How to nurture your portfolio with 2 long-term thematics

A strong rebound in cyclical earnings, a steepening yield curve, optimism around the reopening of economies and expansionary fiscal policy have supported cyclicals over growth stocks during the first quarter, and remain a dominant theme going forward. 

This can be seen in the clear outperformance of Financials and the underperformance of the Technology sector. Interestingly, the Materials sector underperformed during the quarter, despite seeing a strong level of earnings upgrades. A late pullback in iron ore and base metals prices during March weighed on the sector following a period of strong outperformance in 2H20.

Planting the seeds for long-term outperformance

Typically, our best investments are when we identify value in a company that is not widely understood or reflected in the stock price. Often the company in question is unloved by the market which can be overly short-term focused. 

We think of it like planting a seed – we expect that investment to sprout and grow over time. However, the timing of this “sprouting” is hard to predict as it is dependent on others in the market also recognising value in the underlying asset and bidding up the stock price to reflect it. 

This is one reason why our investment performance will vary through time. In some periods many seeds will be sprouting at once, while at others we are planting many seeds but few are sprouting. Consequently, investment performance should be judged over the long term, not monthly or quarterly. 

Two opportunities we're watching sprout 

In March one of our holdings, Mortgage Choice (ASX:MOC), received a takeover offer from Realestate.com (REA) at a 66% premium to the existing stock price. This followed from a weak February when the stock was -13% on a reasonable but underwhelming profit result. Clearly, a stock price can vary significantly from day to day while the underlying value moves more slowly. This creates opportunities for longer-term investors. 

Mortgage Choice is a mortgage broker with a high level of recurring revenue and very strong cashflow. Prior to the bid it was yielding 7% fully franked and growing its cash earnings.

Source: Iress

Another example is United Malt Group (ASX:UMG). Since our purchase, it has generated a moderate return but below the fund’s overall return (it has underperformed). However, we believe the outlook has improved i.e. UMG appears to be a seed that has not yet sprouted. 

UMG is the world’s 4th largest supplier of malted barley to beer and whiskey manufacturers. Its key market is the US (60% of revenue), along with UK (20%), Asia (15%) and Australia (5%). Craft and microbrewers (30% of revenue) are the most profitable segment as they pay a higher price than large commercial brewers, typically use more malt per litre of beer and often use premium, speciality malts. This craft segment was significantly impacted by the COVID-19 lockdown of bars. 

With the US vaccine rollout accelerating (20% of adult population fully vaccinated, circa 3m jabs/day), UMG should benefit from re-opening. Yet the stock is well below its high of late 2020 and valuation looks appealing. 

Interestingly this contrasts with travel stocks, many of which are above their pre-COVID high and exposed to a slower Australian vaccination program. Further, UMG benefits from the longer-term structural growth of craft beer and its de-merger from Graincorp which will deliver efficiencies and higher return on capital. Over time we expect the underlying value to be reflected in the stock price.

Source: Iress

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