Last week we continued to reshape the portfolio with two macro-driven sells and two mid-cap investments, one of them new:

Date Stock Trade Intention
17/11/16 USD Sold 798 units at $13.05 Sold a third of the position
18/11/16 AHG Bought 2903 shares at $3.83 Initiated 2% position
21/11/16 USD Sold 532 units at $13.33 Sold a third of the remaining position
22/11/16 IPH Bought 1307 shares at $5.09 Increased model weight to 2.00% and bought up to this
22/11/16 CPU Sold 815 shares at $11.56 Halved the position

Automotive Holdings Group (AHG): Interesting restructuring story
AHG is one of the leading automotive retailing companies in Australia with an industry leading market share of ~7%. Listed on the ASX in 2005, AHG originally began as a Holden dealership in Perth called City Motors. Since then the business has expanded in WA and across the nation and today sells nine of the 10 of the top-selling volume brands, some truck brands and Mercedes-Benz in the luxury market.
While industry growth rates are low (~2%) compared to GDP growth, AHG is looking to grow market share via acquisitions to take advantage of the current fragmented industry structure. These acquisitions are earnings-accretive due to the relatively lower acquisition multiples of target companies and availability of synergies.
The company also operates a refrigerated and cold storage businesses, contributing ~13% to group profits. This business has underperformed over many years with the businesses requiring large levels of capital expenditure while margins continue to be competed away resulting in declining return on assets, which has fallen from ~20% in FY09 to closer to 5% currently. Part of our investment thesis is the recent change in management is a catalyst for the divestment of this businesses with available capital best used within the core competency of expanding the automotive dealing business.
The main downside risk is the current ASIC inquiry into income earned by dealers from finance and insurance products, which could result in restrictions on the sale of these products. This would be a headwind to earnings, which dealerships could partly offset with other revenue initiatives. Further to this, the recent sell off in the share price from ~$5.00 in late August to current prices suggests at least part of this risk is factored into the share price already.
AHG currently trades well below our FY17 valuation of ~$4.60 and offers an attractive dividend yield of 6.5%. The recent change in management provides a near term catalyst for the divestment of the underperforming business, which is likely to see our investment thesis realised.
Last month’s AGM said the car sales business continues to perform as expected – a good result given soft new car sales in Queensland and Western Australia. The disappointing news was the performance of the Refrigeration logistics business falling short of expectations. Management said the FY17 result will include ~$20m in cost savings to partly offset the weak result. This can also be viewed as AHG preparing to divest this business unit.
IPH (IPH) escrow selldown creates entry point
IPH is the leading intellectual property firm in the APAC region with 20-25% market share in Australia and Singapore. We initiated this position with a 1% weighting bought in July at $6.00. Since then the stock has mostly traded below our cost base. We think the stock is worth over $6.
The recent selldown by original partners created a buying opportunity by depressing the share price. We thought the market was pricing in a short-term negative catalyst, clouding longer term fundamental value. We also like:

  • Market leadership: IPH is ideally placed to consolidate a structurally growing but fragmented industry.
  • Recurring revenues and excellent cash conversion allow IPH to maintain a very balance sheet and fund growth while maintaining a high (80-85%) dividend payout ratio.
  • Leverage to Asian economic growth: with a leading market position in Singapore and the next major acquisition likely to come in Asia, IPH will benefit directly from the strong growth in Asian patent filings.
  • Respected businesses with experienced management and large, loyal clients. This has driven organic market share gains in addition to those from acquisitions.

The downside risks are:

  • Regulatory reforms: may disrupt patent/trademark flow volumes (could also be an upside risk).
  • FX risk: Most of IPH’s revenues are denominated in US dollars, so Australian dollar appreciation dampens the valuation and vice versa (our valuation adopts US$/A$ of 0.75).
  • Acquisition risk: a large proportion of forecast growth depends on continued consolidation of the market, so there is risk IPH overpays or an acquired firm underperforms.
  • Poor growth in patent applications: this is a risk primarily in Asia given the Australian market is mature.
  • Dilution risk through future capital raisings as IPH favours equity for funding new acquisitions.

US dollar strength a chance to sell some at a profit
The US dollar has appreciated against the A$ because:

  • Traders now see a 100% probability of an interest rate increase at the US Federal Reserve’s December meeting given solid employment growth and accelerating wages growth. The monetary policy divergence theme has returned, as Australia’s Reserve Bank is not about to tighten monetary policy here. We think the first hike will be late next year
  • The selloff in US government bonds has sent, for example, 10-year Treasury yields up 58bp in a month to 2.32% at the time of writing. This makes Treasuries more attractive relative to Australian government bonds
  • Investors are suddenly excited about US assets. Last night the Dow, Nasdaq and Russell 2000 all closed at record highs
  • US economic growth is more likely to accelerate than Australia’s, so there is more interest in US assets than Australian assets.

We have owned US dollars in the portfolio since we launched in March last year. Our experience has been mixed and in the future we would rather own dividend-paying shares or hold interest-paying cash unless the Australian dollar surges to popularity and recreates an opportunity to profit from a fall in the A$. Over the last week we sold more than half our position at prices above our $12.95 cost base, and we intend to sell the rest on further A$ weakness.
Computershare (CPU): Taking some profits on the Trump trade
In short, CPU shares have rallied in recent months because higher interest rates increase interest income on investor funds held temporarily in trust during corporate actions and transactions. At $11.56 last week, the stock was trading well above our $11.09 FY18 valuation and we also think the market could be getting ahead of the known reality of how much stimulus President Trump will be able to inject into the US economy. Constraints include existing high ratios of public debt to GDP, a diminishing need for stimulus given pleasing employment and wages growth, the Fed about to tighten to reduce monetary stimulus and of course the need for Congress and the Senate to approve tax cuts and infrastructure spending plans and for the private sector to respond to incentives to invest. It is possible the actual stimulus delivered is less than the transformational dose currently gripping the imagination of financial markets, so as a hedge we decided to halve our exposure to this overvalued asset.
Originally published  on StocksInValue, 22nd November 2016.