Ask A Fund Manager
In part 1 of our interview, 1851 Capital portfolio manager Martin Hickson explained why Uniti’s business model is irresistible. Now in part 2, he tells us how he regrets the way his fund launched last year and the 8 stocks that lifted it out of pandemic trouble.
Overrated and underrated ASX shares
The Motley Fool: What’s your most underrated stock at the moment?
Martin Hickson: I don’t know if it’s the most underrated — we think it’s underrated, it’s Enero Group Ltd (ASX: EGG).
They operate a number of marketing agencies, both here in Australia, the UK and the US. It trades at a price-to-earnings ratio of sub 10 times. Their earnings are growing in excess of 30%.
The company has $50 million of net cash on the balance sheet. So, that provides them optionality to deploy into acquisitions. They’ve got a platform business in the UK which helps their customers deploy their online marketing budgets. It’s very high margins on that business. It’s called OB Media.
We think that the valuation that Enero trades on is quite suppressed, but yet the market isn’t giving them credit for that fast growing, high margin business in OB Media. And also the market is discounting the potential for them to deploy that cash.
They made a small acquisition in the UK a month or two ago, but we think that over time, they can make further earnings, creative acquisitions as they deploy that capital.
One of the largest shareholders has been selling down recently… So we think that the share price has been weaker due to this shareholder selling out. The price has gone from sort of $3.30 down to $2.50. We think it’s very underrated, undervalued [at] where the share price currently is trading today.
MF: What do you think is the most overrated stock at the moment?
MH: I don’t really want to call a single stock out individually. But as a broad statement, I think concept stocks.
So stocks that are trading on revenue multiples, a lot of them in the technology space, but they don’t necessarily have to be. Concept stocks that aren’t making money and are losing money for the next couple of years. I think that a lot of those stocks are overvalued.
There’s been a lot of risk in the last sort of 6 to 9 months. And a lot of those stocks’ share prices are down 30 or 40%. They still can fall further because there’s no valuation support when you’re trading on a 10 times revenue multiple, [and] you’re not going to have any earning for a couple of years.
If we get interest rates increasing over the coming years… that will also put pressure on a lot of these concept stocks. There are longer-duration assets, where when you’re discounting the future earnings back at a higher rate, that can lead to large declines in their valuation and share prices. So, that’s an area of the market that we’re avoiding at the moment.
MF: If the market closed tomorrow for 5 years, which stock would you want to hold?
MH: I’ll probably have to say our largest position, Uniti Group Ltd (ASX: UWL). Reason is 90% of their earnings are recurring — so there’s not a lot of risk around that. They’re providing data to their customers. And so they’re participating in that thematic of increased data usage, demand for high speeds, and that’s not going away over the next 5 years.
MF: Internet connectivity is a utility now, isn’t it?
MH: Correct. Exactly, you’re right. It’s a need to have.
So, for those reasons, if the market was closed and we look at that stock again in 5 years, I think that their earnings would have been able to grow over that 5-year period and it feels like a very safe one to own.
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.
MH: We launched the fund in early February last year.
We’d been running a paper portfolio for 6 months leading up to that. We had a hit list of the stocks that we wanted to buy. We deployed a lot of that capital in the first couple of weeks of February, and then coronavirus accelerated in that final week of February.
So for the first 2 months of the fund’s launch, February and March, [it] was down 33% over that period. It would’ve been great to launch the fund at the end of March. The performance numbers on returns would look a lot better if we’d launched it then!
Having said that though, we’re still pretty happy with the performance… Over the first 15 or 16 months, the fund’s up 43.5% versus S&P/ASX Small Ordinaries Index (ASX: XSO) up 13.5%. So we’ve been able to recover those losses and generate strong returns, post that initial selloff. So, in terms of wrong timing, that would’ve been nice to launch 2 months later.
MF: Which stock are you most proud of from a past purchase?
MH: Post that sell-off, it led to some of the best buying opportunities that we’ve seen in a decade since coming out of the GFC. A lot of stocks were down 60%, 70% in the smaller micro-cap end of the market.
So we found some incredible buying opportunities through that March, April, May period. To call out a couple: Eagers Automotive Ltd (ASX: APE), one of the largest automotive companies here in Australia. We initially started buying shares in AP Eagers at $3.30 back in March. Shares today are around $15. So it’s performed very strongly for us.
Capital Health Ltd (ASX: CAJ), which I mentioned earlier, we started buying it back in April last year at 18 cents. It’s now 34 cents.
People Infrastructure Ltd (ASX: PPE), we participated in a placement at $1.10 and then bought more at $1.50 in April last year. Those shares are now $4.70.
So, there were a couple of really incredible buying opportunities that we saw coming out of that COVID sell-off. And that’s what’s really set up the performance that we’ve been able to deliver over the last 12 months — being able to buy into some high quality companies at very depressed valuations.
MF: At the time, was it nerve-wracking not knowing how we’d recover out of the pandemic?
MH: Oh, you can never be entirely certain. But when both the government here stepped in with JobKeeper and the Federal Reserve stepped in with a massive stimulus program in the US, that was a key catalyst for us.
I remember coming out of the GFC, we had QE one, two, three [rounds of stimulus] and they were big amounts of money that were going into the financial system. As part of the COVID response in the US, the amount of stimulus that’s been put into the market meets around 2.5 times QE one, two, and three combined.
So it’s an incredible amount of liquidity that’s gone into the market. And so, when we saw that occurring, we believed that that was going to be a big tailwind for the market.
The other thing that we noticed in probably late April, early May, was given the stimulus here in Australia — JobKeeper specifically, and also the ability for people to take money out of super — that was going to be very, very supportive of the retailers. We made some really good investments in some of the online retailers.
We sold a lot of them in August, September last year, but we had holdings in Adairs Ltd (ASX: ADH), Shaver Shop Group Ltd (ASX: SSG), Temple & Webster Group Ltd (ASX: TPW), Kogan.com Ltd (ASX: KGN), Nick Scali Limited (ASX: NCK).
A lot of those retailers performed really, really strongly through that period… It was very clear by looking at Google Trends, as an example, you could see that the hits of today’s online retailers websites were just growing at an incredible rate through that period. People were spending that stimulus money.
Don’t get me wrong, it was concerning in March — particularly for us, because we know we just launched a fund two months earlier. But as the market started to recover, we turned around and put money back in the market.
To put some numbers around that, at the end of March, we were holding 40% of the fund in cash. So we had increased cash levels in that final week of February and first couple of weeks of March.
We were preparing for an elongated bear market. And typically bear markets go for 9 months. We were preparing for a large global recession — so we were preparing for the worst. Then we had to pivot quite quickly in April when all of that large stimulus was announced.