The devil and the holy water
Our world has never been linear. There are, have been and always will be contradictions. They are the daughters of the human spirit, subject to different and conflicting forces. They are the daughters of the incessant change that inevitably makes the old and the new coexist for a while. Those who have lived longer probably lose the ability to accept the sudden changes that the world, and consequently the market, propose. There is therefore a risk of struggling to distinguish curious phenomena that are inevitably transient from signs that anticipate structural changes. Awareness of this, in addition to a background in fundamental analysis and an instinctive vocation for value investing, determines our inability to move away from valuations in pursuit of new and distant opportunities, and consequently our unwillingness to even try. We leave this goal to the many good growth managers, as well as to the indistinct market that tends to be fascinated by new growth ideas at any price, whether real or imaginary. However, this does not prevent us from being spectators and observing very powerful and often inconsistent trends. Today, cryptocurrencies represent one of these. This market was worth less than USD 150 billion at the end of 2019. In April 2021 it surpassed USD 2 trillion, not far from all the sterling in circulation (M1). At the same time, sustainable investment is another powerful trend. At the end of 2020, assets under management with ESG integration were almost USD 40 trillion, tripling in 8 years. They are expected to exceed half of assets under management (i.e. over USD 90 trillion) by 2025. We can only enthusiastically embrace this second trend. But that’s not the point. A fellow friend was pointing out to me this week how much energy cryptocurrencies consume. Currently more electricity than Holland. Within a couple of years, according to Nature, they should be responsible for more than 130 million tons of CO2 per year (0.5% of the world’s total CO2 emissions). Elon Musk, the architect of the electrification of transport that is so important for environmental sustainability, recently gave a revitalising endorsement to cryptocurrencies (it will be interesting to read Tesla’s next Sustainability Report…).
The market is therefore focusing on a speculative product, without an underlying valuation, without regulation, excellent for laundering money, which can jeopardise the savings of the retail public (the market so protected by the many Mifid regulations…) and which distances us from the objectives of the Paris agreement. At the same time, there is a huge focus on sustainability. It is suspicious how much these two trends can coexist in the market and often even within the offer of the same management company. Pecunia non olet.
Japanese Gattopardite: “Everything needs to change so everything can stay the same.”
Panasonic’s history is not dissimilar to that of many Japanese conglomerates, but that doesn’t make it any less interesting. Known, until a few years ago, as Matsushita Electric Industrial, Panasonic was established in 1918 by Konosuke Matsushita as a retailer of electrical sockets. He soon started to produce various types of electrical equipment himself. Although the products were simple, their reliability was outstanding, and year after year this helped to build the brand and enter more value-added activities. He pioneered many of these, from bicycle lamps to air conditioning, to PCs. He entered early and exited with dramatically wrong timing in many industries. These include the film industry (it sold Universal Music and Pictures in 1995), semiconductors (sold in 2019) and cells for solar modules (sold in 2020). In this it is reminiscent of the Germans, who are excellent at creating and developing a product, but often fail to interpret the market. Panasonic is a company of engineers, for better or worse. A company that makes high-level hardware. And also a company where research is at the forefront (8% of sales invested in R&D, above Siemens). To give an idea, this group invests absolutely, 50% more in R&D than SAP, which has a capitalisation 7 times larger, and about half as much as Microsoft and Apple, although it has a capitalisation of less than 2% of each of these two players.
Panasonic has an EV of about USD 35 bn after the recent acquisition of an American software company (Blue Yonder). Panasonic is also Tesla’s largest battery supplier and the company with which Tesla is to develop its 4680 battery for the mass market. From this business, Panasonic will soon be able to record an operating income of $1 billion a year, which is likely to grow. Add to that the value of its lithium-ion battery JV with Toyota, the world’s largest carmaker, which owns the patents for its much-vaunted solid-state battery, and the current valuation is justified. At 30x EV/EBIT you can’t really talk about value investing, but after all it represents a 50% discount to the fiercest of its rivals, China’s CATL. Still, one wonders what it is doing in our portfolios if it is a growth stock. Well, Panasonic has a few other assets too:
1) Its “Appliances” division produces high-end home appliances and white goods and is the leader in Japan (33% mk share) and is well positioned in Asia and the US. Although it ranks above Whirpool in reliability and brand, we take this competitor to evaluate it. Whirpool has 20% less sales of appliances than Panasonic and has 10% EBIT margin. Panasonic, however, has an EBIT margin of just 3%. We therefore conservatively take Whirlpool’s valuation and apply a 50% discount. That makes 9 bln USD.
2) Its “Ecosolution” division sells air conditioning and air purification systems as well as heat pumps and photovoltaic systems (it has moved away from solar cells but has stayed on the more attractive generation and connection systems). Here we take the market leader in air conditioners, Daikin, which has the same sales as Panasonic, but with triple the margins (there is room for so much improvement here…) and apply a 67% discount. That makes 20 bln USD.
3) That leaves the “Connected Solutions” division, where the company makes control systems for logistics and manufacturing for a range of industries. It is a competitor to the more valuable part of Siemens and other players related to industrial automation (Industry 4.0). Even here, however, we value the business at a 50-70% discount to peers, at 1x sales. That’s USD 12 billion (not much, considering that they just paid USD 8 billion for Blue Yonder, a software company included in this division that only generates USD 1 billion in sales).
4) Finally, we have the “Industrial Solutions” division, one of the leaders in the production of capacitors and sensors, which has an EBIT margin of 7%. Let’s conservatively value it at 0.5x EV/Sales. That’s 7 bln.
To sum it up, in addition to the automotive division, the company gives us a conservatively calculated valuation safety margin of USD 48 billion, about 150% over its current valuation.
Speaking with Panasonic’s management, one senses the adoration for the company and the great attention paid to employees. The founder’s ethical approach remains unchanged and can be felt. It’s hard not to be fascinated by it. However, there is also a certain lack of interest in the shareholders who, according to them, must share this sense of belonging and values. But the world is changing and so is Japan. From Koizumi to Abe, a path seems to have been embarked on of gradual greater attention to minorities. The forthcoming revision of the Corporate Governance Code (consultations will end on 7 May) should improve the independence of the Board of Directors of Japanese companies. We understand the fear of takeovers by private equity or raiders. We have seen for ourselves that they are sometimes greedy, incompetent and unscrupulous (the third characteristic serves to compensate for the second) and hire managers in their own image. The solution is to become more efficient, to go up in value on the stock exchange, and thus to be an undigestible morsel. Panasonic, which we have been following for many years, is taking its first steps in this direction. The corporate structure has changed and we would not rule out the imminent listing of some divisions to bring out value. The new CEO, Yuki Kosumi, was responsible for the battery division and its many successes. This bodes well for the future of the group. The upside could be substantial and the downside appears limited.
Panasonic is the leading stock in the Pharus EMN fund, held in the Lithium Cells niche with a 7% weighting, and is held by the NEF SDG fund, in the 5G SDG trend, within the Communications theme (1.1%). Finally, the stock is also held by the Pharus Asian Niches fund, within the Electric Mobility niche (0.7%).
Stupid, but beautiful
Dumb pipe is defined in technical jargon as the function of the passive telephone network. Basically a data highway where the provider maintains it and in return is charged a sum that guarantees him a return on capital equal to or higher than his cost of capital, which is what the electricity grid has been until now (pending transformation into a smart grid). For telephone companies, the term dumb pipe was an insult until a few years ago. The aim was to monetise the network through the thousands of opportunities that the Internet could offer. On the other hand, controlling millions of customers without being able to exploit a little bit of their online activity seemed ridiculous. Particularly when the big tech companies were making billions and billions by exploiting their networks. Yet, these companies have been unable to put in place an effective internet strategy. Attempts related to content have failed. They simply inflated the cost of content, often leaving the operator with significant losses. BT entered the sports business in 2012 after Sky entered telephony.
A game of massacre that has left nothing but rubble. In an interconnected world, the winner is whoever owns the content. The risk profile for buying and then reselling is too high. BT announced last week that it will close or sell BT sport. It ends an adventure full of promise that only brought losses. BT is now concentrating on the fibre network whose profitability is clear and visible. A “stupid” telephone company should be worth 7x EV/EBITDA. BT is today worth 4.7x. To get to 7x the capitalisation, (EV minus debt) has to double. It is true that the rebound has been powerful, but the levels reached a few months ago made no sense. This is true for BT and many other stocks. While it is normal for those who do not take a momentum approach to look at how far a stock has bounced, our advice is to only look at current valuations and not dwell on charts from the last 12 months.
We have BT on NEF SDG (1.7%), in the trendSDG 5G, within the Communication Theme. We also have it in the Pharus Asian Niches fund (1.2%), in the 5G Niche.
A week full of results. Here are a few pointers.
The US megatechs, Apple, Microsoft, Amazon Google and Facebook, are reporting well, thus defending their fat valuations. Here we continue to see Apple more at risk as it will start to experience some significant difficulty in growing quarter on quarter from now on. This is followed by Microsoft and Amazon who should see increased competition in the cloud. Overall, all will be vulnerable to regulatory news flow.
Nokia reports acceptable and well above expected results, following Ericsson’s equally acceptable results. We remain convinced that Nokia has an excellent risk/reward profile. Nokia is the first stock in the NEF SDG fund to have exposure here of 2.4% within the 5G TrendSDG in the Communications theme. It is also the top stock in the Pharus Asian Niches fund, with 2% exposure within the 5G Niche.
Hitachi sold its Hitachi Metal division to Bain, making more than it had hoped for and continuing the process of simplifying the business which should lead to a gradual rerating. This will help it to remain nearly debt free despite the recent acquisition of GlobalLogic, a leading consultant in the digitisation of companies. GlobalLogic joins the Lumada division, strengthening it and increasing its global exposure. Recall that while the acquisition was concluded at very high multiples (37x EV/EBITDA), it must be valued for the overall benefit it can bring to Lumada’s digitisation suite. The company trades at around 6x EV/EBITDA despite the high-growth businesses it is exposed to (digitisation, energy smart grid and renewables, construction equipment, laser therapy for cancer, air conditioning, drinking water and wastewater solutions). Hitachi is held (1.4%) in the NEF SDG fund, within the Infrastructure Theme, in the trendSDG Infrastructure for Work.
Barclays reported well. Guidance cautious. However, the stock has reversed. Certainly some people took profits after the good recovery, but some nervousness is understandable. The company has set aside generous bonuses for investment banking, an area investors are increasingly disliking. The perception is that when it goes right, bankers gain and when it goes wrong, shareholders lose (see Credit Suisse). This is exacerbated by a certain caution about dividends, shareholder remuneration. Barclays set aside 0.75 pence in dividends in the quarter, or less than 2% on an annual basis. In the face of rich bonuses and a 14.6% CET1, we can understand the dissatisfaction of shareholders who should be remunerated in proportion to their managers’ bonuses. Bank shareholders, after what they have been through are owed, more, much more. We expect a review of this attitude in the second quarter if CEO James Staley intends to stay in his post. The bank at 0.6x tangible equity and 10% ROTE forecast for 2023 is by no means expensive. Barclays is held (0.55%) in the NEF SDG fund, within the Finance Theme, in the trendSDG The Good Bank.
It pre-announced PostNL positively this week, raising EBIT estimates by 38% on the back of a wave of online deliveries. The stock remains undervalued at less than 10x earnings.
Finally, we highlight the results of Korea’s LG Chem, along with CATL and Panasonic, among the largest lithium cell producers. Results were strong, allowing EBITDA to be revised upwards and bringing the company’s valuation below 10x EBITDA, attractive for a company with this growth profile. We own the preferred shares of this company, which are still trading at a discount of over 40% to the ordinary. The stock is held (2.5%) within the Lithium Cells niche of the Pharus EMN fund.
Among the stocks in our portfolios, we highlight the companies that will report this week. In the US, Pfizer, CVS Health, Maple Leaf (Canada), Gannett, Fresh Del Monte, ODP, CommScope, Nu Skin, Domtar, Unisys. In Europe, Siemens Energy, Enel, Bpost, ING, SocGen, Credit Agricole, Caixabank, Unicredit, Mediaset Espana, Continental, Volkswagen, BMW. In Japan, Sumitomo Corp and Japan Airlines. In Korea, SK Telecom and LG Uplus.