In this Quarterly Commentary, published on 30 September, our sister company Orbis looks at how despite heavy declines this year, global equity markets are still not particularly cheap and real-world risks loom large. But Orbis believes there are plenty of opportunities for bottom-up stockpickers like them. In addition to classic ‘value’ areas such as energy, Orbis is finding compelling value in very different types of businesses, such as Global Payments and Fleetcor Technologies.

 

The heady days of the “Everything Bubble” of 2021 now seem like a distant memory. Global equities have declined over 20% in US dollars since the start of the year, and the most speculative areas of the market have seen far steeper losses. That said, global markets still do not look particularly cheap and there are plenty of real-world risks weighing on both sentiment and fundamentals—rampant inflation, war in Ukraine, and an energy crisis, to name just a few.

Despite this backdrop, we are enthusiastic about the opportunities for bottom-up stock selection. To put things in perspective, the chart below shows that US stockmarkets are still in the midst of a historic dislocation. The dark blue line shows the relative performance of US “value” stocks versus their “growth” counterparts. When the dark blue line is rising—as it has for almost 100 years—it means that value shares are outperforming. For more than a decade, however, it has been a painful time to be a value-oriented investor.

Although we are not beholden to any particular style of investing—be it “value” or otherwise—the behaviour of value shares tends to be a reasonably good proxy for our opportunity set. As contrarians, we are naturally drawn to areas of the market that are out of favour and thus potentially undervalued. The much harder part is waiting for others to share our enthusiasm. Until recently, many investors had an insatiable appetite for growth and were willing to pay almost any price for it. As the green line above shows, the past 18-24 months have been a refreshing change, with value roaring back into fashion.

What’s most exciting about the chart is that we believe value still has a long way to go. This explains our continued enthusiasm and our positioning in our Global Equity Strategy. We are in a period where the portfolio has a stronger tilt in the direction of value than any other time in its history, with the exception of the dotcom bubble in the late 1990s. In our past two quarterly commentaries, we have written about a number of examples in energy and materials such as Shell, Teck Resources and Vale. Despite strong performance amid a resurgence in commodity prices, these shares—which make up about 20% of the portfolio—still trade at very low multiples of earnings and cash flow.

While energy and mining shares would be considered classic “value” stocks by almost any definition, we are also finding compelling value in very different types of businesses. Two of our largest holdings, Global Payments and Fleetcor Technologies, provide an illustration. We sometimes refer to them as “quality cyclicals”, which is to say that they are excellent businesses, but they also come with exposure to the ups and downs of the broader economy. As long-term investors, that’s just fine with us. In the short term, cycles can produce buying opportunities when others are pessimistic, while the underlying quality of the businesses gives us the confidence needed to wait patiently for sentiment to improve over the longer term.

Global Payments provides merchants—often small and medium-sized businesses (SMBs)—with a platform to process credit and debit card transactions. When we began looking at the company last year, its shares were deeply out of favour. Payment providers are generally paid a “take rate”—a percentage of each transaction processed—and the pandemic was a major blow to spending on many of the services and experiences provided by SMBs. At the same time, “disruptive” new competitors like Square (public) and Stripe (private) caught the imagination of many investors, and the “legacy” payment companies like Global Payments, and its peers FIS and Fiserv, were left behind.

As a result, Global Payments went from trading at a 30-50% premium to the S&P 500 prior to the pandemic to about a 30% discount today. There are valid reasons to be cautious. Like any technology, the payments space evolves rapidly and the competitive threat is real. And while SMBs may have begun to recover from the pandemic, discretionary spending may suffer yet again on fresh consumer fears about recession and the cost of living.

Still, we think Global Payments is trading at an excessively pessimistic valuation for a few reasons. The first is that current headwinds are likely to abate over the long term. While there may be more competition today than in the past, the overall industry “pie” is growing at 8-12% per annum as consumer spending and card penetration both rise. In recent quarters, Global Payments’ volume growth compares favourably to its peers and other networks, which suggests that they are not losing market share. And while times may remain tough for many individual small businesses, collectively they remain resilient.

A second reason for optimism is Global Payments’ software strategy. Under the leadership of CEO Jeff Sloan, the company has built, bought, or partnered with dozens of software solutions that are now bundled together with their payment processing services. Software is critical because it ultimately helps customers do a better job running their businesses, which in turn enables Global Payments to share in their success by earning higher fees. Once a software system is in place, customers are extremely reluctant to fix what isn’t broken. Renewal rates of about 95% are not uncommon—and the company’s software-centric strategy means that Global Payments’ customer base is much “stickier” than its competitors’.

A final reason is that Global Payments is expanding into business-to-business (B2B) payments. This is a much bigger market—about two-and-a-half times the total size of business-to-consumer (B2C) transactions—and nearly all B2B payment volume is dominated by paper cheques and bank transfers rather than credit or debit cards. Although this is a nascent area for Global Payments and they will need to demonstrate that they can execute, it significantly extends their future growth runway.

At less than 12 times our estimate of 2022 earnings per share, Global Payments offers exceptional value in our view. We believe that the business should be able to deliver earnings growth of 15-20% per annum over our investment horizon. While not part of our thesis, we also believe Global Payments—as one of the last remaining pure play payment providers of size in a consolidating industry—would be an attractive takeover target, especially in light of its current valuation.

As with Global Payments, Fleetcor shares have also suffered from SMB-related concerns. The company operates niche payment networks in fuel, lodging, tolls and corporate payments. They primarily enable SMB customers to control spending of company money on expenses and payments to suppliers. Importantly, many of these networks are two-sided, which means that Fleetcor controls both the payor and payee relationships. By adding value for both parties, Fleetcor makes money on both sides of the transaction.

As an example, imagine a local towing company whose truckers frequently need to buy fuel. Rather than giving those employees a general purpose credit card, Fleetcor issues “Fuelman” cards that allow the truckers to pay for fuel and other pre-approved expenses. On the other side of the network, Fleetcor has relationships with local gas stations that agree to accept the Fuelman card as payment. For the towing company owner, the cards reduce the risk of unauthorized expenses and make record-keeping vastly more efficient, while the gas station can count on a captive stream of business from the drivers.

B2B payments—which account for about a quarter of Fleetcor’s business—are another important long-term growth tailwind. The vast majority of these payments are still made with paper cheques or bank transfers. Fleetcor offers a suite of B2B services including accounts payable automation, virtual payment cards, and cross-border foreign exchange transactions. As such, Fleetcor is well-positioned at the nexus of several long-term trends in the digitisation of B2B payments—a bit like where the consumer payments space was 15-20 years ago.

Fleetcor is an excellent business with high profit margins, high returns on capital, and double-digit revenue growth. We believe earnings per share can grow approximately 20% per annum over the medium-to-long term. In addition, Fleetcor’s CEO Ron Clarke has a phenomenal track record of value creation. Clarke built the company over the past 20 years and continues to own 2.5% of the company today—currently worth approximately $350 million. Since Fleetcor’s IPO in 2010, the stock has risen sevenfold, driven by a combination of organic growth and savvy acquisitions. Clarke has deployed about $6 billion on more than 80 acquisitions, and we estimate that these deals have earned a 20%+ unlevered return on capital.

Looking ahead, Fleetcor still has a lot of dry powder, and we expect Clarke to put the equivalent of 40% of the company’s market cap to work in the coming years. At current prices, there may be few better targets than Fleetcor’s own stock, and we’ve been pleased to see management reducing the share count at a time when shares are trading below our assessment of intrinsic value. Fleetcor trades at 11 times forward earnings. Like Global Payments, it previously traded at a premium to the S&P 500 just a few years ago, but now trades at a discount that we believe is unwarranted.

Part of the reason for the discount is that Fleetcor shares have been tarred with the same brush as other legacy payment companies. But more specifically, investors have also been worried that electric vehicle adoption will threaten Fleetcor’s fuel card business. We think these concerns are overblown given that widespread electric vehicle adoption is still many years away, and even then, Fleetcor’s customers will still need to manage their charging expenses. In our view, the most likely scenario is that Fleetcor’s customers will operate mixed fleets during the transition and will need access to both gas pumps and charging stations.

It’s always exciting to be able to find shares of above-average businesses trading at below-average valuations. Global Payments and Fleetcor stand out as two—among many—such examples in the current portfolio, and we continue to believe this is an unusually attractive time to be a bottom-up stockpicker.

 

Commentary contributed by John Christy, Orbis Investments (Canada) Ltd., Vancouver

 

Financial advisers can contact their local regional manager to learn more about the Orbis Global Equity Fund.