Mark Draper

Mark Draper

Tuesday, 03 September 2019 15:10

Demergers - the hidden treasure

Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review.

This column was published in the month of August 2019 in the AFR.

 

There have been many Australian demergers in the last 15 years and well known US investor Joel Greenblatt says “there is only one reason to pay attention when they do; you can make a pile of money investing in spin offs”.

A spin off, created from a demerger, is the establishment of a separate independent company through the sale or distribution of new shares of an existing business or division of a company. Generally the reason behind demergers is the belief that the demerged company will be worth more as an independent entity rather than being part of a larger business.  

Unrelated businesses may be separated via a demerger so that the separate businesses can be better appreciated by the market. Sometimes the motivation for a demerger comes from the desire to separate out a ‘bad’ business so that an unfettered ‘good’ business can shine through to investors.  There are many other reasons why a company would pursue a demerger, but broadly the idea is to create the environment where 1+ 1 = more than 2.

Paint company Dulux is the poster child for the demerger Fan Club according to Matt Williams (Portfolio Manager Airlie Funds Management).  He quips he is the founder, president and treasurer of that club.   “The simple fact is that demergers have a higher probability than not, of adding considerable value. In 2010 Orica shareholders received one Dulux share for each share they owned in Orica. Dulux shares closed at $2.54 on its first day as a stand-alone company. Nearly 10 years later shareholders will receive $9.75 as giant Nippon Paints adds Dulux to its stable. The total shareholder return for Dulux over this period was more than 20% p.a.” said Williams.

Goldman Sachs analyst Matthew Ross in a research paper on the value of demergers showed that Australian ASX100 demerged entities on average have outperformed the market by 18.5% in the first year post demerger.

That same study found that one of the significant drivers of value for the shareholders in the companies involved in demergers, was that they typically increased the prospect of a takeover of either business.  Shareholders in demerged companies Dulux, Recall, Sydney Roads, and Rinker can attest to this assertion.  Demergers where the parent company still owns a stake such as Coles lessens this likelihood.

Williams said that “like all good things its pretty simple, demergers work because:

-      They allow good businesses previously trapped inside a conglomerate to be valued more precisely by investors.

-      Management can be properly incentivised and rewarded thereby driving positive outcomes and

-      Companies are able to be taken over, or if not at least a ‘control premium’ can start to be factored into the share price”

Investing in spin offs is not smooth sailing immediately following demergers however as quite often the spin off company is initially sold by investors.  This is because spin offs can often represent a small holding in the context of an investors’ portfolio and therefore sold as nuisance value.  Alternatively institutional investors sell as they are either not allowed to own stocks below a certain market size or they simply do not understand the new spun out business.  After the initial period when this wave of selling is done, an investment in a spin off can be lucrative.

Joel Greenblatt says that “both spin offs and merger securities are generally unwanted by those investors who receive them. Both spin offs and merger securities are usually sold without regard to the investment merit”.  This often results in the immediate performance of a spin off post demerger being poor.  He adds “as a result, both spin offs and merger securities can make you a lot of money.”

So enthusiastic about demergers is Greenblatt that he dedicates an entire chapter to the subject in his book “You can be a stock market genius”, which is well worth a read.

The next demerger that is proposed for Australian investors to consider is Woolworths spinning off their drinks division, good luck in the treasure hunt.

 

 

Tuesday, 03 September 2019 15:00

The Best of the Best - August 2019

Montgomery Investments team have prepared anohther bumper issue of "The Best of the Best".

This edition includes:

  • The 2 big themes for Aussie Investors
  • Risk perception for the modern investor
  • Do we view Brambles as a high quality investment?
  • Does Challengers announcement imply good news

 

Click on the image below to access the report.

Raymond Dalio (born August 8, 1949) is an American billionaire investor, hedge fund manager, and philanthropist.[3] Dalio is the founder of investment firm Bridgewater Associates, one of the world's largest hedge funds.[4] Bloomberg ranked him as the world's 58th wealthiest person in June 2019.[5]

What Ray Dalio says matters.  For further perspective we know that successful Australian global investor, Hamish Douglas (Magellan Financial Group) seeks Ray Dalio's views on a regular basis.

Ray Dalio has been involved with China for decades.  He assisted China estabilsh their stock market.  In this video he discusses the current trade tensions between China and the US and sees them as a natural development.

He also puts the rise of China in perspective by comparing it against the rise of the UK and US in history. 

Ray Dalio believes that the biggest risk for investors is not having exposure to the Chinese economy.

 

 

 

 

 

 

 

 

 

 

 

 

Transcript

Jim Haskel:
I'm Jim Haskel, senior portfolio strategist. I'm here with co-CIO Ray Dalio and the subject today is China. And Ray, you've been going there since 1984, a lot of experience, China in the news today in many different regards. Can you walk us through a little bit about your experiences and how you've seen China evolve over the last 35 years?

Ray Dalio:
I've been able to go to China since 1984 and participate and see the evolution. Yeah, and it's been quite something. The first time I went, I was invited by CITIC, which was called a window company then, which was the only company that was allowed to deal with the outside world, and they were curious about the world financial markets. I was invited there.

At the time, the city was mostly Hutongs, which are small neighbourhoods, poor neighbourhoods. I remember speaking in their office building, called the Chocolate Building, and looking outside, and we were talking about opening up. And at the time, I knew what opening up would mean. The rest of the world had a cost and level that was here and China had a cost level there, and if they could eliminate their inefficiencies, it would go like this.

And so, I looked out there and I said, "You'll see those Hutongs become replaced by skyscrapers and so on." And they told me, "You don't know China," but that force and their character and the creativity that they exhibited took them to what is the greatest economic miracle of all time.

To put that in perspective, per capita income since then increased by 26 times. The share of world GDP went from 2% to 22% today, so it's a comparable power of the United States. The poverty rate went from 88% to less than 1%. And the life expectancy increased by 10 years. There're many, many others, and capital markets, very big changes.

But I never went for making money, I went for curiosity, you know? And that curiosity brought me in contact with the Chinese people who I really, really came to love and admire. The character of them, what type of relationships that they value, all of those types of things.

And I could see that character, and I was able to, over those years, build friendships, I was able to contribute in some small ways to the development of the financial markets and see it. And I remember these people, I have a great old group of friends who were the first pioneers to set up the stock market there.

There were seven companies, each had a representative, and it was in a dingy hotel, and these people were to form the stock market and the financial markets, and so evolved, and that evolution was an intimate evolution in which I brought my family, I brought my kids.

I remember bringing my son, Matthew, when he was very young, along and we would go in, and we'd have meetings, and they'd bring cookies and milk, and he'd be there, and he ended up going to school there when he was 11. It was a whole different world. He lived there.

And that whole different world, just to give you an idea of technology, you know where they are in technology now, which is comparable in many ways to the United States, when I went, I would bring them, as gifts, $10 calculators that they thought were miraculous.

I've gotten to know the people. I go there because I like and admire the people, and I've done that for 20 years or more before we ever did anything commercially.

Jim Haskel:

And so, we're sitting in a time now where China has evolved in a big way, and I wonder, just from your perspective, as an American who's gone to China for years and years and years, how do you make sense of this growing conflict that you've written a lot about between China and the United States? What do you think is the root cause of that?

Well, it makes total sense in a historical context. You know, I've been studying economic history, I used to study what the last 100 years is, and recently, because I wanted to study the rises and declines of reserve currencies, I've studied the last 500 years carefully, and I've looked at the last thousand years.

What I've seen over and over again is that when there's a rising power challenging an existing world power, that there is going to be a conflict. There's a global order, world order, and the way that usually happens is there's a conflict and there's a war quite often, and then after the war, whoever wins the war gets to set what the global world order is.

And then you have a period of peace because no country wants to fight that country until there's a rising power challenging an existing power again. That's happened 16 times in the last 500 years, and in 12 of those times, there's been wars, and sometimes you get around them. I'm not saying this is going to be a war, but I think it's a natural development in terms of China growing, expanding.

We have a small world and it's a big country, and we're going to bump into each other, and so it's that natural conflict. And then the question is how it's best dealt with, but I think just a natural evolutionary step.

Jim Haskel:

And you've sort of put the framework around this where trade is just the symptom of this broader conflict, whereas trade is always in the financial news, but it's really just one symptom. There's also military posturing, there's other elements of this whole conflict.

Ray Dalio

Sure. History has shown us that there's this pattern. I'll describe the pattern. We're now living in a US dollar reserve currency world, so I want to look at the US dollar and the US empire. Before that, I wanted to look at the UK and the British empire, and then before that, I wanted to look at the Dutch empire, and I wanted to follow them in their various dimensions.

I read all of those stories. I looked through the numbers and I read the stories, and I could see that the stories would repeat, the same basic stories. The charts on this page show six major measurements of power.

  • The first is technology and education. 
  • Second is output, how strong the economy is. 
  • Third is trade. 
  • Fourth is military. 
  • The fifth is the strength of the financial centre. 
  • And the sixth is reserve status.

What we did is to stitch together a whole bunch of statistics so that we could measure each one of those. And so, they go back to 1500 and you could watch the cycle repeat over and over again.

This next chart shows the averages of these rises and declines by each of the factors, and I think they tell the story pretty well as to what a classic rise and decline of the empires and reserves currency status is. For example, the Dutch, back in the 1600s, late 1500s and early 1600s, invented ships that could go all around the world.

And because Europe fought a lot, they put arms on the ships, and then they could go all around the world, and the world was their oyster. They could bring back great things. And they then increased their share of world trade to be 50% of world trade.

And when they went global, typically through their businesses, Dutch East India Trading Company, they had to be enabled with military to protect their trade routes, and they developed financial empires.

As a result, we saw not only trade grow, we saw the military grow, we saw them carry their reserve currencies around, and because they were used so commonly, they became world currencies and that's what made them world reserve currencies.

And as a result, they also developed financial centres because they developed capital markets, money came from around the world to invest through those capital markets in those currencies in those businesses that were their businesses and other businesses, so they developed financial centre. Amsterdam was the centre of world cap financial markets as a result of that.

And as a result, they built their trade and their commerce together. They quite often, then, over a period of time, there were forces that led to their decline, and those forces were typically a combination of higher levels of indebtedness, others gaining competitive advantage.

For example, the Dutch ship builders were hired by the English to learn how to build great ships that would carry them around the world, and there was a change in technology, and there was really not much of a difference between the businesses, the technologies, and the governments in terms of making those things happen.

For example, the British East India Trading Company had a military that was twice the size of the British military, and they were the ones that conquered India and so on. I just put together the averages of those forces so that you could just see, let's say, the average power, and it goes back to 1500.

And you could see the blue line is the United States, and you could see its rise and then its relative decline, and you could see the emergence of China to be almost a comparable power.

You look at the red line over a period of time and you could see going back to 1500 that China was always one of the highest, most powerful country, or one of the most powerful countries, until they had the decline from about the 1800 period, but you could see that emergence. And so, to me, this is all very classic.

Jim Haskel:
Now, if you bring this back to the current conflict between the United States and China, I think what's so interesting is that you also believe that global investors must look at China and explicitly start to consider whether China should be part of their portfolios. And so, it seems kind of interesting. We're talking about an emerging conflict, but we're also simultaneously talking about there's really some merit for China to be a component of a global portfolio. Give us your perspective on that and why.

Ray Dalio

Think about it. 

Would you have not want to invested with the Dutch in the Dutch empire? 

Would you have not wanted to invested in the Industrial Revolution and the British empire? 

Would you have not wanted to invested in the United States and the United State empire?

I think it's comparable. Would you not want to invest in those places? And look at the growth in the markets. Over the last 10 years, the stock markets in China has increased, market capitalization, by a factor of four. The bond markets, combining both the government and the corporate bond markets, have increased by a factor of seven. And they're each the second largest markets in the world.

And I've had plenty of contact with those markets and with those people, the regulators and so on behind them, and I have a lot of admiration for that. I also believe in diversification. Yeah, I believe that China's a competitor of the United States, or Chinese businesses with be competitors of American businesses and other businesses around the world, and that you're going to therefore, you want to be, if you're diversified, having bets on both horses in the race.

And then I think, from investing over the years, I've been doing this for a long enough period of time to know that there's a tendency of bias not to do the new things. When I first started, we were at the end of an era where pension funds invested mostly in bonds.

Okay, then they thought it was bold to go to equities, then they thought it was bold to go to international equities, a lot of people argued against going to global equities, and so on. Emerging market equities, and emerging markets, all of that was considered to be bold.

And so, the thing that people haven't yet done, seems like the big risky thing, where, in my opinion, going where the growth is and also having the diversification is a smart thing to do.

Jim Haskel:
When you consider the merits of that, even if you agree with what you're saying, is now the time when the trade part of the conflict may be getting even more serious because we're moving from tariffs into things like supply disruptions, and export interruptions, and prevention of particular exports? Is timing an issue, or do you ignore that completely?

Ray Dalio:
Well, the markets, as you know, are always discounting timing, right? If you have a new, good thing happens and the markets rally, if you have a bad thing that happens and the markets sell off, and so the markets kind of reflect, broadly speaking, the ebbs and flows and the good and the bad.

And so, if you wait for everything to be crystal clear, everything's going to be terrific, you'll pay a higher price than if you don't. I think the real question is, are we going to go to war? If we go to war, then we're in a different world.

I don't think we're going to go to classic war, I do think there's going to be a restructuring of the world order in terms of changes in supply chains, there'll be changes in who's making what technologies, important changes and sort of those things. But I don't think that that's going to mean that there won't be the evolution of China, the evolution of the United States, and I think that that diversification is good.

Yes, I would say that now is the time. The reason now, now is the time that it's opening up. Now, you could be early or you can be late. I think that it's better to be early because, as you know, the inclusion and the MSCI indexes and other such things are meaning that they're opening up, and that will accelerate, those percentages will keep rising.

And so, do you want to be early or do you want to be late? It's better to be early that it is to be late. And I think, also, it's a time for diversification.

Jim Haskel:
Right. Investing in China can be a risky thing to global investors, that's the way they perceive it. How do you think about that relative to the other risks they're already carrying in their portfolios?

Ray Dalio:
I think that every place is risky. We're talking about relative risk, okay? 

I think Europe is very risky. When monetary policy is almost out of gas, and we have political fragmentation, and they're not participating in the technology revolution, and I can go on and on as to why I think Europe is very risky.

I think the United States is very risky in its own ways, having to do with the combination of the wealth gap, the political system, the conflict between socialism and capitalism that'll be part of our election, the fragmented decision making, so many different things, and the absence of the effectiveness of monetary policy.

I think emerging markets, in their own ways, have their own distinct risks, and I think that China has its own particular, distinct risks, which are all different. When I look at it, I think that it's less, or no more, risky in the totality than other markets, and I think what is most risky is not to have a good diversification of those markets.

In addition, the Chinese have more ability to deal with monetary and fiscal policy relative to the United States. I'm not saying everything's a plus, there're pluses and minuses. But as you know, one of my big concerns, and I've got a number of big concerns about the United States and some of the issues that are facing the western economies, and among those are the inability of central banks to be as effective when interest rates get to zero and quantitative policies, quantitative, monetary easing is not as effective.

Let me pause on that and touch on that. If you look at the difference in interest rates to zero and the capacity of fiscal policy to be coordinated, they have a lot more room to be managing those things, and they are managing. I mean, I don't know how long I've heard everybody say, "Okay, the debt problem is going to be a problem there," and so on.

Again, I'd suggest you read the dynamics of my book about the nature of debt and what countries can do when the debt is in their own currency. I also think that not investing in China is very risky. I mean, think about it. Here we are in the early part of 21st century and there's this emergence of China. Do you really want to make the decision not to invest in China and not to be there in the future?

Look, I believe every place is risky. I'm very risk-focused. I tend to see things that are going to go wrong. I have an inclination to do that. I think every place is risky, which is why I like the notion of diversification. I just want people to see China objectively.

I know, over this past number of years, that I have been very pro-China, very bullish on China, in its various ways, and people say, "Why are you so bullish on China?" And I know it's very controversial to be, particularly in this time, to be very bullish on China.

I just want to let you know that I'm sincere. Okay? I've been there. Because I hope you know by now that my main objective is to be as accurate as I possibly can. Yeah, I really admire what is being done, and I want to be a part of it, and I think our investors should be a part of it.

Jim Haskel:
I want to ask you about the best way to actually invest in China. What we see is that most of the portfolio flows go to either the private equity markets or the public equity markets, and that's a little countered to your framework of how you invest across time and throughout the world. How would you think about best approaching the Chinese markets as a new investor?

Ray Dalio:
Well, I wouldn't think of it as being any different than in any other place. Public markets and the liquid markets are going to allow all the advantages that they allow, and the private markets are going to allow all the advantages that they allow.

The public markets are going to provide the liquidity, the diversity, the ability to move positions around and rebalance and so on, which is very important to us. And then the private markets, let's say the venture markets, expose one to the new technologies and the energy that's happening in terms of entrepreneurship and young technologies there, and I think that's important.

I think there's an awful lot of money that is chasing those venture capital investments, and then I think there's a whole lot of opportunity. I would say it's a reflection, really, of how that country has changed. Wow. From my $10 calculator days, to see what the mind-blowing technologies are.

To put that in perspective, they're now the number one country in fintech, number three in AI and machine learning, number two in wearables, number two in virtual reality, number two in educational technology, number two in autonomous driving, and they are wanting fast to be number one in those industries.

They now account for 34% of unicorns in the world, by comparison the 47% in the United States and only 19% in the rest of the world. And in terms of ... That's when they start as unicorns. If they take the share of unicorn value, it's 43% versus 45% in the United States and only 12% in the rest of the world.

If you're looking at venture, I think you've got to be there, so I think it would be important not to miss out on those. As far as the public equity situation, it's analogous. You could see the market capitalization accelerating in the stock, bond, corporate bond markets, all of their instruments, and you could see the foreign flows coming in at an accelerating pace.

You can expect those markets to be bigger than the markets that we have anywhere in the world with time, and they will serve a similar purpose. As far as, let's say, the legal regulatory system, it's advanced, but it hasn't advanced as much as some of the developed countries, but it is more advanced and developing at a fast rate than most of the emerging countries.

And if you deal with the question of whether it's a more autocratic system and whether you prefer a more autocratic leadership system than a democratic leadership system, you'll have to make that choice for yourself. Don't look at it as some unique place in terms of some of those impediments, look at the whole picture.

I would say that the Chinese or Confucian way of approaching things has a lot to be said for it, so you have to make your own choices.

Jim Haskel:
Let's get back a little bit to some of the questions that investors have. For example, should they think of China as an emerging market investment, should they think of it as a developed market investment, somewhere in between, in terms of the expected return, risk, correlation of that investment? You talked a little bit before about diversification, but what about the expected return and risk of an investment in China, and how would you structure that?

Ray Dalio:
When you asked me the question of is it more like an emerging country or more like a developed country, so many different aspects of what defines an emerging country or a developed country's market vary.

So what is the size of the market capitalization? What is the legal form? What are property rights? Just so many different dimensions, but I would make as a generalisation that China is somewhere between 60 or 70% more like an emerging country, 60 or 70% more like an emerging country in those respects than it is like a fully developed country.

It doesn't have a regulatory system that is as developed as the developed countries that have been at it a while, it doesn't have some things. It has market capitalization, it has liquidity, and that's a two-edged sword. It has also greater levels of inefficiency. The greater levels of inefficiency provide investment opportunity. As a generalisation, I would describe it that way.

If I'm looking at it instead in the question of expected returns and risks, I think, as you know, I look at each market and I look at the return relative to the risk, the expected return relative to the expected risk, and the past return relative to the expected risk and what drives it.

By and large, I find developed markets and emerging markets roughly comparable, and that being able to put together portfolios of those in an effective way is the way to engineer that portfolio.

When I look at China, I think that the expected return relative to the expected risk will be equal to or perhaps higher than elsewhere, partially because of the fact that there's the diversification that you could have and put together well.

But also partially because of the greater capacity of the central banks, the central bank, I should say, in being able to ease monetary policy and also run fiscal policy to be able to have a higher ratio. I think that that would be a plus.

Jim Haskel:
You've traced the arc over the last 35 or so years of Chinese history and described the evolution, if you look now forward five, 10, 15 years, what do you think the highest probability, what will we be looking at when we look at China's evolution?

Ray Dalio:
We'll be looking at a very different world, and we'll be looking at a very different China, and we'll be looking at a very different United States in five, 10, 15 years. In some ways that we will never be able today to anticipate, and in some ways that are inevitable in kind of the same sort of way that demographics is inevitable.

The following charts probably help to answer your question. They show a number of statistics, including the sizes of the economies, the relative sizes of the economies, the relative shares of world trade, the shares of the global market equity market capitalization, the shares of the global debt market capitalization over the next number of years.

These projections are based on our 10 year forecast that look at a lot of indicators to determine what the next 10 years growth rate is going to be, likely to be. They're based on the relationships between those types of growth rates and changes in market capitalization, and also work that's now being done to develop the market capitalization and open those economies.

They're not going to be exactly accurate, but they're going to be probably pretty much accurate. In a nutshell, it's going to have the largest economy in the world, the most trade in the world, the most market capitalization in the world.

Jim Haskel:
Those are big changes.

Ray Dalio:
Yeah. And the United States, and Europe, and Japan, and emerging countries are going to have big changes, too.

Jim Haskel:
You're sketching out a continuation of some dramatic trends that have already taken place. Any threats that you see to that progress going forward?

Ray Dalio:
Well, I mean there're always threats. I think the threat is the threat of conflict with the United States in whatever form that'll be. And then, there are always threats. They have to do with probabilistic things. You can have threats that'll affect our countries in terms of anything from climate change issues, pandemics, political disruptions. There's that whole range that can affect any of those countries.

Jim Haskel:
Ray, we've covered a lot. We've talked about the evolution of China, the opening of the capital markets, how to think about it from an investment point of view. I thank you for your time and perspective, and I look forward to sitting down once again and updating this in the not too distant future.

Ray Dalio:
It's my pleasure. It'll always be interesting.

Monday, 26 August 2019 18:40

China and the world economy

Ray Dalio

Friday, 19 July 2019 10:29

Afterpay - the elephant in the room

The daily gyrations in the Afterpay share price recently has given investors motion sickness.  In the light of new information ranging from the Austrac investigation, to Visa announcing a competitive threat, Afterpay investors have been re-examining the investment case.  Here we outline some of the thinking from 3 professional investors on this ASX top 100 company.

Afterpay has changed the habits of millennial spenders who prefer to pay in instalments mostly with debit cards to avoid the punitive interest rates and application process of credit cards.  Afterpay users purchase goods upfront and pay for them in 4 instalments, but the retailer receives the funds upfront from Afterpay. The consumer doesn’t pay interest on the transaction.  

Afterpay makes its money from charging retailers a merchant fee based on the transaction size.  Although Afterpay can charge a late fee in the event of a failure to repay the outstanding amount, the majority of Afterpay’s revenue comes from merchant fees.

“Retailers love Afterpay as average purchase size increases” according to Nathan Bell, Intelligent Investor.

Bell believes that the Austrac issue is of little long-term consequence, even under a worst case scenario.

Andrew Mitchell, Senior Portfolio Manager, Ophir Funds Management was one of the first institutional investors in Afterpay and says that while Australia now boasts 2.5m active Afterpay users since starting 4 years ago, “this is a sideshow to the real opportunity lying offshore with the US market approximately ten times the size and the UK market around three times larger.  Early signs are positive in the US where the monthly rate of customer signups has been higher than the experience in Australia with already over 1.5m active users after just 12 months.”

Late last year when Afterpay’s share price was under intense pressure, Mitchell travelled to the US to speak with retailers personally.  When he discovered the surging take up rate of Afterpay by several leading US retailers, Ophir doubled their position.  Afterpay recently confirmed that they have 4,400 retail partners in the US.

Nathan Bell thinks that Afterpay collecting so much data on spending habits could also lead to new services.  In a wildly bullish scenario he says, Afterpay could eventually have much more in common with a bank than it does today.

Michael Glennon, Glennon Capital is of the view that by being the first to the market does offer the company an advantage. “The best case for Afterpay is that it becomes a globally recognised brand like American Express” he says.  He thinks management is doing a good job and while Visa announced plans to enter the buy now pay later space he adds “these people (Afterpay) have got it right, I’m not sure Visa will get it right”.

Some broker research is dismissive of the threat from Visa as 80% of people using Afterpay don’t have a credit card, and instead use a debit card.  Glennon says that while the threat from Visa may not be in itself company changing, it does tell investors that “if Visa are looking at Afterpay, then you can bet others are too”.

Other risks to the Afterpay business according to Andrew Mitchell include ensuring responsible lending to consumers is adhered to, changes to regulatory framework governing the buy now pay later industry and a material increase in bad debts.

Nathan Bell adds “there have been several governance issues, and the founders have been selling large amounts of shares. This is typically a big red flag, but I would sell some shares at the current price too if I was them.”

The big elephant in the room is valuation. While rapid revenue growth is assured given its early success in the US, Afterpay must continue to grow sales quickly to justify a forecast market value to sales ratio of around 10x revenue based on 2021 estimates.  Those investors with grey hair will recall that the last time the market priced businesses on a price to sales basis (rather than price to earnings) was during the dot.com boom.  

Future growth in the US could of course justify the lofty valuation, but investors would be wise to closely monitor the US rollout.

 

This article is general advice only.  The author does not own shares in Afterpay.  This was published in the Australian Financial Review during the month of July 2019.

Friday, 19 July 2019 10:21

Afterpay - the elephant in the room

The daily gyrations in the Afterpay share price recently has given investors motion sickness.  In the light of new information ranging from the Austrac investigation, to Visa announcing a competitive threat, Afterpay investors have been re-examining the investment case.  Here we outline some of the thinking from 3 professional investors on this ASX top 100 company.

Afterpay has changed the habits of millennial spenders who prefer to pay in instalments mostly with debit cards to avoid the punitive interest rates and application process of credit cards.  Afterpay users purchase goods upfront and pay for them in 4 instalments, but the retailer receives the funds upfront from Afterpay. The consumer doesn’t pay interest on the transaction.  

Afterpay makes its money from charging retailers a merchant fee based on the transaction size.  Although Afterpay can charge a late fee in the event of a failure to repay the outstanding amount, the majority of Afterpay’s revenue comes from merchant fees.

“Retailers love Afterpay as average purchase size increases” according to Nathan Bell, Intelligent Investor.

Bell believes that the Austrac issue is of little long-term consequence, even under a worst case scenario.

Andrew Mitchell, Senior Portfolio Manager, Ophir Funds Management was one of the first institutional investors in Afterpay and says that while Australia now boasts 2.5m active Afterpay users since starting 4 years ago, “this is a sideshow to the real opportunity lying offshore with the US market approximately ten times the size and the UK market around three times larger.  Early signs are positive in the US where the monthly rate of customer signups has been higher than the experience in Australia with already over 1.5m active users after just 12 months.”

Late last year when Afterpay’s share price was under intense pressure, Mitchell travelled to the US to speak with retailers personally.  When he discovered the surging take up rate of Afterpay by several leading US retailers, Ophir doubled their position.  Afterpay recently confirmed that they have 4,400 retail partners in the US.

Nathan Bell thinks that Afterpay collecting so much data on spending habits could also lead to new services.  In a wildly bullish scenario he says, Afterpay could eventually have much more in common with a bank than it does today.

Michael Glennon, Glennon Capital is of the view that by being the first to the market does offer the company an advantage. “The best case for Afterpay is that it becomes a globally recognised brand like American Express” he says.  He thinks management is doing a good job and while Visa announced plans to enter the buy now pay later space he adds “these people (Afterpay) have got it right, I’m not sure Visa will get it right”.

Some broker research is dismissive of the threat from Visa as 80% of people using Afterpay don’t have a credit card, and instead use a debit card.  Glennon says that while the threat from Visa may not be in itself company changing, it does tell investors that “if Visa are looking at Afterpay, then you can bet others are too”.

Other risks to the Afterpay business according to Andrew Mitchell include ensuring responsible lending to consumers is adhered to, changes to regulatory framework governing the buy now pay later industry and a material increase in bad debts.

Nathan Bell adds “there have been several governance issues, and the founders have been selling large amounts of shares. This is typically a big red flag, but I would sell some shares at the current price too if I was them.”

The big elephant in the room is valuation. While rapid revenue growth is assured given its early success in the US, Afterpay must continue to grow sales quickly to justify a forecast market value to sales ratio of around 10x revenue based on 2021 estimates.  Those investors with grey hair will recall that the last time the market priced businesses on a price to sales basis (rather than price to earnings) was during the dot.com boom.  

Future growth in the US could of course justify the lofty valuation, but investors would be wise to closely monitor the US rollout.

 

This article is general advice only.  The author does not own shares in Afterpay.  This was published in the Australian Financial Review during the month of July 2019.

Wednesday, 17 July 2019 08:34

What lower rates mean for investors

Hamish Douglass - Magellan

Tuesday, 16 July 2019 19:04

30 mins with Platinum Asset Management

With permission from our friends at Intelligent Investor, we are pleased to bring you a 30 minute interview with one of Platinum Asset Managements' senior investment management, Clay Smolinski.  Below is both the transcript of the interview and the audio podcast.

This week's fund manager interview is with Clay Smolinski, Portfolio Manager at Platinum Asset Management. Nathan Bell speaks to Clay about the big gap between growth and value stocks and which sectors Platinum has been focussing on of late.

Magellan has been the funds management company that everyone's been talking about for the past few years and people have gone a little bit cold on Platinum Asset Management, who are widely regarded as probably the best international investors in Australia. 

Today, I've got Clay Smolinski on the phone. He's a Portfolio Manager and has been at the company for a very long time. 

I thought we'd look at a few broader issues such as the big gap between growth and value stocks, which is now the biggest gap since the tech boom in 1999, and also take a look at the number of opportunities that Platinum's recently been buying. 

First of all, Clay, thanks very much for giving us your time. I heard Kerr Neilson once say part of the reason he hired you was because you were very mature at what I'm guessing, was a young age. Why was that and what were you doing before joining Platinum?

It's kind of him to say. Look, in terms of what I was doing before I joined Platinum, it was nothing particularly special. I grew up in Perth and I got interested in investing at a fairly young age, but what was apparent in Perth was there probably weren't too many roles in that vocation. Certainly, most of my friends were engineers or going off to get jobs on the mines.

Prior to joining Platinum, I was just in Perth, really just looking for roles that could somewhat get a foot in the door, so I started off as an accountant working in audit. I then moved on to work for the Home Building Society, which was a small little Perth based bank, before I got very lucky that Kerr and Platinum gave me a chance.

Look, I think one of the factors was I was just extremely lucky when I joined Platinum, both that Kerr gave me a lot of his time, and I got to benefit from spending a lot of time with him and getting his tutelage, but also I think my first years at Platinum, I spent a lot of time with the founders, so Toby Harrop, who's one of the founders of the business as well, who was running the European fund. I really worked underneath Toby for the first three years and that just taught me a lot, and so kind of saying the people you spend a lot of time with, some of their attributes maybe just rub off on you a little bit.

But certainly one thing I remember just from the early days of Kerr just coming back and doing analysis, Kerr always had this saying of he'd like you to look around corners when you're making an investment, which is really just another way of saying you don't take information at face value and you try and test your assumptions and look, I always had a pretty healthy insecurity about whether I actually had the facts straight and whether the market was wrong on any particular stock. I think Kerr probably saw that as a positive.

I think most young people that come into a value investing house are very worried about making mistakes, which tends to slow down their turnaround on stocks, which quickens up a lot once they get more experienced.

Yeah. Look, that would describe my early years to a T.

I was going to say, I certainly remember my research director telling me the same thing. A couple of years ago, Andrew Clifford started writing a macroeconomic piece at the introduce of Platinum's quarterlies. Why was that?

Yeah, no that's quite an astute observation. The answer's probably simpler than you think. Look, Platinum, one of our key duty as any fund manager, is to really communicate to your clients at all times exactly how you're managing their money and what you're doing. We always put a lot of time into writing our quarterly letters. Every fund manager wrote their own one and every fund manager had to write one.

But what we were finding that over the years, as each PM would sit down to write their letter, you would have three or four of them wanting to make some reference to the macro environment in that letter, and hence we were repeating ourselves across all of the letters. We just figured, "Look, for the benefit of investors' time and probably to make things clearer, it would just make more sense for us to do. All right, we'll do one. If we want to discuss the macro, we'll do one macro summary up the front" and that's probably better for everyone. That was the genesis of that move.

Do you think you're actually thinking more about the macro environment, just because of the changes in the Frankenstein monetary policies, if you like, that have changed the world?

I don't know if we're thinking more or less about it. I think our approach to macro at Platinum is, you've always just got to understand where you are and what's happening in the world, and I call it the Howard Marks approach. You're going to look at all of the economic data, and you look at investment sentiment, just to give you that picture of, "All right, where am I in the cycle today and what does the data and the sentiment maybe imply where we're going to in the future?"

You pay attention to macro in that way. Then really, the second aspect is we say whenever you're buying a stock, you really need to understand the perspective and the reasons of the people who are selling that stock to you, or other investors. Why are they not buying this business? What are they worried about? In today's world, often that worry is economic or macro in nature, so you really need to have a good understanding of, "All right, what's happening in the data? How are they responding to the data? What forecasts are they reacting to?"

That's how you're always bringing macro into the process. I think the difficulty with macro is it's just, it's noisy data. The world is a very, very complex system and it's difficult to predict the macro, so I think while you want to understand the macro situation and where we are, you want to be very careful that it doesn't then start driving your whole investment process, and you want to make sure it's not preventing you from buying into value and stocks when you see it.

On the flip side, have you found at all that just the markets or particularly, in regard to a specific stock, where macro concerns have actually created opportunities in the business?

Oh look, many, many times over the years. We've got concerns today, so you think about look, we've got roughly 10 per cent of our fund in the semiconductor stocks. Certainly, something that's hitting those businesses are the worries around the trade war. Semiconductors has traditionally been an economically sensitive business, and for sure, part of the reason of why those businesses are trading at book value or on single-digit P/Es are concerns around the next macro move and what happens with the trade war and what happens in China.

We can see why the short-term macro fears are keeping people away from these businesses. We say, all right, well we understand that. We can't really bring a lot of edge to that, but what we can do is say, all right, well, what do these businesses actually look like on the longer-term front? And then you're sitting back and saying, all right, well I don't know what's happening with macro, but in the longer-term, I'm pretty sure consumers will buy 5G phones, companies are going to keep moving their software to the cloud, and companies are still going to invest in artificial intelligence.

Essentially, if those three things continue to happen, it's highly likely these semiconductor businesses will be bigger in the future. That's how we pair it.

Would you put the Italian banks in that bucket as well?

Yeah. Look, the Italian banks are interesting. You can go back to macro, and I think this is a good example of why macro's so hard. Look, I managed the European fund for many years and over that period we had, during the sovereign crisis, you had people believing it was a sure thing that the Eurozone was going to break up. We had interest rates on Greek debt in the high teens. Italy had an 8 per cent interest rate.

We then, fast forward today, the yield on Greek debt is what? 2.8 per cent. The yield on Italian debt is below 2 per cent. How much do things change, right? These were unthinkable situations back in the sovereign crisis. Also, you go back 18 months ago and people were, we had rising rates in the US and people were dead certain that rates were going to be rising in Europe and in other places.

And now we've completely reversed the picture, so no one believes that we'll get rate rises ever again, and we're talking about Europe being in a Japan-style scenario, where we're going to have negative rates forever. Then, you bring it back and say, all right, well let's look at the Italian banks. The banks have de-risked, they've written off a tremendous portion of their loan book. A bank like Intesa still has a large asset management business that is generating very good earnings and growing.

The Italian banks, again, something like an Intesa is still benefiting from their credit costs falling, new NPL inflows have collapsed and you're getting a 10 per cent dividend yield while you wait, and then really the discussion is just around the sustainability of that dividend yield. But that's an example where the sentiment has gone 100 per cent negative, right? No one's thinking that the future can get any better, and we look at that and think, well, actually when you look at a lot of the data, it's not that bad.

Again, not saying interest rates are going to be high in Europe, but could they at least be zero, rather than negative 50 in some point in the future? It doesn't seem that hard. That's an example of where, if you're getting paid a large dividend yield to wait, you can have a portion of the portfolio in that kind of idea I would say.

Just switching gears for a moment, I don't believe shorting stocks is well understood by most people, particularly Australian retail investors. Can you explain Platinum's shorting strategies, the types of situations you short, and position sizing?

Yeah, absolutely. What we look for in shorting is really just the inverse of what we look for in a stock that we want to buy. When you're buying a stock, you want investors to have low expectations for the business in the future, you want to have a low price and you want to ideally be able to identify a reason why the future's going to look much better in a certain time frame. In shorting, you just want the opposite.

So we want companies where investors, they're in love, the company is surrounded by hype, so very high expectations. You want a high price that leaves no room for error, and you want to have a clear reason why the future may look worse than today. Where we can find those situations, we will go off and short, and we've found some of those situations recently in the tech space, and some of the software stocks.

For us, how is shorting different though, to essentially owning a stock? When you buy a stock, even if you are completely wrong, like it's a complete disaster, the most you can lose is 100 per cent, and even that is a pretty rare occurrence. But if you're shorting a stock, and you're wrong, you can lose a lot more than 100 per cent of your initial position. As the stock goes up, your position size continues to get bigger, so it becomes a larger part of your portfolio. Certainly, when we short, we're typically taking smaller positions than when we would go long, or own a stock. And you tend to be a bit more focused on the timing aspect, and being very clear around that catalyst of when you're going to start to see change.

Just in terms of the small sizing position, are you talking like 50 basis points, or might it be a per cent, or..?

Yeah. If you think about it, you're saying a large, one of our full-sized positions in the fund might be a 3 per cent position, and with a short, you can be thinking, again, it comes back to depending on how confident you are with that catalyst. If you're less confident around just the timing, it might be a 50 basis point position, but we have had positions in shorts where we were very confident around the timing and we had ticked all three of those factors that we want to see, and we might have a 2 per cent position. But there, the 2 per cent positions are more of the rarer breed.

Platinum actively manages currencies. How much of Platinum's historical returns would come from currency management?

Yeah, look, I can give you the figures over the last 10 years. If we look over the last 10 years, it works out the currency has added 2 per cent per annum to the return, but that's spreading it out. The returns tend to actually come in lumps, and if we think about that 10 year period, a lot of the money was made via shorting the Japanese Yen, when it had become very expensive. Generally, how we tend to approach the currency positions, we tend to approach it in two ways.

We want a very strong reason to essentially hedge out or go, to take a large position on currency. We just see our natural position on currency is where the stocks lie. If we own Japanese stocks, we will own Japanese Yen, as it were. But if we do it in a situation where we feel strongly, so a good example would be the Yen. A good bell ringer in currencies, so you know a currency is maybe unsustainably strong is when your exporters in that country can't make money at that level of the exchange rate.

When the Yen was down 80, you saw Toyota, these bastions of Japanese industrialisation struggling to make money. It was the same situation when the Aussie dollar was at 1.10 to the USD in this country, and basically all of the car manufacturers left. When we can see examples like that, we typically move in size. Other areas where we might use currency shorting is where it provides very cheap tail risk hedging.

Past examples, certainly something I did in the European fund days, was during the sovereign crisis, you could hedge out some of the Euro at a very cheap rate, and it was very cheap tail risk insurance of a breakup. In China today, we've chosen to hedge some of our exposure to the Renminbi, just with an understanding that look, that is a tool, so the Chinese government may wish to devalue the Renminbi in the event that the trade war continues to essentially accelerate or intensify.

Next one's a very topical question at the moment. The valuation spread between so-called value and growth stocks in the US has recently eclipsed the gap since during the tech bubble. Do you think the gap will close as it has done historically with the next downturn, or do you think the gap might be a bit more stubborn this time around given technology's ability to render businesses obsolete so quickly?

Yeah. It’s that interesting discussion around the disruption and whether this time is different. My own personal view is that it will close, and I don't think it's particularly different this time. First of all, there's a lot of talk about disruption and the pace of disruption today. I actually just don't think this is that new. Technology has been forever rendering businesses obsolete, so an example that everyone will know, we'll talk about how eCommerce is killing retail today.

The new formats in retail have always been killing the old formats of retail over the last 50 years. Whether that be the supermarkets killing the local grocery store, or the department stores getting killed by the specialty retail. So, I think the disruption is very much fitting the words to the music and is being used as an excuse to try and justify some of the valuations.

The other thing I'd point out, just in terms of what is actually driving that valuation gap and difference, look, most of the cheap stocks are actually not being disrupted at all. It's more that these stocks have some cyclicality to their businesses, and investors today are absolutely petrified of the macro environment, and are petrified of having any businesses with a bit of cyclicality. We see this just in the wild prices that are being paid for defensive businesses these days.

You've got what are fairly slow growth businesses trading upwards on 30 times earnings, and then if we look at the valuation spread, the difference between what's the value of the high P/E stocks versus... We look at it by dividing the market into five groups and it's divided by valuation. So you look at, all right, what's the average value of the top group versus the average value of the bottom group?

If you look at this over a very long time period, that valuation difference tends to stay in a band, and that actually makes sense, because investing is somewhat of a relative game. If I can go and buy a whole business on 10 times earnings, I'm getting a 10 per cent return on my purchase price. If, Nathan, you're going off and buying one of 40 times earnings, you're getting two and a half per cent on your purchase price, and your business needs to grow incredibly fast over the next years to catch up to the return I'm getting.

Eventually investors wake up to this and capital rationally moves to the higher returning opportunities. So, this has happened in the past. The simple answer was look, during the tech bubble, the internet was there to disrupt all businesses. You actually look over the ensuing 20 years, and a lot of what it was meant to do actually happened, right? It did disrupt many businesses, but that didn't stop the valuation gap closing, and people who were investing in those wildly priced companies having a pretty rough time of it. I think it will close.

Okay. Nothing new in finance?

No, no, no. We just painfully learn the old lessons again.

This is a bit more of a personal question, but can you provide some insight into how you come across some of the more obscure opportunities in China where you have to do a lot more on the ground research compared to, I guess, some other Western countries? Do you have a team on the ground, for example, or relationships with local analysts and investors?

No, no. It's interesting. We actually keep everyone in Sydney, and we do that very purposefully. We find that just having the team in one place, it really helps with communication. It's much easier to talk and engage with the different ideas the team is working on, and it's much easier to just communicate and saying, all right, well we're seeing this happen in China or, we're seeing this happen in the tech space in the US. How may that apply to other geographies and what's happening in your countries?

We've experimented with the US office and we just think it doesn't work, at least for us, on the communication front. In terms of generating ideas, look I don’t think the idea generation process is that different in China. Maybe the difference is look, the rate of change in that economy is probably greater than others in the West. Whether that be the healthcare system reforming, or the cutthroat competition you see in the internet space, and of course change creates a lot of opportunities, so you're following those.

But I think what helps is Platinum's been investing in China for over 20 years now. Over that time, you build a lot of relationships, you build a lot of relationships with the corporates, and I think that helps. There's several meetings where you'll go in and you'll meet management, and you go, "Ah yes, I remember. We remember you from this company." Because people still move around. That helps, because the companies know that look, you're serious investors and you're here for the long term.

And then how do we bridge that gap of not having the office and not having someone on the ground, is simply that we just travel there extensively. We've got a six-man Asia team, they're focusing purely on Asia, and really if you think about China, we've probably got someone from the investment team on the ground travelling and meeting companies every three months.

Yeah, I think you've owned the large Chinese insurer, Ping An, for a number of years. What makes this company special other than just its huge potential as insurance coverage increases across China?

Yeah. Look, I think the interesting point about Ping An was this was a company that was always run as a private entrepreneurial business, they were primarily competing with the state-owned enterprises. You see that pattern so often, is when you pit the private, fast-moving competitor, versus the state-owned enterprises, it's generally the private company that tends to win over time.

That’s certainly always appealed to us about Ping An. But then you go a layer deeper and you think about, all right, where is the company special, or why is it succeeding? You just look for those signs of excellence, where the company's just operating a lot more efficiently than its competitors. You can look at examples of that for Ping An, so in terms of life insurance, Ping An, the old saying is that life insurance isn't bought. It is sold, right? You need to have someone to come to you, they need to explain it. It's not something you just wake up and go, “Yeah, I'll buy some life insurance today."

Your agent force is very important, and Ping An always placed a very large emphasis on training their agents. Workshops, teaching them what insurance products make sense for customers at different life stages, really teaching them how to sell, and importantly, they very much always focused on how do we sell the more profitable, longer-term, what I would call true life insurance policies? Whereas a lot of the SOE competition would get carried away selling shorter-term savings products that were much easier to sell, but would look good from basically a FUM basis, but were pretty weak profitability.

And because Ping An invested and really concentrated on the agent force, you saw the positives. Their agent force would have far less turnover, their agents would make roughly two times more income than similar agents at competitors. What that meant is just over time, one, you kept the better-quality agents, and two, you just attracted high-quality staff overtime, and that makes a big difference.

Other examples is just one of the impressive things about Ping An is the money they've spent in FinTech. This all really started with Ping An basically saying, "Look, we want to develop software and technology internally to run our insurance businesses better." You've got to remember these are insurance businesses at incredible scale, so Ping An at different stages have had over half a million agents working for them. So after building those systems they then said, "Okay, well, can we actually take this further? Can we open up our systems in terms of software business and actually sell that technology to other businesses in China?"

So, we've got a unique way to approach that and that's led them to kind of develop some pretty impressive software and technology businesses servicing the financial community in China. So it was those factors that always appealed to us, and so look, this is, again, it's a serious company who should win in the long-term.

You recently added online travel agent, Booking.com to the portfolio. This was once a market darling and probably one of the best-performing stocks I can think of since the GFC.

Yeah.

But fears about Google entering the space and hotels offering discounts to book directly have knocked valuations down across the sector. What's the case for Booking.com?

Look, I think Booking's an interesting case and we can cover those two issues directly. But, look, when I look at Booking, I don't see a big problem that's scaring the street, and also there's no amazing angle that I don't think the market particularly doesn't understand for Booking.

I think, overall, this investment is... Look, this is a very high-quality business, it meets a great need for both the hotelier who always has unsold inventory, so they want to sell those rooms, and users. You know, because hotel pricing's dynamic, it's always changing, there's a lot of value to jumping onto Booking and searching for different hotels because more often than not there'll be a hotel owner on there looking to discount rooms to fill and you'll get a good deal.

It's a high-quality business, it's serving a real need, and then I think there's enough growth tailwind. The business is growing at about 10 per cent per annum, and they've got enough growth tailwinds to really sustain this type of mid to high single growth going forward, and those growth drivers are simply in the West we're seeing, I guess there’s a trend of people wanting to spend more on experiences to go travelling, do things, rather than maybe spending their money on more material possessions or more stuff.

The second big driver is just that outbound wave of tourism coming from China. If you think, today, roughly 15 per cent of Chinese nationals have a passport, that compares to maybe 50-70 per cent in most other countries of the world, and really that will only grow, and I think the Chinese outbound wave will continue to grow from here.

On the concerns around Google, in terms of what Google's doing, I don't think's that different. Google for a long time has been a huge partner of Booking.com selling them travel-related keywords, and what Google's trying to do is really become a bit more of a metasearch proposition where you can go and type in your dates and it will present hotel options to you, much like you see on KAYAK or Trivago or even TripAdvisor today. But their business model is still getting that lead and then passing that lead onto the OTAs, because it's the OTAs paying for that lead.

So I don't think it's a vastly different change to the competitive landscape, and certainly the chain hotels have been doing their best to try and attract people directly to their websites to book direct. The simple reality is yes, if you're going to London and you know you want to stay at the Intercontinental London, then booking direct on that website will probably get you the best price or get you a free breakfast.

But the other side to that is, well, if you're not set on the Intercontinental, again, you can go onto Booking.com and there'll be many hoteliers who may be wishing to discount to fill a room, and hence you may get a better room at a cheaper rate by going off and searching. I think that’s one of the real reasons why the whole book direct wave has not really had a lot of impact on these businesses and I think shouldn’t have too much of a pronounced impact going forward.

Okay, last one, Clay. The oil space has been a bit of a graveyard for investors over the past few years. What’s your general view of the sector and what’s a current opportunity?

Yeah. No, look, understand that. We've taken some hits in this sector, but we're still reasonably positive. So you think about our investments in oil, so we've got to hark back that it feels a long time ago, but the oil price collapsed in October of 2014, so we're now five years on from that oil price collapse and it's been a period where industry capex has been down 50 per cent, and so we've had five years of the industry being in a fairly large recession.

In terms of how we've invested in this sector, our first wave was to buy the oil producers with just a belief that, look, oil markets will tighten over time, the price should rise and the producers will be the first to benefit from the higher oil prices. And largely that was a profitable investment. The second wave of our activity was going onto then buy some of the companies that provide the capex side of the equation, so when the oil companies start spending again. Now, this has been the painful area of investment and these haven't performed well and we’ve taken some losses here.

But why are we still positive on the capex producers? And I guess the case for oil is this. So, again, we've had industry capex in recession for five years now. The oil industry has always been about replacing a depleting resource, so if you think about the world consumes roughly a hundred million barrels of oil a day, on average, demand for oil grows at one million barrels per day, per year, and really this has been driven by China, India and Southeast Asia.

But we need to find that one million, but on top of that we also need to replace the natural decline rate of the fields, and globally the fields deplete at 3.5 to 4 per cent a year. So, just to keep round numbers, in any year we probably need to find four to five million barrels of oil to meet growing demand and to replace that decline. Now, what we can observe is that, look, oil has been getting harder to find over the years. The oil industry was not drilling shale and going and developing offshore kind of oil reserves for fun. These were the hardest and most expensive sources. They were doing this simply because the nice, cheaper conventional oil resources onshore or in shallow water, they just weren't there. We were running out of it.

So looking forward, why would oil capex pick up from here? Obviously, the story in this industry has been the effect of shale. Now, we can look at can shale meet the needs of future demand but also replace that decline rate over time? So despite the hundreds of billions of dollars thrown at the shale oil industry, the maximum amount of oil production shale has ever brought on in one year is 1.3 million barrels.

I think you can kind of say, look, shale can't do it on its own back alone. I think the other interesting factor is over the past five years, you've had offshore and conventional oil projects that were sanctioned in 2010 to 2014. These are generally projects that have a long lead time, and they were coming on from '15, '16, '17 and '18 and providing some supply to the oil markets while prices were still low as those projects were being finished.

Really, the bulk of those projects now is done, so the cupboard is starting to look bare, so if shale is going to struggle to do a lot more than 1.5 million barrels a year, we've got to ask where are the other 3.5 million going to come from, and we think that needs to come from new oil capex and will need to come from offshore development to some degree.

That's what we're starting to see the first green shoots of activity around, so you're now starting to see investment decisions around offshore resource development starting to pick up. You look at a business like FMC Technip, over the last seven months they've...new project decisions to the tune of $5-6 billion, and that's why we're still confident that you will see inactivity pick up in this space and we can still make money from here.

Brilliant. Okay, Clay, we'll let you go and let you go and find some more stock opportunities, but we really want to thank you for your time.

More than welcome. Thanks for your time, Nathan.

Thanks, Clay.

Bye bye.

That was Clay Smolinski, Portfolio Manager at Platinum.

 

For investors simply seeking growth tail winds, India has a far clearer economic growth story than China according to Douglas Isles, Investment Specialist at Platinum Asset Management, although he acknowledges that in practice investing is more nuanced.  

Already the world’s 5thlargest economy, with forecast growth of 6-8%pa over the next decade, India is likely to become one of the three largest economies alongside the US and China by 2030.

It is unlikely to be another China though, as India’s Government can’t simply mandate growth in the same manner as China. India is currently where China was around 15 years ago according to Mr Isles based on GDP per capita figures.  Each home to populations of around 1.4bn people, India and China are to become economic heavy weights in the coming decades.

 

 

 

 

India’s scale is extraordinary.  By 2025, one fifth of the world’s working age population will be Indian.  By 2030 there will be over 850 million internet users in India (currently around 500m) Source: Australia’s Dept of Foreign Affairs and Trade.

The Modi Government was re-elected in a landslide victory in May.  His first term was punctuated with many reforms including the introduction of GST, bankruptcy and insolvency changes, digitisation of subsidies which has resulted in large numbers of Indians now having bank accounts, and a steep rise in infrastructure spending on building roads, rail and electrification to power the nation.

India’s road and rail networks are critical to increasing its population’s standard of living and economic prosperity as they connect farmers to markets, children to education and goods to consumers.  During Modi’s first term, India built almost 200,000 km of rural roads. (that is building the road from Adelaide to Melbourne 275 times).  The number of rural villages connected by roads grew to 91%, up from 56% in 2014.  

Modi’s new Government has pledged 100 trillion rupees (US $1.44 trillion) over the next 5 years for infrastructure investment. This is huge considering the expenditure on roads and railways was only about 1.2 trillion rupees for the 12 months to March 2019.

Jack Lowenstein, Morphic Asset Management, believes that the infrastructure sector is one of the greatest opportunities in India and the sector presently looks cheap.  He adds “financials offer the best returns in India, but having seen so many false bottoms to what is now a nearly decade long bad credit cycle, we are going to sit on the sidelines until we see momentum in the recovery story.”

Douglas Isles, empathises and says “India’s banking system has gone through a process of repair, which sets it up for the prospects of an investment boom, perhaps akin to what we have already seen in China. 

This should be good for banks, and companies benefiting from investment in infrastructure. While it benefits the consumer, stocks in that area are well-liked, and the overall market, like the US, trades at all-time highs. This is a stark difference from China, but note that India is at an earlier stage of its economic evolution, and as a democracy, remains more chaotic than its northern neighbour.  The paradox of markets is that a simple growth story does not make such a simple investment case.”

Investing in India through global ETF’s or actively managed funds is the obvious way of gaining exposure to the India thematic.  But it is not just Indian companies that stand to prosper from India’s infrastructure boom.  

Australian businesses who provide finance, maintenance / construction expertise, or other products and services could also be beneficiaries.  

Some of the questions that Australian investors need to ask themselves are:

  1. What Australian goods are likely to be sold to Indian consumers (think A2 milk to Chinese consumers)
  2. What Australian expertise could be exported to India? (perhaps education, infrastructure maintenance)
  3. What Australian companies may be able to assist in the financing of Indian infrastructure? (Macquarie Group is the business automatically linked to infrastructure investing)
  4. Will the increase in infrastructure spending create the environment for another resources boom?

As legend investor Kerr Neilson (Platinum Asset Management) says “Investors have to invest on the basis of what the world is likely to be, rather than as it is now”.  Therefore investors would be wise to think about ways they may be able to gain from the rise of India over the coming decades.

 

This article was written by Mark Draper and published in the Australian Financial Review in June 2019.

For investors simply seeking growth tail winds, India has a far clearer economic growth story than China according to Douglas Isles, Investment Specialist at Platinum Asset Management, although he acknowledges that in practice investing is more nuanced.  

Already the world’s 5thlargest economy, with forecast growth of 6-8%pa over the next decade, India is likely to become one of the three largest economies alongside the US and China by 2030.

It is unlikely to be another China though, as India’s Government can’t simply mandate growth in the same manner as China. India is currently where China was around 15 years ago according to Mr Isles based on GDP per capita figures.  Each home to populations of around 1.4bn people, India and China are to become economic heavy weights in the coming decades.

 

 

 

 

India’s scale is extraordinary.  By 2025, one fifth of the world’s working age population will be Indian.  By 2030 there will be over 850 million internet users in India (currently around 500m) Source: Australia’s Dept of Foreign Affairs and Trade.

The Modi Government was re-elected in a landslide victory in May.  His first term was punctuated with many reforms including the introduction of GST, bankruptcy and insolvency changes, digitisation of subsidies which has resulted in large numbers of Indians now having bank accounts, and a steep rise in infrastructure spending on building roads, rail and electrification to power the nation.

India’s road and rail networks are critical to increasing its population’s standard of living and economic prosperity as they connect farmers to markets, children to education and goods to consumers.  During Modi’s first term, India built almost 200,000 km of rural roads. (that is building the road from Adelaide to Melbourne 275 times).  The number of rural villages connected by roads grew to 91%, up from 56% in 2014.  

Modi’s new Government has pledged 100 trillion rupees (US $1.44 trillion) over the next 5 years for infrastructure investment. This is huge considering the expenditure on roads and railways was only about 1.2 trillion rupees for the 12 months to March 2019.

Jack Lowenstein, Morphic Asset Management, believes that the infrastructure sector is one of the greatest opportunities in India and the sector presently looks cheap.  He adds “financials offer the best returns in India, but having seen so many false bottoms to what is now a nearly decade long bad credit cycle, we are going to sit on the sidelines until we see momentum in the recovery story.”

Douglas Isles, empathises and says “India’s banking system has gone through a process of repair, which sets it up for the prospects of an investment boom, perhaps akin to what we have already seen in China. 

This should be good for banks, and companies benefiting from investment in infrastructure. While it benefits the consumer, stocks in that area are well-liked, and the overall market, like the US, trades at all-time highs. This is a stark difference from China, but note that India is at an earlier stage of its economic evolution, and as a democracy, remains more chaotic than its northern neighbour.  The paradox of markets is that a simple growth story does not make such a simple investment case.”

Investing in India through global ETF’s or actively managed funds is the obvious way of gaining exposure to the India thematic.  But it is not just Indian companies that stand to prosper from India’s infrastructure boom.  

Australian businesses who provide finance, maintenance / construction expertise, or other products and services could also be beneficiaries.  

Some of the questions that Australian investors need to ask themselves are:

  1. What Australian goods are likely to be sold to Indian consumers (think A2 milk to Chinese consumers)
  2. What Australian expertise could be exported to India? (perhaps education, infrastructure maintenance)
  3. What Australian companies may be able to assist in the financing of Indian infrastructure? (Macquarie Group is the business automatically linked to infrastructure investing)
  4. Will the increase in infrastructure spending create the environment for another resources boom?

As legend investor Kerr Neilson (Platinum Asset Management) says “Investors have to invest on the basis of what the world is likely to be, rather than as it is now”.  Therefore investors would be wise to think about ways they may be able to gain from the rise of India over the coming decades.

 

This article was written by Mark Draper and published in the Australian Financial Review in June 2019.

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