It could easily be a volatile month ahead as we face the FOMC meeting and Brexit vote. What I am trying to do is have some cash ready for good entry prices on solid stocks as June unfolds.
I believe dividend GROWTH is the key to long-term outperformance of the ASX200 and today I’m going to explain the investment case for Washington H Soul Pattinson (SOL), a company that I believe is Australia’s Berkshire Hathaway.
If you take nothing else away from this note today, remember this table of annual and special dividends from SOL over the last 15 years. Without sounding like Paul Keating, this is a beautiful set of numbers…
With dividends contributing around 60% of the return from Australian equities, it is therefore no surprise that the chart above (11.3% CAGR in divs) has driven the chart below and a compound total return average of +14% per annum.
While many of you reading this note will think Soul Pattinson is a chemist, and no doubt that was its origins, pharmaceuticals represent just 5% of the entire portfolio. I view SOL nowadays as a $3.8 billion listed investment company (LIC), but one that is far different to any other large scale LIC due to the conviction of holdings and low correlation to different business cycles within its portfolio.
In recent years SOL was criticised by a large domestic fund manager for its corporate structure that includes cross shareholdings in Brickworks (BKW). I believe that activist noise drove some underperformance in SOL shares and opened up a discount to NAV that I think provides an investment opportunity. Similarly, that large domestic investor has voted with their feet, recently filing that they have gone below the 5% substantial shareholder threshold. My AIM Global High Conviction Fund actually bought some of those shares recently at $16.00 in a block and I think this will prove to be a discounted entry price for what will prove a solid medium to long-term investment. Please do not interpret that I think the seller is silly or something. We simply have a differing view about SOL’s corporate structure and corporate governance.
Our very simple investment case is we are buying SOL shares at a solid discount to the market value of their holdings @ $22.80 (-28% discount) and post-tax NTA of $18.33 (-11.6% discount). We see SOL as a LIC and buying LICs at unjustified discounts to post-tax NTA is more often than not a solid investment strategy. You are basically buying a discounted entry into a very transparent “sum of parts” valuation based off listed share prices of investments.
The table above shows you TPG Telecom (ASX: TPM) is SOL’s major investment at 40% of the portfolio. That has been a wonderful investment and should continue to be as it gains profitable share through the NBN rollout. Interestingly though, despite making fresh record share price highs this month, TPM has a very high short position as a percentage of free float (16m shares or 9.01% of the free float). That is a potentially powerful upside combination if TPM continues on its growth trajectory. Below is a 5-year chart of consensus FY17 earnings (EPS) forecasts for TPM overlayed with the share price. This can accurately be described as structural earnings growth.
The reason I compare SOL to Berkshire Hathaway, and I don’t do that lightly, is firstly their value-based approach to investing, secondly their long-term holding periods, and thirdly their focus on income generating investments across a wide variety of sectors. Below is a summary of the brands/businesses you get leverage to via investing in SOL.
That has driven a track record of benchmark index outperformance and total returns to shareholders that is actually only marginally behind what Warren Buffett has produced at Berkshire Hathaway over the last 40 years. Since 2000 however, SOL’s returns have smashed Buffett’s, as the Oracle of Omaha has broadly failed to embrace technology stocks.
SOL vs. BERK (A) since 2000 on a common performance base.
As I am learning in my 10 months as a fund manager, investment management is about risk management, conviction, patience, and repeating a process. SOL’s is a great example of all four, due mainly to consistency of leadership by the controlling shareholder, the Milner family. Rob Milner is the 4th generation Chairman.
To be able to buy generations of investment skill that is delivering total returns above Buffett at an -11.6% discount to post-tax NTA, while being paid a 3.3% annual (growing) dividend yield along the way, is an opportunity that rarely presents itself in the equity market.
I don’t want to overcomplicate the investment case for SOL in today’s note. This is a genuine buy-and-hold idea, with the entry price being while this unjustified discount to post-tax NTA still exists.
My view is that discount will evaporate in the months ahead, as the large seller is complete and others come around to our view that this discount is unwarranted.
If that proves right, SOL will trade up to $18.33, deliver us a +12.3% capital gain and pay us a 3.3% dividend yield. That prospective +15.6% total return, pre-franking credits, will beat the ASX200, beat Buffett, and yet then the stock would only be fair value trading at its post-tax NTA.
I encourage you to have a look at what I think is Australia’s Berkshire Hathaway while it’s “on sale”.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
