HANNA BARRY: Which are the best five shares in the world, what do they look like and why are they the best?
My name is Hanna Barry and in today’s Moneyweb webinar we are going to be discussing just this. Which are the best five shares in the world – according to Anchor Capital, at least. To help me answer these questions I have Peter Armitage, who is the CEO of Anchor Capital with me in the studio, as well as Sean Ashton, chief investment officer there. And then Nick Dennis, who is a fund manager with a focus on global equities, joins us on the line.
So, just to remind you, if you would like to ask questions, you can find the question box on the right-hand side of your screen. Type your question in and we will try and get to as many questions as we can in the last half an hour.
To get us going, Sean, won’t you tell us which are the best five shares in the world? Give us a rundown and then we’ll look at these stocks.
SEAN ASHTON: Sure, it’s always a daunting task to be picking the best shares in the world, but I think we’ve chosen a grouping of stocks that we certainly think will perform well over the next 12 months. Many of them have been performing well already.
The stocks are Pandora A/S, which is a Danish-listed jewellery business, affordable jewellery; Admiral Group plc, which is the second-largest auto insurer in the UK; Sketchers USA, which is a shoe business listed in America; Apple Incorporated – many people will be familiar with that one; and Priceline Group.
HANNA BARRY: Very different businesses, as you say. We’ve got a shoe company, we’ve got a jewellery business, we have a motor insurer. Is there something common to all of these shares that you like?
SEAN ASHTON: I think certainly in terms of our investment process, the kind of things we look for – high returns on capital employed, and sustainable ability to deploy capital. Those would be common threads throughout most of these companies that we are looking at today.
HANNA BARRY: Okay. Then let’s pick up with Sketchers. I’ll start there. Nick, I believe that you are the expert on this business. That company is currently at $30/share if I am not mistaken. What is particularly attractive about Sketchers, and why do you prefer it, let’s say, to a Nike?
NICK DENNIS: Sketchers is in a bit of a different bucket to Nike. It’s a much smaller business, but it’s the number two athletic footwear brand in the United States. So it’s clearly a business with brand equity – perhaps not at the same level as a Nike or an UnderArmour, but it certainly has brand equity.
What makes this stock interesting is it has been on quite a massive tear over the past couple of years. But then in its third quarter of this year it missed the sell-side earnings estimates and the stock got clobbered roughly 30% in a day. And so now the stock is trading on about a 15 times 2016 PE, 12 times 2017 PE. That compares with a 29 times PE for a Nike and a 66 PE for UnderArmour. That’s despite delivering growth that was still just shy of 30% on the revenue and the earnings per share line. So the underlying business is still growing strongly. I think it was just a case of perhaps people needing to rebase their expectations.
But let’s say that the share gets to 20 times forward earnings at the end of next year. This if we are sitting having this conversation in a year’s time, that takes us to a share-price target of around $50, which is 70% higher than today’s share price. So that assumes that the business kind of performs strongly. Some of the reasons that the stock sold off were a bunch of one-offs and they sort of used that in quotations because it sometimes is a one-off wave re-occurring. But, that said, there were currency headwinds and some other things, and there has been some weakness in the department-store channel in the US, potentially overstocking with the other brands which affected them. But nevertheless the business is delivering double-digit comp sales, which is same-store sales. If I sold 100 last year and this year I sell 110, then the business is growing 10% on a same-store sales basis, which is decent in a slow-growing economy.
Then they are growing the international business very strongly. So the US store is just under 60% of revenues and the international business is just over 40%. They want them to both be roughly 50:50. The business is growing 175% year on year in China in the latest quarter. So it’s growing strongly.
So I think as long as they are able to put in a semi-decent performance, I think the stock could have a lot of legs from here, particularly with the huge discount in multiples relative to Nike and UnderArmour. And just to put it in context, Sketchers is a $5bn market-cap stock, whereas Nike is just over $110bn. So if in my mind Sketchers becomes a R10bn stock, then Nike becomes a $220bn stock, and that’s why we think it’s interesting. So I would argue that Nike is a better brand and better franchise, but potentially Sketchers is the better stock looking into next year.
HANNA BARRY: So there is something there definitely – that the best companies are not necessarily the best stocks or the shares that you want to invest in. The one thing that does strike me about this selection is that all of these are offshore companies. They are all international businesses, global equities.
Peter, perhaps you want to jump in here. Why do you think we are seeing perhaps more attractive stocks in the offshore space?
PETER ARMITAGE: I think South Africa is a tiny part of global markets, less than 1%. To be frank, for this webinar we wanted to expand people’s horizons a little. There are lots of shares in South Africa that we like. They could possibly claim a place to be in the top five in the world. But locally we are picking for our portfolios from roughly 120 shares.
From a global perspective we are screening up to 6 000 shares. And these are ones that we are familiar with, we’ve spent some time on, we’ve engaged with management. You asked earlier about what they have in common. I think what they all have in common as well is we think they could all give a total return of 30% or more. But that should be no surprise if we are talking about what we think are the best five shares in the world. There are always shares that can go up 30/40/50%.
I think one of the important things to emphasise as well from a global share perspective, and Nick highlighted it in Sketchers, is that the market is significantly more volatile in South Africa. So if a good company misses its earnings numbers by a little or sends out a wrong signal, it’s very easy for share prices to drop 20 or 30%. So that presents opportunity from an investment perspective if you’ve got conviction in a share.
But at the same time we would also suggest to people that offshore and what we do in offshore portfolios is to have 20, 25 shares because the unexpected can always happen. So these are shares we really like. But if we put together a portfolio of 20 shares I can tell you with a fair amount of certainty that in a year’s time a few of them will be down because Sketchers, again, is a great example. The market was expecting big things. They still came out with good results, but a share price and how it reacts is not about what it has done, it’s about what it has done relative to expectations. So if people expect 50% growth and it grows by 30%, it will be negative for the share price. Often your management sort of is scratching their heads, thinking I produced 30% growth – why did my share go down? Well, it’s often because they’ve been creating an expectation of much higher growth.
HANNA BARRY: And, as you say, expectations of at least a total return of 30% or more. With a share like Apple, which is different from Sketchers in that it is a dominant player in the market, it is very large, perhaps more comparable to Nike, do you really think, Nick, that we will see Apple keep going up and keep delivering growth?
NICK DENNIS: Apple as an interesting case study. It’s the largest company in the world and you would think that it’s got the most eyes in the world looking at it and therefore it should be the most efficiently priced.
But what’s interesting about Apple is you’ve got two quite divergent camps looking at the stock. You’ve got your bulls which look at it, saying it’s a fantastic business, it’s got a competitive advantage and it’s still got a growth opportunity. Then you’ve got your bears that basically say, well, this is just Kodak Version Two, or Sony, or Samsung. Where the share price is priced at the moment, to my mind at least, is that the key in price earnings is more in the latter camp. But we are bullish on Apple. We think it’s still got a growth opportunity.
I think what’s interesting is that, despite it being such call it a high-profile company, people seem to have lost interest in it relative to what I call the FANG stocks – Facebook, Amazon, Netflix and Google – a phrase coined by Jim Cramer. These stocks have been on fire. Apple has sort of been lost by the wayside. And also positioning – there was a statement by Morgan Stanley which showed that US fund managers are underweight Apple relative to their benchmarks, which is not the case, certainly for Facebook and Google. So we look at this and we look at the growth expectations for 2016, which are muted. Sell-side only expecting sort of 5% revenue growth for the next two years and call it high single-digit earnings growth. So we think expectations are relatively low. And I think the key question for me when looking at Apple is that people always look at the iPhone sales and say, “What next?” And they even seem to question the sustainability and longevity of the iPhone earnings trend.
We view this more as an annuity-type business. We think the whole Apple ecosystem with the iOS and iTunes and these other services that they are adding on, Apple Pay, Apple Watch, do more to lock people into that ecosystem. And so we think this creates a recurring revenue stream. So if the mindset changes to this being more of an annuity business, rather than a one-off kind of commoditised business, we would argue that this deserves to trade on a higher multiple than it does. We’ve seen how our large-cap stocks such as Google and Microsoft have had terrific runs in 2015. I think it’s completely possible that Apple has a similar kind of year in 2016 as people see either that they go and they beat earnings expectations or people don’t see the drop-off in sales that the bears might be expecting. Apple has got a 10% free cash-flow yield and it has cash on the balance sheet, the free cash-flow yield; they could virtually buy back the company in eight or so years. There are difficulties around repatriating the cash to the US, but it conceptually just shows you that with some smart capital allocation you don’t need a lot of growth to actually get interesting returns as a shareholder. So we think if Apple trades up to a 14 times multiple on 2017 earnings – so if we were sitting here in a year’s time looking forward – it’s still trading at a discount to the S&P 500, which is trading at more a 16, 17 times forward earnings. And that gives you upside of roughly 30% which for a very, very high-quality company we think is an interesting return.
HANNA BARRY: Okay, let’s leave Apple there and move to Pandora which, I imagine, being a discount jewellery business and slightly cheaper than some of these other stocks, probably does have room for growth. Sean?
SEAN ASHTON: Absolutely, Hanna. This business is really in the affordable jewellery market, so a typical price point could be $50 for a charm that you might want to add to a bracelet that you wear. Many listeners may be familiar with the product and a bracelet itself may cost $150. So that’s kind of the price point we are talking about, very much affordable jewellery. I think as a brand it’s gaining significant traction globally, and specifically in developed markets like the US, where it’s now 30% of their sales. They’ve recently signed up into a strategic collaboration with the Walt Disney Company to co-brand Disney-branded charms, for which they’ve now extended that to Asia Pacific, following the success that they achieved in America. So you’ve got some fairly high profile large corporates that are pinning their badge to this brand. I think as a brand it’s gaining traction globally.
Just to take a bit of a step back, this is a company that had quite a few serious missteps when you look back to 2011/12, the fiscal year ended 2012, where what they really tried to do was push more higher-end products, more gold jewellery, and the price points got ahead of them. They also pushed too much of this inventory out into what was largely still then a wholesale channel in terms of their sales force. The net result was that they actually had to take a lot of that inventory back and take write-downs on it. So you saw a massive earnings retracement in the 2012 financial year as sales stalled and they took a write-down on inventory. They made management changes, they went back to basics, producing the traditional charm jewellery that they produce, got their price points right. And the net effect is that sales have been exploding in the last few years, literally 30% compound growth.
And there is another factor that also plays into it, and it comes through from a bit of a macro theme that we as a house, Anchor Capital, have been quite negative on resources prices and that plays quite nicely into Pandora’s business model in the sense that, as you have falling gold and silver prices, so their gross margins expand. We think a lot of that has happened now. You’ve had margins that have risen from 22% at the EBIT level to 35% today. So I think the margin expansion story has largely run its course, but you’ve still got a business here that’s sustaining more than 20% turnover growth, which is underpinned by the decision to invest in branded stores, not just wholesale stores – a lot of which they own.
So their store number is up 14% globally in the third quarter and they continue to roll out stores and still achieve positive same-store sales growth. So that’s the measure of brand success – are you cannibalising existing stores or not? And certainly there is no evidence of that yet. So we think the margin story has run its course but here you’ve got a business which is trading at a forward 18 PE, bearing in mind we invested for our clients about 218 Danish kroner about 2.5 years ago. It’s now 860, so it has run very hard. But the rating is still at a reasonable level and we think this is a business that can carry on growing its earnings by at least 20% a year for a couple of years. So I think at that rating you should expect to see largely earnings growth plus dividend as a total return.
HANNA BARRY: We do have some questions from listeners. Let’s try and get to some of those. One is from Werner Lundt, who asks will these be the offshore shares that Astoria will typically invest in? Peter, you can jump in there. Just to remind our listeners that Astoria is effectively an investment company that has a secondary listing here on the JSE, a primary listing in Mauritius and it essentially gives access to offshore equities and it invests in offshore equities itself. Is that correct?
PETER ARMITAGE: Ja. It’s a share that you can buy on the Johannesburg Stock Exchange which effectively is 100% offshore equities – through direct equities, through niche funds and through private-equity funds. Anchor Capital is the asset manager of Astoria, so I guess it would be no surprise, if these are our effects, to find them in that portfolio. When we go in and when we invest in them is a function of timing and watching the share prices. Being asset managers, it’s a listed business. We are not at liberty to tell you about every single trade that we do. The directors of Astoria have to put out Sens statements to do that. But I think it would be a logical conclusion that our top five shares would find their way into the Astoria offshore equity portfolios.
HANNA BARRY: Admiral Group is an interesting one. It’s not universally loved by analysts, it would seem. Of the 16 analysts covering the group three would say it’s a buy, six a sell and ten a hold. So kind of a bit of a mediocre opinion on the company. It’s a Welsh motor-insurance business, $1 634/share [corrected below: £16]. Sean, what’s nice about this company?
SEAN ASHTON: I’m glad you introduced it by talking about the consensus expectations, because that’s part of the reason we like it. I think analysts have been bearish on the company for the last two-odd years. It’s a business we identified in late 2013 as a potential investment. We invested in it. We are probably up about 20% or so in terms of capital gain, but that ignores the dividend stream that you’ve got, and that’s significant.
I think this is a wonderful business. You can almost view it as the OUTsurance of the UK. It’s the second-largest auto insurer in the UK. They don’t have a big fancy London head office; everything is done out of Cardiff. They are very scientific in the pricing of business that they are prepared to write, so they will very happily turn away low-quality business, so a very disciplined management team that has a very significant shareholding in the company. And at the same time very data-driven. And this shows up the effect of their discipline around capital management, around pricing and the fact that they have scale shows up in their expense ratios. So when you are an insurer, and you are selling insurance policies, your competitive advantage really is cost and scale, ultimately.
Admiral runs an expense ratio, which is really the overheads measured as a proportion of the premiums that they write. Their expense ratio is about 15%, which is roughly half of that of the broader sector. So they can sustainably run at a more profitable level than the auto industry in general. And I think certainly you had many years of kind of double-digit dividend and profit growth out of this company, which over the last two or three years has stalled. Now why has it stalled? It has stalled because you’ve had quite a tough premium cycle in the UK, so you’ve had a lot of competition for writing auto insurance business in the UK. The net result is that auto premiums dropped I think at their peak in the first quarter of 2014 – at an industry level they would have been down by about 20% year on year. So there has been intense competition in premiums and we are now starting to see that cycle turning. So the premium cycle is moving up. You’ve got quite a nice pricing power returning to the business. So that’s an environment in which they will price up but they will tend to gain market share because they won’t price up to the extent that their competitors have to, because their competitors are all running at a loss. So you would expect to see them gaining market share. They make very extensive use of reinsurance arrangements, so it’s a very capital-light business. They tend to sustain a return on equity of more than 50%.
And I think what’s also quite attractive is the accounting seems to be very conservative in the sense that they build up reserves for expected losses that tend to always be too much. So you have this pattern of reserve releases every year, which basically is telling you that they are accounting their earnings as understated every year. And that results in them always being a bit more overcapitalised than they need to be, and hence they tend to pay out very, very generous dividends as measured by the cover on the earnings that they report. So they’ve paid out virtually all of their earnings as a dividend every year for the last few years and the net result of that is when you are buying it today – I think the share price is about £16 or thereabout – you are paying a forward 16 PE but you are getting about a 6% dividend yield. So you’re getting a 6% dividend yield into an environment where consensus expectations over the next two or three years for growth are very muted. The market is looking for about 3% compound growth between FY ’15 and ’18. I think on the balance of probability they will probably deliver more than that, so there is upside surprise potential to consensus, and you are paid very handsomely to wait. A 6% dividend yield in pounds is very attractive.
HANNA BARRY: Absolutely. And just a correction there on the share price. I got it wrong, got my wires crossed – £16/share more or less is what Admiral Group is going for. I’m sure our listeners are dying to hear exactly how we should be best investing in these stocks.
We do have some questions coming through on the webinar, but I would ask you to keep it to the topic of these stocks and particularly just investing and selecting the best shares in the world.
Let’s just look finally at Priceline Group and then we’ll move on. Nick, this is an online travel company. Also fairly expensive to my mind from a share-price point of view. What do you say is this company offering?
NICK DENNIS: The share price itself is quite high, it’s around $1 300. But then the per-share earnings are high too. So actually it’s quite inexpensive in terms of the PE multiple, put it that way.
Priceline is on about a 19 times forward PE and it delivers about a 34% return on equity, so it’s a very high-quality business trading at what we think is an inexpensive multiple. As you said, Priceline is an online travel agency and the jewel in the crown at Priceline is booking.com, which listeners might recognise. So when you do your hotel booking, looking for places to stay, you go onto booking.com.
Online travel agencies are taking share from offline travel agencies and then Priceline as the leader in the market is growing faster than the other online travel agencies. It shows what we find in a lot of tech companies, where you create this virtuous circle where size begets size and creates a network effect. So the largest company attracts the most hotel properties and in turn then that attracts the most customers. And then, because more people come to transact on the site, that leads to more revenue for Priceline, which they can reinvest in the business through, say, advertising on Google Search. So they would spend call it close to $3bn – that’s what their marketing budget is. So for a smaller player it’s very difficult to compete with that.
To give you a sense of Priceline’s growth, roughly 18 months ago they had 500 000 properties on booking.com. Now it’s over 800 000 properties with 21 million rooms. What’s interesting is that within their existing properties they’ve only got a mid-single-digit share of the total bookings. So we think there is room for booking.com to take share within their existing clients and for them to sign up new properties and for online to take share from offline.
What’s interesting about Priceline is that it’s listed in the US. Around 90% of operating profit is actually generated outside the US. So in US dollar terms, the strong dollar this year has actually been a significant headwind in terms of profitability. So if in 2016 the dollar isn’t as strong as it was this year, then the major headwind has been removed and you can see dollar earnings grow quite smartly again. And we think you could potentially also see a PE re-rating. So we don’t see any reason why it can’t trade at a similar PE multiple to, say, Google. Google trades on 23 times. If over the next year it trades up to a 23 times forward PE, that would imply 30% upside on a one-year horizon. And even at that multiple for a very high-quality growth company with significant competitive advantages, we think that’s quite reasonable.
HANNA BARRY: It doesn’t look to me like the dollar is going to weaken, but let’s not get into that debate. Quickly, Nick, we have a question from a listener, Ian Gibson, wanting to know whether Airbnb is a threat to Priceline, or to booking.com, I suppose specifically.
NICK DENNIS: It’s an interesting question. Potentially there is overlap. So first I would say both have an opportunity to grow. But I would also argue that the customer who is looking for a hotel room arguably is someone who is different from the customer looking for self-catering, which is what you go for in Airbnb.
That aside, we still think there is a long runway of growth for both companies. The offline is still – I think the number is 60% of the market in the US and higher internationally. So there is still a long runway of growth there. But yes, I would say at the margin there probably is some overlap. Theoretically Airbnb could serve to slow down Priceline’s growth rate, bit I don’t think it will disrupt the business model altogether.
HANNA BARRY: Peter, let’s look a bit at how one actually invests in these stocks. Outside of Anchor, what is the best way to go about getting access to these shares?
PETER ARMITAGE: I’m not sure there is any way outside of Anchor. Jokes aside, ultimately you can have a direct share portfolio, so that’s obviously something that we do. Or there are lots of different providers in South Africa – the likes of the Saxos and the IG markets – all through your local stockbrokers. Typically they’ve got some mechanisms for people to invest offshore. So you can have a stockbroking account.
The second thing you need is the ability to transact offshore, and your stockbroker will typically facilitate that for you through an asset swap which will cost you some additional money, but the ideal is to apply to the South African Revenue Service and get permission to take money offshore, and have a direct offshore share portfolio.
Alternatively you can buy a local unit trust which has investments in offshore equities, and there is a range of about 50 of those. Most big asset management companies have an offshore equity unit trust. We’ve got one, which is actually a feeder into Nick Dennis’s fund – who was speaking earlier. He runs the Global Equity Fund. So you will find quite a few of these shares from time to time in his portfolio.
So you can choose to employ it with a professional fund manager who is going to pick the shares, or you can invest directly in a share portfolio, which most stock brokers will facilitate.
HANNA BARRY: Some fund managers are cautioning investors against sending all their money offshore, which I think some South African investors may be prone to do in these tough economic times, for the simple reason that the rand is very weak so you are buying these companies at a very expensive price. So you are at a disadvantage. What would you say to that, Peter, in terms of getting that offshore exposure, but understanding that you are not getting that much bang for your buck?
PETER ARMITAGE: Well, two things. If you were sitting on the moon and looking down at earth, you wouldn’t point at South Africa and say I want 99% of my money at the tip of Africa. It makes sense, no matter where you are in the world, even if it is America, to diversify your portfolio because of currencies – and the unexpected can happen. So different markets can do well or badly, currencies can move. So to have some diversification has merit.
And the second thing I would say is you’ve just got to take a very clear view on where the rand/dollar will be in five years’ time. We’ve got a very high conviction level that it will be materially weaker than where it is today. We have had a big spike in the currency so there is a strong possibility that it could come back to the thirteens or the twelves over the course of the next six or 12 months, but we think that’s largely irrelevant. If you look at the rand over any 20-year period, we’ve had 4 or 5% depreciation per annum, and that adds up pretty quickly. So I think the starting point is: do you have any investments offshore? If you don’t have any there is hardly ever a bad time to diversify. So if you have none we would suggest taking 30, 40% of your money and investing it in offshore assets.
If you’ve already got that, now might not be the ideal time to invest offshore if you’ve got a short-term view. If you’ve got a longer-term view the plethora of opportunities offshore is just so dramatically bigger than South Africa. It makes a lot of sense to do it.
HANNA BARRY: There we go. As you mentioned earlier, 6 000 shares that Anchor Capital is investing in offshore versus 120 locally. We are going to have to leave it there today. We’ve come to the end of this Moneyweb webinar on the best five shares in the world. I was joined by Anchor Capital’s CEO Peter Armitage, as well as Sean Ashton, who is chief investment officer. And Nick Dennis was on the line, a fund manager with a focus on global equities. If you would like to listen to this webinar again or read the text and just get into the nitty-gritty of some of the details of these stocks, it will be on the Moneyweb website.
Otherwise that’s it for us and thanks for joining us.