Investment Matters

The blue line, short but sweet and CML Group

Appen: short but sweet

This week we sold our stake in Appen – which over a short period has been an incredibly successful investment.  For the majority of clients, shares were purchased for $19 in early March and sold at an average price close to $30 this week.

This represents a return of over 50%.

It is unusual for us to realise an investment in such a short time frame; however, the investment was made during a period of very unusual market activity (a greater than 35% fall in the market).  We did not foresee just how quickly Appen’s share price would recover when the investment was first made.

Appen’s share price has benefited from the strong recovery of the Technology sector and outperformance of “growth” stocks more broadly.  However, it is largely the same company it was when we purchased it in March. Thus, it has become expensive relative to our valuation and its prospects even under more optimistic scenarios.

When a company’s share price exceeds what we see it is worth – we look to sell.  This is not to say we do not believe Appen is a remarkable company and would not own it in the future. The market can provide more than one opportunity to own a company for less than what it is worth.

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However, the same discipline responsible for a successful purchase is required for a successful sale.  The sale was at a price near the company’s all-time high, crystallising what has been a remarkable return over a short period.

Harrick Road: an update

Clients with an allocation to Alternatives have held an investment named Harrick Road Properties Pty Ltd.  We are happy to provide an update on the investment and announce that it has been added as a security in Property portfolios.

Harrick Road is a company which owns two industrial properties located in Keilor Park, Melbourne.

We are pleased to share that there has been a significant uplift in the value of these properties over our period of ownership, a result of significant improvements made to these properties and a rise in property values more broadly.  35 Harrick Road continues to be leased to Ferguson Plarre Bakehouses under a long-term lease.

During our period of ownership, we have also, in partnership with the Plarre Family, acquired land adjacent to the property (39 Harrick Road, Keilor Park) and carried out improvements and construction.

A major project was the development of a factory on the land at 39 Harrick Road, Keilor Park, which is now completed and leased for a long term (5 years +options).  The bulk of planned improvements and construction have now been completed.

As such, the characteristics of the investment have changed: it now carries less development exposure and is more in line with a pure property holding.Given this, we see that the investment can now be classified as a Property security.

There have been several transactions over the past few weeks as part of this reclassification process.  Harrick Road has been added as a new investment for several clients and reallocated or sold for others.

For further information about these transactions please contact your Strategist.

CML Group: scheme of arrangement update

On Tuesday, CML Group provided an update on the scheme of arrangement with Scottish Pacific (owned by private equity firm Affinity).  It announced that the scheme of arrangement will no longer proceed - by mutual agreement.

CML is a substantial position in portfolios, and this has had a noticeable impact on portfolio values.  Disappointment has been reflected in the company’s share price – as a small number of shareholders (approximately 5%) sold on the day of the announcement.  We, too, were disappointed by the termination of what was a binding scheme of arrangement.

However, CML’s value remains in place. We are confident in its value.

The company will continue to provide funding to its clients, much the same way it did before the bid. Its trading update indicates it has remained resilient through recent economic conditions.  As the economy reopens, it will benefit from significant growth in businesses’ demand for financing. It also has the ability to continue to grow through acquisition – which it has successfully done in the past.

In short, there has been no material change to our original investment thesis.  However, the time it may take for value to be reflected in its share price has been extended.  We see that CML’s value will ultimately be recognised, either on market or off-market (by another acquirer) - much in the same way it was when the takeover offer was made.

Incitec Pivot

Incitec Pivot released its result for the second half.  Operating performance of its plants was healthy during the period, with utilisation high. However, some weakness in commodity prices, particularly in fertilisers have reduced profitability.

This was partly offset by weaker natural gas prices – which was part of our investment thesis.  Furthermore, improved seasonal conditions (rainfall on the East coast of Australia) have strengthened demand for fertiliser and bode well for its fertiliser business.

Some cyclicality in commodity prices was always expected –Incitec Pivot’s share price often reflects short term swings in pricing. However, we purchased it with a longer time horizon in mind - it is cheap on a through the cycle basis.

The company also raised additional equity this week to shore up its balance sheet, given the decision to retain its fertiliser business. We participated on clients’ behalf.

An update on the “blue line” chart

Clients will remember the following chart from our CIO events in February:

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During the market selloff, we witnessed an even wider gap:

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Why?

Investors continued to pay higher prices for “growth” stocks (in relative terms) leading into and during the sell off.  This has been exemplified by the US market, where large technology stocks (FANGS – Facebook, Netflix, Amazon, Netflix and Google/Alphabet) have led much of the rally seen in the S&P500.

History would suggest this gap will revert at some point.  We have seen the beginnings of this in the Australian market as value stocks have started to outperform:

Relative performance of growth vs value stocks (ASX100 ex Resources)

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The chart above shows the performance of growth stocks relative to value. Post recovery, we are seeing the gap beginning to close (after the red dotted line).

Further reversion will depend on economic conditions: investors are worried about nominal growth of the economy and the impact of this on companies that generate variable cash flows.  These worries will ease as there is an improvement in economic activity and broader reflation of the economy.

This will likely flow on from the unprecedented stimulus and measures we have seen from central banks and governments and as the global economy restarts.  As this gap closes, those parts of your portfolio with a value bias, including companies in Energy, Financials, Industrials and Materials sectors should benefit significantly.