Commentary
Summary
The fund fell 0.4% in the second quarter of 2024 while the MSCI World High Divided Yield fell 1.7% and the MSCI World Index rose 2.5%. The largest positive contributors to performance were Pason Systems, Philip Morris and Winpak. The largest negative contributors to performance were Allegiant Travel, Brembo, and KT&G.
Despite the indices being driven by higher and higher valuations we remain committed to our approach of investing in companies that are attractively valued. The weighted average upside of 62% is well above the long run average. We are even more excited on a relative basis. The broader market is trading on a price-to-earnings multiple of 19 times; this is nearly a 100% premium to the portfolio.
Overview
Warren Buffett’s advice for investors is to be fearful when others are greedy and greedy when others are fearful. Greed is often associated with markets that are trading at all-time highs but today we believe it is fear, the fear of missing out, that is driving markets to all time highs. The posterchild of this fear is Nvidia, a company that has risen over 30 times in the last five years to briefly become the world’s largest company, as measured by market capitalisation (but little else).
Nvidia is valued at 40 times trailing sales and 70 times trailing earnings. People may well point to the growth and suggest the 45 times forward earnings is more acceptable, but this is based on 54% net profit margin, which is unlikely to be sustainable. Microsoft is valued at 13 times forward sales and 38 times earnings with a record 35% net margin. Apple is valued at eight times forward sales and 32 times earnings also on a record 26% net margin. The three largest companies in the world are larger than the entire S&P500 was just over a decade ago and they are trading at record valuations on record margins. The operational performance of these companies is obviously exceptional, however, their beatification may be premature.
The Halo Effect, a book written by Phil Rosenzweig, perfectly highlights this risk. The star of that book was Cisco whose story looks remarkably like Nvidia’s. In 1999, Cisco was a leading networking company which was going to play a dominant role in the prevalent technology of the next decade or two. Cisco had a margin of 16%, a net cash balance sheet and had doubled revenues over the previous two years. Over the next 25 years revenue rose five times and earnings seven times. Today the share price is still nearly 40% below the March 2000 high. One could argue that all the magnificent seven suffer from the Halo Effect fallacy. Valuation always matters.
Performance
Turning to the portfolio, we will avoid the fear and greed and believe that value will out. This time it has taken much longer than we would have liked but we are seeing a lot of evidence that the value in the portfolio is slowly being recognised.
The fund fell 0.4% in the second quarter of 2024 while the MSCI World High Divided Yield fell 1.7% and the MSCI World Index rose 2.5%. The largest positive contributors to performance were, in order of impact, Pason Systems (+19% total return in local currency), Philip Morris (+12%) and Winpak (+10%). The largest negative contributors to performance were, in order of impact, Allegiant Travel (‑33%), Brembo (‑11%), and KT&G (-6%).
Pason Systems announced results with revenue per rig rising 8% year on year as well as completing the acquisition of Intelligent Wellhead Systems (IWS). IWS will add to the business a new growth opportunity that could be as large as the existing business. With the shares trading at 12 times price to earnings this potential is not priced into the shares today.
Allegiant Travel is suffering alongside all the other low-cost airlines in the USA. This is a function of oversupply in the industry and rising cost pressures. Allegiant’s specific position is worsened further by Boeing’s inability to deliver new planes, creating dual running costs; losses on the new hotel Sunseeker; and finally further pressure on yields and profitability from implementing a new pricing system. This all makes for grim reading. However, there are reasons to still think that Allegiant can deliver above average returns going forward.
Firstly, some of the issues highlighted above are temporary. Sunseeker losses, Boeing deliveries and costs associated with implementing new revenue management systems – excluding these items Allegiant suggested that the airline operating margin was in the mid-teens, well above industry average. In addition, over the coming year the company continues to expect that it can increase utilisation steadily back to pre-COVID levels helping increase revenue and reduce costs. If it is successful in this execution, then the shares are extraordinarily cheap.
Allegiant currently generates c.$2.5bn of revenue pre COVID operating margins averaged c.20%, even if they deliver 15% this implies around 3 times price to earnings when allowing for interest and tax compared to a long-term median of around 15 times.
Commentary
Summary
The fund fell 0.4% in the second quarter of 2024 while the MSCI World High Divided Yield fell 1.7% and the MSCI World Index rose 2.5%. The largest positive contributors to performance were Pason Systems, Philip Morris and Winpak. The largest negative contributors to performance were Allegiant Travel, Brembo, and KT&G.
Despite the indices being driven by higher and higher valuations we remain committed to our approach of investing in companies that are attractively valued. The weighted average upside of 62% is well above the long run average. We are even more excited on a relative basis. The broader market is trading on a price-to-earnings multiple of 19 times; this is nearly a 100% premium to the portfolio.
Overview
Warren Buffett’s advice for investors is to be fearful when others are greedy and greedy when others are fearful. Greed is often associated with markets that are trading at all-time highs but today we believe it is fear, the fear of missing out, that is driving markets to all time highs. The posterchild of this fear is Nvidia, a company that has risen over 30 times in the last five years to briefly become the world’s largest company, as measured by market capitalisation (but little else).
Nvidia is valued at 40 times trailing sales and 70 times trailing earnings. People may well point to the growth and suggest the 45 times forward earnings is more acceptable, but this is based on 54% net profit margin, which is unlikely to be sustainable. Microsoft is valued at 13 times forward sales and 38 times earnings with a record 35% net margin. Apple is valued at eight times forward sales and 32 times earnings also on a record 26% net margin. The three largest companies in the world are larger than the entire S&P500 was just over a decade ago and they are trading at record valuations on record margins. The operational performance of these companies is obviously exceptional, however, their beatification may be premature.
The Halo Effect, a book written by Phil Rosenzweig, perfectly highlights this risk. The star of that book was Cisco whose story looks remarkably like Nvidia’s. In 1999, Cisco was a leading networking company which was going to play a dominant role in the prevalent technology of the next decade or two. Cisco had a margin of 16%, a net cash balance sheet and had doubled revenues over the previous two years. Over the next 25 years revenue rose five times and earnings seven times. Today the share price is still nearly 40% below the March 2000 high. One could argue that all the magnificent seven suffer from the Halo Effect fallacy. Valuation always matters.
Performance
Turning to the portfolio, we will avoid the fear and greed and believe that value will out. This time it has taken much longer than we would have liked but we are seeing a lot of evidence that the value in the portfolio is slowly being recognised.
The fund fell 0.4% in the second quarter of 2024 while the MSCI World High Divided Yield fell 1.7% and the MSCI World Index rose 2.5%. The largest positive contributors to performance were, in order of impact, Pason Systems (+19% total return in local currency), Philip Morris (+12%) and Winpak (+10%). The largest negative contributors to performance were, in order of impact, Allegiant Travel (‑33%), Brembo (‑11%), and KT&G (-6%).
Pason Systems announced results with revenue per rig rising 8% year on year as well as completing the acquisition of Intelligent Wellhead Systems (IWS). IWS will add to the business a new growth opportunity that could be as large as the existing business. With the shares trading at 12 times price to earnings this potential is not priced into the shares today.
Allegiant Travel is suffering alongside all the other low-cost airlines in the USA. This is a function of oversupply in the industry and rising cost pressures. Allegiant’s specific position is worsened further by Boeing’s inability to deliver new planes, creating dual running costs; losses on the new hotel Sunseeker; and finally further pressure on yields and profitability from implementing a new pricing system. This all makes for grim reading. However, there are reasons to still think that Allegiant can deliver above average returns going forward.
Firstly, some of the issues highlighted above are temporary. Sunseeker losses, Boeing deliveries and costs associated with implementing new revenue management systems – excluding these items Allegiant suggested that the airline operating margin was in the mid-teens, well above industry average. In addition, over the coming year the company continues to expect that it can increase utilisation steadily back to pre-COVID levels helping increase revenue and reduce costs. If it is successful in this execution, then the shares are extraordinarily cheap.
Allegiant currently generates c.$2.5bn of revenue pre COVID operating margins averaged c.20%, even if they deliver 15% this implies around 3 times price to earnings when allowing for interest and tax compared to a long-term median of around 15 times.