CV Capital

CV Capital Sept 20 quarterly update

To my fellow shareholders,

It appears that the economy is recovering from Covid-19. As I write this, the long talked about Australia-New Zealand travel bubble is finally happening and some state borders are also reopening. NSW has not had a single locally transmitted case in the past 7 days and even Victoria has gotten its local transmissions down to single digits. Relatively speaking, Australia is doing well.   

Earnings season has just ended and overall earnings were pretty good given the backdrop of Covid-19. Based on the reported earnings it appears to me that the worst case predictions for the economy during the lockdown did not materialise. Don’t get me wrong, there are some sectors like travel and hospitality which have been completely decimated and the economy is still very weak but we did not go into a depression and it appears that the worst has passed (unless of course we get another outbreak ala Melbourne).   

The performance of some companies really surprised me despite being in the direct line of fire.  Take for example Motorcycle Holdings (a national motorcycle distributor), Breville Group (manufacturer of small kitchen appliances), JB Hifi (consumer electronics retailer), Adairs (home furnishing retailer), all consumer discretionary companies whom you’d think would have been badly hit from the lockdown but instead reported revenue growth in FY2020. The lockdown has spurred some surprising trends. Even shopping malls were pretty resilient, Scenter Group’s (Westfield) revenue only fell by 16% for the half year despite 3 out of the 6 months being in the most acute phase of the social restrictions. 

No doubt Jobkeeper has played a huge part in keeping employment and spending ticking along in our consumer driven economy. In tourist hotspots like Byron Bay, 67% of all businesses are reliant on Jobkeeper. Whilst I’m sure there are alot of rorting going on, on balance Jobkeeper was the right move by the government which saved many businesses from going under. The alternative could have been a much deeper recession. The next test for the economy would be when we roll off Jobkeeper in April 2021. 

The share market has been more or less flat since June. It’s been a two speed market with the technology companies (Saas, cloud, AI) and “buy now pay later” (BNPL) stocks being the market darlings where no price is too high and other sectors being priced much more modestly. Below are some of my observations which highlight the market exuberance for these stocks:

  1. Afterpay is now marginally more valuable than the Coles Group. A company whose revenue is less than half the net profit of Coles and has yet to post a profit in its entire history is more valuable than the Coles Group, a behemoth who services 21 million Australians every week and has a competitive advantage so huge that it’s near impossible to dethrone in my opinion.
  2. Excluding Afterpay, the next 5 BNPL stocks have a combined worth of $6.3 billion and based on their latest annual reports, reported a combined net loss of $127 million. For $6.3 billion, one could buy all of these Afterpay copycats or a Crown Resort or JB Hi-Fi or Ampol (Caltex) with change to spare.
  3. Then there is Brainchip. Quoting from their website “Brainchip is a global technology company that is revolutionizing Edge AI applications with our event domain neural processor and comprehensive development environment”. Got it? In its FY2019 annual report, it posted $75k of revenue (that’s right, k for thousand) and on its website lists its product applications as “coming soon!”. In early September, this company was valued by the market at close to $1.2b (that’s right, b for billion).   
  4. In America, Tesla announced a 5:1 stock split on 11 August which was set to take place on 31 August. Tesla market capitalisation between 11 August and 31 August increased by US$223 billion, (compare this to CSL, the most valuable company on the ASX worth A$130 billion) going from US$275 million to US$498 million. As there were no other major announcements between these dates or just prior to 11 August, the stock split is the most likely catalyst for the valuation uplift. Logically this makes no sense as a stock split only cuts the cake into more slices, it doesn’t add to the overall size of the cake. But more than two CSLs were magically created just by cutting more slices.

I could go on with more examples of market exuberance but let’s move on to the fund’s activity and performance in the last quarter.

Fund activity

We purchased more shares in Boustead Projects (a company I previously discussed here). My thesis has not changed and I think they will unlock the value of their real estate portfolio possibly in the next 12 months as management indicated in the recent annual general meeting (AGM) that they are still pursuing this option. I suspect if not for Covid-19, the monetisation of these real estate assets could have already taken place.

We took some profit from Baby Bunting, we sold the stake we bought during the March sell off. Baby Bunting’s stock price had gone up 2.7 times from the March lows and I wanted to trim the position as it was becoming a very large position in the portfolio. At Baby Bunting’s current price, I believe there are more attractive opportunities in the market. Time will tell whether this was a good decision.

Our Salmat (I previously wrote about here) investment also finally came to a close with a final distribution paid to shareholders in August. I’m quite pleased with this trade as we made a good return without taking much risk. The return we made was purely from cashflows generated by the business and not from selling our shares at a higher price. We made 58% over a 23 month period.       

With regards to our share purchase plan (SPP) side hustle, we have so far participated in 8 share purchase plans capital raisings and got full allocations for 2 SPPs. I believe this low hit rate is somewhat indicative of the high level of liquidity in the system driven by low interest rates and central banks pouring money into the system. I’m certainly not complaining as we have netted close to $14k profit from a cost base of less than $200.

Fund performance

CV Capital return for FY2021 (30 Jun – 30 Sept) is 9.5%. A big driver of this return was Baby Buntings and Schaffer Corporation, two of the biggest positions in our fund. Baby Bunting reported an excellent result for FY2020 which showed continued revenue growth from new stores and same store sales and the market reacted with a 40% increase in share price from June. Schaffer showed a pretty resilient result despite their key European customers shutting operations from March to May.

Since inception our return is 7.4% on an annual compounded basis (21.4% on a non-compounded basis) and so far we have outperformed our benchmark by 4.0% p.a. Our cash and cash equivalents position are circa 10% of the portfolio and the unit price (including franking credits) as at 30 September 2020 is $1.21.

Note 1: Total returns are calculated by including dividends, franking and other tax credits. The benchmark return calculation does not assume reinvestment.

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