This week: a recap
We touch on three topics this week, beginning with a pleasing update from CML Group – a larger position in your portfolio (which we discuss below).
We also discuss the run up we have seen in Technology stocks - which are looking increasingly expensive.
And while Tuesday may have been Groundhog Day for Melbournians, the Australian share market was less perturbed, ending the week (to Thursday) slightly lower (-1.5%).
Our thoughts on What Mattered this week below.
A positive trading update from CML Group
One of the disappointments of FY-20 was the failed takeover of CML Group (First Samuel holds 17.1%), despite proceeding past an agreed scheme of arrangement with the private equity backed Scottish Pacific.
In our recent CIO update we spoke of the fallacy of concentrated ownership in small illiquid companies. One of the limitations of such positions is the difficult path to realising value; shares either need to be sold over a very extended period, or the company needs to be acquired.
The CML Group position, along with our concentrated ownership in Paragon Care (First Samuel holds 11.1%), are both strong positions in good underlying businesses, but in the absence of takeover interest, or strong markets, they will likely trade at a discount.
For this reason, it is critical their operations maintain strong performance.
We were therefore pleased with an update provided from CML Group this week, which follows the pleasing update from Paragon in recent weeks.
After a disappointing FY-20, CML Group’s share price is now more than 20% higher for the financial year to date. While lending volumes were subdued during the lockdown period, the company has seen momentum as much of the country comes out of lockdown and has developed a strong customer pipeline.
As we discussed last week the strong government support for small business and those directly impacted by COVID, provides a set of conditions in which CML’s core business can grow strongly in the next 12-18 months.
A sign of the health of the business is that despite prevailing conditions, it will pay a fully franked dividend for the full year. This dividend represents a 6.5% yield on the company’s current share price and an annualised yield of over 12%.
Overclocked: technology stocks
We are seeing some exuberance creeping into pockets of the market again.
This is a symptom of a market that in general is beginning to look more expensive. We have subsequently modestly increased the weight of cash in the portfolio (by approximately 4%).
We point to the rise we have seen in the technology sector since the bottom of the market in March, which has been stunning. Australian and US Indexes are now 9% and 16% above their previous peaks.
During the recovery, your portfolio benefited from an exposure to the Technology sector – through holdings such as Appen and PushPay.
We liked these names (unlike many companies in the sector, they generate strong cash flows) and were able to purchase them at a discount to their fundamental value when the market fell, having previously had little exposure to the sector.
PushPay has been one of the better performing stocks on the market and in the Australian Equities Portfolio over the last 3 years, delivering a 150% return since first purchased:
Source: IRESS, First Samuel
Your portfolio's exposure to the sector during the recovery (including profits and the initial position) which has been in line with the market.
And while these stocks have not gained the notoriety that some of the indexes other constituents have, the profits were larger than the standard contribution Technology stocks made to the index.
Source: IRESS, First Samuel
However, in our view the sector has now become expensive and overbought. While the chart above tells part of the story, the selling of shares by founders of many of these companies over the past month (such as Afterpay, Appen and Wisetech) speaks volumes.
Some of this exuberance has been reflected in the share price of your companies, which have rapidly approached our price targets. We have subsequently trimmed your exposure, beginning in May. This included the sale of stake in Appen last financial year and reducing your position in PushPay over the past few months.
Putting some numbers around Melbourne’s lockdown
While the return to lockdown for Melburnians for the six weeks is not the outcome we all hoped for, it is worth putting some numbers around how this relates to the broader share market.
While the ultimate impact is difficult to forecast, estimates are that 15-20% of the ASX200’s earnings likely to be impacted by the lockdown (Source: MST Marquee). Assuming the lockdown lasts for six weeks and all profits were erased, this would be less than a 2-3% hit to aggregate earnings.
Your portfolio has a relatively small exposure to what we see as non-defensive domestic earnings.
These exposures play a role as part of a broader portfolio. They will equally benefit from an improvement in conditions and sentiment, as the burden of the virus eases and as the economy improves. This is more than offset by exposures which may benefit under these conditions, such as exposures to Gold, Consumer Staples, Health Care and is buttressed by a higher cash holding (now 12%).