A negative equity manager is like a bicycle with a flat tire. It doesn’t do you any good, but it keeps you from falling off the bike.
So, with the possible exception of Japan where 20 years of negative markets have Darwinianly evolved into different creatures, most equity managers have a positive view of reality. We occasionally try to take off these rose-tinted spectacles, spectacles that look and look for opportunities in a world that, through ups and downs, is always evolving and growing. We therefore focus on market risks in order to better define the short-term (12-18 months) risk/benefit profile, which is instrumental in defining our tactical asset allocation.
Finding negative material is never difficult. There are people like SocGen’s permabear analyst Albert Edward who have built a successful career on negativity. His analysis, full of statistics, calculations and graphs is the first aid for the manager who needs to motivate himself because he missed a market rally or a handy gimmick. It’s suited for the financial adviser who wants to go on holiday with his portfolios empty so he can take some anxiety away and enjoy the waves and sun.
The press helps. Journalists tend to espouse a cautious reading of reality knowing as well as Ray Dalio, Nouriel Roubini and generations of Swiss bankers, to name but a few, that you will be remembered more for the money you saved than for the money you made. Although, to quote Peter Lynch, much more money has been lost in the market by trying to anticipate the next drop than during the drops themselves. On the other hand, experienced managers also have in mind the famous phrase of the Greek politician and orator Demosthenes written as far back as 358 BC, later taken up and made famous in English by Sir John Mennes in 1641 to ridicule a military expedition to Scotland:
For he that fights and runs away,
May live to fight another day.
(i.e. ‘because he who fights and withdraws can fight again’)
which later became the popular English idiom ‘live to fight another day’.
We all know that if a downturn lasts too long, the risks of losing customers and assets are considerable. Not everyone knows how to wait. So waiting patiently for a possible difficult phase to pass, with a diversified and quality portfolio, which would perhaps be the best thing for the client, cannot always be applied.
The Economist, which we always read for the depth of its journalists and the balance and fairness of its editorial direction, produced a disturbing cover on Friday (the roller coaster shown on the previous page), at least for those who are not short on the stock market.
What goes up will inevitably come down, the article begins. While this is certainly true of the roller coaster, it is not necessarily true of the stock market. The article touches on the valuations of the American market, pointing out that according to the CAPE (Cycle Adjusted Price Earnings), i.e. the ratio between the valuations of securities and their earnings normalised for the economic cycle, the S&P500 traded at the beginning of January at a valuation of 40x (see sidebar graph), valuations only seen during the dot.com bubble. Here the consideration seems quite superficial. Shiller’s CAPE is no longer applicable. The indices contain fewer and fewer stocks that follow the economic cycle and whose P/E must therefore be adjusted. However, they contain a lot of stocks that are exposed to digitalisation and other trends and that have great growth potential for investors, and this is reflected in the valuations, as is normal. It is up to the growth investor to evaluate them by analysing the underlying trend, the proprietary technology, the business model, regulation, competition, barriers to entry, etc. The non-growth part of the market cannot be considered expensive, but rather reflects its growth problems too harshly and places little value on the possibility of growth. It is therefore not, in our view, a drunk market. It is certainly a polarised market. Indeed, there are similarities with 2000. In 2000-2003 there was also a polarisation between growth and value stocks. Back then, however, the overvalued part, in terms of the number of sectors, was larger, or rather, today we have a substantially larger number of sectors and undervalued securities than then, and the undervaluation is also more pronounced.
The article also points out that the banking system, the skeleton of finance, is now much more solid and less exposed to the cycle. This prevents a negative cycle from being accompanied by a financial crisis or the fear of one. It is also acknowledged that the liquidity of the markets is also much greater and this gives the possibility of eliminating excesses quickly without creating a series of coercive measures. The article then continues with an analysis of new risks, such as the leverage we find on hedge funds and the Archegos case is an example. Or the presence of securities or asset classes whose underlying lies solely in the hope that these securities or asset classes will rise (from Gamestop to crypto). There are not only retail investors on these assets, but also funds. It is therefore important to be careful where you invest and the concentration of products in your portfolio. Finally, the article notes that both institutional and retail investors have a degree of fear of market valuations (see chart above), which is always a good thing.
Despite the cover photo, it seems to us that the article is not only unconvincing, but does not express a real conviction on the part of the writer that we are close to a market crash. We agree that the phase of weakness of the most speculative part of the market is not over. These processes are long. The market is used to the fact that these asset classes rebound and is therefore ready to buy them on weakness, but we believe that this time the rebound and the resumption of the trend will not happen and that gradually these asset classes will return to values that better reflect not only the opportunities, but also the future risks. Some will certainly multiply again but the majority will stagnate or go into oblivion. The risk is always that weakness in one part of the market will weaken the cycle and also affect the value part, which is absolutely attractive today. We believe it is worth taking the risk, the risk of lengthening the time it takes to get a return on one’s investment versus the risk of missing the train of a valuation rebalancing on the value side that is due and long overdue. The risk/benefit profile seems to us too good not to be in the market.
War and peace, fantasising between cynical realism and paranoia
Andreotti used to say that it is a sin to think wrongly, but we are often caught. Let us allow ourselves to think badly and ask for forgiveness in advance for the nonsense we are about to write. Take it as bar talk although it is supported by objective data. Using multiple sources we dare to calculate the cost of Russia’s current military pressure in Ukraine at USD 20 million per day. However, the increased revenue for Russia and its oil companies from the crisis is around USD 250m. Also significant are the higher daily earnings for American companies. And for their rich Middle Eastern friends. This impasse represents a hidden tax that improves the balance sheet of many companies and governments. It supports an industry with tens of thousands of jobs in the US. It also provides an incredible incentive to accelerate the growth of investment in renewables and the penetration of electric cars. And, alas, to increase arms budgets. It weakens the consumer to enrich the rich and goes in the opposite direction of what we are doing in the wake of the pandemic. However, until March this situation is basically convenient for many. After that the price of gas will fall regardless, because of rising temperatures. If Putin, instead of stupidly invading Ukraine and “Cubanising” Russia for a decade, managed to reduce the sanctions that were imposed on the country in 2014, he would have hit the jackpot. The Russian market would fly. Meanwhile the price of fossil fuels along with the price of many goods whose increase is due to the lockdown will fall, and so will the fear of inflation and war. Meanwhile the market will have been further cleansed of the many excesses among the more speculative companies and it could start again.
In the event of an invasion, governments have well anticipated this possibility in the media. So we don’t think there would be many days of market weakness and this could be a good buying opportunity. Especially in value stocks, i.e. those with low valuations, solid balance sheets and good franchises. Never forget to diversify.
Dogs, lungs and bacilli
In a scene from the famous film Wall Street, the young broker Buddy Fox is received by the great financier Gekko. He offers to invest in some apparently attractive securities, but Gekko is not satisfied. He wants safe securities. He wants to benefit from non-public information. The Gekko drawn in the film, a controversial figure but far from being completely negative in 1986, would today be immediately judged a criminal. The securities proposed to him by the novice broker are very cheap, overlooked by the market. Classic value stocks. Gekko calls them dogs, in the English version, which is inexplicably translated as lungs with bacilli in the Italian version. Niche AM manages a breeding of about 500 of them. Some of those on which we have the largest positions have recently dropped following the quarterly results. It seems appropriate to give an update
We read from the renowned British newspaper the Guardian “…the Swiss giant can’t stay out of trouble”, and again “game over for the exclusive Swiss bank?” and quoting an analyst of JPM, “after the latest scandal the institution could sell or close the Investment Banking division”. The company was bailed out by the Swiss government in 2008, when it had to write down sub-prime securities by 48 billion USD. As if that wasn’t enough, in 2009 it was accused of helping US citizens not to pay their taxes, which cost it about USD 1 billion. In 2011 a rogue trader without controls caused the bank to lose USD 2 billion. More tax problems cost the bank 300 million euros that it had to give to the German government in 2013, and 780 million euros that it had to give to the French government in 2014. In 2017 it was ordered to pay €5bn again by a French court for helping customers evade, a figure reduced to €2bn in 2019. But how on earth is Credit Suisse run?
In fact, the company to which the above information refers is not Credit Suisse but UBS, but the dramatic headlines you read then about it are very similar to those you read today about its peer. Today UBS is the darling of the market worth 1.2 TBV, a barely adjusted number for a nice franchise, compared to 0.5 times for Credit Suisse. In 2019, the two banks were worth the same, both as P/TBV, 0.8x, and as a price per share, CHF 15. Today, UBS is worth almost CHF 20 per share and CREDIT SUISSE just over CHF 8. The CHF 5 bln of various losses incurred by Credit Suisse over the last two years (from Archegos to Gupta) have cost the bank over CHF 20 bln in capitalisation. It is true that the bank’s IB downsizing has reduced its ability to generate profits, but it is also true that it will now be much less risky than many of its peers.
2022, a horrible year for the bank, actually marked one of its most profitable years ever, with over CHF 6.5 bln pre-tax. If you look at the presentation you’ll find that its Swiss banking division (CS is the largest banking institution in Switzerland) made pre-tax profits of CHF 2.7bn, with a return on regulatory capital (not far off ROTE) of 17%. Today, this part of Credit Suisse, which contributed just under half of the bank’s normalised profits, would be worth as much as all of Credit Suisse or more. The rest, wealth management, asset management and the Asian division are free. If these were valued at a modest 10x EBIT, and IB 4x the bank would be worth CHF 20 per share. We believe that the opportunity for UBS to merge with CS, and then list the latter’s banking division for antitrust reasons, is considerable, and that the power vacuum now in CS may help. The new structure announced a few days ago by Credit Suisse, which is spinning off the Swiss Wealth Management division from Universal Swiss Bank (which becomes just Swiss Bank) and merging it with the global Wealth Management division, goes in that direction. However, politics plays an important and inscrutable role here. This can be considered a free option. The alternative is to invest in a bank that is perceived as risky by the market at a time when it is actually less so, at extremely attractive valuations that greatly limit its downside. If you feel you have somewhat missed the boat on the bank re rating CS offers a good opportunity in our view. Here too, as always with value, you have to be patient. Here are the slides of the presentation.
The company reported the figures on Thursday after announcing them on 10 January. Nothing significantly negative emerged to justify the almost 10% that was lost over Thursday and Friday. Among the new elements was the impairment of IB-related goodwill, which is being downsized (a necessary act with no economic or equity consequences) and variable employee compensation components that will weigh in 2022 (CHF 1 bln), which is still a transition year, but let’s remember that the market anticipates. The company has confirmed a minimum ROTE for 2024 of 10%, which would mean less than 4x earnings and 0.35x TBV at that date. Japanese multiples for one of the world’s most prestigious wealth managers in a normalising rate environment.
Panasonic reports weak figures for the third quarter related to its Lifestyle division, a cash-cow division with limited growth prospects. The division produces consumer electronic goods and enjoys a good mark-up due to its highly recognised brand in Japan. Weakness stems in particular from pressure on margins related to material price increases. However, the company confirmed its year-end targets. The electric battery division is performing well and will continue to grow strongly. Panasonic’s new 4680 battery will give the Tesla S over 100 km more range, and capacity to produce 10 Giga of this battery per year whilst it is already under construction. The company is also one of the biggest players in aircraft infotainment, a sector that froze with Covid and is now recovering.
We will meet with Panasonic in the next few days and ask that the electric battery division not only be made independent (which has been completed) and listed (which we believe is very likely), but that it first be spinoff and distributed to shareholders. This is to bring out the value. LG Chemical’s electric car battery division, LG Energy Solution, was recently listed and all the value has gone to the new company whose valuation has aligned with the extreme valuation of China’s CATL, while the holding company, which owns 82% of the company is worth about 1/3 of the latter even though it also owns a traditional chemical division. If we value the latter division at a modest 11x normalised earnings, the 82% of LG Energy Solution held by LG Chemical is valued at only 6 bln usd, or 3x 2023 EBIT and at a discount of over 90% to the market value of this stake. Clearly, we are buying LG Chem, particularly the saving that trades at a further 50% discount to ord (!!!), because we believe this anomaly cannot last and the risk/reward profile looks very attractive. However, in order not to repeat the same thing with Panasonic, a spin-off and an attribution of the shares to the shareholders may be the best choice (as Exor did with Ferrari, for example). Panasonic is worth a little more than 4x EV/Ebitda and 10x earnings and, despite the significant acquisition for 7 bln USD of the American company Blue Yonder, at the end of the year it will again be debt free (adjusted for liquid financial investments). Click here for the slides from the presentation.
Atos never disappoints. Every time the company speaks the stock loses 4 to 15%, now for 3 years. The company lies more than 70% below the highs touched in September 2017. Since that date, for that matter, successful rivals such as Accenture or CapGemini have racked up gains of around 110% and 85% respectively. Part of this gap is explainable. We cannot emphasise enough how crucial management is. People can make or break a company. Readers have certainly had concrete experiences in this respect. However, this has gone too far. By quite a lot. The company in a horrible year made 400 mln EBIT and is worth 3.5 bln euros with an EV of 4.3 bln euros. In 2019 EBIT was 1.2 bln euro.
After coming out with a profit warning on 10 January, Atos came out again on Thursday with another (final figures will be released on 28 February). A few days earlier, there were rumours, which were not denied, that Thales was interested in the BDS Cybersecurity division of Atos, a division that is valued at the same level as the entire current valuation of Atos (valuations range from €3.5 to €4.5bn), despite the fact that it produces only 15% of the group’s sales (€1.5bn out of €11bn in sales). Atos on Thursday quantified the impairments (goodwill write-down) related to a series of (obviously wrong) acquisitions made in the past. The company then announced EUR 500m in provisions for various, ill-defined items, such as losses on outstanding contracts and credit losses. On the balance sheet side, adjustments had already been made in January, with deferred receipts and advance payments that have increased the debt, which nevertheless remains low. Atos and Rodolf Berner offer us a case study to help us understand the meaning of kitchen sinking, which in a nutshell is nothing more than an “over-cleaning” of the company that the new management does when it takes it over to improve the comparison of future results with past ones (and thus show how much fun it is). On the other hand, it is not on the basis of stock results, but on the perception of improvement that a company is assessed, valued and the CEO is remunerated. As with human happiness, for the stock market where you are matters little, but where you go matters far more… The impression is that Rodolf has laid a solid foundation for a series of good surprises in 2022, for shareholders and for himself.
Don Giovanni, Kierhegaard and Casanova
The seducer is an intriguing literary figure to whom much space has been given in literature. We have Don Giovanni, made famous by Moliere and Mozart, a passionate and ruthless man who aims to possess his prey and then abandon them. We have the Giovanni of Soren Kierhegaard’s opera, a subject that inspired the character of Viscount Sebastien de Valmont in the wonderful film Dangerous Liaisons, played masterfully by John Malkovich. This one, although sharing with Don Giovanni the ruthlessness, not the passion he uses psychology to completely conquer a woman and then, again, abandon her. Finally, we have Giacomo Girolamo Casanova, a Venetian libertine who lived in the 18th century and left us a book of memoirs (Histoire de ma vie) considered one of the most authoritative sources for reconstructing the customs and traditions of Venice at the time. Casanova fell in love. He really did. He went mad and pined for his beloved to conquer. Once conquered, he would invariably soon tire and fall in love with another unfortunate. The average investor, professional or not, is certainly comparable to the Casanova. He encounters a growth trend, gradually gets to know it better and then becomes crazy about it. He talks about it, extols it and projects it to the skies. Then, invariably, as soon as the trend shows signs of vulnerability, as is normal, he abandons it. He no longer talks about it. He forgets it. He denies having followed it, longed for it, loved it.
Growth trends, as we know, are not constant, but subject to accelerations and slowdowns. We still remember the enthusiasm for electric vehicles in 2011 and 2017, which ended up in the dust, only to be resurrected in a big way. Or the internet. There are so many examples that can be given. Well, when a powerful and objectively unstoppable trend ends up in the dust, when it is abandoned by Giacomo Girolamo Casanova, we believe it is time to reach out to it. Gradually but without hesitation. Two trends, and we have already mentioned them, have been abandoned recently. The one on renewables and the one on the transition to vegetable proteins. Stocks such as Nel or Beyond Meat are sitting at 70% from their highs. However, one has to be careful. Losing 70, 80 or 90% is not necessarily synonymous with good valuations and/or some degree of capital protection. When the tide recedes, the fish can go without breathing for a long, long time. It does not matter if the tide comes back in. It will in many cases be too late. And so when the market retreats from a sector you have to be careful to choose the subject that can survive without water or, in this case, without more money. But not only that. Even those whose valuations are supported by hard facts, i.e. cash-flow and real assets. This dramatically increases the chance of getting our money back, however things turn out. We therefore reiterate the possibility of exposure to these trends with companies such as Siemens Energy, which owns 67% of the largest player in offshore wind energy but is also solid and exposed to other sectors in strong recovery, and Maple Food, which in addition to being the largest listed operator in North America in the vegetable protein sector is also the largest producer of sustainable meat on the market, through animal-friendly breeding and slaughter processes. For those in need of daily adrenaline, these stocks may not be the best choice, but for those who want to invest in the medium term in sectors with great future opportunities, benefiting from a phase of strong ebb and without wanting to be speculative, these may be two good stocks to further enrich a diversified portfolio.