As you know, I am bullish on the Eurozone and China, feeling the greatest growth and upside is in those geographies.
Over the next few weeks, I will be in the UK and continental Europe, seeing companies and policy makers. My fellow portfolio manager, Angus Wright, will be in mainland China, doing exactly the same.
At AIM we strongly believe you have to “get out to find out”, with real world “tyre kicking” the best research anyone can do. Our job is to predict where earnings and dividend growth is in 6, 12 and 24 months and you don’t work that out sitting in front of screens in the office.
We find the best investment ideas you see with your own eyes in everyday life. We also find the best investment ideas are simple to understand and easy to create a financial model for. We also find we have to back those ideas hard in a high conviction sense inside the portfolio, otherwise we will simply produce the index return.
The goal is also to find investment ideas in stocks and sectors that simply aren’t available in Australia. Nobody needs my fund to buy them more Commonwealth Bank shares. What you need us to do is find you the best international structural growth stocks that you simply won’t find yourselves.
So far we have done that. In the last financial year, the AIM Global High Conviction Fund delivered a return of 17.6%. But it is travelling where you generate the best ideas. Getting out and kicking tyres is why you pay a fund manager to manage your money. This is particularly so as an international investor based in Sydney.
The weeks ahead for me are genuinely exciting: I have a tremendous schedule of meetings and presentations, which will yield some genuine money making ideas. I have no doubt at all about that.
I’m typing this note from London, which to me offers Australian investors potentially once in a generation contrarian opportunities, due to the weakness in the British Pound created by the uncertainty of Brexit. However, I am a British Pound bull as I have written in these notes, feeling the currency is discounting “hard Brexit” when the more likely outcome is “soft Brexit”. In recent times, the GBP/USD has recovered from $1.20 to $1.33, which to me is a clear sign the Pound has bottomed.
For Australian investors, the Australian dollar has also bounced from recent lows, which means will still have the ability to buy UK assets cheaply, as GBPAUD at 1.69 is well below recent highs around 1.75. I think GBPAUD will head towards 2.00 in the years ahead and that is why we have our UK investments unhedged.
Inflation is picking up in the UK and the next move from the Bank of England will be an interest rate rise. The GBP is starting to acknowledge this, as is the UK rates market. The BOE will raise cash rates before the RBA and add further fuel to the GBP/AUD cross rate.
This is good news for UK Banks, which will see some NIM margin expansion as the BOE raises rates. I’ve said before that UK Banks are cheap, very cheap in fact, and my fund has been increasing its exposure to large ca and mid-cap UK banks.
For Australian based investors, who don’t or can’t buy UK Banks directly, I remain of the view that the best way to get exposure to this strong theme is Clydesdale PLC, which is dual-listed in the UK and ASX. CYB. ASX is one of my funds largest holdings because it ticks all the boxes of value, growth, currency, management and catalysts.
Even this week, Moody’s the ratings agency hinted they were in process of UPGRADING CYB’s credit rating. So they should be as this mid-sized UK bank, spun off from the National Australia Bank (NAB.ASX), is in the midst of a genuine operational and balance sheet turnaround. However, on current investment metrics, the stock remains very cheap and somewhat dubious of this clear turnaround.
CYB recently produced clear evidence of their turnaround moment at the 1H result that beat consensus estimates at every level and lead to analyst upgrades.
The August result highlighted solid volumes and better margins while beating expectations on the cost out. Analysts were pleasantly surprised by both the mortgage lending growth (5.8% annualised) and the SME lending growth (4.7% annualised).
A major factor for AIM is that the CYB bottom line is very sensitive to interest rate movements. Market estimates suggest that if interest rates rise 1%, revenue will rise by £107m and profit by £80m. Consensus estimates currently have net income at £146.2m for FY17, highlighting the significance of such interest rate exposure. At AIM we believe interest rates in the UK are set to rise off the back of UK inflation being at 4 year highs. Over the last week, there has definitely been more of a hawkish tone from the Bank of England. The graph below shows UK inflation:
Continued cost management will also be important for CYB going forward. The company had previously issued guidance for underlying costs to be in the range of £690-700m, however this has now been revised to below £680m. We see this as a faster delivery of benefits, and also a structural change going forward. We believe there is greater upside for this cost saving lever, which will go straight to the bottom line.
NIM was ahead of estimates at 9M17 annualized 229bps. This mainly came from deposit repricing and mix, and asset yields in retail. Asset quality was also in line with the broader sector with a 16bps cost of risk.
The result also confirmed the CET1 ratio within the guided range of 12-13% (12.4%) and a LDR below 120% (119%). While the company trades on a PE of the average UK bank, it is clearly undervalued on a price to book basis. Interestingly the overall analyst view remains a somewhat cautious 4 holds, 3 buys and 3 sells. Consensus analysts’ price targets of $4.94 will prove too low.
CYB is a high conviction investment for the AIM Global High Conviction Fund. We can see 50% further upside in CYB over the next few years as they execute on their turnaround strategy, release excess regulatory capital, experience NIM expansion and start paying a dividend. The icing on the cake will come from GBP/AUD appreciation helping the equity conversion price back to the ASX listing.
If you are looking to add offshore exposure to your portfolio, I suggest you consider adding CYB as a holding. This is the start of a multi-year re-rating story and we feel the momentum is strong.
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.