach (developed by Benjamin Graham in the 1920s, but largely dismissed by Graham himself by the 1970s) has actually delivered any performance attribution. I have yet to see any solid academic data on the validity of a Fair Value approach. Conversely, a momentum approach has also been shown to deliver long term performance benefit. But this fills a contradictory narrative and is often described as an irrational venture of the greedy and fearful and so does not appear to be utilised despite its long term history of success. So I question whether there is any genuine foresight in the analysis or a stubborn reinforcement of a preconceived idea. P.S. Alexey, great link to the MSCI factors page.
Thanks Anton for the reality check. The virus has presented a once in a lifetime (we hope) opportunity to make some fast money. So is now the time to jump out of those fast rising stocks? I can't help noticing the pundits and pushers are having a bit of difficulty coming up with new stories. This might be a sign.