ZagInvestor August 2020 Newsletter

August 2020 Zaginvestor newsletter

At the time of writing, both S&P and Dow Jones are now positive for the year! Who would have thought? With almost unlimited liquidity injected by central banks, can this go on forever? What does this mean to the stock market? Full speed ahead or the forming of a bubble? We don’t have the answer, but for hedged portfolios, we would be buying insurance, especially when they’re cheap now.

As usual, we provide an update to our portfolio holdings and update our view on what could play out going forward.

In case you’ve missed, here’s a list of articles we’ve published in August.

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    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.

    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 not to change. As discussed 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.

    August marks the month where cloud services, web-infrastructure and website-security companies suffer a drawdown despite its better than expected results. Perhaps, this is unsurprising given its massive rally since the March lows. Companies such as Keysight Technologies (KEYS), Cloudflare (NET), Fastly (FSLY), Alteryx (AYX) etc look overdone from a price technical perspective. We continue to seek opportunities in this space.

    Portfolio updates

    ZagInvestor Portfolio performance since inception
    ZagInvestor Portfolio performance since inception.

    The portfolio delivered +7.5% in August, relative to S&P’s +7.0% and FTSE 100’s +1.1%. In alpha terms, we have delivered +3.3% this month, with an annualized vol of 21.1% and a portfolio beta of ~1.

    The key driver in August was Disney and Peloton, both delivering +12.2% for the month. Direct Line continue to stage a strong comeback since we added to the portfolio in April, delivering ~7.0% for the month. Our new addition TSM and S4 Capital returns’ were muted for the month.

    This is our fourth consecutive month of beating our benchmark. A clean record so far and we aim to keep that. Since inception, we delivered a total return of +39.8%. This compares with our benchmark of +10.6%, equivalent to an alpha generation of +20.2%.

    ZagInvestor Portfolio Stats for August 2020
    ZagInvestor Portfolio Stats for August 2020.
    Global equity markets performance in August 2020
    Global equity markets performance in August 2020.

    Direct Line Group

    What else can we say about Direct Line’s blowout earnings? Besides the record low pandemic-led claims, Direct Line benefited from a more sustainable source of fundamental improvement: underwriting and cost control.

    We have previously highlighted how Direct Line is one of UK’s leading insurer (if not Europe) championing in investing in its IT infrastructure since the very beginning. Through years of investment and now under CEO Penny James, we expect further efficiency gains in its 3-year plan outlined in the recent Capital Markets Day presentation. In fact, there has already been encouraging signs of improvement from the latest update.

    With its capital position remain solid, the highlight of this update has to be the resumption of its dividends. Management announced a normal dividend of 7.4p and a special dividend of 14.4p. This equates to 6.5% yield solely for the interim!

    In our investment case, we highlighted the possibility of returning to its capital return policy some time in 2021. Obviously, the stock has reacted positively with the earlier than expected resumption of not only its normal dividend policy, but also a “catch up” on previously missed dividends.

    Direct Line remains a strong business and perhaps the best one in Financials (in Europe). It’s a rare breed of financial services company that has a stable and predictable cash flow, strong capital position and a track record of growing its base dividend since its IPO.

    Disney

    There’s no question that Disney has suffered significantly from its park business driven by the pandemic. As always, with crisis comes opportunities. This quarter is a transformative one for Disney, especially for its streaming video business. Disney+ reached the 60 million subscribers mark, which was initially targeted to reach by 2024.

    Netflix vs disney subscribers
    Source: Company report, CNBC.

    Additionally, it intends to release the long-awaited movie Mulan via Disney+ for $29.99. This marks the first foray of the Group into the video-on-demand rental business. Consequently, this could be the beginning of a highly lucrative business.

    Some rough maths, Mulan’s production budget was $200 million. Taking into account of the pricing and subscribers, it needs ~6.7m of subscribers to breakeven for the movie. That’s ~11%, which is fairly high in our view. Nonetheless, we believe Disney is merely testing the market for now. Imagine if Avengers movies will now only be exclusively available on Disney+!

    Disney revenue by segment
    Source: Company report, CNBC.

    Revenue wise, Disney continues to experience an extremely challenging period especially on its parks business. With the stock price reaction since results, the gradual appreciation of its Media Networks (Disney+, Hulu, ESPN+) business is gradually happening, in our view.

    Peloton

    Peloton has been on a tear in the month of August, aided by Goldman’s lifting of its price target. Specifically, the market’s expectation for Peloton’s growth and profitability remains far too low. With the company’s doubling of production, the weeks long order backlog and the absence of any material marketing spend, this could be a steepening of the adoption curve, rather than just an acceleration. In other words, this could be the new normal.

    We do feel that the from a short-term price action perspective, it may feel a little too toppy! Nonetheless, we are confident with Peloton’s longer term growth plans and expect the timeline to profitability sooner than the market is currently pricing in!

    On other news, Apple is reported to be developing a Peloton-like fitness app that could rival Peloton. While any company should be afraid when big tech steps into their ground, Peloton’s core business remain intact. In fact, we do see the possibility of Peloton being acquired by Apple one day (we hope!).

    S4 Capital

    Another day, another acquisition. S4 Capital recently acquired Brightblue Consulting, a data analytics business focused on using a range of mathematical and econometric techniques to allow marketers to gain greater insight into their digital audiences. The price was not disclosed, which we can only assume to be low single digit millions.

    The company employs more than 25 mathematicians and econometricians working for clients including Co-op, Royal Mail, Secret Escapes, Hiscox, NHS, LV, and Habito.

    Strategically, we do see how the acquisition make sense given the synergies between businesses within the Group, as well as the international outreach that S4 can offer.

    As for the relative modest changes in stock price this month, we don’t think there’s much to read into, other than “Business As Usual”.

    Taiwan Semiconductor

    A new addition to our portfolio earlier in the month. Check our write up here.

    Briefly, despite the strong rally, we like the stock stemming from its pure foundry model. Intel’s slip up has provided TSMC with an even stronger market position than before. Structural trends in the big tech, renewable energy and electric vehicles industry are just some of the key highlights of our investment thesis in TSMC.

    Macro

    The FED's new inflation target

    In its widely expected annual policy symposium in Jackson Hole, FED Chairman Jerome Powell pivot to a shift on its inflation goal. In contrast to previous inflation target of 2%, the FED now allows inflation to “moderately” overshoot the target, or the flexible use of “average inflation targeting”.

    The idea behind this is to pursue growth that it had previously fall short of. Essentially, this means to achieve a higher inflation to compensate lower than expected inflation. Obviously, this is not the sole objective of the Fed. Its congressionally assigned goals remain maximum employment and price stability.

    The conundrum remains: low rates for longer, but how long? Our base case remains that US 10 year treasury yields (currently ~70bps) will continue to drive towards below 50bps in the medium term. The rest is history.

    From a stock perspective, this may be good news given low rates, we’re also acutely aware of the possible bubble that is gradually forming in some parts of the market.

    Vaccine wars

    There will be no macro news without the mention of the coronavirus that has plagued the world since early 2020. With various verticals being considered in the race to a vaccine, we struggle on two key questions: who would win the race and is there a need for multiple vaccines?

    We tackle the latter first. At present, we have multiple types in development ranging from mRNA-based vaccines to viral vectors. Whilst there are a list of very promising vaccines in development today, the timeline remains uncertain. The big question is do we need multiple vaccines? From a manufacturing point of view, we see the need to have multiple vaccines. But one cannot help to think why would the world needs more than one, assuming it does work. (We’re by no means a medical expert!)

    Secondly, who would win the race? Russia already won, some might say. Others are more skeptical. Our consensus remains that Moderna (MRNA) will edge ahead in the race. The first to begin phase 1 clinical trials, its RNA-based vaccine has so far shown encouraging results. Its latest results also show promising results in small trial of elderly patients. We’re aware that the sample size is insignificant.

    In addition, the company also started a phase 3 trials testing the safety and effectiveness on 30,000 people with the results expected as early as October. The company also adds that it anticipates completing enrolment for its phase three trial in September.

    Politics aside, we remain upbeat that Moderna will win in this race. Until then, time will tell.

    Corporate & sector news

    SPAC attack: The rise of SPACs

    SPACs or Special Purpose Acquisition Company, sometimes called a blank-check company, is a shell company that has no operations but plans to go public with the intention of acquiring or merging with a company with the proceeds of the SPAC’s IPO.

    Spac issuances
    SPAC issuance ($bn) since 2005. Source: Refinitiv, 2020 figure is year to August 5.

    Chart of the month

    The magical stock split all companies must know.

    When a company announced a stock split, it’s a trade-off between having more shares outstanding and a lower valued absolute stock price. Fundamentally, it doesn’t make any difference, since nothing has really changed. 10 stocks of $1 is the same of 1 stock of $10. Simply put, no matter how many slices you get from a pizza, you still end up with a pizza.

    pizza slices
    Stock split and pizza slices.

    So, we can agree that’s fundamentally sound, except it wasn’t what the market think. Take Apple and Tesla as an example, especially the latter. Tesla delivered a +61% return since announcing its 5-for-1 stock split on 11 August. Could Amazon be next?

    Apple Tesla stock split
    Tesla and Apple’s cumulative return since announcing stock splits.

    Whilst Tesla may be a tech-driven car company, we think the market is missing out on its battery technology that could propel the stock further into a renewable energy company. Having said that, we are sensing some fatigue in massively shorted names and retail favorites.

    While some commentator argue that stock splits provide retail investors to own Tesla, we are less convinced on its impact. Even including the imminent S&P inclusion of Tesla, we’re still unable to make sense of a +61% move since.

    On the other hand, Apple became the first $2 trillion company on 19 August. Interestingly, Apple took just slightly over a year to increase double its market value having won the title of the first ever $1 trillion company 2 August 2019. Time will tell. Our bet will be on Amazon and Microsoft both reaching $2 trillion in a year, while Facebook will join the trillion dollar club soon!

    That’s all for August, see you in September.

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