Growth and yield stocks have had a strong run for several years and the unwinding of this “HIPP bubble” (Health, Infra, Property … and Pizza) has only just begun in recent months, and has a long way to unwind yet. We are conscious that we may be at – or very close to – the bottom of the global interest rate cycle, which has driven the growth and yield stocks to these extraordinarily high levels. We think this is yet to be fully reflected in the market.
In 2017 we have largely been sticking with stocks that we have held through 2016. Our style selects out-of-favour value names with a special focus on companies that demonstrate these four characteristics:
- Good balance sheets
- Quality earnings
- Good management
- Favourable industry dynamics
This approach has led us to own selective consumer names, financials outside the big four banks, some gaming and media stocks and some overlooked materials businesses. We also have a mandate to be able to buy some great global stocks, which often trade at much lower multiples than their Australian peers.
We have avoided expensive healthcare names (with Australian healthcare overpriced by global standards), have avoided Telstra and the telco sector in general, overpriced REITs, utilities and the infrastructure space. Many of these stocks have too much debt, and they do not pass our strict debt filters designed to avoid excessively leveraged companies.
We have also been happy to keep a large stockpile of cash as value opportunities have diminished given the recent rally.
Regarding resources, we are cautious as to whether this is a sustained bottoming of the sector or just another inventory re-stocking cycle. Resources stocks are increasingly not priced for the latter scenario.
Woolworths is a good example of the opportunities we have identified. Once a darling of growth fund managers, the company’s share price in 2016 had nearly halved from the heady heights of nearly $38 in 2014. Yet at just above $20 few investors wanted to touch it.
Despite never-ending changes to the competitive environment, Woolworths continues to be the largest operator in an oligopolistic industry with many of the best store locations in the country.
The mismanagement of the otherwise high-quality food business has been temporary with a new management and strategy making significant strides already in its turnaround.
We think management’s continued focus on the turnaround of the core business and potential to restructure or sell non-core assets will help to restore confidence in the business we bought on a compressed P/E at trough earnings.
Vince Pezzullo, Portfolio Manager, Perpetual Equity Investment Company