Ask A Fund Manager
In part 1 of our interview, Sage Capital portfolio manager Sean Fenton gave his thoughts on the inflation outlook. Now in part 2, he reveals what he regrets about his Afterpay experience.
Overrated and underrated shares
The Motley Fool: What’s your most underrated stock at the moment?
Sean Fenton: I was having a think about that one — it’s always a little bit tricky because underrated can often mean it’s got a few fleas attached to it.
But one that fits into that camp was QBE Insurance Group Ltd (ASX: QBE), which has been a bit of a perennial disappointer in recent times.
As you’ve seen, a lot of liquidity around the world, a lot of money chasing insurance premiums down, and it hasn’t been a great environment. Falling interest rates meant less and less of an income and they take more risk. And it’s as if their business hadn’t been focused and they under-provided for things and generally disappointed [investors].
But one of the things that we are seeing at the moment, with low rates across the insurance industry as a whole, [is] a little bit more rationality coming back into it. You’re seeing a very strong price cycle. Global insurance companies have under-earned and they’re looking to re-establish their insurance margins. And that has created a very strong global cycle for insurance premiums, which QBE does benefit from.
At the moment, as we’re talking about inflation and potentially higher volumes, they’ve got a bit of a natural hedge there — because they’ve got a very, very short duration investment portfolio and as yields split up, they’ve got a bit of carrying investment yield there.
One of the aspects driving that inflation is insurance premiums. So they’re actually got strong pricing power and pass-through at the moment. Whilst it started to bounce at its lowest we do see more upside in that cycle it should be in.
MF: What do you think is the most overrated stock at the moment?
SF: Commonwealth Bank of Australia (ASX: CBA) must be the most overrated at the moment. It’s not often you see a bank trading over 20 times earnings.
It’s clear they’re the highest quality bank in Australia, they’re the best long-term earnings track record, probably the best technology platform and systems and some of the best growth. So you give it a tick all around. Well capitalised, so there is nothing wrong with the way they’re running their business.
But it’s the premium to the rest of the sector… The market’s fallen a little bit too much in love with that quality at the moment, and it’s very hard to be sustained, particularly if you do see a bit of inflation and rate tightening down the track.
MF: If the market closed tomorrow for 5 years, which stock would you want to hold?
SF: That’s really difficult because I’m thinking ‘what can happen over the next 5 years?’. As we said, inflation could go up, interest rates could be structurally higher, it might get lower or could be all great.
I don’t think you want to go for a stock that’s got too much growth, that would be pressured by rising yields. And you don’t want to go for something that’s too cheap… or too cyclical because the cycle could have turned within 5 years.
So I see in the middle of the road, we quite like Metcash Limited (ASX: MTS). We were talking about Coles Group Ltd (ASX: COL) before, but that’s one where we see some operational improvement come into the business.
[Metcash] has been pressured for quite a while from Aldi moving into the supermarket space. But they’ve been a bit of a beneficiary of COVID and I think, as opposed to Coles and Woolworths Group Ltd (ASX: WOW), some of that might persist for longer as we do expect to see a lot of working from home and even working [from] more regional areas, being a more permanent trend. We don’t see people coming back to CBDs to the extent that they were pre-COVID. And that benefits Metcash and their IGA network being more exposed to suburban regional areas, less CBD-style areas. So they’ve got a bit of benefit there.
With that competition from Aldi, they’ve been forced to become more efficient themselves and become more competitive in terms of price. And franchisees [are] reinvesting to improve the format in a lot of those stores as well and make it a more compelling offering. So we do see them improving their business.
And they’ve also been moving more into hardware — so from Mitre 10 to buying Home Timber & Hardware from Woolworths and Total Tools recently, that’s an area that’s really benefitting.
We’ve seen obviously detached housing approvals get very strong with COVID, but in parts we’ve seen there’s also a real surge in renovations. It’s probably going to persist longer than the housing cycle. And that’s what we noticed, even the last down cycle, with low affordability, people spend more time renovating their homes and there was certainly an uplift in people spending more time at home through COVID.
So they’re well-positioned there, and trading around 15 times [earnings] and the 5% fully franked yield and, of course, their valuation support as well. So that’s not a bad one for the bottom drawer for 5 years.
MF: Which stock are you most proud of from a past purchase?
SF: You make so many good and bad decisions as a fund manager — to have a single point of pride or regret is often tricky. But one that has done very well for us over a long time would be ResMed CDI (ASX: RMD).
In various guises, we’ve owned [it] for well over a decade… It had a few blips here and there from quarter to quarter. But generally did very well and continued to grow and lead its segment — invested more and more in informatics and getting closer to the customer, and they really embedded themselves into having insurance payers and employing technology and improving their product and rolling it out. So there’s still growth in their target market of sleep apnea and improving sleep outcome.
I remember owning it around $3 on the other side of the GFC, but to be honest, I can’t remember if I owned it before then or not. It’s going back too far in time.
Most recently when we [purchased] it, it’d been trading at around $20.
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.
SF: Not holding Afterpay Ltd (ASX: APT).
It’s one where we actually like the business model, see the benefits that it brings and millennials love using it. And the network effects of being able to bring a cohort of shoppers to retailers and help drive their sales… Their first-mover advantage in terms of buy now, pay later as well. So [we] certainly don’t see its effect going away.
We owned it in the fund before COVID — then this economic Armageddon was before us, we sold out of it, which is the right thing to do because [of] the potential credit risk and everything else.
But the regret’s not buying back into it early enough, when it’s trading sub-$10. So it’s a real missed opportunity — but you can’t get them all right.
The truest thing about investing is everything’s easy with hindsight.
MF: Retail investors need to be aware that even professionals don’t get it 100% correct either.
SF: No, to be perfectly honest, we target getting 60% of our decisions correct.
I don’t think a lot of people realise because everyone does have a bit of a hindsight bias. You always think that knowing things is easier than it actually was. And people also have very selective memories in terms of remembering their wins and forgetting their losses.
If you don’t do the hard accounting and actually track your investment decisions and work out your wins and losses, people tend to overestimate their skill.
But we do do that and if we can get 60% of our investment decisions right, it means we’re absolutely knocking it out of the park.