- Amalgamated Holdings sold from all three portfolios
- The Reject Shop sold from Moderate and Aggressive portfolios
- Carsales and IOOF Holdings added to all three portfolios
- Perpetual added to Moderate and Aggressive portfolios
Regularly reviewing your investments to determine whether any changes are required is sensible portfolio management. How often you do so, however, depends on a number of factors including time and inclination.
Here at Super Advisor we review our model portfolios every quarter during the preparation of the quarterly report. The latest quarterly report will be published shortly but, in the interim, we wanted to let you know of a number of changes we've made to our model portfolios.
Firstly, we sold Amalgamated Holdings from all three portfolios. At the time the portfolios purchased Amalgamated, we viewed the company as a slow-growth stock that would likely provide most of its returns via dividends and franking credits. Yet its improved operating performance since then, along with its steadily increasing dividend becoming more attractive as interest rates continued to fall, mean the portfolios have generated a 56% capital gain from this investment. With its valuation currently stretched, our colleagues at Intelligent Investor recently downgraded Amalgamated to Sell and we agree with them.
The Reject Shop
We first added The Reject Shop to the Moderate and Aggressive portfolios in early 2014. Despite concerns over the state of the Australian economy and management upheaval subsequently causing a 40% decline in the stock, we felt the decline was unwarranted and increased each portfolio's holdings earlier this year. Since then, however, the new chief executive has announced an underwhelming strategy that includes a slowdown in the opening of new stores. This has caused the analysts at Intelligent Investor to downgrade the company to Hold and we feel the funds raised from selling The Reject Shop can be invested more profitably elsewhere.
In terms of additions, we’ve added two stocks to all three of our portfolios this quarter: Carsales and IOOF Holdings. Both are characterised by high returns on capital and strong free cash flows, which enable high distributions, but they make their cash in very different ways.
Carsales’ focus is on organic growth. It has a market leading online auto classifieds business in Australia, to which it has added stakes in several overseas (in Brazil, Korea, Malaysia, Thailand and Indonesia), and its aim with each is the same. By building dominant classifieds businesses, it can benefit from powerful network effects – where the network is the most attractive to buyers because it has the most sellers, and vice versa and so on ad infinitum.
These network effects mean it can add the most value (and earn the highest margins) to customers, but the company doesn’t stop there. By improving its technology it’s able to offer more value than print classifieds ever could.
Sellers, for example, can load multiple images to advertise their vehicles and, for the same amount of work, they get an ad that remains visible until a vehicle sells. Buyers have the assistance of powerful searching tools and dealers, who might be managing large numbers of listings at any point in time, are given specialist tools to help them do so.
All this helps cement Carsales’ position as the market leader, polishes up its network effects and allows it to provide more value. This in turn will enable it to earn higher margins than its competitors.
Through its eponymous website, Carsales has already pretty much won the battle in Australia and is now poised to reap the benefits. In the first half of the 2015 financial year its sites garnered 94% of the time spent online looking for a vehicle, compared to just 3% for its nearest competitor, earning an operating margin of 52%. It also broadened its horizons last year with the purchase of Stratton Finance, a vehicle finance business. Having introduced buyers to a car, Carsales can now also provide them with the wherewithal to buy it.
Internationally, Webmotors in Brazil (in which Carsales owns 30%) and SKENCARSALES in Korea (in which Carsales owns 49.9%) are already profitable, achieving margins of 29% and 57% respectively. The same can’t be said of iCar Asia (in which Carsales has a 20% stake) which recently delayed its projected breakeven point until 2017. We have high hopes for all three overseas businesses, however, as we do for the overall group.
While Carsales’ focus is on organic growth, IOOF’s has been unashamedly on acquisitions. Although it has a high-quality business at its core, its growth has been achieved by adding to it incrementally and reducing costs. Slightly more than half the business’s profit comes from administering the investment platforms that aggregate an individual’s financial affairs. This is a business that relies heavily on economies of scale; it doesn’t cost that much more to run a platform for a million accounts as it does for a thousand. Hence the acquisitions: by buying up other platforms and merging everyone together, IOOF can reduce costs for all and earn a nice crust for itself in the meantime.
IOOF’s second biggest earner, with 35% of underlying profit, is financial advice and distribution. Following last year’s acquisition of SFG Australia, this division operates the country’s third-largest financial planning network (after AMP and CBA) with $54bn in funds under advice.
This isn’t a great business in its own right. Financial planners expect to take a large portion of their fees for themselves, and it’s hard to get people to pay for financial advice in a fair and upfront fashion – hence the regulatory headache that has surrounded this sector in recent years. The value of this business for IOOF, though, is that it helps to direct funds to its larger and much superior platform business.
Rounding out IOOF’s stable of businesses is a funds management business (recently diminished by the sale of Perennial Investment Partners’ Growth and Fixed Income businesses to Henderson Group for $72m) and a small trustee services business.
IOOF is yet another example of the fact that, in investment matters, good things come to those who wait. After originally upgrading IOOF to Buy at $8.28 just over a year ago, our sister publication Intelligent Investor downgraded the stock to Hold at $10.69 after February’s interim result. Recent allegations in Fairfax newspapers of compliance breaches, however, smashed the stock back into buying territory.
Financial advice and administration is undoubtedly a trust business, and the allegations certainly can’t help. However, they mostly predate current chief executive Chris Kelaher’s arrival at the company in 2009. The company believes it has already dealt appropriately with the matters at hand, and it has additionally appointed PwC to do an all-encompassing check on its compliance systems. All in all, the allegations make for unsavoury reading, but we expect them to blow over and, in the meantime, they’re providing investors with another opportunity to buy this quality business.