Good afternoon,

ASX 200 pretty much flat again this week, down fractionally. Bit of money flowing out of the expensive small caps and into relatively better value large caps. I still feel mid-cap value stocks are probably the sweet spot right now, though opportunities are tough to come by.

  • Stocks are either fairly priced and you are playing for the unexpected and more unlikely upside or
  • Require very contrarian points of view to support an earnings growth thesis.

Anyway, banks rallied 1%, CBA ex-dividend in a couple of days. AGL (-7%) dragged utilities lower.


My best performing clients

I woke up (it’s Saturday morning as I type this) this morning reflecting on the conversation I had with Karl Siegling on Friday over a couple of beers.

You might know who Karl is, he’s the CEO and major shareholder of listed investment company  Cadence Capital (ASX Code: CDM) which under his guidance has generated 15%+ returns over the 10 years including the GFC. I think they have c. half a billion dollars under management (don’t quote me.)

Karl popped in for a one-on-one with me after 7 back-to-back broker presentations on Friday in Melbourne (which I’m always super appreciative of… much easier to just go have a nap in the business lounge than talk at that point!)

One of the things we talked about was how investment ideas are great, but the difference between a professional and an amateur is the execution. What do I mean by execution? I mean the process and how it’s applied.

Amateurs want to “know” what price to buy or sell at. They want to buy at $1 and from that point forward, the share price to only trade at $1.01 or higher. Professionals understand they’ll never “know” what the share price will be, so they “average in” or “average out” of their positions based on their assessment of risk and return at that given price.

Professionals can only do this because they have discretion to do so. Over their fund or over their client’s account. Talking to clients about trading actually doesn’t allow us the space to best serve you.

In a similar vein, amateur investors love hearing what stock I (or insert your other favourite professional’s name here) are buying/selling. They seem to think there is some IP in knowing a stock code and a price.

And whilst the pro’s probably have done a greater quantity of higher quality work to come to that conclusion than the at-home amateur but the IP is actually in “the work”. The “work” creates context.

  • Where the company sits relative to peers or other investment alternatives,
  • how the management thinks,
  • how much it could be worth (up & downside) in certain scenarios.

And the kicker is that work fuels other ideas. That might be to buy another company or avoid a certain sector or try something that doesn’t work and learn an important lesson.

The work also creates “conviction”. Professionals (mostly) don’t have to “sweat the small stuff” because we understand the business, it’s place in the market and the trends. Without the work, how do you know what information to act on? What to ignore? I mean, how do you change your thesis if your whole premise is “well Alan Kohler said it was cheap”. Importantly, how do you know when it’s not cheap anymore? A tip and “the price you pay” I’m sure you’ll agree is grossly inadequate data to make an investment decision.

I suppose the conclusion we came to (around the end of beer #2) was that “the work”, “the process” is where the IP is, it’s where the returns are made. It’s ‘how’ and ‘why’ more so that ‘what’. It’s practioner-ship (yes, I realise this isn’t a word!), its execution. It’s not a stock code and ‘buy low, sell high’, it’s not outcomes.

And whilst you’re focused on outcomes rather than process, I don’t think you’ll succeed in this business of businesses. In fact, in my experience dealing with hundreds of clients over the years, the worst performing, most dissatisfied clients fit exactly this mold and the best performing, happiest clients are those who just set the boundaries and let the professionals get to work.


Data Exchange Network (DXN)

I had an institutional enquiry about DXN during the week on the back of the company update (click here to read it) and sat in on the call I arranged for them with CEO Peter Christie.

DXN shareholders have a lot to be excited about. Melbourne & Sydney construction is largely going as originally planned, though both sites have been upgraded in size/scale to conform to the Uptime Institute specifications. I’m hoping that DXN will have some good news around their Tier IV certification from the Uptime Institute in the coming weeks. I’m led to believe this would make them the 1st Tier IV certified modular data center operator in the world.

We expect first revenues from both of these centers just before or just after Christmas (depending on how things go leading into the Christmas construction industry holidays.) In the interim, DXN’s manufacturing business is continuing to perform strongly, booking further unit sales and winning service contracts. $3.1m in revenue booked during the 4th quarter.


Zip Co (Z1P)

I dialed into the Z1P money results call last week. You can view the slide presentation here.

CEO Larry Diamond seemed quite upbeat. He was excited about the pending pipeline of billion-dollar merchants and reiterated that the business intends to be cash-flow break-even on a month to month basis from here on out.

Continued loan book growth should create opportunities for Z1P to further reduce its cost of capital (with a bolt on new facility being negotiated) and based on commentary around overheads, I’d expect revenue to growth to be greater than cost growth from here on out with management clearly focused on running a zero-cash burn operation.

The market seems pretty obsessed with the 2.6% bad debt write-off (up from 1.28% last year), which surprises me, given since before the IPO Larry & Peter have guided to sub-3% bad debts at scale…. Analyst coverage of Z1P is terrible sometimes. Anyway, that’s a topic for another day.

I still reckon analysts don’t really understand this business. They all focus on costs when costs have always been this management teams cornerstone competency.

  • They have a fantastic (and ever improving) decision engine to control bad debts.
  • as they scale their cost of capital naturally falls (interest expenses) and,
  • fixed costs (overheads) ‘cap out’ at a certain point (about now in my opinion)
  • Customer acquisition has been largely outsourced to vendors (much cheaper cost per customer than say, credit card comparables) – though this appears to be changing and I’ll be watching marketing expenses as a function of incremental transaction volume and revenue very closely.

The key metric for mine is not cost but revenue. Can Z1P earn enough revenue per customer to exceed these for 4 costs? And can they do it in a sustainable way, that is, can they continue with the next incremental $300 million dollars worth of customers as they have with the last $300 million?

High repeat patronage helps (as does more merchants – driving repeat use) and you’d think with the sheer quantum of addressable market, the risk is largely in execution more so than strategy. And I can’t say Larry, Peter and Z1P have ever struggled with execution in my experience with them.


Magellan (MFG)

Stock put on 16% since reporting a good set of numbers last week. Everyone in the market was pricing MFG like active management was dead and you all had sold all your share portfolios and bought Vanguard MSCI Global ETF.

Sorry Vanguard, that’s never going to happen. In the same way you’ll keep buying investment newsletters (because you want to “claim” your wins and “blame” your losses), ETF’s won’t keep growing at the same rate (without further innovation) because it’s human nature to try and ‘beat’ their next door neighbour. It’s why Instagram has over a 1 billion active monthly users, it’s why you’d rather drive a Mercedes than an equivalent Hyundai and it’s why you wear Nike’s. It’s the race with the Jones’.

Anyway, MFG is a super well run business, always innovating and pretty much leading funds management in this country. Made a couple of smart acquisitions last year (Airlie FM in particular… hi Spotty & Riggsy!) and now that it’s mature, will probably continue to spit off huge dividends for the foreseeable future.

Dividend per share and dividend yield over the last 5 years below.


Movers & Shakers

The old OzForex (OFX) business seems to be undergoing a bit of a makeover, up 40% from $1.30 lows to be trading at $2.02 but still a long way from the lofty heights of $3.30 in 2016.

Macquarie Telecom (MAQ) continues on it’s merry way, I reckon benefiting from fund manager distain for Telstra (TLS) and just about everything else in the sector. Good business and doing well operationally nonetheless.

Suncorp (SUN) also reported really well and is making new highs. JBH, CWN and REA also all had pretty good FY18 reports.

Bellamy’s (BAL) goes from bad to worse, lithium darlings copped a whack! and AGL gave some weak guidance so it got clipped as well.

Amcor (AMC) down on it’s Bemis (BMS-US) merger, though to my mind, that’s more of an opportunity that something to worry about for the yield conscious, quality focused and long term investors. Amcor (AMC) report later this month.

Previously part of Amcor was Orora (ORA), which also had a nice report, though expectations from some analysts were overdone so the stock sold done a bit.

Have a good week,
LL