Finding undervalued quality on the ASX

Our next speaker is Vinay Ranjan from A.L.E.

Funds Management.

His presentation topic today is finding undervalued quality on the ASX.

A.L.E.

is a specialist Australian equities fund manager with an active investment style that aims to deliver attractive long-term capital growth and regular income to its investors.

Magellan Asset Management purchased Aili in early 2018, providing retail investors exclusive assets to Aili's investment expertise through the Aili Australian Share Fund and the Aili Small Companies Fund.

Vinay is a senior investment analyst in Aili.

Previously, he worked at Heyberry Global Fund, Macquarie Capital, where he advised on a number of complex M&A transactions including

trade sales, recapitalizations, and leverage buyouts.

Welcome, Vinay, to the presentation.

Thank you very much for having me.

Delighted to be talking about the Airlie Australian Share Fund and where we're seeing opportunities at the moment.

Before we start, I'll just draw your attention to our disclaimer.

I think it's helpful to give a bit of background on Airlie.

Airlie was founded in 2012 by portfolio manager, John Sevio.

and we've had significant institutional backing from day one.

Co-portfolio managers, Matt Williams and Emma Fisher joined early in 2016, and we've since launched the early Australian share fund, giving access for the first time to retail investors to our strategy.

And we know Aussie equities is a really competitive space and can look very similar at times.

So I think it's important to outline where our competitive advantage sits.

And it's probably in these three areas.

The first is we believe in concentration.

It's very rare that a company meets all of our criteria and we'll touch on the process a bit later So when we do find a good idea, we want to own a large position in it Secondly and really the focus of today's presentation is we're looking for undervalued quality So I want to emphasize this is not a strategy where we're trying to find the best businesses on the ASX and pay any price for them we're really focused on situations where

the quality of business is not reflected in the share price.

And that might occur for a variety of reasons.

Maybe you've got a jewel in the crown asset that's hidden behind some more mediocre assets, or perhaps you've got a founder who's not very promotional, so the business flies under the radar.

And lastly, we have the flexibility to move up and down the market cap spectrum.

So if we find an exciting small cap, we're happy to add that to the portfolio to enhance our returns.

Turning to performance, we're very proud of our track record.

And I guess the most pleasing aspect has just been the consistency of the alpha generation across each of those time periods.

And I think that speaks to the fact that we don't rely on a particular style to be in favour, whether that's growth or value.

The focus is really finding is on finding undervalued quality.

So how do we go about finding undervalued quality on the ASX?

Well, it comes down to having a really clearly defined investment process, and this is ours.

We start with a balance sheet, then we're assessing business quality, management quality, and lastly, we're looking for situations where those three factors are not reflected in the valuation.

And the way I like to think about it is we're stripping out the companies with shaky balance sheets and those with overly optimistic valuations, and of what's left, we have a preference for owning

the better quality businesses run by the better management teams.

And I'll take you through why I think each of these factors is important over the next couple of slides.

So we think it's pretty self-evident that companies with strong balance sheets outperform those with weak balance sheets, but we got Macquarie to go and test this by splitting the index into quintiles based on interest coverage ratio.

So effectively the amount of times your profit covers your interest expense.

And what we found was the companies in the top quintile for interest coverage ratio outperformed those in the bottom quintile by a factor of five times.

So it's a very significant gap.

And that makes sense to us.

You know, if a company has a weak balance sheet, it's more likely they're going to need to raise equity and dilute shareholders.

Star's a great example of that at the moment, having raised capital twice in the last nine months.

Or worse still, you know, a company can go bankrupt if it's unable to raise capital.

So it's the first step in our process and probably the most important.

Secondly, we're looking for business quality.

I think it's worth defining what quality is.

For us, it's a high return on capital.

The reason we look at return on capital is we think it's this big flashing light telling you that there's something special going on in the business.

If you're able to sustain a high return on capital for long periods of time, it means you've got some kind of sustainable competitive advantage because competitive forces haven't been able to bid down those returns over time.

So to put things in context,

The median business when you're investing on the ASX has a return on capital of about 11% and it trades on 20 times PE on average.

And if we bring in a bunch of obviously good companies, companies like REA, Cochlear, SEEK, you can see they generate two, three, four times the market return.

But when the quality is obvious, the market's pretty efficient.

It puts these businesses on a really high multiple.

And so for us, our objective is to find similar

quality businesses, but on lower valuations.

And you can see here from the pink dots, these are all companies we own in the fund.

They also generate two, three, and in Nick Scali's case, six times the market return, but they're trading on much more palatable multiples.

And that's what we mean when we say undervalued quality.

The third step in our process is management quality.

We like managers that have skin in the game,

The best version of that is really owner-managed businesses where the founder is continuing to run the business.

To test this, we went back and created an index of owner-managed companies to see how it performed relative to the index.

What we found was that the owner-managed index significantly outperformed the ASX300.

It makes sense.

An owner-manager has his reputation on the line, has his own money in the business, and is incentivized to drive good outcomes.

Finally, the last step in our process is valuation.

Hopefully it's clear, you can only really understand the value of something if you first understand the quality of the business.

PE multiples in isolation don't tell you very much.

So it's all about understanding quality first.

To bring it all together, I wanna share an example with you of a company that meets all of our criteria, and that's Premier Investments.

You might not be familiar with Premier, but I'm sure you've shopped at one of their brands, whether it's Peter Alexander, Smiggle, or maybe a pair of jeans

at Just Genes.

You know, Premier has a fantastic balance sheet.

They've got 350 million of net cash and about a billion dollars in investments in listed companies Breville and Meyer.

They generate very good returns.

Return on capital is in the mid 20s of the last five years.

And it's an owner managed business.

Solomon Liu, who's the chairman, owns just under 40% of the company and has been very shareholder friendly over the years.

And yet, despite the enormous quality of this business,

Premier only trades on 15 times PE, which is well below the market average.

So we have to ask ourselves, why is it that Premier's quality is not reflected in its share price?

And for us, the reason is two of its most valuable brands, Peter Alexander and Smiggle, perhaps hidden behind some more mature and less attractive brands like Portmans and Jack EE.

And if you look at the chart on the left-hand side, you can see the sales performance of Peter Alexander and Smiggle over the last 15 years.

and it's quite phenomenal.

Smigiel has increased sales 15 times over the last 15 years and continues to have a long international runway for growth.

So for us, you know, premier investments, it's a really undervalued quality opportunity that we're invested in.

To summarise, you know, at Ailey, we think we've got a very sensible investment philosophy focused on undervalued quality.

want to find out a bit more about how to invest in early please visit our website.

Thank you for your time and I wish you all the best in your investing journey.

Thank you Vinay for the presentation.

Do you have time for two questions?

Certainly do.

The first one being where are you finding opportunities and value in the market at the moment?

Sure look we're bottom-up stock pickers we tend not to to look for sectors or particular themes

But what I would say is if you look at the areas of the market which have been beaten up the most, whether it's consumer discretionary rates or more recently healthcare, that's where we tend to find opportunities emerging where the quality of the business perhaps is unchanged but the valuations have pulled back.

And I think Premier is a great example of that.

It's been caught up in a retail sell-off.

But as I touched on, the quality of that business is much higher

than other listed retailers.

And do you have a current investment that investors may not be as familiar with?

And if you do, why do you like it?

Yes, we think the concerns around GLP-1 or the obesity drugs has really given us an opportunity to invest in ResMed.

ResMed, in our opinion, is one of the highest quality companies on the ASX, generates great returns and has a phenomenal track record.

I think it's compounded

It's increased 15 times over the last 20 years.

And in our view, we think the market thinks the outcome of these drugs is binary, whereas we think the outcome could perhaps be that patients are prescribed both CPAP therapy and these drugs, given the obesity drugs probably have a potential to reduce your severity, but probably not cure sleep apnea completely.

Well, thank you Vinay for the presentation and QA.

It's great to see you.

Thank you.

Take care.

Bye-bye.