Is growth at a reasonable price possible in 2020?

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Livewire Markets

Growth stocks dominated markets in 2020. So much, so that value investing has now had it worst run in twenty years. The speed at which these companies grew captivated investors, pulling markets upward to their February 2020 levels. However, as vaccine candidates emerge and US political tensions settle, there is a broad discussion about a 'rotation' towards more economically sensitive sectors.

In this thematic, Bella Kidman leads the panel in a discussion as to whether investors can find 'the best of both worlds' - growth at a reasonable price. Joining Bella is Ben Clark from TMS Capital and David Wilson from First Sentier Investors who explain what the 'rotation' means, how it impacts their strategies and both guests nominate a stock offering growth at a reasonable price.

Notes: Watch, read or listen to the discussion below. This episode was filmed on 5 November 2020


Edited Transcript:

Bella Kidman: Welcome to Buy Hold Sell, brought to you by Livewire Markets. I'm Bella Kidman. After countless debates on growth versus value, it seems as though the market has finally made up its mind, for now. Markets were chattering about a rotation from growth into value stocks, but you really never know. To discuss this, I'm joined by Ben Clark from TMS Capital and David Wilson from First Sentier.

Ben, I'll start with you. There's been a lot of discussion about this rotation from growth into value. Before we get into it, what does that rotation actually mean, and what does it entail?

Ben Clark: Value stocks typically need somewhat of an economic tailwind to blow to help them grow their earnings, and we've obviously been in a very difficult economic environment in 2020. What it means is that, the value stocks the market is pricing in 2021, we might get that resurging economy. With pent-up demand and relaxation of restrictions, we could see quite strong earnings growth out of businesses that have been really beaten down by COVID.

Bella Kidman: There's been a lot of discussion about the rotation. Is that something that you're seriously considering when you're thinking about investing?

Ben Clark: Look, it's real. It's happening. The question will be, is it a short, sharp rotation, or is this something that plays out over a number of months, maybe even six months? Which we have seen occur in the past. I think the last good example is when Trump won the election and surprised the markets.

For us, it's something that we've pushed a bit of exposure in the portfolio towards, but at the more conservative end. However, we're a big believer in sticking to our knitting and holding the businesses we like through various economic cycles, so it's not something that we're chasing.

Bella Kidman: David, same question to you. Is this just noise, or is it something that you're seriously considering?

David Wilson: I think it's real, and I agree with Ben. It's something you have to consider, but I don't think it really changes our underlying process. We still think about the stocks, and looking at their longer term earnings potential, just how they're positioned. It really doesn't change our portfolios materially.

Bella Kidman: Okay. David, we’ve got two potential vaccines on the way, it seems like society could be opening up pretty soon. How do you account for that when you're investing?

David Wilson: I think you've just got to think about the companies in a certain way. Is there a fundamental shift in how they're positioned? Have they adapted their business models for that opening up? Have they actually taken the opportunity to address their cost structures during what is quite a difficult period?

You look at an example like a Qantas, where there's a company that actually dealt with this cost structure, took the opportunity, didn't waste a crisis, and has now set itself up for that recovery.

Bella Kidman: Ben, same question to you. How can you anticipate the opening up of society, and how do you account for that?

Ben Clark: It's not easy, because the timeframe is problematic. We've seen another short lockdown announced in South Australia. It feels a bit at the moment like it's two steps forward and one step back. The timeframe is unclear.

For me, I think you want to find businesses that have been able to grow during a difficult period. You think, regardless if you get the timeframe wrong on the reopening, the businesses you own will continue to grow. One thing I'd be wary of is the companies that have had a real sugar hit from COVID. Potentially that growth is going to slow or even maybe go a bit backwards. I think it comes down to the style that you've got when you're managing money.

Bella Kidman: Okay. Let's paint a really positive picture here. We've got low interest rates. The economy's reopening. Do you see more opportunity in a wider range of sectors and stocks, or are the same companies going to continue to win?

Ben Clark: In 2021, I think you're going to see better growth across the market as opposed to in parts of the market. We'll probably see more candidates who will win. The market, has looked through a lot of the weakness and has already priced in that surge in earnings growth, and share prices are reflecting what we think's probably going to happen anyway. Then you have to think, "Is it going to be faster? Is it going to be more pronounced?" To give those companies an even better share price reaction.

Regarding our approach to playing it, we've liked the infrastructure stocks, like Atlas Arteria, the airports, Transurban. Stocks where we think you can be wrong by six months or a year, but ultimately you'll still be right. You're not going to get tapped for more equity. That the businesses ultimately will normalise, it's just a question of when. You can sit back and not take a big bet on that.

Bella Kidman: David, it seems like a pretty ideal world, low interest rates, economies re-opening. What do you think? Are there going to be more winners, or are they going to be the same?

David Wilson: I think through these periods you can't be dogmatic. I think you just can't say, "oh, I you look at these companies in a certain way." You have to try and picture a point, say, 2022, just look at where earnings may be then and just use that as a focal point on how you can look at the relative merits of companies.

Bella Kidman: There're going to be obvious beneficiaries to getting a vaccine, society re-opening, and all that. Do you see that some companies will go under some funding pressure to fund those companies and those opportunities?

David Wilson: I think what you've got to say, from an Australian company perspective, that actually equity capital markets are very, very fluid in Australia. Actually Australian companies' funding is actually in pretty good order. Australian companies raised equity, very quickly and put their balance sheets in good place. They did the same thing in 2009. I think it actually, just the whole equity capital market seen in Australia, means that you don't have the balance sheet pressures in Australia that you have in a lot of Northern-hemisphere countries.

Bella Kidman: Ben, do you agree with that?

Ben Clark: Yeah. I completely agree with that. We're lucky we've got a great system here. Investors were happy to stump up quite significant amounts of cash in a pretty scary period. It allowed companies to get through. You'd almost say some companies were probably a bit conservative, but I don't think you could really point fingers at them. No one knew what the future held in March and in April.

Ben Clark: We really haven't seen any big disasters come out of COVID. Even the obvious ones, your Webjets, your travel stocks managed to get through, and hopefully they will catch the resurge in travel that we'll see.

Deterra (ASX: DRR)

Bella Kidman: Ben, growth at a reasonable price. It's everybody's dream, isn't it? Can you name one stock that you think offers growth at a reasonable price?

Ben Clark: Look, this is a bit left of field, this one, but one stock we've started buying is a company called Deterra, which has just been spun out of Iluka Resources. It owns a mining royalty over some land that BHP mines in, and BHP's going to almost triple its output from MAC, the Mining Area C, over the next three years. You're almost certainly going to see very strong growth in their underlying earnings even if we see quite a significant pullback in the iron ore price.

Ben Clark: For us, it ticks a number of boxes. When you can compare it to the royalty companies that trade in Toronto and in New York, it looks quite cheap. We would argue it's probably one of the highest quality mining royalty streams anywhere in the world, given the counterparty, the production growth, the length of the asset. That's one that we've been watching as Iluka's got closer to doing it, and we think offers growth at a reasonable price.

Aristocrat (ASX: ALL)

Bella Kidman: David? Growth at a reasonable price? Can you really get the best of both worlds?

David Wilson: I think you can. A stock that we like is Aristocrat. I think that, a little while ago, they took the bold step to actually step away from their traditional business and move into the digital space. That digital part of their business is now 40% of their earnings.

There's still risks, and they took on more risk in doing that, but I think it was a brave decision where they said, "No, we need to step away from our core business, but try and get to where our business is going to be in 10 years’ time." It's going to be rough at times, but I think you can't fault the way that they've executed thus far.

Bella Kidman: Growth versus value. It's a debate to last a lifetime, whichever side you're on. There's one thing we can agree on, 2021 looks pretty promising.

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