Why this fundie thinks Qantas is a buy

Future Generation (FGG and FGX) recently hosted a conference call with Geoff Wilson AO, Founder and Chairman, Blake Henricks from Firetrail Investments, and Chris Dixon from Cooper Investors. The Future Generation listed investment companies’ investment portfolios fell by just 1.4% (FGG) and 6.4% (FGX) in February, though investors will no doubt be wondering whether the underlying managers have held up through the March carnage.

In this wire, I pull out a few of the key quotes and takeaways from the call, including some stock ideas for brave investors.

Geoff told listeners that roughly half the investments are exposed to beta – meaning that they tend to rise and fall with the equity market. The other 50% is a combination of absolute return and market neutral. Most of the underlying managers can hold high cash levels and short stocks to hedge market risk.

“It doesn't stop you from losing money, but what it does do is balance out the performance” – Geoff Wilson

Blake Henricks from Firetrail said he’s focused on currently is balance sheets. In these wild conditions, a strong balance sheet will separate winners from losers.

He also commented that while the banks were well capitalised, they faced earnings pressure as net interest margins contracted as rates head towards zero He warns to expect dividend pressure in the near future.

Broadly speaking though, he believe CEOs days have learned from the GFC corporate balance sheets across Australia are in better shape.

Chris Dixon from Cooper Investors is seeing some opportunities from the sudden boom in working from home. Video conferencing has become an essential service, and laptop sales are booming. He said that even in Italy, the business to business economy is still operating.

Oil prices

The combination of rapidly falling demand and plentiful supply have push oil prices to multi year lows, falling from $70 last year, to $35 a couple of weeks ago, and as low at $22 this week. Typically, OPEC would step in to cut supply and balance the market. But a disagreement between Russia and the Saudis has resulted in the Saudis flooding the market.

Henricks says the key question to ask is whether $35 oil prices are sustainable. He doesn’t. The US supplies are variable, but to survive they need prices around $50 per barrel. Saudi Arabia needs around $78 just to balance their budget, and Russia probably needs oil around $50 a barrel to balance theirs. Regardless what happens from here, he doesn’t think $35 is sustainable long term, but a recovery may take some time.

Stock ideas

Blake Henricks suggested a ‘barbell strategy’ with Qantas (QAN) and Medibank (MPL). Henricks freely admitted that Qantas was “not for the faintehearted”, but argues that more that at today’s prices you’re essentially paying for the loyalty business and the domestic airline, with not value ascribed to the international

Looking beyond that, he says that for Qantas the current situation is a “win-win”.

In the first scenario, things recover in a reasonable period of time; earnings recover and people feel more comfortable owning Qantas again. This is the base case.

In the second case, it gets worse. There are only two players in the Australian domestic airline business - Qantas and Virgin. Virgin is in poor financial health, with net debt that’s five times EBITDA and getting worse. Virgin’s recently issued bonds are trading at 60 percent of face value.

If things get worse, Henricks expects Qantas to take material market share from Virgin. This could potentially be a long-term positive for Qantas.

The other company he mentions is Medibank, which he describes as “a lot more defensive”. Medibank holds about $150 million of excess capital on it’s balance sheet, which he says is “rock solid”.

Medibank could also benefit from industry consolidation. Unlike airlines, private health insurance is a fragmented market with a total of 37 players. Medibank, BUPA and NIB are the big ones, but there’s a “long tail” of small competitors, many of which are struggling to make money. With APRA putting them “in their sights”, there’s a real risk that many of these players disappear.

Taking a global view, Chris Dixon from Cooper Investors reckons Eurofins Scientific (Frankfurt: ESF) is attractive in the current climate. Eurofinds is the world's largest and leading food and pharmaceuticals testing company. It runs more than 800 laboratories around the world and it’s a key service provider for big food and drug companies.

The company is 30% owned by its founder, Gilles Martin, who dreamed up the company in his bedroom several decades ago. Gilles has since built the company into an industry leader with almost five billion Euro in sales each year. Dixon expects that they can grow sales by around 10% p.a. through both organic growth and M&A.

But he says that “the real juice” is the company’s free cashflow, which he sees doubling over the next two to three years as margins rise and spending declines.

He also notes that the company’s diagnostics business has recently developed a coronavirus test that can provide results quicker than those currently available.

Dixon also sees value in Ferguson (London: FERG), the number one wholesale distributor of plumbing supplies in the US. Despite being listed in London, 95% of its earnings come from the US. He says the company could move its listing to the US in the future though. The CEO has been running the business 20 years and it’s been one of the best performers FTSE100 over the past decade. He says the company’s got a strong balance sheet and is returning cash to shareholders at a rate of about 5% p.a. through dividends and buybacks.

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