How owning too much Afterpay (ASX:APT) was our biggest regret

Ask A Fund Manager: TMS Capital’s Ben Clark also reveals the 2 hottest stocks to buy right now.

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Ask A Fund Manager

The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In this edition, TMS Capital portfolio manager Ben Clark reveals his 2 hottest ASX shares right now and what he regrets about his Afterpay stake. Also read which two of his fund’s holdings are still going strong after 5 years.

Hottest ASX shares now

The Motley Fool: What are the 2 best stock buys right now?

Ben Clark: Another stock that’s been held for us since inception is Fisher & Paykel Healthcare Corp Ltd (ASX: FPH)

Now they have two key parts of their business. The first is they’re the world’s largest manufacturer, or one of the largest manufacturers, of breathing devices. So they had this COVID boom because of the demand [for] ventilators, breathing masks and related things. At the same time, they sell a lot of the devices that are used in elective surgeries, et cetera. So if your anaesthetist gives you a gas or something, it’s probably through some Fisher and Paykel devices. And that part of the business was a real struggle for them because we all know elective surgery went to zero in many markets around the world. 

But overall you’d have to say it boomed.

And then they’re the third largest player globally in sleep. So they compete against Resmed CDI (ASX: RMD) and Koninklijke Philips NV (AMS: PHIA), who own Respironics. 

They’re an out-of-cycle reporter — they reported in May an incredible result. I think it was like an 82% increase in NPAT [net profit after tax], but they actually got sold off because for the first time I can remember, they couldn’t give guidance. 

There was a good summary that your readers could look at in that announcement, which summed up the moving parts going on globally in hospitals and ventilator demand. Forecasting with COVID continually changing and different countries reopening and in lockdowns and battling the virus, trying to estimate what your sales look like in that environment, it’s almost impossible. 

So they did the smart and right thing, which is just to say, “Look, these are the things that could do well for us and might not do well for us.”

What they’re going to turn out to be is incredibly hard to say, and you’re going to have to do your own work to an extent. I believe with the Delta outbreaks we’re seeing around the world, the demand for the ventilators is still going to be better than [expected]. The market was saying, “Look, no one’s going to need any more ventilators. We’re getting past COVID.” But I think that has changed somewhat.

Then the sleep business, which was a real battler during COVID as Resmed found, to me is going to be a big winner out of the Respironics recall. It just doesn’t, to me, feel like that’s being factored into the share price at the moment. 

We’re seeing Resmed’s risen 30% or something over the past couple of months. Fisher and Paykel’s gone sideways. 

In a market where growth stocks are hot again, I think now if we had this call 3 or 4 months ago, I would have said 15 of our 20 stocks look like really good buys. Now it’s probably less than 5 just because the prices have re-rated. But Fisher and Paykel’s one that doesn’t, to me, look like it has.

The second one is actually probably the newest stock in the portfolio, which is a business called Deterra Royalties Ltd (ASX: DRR). It is the only resource stock that we own in the portfolio. 

This is a really interesting company. It is the first mining royalty company to trade on the Australian stock exchange. It was spun out of Iluka Resources Limited (ASX: ILU) last year. Pretty much its only asset is a royalty stream over a mine called the MAC, which is one of BHP Group Ltd (ASX: BHP)’s biggest iron ore mines in Western Australia. It gets 1.232% of revenue that is pulled out of that mine. So there are about 57 million tons of iron ore being produced each year. This mine has a mine life through to the 2070s, it’s estimated at this stage.

So times 57 million by whatever you think the iron ore price will sustainably be by 1.232%. And you get a number. 

Normally that would be interesting to us. But because it’s such a capital light business, it literally does not have to do a thing to get sent a cheque from BHP every quarter. I’ve never seen anything like it.

MF: Considering how dominant mining is in Australia, it’s amazing that it’s the only mining royalty company on the ASX, isn’t it? 

BC: Yeah. But think about where some of the wealthiest Australians have got their wealth from. It’s mining royalties. You look at the Hancock families. Gina Rinehart. I think the best ones are privately owned. And it’s almost like an infrastructure-style business where you’re kind of clipping the ticket.

But where the real excitement lays for us is that BHP has completed, after several years, the expansion of the MAC. And over the next 2 years, we’ll move from producing 57 million tons to 146 million tons of iron ore per annum from this mine. And so the max royalty is going to triple over the next 2 years. 

But the question mark is what will the iron ore price be? We think the iron ore price will be a fair bit lower over the next couple of years than where it is now.

But with the tripling of the production, we still think the profit of this business could materially be higher. And we don’t think the market is looking. I tend to find the market at best looks 6 to 12 months ahead… It’s just a bit too far outside the time zone for it to start getting priced in. So that’s one that I think looks pretty good.

ASX share to buy and hold

MF: If the market closed tomorrow for 5 years, which stock would you want to hold?

BC: This is probably not the most exciting answer in the world, but it would be CSL Limited (ASX: CSL), which is the third largest holding in the fund. And again, it’s been held since inception. 

I picked that one because I think, come hell or high water, whatever gets thrown at us over the next 5 years that you couldn’t do anything about because you couldn’t trade the shares, it is a business that is incredibly resilient. You can sleep well knowing CSL will come through it because it has the balance sheet [and] the industry it operates in is forecast to continually grow. 

In the short term we think it looks good because we saw plasma donations across the United States dry up over the last year. Unfortunately, when people go and donate blood in America through CSL’s collection centre network, most of the people are poor. The United States is one of the only Western countries that will allow companies to pay for people’s blood. The reality of COVID in America last year and probably to this day to a lesser extent, is that most poor people in America don’t have health insurance. And if you got COVID, there was a really good chance you would die. And so, to get paid $100 to donate blood or maybe die, people just weren’t turning up to donate.

Also, [President Joe] Biden sent out $3,000 or $4,000 to every household. So there was cash coming in to this demographic. And that was a real issue for CSL. At the same time elective surgery around the world was cancelled. So there was a bit of a drop-off in demand for the blood products. And there was more cost in running the centres. People had to be spread further apart. They had to pay more to the people working in the centres. They had to clean the centres more frequently. 

Everyone goes on about the vaccines with CSL, it’s a good part of the business. [But] it’s not going to really turn the needle. It’s the blood collection business that’s the engine that drives CSL and that’s had a really difficult year and it should start to accelerate.

So I think you’ve got short-term earnings growth starting to go again, but if the market closed for 5 years, I just don’t think you’d lose a night’s sleep knowing you can’t trade CSL.

Regrets, I’ve had a few

MF: Is there a move you regret from the past? For example, a missed opportunity or buying a stock at the wrong time or price.

BC: Oh, look, there have been plenty. There have been so many, I couldn’t even narrow them down. 

I would look back and say we started out talking about Afterpay Ltd (ASX: APT). Skimming that down to what we thought was a good risk-adjusted position, that killed us in hindsight. 

If we just held what we originally owned… The fund’s done 15.5% per annum since inception — it probably would have been closer to 20% just on that one stock, as crazy as that sounds. That’s quite extraordinary. 

Your mind tells you things are cheap when they fall, and they’re expensive when they rise. If I look back and thought, “What’s the mistake that has been made?” it’s probably been trimming winners or selling a couple of winners and putting that money into things that you felt hadn’t performed as well, were looking cheaper, and might have a bit of a catch-up. 

Almost inevitably that doesn’t work out the way you think it’s going to. The winners keep going up and the ones that have struggled and you perceive to be “cheaper”, actually aren’t. They might actually be more expensive because the market is onto a change that’s happened with the business.

One I’d put into that category that has been a poor performer for us, has been Appen Ltd (ASX: APX). Now we did skim some money out of Appen in the high $30s. So that was good. And sometimes trimming your winners does work, but we did go back to it after it fell, when it continued to fall. And clearly the issues that it’s facing, particularly [the] suspending of its big customers, has lasted longer than we thought it would and has affected the business to a bigger extent than we thought.

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Motley Fool contributor Tony Yoo owns shares of AFTERPAY T FPO, Appen Ltd, and CSL Ltd. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and has recommended AFTERPAY T FPO, Appen Ltd, and CSL Ltd. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has recommended ResMed. The Motley Fool Australia owns shares of and has recommended AFTERPAY T FPO and Appen Ltd. The Motley Fool Australia has recommended ResMed Inc. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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