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It’s always fun when people who earn their daily bread scanning share markets decide to share their very best ideas with you. I got together with old pal Jarrod Cahn, resident stock picker at Credo in London, and his boss Deon Gouws to talk about the firm’s equivalent of the Big Five. We focused on their views on the FANGS, Oracle, Apple and IBM but then around eight minutes in Jarrod shares his five best opportunities – shares which at the very least are worth further investigation. Some surprises among them, including a global gaming business that operates primarily in the gambling-crazy Far East. – Alec Hogg
Jarrod Cahn, then a director at Chan Shapiro, a stockbroking firm, was a regular guest on my radio show in South Africa during the late 1990’s. That was the time of the internet boom, high flying stocks whose prices rose ever higher and of course eventually came down to earth. Jarrod is now the resident stock picker at Credo in London where he scans the world’s markets. Most of this interview focuses on Jarrod’s top five favourite shares, but for context we kicked off with his colleague, Deon Gouws, who’s the Chief investment officer there, asking him whether the Dutch election results signal Europe’s political populism has now peaked.
Not really. I think there’s a difference between Northern Europe and Southern Europe. I think Northern Europe has more money, they have more of a reason to keep the EU together, and they’ve always been a bit more liberal. If we see a similar result coming out of Italy later in the year, then I’ll buy it, but at this stage I think the populism trend is still on track and I think Europe is still under threat.
What people are forgetting is if you go back to 2012 there has definitely been a swing towards the tree people, in other words, the more populists and the people who want more sovereignty and anti EU, but not as bad as it had been anticipated before the election.
Yes, there have been a few results of late, of course, that has been consistent with what you’ve just said. It’s not only the Dutch yesterday; it was also Austria towards the end of last year. So there’s been a few examples to the contrary, but I think the populism argument is with us to stay for some time and if you analyse this with a bit of hindsight now, a lot of it, I think, goes back to the much celebrated and not so widely read book of Piketty a few years ago, the whole inequality debate, which has really kicked off a lot of this discussion. I do think it’s an important factor. I still think it’s hugely ironic that the person that won the US election on a populist vote was a billionaire who then went and staffed all his advisory panels with ex-partners with Goldman Sachs but I guess that’s a debate for another day.
Jarrod, we’re going to talk more specifics now. Do you even look at South African shares, given that you have the whole world to choose from?
To be honest, we don’t. A lot of the reason is the demographic of our client base. They want international exposure, so they’re trying to get away from say, the South African market. Having said that, from time to time there are some great companies that have screened very well and because they are great global international businesses, we will look at them. Although, we don’t own any of them now, obviously some of the commodity players in the past, the likes of a BHP or an Anglo’s, a Richemont stands out, you always have Naspers, which is a favourite, but as it stands today we own no South African names.
So, the best ideas that you have come up with out of those hundreds of shares which have been screened from thousands or tens of thousands of shares, are they primarily in the US or in the UK or in Europe?
What’s tended to happen over the last three years, is we have fortuitously been more US based, so we’ve had the double whammy of the strong US market, strong currency and obviously it’s all played out quite well. I think what’s quite interesting though is that if we look at some of our most recent picks, there’s definitely been a trend to start buying UK stocks again. At the moment, just to give you an idea, we have about 48% of our portfolio in US denominated stocks. About six months ago there was as close to 75%, so we’ve been trimming back that holding. It hasn’t been something that’s been thought about, it’s just happened. Valuations have got a little bit ahead of themselves and some of the names that we’ve owned and clearly some of the UK names have screened much better from a value perspective.
The big question in the last few years is did you have any of the FANGS, Facebook, Amazon, Netflix, or Google?
The answer to that is, no; again, given the way we screen for stocks, fortunately, or unfortunately, however way you want to look at it, they just don’t screen on a value type base. I mean you can argue about quality, you can argue about growth, it’s not what we’re involved in and it’s not picking up the ‘stompies’ so as to speak, it’s not that kind of deep value investing, but the closest we’ve got to buying one of those four names is Google, which looked cheap for a time. We were unfortunately, worried about the growth of the advertising and that’s now come through and they’ve actually managed to diversify the business much better and we’ve missed that one.
The only two tech names that I would say that we do own, one is Microsoft, which we’ve owned since inception and that’s pretty much travelled since we’ve owned it and it continues to be a core holding in our portfolio, but again looking at valuation today, it’s not as cheap as it used to be. The other name we own and it’s quite topical right now is Oracle. We’ve owned that in our Special Opportunities Portfolio and in our fund. It’s all about cloud computing and the fact that Oracle, the valuation today is very much where Microsoft was three, four years ago.
We think it could be an inflection point and you’re not paying much for a potential rerating and so if there’s follow through in terms of the cloud-based growth, you could be buying a stock which trades at a huge discount to the tax sector at a discounted S&P, is a technology name, and although it has many legacy issues, could be in a new growth sector or area, so we’re quite excited about a name like that.
The ultimate value investor, Warren Buffett has two tech stocks now, Apple and IBM; you have them in your portfolio?
No. Apple we owned for a long time, we sold it about 18 months. We sold it slightly early, we sold at $100. I think it then went up to $130 and then came back down to $95. We have this internal debate about Apple because Apple does screen quite well as a cheap stock, let’s put it that way. The worry we have with Apple is the whole issue about commoditisation of their product. Some will argue it’s a luxury stock, some will argue not. It’s just having seen the trend of businesses like this, when you have such high margin businesses, those kinds of competitive advantages get diminished away through time. We worry that unless Apple can continue innovating, the premium rating that they have, or the premium competitive advantage and margins they have will be diminished away.
You’ve seen companies in China that have very much a look alike Apple see to it that are trading at $300 a unit as opposed to $700 and you kind of question will people who are not subsidised by the big Telco’s actually pay the $700 when they’re not getting the subsidy and the worry there is that without innovation Apple may lose the edge. Either they stop selling quantity or they have to cut their margins and that’s kind of been the argument for the last 18 months. Clearly there’s been a nice uplift in the share price recently. Everyone’s getting quite excited about growth rates again and you’re seeing all the analysts rerating the stock. We’ve stayed away from it and it’s unlikely we’re going to be investing in it.
What about an IBM?
Again, IBM does screen quite well. We worry about the business as a potential legacy business in totality. There are many moving part to IBM. I think the consultancy side of the business is a very good business and you compete with the likes of Accentua and you see the multiple that an Accentua gets, but there are so many other bits to it, the hardware side, the sale side and it’s very commoditise and we’ve been tempted at times, but we just think that technology is a difficult space and long-term, although they’ve had an incumbent position for so long, it’s unlikely that there’s going to be too much growth in the business, so we’ve just stayed away.
Well, that’s what makes a market. Dion, do you guys always agree on these kinds of issues?
We don’t and I remember seeing a presentation once by Peter Drucker, where he said, “If you run a team where everybody agrees with you, you have to fire most of them because you don’t need more than one of the same opinion in the room at any point in time”. I think it’s a bit of an extreme version of the argument, but I think there’s some value in it.
All right, let’s get your five best ideas from your Best Idea Fund.
These are long-term investments. I can’t tell you it’s catalyst based on a six month basis, it’s long-term over a period of time. We like, in the UK Babcock International FTSE 100 company. It’s a fairly unloved business. You may know it because it has a South African edge to it although it’s a very small side of the business. So support services, they help the military, they have a helicopter business, they have a railway business, they do nuclear plants decompressions.
The perception here is UK, you think of government contracts, you think of austerity, you think of military budgets being actually cut and people want to stay away from that, but when you start drilling down into the business, you actually realise they have significant long-term contracts that are underpinned by quite healthy margins, granted there have been parts of the business that have been suffering. You’ve had a helicopter business or support for the army in Europe which has been a bit soft, but you have a business basically that’s trading on a 10/11 times multiple on a very healthy dividend yield.
When you look at it in terms of the negativity in the market, you have quite a lot of downside protection and again, when you start drilling down, you actually realise that the UK government’s actually held its defence spending every year. The companies that they’ve contracted with have actually helped increase their margins, so they’ve actually been quite supportive in those cases and other parts of the business is cyclical. They’ll come right and it’s already been discounted. So that’s a name that we think screens very cheaply, it’s a bit unloved at the moment, supported by a nice yield and you have some downside.
We have the first one, how about number two?
Number two is a bit of a softer play, it’s more consensus, Wells Fargo, I’ll go for Wells Fargo in the US.
So, you do like Buffett.
I do like Buffett. Clearly there are a number of stocks we do own that he owns. Wells, again, slightly controversial in the sense that if you’ve followed them in the past year, or 18 months, they’ve gone through a bit of a nightmare situation where there’s been impeachment, there’s been scandals, they’ve had to sit in front of committees in the US, they’ve had their chairman, the CEO resign to give back $50mn of his payment plan and the scandal basically leads to what we think is opportunistic investment and the reason we say that is Wells Fargo, in terms of their franchise and in terms of their positioning in the US banking system are still a gorilla and that’s unlikely to go away and what you’ve learnt in this market, that investors have a short memory.
You think of Goldman Sachs, I don’t even know many years ago, but Blankfein was in front of the TV making a mockery of the system, everyone hated Goldman’s, yet a few years later everyone still loves Goldman’s and the share price is reflected and I think when you have opportunities like that where great brands and quality businesses are knocked down on short-term scandals, you’ve got to look intrinsically over the long-term as to whether they are buying opportunities.
So you’re in a situation now where the banking sector doesn’t necessarily screen that well in the US because after the Trump victory you’ve had a massive rerating of a lot of these stocks because of deregulation in the sector, but yet, Wells Fargo, which was a stock that always traded a premium to the banking sector pre the scandal is not only trading at a significant discount to the banking sector, but actually a discount to the S&P as well. So we think that’s just a pricing anomaly and if you have the stomach to hold these stocks through some negative short-term headlines over the long-term, these things reprice, and I think there is a gap in a stock like that.
Nice one and it is Buffett’s biggest shareholding by quite some distance, almost $30bn he’s got in it with Apple, number two at 19, so you’re in good company there, number three?
Number three, again slightly controversial stock, Sainsbury’s in the UK, one of our most recent purchases. The reason I say controversial is you mention anything retail in the UK and people will say, “Are you mad, have you not learnt about Amazon, do you not know that High Street is dead?” and again, you’ve got to look at underlying factors on a business like that. First of all, the price war that went on over the last five years with the likes of Aldi and Lidl has kind of played out and the real casualties of that war were the lower cost type of food retailers, the likes of Tesco and Morrisons and Asda and they’ve had to adjust their business to that kind of model and that’s kind of played its way through.
If you actually look at market share loss over that period, quite interestingly, Sainsbury’s has actually held onto market share. That’s mainly because they are South-East based, they’re more affluent middle-classed type of customer base and hence, not as sensitive to pricing as the others. The other reason we like it is food inflation is likely to hit the UK. It’s already started, the weak Pound has led to, we’ve imported a lot of inflation and the big question mark, I guess, the market’s really asking now is to what degree we can actually, or the retailer can pass that on to the consumer. Historically, they’ve managed to pass it on quite successfully and obviously inflation is good for retailers.
So we are of the opinion that yes, there will be some cost that has to be absorbed by the retailer and there’s going to be quite a lot of cost that’s absorbed by the customer at the end of the day. The second leg to the argument is that they recently bought Argos, which was a deal that wasn’t, at the time liked by the market. They felt that Argos was a business that was actually in a state of perpetual constructive decline and weren’t quite sure on the dynamics, but in reality when you strip away what they actually paid for the business, their relationship with Argos going into the deal; it was quite a low risk strategy.
Yes, Markus Jooste was the other bidder, under bidder if you like, for Argos and he still thinks it was a great business and very good for Sainsbury’s, onto number four.
I’m going to make them number four as combined trade, BP and Royal Dutch Shell and the reason I’ve picked those two stocks is, we’ve been very constructive on oil. In fact, for the last 2.5 years we were a little bit early in calling the bottom of oil. We saw it down to $22, $23 and back up to recent highs of $55, $56, but I think you’re buying stocks there either BP or Royal Dutch, it doesn’t really matter. In terms of valuation they look quite attractive. Fundamentally, one may argue that commodity stocks aren’t the best manged businesses in the world.
They tend to sell assets at the wrong side of the cycle because they’re stressed and buy at the highs at the markets, but having said that you’re buying two businesses. I think BP is probably a better quality business, but again, you’re buying two businesses that are trading on fairly low multiples, but on very high dividend yields and the big concern, more so in the case of Royal Dutch has been the ability to pay that dividend. Having said that, they continue to pay it and you’re getting paid 6% and 7% dividend yields on both stocks on a relative PE that, well, it’s difficult to rate these on a PE because they have very depressed margins.
Although, if you remain constructive and again, constructed, I don’t’ talk about in the next three months or six months because picking the oil price over that period is going to be very difficult, but certainly, over the next five years we believe that even if shale does exist, if you look at the entire market for oil, there has to be an increase in the oil price which will be constructive for all the oil majors and in the short-term given where we’ve been positioned in the oil trade, we’ve had quite a lot of strong positioning in the support services side of the business, companies like Halliburton TGS-NOPEC, these companies have actually had a huge rally in the short-term and they don’t show or screen as much value as the other two do. So, we think they’re quite quality benchmark type stocks that are giving a nice yield.
Great and number five?
Number five, I go for something a little bit more speculative, but it happens to be one of our largest holdings and that’s Las Vegas Sands.
Now there’s an interesting name. I’m sure you were behind this one.
Absolutely, it started out in our Special Opportunities Portfolio and then more recently it was an entrance into the dividend growth portfolio. So we’ve built our conviction on this stock, we’ve actually increased our positions and I’m very much behind this as well, but Jarrod will explain why.
So, Las Vegas Sands may not be for everyone, as you can imagine. It’s a casino business. Although it’s called Las Vegas Sands, only about 10% of their business is actually generated out of the US and the bulk of their business comes out of 50 odd percent Macau and 40 odd percent Singapore. I would say that Macau in terms of having the perfect storm of negativity, that’s where it’s really been, it’s been the last two years, starting from the Chinese anti-corruption and bribery crackdown moving onto smoking bans, moving onto visa restrictions, moving onto the amount of tables that you’re allowed in casinos in Macau.
It’s just been an endless stream of negative news for the operators in Macau and again, we got into the trade slightly early, but as we’ve built a position we’ve averaged at a very, very nice price and we just believe that if you look at the Macau week-on-week or even month-on-month traffic, it’s bottomed and you’re seeing signals of life coming back into the stock. So we think you have a stock again that’s trading on quite a fair multiple, very high dividend yield, you have Adelson who owns a significant portion of the business and who continues to be very constructive in terms of increasing the dividend on the stock.
So you have three very highly cash flow generative businesses and then you have something which is almost blue sky, which is the Japanese casino regulation, which, up until this point has been a little bit quiet, but in December we saw some life coming back into it and the Japanese are finally going to allow casinos in Japan. They’re probably going to allow two licences, most likely one will be in Osaka, and the other one will be in the capital. If you look at the business model of Las Vegas Sands, they are without doubt one of the three preferred bidders in terms of their middle class strategy.
It’s not only about gaming, it’s about entertainment and we think they would fit in very well there and Adelson’s been on record saying he will throw whatever he has to in terms of making it happen, you know, X-billion and that we believe is the golden ticket. Having said that, it’s not in the price, it’s not going to happen for at least another five years, but it is almost a free option on this stock. So, again, we think it’s an unloved sector. You’re getting paid a very healthy dividend yield on the stock and we think as a recovery in Macau and cash flow through Singapore and Vegas, which is again, a very slight portion of the portfolio, comes through, you have quite a nice growth stock.