Welcome to our second monthly newsletter for June 2020! This newsletter is intended to discuss our performance so far, as a way to track, learn and improve our process. In addition, we also share what we learned so far and our view on the global economy. Nothing too boring! Please visit here for our live update of our portfolio.
If you think you think there’s anything interesting we should discuss, please reach out here. We have lots to go through, so let’s make a start. As usual, we start with our "Portfolio Updates".
Just a friendly reminder of the articles we've written in the month of June
Portfolio updates
We delivered a +6.4% return for the month of June, relative to S&P 500’s +1.8% and FTSE 100’s +1.5%. In alpha terms, we've delivered +5.7% this month.
The key driver of the portfolio was S4 Capital, delivering at +21.5% return for the month, while the laggard is Disney, with a -2.1% return.
We aim to own around 10-15 names and adopt a buy-and-hold bottom-up investing strategy, with a 3-5 years’ time-horizon (or earlier if fully valued). Our current exposure to both US and UK stocks means our goal is to outperform the weighted total return of S&P 500 and FTSE 100.
Since inception, we delivered a total return of +13.6%. We remain disciplined in our stock selection process in this challenging time.
Peloton Interactive
This month, we welcome Peloton to the ZagInvestor Portfolio. Driven by our detailed analysis on the name, we are convinced that Peloton is more than just a fitness fad and have a credible profitability plan going forward. We are optimistic on its margin expansion potential, in particular, its subscription revenue segment. More importantly, when we compared its EV/revenue forward multiple with larger more established big techs, we do not find a noticeable deviation despite its significant growth.
Peloton doesn’t not pay dividend, is not cash flow positive and has outperformed 95% of global stock this year. We are bullish on the company itself, but are more cautious on its current price purely due to technicals. We look forward to add more as we see opportunity.
Just a few days ago, Lululemon bought Mirror, one of Peloton’s competitors. We see the rationale of the deal and do see some competition heating up in the sector. Arguably, although the tie up addresses a different segment of the fitness, it’s nonetheless a subscription-based model, similar to Peloton. On the plus side, we see further evidence that the industry may soon come to terms with the changes in how we exercise in the future.
A personal favourite of us is Tonal. Essentially, it’s Peloton but weight lifting. Uniquely, it uses electromagnetic resistance engine powered by advanced math to generate resistance up to 200 lbs. How cool is that?
Direct Line Group
Direct Line Group had a pedestrian month, with June’s performance being flattish. We see little to be concerned given the lockdown. Don’t forget the Group’s capital continue to be resilient and provide a great entry point for dividend growth investors, with an expected dividend of 8%, with 1-3% of possible stock repurchase.
A stable and predictable cash flow with an edge in cost, we intent to add more ~240-250p should there be any pullback, ceteris paribus.
Disney
A roller coaster ride for Disney’s stock in June, with the reopening hopes being subsequently dashed by the imminent possibility of a second wave of coronavirus. Parks have now been taking stricter precautionary measures and possibly to remain close should the virus get out of hand again. On the other hand, we are beginning to see some momentum in Disney+, with free trials ending and a move to consolidate Disney+.
We continue to be bullish on its long term prospect with the key point being its deeply discounted Disney+ franchise. In our view, the market continues to put heavy emphasis on its parks businesses, missing the bigger picture of its Disney+ business.
- Walt Disney World employees petition to delay reopening as coronavirus cases surge in Florida
- Walt Disney Studios once again delays release of live-action 'Mulan'
- Disney Plus no longer offers free trials just before Hamilton release
- Disney is eliminating Disney Channel in the UK, moving titles to Disney Plus
S4 Capital
S4 Capital has had a great month, posting a respectable +21.5% return. We note that Morgan Stanley, an investment bank, recently initiating on the name, which briefly pushed the stock to ~285p. We expect greater coverage as the firm grows and on investors’ radar.
The Stop Hate for Profit campaign has instigated a major boycott of advertising via social media, with Facebook being the most affected. Firms from Coca Cola to Ben and Jerry are halting their advertising campaign.
Optically, these may be a headline grabber. However, digging through its press releases, we found that most companies are only halting its campaign for ~30 days, which we thought does not reflect the share price reaction.
From Facebook’s perspective, while it’s negative, the impact over a multi-year investment period is insignificant, in our view. Existing / potential new investors in the name may want to consider this.
As S4 Capital functions as a facilitator, it will inadvertently be negative impacted as well. We, however, don’t expect this event to have a significant impact on its business due to its well-diversified client-base.
Macro news
June continue to be a month fueled with continued macro uncertainty. Here are the key headlines
Second wave of coronavirus in the US
Clearly, the key talking point in June was the sharp increase in confirmed coronavirus cases in the US. The recent protest/demonstration in the US has also fueled the increase, in our view.
This time around, the market was quick to react. Stay-at-home stocks continue to surge, while retail, airlines and casino operators falter on the back of a possible delay of reopening its doors.
A pro-longed lockdown has numerous impacts to the global economy. With the Federal Reserve expanding its mandate to buy individual corporate bonds in addition to ETFs, we expect its counterparts will do the same, especially the Bank of England. Central bank balance sheets can and will continue to expand for the foreseeable future.
Keeping in mind that election is just over 4 months to go, volatility in the market would gradually pick up after the summer months of low liquidity, in our view. We will, of course, provide a big picture policy assessments of US presidential candidates and how it will affect the market closer to time.
Hong Kong security law
The law which is effective 2300 local time on 30 June, gives Beijing a stronger grip on Hong Kong. Here are few key points on what this will mean to Hong Kong and the rest of the World.
- Beijing will establish a new security office in HK, with its own law enforcement personnel, operating independently of the local authority’s jurisdiction.
- Beijing will have the power over how law should be interpreted, not any HK judicial or policy body.
- The law will also apply to non-permanent residents and people from outside HK.
(source: BBC)
Ultimately, we think that this is a moment of heightened uncertainty for the city and certainly MNCs in reconsidering their long-term investments in HK. A period of readjustment by firms would be evident when HKMA, its central bank, publishes its financial data in the coming months.
China vs India
This is event was seemingly below the radar of many market observers given the issues at hand. In fact, this conflict dated back to 2017, known as the Doklam standoff. The 2020 conflict started due to territorial dispute between both countries which eventually led casualties for the Indian troops.
In recent weeks, the conflict seem to have shifted economically, with India’s recent ban of 59 Chinese apps, including TikTok. The big question here is whether India can afford to boycott Chinese products? In 2019, China remains India’s top three trading partners. While the Indian government hasn’t announced an official boycott, there seem to be an effort to encourage firms to seek alternatives.
Economically, it’s a lose-lose situation. At least in the short term. China already has enough on its plate, with the possible resurgence of the coronavirus, the recently implemented HK security law, and the ongoing trade uncertainty with the US. For India, losing China as a trading partner when the country is faced with the pandemic may not be the best idea. For example, according to Indian Pharmaceutical Alliance, >70% of India's drug intermediary needs are fulfilled by China.
Corporate news
Oil and gas
- Fracking pioneer Chesapeake Energy files for bankruptcy
- Shell to write down as much as $22 bln after coronavirus hit
It is estimated that shale producers can only survive with Brent >$50 per barrel. With oil majors writing down its assets due to oil prices fluctuations, we’re really seeing the beginning of more hardships for shale producers.
Financials
- JP Morgan, Bank of America, Citi and Goldman maintain dividends post-stress tests, Wells Fargo to cut
- FT: Wirecard investigations
- The Fed says it is going to start buying individual corporate bonds
The current climate means central banks are forced to provide almost unlimited stimulus through “whatever it takes” measures. The Federal Reserve, for example, has expanded its stimulus to not only continuing to buy ETFs, but also starting to buy individual corporate bonds. The programme has the ability to buy up to $750 billion worth of corporate credit. This is truly unprecedented, both the depth and the size of the stimulus.
Consequently, we see a few immediate impacts. First, the traditional way how banks make money will collapse in a lower for longer environment. Secondly, banks who are active in capital market activities stands to benefit as demand for capital raising, M&A and restructuring activities increases. We expect this to remain the key driver for banks earnings in the medium term.
Transportation
- Airbus shedding 15,000 jobs, mainly in EU
- American Airlines Looks to Raise Another $3.5 Billion in Debt
- United Airlines expects to raise $3 billion in debt offering
- Fauci criticize airlines for planning to full airline flights
Our recent article highlighted why we think the airline industry is a value trap. In addition, for it to be a worthwhile investment, we would need a ~40-50% de-rating. This is primarily driven by the structural headwinds the industry is facing.
US airlines is characterised by overspending its cash over the years in a capital intensive and thin margin industry. Consequently, there is no surprise that US airlines continue to raise money during this extremely challenging period.
We think there are further measures that the industry will take once after 30 September, ie further reducing headcount. This is the deadline which companies are not allowed to let go its employees stipulated as part of the CARES act, the aid received from the US government.
In addition, Dr Fauci, a lead expert in the COVID-19 pandemic, has recently questioned US airlines about their plan to return to full capacity. Our view remains that this is unlikely to happen, ie flights may remain 60% at best for the foreseeable future, adding another layer of difficulty for the industry.
With EU now officially banning US visitors, we can only expect a deteriorating landscape for US airlines for now.
Chart of the month
We end the newsletter with our “Chart of the Month”, which this month features none other than Wirecard, the once beloved German fintech darling.
In short, Wirecard, nicknamed “Enron of Germany”, was caught in one of the biggest accounting fraud that revolves around €1.9 billion of cash that was missing from its balance sheet. The truth is that it wasn’t even there in the first place. Interested readers can follow the trail on FT’s Wirecard investigation.
On a side note, we were actually short the name about two years ago when we started discovering several red flags with the company. (kicking ourselves for not holding long enough).
Anyways, that’s a pre-cursor to why Wirecard ended up as our “Chart of the Month”
With the rise of commission free-trading, people staying in home more, and the fact that casino are now somewhat inaccessible, the stock market has become the de-facto gambling den of many young retail investors.
Consequently, we are seeing a huge inflows to the equity market, and to some extent, greater volatility through special situations stocks. Hertz, Luckin Coffee and Wirecard displayed similar statistics, after it was found fraudulent/bankrupt.
Nonetheless, we think this generates huge opportunities for long term investors like us. Not on those three stocks, of course.
That’s all for this newsletter. We look forward to the next and will continue to seek stock ideas that can reflect our coherent view of the market. Thank you for your support and see you next month! Let's make some money!