Fund Reviews: Australasian Funds

Monday 7 October, 2019

Fund Reviews: Australasian Funds

Written by Chris Bainbridge, Senior Investment Analyst and Portfolio Manager

Growth 2 Fund 

G2 was up 11.46% during the quarter vs the Australian Small Ords which was up 3.11%.

G2 has had a strong run recently on the back of a satisfying win/loss ratio and solid contributions from EML Payments Limited (ASX:EML) and Megaport Limited (ASX:MP1). However, I caution against extrapolating recent returns into the future. Markets have been supportive and this won’t always be the case. Even with a supportive market, I make mistakes. Below, I summarise a detractor which cost G2 -1.3% and what I learned.

When investing, it’s important to be right, but it’s much better to be right at the right time. I believe I’ll achieve the former with Gentrack Limited (ASX:GTK/NZX:GTK), but I haven’t achieved the latter. Gentrack provides mission critical software to utilities and airports globally. I first invested in GTK at $2.45 in May 2016. It was a good investment and I exited around $7 in June 2018 on valuation grounds.

In November 2018, Gentrack downgraded expectations for 2019 due to project delays leading to a significant de-rate in the share price. Gentrack then downgraded expectations further in February 2019. I re-entered Gentrack at $4.65 in March 2019. My thesis was that the market was underappreciating three key points:

  1. GTK’s significant global growth opportunity; 
  2. the change in GTK’s pricing model; and
  3. GTK’s impressive customer retention.

Since re-investing, GTK has downgraded twice more, the first based on further project delays in the UK and the second due to bad debts associated with smaller UK customers entering administration. Where did I go wrong? First, I invested too early / position sizing. Downgrades generally come in threes not twos. With hindsight another was likely and I didn’t place enough weight on this outcome. My first investment in Gentrack had made me too optimistic. I should have taken a smaller position to begin with and added to that position as the investment thesis played out. What’s the lesson? Leave picking bottoms to monkeys.

Secondly, better analysis. Deregulation of the UK energy market has created a significant opportunity for Gentrack. How? Deregulation has opened the UK market up to new entrants which use Gentrack’s software as it allows them to service customers at a lower cost than the incumbent Big 6 energy suppliers. Deregulation is also forcing the Big 6 energy suppliers to consider Gentrack’s software in order to compete with the new entrants. I believed the sector would consolidate, but I failed to appreciate the impact the Darwinian process of weeding out the weaker challenger brands would have on Gentrack’s FY19 earnings. Note, the customer bases of failed challenger brands are generally acquired by other Gentrack customers, so there’s no long-term impact.

In summary, the impact of political uncertainty in the UK, industry consolidation and the change in Gentrack’s pricing model are timing issues. I believe that the combination of Gentrack’s high recurring revenue growth (27% yoy at 1HFY19), large reinvestment runway (I estimate it has 7% share of its current markets), strong customer retention (98%) and balance sheet flexibility will lead to a substantial re-rate over time. However, in the short term, less hubris, better position sizing and sharper analysis could have achieved a better outcome.

 


 Written by Doug Jopling, Senior Investment Analyst and Portfolio Manager

Growth Fund 

The fund rose 10.0% for quarter ended 30 September. 

Over 60% of the stocks in the fund gained in the period; a couple fell (but were not large positions) while the remaining stocks were largely flat. 

Top contributors during the quarter were iSignthis (ASX:ISX), EML Payments (ASX:EML), Red 5 (ASX:RED) and Maquarie Telecom (ASX:MAQ). iSignthis, a fintech company acquired in February, increased ~43% over the quarter, although at its highest was up ~150% (equating to a ‘10 bagger’ meaning the price was 10 times the acquisition price). The company has been very volatile in September/October, with allegations in the press of governance concerns. We have taken profits by substantially trimming our holding, including selling some close to its peak (it currently represents just 0.14% of the fund). This example shows the importance of taking profits on the journey up, especially in this case when it climbed so rapidly.

Main detractors to performance were Universal Coal (ASX:UNV) and Australis Oil & Gas (ASX:ATS). Universal Coal fell after a non-binding bid for the company was withdrawn.

We exited positions in Aveo Group (ASX:AVEO), Fenix Resources (ASX:FEX) and Stanmore Coal (ASX:SMR). AVEO and Stanmore were exited when bids for the companies materialised and Fenix was exited to lock in profits, after iron ore prices fell from their recent highs. We have also initiated a position in Cardinal Resources (ASX:CDV) an African gold mine developer.

  


 Written by Chris Bainbridge, Senior Investment Analyst and Portfolio Manager

Emerging Fund 

ECF performed well during the quarter, up 11.3% vs the Australian Emerging Companies Index which was up 13.7%. 

We note that the index has a high weighting to materials and energy which are sectors we typically don’t have exposure to, but which performed well during the quarter.

Key contributors during the quarter included Atomos Limited (ASX:AMS), Somnomed (ASX:SOM) and Konnekt (ASX:KKT). Key detractors included Universal Coal (ASX:UNV) and Rhipe Limited (ASX:RHP).

We mentioned in our last quarterly update that we had initiated a position in Atomos Limited. AMS is a founder-led video technology company which designs, develops and commercialises video monitor recorders, a device which, when used in conjunction with a video camera, significantly enhances quality and recording/monitoring capabilities. We significantly added to our position as part of a sell down / capital raise at $1 on 1st July and the stock has performed strongly since, up 52% at the time of writing. Content and video creation are now migrating into professional consumers in the social space and AMS is uniquely positioned to capture this burgeoning opportunity. Blue chip partnerships with the likes of Apple and Adobe coupled with almost cult like feedback from customers bodes well for the future as AMS looks to double its product range over the next 12-24 months.

Blue chip partnerships with the likes of Apple and Adobe coupled with almost cult like feedback from customers bodes well for the future as AMS

Rhipe Limited has been a strong contributor to ECF, rising from just over $1 to closer to $3 in the past year. RHP reported a strong result, beating market expectations across all key operating metrics. RHP also guided to operating profit of $16m in FY20, which was in-line with expectations. However, RHP tempered that this guidance was subject to investment in the recently announced JV in Japan with management guiding to spend of $2m-$3m in FY20. This disclaimer has seen RHP’s share price come under pressure. We’re holding. Although RHP has certainly done much of its re-rating from a multiple perspective, it continues to offer significant optionality including: 

  1. potential earnings conservatism (to put it in context, operating profit of $12.8m in FY19 compared with initial guidance of $10m), 
  2. a large net cash position with potential to deliver an extremely accretive acquisition, 
  3. upside from Japan which the market appears to be discounting, and 
  4. further vendor additions.

 


Written by Mike Ross, Senior Investment Analyst and Portfolio Manager

Dividend Fund 

The Dividend Fund returned 11.3% during the September quarter versus the benchmark return of 3.1%. The fund held an average cash balance of 32% over the quarter with market hedging.

Data#3 (ASX:DTL), Baby Bunting (ASX:BBN), Eclipx (ASX:ECX) and Austal (ASX:ASB) were the largest contributors to returns during the quarter. Vista (NZE:VGL), Midway (ASX:MWY), SRG (NYSE:SRG) and market hedging detracted from performance.

The fund navigated the August reporting season well. The best performing stocks tended to be the higher weighted positions and detractors were lower-weighted/conviction ideas. There are important lessons to be learned here, including backing best ideas and following process to justify holding lower conviction positions (or selling them).

The fund favours investment opportunities that fall into one of three buckets:

  1. Businesses undervalued by the market that can achieve a “re-rating”;
  2. Businesses that can grow earnings above market expectations;
  3. Great businesses with tailwinds at a reasonable price.

It is always hard to find businesses in the third category, especially after the market has enjoyed a good run.

There are opportunities to invest in businesses with prospects of a valuation re-rate but these are weighted to cyclical industries such as retail and mining services. The fund does have exposure here although it is hard to have conviction about businesses very exposed forces outside of their control. Therefore, when hunting for opportunities in this space we look for attributes that can help to withstand a deterioration in the macro.

Baby Bunting is a good example of this. The company has a strong store roll-out program that is likely to be upgraded, an improved competitive landscape, margin upside and arguably a more defensive product category.

Comparing Baby Bunting to the investment framework above, the company ticked two of the three points:

  1. We first invested in Baby Bunting in mid-2018. The company was a “fallen-angel” at the time, having been de-rated by the market following a number of earnings downgrades caused by the impact of competitor closures. My view was that a normalisation of operating conditions would lead to a re-rate.
  2. We believed analysts had become too pessimistic on the potential earnings of the business.
  3. Retail is competitive industry and earnings are volatile, so it is rare to find a retailer that is a great business. A strong management team and the characteristics above gave us the confidence to invest.

Baby Bunting’s shares are up by more than 60% since the FY19 result and almost 140% since our original purchase. We’ve taken profits to trim the position and will continue doing so, depending on price.

DivFund Article

 

Past performance is not an indicator for future performance. This is not intended to be financial advice and does not take into account any particular person’s circumstances. Before relying on this information, please speak to an independent financial adviser. Pie Funds is the issuer of the Pie Funds Management Scheme. For access to the PDSs, please click here.