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, Elvest Co portfolio manager Adrian Ezquerro nominates two ASX shares that he'd be happy to hold for years to come.
The ASX share for a comfortable night's sleep
The Motley Fool: If the market closed tomorrow for four years, which stock would you want to hold?
Adrian Ezquerro: This is a really good question. I must admit it's something I've thought about. Being an analyst, you think about these sorts of things and having been well read in Warren Buffett, it's something I've considered for a long period of time.
I actually tend to think about this in two different ways and maybe that might be a bit strange. But anyway, without being too crass, firstly I think about a scenario where I'm asked about what would happen if, say, I was hit by a bus and I had to nominate one stock to leave to my wife and kids. This is the first way that I would frame it.
With that in mind, this would obviously need to be a stock that's got a great long-term track record. It's a strong, well-diversified business, it still has some long term growth potential, but has significant downside protection and preferably pays a regular dividend income.
It's in this context I'll nominate Brickworks Limited (ASX: BKW). Brickworks has three core divisions. That's investments, industrial property and building materials, as the name suggests.
The investment division is basically a 26% shareholding in Washington H Soul Pattinson and Co Ltd (ASX: SOL), and that's got a market cap in excess of $9 billion. And that provides exposure to high-quality assets across telco, energy, financial services and basically the industrial sector of the Australian economy. That's the investment division.
The industrial property division largely sits within a 50-50 joint venture Goodman Group (ASX: GMG). Brickworks is a massive landholder and over time they vend industrial property into that JV and that then becomes a trust. That's developed into industrial assets and it's leased on long-term deals to the likes of Amazon.com Inc (NASDAQ: AMZN), Coles Group Ltd (ASX: COL), Woolworths Group (ASX: WOW), et cetera. That's highly valuable itself.
For context, the current market cap of Brickworks is about $3 billion. If you were to have $3 billion and you were to buy the whole company, you would get that shareholding in Soul Patts, and that's worth about $2.4 billion at current prices. The net assets of the industrial property and Brickworks' share of that's about $1.5 billion. Then you'd get the net tangible asset base of Brickworks building materials business, which minus group net debt is worth a few hundred million.
In total, you get asset backing of about $4.2 billion, which is close to $28 a share on a pre-tax basis. The current market price is between $20 and $21, and for that you get exposed to a really high-quality diversified portfolio at what we feel is a substantial discount to fair value.
And that's for a business that has consistently grown its ordinary dividend for, I think it's something like 45, 46 years consecutively. That's a remarkable achievement. It's quite rare in the Australian market.
I'd say, on a relative basis to my second stock that I'll mention, it's a lower-risk option and certainly more stable with downside protection.
Now, the second way that I tend to think about this type of question is what's a stock that's highly likely to substantially grow its earnings in the coming years? And, of course, the extension of that is, what stock might have multi-bag potential?
In this context I'd probably highlight the stock RPMGlobal Holdings Ltd (ASX: RUL). RPM is a leading provider of mine planning and operations software and that's mainly to global tier one and tier two miners, many of which you'd know. The likes of BHP Group Ltd (ASX: BHP), Rio Tinto Limited (ASX: RIO), Glencore PLC (LON: GLEN), et cetera.
Their products basically improve the efficiency of mining operations. In many cases, it replaces more manual legacy processes with more efficient software solutions.
For context, its market cap is about $350 million. It's got close to $40 million in cash, so it's a well-funded business and the CEO has got a pretty good track record. He's invested quite heavily over the past decade in evolving this business and its software solutions so that it's now really well positioned as a vendor-of-choice for major mines.
One of the most significant developments, though, in RPM's recent history is that it successfully transitioned its revenue model from a perpetual licence model to a subscription revenue model.
This is really powerful and it's important to understand in the context of its recent results because as you take out the value of the more lumpy perpetual sales, which have a higher one-off dollar value, and you transition that to a subscription revenue model, that has implications for your year-on-year cash flow. What it does [is] it clearly embeds longer-term value in the business.
They're now about to see the fruits of all that labour. If you look ahead, its revenue base now from a software division is largely recurring and it's now pretty well established in the operations of BHP, Rio, Glencore, and many, many others. We actually see scope for substantial further contracts in the next 12 to 24 months. And for the first time in many years, management has actually provided guidance for the year ahead and I think that reflects their confidence in this pivot towards subscription revenue.
They guided to EBITDA of $14.2 million in the coming year, and that's up from about $4 million achieved in FY22. And we actually think that that might, firstly, prove conservative and we're also expecting even more growth in FY24 given the timing of new contract awards.
You've got a scenario where you've got pretty explosive earnings growth, cash generation we expect to be really strong and… backed by growing recurring revenue profile. That's pretty exciting. Again, it's not without risk, but if it's executed to plan, we expect that the stock may do pretty well over the next four or five years.
MF: The company was founded in 1968, which is quite old for a software company, isn't it?
AE: Actually it started as an advisory business and RPM itself, the initials of some of the founders, it evolved out of an advisory business and that advisory business still exists today.
I know I've talked about the software division, but that in itself has done pretty well in recent times and they've now got an ESG division, which as you can imagine, is seeing a lot of growth in demand.
MF: That's great. One safe one and one exciting one to hold onto for the next four years.
