July continues to be a month of great volatility. From the resurgence of the second (or even third) coronavirus to the closures of US and China’s respective consulates, geopolitical risk remain heightened in an already jam-packed 2020.
As usual, we provide an update to our portfolio holdings and update our view on what could play out for the remaining year.
In case you’ve missed, here’s a list of articles we’ve published in July.
- Should you Invest in Lemonade Insurance? 🔥
- How to Identify Red Flags and Avoid Bad Investments 🔥
- What is Tesla’s Profit Per Vehicle?
- Life Inside a Hedge Fund
- What does stock price mean for a company?
- How to Improve Returns by Tracking Insider Trading 🔥
- Is it Possible to Live Off Dividends?
- Why are We Waiting to Invest in Callaway Golf? 🔥
Our investment philosophy
We aim to own around 10 names and adopt a buy-and-hold bottom-up investing strategy, with a 3-5 years’ time-horizon (or earlier if fair value is achieved). Our current exposure to both US and UK stocks means our goal is to outperform the average total return of S&P 500 and FTSE 100.
Our investment philosophy reflects our view of the global economy. We adopt a style-agnostic approach, which means we are solely focused in investing in the best companies, whatever the “style” of investing. We employ a bottom-up fundamental investing complemented with a macro overlay.
In terms of sector allocation, we continue to avoid sectors with high dependence on interest rates, such as banks, especially those with a significant exposure to retail and commercial lending.
Our view on the airline industry has yet to change. As forecasted in our article written in early June, we expect further furlough and capital infusion in to the industry given the balance sheet weakness. We continue to think that the current valuation for airlines is unsustainable and consolidation would be inevitable.
In the semiconductor world, we are paying close attention post the Intel meltdown, which also led to the “melt-up” of AMD and TSMC. Globally, we still see value in niche chip producers.
The portfolio delivered +15.3% in July, relative to S&P’s +5.5% and FTSE 100’s -4.4%. In alpha terms, we have delivered +14.7% this month, with an annualized vol of 24.5% and a portfolio beta of ~1.
The key driver in July was S4 Capital and Peloton, +25.9% and +18.1%, respectively. Direct Line is also staging a strong come back this month with a +9.4%, while Disney delivered +4.9%. This is our third consecutive month of beating our benchmark.
Since inception, we delivered a total return of +30.1%. This compares with the market average of +12.3%, equivalent to an alpha generation of +17.8%.
Direct Line Group
- Next earnings date: August 4, 2020
- Investment case
Direct Line has its best month yet, +9.4% on the month. Our view remains that dividend and share buyback should return by its annual report in February next year. The valuation remain attractive in a beaten down Financial Services sector and in the European region.
Separately, Direct Line announced its acquisition of an insurtech start-up Brolly, an app-based monthly subscription contents insurance product for renters and homeowners (smells like Lemonade 🍋). The acquisition adds to Direct Line’s pivot to their Darwin online proposition.
- Next earnings date: August 5, 2020
- Investment case
Disney’s struggles this month seems to be reflected in its stock price, underperforming the S&P. With new Covid-19 cases skyrocketing across the US, the probability of closing its parks again is creeping up.
The market’s laser focus on its parks provides a fantastic investment opportunity, in our view. Simply because we do not believe that is what drives the company in the medium term. We continue to think that the market underappreciates the shift of earnings from parks to its subscription-based Disney+ business.
Additionally, we identify how the market would view the company with increasing revenue and earnings deriving from Disney+.
Firstly, a subscription-based business would yield a higher valuation multiple from the market, due to the nature of being more consistent and less volatile.
Secondly, from an equity investor point of view, diversifying its business away from Media and Parks will be viewed as lower risk, ie lower cost of equity, leading to a higher fair value of the stock. We have yet to see any conclusive evidence that the market has reflect our case.
- Next earnings date: August 5, 2020
- Investment case
Peloton continues to muscle through its competition and the market has somewhat reflect that with a +18.1% gain in July. We previously mentioned that how Peloton’s USP revolves around its patents.
Guess what? Echelon, a competitor who’s in an ongoing lawsuit with Peloton, recently filed petitions seeking to invalidate its patents. We remain confident that the outcome will work in Peloton’s favor. All in all, while patents form a key part of the thesis, it is growth that will ultimately drive the company towards cash flow positive territory.
- Next earnings date: September 9, 2020
- Investment case
The run continues for S4 Capital, delivering a whopping +25.9% for the month. What has started as digital advertising start-up is now worth ~25% of WPP, Martin Sorrell’s previous company.
In what was an unscheduled (but positive) trading update, it announced that gross profit increased by almost 5% in May and 3% in April. While this may not be the one of the pillars why we invested, nonetheless, it’s good news.
Separately, S4 Capital also raised approximately £100m ($126m) @ 315p per share, with Sorrell putting his money where his mouth is, subscribing to stocks worth £8.5 million. An extremely bullish signal indeed.
Sir Martin Sorrell had no time to waste. On July 29, it announced the merger between MightHive and Orca Pacific, a market leading full-service Amazon agency based out of Seattle. The agency employs more than 40 former staff of Amazon and is expected to provide S4 with enhanced e-commerce proposition. The growth story continues, at least for now.
Similar to June, July continues to be macro-fuelled month. July has seen increased geopolitical risk, however. The run to safe havens such as gold, silver and crypto is driven by increased pessimism of global economic growth as well as heightening tensions among global powers.
Second wave of coronavirus globally
A continuation of June in terms of continuing built-up of confirmed coronavirus cases. However, this is turning into a global phenomenon rather than just the US. Countries like Hong Kong, Malaysia, Vietnam who pretty much flattened the curve earlier has seen signs of resurgence.
The recent Fed meeting was telling. To quote J Powell, “Hope for the best and plan for the worst”, Powell did his best to project optimism despite presenting a fairly dim outlook of the US economy. With the Fed leaving interest rate unchanged, the question is what more can the Fed do with sub-zero rates. US congress has yet to come to terms about the latest coronavirus stimulus packages.
In addition, US reported a decline in GDP of 32.9%, according to the Bureau of Economic Analysis. We continue to think any plans to reopen the economy in the near term is detrimental to the economy. Having said that, we do think that the stock market has potential to achieve new highs, given the record liquidity global central banks and governments and injecting into the system.
China vs the Rest of World
In our last newsletter, we highlighted the conflict between China and India. While a full-blown conflict is unlikely given more important matters at hand, India is banning more apps and reportedly reviewing hundreds more from Chinese companies.
UK also joined in the fun by making a U-turn by banning China’s Huawei from 5G networks. In essence, UK mobile operators will be forced to stop buying equipment from Huawei by the end of year, in addition to removing all Huawei kit by 2027. The decision does seem rushed at a time of crisis, rumored to be pressured by the US.
Separately, the relationship between China and US took another leg down with the ordered closures of consulates on both sides. US is accusing China of using its Houston consulate as a spying base. As retaliation, China ordered the closure of US consulate in Chengdu, in addition to accusation that its staff meddled in its internal affairs. The escalation has surely increased risk premium of investing in the world’s most populous country.
Furthermore, it also has been reported that the number of scrambles against airspace violations has been increasing rapidly, especially in the region of the Senkaku Islands, the uninhabited group of island under Japan, but claimed by China as one of theirs. This has prompted the US to get involved, deploying two Navy carrier strike groups to the region. Consequently, few others allies also took part in its recent naval exercises.
More to come.
Corporate & sector news
Financials: Value or value trap?
- 32% of U.S. households missed their July housing payments
- Wells Fargo shares tumble 5% after psoting $2.4 billion loss, dividend slashed to 10 cents
- Morgan Stanley post record profit on trading boom
- Goldman Sachs shares rise as earnings blow past the Street on the best trading results in years
Looking back, investing in banks post 2008 crisis has been challenging. However, there are winners and losers. Investment banks, despite having exposures to credit losses over the Covid-19 crisis, benefited from strong trading and capital market activities such as advisory and debt issuance. In general, the capital market businesses act as counter-cyclical diversification for the business.
On the other hand, banks with a commercial and retail focus, such as Wells Fargo, are and will continue being losers in the banks sector, in our view. With record low interest rate and worsening credit losses, there shouldn’t be any surprises on its dividend cut. We predict the same for regional banks, if not worse. There is a fine line between value and value trap.
Despite a lower yield, the insurance sector remain the best play to hunt for yield for long term investors in the Financials sector. In particular, non-life insurance with short term asset and liability duration.
Transportation: More of the same for airliners
- Delta may avoid furloughs after demand for buyouts, other US airlines sound alarm
- United warns it could furlough more pilots, extends voluntary leave deadlines
- Majority of US house backs new bailout for US passenger airlines
The story hasn’t changed since we last updated, but if anything, it became worse. We highlighted previously that the industry will furlough a significant proportion of its staff after September 30, as stipulated in the CARES act. In anticipation, major airlines have already been taking steps to temporary alleviate its dire situation, such as extending voluntary leave deadlines.
It goes without saying that the industry requires further capital injection. This would mostly come in form of government aid and issuing debt. We also considered the possibility of consolidating in the sector, ie mergers etc. It is definitely a workable solution, but that will take time. But, unfortunately time is a precious commodity for the industry right now.
Telecoms and semiconductor manufacturers: The future?
5G has always been the back of investors’ mind. Naturally, while the pandemic may push back its schedule, we think it’s worth exploring the concept and the players involve in more detail. From its infrastructure to manufacturers of equipment and raw materials needed, this is a sector with lots of untapped potential.
This month saw the story of Intel shooting itself in the foot after it announced the unexpected delay of its 7 nanometer chips. As a result, Advanced Micro Device (AMD), Intel’s main competitor, stands to benefit from Intel’s manufacturing setback.
Another beneficiary is Taiwan Semiconductor (TSMC). One of the largest semiconductor manufacturers, boasting clients such as AMD, Nvidia, Xilinx and Broadcom, it benefits from the need for more chips to be sold. Traditionally, Intel insource part of its manufacturing process. Due to this set back, Intel CEO Bob Swan is said to be considering outsourcing its manufacturing, potentially benefiting TSMC in the process.
This debacle cause a huge rift between the share prices of all three companies. At the time of writing, Intel lost 20%, while AMD and TSMC gained +31% and +18%, respectively, since the announcement.
Chart of the month
This month features none other than Kodak. Yes, the Kodak of the photography industry. On July 28 (before market opening), Kodak announced it has secured a loan of $765 million from the Trump administration to make the ingredients used in generic drugs to fight coronavirus. From photography to pharmaceutical, overnight. How we wish one of our holdings did that.
The stock closed $2.62 the day prior before skyrocketing to an intraday/week high as much as $55, that’s almost ~2100%! The fear of missing out and a potential short squeeze are thought to have contributed to the unfathomable stock price movement.
Two things we find even more interesting.
First, the trading volume prior the announcement. Looking at the table, we use “Daily volume/20D average” as a proxy to detect any unusual trading activities. This is pretty common in the market usually around events, especially earnings releases. What is striking is the trading volume on Jul 27. This is almost 8x the average volume, which is suspicious because the news was only released officially after close. Definitely something that should be looked further into.
Secondly, its Executive Chairman James Continenza bought 46,737 additional shares on June 23, along with another board member Phillippe Katz of 5,000 shares. Both bought @ 2.22. At the time of writing, their “investment” has increased more than 10x! According to the SEC Form 4, the Chairman also owns another 2.05m stock options with an average strike price of ~$4.67 and another ~240k of phantom stocks (right to receive one common share after certain criteria has been met).
No, I’m not jealous.
That’s all for this newsletter. See you in the next one!