Ask Alan: 11 September 2019

Welcome to Ask Alan for this week and it’s great to see you, thanks for joining me. It’s all happening at the moment, isn’t it? What we’ve got at the moment is bond yields rising. The question is is the bond/bull market over? I don’t think so but I will examine it in more detail on Saturday in the briefing along with a bunch of other stuff. Remember, the livestream today is general advice, it may not be appropriate for you so please bear that in mind and if you’ve got any questions as we’re going along please feel free to pop them in and I’ll get straight to them. Let’s get stuck into it.

Andrew says, can we have an update on Electro Optical Systems, laser-based armaments. I bought a swag some years ago, 73 cents, when you interviewed the CEO. Shares are on a rocket following their latest profit announcement, they’ve gone from eating cash at a massive rate to generating it even faster and are now pushing $6 a share. They have been a great stock, no doubt about it, and I think I was pretty positive on them when I interviewed them. Could we get an interview with the CEO again and get a feel for how well they’re making the transition from start-up to major manufacturer. In the current macro environment they seem like a company with great upside.

They do, indeed they do. Alright, they’re on the list, Greg, put them on the list, EOS. I can’t even remember the bloke’s name but yes, definitely we’ll get to them at $6 a share, heavens above, that’s been great.

Tim says, hi Alan. Quick question on deciding between an LIC and a fund of the same manager, EG Magellan Global Fund MG or investing in the actual fund itself. Obviously, both represent the same holdings however I was looking to dollar cost average, would it make more sense to invest in the fund directly given they probably receive wholesale rates. Meanwhile, if I was to buy directly from CommSec I would pay the regular $29. If I do two $1,000 trades a month then it builds up in the long term as it’s still 2.9% as opposed to maybe $5. Of course, if it’s $5, it depends on the price.

I think the main thing you’d have to watch, Tim, would be the minimum investment. If the minimum investment is $1,000 you’re fine but a lot of these wholesale funds, or at least retail funds that are unlisted, have a minimum investment of $10,000 or something like that. You might find that you can’t really do dollar cost averaging with that but you’re right, you’re absolutely right to pay attention to the transaction cost because that’s where dollar cost averaging can bring you undone, absolutely. The $29 is not the cheapest in the market so you might want to think about changing brokers.

You can get $15, I can’t remember who it was with now but there are cheaper brokers and obviously they perform the same service, you’re not relying on them to stay solvent particularly, you’re not investing with CommSec or the other broker. Just keep an eye on that, you might be able to get better than that. The last time I looked in fact the cheapest broker in the market was Self Wealth which I think was $9.50 per trade at the time. You could certainly do better than $29, CommSec is possibly the most expensive in the market but you’re absolutely right that the killer with dollar cost averaging is the transaction cost which as you point out could be 3% each time you do it in which case you’re really hampering your investing. If you can dollar cost average through a fund that has no entry fees and zero costs to buy, or maybe $5 instead of $29, then you’re obviously better off doing that.

It just depends on the actual conditions of each of the funds. Dollar cost averaging generally works better with a listed security but the problem is the transaction cost so it’s probably best to do it less frequently in bigger lumps so the percentage of the transaction is lower. Maybe once a quarter instead of twice a month investing, you still get the benefit of dollar cost averaging if you’re investing $6,000 a quarter instead of $1,000 every fortnight.

Chris says, hi Alan, excellent audios. I know you can’t give personal advice but my partner wants to put some money into REITs, would this be a good idea with a world that is going slightly bonkers?

Well, as you say this is not personal advice, in general I reckon you’ve got to be careful of REITs at the moment because obviously the valuation is influenced by long term interest rates, bond yields, both for the reason of discounting future cash flows back to the present but also comparing their yield with the bond rate. If the bond yield goes up that would tend to depress the valuation of the REIT.

It depends, I don’t think we’re going to see a big increase in bond rates at the moment, we have seen a bit of an increase in the past week or two, the Australian ten year bond rate has gone from 0.9 to 1.2, so up 30 basis points. I don’t really know where that’s going. At some point interest rates are going to rise at which point REITs will decline in value, that’s for sure. The other thing to be careful of is questions of what they actually own because a lot of the REITs are retail REITs, shopping centres and so on, and a lot of shopping centres are in strife.

The thing is not all of the shopping centres are in trouble. I was out at Chadstone on Sunday and could barely move, it was unbelievable. As I was leaving, I was leaving, I was leaving at lunch time from Chaddy, there was this massive queue of cars to get in. There’s REITs and REITs. Vicinity Centres owns part of Chadstone, that’s clearly going to be okay or for a while at least, Chadstone shopping centre is fine. A lot of the regional centres, which some of the REITs own, are perhaps not going to be fine so you just need to be careful which REITs you buy into also you need to make an assessment of whether it’s office or industrial, where the things are and so on.

Have a look at what they own and make an assessment of whether you think those assets are any good or not and just bearing in mind that the overlay of interest rates, low interest rates which have been benefitting the valuation of REITs, is likely to come to an end at some point, we just don’t know when.

Andy says, on a previous episode you had disdain for CFDs and I can understand this. I don’t know about disdain, I was saying that CFDs are on the whole gambling because you’re just betting on the contract for a difference, you’re not actually investing in an asset. Leaving that aside I do have a fairly significant portfolio for a sole investor. I do have some funds put away in one of the CFD platforms as a hedge against the markets falling. I use it very infrequently and only for covering the indices. This may sound simplistic and an inefficient way to hedge against a substantial market fall and keep my portfolio intact. I have a cash stash so I’m not looking to panic sell but I do believe in insurance against a fall.

I do too, Andy, and I think that that’s a good idea to take out insurance if you’re concerned. CFDs are one way to do it, as a hedge I have got no problem with short selling a CFD. It just leaves you a little bit exposed, that’s all, because you are gambling, it’s still gambling. Another way to take out insurance is options, in particular a put option, but that’s up to you really. You could put options over individual stocks as well as the index, I think, and they don’t leave you quite as exposed as a CFD contract.

Matt says, hi Alan, I’ve got a question about growth investing in the current environment. You have mentioned recently that it may not be the best time to invest in growth and cash burning stocks. I’m wondering why this is the case, I would think companies with good products or services that are growing faster are always worth investing in.

You’re absolutely right, Matt, of course that’s true. High growth companies that have good products, good businesses, they’re fine, of course, always the case.

There is a difference between a growth stock and a cash burner, obviously a cash burner would generally be defined as a growth stock but there’s a lot of companies that are not burning cash that are making money that are regarded as growth stocks simply because they’ve got a high PE. I think the simplistic definition of a growth stock versus a value stock is a high price earnings ratio versus a low PE. The fact is that over the past few years, about two or three years, high PE stocks have outperformed value stocks, low PE stocks. That’s partly because with low interest rates future cash flows are worth more than present cash flows so really when you get down to it to some extent a value stock is valued, and wanted but valued in the broader sense, for its present cash flows.

Growth stocks are all about the future, investors are buying them at 50 times PE because they believe in their future cash flows and future cash flows when interest rates are low, future cash flows are worth more in some ways than present cash flows simply because of the way the discount rate works. The lower the discount rate the higher the present value of future cash flows. That’s one of the reasons growth stocks have been outperforming but also it’s just simply that there’s a lot of excitement around a lot of these technology stocks that are inherently growth high PE stocks so that simply has led to a bit of a kind of a rebirth of the dotcom bubble in a way.

A lot of these stocks have been really highly valued. In America they’re called the FAANGs, Facebook, Apple, Amazon, Netflix and Google. In Australia it’s the WAAAXs, so Wisetech, Altium – I can’t remember them all now, not Atlassian, and Xero – there’s three As in the middle there, WAAAX, I can’t remember all the As. They’re all kind of technology stocks that are highly valued, they have been driving the growth area of the market higher.

The problem with cash burners which is kind of distinct from growth stocks is the need to get through the valley of death which we’ve been writing about in the briefing, which is getting to cash breakeven. Cash burn is fine if they’ve got a good product and most importantly they’ve got plenty of cash in the bank or at least access to cash. The difficulty is that a lot of these companies cash burners that haven’t got much money in the bank, they can’t make it because even if they’ve got a good product they need a couple of years to get it to cash breakeven and nobody will give them the money.

Uber, for example, is a big cash burning stock, it’s burning colossal amounts of money but it’s got so much money in the bank it’s probably okay. That goes for Xero as well, I don’t know how much money Xero has got in the bank but it’s still burning cash even though it’s capitalised at 8 or 9 billion, or maybe even 10 billion now. Even if it hasn’t got that much money in the bank it’s got access to tonnes of it so it’s fine as well, no problem. The problem is for companies that have got a low share price, falling share price, and difficulty getting cash to make it to cash breakeven and still burning a fair bit trying to get there.

That’s the problem with cash burners, you’ve got to really watch them and only invest in ones that have got enough cash in the bank, if you can, to make it or at least have access to cash. Growth stocks, there’s a bit of a debate going on at the moment as to whether growth stocks have had their day and as values turn I think maybe not, I think we’re for a while yet in a growth investing era and value investors are still going to struggle for a little while.

Lisa says, hi Alan, thanks for your info regarding the Macquarie Bank SPP, share purchase plan, last week. Just wondering, why do companies in general offer an SPP? I think a lot of the time Stephen Mayne shames them into it, he writes to them all the time and tells them to have SPPs because a lot of companies would prefer to just do sweetheart deals with institutions to a placement for the money because it’s easier, that costs less, they don’t have to worry about going to the market and so on but it’s not fair on shareholders because usually they’re giving these institutions a discount on the share price.

Leaving aside Stephen Mayne shaming them into it I think a lot of the time they are conscious of the fact that a very large proportion of their share registers these days are owned by self-managed super funds and so they’ve got to really be careful about pissing them off because self-managed super funds are still growing quickly and they’ve got to be careful to make sure they look after them. The SPPs are a way of looking after them, they’re raising money, they do a placement and at the same time and at the same price they do an SPP which allows shareholders of Macquarie or Transurban to buy $10,000 to $15,000 worth of shares at the same discount and I think it’s a good idea, it’s a good thing they’re doing.

A lot of companies do it for the purpose of keeping in sweet with their SMSF shareholders and also to keep Stephen Mayne off their back.

Jessie says, g’day Alan, my question is regarding Genex Power, GNX. You’ve interviewed them twice and they have since confirmed NAIF – I’m not quite sure what that means – and state funding for their pet project, the Kidston Hydro project. There’s only really been positive news flow since your first interview in June 2018 and the share price hasn’t budged since. There has been some dilution from equity raising and cash flow from the hydro project is some years away so it’s a long term prospect but I am somewhat surprised there hasn’t been any share price appreciation for more than over a year. If you were to enter at these levels and hold long term it would be paying a solid yield, something very sought after from the investment community these days. What are your thoughts?

You’re absolutely right, Jessie, it’s a long term investment and it’s a classic case of the market being worried about stocks that have to raise capital to keep going and to get to breakeven. I agree with you, I think that this project is a good idea, I think it’s undoubtedly going to work as long as they get to build it. GNX share price is 25 cents, as you say it’s been at that level for a while now, a couple of years, it’s been gradually trending down. I’m not quite sure what their cash situation is but I should interview them again soon. The capitalisation is $100 million, have they got access to cash? Maybe. The problem is the share price.

This is the common thing, share price has been falling gradually over two years, peaked at 39 cents in late 2017 now 25 cents. The trouble is that as they need capital the lower the share price goes the more dilution there is, they don’t want to do that but gradually they have to and I don’t know quite what their cash situation is, I probably can’t call it up while I’m talking to you. Obviously, they need to get through the valley of death which is not that simple. I suppose the market is a bit worried about that but I agree with you, I think it’s a good prospect over the long term and I might get them back on to talk to them about it.

They do make money, it’s not as if they’re completely without any cash flow. They’ve got net revenue of $15 million in the year to June, EBITDA of $5.5 million, net profit after tax minus $5.5 million, cash in bank $3.4 million. They got a placement in June of $21.5 million, so they’ve got a fair bit of cash there, they should be right for a while. As to whether it gets into breakeven, I’m not sure but maybe we should get them back on, Simon Kidston back on. The trouble is there’s so many companies to interview I can’t keep interviewing the same ones, I’d like to just to make sure we keep on top of them but we’ll put them on the list. We’ll probably get to them in a month or two but we have plenty of people to interview, plenty of prospects ahead.

That was the last question. Thanks for joining me today, it’s been great talking to you, we’ll see you next week. Remember, this livestream and the answers were general advice only and may not be appropriate for you. I’ll see you next week, thanks.