Financial Review: hedge funds’ best long and short ideas 2019

Financial Review: hedge funds’ best long and short ideas 2019


* Catherine Allfrey and Raaz Bhuyan from WaveStone nominate gaming machine developerAristocrat Leisureas their long idea. “If we assume Aristocrat’s historic rate of return on its design and development spend at 11 to 12 per cent of sales (circa $500 million in 2018-19), Aristocrat should organically be able to grow its EPS 8 to 10 per cent per annum over the next three to five years. Trading on 15 times P/E we think this too cheap for a global leader.”

The WaveStone pair are short select ASX-listed technology names, as “the multiples that some of the technology stocks trade on are too high in Australia and the blue-sky earnings estimates will need to be brought back”, they say.

* Tribeca’s Jun Bei Liu is also betting on good fortune forAristocrat Leisure, which is trading at a meaningful discount to the market “despite strong growth projections over the next few years”. She is expecting at least a 30 per cent return over 12 months.

Shecontinues to bet against online jobs classified siteSeekeven as the share price has fallen 25 per cent since September.

Seek continues to trade at a substantial premium to the market with a limited growth projection taking into account investments.

“With domestic job ads turning negative, coupled with a cooling Chinese employment market, Seek will experience further earnings disappointment.”

* Alleron’s long isQBE Insurance. After years of painful change, chief investment officer Sean Sequeira believes that “a simplified, more focused company provides a great ‘back to the future’ opportunity to improve risk outcomes and returns to shareholders”.

QBE chief executive Pat Regan’ssale of the troubled Latin American businessfor $100 million above book value in 2017 got the fund manager interested – “a change in the quality of earnings was taking place” – and a new reinsurance program will improve the quality of earnings “similar to that of the early 2000s”.

With a valuation of 1.1 times book value, Alleron believes there is “minimal downside risk but potential for significant gains” if management can execute their strategy.

Alleron is shortCaltex Australia, a stock it previously owned, as it will face an ongoing $80 million hit to earnings fromrenewing the Woolworths contract, the fund manager says.

“We also believe management has underestimated the difficulties and time it would take in transforming the existing retailing business to a fast-food and convenience business, initially at a cost of $100 million to $120 million for buying back the business from its franchisees. This is occurring amidst a backdrop of a significant doubling in net debt to $1 billion in just two years at a time of pressure on refining margins that still comprise 20 per cent of earnings.”

* PWR Holdingsis a rare opportunity to buy a quality growth stock that ticks all the boxes for Indian Pacific’s Preston Hamersley. The Gold Coast-based manufacturer of high-performance vehicle cooling solutions is a leading player in Formula 1 motor sports, supplying nine of the 10 F1 teams with their coolers.

“They have a pristine balance sheet ($12 million cash and no debt), have a down-to-earth and fiercely-engaged management team with skin in the game (Kees Weel and family founded the company 30 years ago and still own over 30 per cent of stock), the business has a very strong market position with embedded customer relationships and margins are healthy (30 per cent-plus EBITDA margins and 20 per cent net profit margins).” Also cashflow conversion is very strong, there are plenty of growth opportunities and there is upside risk to 2019-20 forecasts.

Hamersley’s short idea isStockland, which might appear cheap on headline numbers, but he is cautious about capitalising current earnings into any yield or multiple analysis. “Whilst not wanting to single out an otherwise reasonably run company, if you are bearish the Australian housing market in 2019 and 2020 (as I am) then it will be a tough year for Stockland given around 30 per cent of group EBIT comes from their residential land business.”

* Monash Investors’ long stock pick isNearmap,the aerial surveyor, whose market it estimates is massive at $US7.4 billion in 2018. “With a proven organic growth track record, ongoing research and investment into new market-leading products, a very strong balance sheet and its highly-attractive operating leverage, Nearmap seems well positioned to climb through these turbulent market times,” investment analyst Sebastian Correia​ says.

One of its favourite shorts isCoca-Cola Amatil, which – despite its recent decline – “remains expensive”, according to Monash. “Coca-Cola Amatil has been struggling for years and its market is getting tougher. Consumers continue to traverse away from sugar drinks and their water business is struggling,” Correia says. Indonesian expansion hasn’t worked and, given its 5.5 per cent dividend yield relies on a payout ratio of 85 per cent, and the structural challenges CCL faces, Monash expects further pressure on the share price in 2019.

* Worley Parsonsis the long pick of Firetrail Investments’ James Miller. The oil and gas engineer had a tough end to 2018, but Miller believes it is well positioned to outperform in 2019. Since its peak in September, the stock is down more than 40 per cent because of the fall in the oil price and the market’s apparent scepticism over its large offshore acquisition.

“Worley Parsons is a cheap stock which has diversified its end-market exposures further away from oil with this acquisition. However, what really excites us is the internal rigour that has emerged in the business over the past three years. When oil hit $US28 in 2016 Worley Parsons did not let a good downturn go to waste, and has significantly improved its cost control and workforce utilisation,” Miller says.

Firetrail is short the listed property sector. “Low rates have been driving high valuations, but there are signs that this may be turning. Despite most REITs trading at a significant premium to their net tangible assets, we are seeing transactions being done at close to book value. This is particularly true for retail property assets, which in some cases have been changing hands at a discount to book value.”

Miller says that, when equity markets become volatile, listed property is often thought of as a safe sector. “However, if the economic reality of falling property valuations hit this can unwind quickly, and as an investor you don’t want to be caught out in the space,” he warns.

* Regal Funds Management’s Phil King is sticking to his guns shortingJB Hi-Fi, the electronics retailer thatcontinues to divide hedge funds. He says the repercussions of Amazon’s entry into Australia will continue to mount and will be acute over the next few years. “At the same time, the weakest housing market in at least a decade could cripple discretionary spending on items such as electronics,” King says.

JB Hi-Fi is “a classic value trap”.

On the long side, King picked insurance brokerAUB Groupas he views rising insurance premiums as a huge positive for the sector.

The stock was hurt by dilutive equity raisings in 2018, but King says the benefits of a series of accretive aquisitions hopefully will emerge this year. At a P/E multiple of 16 times before factoring in acquisitions, AUB trades at a “material discount” to Steadfast.

* Jacob Mitchell of Antipodes Partners has picked long-discarded Finnish handset makerNokiaas a long as the fund sees “connectivity” being a theme in 2019. While telecom operators have cut back spending,5G investmentswill get underway, benefiting companies such as Nokia.

“Nokia itself has been transformed in recent years, no longer focused on handsets but instead the critical infrastructure that enables communication systems means it is poised for accelerating growth at a time when growth elsewhere will naturally slow.”

On the short side, Mitchell expects a period of unprecedented central bank liquidity creating a premium for growth assets, regardless of the underlying business quality, “not seen in a generation”. But as liquidity retreats, the same stocks are coming under pressure.

“We see a further shakeout as likely and are focusing our short attention on weak businesses and/or weak balance sheet businesses that are excessively valued – spanning certain technology, industrial, real estate and infrastructure assets across the globe.”

* Clay Smolinski and Andrew Clifford of Platinum Asset Management say the sell-off in oil prices presents an excellent entry point to Canadian oil and gas companySeven Generations Energy,which has one of the lowest break-even production cost bases in North America.

“Seven Gen is likely to self-fund 10 per cent per annum production growth over the next five years at modest oil prices and shareholders may see dividends or buybacks.”

Platinum’s short idea is US-listedMongoDB, which is one of several “hyper-priced” tech stocks. The company, which trades at 20 to 30 times revenue, developed a free open-source ‘NoSQL’ database and makes money by selling subscriptions to its ‘enterprise’ edition.

“It has never made a profit and looks unlikely to do so in the medium term, with competition from Microsoft, Amazon, Google, Oracle and a litany of smaller competitors, many of whom can offer document-oriented database services for free as part of overall service offerings.”

Catherine Allfrey and Raaz Bhuyan from WaveStone nominate gaming machine developer Aristocrat Leisure as their long idea. Peter Braig

* Ben McGarry and Sam Granger of Totus Capital believe big tech is offering value and have pickedAlphabetas a long. “The business has been caught in the downdraft of the tech sell-off despite not having missed a beat on earnings this year. Revenue is still growing at 20 per cent per year, it has $US100 billion of net cash on its balance sheet and in 2019 we should begin to see how they plan to monetise loss-making businesses like Waymo.”

On the short side, Totus is betting againstG8 Educationdespite a strong rally in the stock, anticipating headwinds as it rolls out new centres in an “already oversupplied” market.

“The childcare sector has been a graveyard for listed equity investors and we think the sector’s reputation as a defensive is not borne out by the historical facts.”

Globally, Totus cannot resist shorting Elon Musk’sTesla, which it says has all the hallmarks of its previous successful shorts – Blue Sky and Quintis.

“It has a charismatic founding CEO, cult-like investor following and a share price that has completely detached from fundamentals. The company has never posted an annual profit and the stock is trading within a whisker of all-time highs despite intensifying competition, the expiry of EV subsidies in the USA and a stretched balance sheet. We see the risks as asymmetric to the downside in 2019.”

* NSX-listed hedge fund East72’s most obvious short is Tesla given its “ludicrous” valuation, but portfolio manager Andrew Brown is also betting againstWorld Wrestling Entertainment. Shares in WWE more than tripled in 2018, before selling off, but Brown says they have further to fall.

“We see WWE as a poor cousin of other televised sports – notably UFC – with declining live attendances and a flattening social media following. At 51 times EV/EBITDA the shares reflect exultant hopes for international growth in a crowded market.”

On the long side, Brown is betting on US market-makerVirtu Financial,which was cast as the villain in Michael Lewis’ high-frequency trading exposéFlash Boys.

Alleron’s long is QBE Insurance Bloomberg

Brown says the firm’s acquisition of ITG will diversify its earnings away from a reliance on higher market volatility, which is favourable, and it has a good track record of integrating acquisitions. “The high level of equity volatility in Q4 2018 should also provide for exceptional near-term profit results and cash flow.”

The shares trade at 10 times 2020 pro-forma profits and Brown says the company is “erecting higher entry barriers to their business“.

* Andrew Macken and Chris Demasi of Montaka say French-listedVivendiis the best way to profit from the acceleratedtrend towards music streaming.Vivendi’s Universal Music holds the rights to a third of all the world’s music and Montaka says its back catalogue is perfectly positioned to be re-monetised.

“Two thirds of all music streaming is back catalogue with consumers gravitating towards nostalgic tracks versus new releases. This means that Vivendi is monetising an asset (UMG) much more efficiently than the market has ever seen before and appears to have materially undervalued.”

* James Tayler and Chad Slater of Morphic Asset Management are once again putting their faith in Hong Kong-listedChina Everbright, despite “an unexpected and badly communicated” rights issue in 2018.

Everbright has a strong balance sheet and is poised to benefit from the Chinese government’s environmental policies.

The fund manager has picked London-listedBritish American Tobaccoas its short, even after a terrible 2018 for smoking stocks. They say it’s a mistake to gravitate towards the sector for its “bond-like attributes” if interest rates decline because it faces multiple threats.

“High barriers to entry are less relevant as new entrants provide alternatives (vaping and heat-not-burn products) that are rapidly gaining market share at the expense of incumbents’ revenue growth.”

One of Monash’s favourite shorts is Coca-Cola Amatil, which – despite its recent decline – “remains expensive”. WILL BURGESS

Jacob Mitchell of Antipodes Partners has picked long-discarded Finnish handset maker Nokia as a long Supplied

Ben McGarry and Sam Granger of Totus Capital believe big tech is offering value and have picked Alphabet as a long. Jens Meyer

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