Investing is a strange profession.
If someone had access to 508 skilled engineers to help them build a bridge, and 507 advised constructing it in a particular way while one argued in favour of using a different method, it would probably be ill-advised to ignore the accumulated expertise.
But investing is different, argues Tamryn Lamb, who is head of retail distribution at Allan Gray and responsible for Orbis client servicing in Africa. Orbis is Allan Gray’s offshore investment partner.
“If 507 people told me to buy electric vehicle manufacturer Tesla, I should probably be listening to the one person who told me not to. And why is that? It is because all that optimism and positive sentiment is most likely going to be reflected in the price.”
Put simply, there is a risk of overpaying.
Lamb says history is littered with examples of over-enthusiastic investors overpaying for assets. Notable examples include the Japanese housing and stock market bubble of the late 1980s, the tech bubble of 2000 and the 2008 global financial crisis.
The problem is that, at all those points in history, it would have been uncomfortable to go against the herd.
“But actually, being different was the lowest risk option – and certainly the option in which you would have protected your capital because you would have avoided making that big mistake of overpaying for assets.”
While there is a lot of excitement around Tesla and its South-African born CEO Elon Musk, Orbis believes Honda offers better value. The same goes for US sports apparel group Nike, which it prefers to its competitor Adidas.
Nike vs Adidas
Lamb says Nike has performed relatively poorly in recent years. Like many other retailers, it struggled to come to terms with online retail and started losing control over how its brand was perceived. It has also been in a weak competitive position relative to Adidas, whose new shoe and apparel ranges have been well-received.
“Adidas has been outperforming Nike from a fashion perspective.”
To counter the threat of online retail, Nike has been investing in its website – which is the right thing to do to take control of its brand and positioning – but this has negatively impacted profitability, she says.
The graph below shows the performance of Nike relative to Adidas and the broader US stock market since January 2016.
Source: Capital IQ, Bloomberg, Datastream, Orbis analysis. *The Orbis Global Equity Fund established a position in Nike at this date.
A $100 investment in Adidas would have outperformed the same investment in Nike by almost 2.5 times over the period.
So why does Orbis believe Nike is a good investment?
Lamb says all the reasons Nike has been underperforming form part of its “bull thesis” for the stock.
Nike is transforming from being a wholesaler to having more direct consumer relationships, which would increase its interaction with end consumers. This would enable it to improve product personalisation and profitability.
Although Adidas is dominating, Nike’s product cycle is turning around, she adds.
“It has a long history of executing in this space. We don’t think the model is broken.”
Honda vs Tesla
Tesla is a great example of how a lot of exuberance and positive sentiment can cause a tailwind in the stock price, Lamb says.
The chart below depicts Honda’s revenue over the last 40 years (the light blue bars) while the red blocks to the bottom right show Tesla’s revenue over the past decade. Honda and Tesla’s market capitalisation are represented by the dark blue and red lines respectively.
Source: Company results, Datastream, Orbis
“People are so positive about Tesla that they think it is worth about the same as the whole of Honda, despite the fact that Tesla only generates one tenth of Honda’s revenues.
“Over the past 40 years, Honda has never made an operating loss. Over the past 10 years, Tesla has never made an operating profit.”
But just because Tesla is expensive doesn’t necessarily mean that Honda is a good investment. Why did Orbis invest?
“We believed that the business was trading on too depressed a valuation, given the underlying fundamentals.
“Profitability has been recovering as recall-related expenses due to faulty airbags supplied by a third party have reduced,” Lamb explains, adding that the share has historically traded at around 1.8 times its tangible book value on average compared to the current 1 time, which makes it relatively cheap.
Honda also has a very dominant motorcycle business, with a market share of about 40%.
Orbis will be one of four international fund managers presenting at the Allan Gray Investment Summit, taking place on July 17 at the Cape Town International Convention Centre and July 18 at the Sandton Convention Centre. To book tickets visit https://www.investmentsummit.co.za/.
Brought to you by Allan Gray.