Commentary

August provided healthy absolute returns for investors but the portfolio lagged the MSCI World index which continues to be driven by the mega cap growth stocks in the US. This has been true every month of 2020 so far. August’s gain of +7% in the S&P500 was its best August performance since 1984 and saw the index fully erase its losses from the pandemic lows of March. The NASDAQ now trades on 30 times forward earnings compared with 32 times at the peak in 2000. While the NASDAQ’s valuation looks expensive in the context of its own history, it actually looks cheap relative to US treasury bonds using a basic yield gap analysis. The huge liquidity injection by central banks is driving markets higher helped by the ever-increasing influence of passive funds. Such funds favour the larger constituents of the index being tracked. Amazon, Netflix, Microsoft and others maybe having a ‘good’ pandemic but sustainability of their current valuations is questionable. Analysis of the MSCI World index shows this impact almost perfectly with the largest companies performing best due to their size as money floods into passive funds:

Commentary

The stocks with the biggest negative impact on the portfolio’s relative performance were, in order of impact, Samsung Electronics (-7%, total return in local currency), Sanofi (-4%), E.ON, Nokia (both unchanged) and Hewlett Packard Enterprise (-2%).

Samsung has several attractive attributes: it is the lowest-cost operator in its core business of computer memory, it generates good returns on capital over the cycle, is committed to returning 50% of free cash flow to shareholders, and it has a strong balance sheet (net cash of $80bn, equal to 30% of the current market capitalisation and providing significant support for the investment required to maintain its market leading positions). Samsung’s main business lines are semi-conductor memory, mobile phones and visual displays. It is particularly strong in memory, an area that should benefit from the structural tailwinds of datacentre growth as well as next generation technologies such as artificial intelligence. Moreover, there has been considerable consolidation in the memory industry. This consolidation has made the industry more rational by limiting the build-out of new capacity which should support pricing and profits over the long-run. Samsung is trading on 10x historic price to earnings (excluding cash) and those earnings have grown at 10% a year over the last ten years.

The largest positive contributors to performance were, in order of impact, General Motors (+19%), Toyota (+13%), Mitsubishi UFJ (+13%), easyJet (+28%) and Siemens (+8%).

Shares of General Motors benefitted from market speculation that they may spin-out part of its electric and autonomous vehicle technology and assets allowing the market to give it some Tesla-like glow and provide a business unit with its own stock to attract and retain the talent required to compete against Tesla and new automotive technology companies. GM’s electric vehicle assets include its battery joint-venture with LG Chemical in Korea called Ultium Cells that aims to provide enough batteries for up to half a million cars a year from a factory being built in Ohio, not dissimilar in size to the first phase of Tesla’s Gigafactory in Nevada. Morgan Stanley has valued the EV and Ultium business units at $28 a share for GM and another $2 a share for its autonomous vehicle unit, Cruise – together equalling the month end closing price of GM stock. These valuations imply that we get the ‘old’ GM business with sales of £137bn for free today. While anything seems possible in the current euphoric environment we remain of the view that GM’s fair value on a two year view is closer to $38 a share offering more than 25% upside.

easyJet’s share price was buoyed by better-than-expected cash burn reported at its August 4^th investor update. We invested in April after it passed our stress test assumption of twelve months of no flying. This assumed a modest rights issue as well as the tapping of Government support without further borrowing against its fleet. Four months on, easyJet’s current liquidity is sufficient for twelve months of operating at the average levels of cash burn seen in the second calendar quarter, or nine months of no flying, with another six months of no flying coverable by borrowing against its fleet. The shares are likely to remain volatile as news on UK travel restrictions change with the rise and fall in new COVID cases across Europe, but its long-term potential remains significant as weaker players cut capacity further. We see fair value at £14.50 a share, some 130% upside from the current price.

The upside on the portfolio remains an historically attractive 50%. The portfolio is trading at 12.9 times historic earnings and 0.9 times book compared with 24.7 times and 2.7 times for the MSCI World Index.

Commentary

Commentary

Commentary

Commentary