After over 20 years in markets I have now officially seen everything. I can say that because in the last 24 hours I have witnessed the Dow Jones Industrial Average futures trade in a range over 1000 points!
I need to firstly try and explain what happened in US equity futures and the US equity market over the last 24 hours. It is not all positive and the index gains mask a severe sector rotation, driven by sharply rising long bond yields on fears of inflation from Trump policies. Capital losses in bonds are huge, as we warned you they would be.
This morning’s US equity market return may look like a good headline but there is likely a lot of pain being felt by many fund managers. The problem is that not all stocks are rising – 6 sectors are up but 5 are down. The sector performance dispersion in the market is the third highest we’ve observed since 2005.
And the problem is that hedge funds are not necessarily positioned the right way. According to the Morgan Stanley Prime Broker Content Group, hedge funds have the greatest net exposure (relative to S&P 500 weights) to Tech and Consumer Discretionary, both of which are down today. At the same time, they have the least exposure to Financials and Industrials, the #1 and #3 best performers today. Hedge funds do have some right-way bets – Staples, Real Estate, and Utes – but these are in the minority.
Combined with what is still relatively low net exposure of ~48% (83rd 1-year percentile, but the 29th 5-year percentile, according to the MS PB Content team) means today’s rally likely isn’t going hedge funds way.
The wrong-way positioning is likely contributing to covering and performance chasing – the Morgan Stanley High Short Interest Basket (MSXXSHRT) is up 2x that of the S&P500 today.
Today’s price action is being driven by the same forces that have been driving sector performance dispersion for the last few months – the rise in interest rates and steepening of the term structure. Today that is being considered a risk-positive outcome, as it comes on the back of expectations for greater growth and inflation together. The risk is that the growth side does not deliver while the inflation side does – this would create a stagflationary environment that is bad for both the bond proxies and cyclicals. Higher correlation within equities in a down market means higher equity volatility, and higher correlation to bonds, and de-leveraging from risk parity funds.
All that means is, I think, that it is highly unwise to believe last night was anything other than an ugly pain trade for most hedge funds. My advice to all of you, and to myself, is to be patient and let the dust settle from this stunning Trump victory.
My fund went to zero weight all US equities about a week ago on fears of a Trump victory. We will wait and see what happens in the US over the next few weeks, looking for stock specific ideas to reinvest our capital in the USA.
Our view is the BETTER risk adjusted buying opportunities lie in Australian equities. Last week I “thumped the table” on the value we see in Link (LNK), Star (SGR) and APN Outdoor (APO). The good news APO UPGRADED their earnings guidance and the stock rallied +16% on the day. I remain of the view APO is still very cheap and my fund has bought more APO in recent days. Similarly, I continue to feel LNK and SGR are very cheap versus the likely earnings growth they will deliver. I’m still thumping the table on all three as they have absolutely nothing to do with the USA.
Today I thought I’d update you on what APN Outdoor (APO) said and why I still think it will prove a tremendous medium-term investment. “Tremendous” is my one “Trumpism” of the day.
To be clear, there was very positive news on two fronts from APO. Firstly they upgraded their earnings guidance and secondly they accelerated their digital billboard rollout.
We have even higher conviction in our APO investment thesis after these two developments. The upgraded earnings guidance provides confidence in both the outdoor advertising segments continued structural growth and APO’s ability to participate in this shift and hold its ad revenue share. We also strongly believe it makes both strategic and financial sense for shareholders for APO to take advantage of its competitive advantage and accelerate its digital billboard roll-out from 20.25 in C2016 to 36.
APO is a play on the “digital economy” via switching its billboards from static to digital screens therefore enhancing their revenue yield. APO is a classic example of an investment idea you can see with your own eyes in everyday life. APO signs dominate every major motorway and airport we travel through and the digital screens clearly attract your attention more than a static billboard. You can see how dominant their billboard positioning is and how much more effective the digital screens are as they flick between advertisements.
We believed outdoor advertising will continue to take share from other traditional media platforms. The outdoor segment has growth +16% in the first nine months of 2016.The table below from Morgan Stanley confirms the revenue share gains outdoor is taking.
Advertisers want more digital boards because of the speed to market, added functionality and effectiveness.
APO’s great advantage is it currently has around 600 traditional (static) billboards that are ripe for conversion to digital screens over the years ahead. Note well new approvals of billboards are proving harder for the entire industry, so existing inventory is increasingly valuable. The equity market appears to not really value these 600 “old” boards at anything, but they are the key attraction of APO and will be how the company delivers double digit compound EPS growth over the years ahead as they are converted to digital.
APO’s previous guidance is to convert 15-20 billboards to digital per annum. Now this debt free company has accelerated that rate to 36pa. Digital billboards have an ROIC of greater than 50% and a 2-3 year payback. On that maths, accelerating the conversion rollout is a no-brainer. This is particularly so when you look at the table below from Morgan Stanley and see digital conversion is the key driver of APO profit growth.
AIM did not own APO before its spectacular de-rating post its last result, but we think the stock is now compelling value and will revert, through time, back to a growth multiple from its current value multiple. We felt the profit warning would prove “one off” due to the Federal Election and Olympics and that APO will resume growth. That view has been vindicated.
APO is a classic example of a mid-cap stock that got over-owned and over-priced, yet we feel the register wash-out has now occurred and the road to recovery will be with less expectation. We now believe APO is structural growth at a cheap price. We note the James Packer backed Ellerston has increased its holding to 9.5% of APO.
The chart below shows the gap between CY17 EPS forecasts and the APO share price. We believe the APO share price will close this gap by rising.
At $5.25, APO is trading on a forward CY17 P/E of 15x and offers EPS growth of +15% and a prospective dividend yield 4.00%. EV/EBITDA is just 9.5x CY17 estimates. That is a -20% valuation discount to the ASX200.
Put it this way, if the market became truly comfortable that APO had genuinely resumed structural growth, as we do, it would be trading back up at a 20x multiple, which equates to a $7.00 price target in 12 months’ time. In our view APO is structural growth at a cheap price.
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.