ZagInvestor December 2020 Newsletter

December 2020 investment newsletter

Happy 2021! Let’s hope this year will be kinder than the previous.

2020 has been a year no one had expected how things would turn out. Going back, we started ZagInvestor in April 2020, with the aim to share (for free) our views, know-how and experiences in investing to our readers. What a journey it has been!

Thank you for your continued interest in us.

There are a lot to talk about in this month’s newsletter. Specifically, since inception, we have delivered ~200% return. Let’s make a start!

There are no new additions to our portfolio this month as we continue to navigate through this already punchy stock market. Nevertheless, we continue to seek for new, yet to be discovered and attractive investment opportunities.

As usual, we start by providing 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 December.

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Table of Contents
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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 2020, 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.

    Finally, with the ongoing electrification of vehicles and ever-increasing awareness on clean energy, we are seeking long-term opportunities in the metals/raw materials space, where demand will outgrow supply significantly.

    Portfolio updates

    Zaginvestor portfolio performance
    ZagInvestor Portfolio performance since inception.

    The portfolio delivered +13.5% in December (+16.3% in November), relative to S&P’s +3.7% and FTSE 100’s +3.1%. In alpha terms, we delivered +9.9% this month, with an above average annualized vol of ~15% and a portfolio beta of ~1.05.

    The key driver in December was Disney (again) and Peloton (the gift that never stop giving), delivering +22.4% and +30.0% respectively, due to positive news flows.

    Additionally, TSM again delivered a strong performance with +12.4%, with the market increasingly realizing the importance of an independent pure foundry model.

    We continue to be encouraged by Direct Line’s performance, delivering +7.8% for the month, possibly attributable to positive Brexit related news as well. Lastly, both S4 Capital and ATSG took a breather for the month, delivering +4.6% and +2.0%, respectively.

    This is our 8th 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 +99.2%. This compares with our benchmark of +18.9%, equivalent to an alpha generation of >70%.

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

    ATSG

    ATSG delivered a flattish return over the month, +2%, despite the strong volumes reported by across the logistics industry. We are of the view that even with current added capacities, demand continues to outweigh supply, which encourages the industry’s margin.

    Consequently, we remain convinced that ATSG has both the structural and a possible takeover potential and currently trades at a reasonable price.

    With the final quarter of each calendar year being the busiest, we expect the next catalyst to be its earnings results in March.

    Direct Line Group

    • Next earnings date: March 2, 2021
    • Ex-dividend date: April 8, 2021
    • Investment case

    Direct Line continues its rebound post the FCA proposal on the industry’s pricing practices, delivering +7.8% over the month, outperforming the wider stock market.

    In a month where macro news dominated, i.e. positive developments in Brexit, Direct Line stands to benefit from the reduced uncertainty.

    Another point worth noting is that the strengthening of the Pound. Given that the claims inflation is somewhat correlated to the currency, a stronger GBP would lead to a lower claims inflation, all else being equal. The rationale here is that most car parts are imported, leading to a lower claims inflation with a stronger currency.

    Nevertheless, Direct Line Group remains an out-of-favor but strong and quality compounder, in our view.

    Disney

    Our patience continues to pay off for the stock, with our thesis that the market will re-rate the stock through the lens of Disney+ rather than Disney’s Park and Cruises business is starting to realize. Disney delivered its best month yet, +22.4% over the month.

    The Virtual Investor Day held on December 10, 2020 is an inflection point for the business. Centered on Disney+, the company gave a set of bullish indicators, namely

    • Disney+ service now has 8 million subscribers (26.5 million early 2020)
    • Disney+ is announcing various new content for the platform (Mandolorian Season 3!)
    • It now expects Disney+ subscribers to be around 230-260 million by 2024.

    Interestingly, despite the announced increased investment in original content, Disney is reiterating that Disney+ will be profitable in 2024.

    As an investor and a fan of Disney’s franchise, we are most interested with the investment in its original content.

    Kareem Daniel, head of the company’s new media entertainment distribution group said that Disney+ will become home to 10 Marvel series, 10 Star Wars series, 15 Disney live-action, Disney Animation and Pixar series, and 15 Disney live action, Disney Animation and Pixar films. This is strong competitive edge Disney has and will drive it to be a growth company again, in our view.

    We expect a continuation of re-rating in the stock as it remains an attractive benchmark relative to the current streaming services companies out there in the market today.

    Peloton

    Our star of the month (one time too many, perhaps), Peloton delivered a whopping +30% in December!

    The primary catalyst of the outperformance is because of its announced intention to acquire Precor, one of the world’s largest suppliers of commercial fitness equipment, for $420 million. This is excellent news in many facets.

    First, the pandemic has led to supply constraints affecting retailers & manufacturers. Peloton is not an exception. With the recent new product launch, the acquisition would bring significantly more production capacity, especially important to cope with its already long waiting list for its Tread and Bike products.

    Secondly, we think that by acquiring Precor, Peloton essentially “cornered” the market in terms of manufacturing, compared to its competitors who mostly operate on an outsource basis.

    Finally, Precor offers Peloton a much needed entry into manufacturing and distribution capabilities worldwide, with offices in the UK, Germany, Benelux, Spain, France, Japan, China etc. Given that Precor also supply commercial gym equipment, this could very well imply Peloton’s growth intention into this market with has been historically dominated by traditional commercial gym equipment providers such as TechnoGym (TGYM.MI), among others.

    Overall, this is a continuation of our investment thesis in Peloton.

    S4 Capital

    Nothing to see here.

    S4 Capital had a quiet month of news flow. Over the month, it has delivered +4.6%, slightly outperformance relative to the wider market, although there’s nothing to write home about.

    We continue to see the confidence in the board as it reiterates its three-year plan for 2021-2023 to double top and bottom line organically. Despite more than doubling our money since we entered to position, we expect the stock to re-rate further.

    TSM

    Over the month, TSM delivered a +12.4%. Pretty impressive considering there were little company specific news.

    In our view, reflecting on its stock price, we think that the market is beginning to realize the potential of a pure foundry model such as TSM. Not only is the company getting a tailwind from its existing tech and manufacturing capabilities, its competitors, such as Intel (INTC), continue to lag behind, giving further prospects to TSM’s already flourishing business.

    Third Point, an activist hedge fund, has recently taken a stake in Intel, urging the company to explore strategic alternatives, which could see further shake up in one of TSM’s largest competitors.

    While this could be positive for TSM in the short term, the medium-term impact, if any, would depend on what strategy they intend to pursue.

    Nevertheless, we think TSM will maintain its strength and lead in its tech infrastructure in years to come.

    Macro: 2021 - the year we defeat COVID-19

    2021 is the year we defeat Covid-19. That’s the hope.

    With various vaccines being roll-out, there’s every reason to be optimistic about this. But before we cross that bridge, we need to address the current out-of-control Covid cases that are increasingly every day.

    The new coronavirus strain first discovered in the UK just before Christmas had a lot to do with what we’re facing today. Despite some travel bans in place, this new strain has also been recently discovered in the US, suggesting that the virus has mutated locally.

    A substantially higher transmissibility than other variants, this strain is the key reason why global infection has shot up significantly recently. Take the UK for example, cases continued to skyrocket despite lockdown.

    UK Coronavirus daily cases
    UK daily coronavirus reported cases. Source: UK government coronavirus data.

    With hospitals’ capacity shrinking daily, we are almost reaching a breaking point in this pandemic.

    But, there’s hope.

    Our view is that global government needs to double their effort is helping to get its population vaccinated (for those who wants, of course). The speed of execution needs to be hasten to combat this virus. The quicker we get out of this, the more lives can be saved and the quicker we can rebound economically.

    Chart of the Month: The ultimate FOMO in Clean Energy

    The rise of interest in clean energy stocks should come as no surprise to investors. With Tesla being at the forefront of this revolution, clean energy stocks has skyrocketed in 2020.

    But, one stock is particular more than caught our attention.

    QuantumScape.

    quantumscape stock price
    QuantumScape stock price post deal announcement. Source: Bloomberg

    Founded in 2010, QuantumScape is an American company that produces solid state lithium-ion batteries for electric cars. Its investors include Bill Gates and Volkswagen. It boast an even more impressive board including John Doerr, chairman of VC firms Kleiner Perkins, JB Straubel, Co-Founder and ex-CTO of Tesla and Vinod Khosla, Co-Founder of Sun Microsystems and Khosla Ventures.

    You can see where this is going. The rise of electric vehicles (EVs) implies the greater demand for battery tech. Joining in the a SPAC mania, QuantumScape

    QuantumScape entered the public market via Kensington Capital Acquisition Corp. (KCAC) in early September 2020.

    When the deal was agreed back in September, both QuantumScape and KCAC agreed on a valuation of $3.3 billion. At peak just before Christmas, the stock was trading ~$46 billion!

    That’s almost 14x the value agreed less than 3 months ago.

    Before we jump to any conclusion, let us make one thing clear. QuantumScape is a great company with excellent potential in the space, driven by its unrivaled tech it has built up over the years.

    Based on its Analyst presentation, the agreed valuation of $3.3 billion equates to ~1.0x of 2027E sales. That was then.

    Today, it’s trading at 9.0x 2027E Enterprise Value to Sales ratio. We, the ZagInvestor team, have never seen anything like this in all of our investing experiences combined.

    First, it’s 9.0x. And secondly, it’s 2027E. I guess we can accept the high valuation if we have good visibility ahead, but we’re talking about 2027E, so 6-7 years at the time of writing.

    We think investors should be cautious about such valuation despite the company’s potential. The market as it is today is extremely different from a year ago. Clean energy remains the key theme in the market, but everything has a value and price distortion do happen frequently.

    That’s all for this month.

    Looking forward to replicate our successful 2020 performance in 2021!

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