Written by Doug Jopling, Senior Investment Analyst and Portfolio Manager
Australasian Growth Fund
The Australasian Growth Fund was down 0.2% for the month. The technology sector was the laggard this month, while financials, consumer discretionary, consumer staples and materials outperformed.
In the portfolio, the IT stocks were generally flat apart from Empired Ltd, an IT services provider, which gained 11%. Given only a small current weighting in technology at the moment, the fund escaped the 10% fall that the general technology sector had. I did use the tech sell-off to add a new position although as it is quite illiquid, I only managed to get about a half of what I want, so will carry on buying slowly to avoid pushing up the price.
As mentioned, financials were the leading sector this month and my biggest contributor for the month came from this sector. Wisr, a fintech online loans provider, increased by 31% in the month after announcing a successful asset backed securities transaction which will lower the cost of its borrowing going forward. I also acquired a smaller stake in another online loans provider during the month.
Cyprium Metals, a copper mine developer, continued its recent good run by being up 18% for the month as the material sector outperformed. My mistake was not buying back some of the medium-sized gold producers in April which generally showed 20-40% gains in May as the gold price rallied back from recent lows. I have some smaller positions in some gold mine developers, but these will take time to bear fruit.
On the negative side, a couple of telecommunication companies dropped by 14% and 24% in the month, one on lower forecasts from a broker and the other falling in sympathy with tech stocks as it is more of tech company than an old-school telco. I used the weakness to top up one of the positions.
In terms of other detractors, Allegiance Coal, was down 14% after being up 39% the previous month. I also managed to exit an old illiquid position which I have been trying to exit for a while.
Written by Mike Ross, Portfolio Manager
Australasian Dividend Growth Fund
The Australasian Dividend Growth Fund returned 0.2% in May, outperforming the S&P Small Ordinaries Accumulation Index (NZD) by 1.15%.
Contributors to performance included Maas Group, Collins Foods and Uniti. EML Payments, Karoon and Macquarie Telecom detracted.
After a brief recovery in April for growth stocks, the market resumed its rotation out of growth and into cyclical companies during May. Rather than looking for ideas that tick the “growth” or “value” box, our process is focused on analysing business quality, earnings growth and finding a divergent view. Opportunities to buy high-quality compounders are not abundant after a strong run for equity markets. Fortunately, the fund holds a core of high-quality businesses that we believe can compound earnings at attractive rates with room for further valuation upside.
Feedback from company meetings and economic data suggest the strong domestic economic backdrop could be sustained for some time and is more than a post-Covid short-term spike. The fund continues to hold investments exposed to an improving housing market, consumer sentiment and business confidence.
In terms of portfolio news, Alliance Aviation announced that Qantas had exercised its option to take another five of its Embraer aircrafts under the recently announced wet lease agreement from late June. The Qantas services and resumption of work for Virgin will deliver strong earnings growth in FY22.
Eagers Automotive provided an update at its AGM that underlying profit before tax for the first four months of the calendar year were approximately $127m. Eagers continues to benefit from an extensive cost out program, gross margin expansion and a return to growth in the new car sales market. Some of the margin benefits are likely temporary but we believe the market is underestimating the sustainable earnings power of the business post its merger with AHG and with an improved economic backdrop. This earnings profile should be further bolstered through acquisitions, as flagged at the AGM.
EML Payments announced the Central Bank of Ireland had raised serious concerns with its risk and control processes. The shares finished the month more than 40% lower. While history would suggest the likelihood of EML’s licence being revoked is low, a negative outcome could be material given the gross profit contribution and the risk of wider scrutiny of the business.
Written by Chris Bainbridge, Head of Australasian Equities and Portfolio Manager
Australasian Emerging Companies Fund
May was a challenging month, with ECF finishing down 0.9% versus the Emerging Companies Index which was up 0.8%. A strong performance from resource companies combined with a market wide sell off in technology companies resulted in our slight underperformance.
Positive contributors this month included a new position in Access Innovation, Atomos and Bigtincan.
Access Innovation (AIM) is a global leader in the provision of high quality live and recorded captioning services. AIM listed in September last year and quickly fell below the IPO price of $1.23 as investors realised that it was a technology enabled services business rather than a pure technology company. We tracked AIM, but it was only the launch of Smart ASR and the acquisition of EGG in April which provided the catalyst for us to invest. Smart ASR and EGG are transformative.
Smart ASR: at the time of IPO, AIM used stenographs to deliver human-curated restreaming and captioning services that delivered 99.5% accuracy. Stenographs are expensive, both for the customer and AIM. Smart ASR (human-curated dictionaries) delivers accuracy rates of +98% with significantly less human involvement. This is a giant leap forward as +98% is the minimum level mandated by many customers and is vastly better than the 92% delivered by out-of-the-box solutions. Why does that matter? Smart ASR increases AIM’s TAM by lowering the cost of captioning for customers. At the same time it provides AIM with significant upside at the gross profit line. The attractiveness of Smart ASR for both customers and AIM has already been evidenced in the recently announced deal with Sky News.
EGG is perhaps more important than Smart ASR. EGG:
- provides AIM with an end-to-end solution by enabling the pairing ofcaptions with video and audio stream real time in any format to any device in multiple languages; and
- improves the quality and leverage of AIM’s earnings via its high margin SaaS revenue.
As investors, we’re paid to look ahead and based on consensus numbers (which could prove conservative), AIM’s trading 10x FY23 EV/EBITDA. For a high growth technology business with strong founder alignment and a market leading position, this is too cheap. You don’t need captions to understand that we’re excited about the upside ahead for AIM.
Detracting from performance during the month were Viva Leisure and Frontier Digital. Viva Leisure (VVA), a gym and health club operator, came under the pump when The Australian Financial Review reported that 53 franchisors had sent a draft statement of claim to VVA alleging breaches of geographical exclusivity terms within the franchise agreement. VVA is working with the franchisees to resolve the issue. The entire franchise business only generates 9% of FY22 group EBITDA indicating a small earnings risk in the event of disruption to this business segment. We’re confident of a work out here and continue to hold the position.
Written by Chris Bainbridge, Head of Australasian Equities and Portfolio Manager
Australasian Growth 2 Fund
Growth 2 finished the month down 8.7% versus its index which was down -0.9%. May was our worst month since Covid for two reasons: One, there was a market wide sell-off in technology companies; and two, unexpected events impacted two of our largest positions, EML and NEA. Combined, these cost the fund 6.5%.
What happened? EML revealed the Central Bank of Ireland (CBI) was undertaking an investigation into the recently acquired PFS business amid concerns of Anti-Money Laundering. PFS accounts for 27% of EML’s revenue. EML opened down nearly 50%.
How did we react? We analysed past CBI settlements, in particular, AML breaches. We then overlaid a discount for likely operational and reputational impacts. Our conclusion was that the market was confusing risk with uncertainty. Risk is the potential for loss. Uncertainty is the unknown. In the case of EML, while the ultimate impact of the investigation will remain ambiguous until CBI concludes its inquiry (high uncertainty), the potential loss (risk) should be much lower than the $800m discount the market was applying to EML’s market cap. Real opportunities for profit only exist in the face of uncertainty and such dislocations are rare, so we added to our position.
Where could we be wrong? A scenario of cascading failure. CBI could cancel PFS’ licence, causing other regulators to take actions which impact EML’s operations in those countries. However, cascading failure is dependent on compounding probabilities which are unlikely. Consequences are more important than probabilities. For example, no amount of money is worth playing Russian Roulette. The good news is that a scenario of cascading failure would take time to play out and we would exit before it did. We must make decisions using base rates, probabilities and prospective IRRs. The most likely scenario with EML is that the market overreacted, providing a rare opportunity to buy a great business at a bargain price.
Nearmap was the right process with the wrong outcome. Heading into May, NEA ticked several boxes (1) tightened guidance at 1HFY21; (2) significant director buying on-market and (3) competitor feedback that NEA was humming in the US. We felt confident NEA would upgrade and it did just that. However, investors barely had an opportunity to digest the upgrade before NEA’s competitor EagleView filed a patent infringement claim relating to NEA’s roof estimation technology. There’s a similar uncertainty vs risk trade-off playing out with NEA to EML. Patience will be required, but the IRR remains strong, so we remain a holder.
Unexpected events with two of our largest positions in a month required a rigorous post-mortem. EML was an unknown unknown (left-field event). NEA was a known unknown (aware of the possibility, but the same probability as Matthew Perry making a successful career comeback). Sometimes you can have the right process and get the wrong outcome. In terms of process, good ideas are rare. We run a concentrated strategy because being too timid about the few good ideas we have is the biggest mistake we could make. Of course, to take large positions, we have to be willing to be wrong. We were wrong this month (for unforeseen reasons), but we’re confident in the process and confident in the prospects for our companies.
Information is current as at 31 May 2021. Pie Funds Management Limited is the manager of the funds in the Pie Funds Management Scheme. Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Pie Funds Management Scheme investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a guarantee of future returns. Returns can be negative as well as positive and returns over different periods may vary.