Seeking value in the Land of Oz? Follow the Tagliaferro road

Nick Grove

Livewire Markets

Many value investors would undoubtedly feel a lot like Dorothy in the current market environment, like they have taken a knock to the head during a violent twister only to have woken in a strange land where very little makes sense.

Also, many a seasoned investor would argue that this is one of the toughest stock-market cycles they have ever lived through. Like Dorothy and her companions, investing in the current market looks like a journey fraught with danger for those lacking either brains, heart or courage.

Investors know they're not in Kansas anymore.

Investors Mutual founder and legendary Australian value investor Anton Tagliaferro agrees that things are getting "very tough" in the present climate. Rates are low and people are looking for ways to make money to earn income, and obviously the stock market is one place they're looking.

But he says the truth is that many companies are struggling or overpriced, people are getting desperate for yield, and it looks like there may be further interest rate cuts to come.

In a recent conversation with Peter Switzer (founder of Switzer Financial Group) he lamented the fact that if you're looking for income either now or in retirement, it's very hard to know where to invest, particularly as rates come down.

"To be honest it's an issue people in other parts of the world have been grappling with for a while, because you know Europe has had zero rates for a while – and their stock market hasn't exactly boomed either by the way – but Japan has had zero rates for a while, and you know Australia is sort of heading towards zero," Tagliaferro says.

Switzer pointed out that not only are investors dealing with interest rates at unbelievable and unprecedented lows, but they are also dealing with an unpredictable factor in the form of Donald Trump – who Switzer dubs "the most difficult US President to invest with".

While Tagliaferro agrees that he's unpredictable and makes a lot of noise on issues such as trade, the thing that's the major driver of markets at the moment is still this low interest rate environment. Switzer therefore asked how Tagliaferro is approaching such a tough market environment and asked him to take him down "the famous Anton Tagliaferro value road".

"I think what is clear is that certain sectors of the market are very overheated. The IT stocks obviously – it's hard to justify many of their valuations," he says. "If you look at the REITs, the property trusts, where you've got Mirvac (MGR) at a 50% premium to asset backing, that seems a bit difficult to justify."

Tagliaferro also believes the banks are getting a bit overheated, with CBA's share price back to where it was pre-Royal Commission. And while it may pay a good yield, the outlook is pretty tough.

"So, you've just got to stay away from the overheated areas as much as you can and try and look for value if there is any," he says.

Caltex: Not sexy but looking solid

While the market may very much be momentum-driven at this point in time, it's hardly surprising that a lot of "old-school" non-tech stocks may have fallen out of favour. One such example is oil refiner Caltex (CTX).

"So, you look at something like Caltex and everyone goes, 'Electric vehicles!' But you know they're years and years away. And if you look at Caltex, they're the largest distributor and retailer of fuel, not just to cars but to trucks and airlines," he says.

"They look pretty solid, I think – good asset base, they own many of their petrol stations, have $2 or $3 a share of franking credits, to me it looks quite good. It pays a good yield and is growing in different markets."

Nine Network: Still the one?

When pressed in the conversation by Switzer for a "sexier" stock pick than Caltex, Tagliaferro points towards his recent purchase of shares in Nine Network (NEC).

He says that while people may scoff and point out the well-known structural challenges facing free-to-air broadcaster Channel 9, Tagliaferro notes that Nine still has valuable assets like Domain and streaming app Stan within its stable of businesses.

"So, those areas are growing pretty quickly. I mean, if you put Stan on a Netflix multiple you would probably double the Nine share price overnight! So, Nine looks okay I think … it pays a good yield, has a good balance sheet and good management."

Pact Group: Not giving up

Switzer asked Tagliaferro about a stock that he had been a firm believer in but which rumour had it Tagliaferro had given up on: Pact Group (PGH).

"I haven't given up. I mean, it's been very disappointing. There has been no doubt," he says. "The thing about Pact is it had this good solid packaging operation – they're the largest rigid plastics packaging manufacturer in Australia."

"And they’ve used that to go into new areas such as contract manufacturing. So, they produce a lot of stuff for Woolworths and Coles, the non-branded stuff, the house brands. They've also gone into pallet pooling, so they do the pallet pooling for Woolworths now – they won that contract off Brambles, and they recently won the Aldi contract too.

"They were making moves into what looked like good directions. Unfortunately, the core business, the packaging business, has been hit by the higher electricity prices, because as you know electricity prices have doubled. What Pact does essentially is it melts plastic to make containers, but it's a very electricity-consumptive industry. So, that's hurt them."

For Tagliaferro, Pact is a perfect example of why many companies are struggling in the current environment – they're finding it extraordinarily difficult to lift their prices.

"Part of it is the slow economic growth, lower inflation – you know it's very difficult if you have an input price that goes up, to try and put your price up. Pact has definitely suffered from that," he says.

"But they have a new CEO, who has come from places like BlueScope (BSL) and Orica (ORI), where he turned them around. And his focus is to turn around the core packaging business.

"So, we think, going forward, the outlook hopefully will be better. And he said he's going to take $50 million of costs out of the packaging business."

Tagliaferro also noted the recent purchase of Pact shares by all of its directors, which he took as a sign that they're comfortable with where the company is heading with the new CEO at the helm.

According to Tagliaferro, in the short term, investors in Caltex and Pact are probably not going to do well given all the market action seems to be in the Wisetechs, Mirvacs and CBAs. But this is because people are charging into things for yield and are "seemingly not taking much notice of the price they're paying".

Straw hats in winter … and so forth

Tagliaferro emphasizes that now is the time for caution. The higher the market goes, the more tempted people are to come in, and when headlines scream, "Stock market hits new record highs," people will often think, "Oh wow! Maybe I should put money in the share market now because it's going quite well."

And that's probably not the best time to be thinking about it. For Tagliaferro, the old investing approach of dollar-cost averaging and well-worn adages such as "buy straw hats in winter" all come to mind.

"I mean it's not dissimilar to looking to buy an investment property two years ago when everybody said the Sydney property market would never go down. And here we are two years later and there's as much property as you would like for sale," he says.

An historically reliable strategy

In his final question to Tagliaferro, Switzer asks whether buying primarily good quality, dividend-paying stocks is nowadays still a reliable strategy. He casts his mind back to the GFC, where dividends didn’t in fact collapse in the same way that share prices did.

"You're correct – the volatility of returns from dividends is a lot lower than the volatility of share prices. I think that is the case," Tagliaferro says.

"Let's say you've got $1 million today and you put it in the market and you're happy getting you're 4% or 5% - that's better than a term deposit. That's fine. As long as you're prepared in the short term where that $1 million might be worth $900,000 or $850,000, which might happen if there's a correction. But your income levels should be relatively stable.

"But the key is whoever is buying today, if they're going to buy with that in mind, to not forget why they're buying, because unfortunately often what happens when people come late to the stock market, they say, 'Oh that's great I'll buy $500,000 worth of shares and I'll put them away and not worry'.

"Then there's a correction and guess what they want to do? Sell at the bottom of the market. And that's the key. If you are going to take that longer-term approach and income is the thing, then you have to try and stick to that."

Tagliaferro concludes by cautioning that while a portfolio with income at its core is not a bad idea, investors have to be aware that, at the moment, prices are "a bit toppy".

"They may go higher in the short term and you have to perhaps put up with that depreciation in value if there is a hiccup. So, that's the thing you've got to be careful of," he says.

"And what concerns me a bit now is the headlines will soon be saying, 'Stock market at new highs' and a lot of people are going to say it must be time to get in.

"And it's difficult to say the market won't go higher, but again, like the property market was in Sydney a couple of years ago, there were signs then that it was a bit overheated, and there are signs today that the stock market is overheated."

For those seeking value remember – use caution, buy straw hats in winter, and follow the Tagliaferro road.

There are still great investments somewhere over the rainbow.

Invest in quality rather than the latest market trends

Focusing on both quality and value, Investors Mutual has an active, ‘bottom-up’ approach to identifying, researching and valuing companies. To find out more, click the 'contact' button below.

Peter Switzer is founder of Switzer Financial Group, a business that spans financial and business content, financial advice, wealth management and home loans.  

Nick Grove
Nick Grove
Content Editor
Livewire Markets

Nick brings over 17 years of experience as a journalist and editor to Livewire. He has worked across both print and online publications for organisations including Australian Associated Press, Thomson Corporation, Money Management and Morningstar.

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