Vince Pezzullo, Deputy Head of Equities at Perpetual, explains that companies need to clear four hurdles before being considered for investment. The criteria are a quality businesses with low debt, good management and recurring earnings. Many ‘tech’ stocks pass the first three of these hurdles but fall down when it comes to earnings.
“The concept style business, we struggle with those, because of the four quality filters. One is you have to make money, you have to be profitable.”
In this short interview, Pezzullo explains how he is thinking differently in order to gain exposure to technology and IT. He also explains why he has reduced his exposure to consumer staples and the banks in recent months.
Click on the player to watch the discussion or read a transcript below.
Vince, one of the areas that I looked that had low representation, was IT. Was there a temptation to look at some of those names or did they just not pass through the four-step process?
So, a lot of them passed through the filters, except for the ones that don't make any money. The concept style business, we struggle with those, because of the four quality filters. One is you have to make money, you have to be profitable. But there were some there that we considered and we thought about, just the valuation didn't get to a point where it stacked up for us.
We found some offshore. Like Flutter (Flutter Entertainment Plc (LON: FLTR)) is actually an 80% online business. It's effectively quasi-tech in that it is a tech business where most of its sales do come through mobile or computer. So that's effectively for us like a tech stock, but it's a sports book with a great collection of assets. If you think about it, they probably have one of the preeminent brands in the US with FanDuel, which they own 58% of and are rapidly opening up the US sporting market. And they own Sportsbet in Australia and BetEasy through the merger with The Stars Group.
So we look at that and go, that's a tremendous business. It's hard to replicate that in Australia. So I think of that sort of covers a few things for us on tech, it serves a few masters.
Auto Trader (Auto Trader Group (LON: AUTO)) is also effectively that style of business. It's a cyclical tech business because it is used car sales and some new car sales. So when the economy turns over a bit, used car sales will fall typically, but it does recover very quickly. And again, you're buying a business with a dominant market position.
I noticed staples like Coles, Woollies don't feature in the top five. I know Perpetual has been supporters, particularly of Woollies in the past. I also note the big four, a notable absence from some of your larger positions. Can you talk me through the exclusions on those fronts, why they don't feature?
So initially, we had some of those - Woollies (Woolworths Group Ltd (ASX: WOW)) and some of the staples in the portfolio, and they were the early winners in this. Coles (Coles Group Ltd (ASX: COL)), Metcash (Metcash Limited (ASX: MTS)) and some healthcare stocks in particular, were one of the very early winners where everyone was trying to buy short term certainty given the hoarding that was going on and Woollies and those sort of names did particularly well. But for me, that was enough, as the valuation spread between names like that and stocks which are cyclical or had been beaten for a short term reason had become so extreme, I wanted to use those sort of stocks to fund these newer names. I still like the quality of Woollies but they're probably over earning at some level at the moment. So they were a funding source for us. So we're selling those to buy these other names.
With the big four banks, we actually traded a bit into them. So when NAB did the raising, we participated in the raising. ANZ, we went back into it at around $16 which was quite cheap. These were big discounts to book value. As my analysts said to me:
"If you're not going to buy an Australian bank at a discount to book value, you never will."
This is also given the underlying economics, and there was quite a bit of fear about further capital raises, etc. But they have rebounded pretty aggressively, trading at book. They could probably go on a bit more but we're finding a bit more value in some of those industrial cyclicals still. So we're sort of parking our money in those parts, because there's still a bit more upside, I feel, in those. That is not to say we won't to go back into the banks.
We took on a big position in Austbrokers (AUB Group Ltd (ASX: AUB)) as well, and they've fallen from $13-$14 down to $8.50-$9.50 type range. They are a high quality business. So I've taken financials exposure a bit differently this time. That's a 5% position in the Perpetual Equity Investment Company (ASX:PIC).
So, we've played it a little bit differently this time.