The old market adage “Sell in May and go away” is proving somewhat accurate in global equities this month, with the MSCI World Equity Index down -5%. The combination of an escalating trade war between the world’s two largest economies and inverting yield curves, has seen investors and traders rush to lock in the profits of the first four months of 2019. China facing stocks and global cyclicals/financials have performed worse than the benchmark index falls.
It’s easy to understand the rush to lock in some equity profits after the stellar gains of this calendar year. Clearly, short-term risks have risen and investors have been quick to price those risks in.
My approach to these sort of market situations is to rotate the portfolio a little to where I see greater total returns over the next 12 months. Considering the Australian ASX200 is the only developed world index actually up this month, in response to the surprise federal election result, I believe it’s prudent to selectively trim/sell Australian equity exposure, particularly where I believe a stock has hit our valuation and now offers little upside.
Two Australian stocks that have reached my valuation, and I have now exited (sold out of), are Aristocrat Leisure (ALL) and Kidman Resources (KDR). Both have been strong recent performers for different reasons, but I believe they offer little upside from here and there’s better potential total returns available elsewhere.
Let’s start with Kidman (KDR). If you’d ever told me that Wesfarmers (WES) would bid for Kidman you’d have won a lot of money from me believing it was a joke. The good news for KDR shareholders is that it wasn’t a joke and the cash bid from Wesfarmers has driven KDR shares up to $1.88 , or a market capitalisation of $763 million.
All lithium related stocks have been falling over the last six months. KDR was also performing poorly before the takeover bid. To reinforce how fortunate we were that Wesfarmers decided to take over KDR, the chart below graphs the performance of Kidman (+46%) (white line), Tesla (-45%) (red line) , SQM (-32%) (the world’s biggest lithium producer, green line) and the Global Lithium ETF (-21%) (purple line).
With the Lithium and Electric Vehicle (EV) bubble clearly bursting in the short term, to be on the right end of a takeover bid in a lithium explorer/wannabe producer, was, let’s just say again, “fortuitous”. We all need a little luck in investing and that’s why I believe the right course of action is to sell KDR, take the cash, and recycle the profits back into another next generation investment with greater upside. There also seems a very low likelihood of a higher bid as it appears all the major shareholders support the transaction at the current price.
Anyhow, I hope some readers held on to KDR and benefited from the Wesfarmers takeover offer.
Let’s move on to Aristocrat Leisure (ALL), which has rallied +32% in 2019. It has obviously been nice to be on the right side of that move, yet the stock has only really recovered to where it was in October 2018. That said, on what we know today, I think the stock is now fully valued around $29 and it’s time to take profits/sell.
The ALL first half profit was solid (+16%), leading to consensus analyst upgrades for FY19 of between 1% to 4%. The aspect of the result that led me to take profits in the stock was that the earnings surprise was driven by the traditional “land based” business of ALL (physical poker machine cabinets and software) but not by the digital/online businesses where they have spent billions on acquisitions.
US poker machine unit sales growth of +39% was the standout of the result, while most analysts believed digital revenues were around -5% below expectations, with margins also being lower than expectations. This is a problem in the way I approach ALL, as I simply don’t apply a 21x P/E to a land-based poker machine sales story. The P/E multiple expansion, under my investment thesis, was meant to be coming from the digital/online businesses that have been acquired. The earnings mix ALL delivered in the 1H wasn’t the one I would expect would deliver sustainable P/E expansion, in fact, quite the opposite, if it continues.
While the market arguably doesn’t discriminate how a consensus earnings upgrade was generated, I do. On that basis and after a +32% rally this year, I have acted and sold out of ALL. I don’t think it’s likely to fall sharply or anything like that, but I do think it’s now fully valued on what we know today and there’s potential greater total returns to be found in other stocks.
Price is what you pay, value is what you get. I no longer think KDR or ALL are good value versus the market and I think it’s time to take profits in both.
I’ll keep it short today, you can find my other comments on Monday’s YouTube edition of Switzer TV. Next week I’ll find some places to put KDR and ALL proceeds to work.
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