ZagInvestor October 2020 Newsletter

ZagInvestor October 2020 newsletter

The month that most investors (especially those are long) want to forget! Besides the Hang Seng Index (see table below), global stock indices saw a sea of red in the month of October.

But, was it a surprise to investors given arguably one of the most contested US Presidential Election is just around the corner? With stock prices at all-time highs, the never ending re-rating of tech stocks, surely, a minor drawdown seem reasonable/healthy? Perhaps not all investors share this view.

Despite the heightened volatility in the market, our portfolio proved resilient, delivering +3.9% over the month of October. While we delivered fairly similar return with last month (+4.1% for September), what’s interesting is our outperformance of ~8% over our benchmark (which returned -4.2%) despite the market downturn.

Excitedly, we also added a new stock Air Transport Services Group (ATSG) to our portfolio early in October. We think the business is a fundamentally solid business with “interesting” optionality not explicitly priced in by the market. For more, see below or our full article here.

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 October.

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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, 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.

    We have been looking into cloud services, web-infrastructure and website-security companies, as they 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. The recent IPO of Palantir (PLTR) and Snowflake (SNOW) might create opportunities between them.

    Portfolio updates

    ZagInvestor Portfolio performance since inception
    ZagInvestor Portfolio performance since inception.

    The portfolio delivered +3.9% in October (+4.1% in September), relative to S&P’s -2.8% and FTSE 100’s -4.9%. In alpha terms, we delivered +7.8% this month, with an above average annualized vol of ~20% and a portfolio beta of ~1.02.

    The key driver in October was Peloton (again!), +11% driven by the continued rally in stay-at-home stocks given worsening pandemic outlook. Our new addition ATSG delivered +6.7%, driven by good results and the fact air freight rates are going up drastically, benefiting all segments of the business. Direct Line Group and Disney are the laggard for the month, delivered -2.2% and -2.3%, respectively.

    Separately, TSM continues to gain appreciation in the market with its defensive business model, gaining +3.4% in an extremely tough environment. Little change in S4 Capital, having delivered close to 100% since we added it to the portfolio in April.

    This is our 6th 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 +52.5%. This compares with our benchmark of +3.1%, equivalent to an alpha generation of ~49%.

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

    ATSG

    ATSG is our latest addition in the portfolio. An aviation company active in providing air transportation to domestic and foreign carriers, we believe ATSG stands to benefit from the secular trend of e-commerce.

    With demand for cargo and freight spaces skyrocketing, we expect such trend to not only provide a short-term boost in freight prices, but also a sustainable revenue growth for the sector, hence, ATSG.

    More interestingly, Amazon, who has been aggressively expanding its fleets via Prime Air, owns ~40% of total diluted outstanding shares via warrants. We think this provides a strategic optionality for the business. Importantly, we do not think the market is pricing in such upside!

    Direct Line

    Following the FCA’s ruling (discussed here), Direct Line has somewhat produced a lackluster October. Despite outperforming the wider UK & Europe markets, the stock returned -2.7% for the month.

    As long term investors, we are convinced that Direct Line is a quality compounder with a solid business model, albeit operating in a challenging environment. We view the market’s under appreciation continues to provide an excellent entry point for investors.

    Disney

    • Next earnings date: November 5, 2020
    • Virtual Investor Day: December 10, 2020
    • Investment case

    Disney had a unique month. Traditionally, the market has been quick to sell off the stock whenever Covid-19 cases spikes, with the rationale being its parks and cruises businesses will suffer more. Interestingly, that didn’t really happen this month! One can argue that the market is beginning to realize that Disney’s crown jewel is its streaming business, and not its parks and cruises!

    Since our investment thesis, we have on numerous occasion argued that Disney should ditched its low RoE businesses and focus on its streaming. Our voices did not fell on deaf ears when activist investor Dan Loeb of Third Point Capital calls on Disney to end its dividend and instead use it for its Disney+ content.

    In fact, shortly after the letter was published, Disney announced that its ‘primary focus’ for entertainment is streaming. If this turns out to be true, Disney could be able to revive its multi-year growth story. As utopian as the plan may be, we think Disney will adopt an approach that is somewhere in between, ie not ditching all of its dividend, purely to satisfy some of its core investor base.

    The announcement of a major reorganization remains unclear, however. Not until its Virtual Investor Day on December 10. The other talking point is how ‘Mulan’ has performed since it sold it through Disney+ for $30.

    S4 Capital

    Perhaps the quietest month for S4 Capital, both in terms of its stock price and news flow. A month without acquisition does seem odd for the stock after all.

    There’s little to update for this month. We should have more to discuss about it regarding its Q3 results in November.

    Peloton

    The Peloton trail does not end! Another month of outperformance, delivering +11%, despite a horrid month. While there are little news flow in the name, we hypothesize that Peloton is being grouped as one of those “stay-at-home” basket, where a spike in Covid-19 cases seem to have positive correlation with its stock price.

    We continue to hold Peloton for its growth potential and accelerated cash flow positive position in the near term. Having said that, we were definitely much more bullish when we first entered ~$55 than the current price.

    While still remaining bullish, we note a few things. First, we expect the near term upside to remain capped given how the stock has traded lately. Secondly, since September, we have seen a significant increase in insider selling. While nothing alarming, it’s always worth to keep that in mind. Lastly, we think our growth thesis has so far played out and the market has definitely reflected our view. The next catalyst for the stock is its profitability and its international expansion strategy.

    TSMC

    TSMC announced what we thought is a strong 3Q result in a challenging period. Specifically, it hiked its revenue outlook, which translates to more than +30% for 2020 revenue relative to prior year. Among the trends discussed were how Covid-19 has accelerated the demand for digitalization, upcoming iPhone and the growing secular trend of 5G. All of these will benefit TSMC’s pure play foundry business model, in our view.

    On the recent iPhone launch, the consensus so far points towards an underwhelming start, given the specifications, price range and the current situation we’re in. Nevertheless, it’s still early days. Watch this space!

    Macro

    A veritable smorgasbord

    The resurgence of coronavirus and the 2020 US presidential election one of the few key events that will continue to exacerbate volatility in the equity market stretching towards end of the year. A few near term events to note, however.

    First, fresh US stimulus package by congress. At the time of writing, there are still big obstacles in reaching any agreements between both Reps and Dems. We are convinced that regardless who wins the election, fresh stimulus will be passed imminently. As Jerome Powell alluded to again in early October, it is now up to Congress for continued aggressive fiscal and monetary stimulus in order for an economic recovery to continue.

    “Now, it’s not the time for politics.” – Said no politicians ever.

    Second, the beginning of lockdowns in Europe. So far, UK, France and Germany have impose another round of lockdowns. It is obvious that more stimulus is needed by Europe and UK, or else a further permanent reduction economic activity is forthcoming. Airlines, brick and mortar retailers and leisure companies are the obvious candidates to stay away, despite its “value”-like valuations.

    Chart of the Month: US presidential election and stock market returns

    Rather than CoTM, we’ll discussed about the ToTM, Table of the Month.

    We thought it would be interesting to find out how stock market returns fared before any US presidential election, with the aim to get a feel of how the market is positioning into these events.

    As you would have realize from the table below, 2008 was indeed a special year – an outlier nonetheless. For our analysis, we calculate the total return of S&P 500 before the Election Day since 1980 and computed the following table.

    US Presidential returns and stock market
    S&P 500 returns prior US Presidential Election. Source: Bloomberg.

    There are a few interesting point. Firstly, excluding 2008, buying into the market 6M and 1Y prior any US presidential has made you money. It does seem to be almost fool proof from the surface. The average return for both 6M and 1Y are +5.7% and +9.4%, respectively.

    Secondly, the track record of 1M and 3M prior any election day seems mixed at best, with a % of positive return of ~55% for both.

    Finally, the drawdown in the stock market last week (week prior to the 2020 election) is odd, given the data. We can only hypothesize that the coronavirus and worsening political climate drove the selloff.

    That’s all for October! Buckle up and get ready for the Santa rally!

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