Buy Hold Sell: 4 top stocks (and 2 that have lost their shine)

In case you missed it, Livewire's Ally Selby was joined by WaveStone Capital's Raaz Bhuyan and Perpetual's James Rutledge for a jam-packed episode of Buy Hold Sell. Don't miss these fundies analysing each other's highest conviction holdings, as well as two market darlings in for some troubled times ahead. 
Buy Hold Sell

Livewire Markets

It's the finance industry's worst-kept secret. Over the long term, the majority of active managers underperform their benchmarks. In fact, SPIVA data shows that over a 10 year period, 79.82% of funds underperformed the S&P/ASX 200. 

Many believe this underperformance is thanks to the proliferation of index-hugging funds. While others believe it is because managers are forced to invest in more stocks as funds under management grows. Then, of course, there's the matter of fees detracting from performance. 

But according to a study by US-based portfolio manager and author Robert Hagstrom, a high conviction portfolio of investors' best ideas can increase one's chances of outperformance. 

In fact, he found that a randomly generated portfolio of 15 stocks would generate a maximum return of 26.6% annually over a period of 10 years. For 50 stocks, this was 19.2%. Meanwhile, among the portfolios with 250 stocks, the best return possible was 16% per annum. 

So in this episode, Livewire's Ally Selby was joined by Perpetual's James Rutledge and WaveStone Capital's Raaz Bhuyan - two high conviction fund managers - for their analysis of each of their two top holdings. 

Plus, we also asked our fundies to analyse two market darlings that could be in for some troubled times over the months ahead. 

Note: This episode of Buy Hold Sell was shot on Wednesday 30 March 2022. You can watch the video, read an edited transcript or listen to the podcast below. An earlier version of this video contained two "BUY" graphics at the end of the video where there should be "SELL" graphics. 

Edited Transcript  

Ally Selby: Hey, how are you doing? And welcome to Livewire's Buy Hold Sell. I'm Ally Selby. And today, we'll be asking our guests to analyse each other's highest conviction holdings. Plus, we'll also ask them to name one market darling that is in for some troubled times ahead. To do that, we're joined by Wavestone Capital's Raaz Bhuyan and James Rutledge from Perpetual.

First off the ranks today is ResMed. It's one of Raaz's top holdings. Its share price has lifted around 30% over the past year. Raaz, I think I might know your answer for this, but is it a buy, hold or sell?

ResMed (ASX: RMD) 

Raaz Bhuyan (BUY): It's definitely a buy. It's one of our conviction buys. It has been in the funds for a long time and has done our unitholders really well. The company is obviously a global leader in sleep therapy, but what's important is in the last 12 months, we've had its biggest competitor, Philips Respironics have a recall. We are really big on industry structure. And here is a classic example of where the market, in our view, will shift quite dramatically over the course of the next two years, as ResMed take share from Respironics.

Ally Selby: ResMed is down around 10% year to date and it's suffered quite a lot from supply chain shortages, in particular semiconductor chips. James, over to you, is it a buy, hold or sell?

James Rutledge (SELL): It's a sell for us. We think that the market's overestimating the benefits from the Philips recall and given the chip shortage over the next six months, we think that could be prolonged just given the situation in Ukraine and the neon gas shortage that we're seeing there. So we think the market's overestimating that benefit and given the valuation, we think it's looking fully priced here.

Transurban Group (ASX: TCL)

Ally Selby: Next up, we have another of Raaz's top stocks. It's Transurban Group. Traffic decreased by 4.8% in the half and saw earnings drop around 7%. James, over to you. Is it a buy, hold or sell.

James Rutledge (SELL): That's another sell for us. We do struggle with Transurban just given the level of gearing within the business. Operationally, we expect to see traffic volumes improve, maybe overshoot pre-COVID levels. But structurally, probably go back towards pre-COVID levels. But really, the dividend is reliant on refinancing the assets and in a higher rate environment, a heavily indebted long-duration asset could struggle to outperform.

Ally Selby: Raaz, this is one of your top stocks. Why is Transurban Group a buy right now?

Raaz Bhuyan (BUY): I totally agree with some of what James has raised. Transurban has been in the portfolios for a long time and we've always been quite big on infrastructure stocks. We obviously own Sydney Airport. That's been taken out and Transurban is the other business that has infrastructure assets - road networks in the eastern seaboard and the capital cities. We've always liked these alternative assets. What Transurban brings is internal growth inside the network, because they've obviously got NorthConnex coming on, they've got WestConnex. And as James pointed out, we've obviously had issues with COVID in terms of the traffic, so that comes back.

Typically, Transurban's assets have an average duration of over 30 years. We can worry about inflation in the short term and interest rates going up a little bit. But the reality is these are long-duration assets and are basically irreplaceable assets. And Macquarie Bank and all these managers are looking for these kinds of assets. You think about the sovereign wealth funds the super funds - they're all looking for long-duration assets. And this is one of the few listed companies in Australia that give us exposure. And we really like it.

Insurance Australia Group (ASX: IAG)

Ally Selby: Raaz, it's your turn to tell us what you think of James's stocks. First up, we have Insurance Australia Group, IAG. There's obviously still ongoing flooding around the eastern coast of Australia. Not great for IAG or the people of Australia for that matter. Is it a buy, hold or sell?

Raaz Bhuyan (BUY): It's a buy for us. And the reason for that is, I know we've had these one in 100-year flood events and we've had bushfires every year now for the last three years. But the reality is that they are typically longer duration events. And our view is that typically, because of the market structure that we've got in Australia of the insurers, the personal insurers, they should be able to price up. And typically, there's a lag between the pricing here that you get versus the perils that you've experienced - the floods that you talked about. And our view is that they'll price up to make sure that they're protected from those perils. And then the other big thing, of course, is something that we've talked about with Transurban. Where interest rates have been a massive headwind as they've fallen, and we should get some rebound back.

Ally Selby: Okay. Over to you, James, this is obviously one of your highest conviction calls. What do you like about IAG? 

James Rutledge (BUY): IAG's a buy. It reminds us a lot of Woolworths a number of years ago when Woolworths was trading in the low ~$20s. It's a great business that's fallen on hard times, in part, due to mismanagement. And we think that the Australian general insurance market's a great market. It is very attractive and IAG's a clear number one player. Valuation wise, it trades below the sum of shareholder funds and technical reserves, which is a really attractive entry point for any insurer, let alone one of as high quality as IAG.

Santos (ASX: STO)

Ally Selby: Let's talk about another of your top stocks. It's Santos. It seems fundies are super keen on this stock at the moment. I've heard it spoken about a lot lately, it's been written about a lot on Livewire Markets. It's seen to be this energy transition play. Is it a buy, hold or sell?

James Rutledge (BUY): It's a buy. It's one of our largest holdings. We're quite positive on the oil and gas space, just given the limited CAPEX that you've seen over the last number of years. And especially gas, as a transition fuel over the coming decades. Santos has really lagged the oil price over the last 12 months. And we think the main reason for that is really the lack of free cash flow generation over the next few years, as a number of its projects really pump CAPEX. So we think to see the stock outperform from here, you need to see a sell-down, especially around the Alaskan project or a complete exit there, and that'll improve the free cash flow outlook for the company. And they do have some projects in that carbon capture and storage space as well, which could drive further valuation upside. But it's a clear buy for us.

Ally Selby: The stock has already outperformed this year. It's up around 19% compared to the ASX 200, which is relatively flat. Raaz, over to you. Is it a buy, hold or sell?

Raaz Bhuyan (BUY): I think it's a long term buy. You raise the issue about the stock price being up. That's true for Woodside as well, which is the only other large oil and gas company. And that's largely because of what's happened in Ukraine. We still think that the gas markets have structurally changed. And so we think that Santos, as largely a gas player, should benefit from the fact that Australia is a big exporter of LNG. So we think it's a buy. We like the management and what they're doing with the business. There's a lot of organic growth inside the business. And as James pointed out, he talked about carbon storage and transition, which again is quite material to us.

Market darlings to fallen angels

Ally Selby: We asked our fundies to bring along one stock that they think is in for some troubled times ahead. Raaz, I might start with you, what did you bring for us today?

Raaz Bhuyan: Reliance Worldwide (ASX: RWC), which obviously floated a few years ago and has done exceptionally well growing in North America. They bought the John Guest acquisition in the UK and that's done quite well. What's happened over the course of the last 18-24 months is, with COVID, you've seen the likes of Home Depot and Lowe's do exceptionally well. And their biggest buyers are effectively the retailers in the US. And so they've done remarkably well out of that. 

Our view is that the underlying market for Reliance grows at 2-3%. And they're obviously growing share, but they're not growing at 20%. We are quite valuation driven, and so when the stock went through $5, that was enough for us. But in the short term, we just feel the market's expectations for earnings, at a time when the Fed is raising interest rates and is quite aggressively trying to slow the housing market down - it's almost like you're fighting the Fed.

Ally Selby: When did you sell out of that one?

Raaz Bhuyan: That would've been late last year.

Ally Selby: Over to you, James. Is there a market darling that you think could be in for some troubled times ahead?

James Rutledge: Similar theme to Raaz, so US housing-exposed James Hardie (ASX: JHX). The stock looks optically very cheap at the moment, it's trading at just 18 times one year forward price to earnings. But we think that margins, where they are at 32-33% in FY23 are unsustainably high. The tailwinds that you've seen from a stronger US housing market have really helped that margin in terms of the "mix shift" benefit. And with mortgage rates in the US - the 30-year mortgage rate knocking on the door of 5%, we think that's a really tough backdrop for housing to grow. So we're concerned about the margin. US housing's above mid cycle, probably going to come down with the move in the mortgage rate, and they don't have a CEO at the moment, so a bit directionless in terms of the strategy. So that's the one that we think is well held by the market and is probably in for a tougher time, despite the derating that you've seen.

Ally Selby: Well, that's all we have time for today. We hope you enjoyed that analysis of James and Raaz's highest conviction holdings. If you enjoyed that episode, give it a like, and remember to subscribe to our YouTube channel. We're adding new content every week.

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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.

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