The last 12 months have been bruising and emotional for equity investors enjoying the market grinding higher from July to early February based on FOMO (fear of missing out) and TINA (there is no alternative to equities). The ASX then collapsed -35% in March as panic selling set in on CV-19 fears. Since the depths of despair in March the market rallied 30% as investors stepped in to buy stocks at a fraction of the price that they were trading a few months before, perhaps spurred on by the negative real rate of return being earned on cash deposits. High levels of volatility can often create opportunities as the market can be excessively pessimistic as to a company’s prospects.
In this piece, we are going to look at the Dogs of the ASX in the 2020 financial year, see how 2019 Dogs performed and review how accurate Atlas’ predictions were in July 2019.
The “Dogs of the Dow” is an investment strategy made famous by O’Higgins in his 1991 book “Beating the Dow" and seeks to invest in the same manner as deep value, and contrarian investors do. Namely, invest in companies that are currently being ignored or even hated by the market; but because they are included in a large capitalisation index and paying a dividend like the DJIA or ASX 100, these companies are unlikely to be permanently broken.
Inclusion in a large capitalisation index such as the ASX100 indicates that the unloved company may have the financial strength or understanding capital providers (such as existing shareholders and banks) that can provide additional capital to allow the company to recover over time. Additionally, if it is still paying a distribution, the company’s business model is unlikely to be permanently broken, as the company's directors are unlikely to authorise a dividend if insolvency is imminent. Smaller companies tend to face a harder road to recovery with a higher chance on bankruptcy when they make it onto the “Dogs” list. Over the last seven years on the ASX, the Dogs have outperformed the index on five occasions, but the strategy of investing the Dogs did not work very well in the 2020 financial year.
Investing in an equal-weighted portfolio of the dogs from 2019 would have resulted in an investor underperforming the ASX200 by close to 20%, as the majority of these stocks continued their downward trajectory in 2020. The sole bright spot among last year’s unloved mutts was Lend Lease that delivered a modest gain over the past year as the company progressed in their moves to divest their troubled engineering division.
Our picks from July 2019
When we looked this list last July in Dogs of the ASX from FY'19, we correctly speculated that AMP was unlikely to bounce back in 2020, as the new CEO’s strategy to turn around sprawling financial services company would take longer and be more expensive than forecasted. Our caution towards Challenger proved to be correct, though for the wrong reasons. Atlas saw that falling interest rates would continue to reduce the attractiveness of Challenger’s annuities; however, market declines in 2020 necessitated a $300 million capital raising to top up Challenger’s regulatory capital. Similarly, our view that Lend Lease would recover in 2020 looks accurate. The company’s funds management and global residential development businesses performed well, and in December 2019 Lend Lease announced that they had sold their troubled engineering business to Spain’s Acciona.
Less successful was our prediction that both Unibal-Westfield and Flight Centre were candidates to outperform in 2020. These two companies were dealing with company-specific issues with Unibal-Westfield under pressure from concerns about retail sales in Europe and the USA and Flight Centre from restructuring their Australian leisure business. However, in 2020 their share prices took a further leg down as shopping centres and travel agencies were two of the industries most affected by CV-19 lockdowns.
The Dogs of 2020
The table below shows the bottom ten performing stocks ASX 100 stocks over the past twelve months, and there will undoubtedly be some fallen angles that will outperform in the 2020 financial year. The key themes in the list of the bottom 10 of 2020 are companies exposed to either oil prices or heavily impacted by travel and shopping restrictions.
Rabid hounds best avoided
Picking potential winners from the list of last years “Dogs” is arguably harder in July 2020 than during other periods. The principal reason for the falls over the past year was not a company-specific issue that is in management’s power to fix during a period of otherwise benign markets, but rather due to an external shock that the company has no influence over. The two Listed Property Trusts on the list, Scentre and Vicinity, own the best retail assets in Australia and have recovered some of their losses from March, but have little control over further lockdowns and the impact that the potential removal of JobKeeper in September will have on retail sales.
Flight Centre is well capitalised after raising $700 million in April. Still, management has no visibility over when travel restrictions will be lifted and how eager consumers and businesses will be to book travel when they can do so. The energy companies all had a poor 2020 courtesy of a 35% fall in the oil price stemming both from falling demand and the curious decision of Russia and Saudi Arabia to engage in a price war right in the middle of the CV-19 crisis.
While Virgin Money has fallen 69% over the past two years and is deeply unloved by the market, it is difficult to forecast a sharp bounce in the bank’s share price over the next year. The economy in the UK has both been hit hard by CV-19 (44,220 deaths so far) and is concurrently seeking to extricate itself from the European Union. In May the Bank of England forecasted that the UK economy faces the fastest and deepest recession since the “great frost” of 1709. The trajectory of bad debts incurred by a British bank will undoubtedly be complicated for investors in Australia to accurately forecast.
Rescued pooches just in need of a good home
Construction company CIMIC stands out in the above list of the Dogs of 2020 as being a candidate that could outperform in 2021, as the reason for its share price fall was not due to CV-19, but rather due to the exit costs of their Middle Eastern joint venture revealed in January. Operationally, CV-19 has had a minimal impact on CIMIC’s business as construction has continued throughout 2020, and the company will benefit from increased infrastructure spending. Additionally, in 2020 the company has repurchased $147 million of their stock on-market, a move that appears to presage a takeover from major shareholder Hochtief. Health Insurer NIB could well surprise in 2021, as CV-19 restrictions reduce the number of elective private hospital procedures and healthcare premiums are paid upfront.
Likewise I see the travel stocks, Flight centre, Webjet and Qantas continue to face strong headwinds at a 45 degree angle forcing they’re noses noticeably downward (“pullup Terrain, pullup Terrain”) Having participated in a little short term profit making in these stocks in May and June, it become clear over two weeks ago that the headwinds had strengthened and it was time to leave them well alone. Checking every day since, I was astounded to see money continuing to pour into travel stocks and continue to pump. That was until Qantas announced mass retrenchments. Again expecting these stocks were toast I am still surprised today at their relative strength. As an easily side-tracked, working from home, Covid-19 home office participant, my mind had rattled off into holiday fantasy land and I felt the immediate urge to research flights to my favourite island in South Thailand for July 2021 and South America December 2021. My thoughts, there must be some cheap tickets on offer and as long as they’re fully refundable, may be worth a punt. As for the timing, well we’re hearing no international until mid-2021, so the dates seem plausible. On entering the travel dates I was immediately confronted with a problem, a very big problem. One of my favourite films is the Big Short and a notable take-away from this film is the message to get off your arse and do your own research. The scene of the Wall Street boys in the car of a Real Estate agent in some Midwest American town, streets lined with vacant houses and “for Sale” signs, will always stick in mind. It was a big problem that hadn’t yet hit their Wall Street spread sheets. I’m afraid my attempted flight booking just played out in the same way. Put simply, due to fuel hedging and other uncertainty which affect the costs associated with operating an airline, flight tickets can only be purchased 11 months in advance of your return date (I was using flight centre). July 2021 was greyed out and I couldn’t even book beyond a return date of mid May 2021. In a nut shell, there is nothing you can possibly purchase in the way of an international flight that will likely actually fly. The belief that the travel industry will have a trickle of sales to help drag out the capital raised funds is just not plausible. This means apart from domestic travel, you actually can’t even give the travel companies your money for international travel under the current forecast resumption date of June 2021. Is that another cap raise I hear? Terrain – Terrain - Terrain
Re "the curious decision of Russia and Saudi Arabia to engage in a price war" , maybe it was not a war at all but a ploy to put the blow torch on the US fracking industry. Just a thought.
Ignatius, FLT is in a tough situation. In April they raised $700M to strengthen the balance sheet, but mostly to pay for the closures of over 400 retail stores. Despite these laudable moves to reduce their cost base, it still costs FLT $65 million a month to open their doors in an environment where travel has effectively ground to a halt. As for investing in the vanity projects that are airlines, few have been more eloquent that Warren Buffett, though he did not follow his own advice selling positions in United, American, Southwest and Delta Airlines at a loss in May 2020. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. -- Warren Buffett, in the 2007 Berkshire Hathaway shareholder letter
"The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money." That represents some of the biggest gainers over the last while Afterpay and Tesla amongst many others.
Spot on Chris. As a tech company though I would say that your view is in currently in the minority. APT is very different from a classic tech company like Xero, where the marginal cost of signing up another customer to use their account software is close to zero. When APT signs up a customer who then spends $1K on a new LCD TV, this increases APT's receivables book that needs to be funded. Tesla consumes capital albeit for different reasons; as it is primarily involved in heavy manufacturing, which involves the construction of factories and the purchasing of raw materials.
Thanks Malcolm. I really enjoyed reading what you wrote. I could relate to a lot of that - especially regarding travel stocks, working from home, and Thailand. Much appreciated.