Three stocks for a shifting market

Livewire Exclusive

Livewire recently asked Sean Fenton of Tribeca, Vince Pezzullo of Perpetual, and Simon Shields of Monash to share their views as to whether the trend that emerged last year, whereby growth stocks struggled and cyclicals rallied, could continue through 2017. Following on from their enlightening responses, we asked our three contributors how their view is impacting their fund positioning, which areas they are avoiding, and finally, for an example of a stock that demonstrates their investment thesis. Click below to read which three stocks from the telco, chemical, and retail sectors they nominated for Livewire’s first buyside brief of 2017.

Searching for opportunities after growth stock deratings

Simon Shields, Principal at Monash Investors (ASX:MA1): (VIEW LINK)

The first rule of managing stocks is to do no harm… It was the growth stocks that had problems with their business have been the ones with the most spectacular declines, so by setting the bar high and becoming increasingly selective in 2016 we have avoided the blow-ups. However, now that we have seen large de-ratings we are searching harder for opportunities amongst high-quality companies with strong outlooks, particularly in the larger cap stocks. In the later part of 2016 we also added some resources stocks to the portfolio, wanting to get a broad exposure to energy, base metals and bulks.

One company we have bought is SpeedCast, a leading Telco for commercial ships and remote businesses. Last year, growth telcos such as TPG, Vocus and SpeedCast suffered large deratings. SpeedCast also made a substantial acquisition and this provided further downward pressure on the share price because of the size of the capital raising required.

SpeedCast should continue to do well as a business. The acquisition was strongly EPS accretive even before any allowance for cost synergies. Also, demand from its offshore oil & gas customers (such as tankers and offshore platforms) will pick up with the recovery of the oil price over the last year, taking the pressure off needed capex spending. We did not participate in the capital raising, but rather, waited for it to mostly play out. This allowed us to enter the stock from $3.10 post the raise, and it has since traded to at least $3.80.

Moving into energy, chemicals, steel and US cyclicals

Sean Fenton, Portfolio Manager, Tribeca Investment Partners: (VIEW LINK)

We have been tilting our portfolio more towards value based cyclical stocks and away from the more expensive growth and yield sectors. The financial crisis of 2008 saw a massive response by central banks, which flooded the world with liquidity. This, along with a patchy growth recovery, encouraged a search for yield, which saw growth, defensive and low volatility stocks heavily sought. An end to this support as central banks normalise monetary policy, led by the US, is likely to see this premium for certainty come under pressure.

The portfolio has been tilted towards bulk commodities, but is now moving more broadly into energy, chemicals, steel and US cyclicals. Stocks with mature growth franchises and high multiples across much of the internet, and health sectors have funded much of these moves. This is not to say that there won’t be growth stocks that perform well, and we like many, but there is a much higher burden on delivering on earnings and bigger consequences for missing.

A cyclical style stock that we have bought into recently is Incitec Pivot (IPL). The stock had been under pressure as falling mining sector activity depressed pricing for ammonium nitrate, a key explosive, and soft fertiliser pricing also impacted profits. A recovery in oil and gas pricing has helped urea and ammonia prices bounce which is timely as IPL completes the construction of a new ammonia plant in the US. More stable mining activity, an improvement in the US coal sector and the potential for increased explosive demand from construction in the US all provide earnings upside and leverage. While the stock doesn’t look cheap on this year’s PE, this is often the case for cyclical stocks when they are at the bottom of their earnings cycle.

Woolworths is a good demonstration of our strategy

Vince Pezzullo, Portfolio Manager at Perpetual Equity Investment Company (ASX:PIC): (VIEW LINK)

We have largely been sticking with stocks that we have held through 2016; out of favour value names with a special focus on companies that have good balance sheets, quality earnings, good management and favourable industry dynamics.

This 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 also been happy to keep a large stockpile of cash as value opportunities have diminished given the recent rally.

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.

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.

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You can read the first part of this report, 'Lessons from 2016’s best and worst performers' by clicking here: (VIEW LINK)


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