Freelance Journalist Zilla Efrat – Allan Gray Investment Forum, Sydney, Wednesday 1 November 2017

While some equity experts worry that share prices have risen too much in recent times, contrarian fund manager Allan Gray continues to find opportunities in some unloved sections of the market.

Speaking at the Allan Gray Investment Forum in Sydney earlier this month, Managing Director and Chief Investment Officer, Simon Mawhinney, observed that the Australian Securities Exchange (ASX) did appear pricy relative to its history and recent multiples of earnings.

And, even though there were still investment opportunities to be found by going against the herd, he said they were becoming fewer and fewer.

One such opportunity was insurer QBE, in which Allan Gray had invested five per cent of its portfolio, particularly over the past six months.

“It hasn’t been screamingly cheap, but it has been cheap relative to the stock market, so QBE has been a good opportunity over that period,” said Mawhinney.

Increased exposure to oil and energy

Allan Gray had also increased its exposure to oil and energy stocks, which now accounted for 25 per cent of its portfolio and included names such as Woodside Petroleum and Origin Energy.

Mawhinney explained why. Although there was currently a 10 per cent oversupply of liquefied natural gas (LNG) globally, he said this was likely to switch to an undersupply by 2020 and maybe even before, because LNG was widely seen as the cleanest hydrocarbon for energy production.

Allan Gray also believed US shale production was unsustainable at US$50 a barrel. And while the use of electric vehicles was rising, Mawhinney noted no more than 25 per cent of oil or hydrocarbons in the market were used for transportation.

“Even if the internal combustion engine is no longer sold or used, the worst possible outcome could be 20 to 25 per cent demand destruction in a world where production is falling at 10 per cent per annum. That’s not such a bad outcome,” he said.

“The other thing to consider is electric vehicles do plug into a power point somewhere and that energy comes from somewhere… coal, gas, wind and so on. It’s widely believed gas is going to have a seat at the energy generation table for many years to come. This increased grid utilisation from growing electric vehicle sales may not necessarily be a bad thing for the LNG producers in Australia.

“But there are risks. As with everything, it comes down to how much you pay for a stock. Invariably, the bears tend to focus on the worst-case scenarios and it’s often at that very moment, opportunity comes knocking for us.”

Global opportunities despite higher valuations

Dr Graeme Shaw, Investment Counsellor at Orbis, Allan Gray’s sister company which invests in global equities, had a similar message for the Forum.

He noted that international shares have had a pretty good run since markets bottomed in 2009, with share prices outstripping the potential growth rate in earnings.

“As a consequence, PE multiples have risen across the developed markets. Developed equities sell at about 20 times earnings,” said Shaw.

“The growth rate is even higher in the US where the average PE has risen to about 23 times. This has caused some investors to worry about investing in shares in general and in US shares in particular.”

Still, Shaw said there were some cheap stocks around and identified 370 of these companies in the US and 350 in Europe.

However, he noted that Orbis had much less invested in North America than its benchmark index and had chosen to invest in emerging markets instead.

“The PE for emerging markets sits at about 14 times and hasn’t increased very much over time,” he said.

Emerging markets looked cheap and had underperformed by about 40 to 50 per cent over the past five or six years.

“We find it easier to find ideas in places like Korea and Russia than in places like India,” said Shaw, noting that Orbis was still able to find opportunities in the “cheaper part of a cheaper market”.

One Korean stock Orbis had invested in was Samsung SDI, which was marked down following reports of the Samsung Galaxy S7 catching fire because of its battery overheating.

After some research, Orbis concluded the battery overheating was just a glitch and not a permanent defect. “We also spoke to Samsung SDI’s other customers and they were very happy with the quality of the products they were getting from the company. And, Samsung Electronics, which made the phone, appeared to have retained confidence in Samsung SDI and it certainly looks likely that Samsung SDI will be the primary manufacturer for batteries of the S8 phone when it finally launches,” observed Shaw.

“Once you can overcome the battery fires, Samsung SDI is actually a very interesting company because you get exposure to the electric vehicle battery business too.”

Shaw believed Samsung SDI has a few advantages over Tesla in this regard. Samsung SDI’s batteries were easier to stack and had a better gel chemistry which allowed them to be charged twice as often over their lifetimes than Tesla’s.

Samsung SDI also held interests in some other companies, a chemicals business and Samsung Display, which was producing the OLED displays for Apple’s new iPhone 8. And, according to Shaw, the price Orbis first paid for Samsung SDI when it began investing gave the car battery business for free, unlike Tesla, which was trading on very high multiples.