MoneyTalks: Here’s what contrarian investing involves, and which ASX large caps it’s led Allan Gray to back

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MoneyTalks is Stockhead’s regular recap of the stocks, sectors and trends that fund managers and analysts are looking at right now and in this edition we’re looking at contrarian investing.

Today we hear from Suhas Nayak – analyst and portfolio manager at Allan Gray.

Allan Gray’s Australia Equity Fund (Class A) launched in May 2006 and in the past 12 months has returned 40.6%, ahead of the benchmark (the S&P/ASX 300 Accumulation Index) 30.9%.

As at September 30, 48% of its holdings were in materials and energy with another 27% in financials.

What is contrarian investing?

Nayak said Allan Gray’s philosophy of contrarian investing involves buying and selling in an opposite direction to the general market sentiment.

“We like to buy things that are out of favour for whatever reason, we try to look out a few years to see what normal earnings might look like and to that extent, and as a result we are long term investors,” he told Stockhead.

“We do have at the moment a heavier weight towards energy and resources, but I wouldn’t say it is due to a sector view – we are very bottom up investors.

“We look at fundamental drivers of earnings for individual companies before we make investments.”

Nonetheless, Nayak says sometimes sectors being undervalued can present opportunities, noting energy is still undervalued in spite of oil prices reaching seven-year highs and energy shares bolting in North America and Europe.

“When a sector such as energy has had masked underperformance over a number of reasons, it’s natural to think we’d be looking at it closely and trying to find opportunities in this sector,” he said.

Nayak says the oil and gas giant is one of Allan Gray’s biggest holdings right now.

“It’s had a long period of underperformance over the last few years from a share price perspective – that’s been driven by challenges in the oil prices,” he explained.

“In the last six months, oil price has well and truly recovered but Woodside has lagged by quite a significant amount and has lagged European peers as well as American peers.”

Further sweetening the deal is Woodside’s proposed Scarborough development which the market doesn’t appear to be taking account of yet.

“As a result, we’re buying the company at quite a big discount from EV to EBITDA perspective relative to market as a whole so I think that presents an opportunity for longer term investors like us,” he said.

Woodside (ASX:WPL) share price chart

 

Think of financial stocks and the big banks would spring to mind.

But insurers sit in this sector too and they have been underperforming, representing an opportunity for funds managers with a contrarian investing philosophy.

“We’ve seen a long period of insurance companies under-earnings relative to their cost recovery and that’s because they haven’t been able to get premiums to go up fast. That’s happened for a number of years and last year has finally seen uptick in premium rates,” Nayak said.

“As a result insurance companies worldwide should start to see increased profitability and QBE will hopefully be no exception.

“And I think at these prices the stock isn’t pricing in some of that strength in premium rates and subsequent increase to tangible book value that may well result in the next couple of years.”

QBE (ASX:QBE) share price chart

 

Back to materials and Incitec Pivot is a stock Allan Gray has bought in the past year and a half.

While most materials stocks are in the mining and mineral exploration space, Incitec Pivot’s bread and butter is the manufacturing and supply of fertiliser.

“I think it’s had a number of challenges so 2-3 years ago floods in Queensland, more recently outages at their plant in Louisana and I think that has shaken confidence in the reliability of the end stream for Incitec Pivot,” Nayak said.

“Commodity prices for the commodities Incitec sells have really increased considerably over the last little while…but [it] trades at a very low multiple.

“I think the market may well have forgotten what the earnings capacity of this business actually is over the long term.”

Incitec Pivot (ASX:IPL) share price chart

 

Another non-conventional materials stock is this metal recycler.

“While the fuel scrap price is quite volatile and Sims is exposed to that, we think normalised earnings should be in excess of $200m a year and enterprise value is around $2.5 billion,” Nayak said.

“And that sort of multiple is quite a discount to the market to a lot of resources companies at the moment whose earnings are above that.

“On spot multiples is lower than that and we think it’s one of those companies that has ESG credentials as well, given that it is a recycler and the emissions associated with recycling is far less than emissions associated with producing mineral from virgin resources.

“We think Sims has that little benefit on top of its valuation discount.”

Sims (ASX:SGM) share price chart

 

Contrarian investing isn’t just about picking assets

Nayak says contrarian investing also involves paying less attention to macroeconomic issues that can distract investors from the fundamentals of individual companies.

Except of course when it presents a buying opportunity.

“We don’t spend too much time thinking about some of those really macro issues, we try and focus very much on buying stocks cheaply because we think that’s the best protection against whatever might happen on the macro front over long term,” he declared.

While several recent interviewees in this column consider scrutinising and proactively engaging with management an essential part of the process, Allan Gray appears more indifferent.

Although of course large caps are a different kettle of fish to small caps in employing dedicated investor relations staff, whereas for small caps management will seek to engage directly.

And, management are just one attribute to consider when investing.

“We participate in analyst calls and broker hosted group meetings and also from time to time we speak to management on the back of results announcements and that can often be on one to one basis,” Nayak said.

“I think it’s helpful at times to be able to speak to them but it can also detract as well.

“And so maintaining an even feel but not to be too influenced by what management says is an important attribute to good investing.”

The views, information, or opinions expressed in the interviews in this article are solely those of the interviewee and do not represent the views of Stockhead.

Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.

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