I continue to remind investors (and myself) that the idea is to “buy low”, or “buy the dip” in high-quality companies when their share prices take kneejerk reactions to short-term news.
In Australia, my fund has taken advantage of around -15% pullbacks in three stocks we like for the medium-term: Star Entertainment Group (SGR), Link Administration Holdings (LNK) and Regis Resources (RRL). In fact, we believed these respective share prices are so oversold on short-term noise we have had a genuine crack at them in the AIM Global High Conviction Fund.
Sure, we may not get instant gratification from buying these stocks but we set our portfolio for the next six to 12 months and believe at these respective share prices that all three stocks have the clear potential to generate total returns better than the market can. Entry price is the key determinant of total return and we think the current entry prices in SGR, LNK and RRL are the right starting place for generating solid total returns in the year ahead.
In a world where Twitter headlines dominate, yet Twitter makes no money and can’t find a partner, combined with very short performance measure periods for professional fund managers (i.e. no tolerance for short-term losers) and high frequency trading being 50% of daily equity market turnover, you can see why “bad news” gets exponentially punished in terms of share price.
But for those of us who have patient capital backing us and more than a one-day performance view, the recent events in SGR, LNK and RRL make us excited as they should be able to generate us future performance. We are taking advantage of short-term pain hopefully to generate longer-term total return gain.
We should have all learned this lesson this year. How many of us really bought enough BHP Billiton at $15.00? Peter Switzer told us to, but even I got a touch scared of future BHP share price falls and didn’t buy enough of them. I really regret that but I have learned from the experience and now strike harder for my fund when I see similar situations.
On a case-by-case basis, today I want to go into why we think SGR, LNK and RRL are oversold on fundamentals and offer an opportunity for genuine investors.
Star Entertainment Group (SGR)
Star Group (“SGR”) has fallen from around $6.00 to $5.37 at the time of writing on the back of stories surrounding the arrest of some Crown employees in China. Whilst the exact details of the arrests are unknown, media reports suggest that the staff have been detained for offences relating to the solicitation of gambling activities in China. It is also likely that these arrests could also be related to the Chinese Government’s wider focus on controlling capital outflows from the country. As such, the events of the weekend could impact the broader Chinese inbound high-roller market in Australia (or VIP market as it is known).
However it is important to realise that total VIP represents only ~15% of SGR’s EBITDA, of which Chinese players are ~80%. So if we make the drastic assumption that 30% of all Chinese VIP players elect not to come to Star Group’s casinos going forward, then we are talking about a drop in EBITDA of ~4%. We think this scenario is unlikely, with any potential impact likely to be less severe and probably short-lived.
Supporting this view is the fact that SGR’s most important marketing channel is Chinese junket operators, who organise travel, entertainment and credit arrangements for their VIP clients. The Chinese junket operators are responsible for more than 80% of Chinese VIP players to the region. The Crown employees arrested were most likely involved in “Direct” channel marketing. It is likely that direct channel will be more impacted than the junket channel.
There has been a historical precedent of a group of employees of Korean Casino operators being arrested in June 2015. This saw a 3-6 month drop in Chinese VIP traffic to those properties of around 30%. However, visitation has subsequently rebounded. Note that in the case of Korean casinos Chinese VIP players represent 45-55% of total turnover and the majority are sourced directly rather than through junket operators. Therefore they are far more exposed to such disruptions.
SGR shares have fallen back to a P/E of 17.5x FY17 consensus earnings. We think that will prove too cheap and we expect more clarity at the SGR AGM on October 28. At the AGM, we expect confirmation of strong domestic trading conditions that should ease concerns and lead to a re-rating SGR shares.
Link Administration Holdings (LNK)
LNK shares have fallen from $8.30 to a recent low of $7.60 on news that the ACCC had concerns about their potential acquisition of competitor Pillar. In our view, this is a complete over-reaction and comes shortly after a private equity sell-down of 30% of the company.
This is not one of those events where “private equity knew something”. Rather, the market has been somewhat surprised by the breadth of what the ACCC considers the market. However, these ACCC issues in our view are not insurmountable for LNK, nor form part of our modelling.
What is interesting and suggests this is more of a short-term liquidity event than a fundamental event, is no analyst had the Pillar deal in their LNK earnings forecasts. In fact, quite the contrary, analysts were waiting for a confirmation of the deal (which is a competitive tender) before upgrading their LNK estimates for the forward years.
To confirm this, the table below overlays consensus FY17 EPS estimates for LNK and the LNK share price. You can see consensus estimates are unmoved.
All that has happened at LNK is the P/E has dropped from around 28x to just over 23x for exactly the same forward EPS estimates.
While it’s unfortunate that 30% of the company changed hands just before the ACCC’s shot over the potential LNK/Pillar deal, I tend to believe that is the real reason for the share price drop: some traders who took part of the block of stock and are moving on at a loss. For fundamental medium-term investors, this is simply providing a better risk-adjusted entry price and that is why my fund has bought LNK into the pullback.
The structural growth case for LNK is unchanged in our view. The Pillar deal is still a chance but the share price and P/E is back to where it was in March. All things being equal, we would expect LNK shares to recover around $1.00 in the next 12 months from these levels, while paying a prospective dividend yield of 2.3%. Great structural growth businesses are rarely on sale. LNK is on sale now in our opinion and the private equity share price overhang has also been cleared.
Regis Resources (RRL)
RRL is a high-quality mid-cap Australian gold producer whose shares have recently fallen from $4.00 to $3.30. Yes, part of this can be explained by the $50oz fall in the spot gold price but during this time RRL confirmed another quarter of solid mine production, exploration success and low costs, which to us made the investment case stronger.
This debt-free gold miner confirmed all-in-sustaining-costs (AISC) of A$946oz, below the FY17 guidance range of A$980-A$1,050oz. This was also a lower cost outcome than the consensus analyst view. Drivers of the lower costs were the strong performance of the Moolart Well and Garden Well mines. However, grades for the quarter and throughput of material were fractionally lower than consensus analyst forecasts.
We see those quarterly grade and throughput slight disappointments as transient for RRL and another reason we are buying the stock at current low prices.
The other reason is RRL is having genuine exploration success. RRL’s brownfields exploration success over the last year had led to a rapid infilling of its development pipeline. The Gloster project will contribute to production from the current quarter, with the high grade Erlistoun following shortly after. This is leading to mine life extension and gives us greater confidence in production & cost forecasts.
RRL has over $100m of net cash (inc bullion) and on our analysis is a cheap gold growth stock.
On current consensus estimates RRL trades on 11.4x FY17 EPS, EV/EBITDA of 5.7x, Price to free cash flow of 7.7x, and prospective dividend yield of 4.35%ff.
While we never, ever, ever buy a resource stock purely for dividend yield, the dividend yield is part of the attraction of RRL and why we favour it over other Australian and global gold equities. If we are right about the 4.35%ff dividend yield, then it adds to the total return potential of RRL from this price.
The consensus NPV valuation for RRL is around $3.70 and we feel that’s fair value for RRL at current gold prices. On that basis, we see over +10% capital gain potential accompanied by a 4.35% dividend yield over the next 12 months. The stock also tested and held the 200-day moving average, which we also see as an encouraging development.
So there it is: three Australian stocks (SGR, LNK, RRL) we have “bought in gloom”, taking advantage of what we think will prove short-term mispricing in high quality long-term growth stocks. All three stocks are heavily oversold on relative strength indicators (RSI’s). Think of an RSI as a stretched rubber band, now we await the rebound.
They sit alongside APN Outdoor (APO) as contrarian Australian growth ideas inside the AIM Global High Conviction Fund.
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.
