Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Redpoint Australian Equity Income Fund portfolio manager Max Cappetta reveals how he would deal with three ASX shares that have had a shocker this year.
Cut or keep?
The Motley Fool: Now let’s see what you think about three ASX shares that used to be darlings but have fallen considerably off the perch this year.
Max Cappetta: Because it has fallen this far, we think that it is probably trading at a “more attractive” level than it has in the past.
Investors should bear in mind that that thematic of higher interest rates, therefore impacting the valuation of some of these stocks, is still there. So even though it has fallen, it’s more attractive. If it falls further from here, then it does in fact become quite attractive for the growth profile that the company has put forward it can achieve.
MF: Domino’s Pizza Enterprises Ltd (ASX: DMP) shares have more than halved since September. What are your thoughts?
MC: I think the disappointing aspect that we’re seeing through our quantitative analysis of their financials, is really the weakening of their profit margins over recent years.
We know that revenues have grown quite strongly for the company over the past few years. And we do know that the promise of their global growth ambitions, really, was to bring that incremental profit growth. And I think there’s just been disappointment about how that has actually been delivered and whether, right here right now, they can get back onto that path.
If there is that uncertainty, then that’s just going to depress the premium that investors are willing to pay for maybe less certainty around the growth of that company.
We do know just in recent weeks the company has moved to add a service delivery fee to try and combat some of the higher costs within the business. But, for us, that is a little bit of a stop-gap measure. What we still need to see is an underlying improvement in their operating efficiency, to really justify a much larger rebound from these price levels.
MF: And the quick-service restaurant industry is so competitive and commoditised, isn’t it?
MC: Yeah, absolutely. It’s that substitution effect, that, if I’m not going to take that one, I’ve got plenty of other options, both in terms of freshly made and also frozen varieties through the supermarkets as well.
MF: Sims Ltd (ASX: SGM) has lost 40% of its value since April. What do you think?
MC: Sims is a real interesting one here. I think for people that might recognise the name, they’ll know it as a metal recycling business. But I think maybe what is less well known is the fact that it really is at the forefront of this global drive to a more sustainable economy.
The company was founded back in the early 1900s and has really been mainly focused on trading in ferrous metals — iron and steel — as well as other metals, such as copper, aluminium, lead, zinc, and nickel. But I think the interesting element is the diversity that they’re now building, particularly in North America, around some of their electronics recycling and also their curbside recycling businesses.
Now I do take that it has been really a long-term underperformer relative to the market over many years. And that has been really in line with the volatility of iron and steel prices in the marketplace, which impacts the demand for iron, which is one of the key things that they obviously purchase and then recycle.
Now, I think this could be changing over the years ahead as the company diversifies into these recycling activities in a more broader sense. And as I said before, that ongoing focus on the transition to more sustainable global practices should provide it a tailwind.
Looking at it from an income perspective, it’s trading at a gross dividend yield of approximately 4%, which I think still remains attractive relative to interest rates available, notwithstanding that interest rates are on the way up, but we’re only at around 1.5% there at the moment.
It’s going to deliver a record profit in financial year 2022 of about $2 per share. Now we do note that expectations in 2023 are that profits will weaken slightly, back to around $1.50 per share, but this is still well ahead of the $1 per share that it made in 2018. And the share price is actually trading at slightly below where it was in 2018. So from a valuation perspective, we think that it is attractive, and maybe some people are staying away from the company due to its volatility. But as the business diversifies into these recycling and sustainable processes outside of the metals industry or related to it, they’re going to be able to provide a more diversified and consistent profit growth in the years ahead.