One of the themes that emerged from Saturday's extended interview with Ben McGarry of Totus Capital and Steve Johnson from Forager Funds was for investors to check their portfolio and evaluate the balance sheets of their holdings.
In this episode, we get Ben and Steve to put some widely-held stocks under a stress test and gauge whether they have what it takes to ride out the rapidly deteriorating economic environment. The names include Tabcorp, Carsales.com, Afterpay, G8 Education and Super Retail Group.
Steve also offers Livewire subscribers a 'high octane' stock idea that he reckons is being "dramatically mispriced". This company has government and corporate contracts, and could see a severalfold increase if it retains them and conditions bounce back.
Notes: You can access the video, podcast or edited transcript for this Buy Hold Sell episode below. This episode was filmed on 25 March 2020.
James Marlay: Welcome to Buy Hold Sell, brought to you by livewire markets. My name's James Marlay and I'm joined today by Steve Johnson from Forager Funds and Ben McGarry from Totus capital and we know in times of stress you need to look to the balance sheet to see if these stocks can make it through the troubled times.
We're going to have a look at a couple of stocks that we thought were defensive that might not be just as defensive as we would have hoped. First one, gambling, we know the punters, it's an all-weather activity, Steve, Tabcorp buy, hold or sell?
Steve Johnson (Buy): It's a buy for me, taking on the risk of some form of a rights issue or capital raise here. So I think you'd want to own it. Anticipating that you might have to put some more in at some point. I really, really like the lottery business here, they're shifting that from distributing through newsagents where they have to pay 10% of the revenue to the newsagent to their own online distribution networks.
It's much more profitable for them. That train's been underway for some time, but it's only been accelerating, but it's going to come under pressure. As people don't go to use agents and obviously the TAB side of things with less sport. People being outside less is going to come under enormous pressure in the short term and it's got a fair bit of debt on the balance sheet. I think it'll be fine. It's a big enough business for people to stand by and ride through this. So I would say buy, but beware.
James Marlay: Ben, just about everything there is to bet on has been cancelled. Can you put a bet on Tabcorp?
Ben McGarry (Hold): Neutral. I'd probably wait for the capital raise if there was one. But their competition's certainly been decimated in the sports, on the betting side of the business given the cancellation of sport around the world. The lotteries business, I totally agree with Steve is a good one for these tough times. People tend to want something to look forward to and buy a lottery ticket. So, and that business you could probably buy the whole of the Tabcorp business for roughly what people were prepared to pay for the lottery's business a few months ago. So, the only caveat for me is the balance sheet is a lot of fixed costs, in that network of TAB outlets. So if you did get a chance to buy it on a raise, I think that would be a good opportunity.
James Marlay: Okay, great. Staying with you, Ben, Carsales. Now I can imagine from the supply side there is reason to believe there'd be a lot of cars coming on the market for sale. But the demand side, I can't... I struggle to see how that holds up. It is the number one player in the market. Buy, hold, or sell?
Ben McGarry (Hold): It's a hold for us. I mean we've always thought Carsales, like SEEK and REA, were just a bit expensive and not really very attractive relative to what was on offer in the IT or tech space offshore. For volumes of cars, you need some people to be buying new cars and it's not a great environment for that. So share price has come back a bit. It's a hold to a sell for us, but the balance sheet is not as bad as you know SEEK and others in the space.
James Marlay: Okay. Steve, Carsales, it's a stock you know well. Buy, hold or sell?
Steve Johnson (Hold): Put it in the hold category as well, James. We do own the stock in a small size in our Australian fund. I love the long term economics of this business. The pitch for us is that they are the gateway now to secondhand car sales. The average dealer is making $2,000 a car on a second hand sale. At the moment Carsales.com are making $200 and we think that $200 can be a lot higher over a period of time. The client base is going to be struggling massively through this and I don't think in previous recessions second hand car sales have held up well. This is going to be a consumer strike as much as a recession. So people are just not doing anything, including not going out and buying cars I would imagine so, I think short term, their customers are going to come under a huge amount of pressure. They've got a Korean business there that I would say more than offsets the debt, so I'm not super concerned about the balance sheet with that one either, but I think the business will probably come under more pressure than it has historically.
James Marlay: Steve, Afterpay. It's a stock that the market has really struggled to figure out what the right price for it has been. It's a lot cheaper today than was just a couple of weeks ago. It's been bouncing around. Buy, hold or sell?
Steve Johnson (Hold): Hold. It's a lot more expensive today than it was yesterday. Look, I've been on the fence with this stock from the start and I'm still on the fence today. I think the next 60 days is going to be really interesting in terms of resolving some of the questions about this business.
There've been a lot of people through the boom times saying that their write-offs are going to be much higher through the cycle. And we're about to go through a very, very vicious cycle and test that assumption. Again, I'm on the fence about whether it is a credit product or a payment product. I know a lot of people that have got plenty of money that use Afterpay cause they like it as a payment mechanism and it just works for them. So I think there's an element of the business that is better than some of the very strong base think. And I actually don't think this is going bust. There's $700 million of receivables there and about $400 million of debt. They could lose 20% of that receivables book and you'd still have net equity in that. And then there's $400 million of cash on the balance sheet. So for me, it is absolutely not going bust, but you're still, even at yesterday's price paying $2.4 billion dollars for it. So it's not a question of whether it goes bust or not. It's a question of whether it's worth that much money over the full cycle.
Ben McGarry (Sell): It's a sell for us. Amazingly well managed business. Nick and Anthony have executed beautifully, but that was in a different economic environment. It's in the process of turning from a FinTech stock into a consumer finance stock and there's a massive de-rate underway in terms of the multiple of book value that you would pay for that kind of business. So it was barely profitable in the good times when it was growing, hugely reliant on capital raisings to fund its growth. So it's in the... I agree with Steve. Over the next six to eight weeks, we're going to find out how resilient the business model is. But I just wouldn't want to do it by owning the shares. So it's a sell.
G8 Education (ASX:GEM) & Super Retail Group (ASX:SUL)
James Marlay: Alrighty. Ben, I've asked you to bring along a stock where you think there are some questions or that the balance sheet's going to be tested. Have you got one you want to call out for us?
Ben McGarry (Sell): Well I was going to say Afterpay, but look there's a range of businesses across the retail and space. Anything with a lot of lease liabilities and potentially a variable revenue line. Afterpay was the one I was going to talk about but we've been cautious on the childcare sector for some time. I think G8's got balance sheet and revenue issues and was struggling even prior to this. But in the retail space, Supercheap auto, well managed by an old mate of mine from school, but certainly not a great stock for this kind of environment. So either of those I would be avoiding at the moment.
Eclipx Group (ECL:ASX)
James Marlay: All right, Steve, have you got a stock that you thinks got the balance sheet to get it through this environment where there might be few questions being asked?
Steve Johnson (Buy): I'm going to go with something high-octane here, James. So this is a caveat that it should be very, very small position size because I'm actually not 100% convinced that it has the balance sheet to get through, but I feel like the risk has been dramatically mispriced at the moment. That's Eclipx in the car leasing space. The share price is down 75% or 80% there over the past six to eight weeks. It's been absolutely smashed and it is dependent on funding, but it's clients I think will hold up better than people are anticipating at the moment. It's largely a corporate and government fleet there. They've got less exposure to novated leasing than the other leasing companies.
A car is often the last thing that people are willing to get rid of because they're very dependent on it to work and keep their job and you're trading at a price that is extreme on the downside here. So, you're going to make many multiples of your money if it works out okay on the upside, but it is certainly not without risk.
James Marlay: Well, there you are. There's a couple of ideas on the long side and the short side where the balance sheet is going to be the key determinant of survival over the next few weeks and months. Steve and Ben, thank you both very much for your time.
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- Check out the extended interview with Steve and Ben from Saturday, and their previous Buy Hold Sell discussion '5 cash earners for a crisis'
- For further ideas, it may be timely to revisit Steve's 'Recession proof, property proof' ASX portfolio that he designed for Livewire subscribers
- In Totus: ‘Cash Earners’ vs 'Cash Burners’, Ben discusses how you can find an investment style that can perform regardless of what is going on in the market