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AFR6-7 January 2018The Australian Financial Review | www.afr.com

20 Companies

Five stocks fund managers are tipping to run hard this year...

Best and worst of 2018

‘Syrah is in production and fully funded for all current development plans – the only graphite miner ex China in such a position.Harry Cator, DMP

‘There is no peer globally to Smiggle, and those who have tried have so far failed.Matthew Ryland, Greencape

‘The Domain spinoff has highlighted the undervalued nature of the remaining parts of the business.Tim Carleton, Auscap

‘In a market that is awash with overpriced stocks, GCS is currently trading on a forecast single digit PE multiple.David Prescott, Lanyon

‘HUB’s platform offer planners far greater functionality than the traditional bank-owned legacy platforms.Steve Black, Ed Prendergast, Pengana

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FUNDIES’ BESTLONG AND

SHORT IDEASThe year ahead Jonathan Shapiro and

Vesna Poljak take a look at what investorsare buying and the names being shorted.

David Prescott ofLanyon is willing toback cinema chainAMCEntertainment;Alcoa Corp boastsan ‘‘attractive’’portfolio of assets’’;Amcor is seen as adependableinvestment that willbenefit from the riseof e-commerce.PHOTO: PHOTOS: AP,BLOOMBERG, JOHNWOUDSTRA

Apyjamas retailer, twoAustralian mediaicons, and a Polishmobile disrupter arethe unlikely sourcesof inspiration forintrepid fund man-agers looking to beat

the market this year.Those long ideas are the counterpoint to a

handful of battleground stocks in the hotareas of technology and resources thatinvestors nominate as the stocks to short, oravoid, in the longest bull market in a genera-tion.

AFR Weekend’s survey of the best long-short ideas for 2018 saw longs outnumbershorts and Australian fund managers, forthe most part, shy away from calling outstocks that they are betting will head south.But a handful of strongly hyped technologynames have elicited concerns about overlystretched valuations and invite counter-consensus thinking.

■ Karen Towle of Tribeca identifiedUpdater (UPD:ASX), which tripled in valueduring 2017, as a short candidate. The busi-ness partners with real estate agents in theUnited States to help people moving house.While Updater has been successful in gener-ating demand for its service, Towle says thecompany has battled to monetise its offer-ing.

That’s led them to explore other areas likeinsurance, which she says are more com-petitive and uncertain.

‘‘With little in the way of revenue, noearnings in sight and a market capitalisa-tion of over $700 million, we believe theshare price has run too hard,’’ the Tribecaportfolio manager says.

■ Ben McGarry and Sam Granger of Totusmake the case for betting against GetSwift(GSW:ASX), the delivery software stock,which surged after announcing a deal withAmazon, which it promptly followed with acapital raising. They regard the $670 millionvaluation as ‘‘ridiculous’’ for a companywith $300,000 of revenue and claim‘‘industry feedback on the product is luke-warm at best’’.

The Totus pair believe GetSwift’s promo-tional partnership announcements arereminiscent of the tech shocker 1-Page.

And just to show value is in the eye of thebeholder, investors would recall that digitalupstarts Afterpay and WiseTech Globalwere both tipped as shorts for 2017, only tomake their backers richer and detractorspoorer.

■ In funds management, Totus sees turbu-lence for the $1 billion high-flying fundsmanagement outfit Blue Sky AlternativeInvestments (BLA:ASX).

McGarry and Granger are uncomfortablewith what they say are complicated finan-cial statements, an aggressive exposure tothe Brisbane property market, and a largeaccounts receivable balance ‘‘as a result ofaccruing performance fees before cash real-isation’’.

Totus also called out ‘‘delays in invest-ment timeframes’’ at several Blue Sky fundsthat were scheduled to return funds toinvestors some time ago, but were still oper-ating.

Australian hedge funds bounced back instyle in 2017, clocking double-digit returnsafter a difficult 2016.

■ Long-short manager Paragon – whichshrewdly selected Magnis Resources as ashort and Kidman Resources as a long lastyear – finished notably strong. John Denizof Paragon is tipping small potash playAgrimin (AMN:ASX) for success. Hedescribes its sulphate of potash (SOP) pro-ject in Western Australia as a world class,strategic asset.

‘‘SOP is a premium and essential fertiliserfor the fastest growing segment of the globalfood market, being fruits and vegetables,’’he says. ‘‘In the face of a strong demand out-look, we are seeing supply shutdowns at

highly polluting secondary production facil-ities around the world.’’

■ Paragon’s short idea is the $2 billion Pil-bara Minerals (PLS:ASX), a hard-rallyinglithium interest. Deniz does not share themarket’s confidence in the ‘‘highly pro-moted story’’ where management hasaggressively guided for stage-one first con-centrate production by June 2018.

‘‘We view this as a stretch target and costoverruns in addition to the recent capexincrease of $40 million are likely,’’ he says.‘‘Whilst direct shipping ore sales will help,any delays will see a funding shortfall beforefirst cash flows.’’

■ Sebastian Evans of NAOS is looking to thelocal real estate investment trust sector forstocks that could come unstuck as bondyields rise. Investors have piled into REITsas an alternative to low-yielding bonds,pushing up valuations, but Evans believes

there are subtle changes in the global econ-omy which could reverse these flows.

‘‘If inflation continues to climb, then theFed Reserve will likely move faster on theirinterest rate rise program, and if they do so,then eventually Australia will have to fol-low,’’ Evans says. ‘‘The entire REIT sector istrading well above the stated value of theirassets and we don’t see this lasting in a raterise environment.’’

Global equities manager Antipodes Part-ners agrees there is an opportunity bettingagainst interest rate sensitive stocks.

‘‘The extreme thirst for yield has pushedthe US high yield corporate debt cycle intouncharted territory with the average lever-age ratio expanding significantly beyond theprevious 2007 profit cycle peak,’’ says JacobMitchell, Andrew Baud and Sunny Bangiaof Antipodes.

Antipodes is shorting two types of stocksthat have benefited from the high-yieldboom: ‘‘over-hyped, thematic disrupterssuch as Tesla (TLSA:NASDAQ) that areincreasingly vulnerable to a fight-back fromstrong incumbent competitors such asToyota and Hyundai’’; and, ‘‘bond proxiesfavoured by passive strategies that confusemomentum with value and low volatilitywith quality’’.

Mitchell points to the mobile tower oper-ators as the kind of equity that is ‘‘priced forthe illusion of duration’’.

■ Last year, any business that came withinAmazon’s radius was aggressively sold. ButAndrew Macken and Chris Demasi of Mont-gomery Global believe the market hasmissed some Amazon-sensitive shorts. He’spitched $US3 billion battery makerEnergizer Holdings (ENR:NYSE) as vulner-able to a correction.

Not only is single-use battery demand instructural decline, over 90 per cent of salesare occurring on Amazon which has its ownprivate label battery line. ‘‘Amazon is simplygiving Energizer’s 50 per cent gross marginback to consumers!’’ Demasi says.

Chad Slater of Morphic is shorting fash-ion house Prada (1913:HK) which has ‘‘con-sistently failed to deliver on earningsexpectations over the last three years’’. At

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AFR 6-7 January 2018www.afr.com | The Australian Financial Review

21Companies

SOURCE: FINANCIAL REVIEW, BLOOMBERG

... and the stocks they’re betting against

‘With little in the way of revenue, no earnings in sight and a >$700m market cap, the share price has run too hard.Karen Towle, Tribeca

‘Over-hyped, thematic “disruptors” are increasingly vulnerable to a fight-back from strong incumbent competitors.Jacob Mitchell, Antipodes

‘Promotional partnership announcements are not supported by revenue generation.Ben McGarry/Sam Granger, Totus

‘It seems something is wrong with the brand. Something is also wrong with the treatment of shareholders.Chad Slater, Morphic

‘Pilbara is a highly promoted story, where management are aggressively guiding for Stage 1 first concentrate production by June 2018.John Deniz, Paragon

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Short: Tesla is seenby some asincreasinglyvulnerable to afight-back fromstrong incumbentcompetitors such asToyota and Hyundai;Chad Slater ofMorphic is shortingfashion housePrada, saying ‘‘itseems something iswrong with thebrand’’ and the‘‘treatment ofshareholders’’.PHOTOS: SUPPLIED,KATE GERAGHTY

first this was put down to slowing Chinesedemand, but as China has stabilised andaccelerated, the story lacks merit he says,citing soaring sales at Louis Vuitton.

‘‘It seems something is wrong with thebrand. Something is also wrong with thetreatment of shareholders: the co-CEOs paidthemselves €24.8 million in 2016 for thispoor performance. Consultancy and direct-ors fees for the co-CEOs total more than€240 million since the IPO.’’

■ Slater is dark on the storied Italian fash-ion label but he is happily buying rubbish inChina: Morphic’s long pick is China Everb-right International (257:HK). The waste dis-posal and incineration business looks cheapas value stocks lag more ‘‘sexy’’ tech plays.

‘‘With growing cities, large scale landfill isnot a viable long-term option for the coun-try. A recent plant to trip to China by one ofour team confirmed that the targets set outby the central government in their currentfive-year plan are being implemented,’’Slater says.

■ David Prescott of Lanyon is willing toback cinema chain AMC Entertainment(AMC:NYSE) which halved in value lastyear.

‘‘The cinema industry has experiencedrobust attendance and reliable pricingpower over the last decade – a period whichincludes substantial disruption from thelikes of Netflix.’’ Prescott believes that asAMC’s refurbishment plans wind down,capital expenditure will decline and lever-age will fall.

‘‘The shares today are offering more thana 15 per cent normalised free cash flow yield.With the company planning to eventuallylist its European cinema business and the2018 box office outlook looking strong, wethink AMC is a compelling opportunity inan already unloved sector.’’

■ Justin Braitling of Watermark is cool onthe UK’s Metro Bank (MTRO:LN), a play onfounder Vernon Hill’s success in the US with‘‘fast-food banking’’ Commerce Bancorp.‘‘Our sense is that Metro’s branch-bankingmodel will be far less successful in the UK

than Commerce was in the US,’’ becauseretail banking and the role of branches havechanged since Commerce swooped.

‘‘The company has a lot of wood to chopto get from 2017’s 3 per cent return on equityto 2022’s 18 per cent, and on 3 times tangiblebook the stock has a long way to fall if any-thing goes wrong.’’

Braitling is bullish on Play Communica-tions (PLY:WSE) which he calls ‘‘the mostsuccessful mobile disrupter anywhere inthe world’’.

‘‘Play is the most capital-efficient mobilenetwork in the world with a 7 per centcapex/sales budget. Its network design isunencumbered by legacy systems, andattention is paid to every element of the net-work to be as efficient as possible.’’ Incred-ibly, it is also cheap, trading at a 30 per centdiscount to the telco sector average and ahigher yield than Telstra.

■ Turning to healthcare, Antipodes favoursGilead Sciences (GILD:NASDAQ), which ata price-earnings multiple of 11 times is alsoone of its top 10 investments by virtue of itsdominant and growing share in HIV treat-ments.

■ Lev Margolin of L1 Capital favours $US10billion aluminium producer Alcoa Corp(AA:NYSE) which boasts an ‘‘attractive’’portfolio of assets that would be impossibleto replicate even with unlimited capital. Infact, ‘‘its replacement cost would be over$US100 per share, or double the currentshare price.’’

■ Harry Cator of DMP took a metaapproach, shorting Australia’s ‘‘tall poppysyndrome’’ by going long poppy stock TPIEnterprises (TPE:ASX) and challengingconsensus short Syrah Resources(SYR:ASX), the most-shorted stock on theASX.Syrah has an ‘‘ultra high grade product’’ innatural graphite which is vital to the expan-sion of electric vehicles, a 40-year-plus pro-duction lifespan, downstream productioncapability, a project in production and fullyfunded for all current development plans.(‘‘Note to the shorts – stop hiding behind

your ‘‘For Education Purposes Only’’ reportsthat are factually incorrect’’, he says.)TPI ‘‘may just be on the brink of becoming avery tall poppy, through its lowest cost, licitproduction of narcotic raw material, to con-vert into an active pharmaceutical ingredi-ent, for input into a fixed dose tabletformat.’’ It is only one of a small number ofcompanies worldwide with the capabilityand capacity to supply all markets, outsideof the US, for codeine phosphate finisheddosage product.

■ For value-oriented small cap hunters,Tribeca’s Towle nominates Southern CrossElectrical (SXE:ASX) as a long idea. The sup-plier of electrical contracting services hashistorically been exposed to the miningindustry in Western Australia but theiracquisition of Heydey brings exposure tothe East coast infrastructure boom.

■ Chris Prunty and Tony Waters of QVGpicks Somnomed (SOM:ASX), the manufac-turer of an appliance that treats sleep apnea.The company has had success in Europe butPrunty says the ‘‘real kicker’’ in 2018 will beroll-out of their own direct-to-patientcentres in the US.

■ QVG is also backing New Zealandthermal and coking coal producer BathurstResources (BRL:ASX) which has a 65 percent interest in Stockton, an asset that pro-duces high quality export coal. ‘‘With thecurrent hard coking coal price over $US200per tonne and guidance set assuming a$NZ185 price, we see scope for meaningfulearnings upgrades.’’

■ Lanyon’s Prescott is bullish on GlobalConstruction Services (GCS:ASX) whichowns one of Australia’s leading claddingbusinesses and is ‘‘well placed to benefitfrom the mountain of industry work’’. ‘‘Themarket is only just now slowly starting toappreciate the significance of the prob-lems,’’ referring to highly combustible, non-compliant aluminium building cladding.Evans of NAOS believes 2018 will be the yearthe market finally appreciates the ‘‘envi-able’’ position of finance broker Consolid-ated Operations Group (COG:ASX).Steve Black and Ed Prendergast of Penganalike Hub24 (HUB:ASX), the investment plat-form that is winning around 11 per centshare of net investment inflows, or around$200 million a month. Planners prefer itsfunctionality over the traditional bank-owned platforms, with the benefit of inde-pendence from the maligned banks.Just by growing its share of industry fundsunder administration from less than 1 percent to 5 per cent over the next seven years,the Pengana pair expect profitability toclimb above $100 million annually due tothe scaleability of the business.

■ Black and Prendergast also favour Life-style Communities (LIC:ASX) retirementvillages where homeowners own theirhome but lease the land for a weekly fee.They’re encouraged by the growth from 150homes under management to almost 2000

and a high referral rate validating claims ofhigh customer satisfaction.

‘‘We rate management very highly, hav-ing grown the business at rates above 20per cent per annum for over a decade with-out raising capital,’’ they conclude.

While hedge funds have preferred (andsucceeded) betting against old media, twotop performing managers advocate longpositions in News Corp (NWS:ASX) andFairfax Media (FXJ:ASX), the publisher ofAFR Weekend.

■ L1 Capital’s Margolin believes Newscould be at least 50 per cent undervalued,even after ascribing modest multiples onwhat he regards as ‘‘free assets’’ includingthe Wall Street Journal, Barron’s, The Sun,The Times, The Herald Sun and Daily Tele-graph.News’ combined stakes in its two largestassets – online real estate portals REAGroup and Move – plus the $US2.5 billion ofcash on balance sheet is almost equal to itsmarket cap, implying cheap publishingassets which ‘‘have a look through consol-idated EBITDA of $1.2 billion’’.

■ And Tim Carleton and Matt Parker ofAuscap, a high-performing long-shortfund, argues the spin-off of Fairfax’sDomain has ‘‘highlighted the undervaluednature of the remaining parts of the busi-ness’’ being radio, digital and publishingassets.Fairfax’s residual stake in Domain is worth$1.2 billion, which implies that the rest ofthe business is worth less than $600 millionat current prices, with Fairfax in a net cashposition, he says. Last year, Carleton adds,these assets collectively generated over$190 million of earnings.

Auscap also favours Macquarie Group(MQG:ASX), ‘‘a high quality, cash generat-ing, strong return on capital business withsignificant cyclical and structural tailwindstrading at a modest valuation’’.

In a twist on the Amazon effect, MatthewRyland of Greencape’s picks appear to playboth sides of the trade.

He cites packaging stock Amcor(AMC:ASX) as a dependable investmentthat will benefit from the rise ofe-commerce with a track record of allocat-ing capital skilfully. ‘‘It’s a liquid blue chipglobal leader that’s very well run that tradesin line with average industrial Aussie listedstocks, whilst growing faster, with less risk.It’s too cheap.’’

The other is Premier Investments(PMV:ASX) because of the ‘‘hidden value’’in the Smiggle and Peter Alexander brands.

Premier, Ryland says, is a cheap, high-growth global retail rollout story with themarket ascribing a near-zero valuation toits legacy brands Portmans and Just Jeans,even though they are turning a profit.

‘‘Management have been very discip-lined targeting rent savings, closing storesand managing risk, which is what investorsshould expect from good retailers in chal-lenging times.’’ The stock is trading at 16times forward earnings, forecast to grow by15 per cent.