Ask A Fund Manager
In part 1 of our interview, Pengana Capital senior fund manager Rhett Kessler told how he started a successful fund during the chaos of the global financial crisis. Now in part 2, he reveals the finance company that’s almost been a 30-bagger for his team.
Overrated and underrated shares
The Motley Fool: What’s your most underrated stock at the moment?
Rhett Kessler: In our portfolio, we’ve got a few – that’s why we own them.
By underrated, you say ‘it deserves to trade at a much higher share price’. And so probably the most underrated one for us at the moment is one we are puzzling over – trying to work out what we’re missing – and that’s Super Retail Group Ltd (ASX: SUL).
The investment thesis is that it’s a well-managed, strong branded business, particularly Rebel and Supercheap Auto, which make up about 85 cents in the dollar.
They have successfully built moats around their business through buying power, as well as an omnichannel retail capability that’s very strong. Thirdly, the company has no debt, that’s got net cash positive. And fourthly, we can buy on a roughly 10% after-tax cash earnings yield, which implies a barely double-digit PE [price-to-earnings] multiple.
We understand that they have benefited from the lockdowns and COVID-19, but the business continues to do good numbers. And we think even if they go backwards while they catch up to the trend, in terms of the top line, buying in on a 12 or 13 PE, which it quotes at 8% after-tax cash earnings yield, [with] no debt, is still a really compelling value proposition.
MF: When did you buy in?
RK: Before COVID. And one of the things we participated in quite heavily was the deeply discounted placement. It’s a place we deployed a lot of cash.
MF: What do you think is the most overrated stock at the moment?
RK: We have quite a large collection of companies that we’d love to own, but think the multiples are just way too high for us. And that doesn’t mean that we think if they fell 10 or 15% or 20%, we could own them. It means that we can’t get close to the price, even if they fell 30% or 40%.
I’m always loathe to name them, but we watch them jealously – we think they’re great businesses run by competent management. They’re just nowhere close to the right price.
Our biggest concern is that, like with some of these cryptocurrencies, that when someone actually finally calls out that the emperor has no clothes, they’ll come tumbling down.
MF: Is there a sector that worries you in that regard?
RK: Yeah. This seems to be a bifurcation in the market.
Companies that have a sexy story with a charismatic CEO that make no money and have had enough people to buy into the story. So that has given them a big cash file so that they can sell products that are worth a dollar for 80 cents. Which is problematic for us, right?
We’ve actually bought some puts because at the end of the day, if the proverbial does hit the fan, we think that people will push the liquidity button. And liquidity won’t only be in those stocks. It’ll [also] be in the other more robust companies that people are happy to own.
So we think the market, together with very cheap money, is just being pushed up to levels that we’re concerned about.
MF: Do you think that scenario will come in the next 12 to 24 months or is it further down the track?
RK: I don’t want to avoid answering this question directly. We have two issues. The one is that this enormous amount of stimulus will turbocharge most businesses, probably around the world. Because not only is there a lot of liquidity around available for consumers and even businesses to spend, but more importantly, you earn absolutely nothing for holding it in cash.
You don’t get rewarded for holding it in cash, plus you actually probably get penalised because the cost of everything is going up – even though inflation is only at 1.8% or whatever.
I don’t know if anyone’s tried to buy a domestic holiday, or a second-hand car, or a property, or pay their electricity bill, or buy insurance or school fees. Everything’s going up.
So we think that the only safe place is hard assets that aren’t overvalued. Luckily there’s a bifurcated equity market.
MF: If the market closed tomorrow for 5 years, which stock would you want to hold?
RK: I have great aspirations for CSL Limited (ASX: CSL) on several levels. Not only have they’ve got a big cash cow in terms of their immunoglobulin business, but in addition, they’ve got a number of R&D projects that we think over 5 years, even if they only get half of them right, will create enormous value for shareholders.
I’m referring directly here to CSL112. You and I [will] definitely partake because it’s the first pipe cleaner to clean your arteries. And secondly, that their very big, but not well understood, transplant biotech business, which we think has got great promise. But that’s a nice, longer term pipeline of money-making businesses.
MF: Which stock are you most proud of from a past purchase?
RK: Probably Credit Corp Group Limited (ASX: CCP). It’s been a remarkable winner for us. I remember turning up at a management meeting to try to understand the banks when I first started my fund. And I thought Credit Corp would be a good place to get some insights.
[I] discovered a business that was new management with a remarkably common sense turnaround strategy. And we were able to buy it at close to $1. It’s paid healthy dividends all along the way, and currently, it’s almost $30.
It’s been a remarkable journey. We still hold – it’s still one of our larger positions.
MF: If you bought at $1, it might have even been one of your early ones when you started the fund?
RK: It was.
That one and NIB Holdings Limited (ASX: NHF). The health insurance [company] was $1 with massive dividends and capital return. So, those two.
Every year we have an event where we thank not only our investors but also the CEOs of the companies who’ve never lied to us and have just consistently delivered. And both Credit Corp and NIB have been on that list almost every year.
MF: Is there a move that you regret from the past? For example, a missed opportunity or buying a stock at the wrong timing or price.
RK: I can’t even remember their names anymore that I’ve struck from my memory. It’s been suppressed, so I won’t even name them.
We really did get caught out with Spotless Group Holdings Ltd (ASX: SPO). We like to think that we understand and know management pretty well, but we certainly got caught out there.
When I went back and did a forensic on how we did, it was all in the provisions that we should have picked up. And yeah, we paid the price and ended up losing a bit of money.
MF: Were you still holding when it delisted from the ASX?
RK: No, they were actually bought out by Downer EDI Limited (ASX: DOW), I think. But that actually gave us a great opportunity to at least lick our wounds a little bit where there was a lot of talk from M&A, and the share price ran up quite strongly on the back of that.
Still well below what we paid for it, don’t get me wrong.