We initiated a short position in Telstra in February 2017, premised on rising mobile & broadband competition, which was likely to impact on Telstra’s growth outlook. Rising 10-yr bond rates make it a double-whammy for Telstra, which we also view as a bond-proxy.
Underlying core 1H18 earnings weakened again as the risks in mobiles continue to play out to the downside, with the average revenue per user and margins deteriorating. We continue to see Telstra’s dividend at risk and remain short on the stock.
Below we outline four other stocks we have short positions in.
Invocare (IVC) – Short
Invocare has long been a market darling and popular small cap stock. Since its IPO it has delivered strong returns as it rolled-up the Australian funeral sector. Over this 15-year period, the company has grown to over 30% of the industry, whilst it has branched out to NZ, Singapore and a short (and failed) attempt in the US.
Despite the company’s success, we believe Invocare has been losing its lustre more recently, as it succumbs to a number of challenges:
- Changing consumer preferences;
- Greater price transparency (Invocare brands typically rank amongst the most expensive); and
- Increased competition.
In order to meet these challenges, Invocare has embarked on a three-year $200m capital program (named Protect and Grow) to refresh their brands, facilities and organisational/operating structure.
To fund this, the company is using debt and tapping out its balance sheet in the process (noting that the FY17 report was the first of many where Invocare highlighted the prospect of raising equity to fund acquisitions).
We established a short position (at ~25x operational earnings) in early February leading into the FY17 results.
These challenges have become more evident - another negative volume and market share loss in a market that grows steadily each year, as well as heightened marketing spend against an increasing competitive threat.
In addition, Invocare delivered a negative surprise guiding to marginal EBITDA growth and zero earnings growth. We believe the challenges facing the company will persist over many years and that during this time, the multiple afforded to an incumbent laggard in an increasingly competitive sector will reduce.
IPH Limited (IPH) – Short
IPH was the first of three patent and trademark law firms to list on the ASX between 2014 and 2016. Over this period, it has generally been another poor experience for investors in professional services firms.
All three companies (IPH, Qantm and Xenith) listed on the basis that intellectual property work was a steadily growing and stable ‘cash cow’. However, this was when these companies were in a position to roll up the sector in Australia and buy growth in Asia where patent and trademark volumes have been growing strongly.
In February, IPH reported a material negative surprise with earnings declining ~11% compared to the prior period, despite top-line growth of ~9% (via acquisition). A far cry from the steady growing ‘cash cow’ promised to investors.
The company struggled with a continuation of negative volume growth (-2%) in Australia (~66% of revenues), which resulted in a leveraged revenue decline (-5% pcp), with the bottom line experiencing smaller declines due to one-off cost cutting.
Our fundamental research included speaking to various industry contacts and has led us to conclude that the sector is more cyclical than it appears. We believe that the sector is facing a range of headwinds, which could have a further negative impact on earnings.
We believe IPH is ex-growth and at risk of materially downgrading again. IPH’s weak paper all but precludes it from making acquisitions (hampering their only remaining growth driver). We continue to remain short the stock despite the relatively low headline Price-Earnings multiple.
IOOF (IFL) – Short
As evidenced in IOOF’s 1H18 result, margin pressure in the advice and platform segments continue to constrain revenue growth with cost control helping the group for now.
The structural shift from large incumbent wealth managers to independent advisers with preferred technology offerings is going to remain an ongoing headwind for the company.
IOOF’s expensive acquisition of ANZ Wealth compounds risks around margins, flows and falling adviser numbers.
We believe revenue margin pressure will continue at a faster rate than IOOF can cut costs. Our view is that market expectations are too high and we maintain our short position.
Ramsay Healthcare (RHC) – Short
Ramsay reported a low-quality 1H18 result and moderately missed both revenue and EBITDA expectations.
Ramsay joined the ‘2H-club’, in guiding for improvements in the second half of the financial year. While some operating tailwinds improve in 2H18, growth is likely to again be low quality.
We believe the stock is expensive given its cloudy earnings outlook and we continue to hold a short position.
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