By Kylar Loussikian
It’s been a tough year for Rob Luciano. And that’s not just what the market is saying.
The star hedge fund manager admits as much. After years of stellar returns, his VGI Partners and its various listed and unlisted funds are underperforming.
But, as Luciano says, he isn’t investing in the short term. It’s the quality companies that will deliver for the long term that has been his bread and butter since his time at Caledonia, where he first took a position in the Chicago Mercantile Exchange – a wildly successful bet.
Now he is doubling down on some of VGI’s biggest positions, and tells The Australian that he is confident they will pay off for his fund – and for other investors.
“Yes, we’ve had a good year to June 30 but a tough last six months,” Luciano says.
“We manage a concentrated portfolio, and the portfolio obviously hasn’t worked over the past 12 months. But key parts of the portfolio have done extraordinarily well, like (Cartier owner) Richemont and CME, while a few others like Olympus and SAP have been decent performers. But when you’ve got 15 per cent, 16 per cent of your portfolio in Amazon like we have and it doesn’t go up, well it’s a drag. Also shorts have been tough and dragged us.”
“I always think you should pick stocks that you actually think are going to work over a couple of years because you want people to buy something and in a couple of years time, it’s a good outcome. I think if you buy Amazon today, you’re going to make money. If you buy Pinterest today in 12 to 24 months I think you make a lot of money.”
Luciano is speaking to The Australian as part of an end-of-year stockpicking series organised by Future Generation, the Geoff Wilson-founded fund to which he donates his time, along with other major investment managers including Caledonia, Ellerston and Regal.
Future Generation funds, both ASX-listed, donate about $10m every year to a range of charities supporting children at risk and youth mental health initiatives. Since they began in September 2014, the funds have returned an average 11.4 per cent per annum, compared to the All Ords’ average of 8.7 per cent.
Caroline Gurney, the chief executive of Future Generation, said the range of fund managers put investors in safe hands.
“For us, we want that diversity of investment, strategy and style, we want downside protection and we need to reduce volatility,” she said.
“Just as the impact of climate change has come to shape investment decisions, companies now recognise the costs associated with not addressing employee mental health issues.”
This year, Luciano is talking about some of his big positions: Amazon, Pinterest and Qualtrics.
Of those, the world’s largest e-commerce retailer is his biggest.
“It’s had some, you could argue, disappointment in its earnings because they have continued to invest in their e-commerce operations, continued to invest in their business in general,” he says.
“The revenue has grown, but the growth has been less than what the market was forecasting.
“What that’s resulted in is largely a de-rating of the valuation. You could argue it’s a lot more attractively priced.”
VGI took a position in Amazon more than six years ago, attracted by the hidden potential of different parts of the business. Since then, Amazon has expanded rapidly into logistics and content. In November, it signed a deal with Hilton as it rapidly expands a new business: health insurance.
“They are one of the only, or the only, mega-cap technology companies, in fact, one of the largest companies in the planet, that still continues to be able to reinvest all the free cash it generates back into its business,” Luciano says. “Most other businesses can’t do that because they ran out of the capacity to invest, so they pay dividends, buy back shares instead.
“People wonder ‘where did Amazon Web Services come from’, well it came from within Amazon. It serviced Amazon, and then they offered it to other external customers. Now, it’s become the biggest cloud player on the planet, bigger than Microsoft, bigger than Google Cloud. And that’s due to a very long-term strategic timeline.
“So when you sit there and you see Amazon continuing to invest in their business, that might annoy the short-term traders and impact the share price in the short term, but that’s a high-quality outcome for long-term investors.”
And the share price has come down in the six months.
Amazon shares have fallen to $US3408 ($4780) in that time, down more than $US97. In the last five years, however, they’ve risen 348 per cent – or $US2648.
But in Luciano’s view – one shared by plenty of equities analysts – newer products like the company’s subscription offerings are only just beginning to pay off.
“The whole point of the Prime subscription is to lock you in as a consumer, to create in effect a flywheel, so that you have more and more points of contact with Amazon, whether that be for your daily purchase, for sporadic purchases, you now have free video and music streaming. So you’re getting more and more value from your Prime subscription,” he says.
“I think the Prime subscription went to the very core of their desire to lock in customers, offer them huge value – at the time it was a huge cost incurred by the business, you could say it was a loss-leading strategy – and very slowly, but surely, you see an increase in the Prime subscription price, more usage and it becomes clear it is no longer loss-making.”
A recent note from analysts at investment bank UBS made similar observations. “Amazon is raising Prime fees in India, where the revenue impact – on a consolidated basis – may be modest, but as we discussed in our initiation we think it could presage a price increase in the US too where the last time Amazon increased prices was in 2018,” researchers wrote. “If we assume a 20 per cent price increase across the board (similar to the increase in 2018), it could drive an additional $US6bn of revenue with zero incremental costs.”
Another major VGI position – and one that has also underperformed this year – is Pinterest, the world’s largest visual search and social network. Luciano’s fund bought in last year at around $US20. Pinterest’s shares surged to more than $US80 before halving – they are down 49 per cent over the year.
“It was priced for a certain amount of growth,” Luciano says.
“Some of that growth has continued to come through but a key part of the sell-off has been that the amount of people using their site over the last six months has declined because they had a Covid benefit and a portion of that has washed out.
“The price has come off purely because of that short-term wash in monthly average users, and that looks like it’s stabilised and is going to continue to grow. They’re monetising the users at a higher rate, which is very positive.
“Obviously, you want to have users. But the difference between 93 million US users and 90 million US users is, with a medium-term view, irrelevant.
“Yes, it would be great if some of those users stuck around, but if they’re not high quality, there’s no efficacy for the end advertiser.
“This sell-off has resulted in some exceptional opportunities.”
Pinterest users looking for home renovation products to buy is a part of the platform’s potential.
For Luciano, part of Pinterest’s attraction is its ability to outlast mega-tech. Another is how likely users are to spend with the platform’s advertising partners.
“Facebook had a competing product, and closed it down. Google had a competing product, closed it down,” he says.
“What is the key? Why are we so excited about Pinterest? They attract 450 million users a month globally, more than half go to Pinterest with high purchase intent and are typically going to it for a renovation, they’re going for beauty products, they’re going for fitness, for cooking, for certain key interest groups, where ultimately you are looking for ideas, you’re looking for inspiration, and ultimately you’re looking to buy something, consume something.
“The beauty of Pinterest is it has been a safe place for advertisers with no political or harmful content, which is increasingly important these days for corporates and their brands.
“Pinterest is deemed to be social media, but it’s not – it is a bona fide search tool. And what they’ve been able to do over the last couple of years – they’ve been relatively slow to do it – is look to monetise that global audience. They’ve monetised it slowly but effectively in the US, and they’re increasingly very slowly starting to monetise it internationally.
“They’ve only just recently opened an office here in Australia, for example … so their international businesses is still at the formative stages, but yet they have a very substantial audience which they can monetise.
“But most importantly, an audience that isn’t going there to communicate with friends. Rather, more than half of the people who are using the site are going there with intent to purchase. And so if you’re an advertiser, the efficacy of your ad is high.”
Pinterest, meanwhile, is working on deepening its relationships with advertising agencies like IPG Mediabrands and Dentsu. It’s also working directly with major brands such as Home Depot, Ikea, Lowe’s and Pernod Ricard, which spends 10 per cent of its digital marketing budget on the platform, up from 6 per cent in 2020.
“Could we have traded it better or been smarter? Possibly,” Luciano says. “Why pitch it now? Well, I think that if you buy it, you’re going to make a substantial amount of money with it. I think you can more than double your money.”
Luciano’s third pick for the Future Generation series is far lower-profile than either Amazon or Pinterest. It’s experience management software firm Qualtrics, spun out of SAP in January.
Since then, its share price has slid 22 per cent to $US35.30.
Customer relationship management software emerged a decade ago, and experience management software is poised for the same type of growth, Luciano says, “particularly driven by Covid, remote work, digital interaction and e-commerce”.
“It allows you to effectively create a map of what your customer is thinking, what your employees are thinking and, if you’re a government organisation, what your constituents are thinking,” he says. “So why would a company want to know that info? It allows you to know who is a high-performance worker, who maybe needs some coaching and improvement, who could be a threat to the organisation. That’s quite important for firms these days.
“So then flip that to an organisation that wants to better understand its customers, there’s only so many legal avenues they can access information, but they can look at things like all the interaction with the call centre, all the interaction on social media, all the interaction via email. So any electronic form of communication, including voice, Qualtrics can allow you to have a single snapshot of your customers’ intent and view of your brand.
“Are they looking to spend more? Are they upset with the product or the service? Are they likely to defect? Are they satisfied? Are they on the verge of causing brand damage? It alerts you to these issues so you can rectify it.”
Luciano says VGI estimates growth in the business could be in excess of 30 per cent over the next few years – and may well be “substantially over that next year or two”.
“What do we think the share price could do within a couple of years? I think it could more than double,” he says.
Three more picks for 2022
We asked three more prominent investment managers for their top stock pick for next year.
Ronni Chalmers: Insurance Australia
For Clime Investment Management director Ronni Chalmers, Insurance Australia looks a bargain compared to many of its peers. “The insurance sector has been significantly impacted over the past two years by the fall in interest rates and above trend catastrophe claims,” Chalmers says. “However, the sector is now increasing premiums to restore profitability.”
That means there is plenty to be positive about this coming year. “Interest rates have begun to rise, flowing through to investment earnings (and) IAG has taken over a billion dollars in business interruption insurance provisions and there are strong indications that these provisions may prove to be too conservative,” he says.
“At the same time, earnings growth looks set to recover. If the above thesis proves correct, the stock is cheap at the current level.”
IAG didn’t have a great year. Its share price has sagged 11.7 per cent of the last 12 months to close on Wednesday at $4.23. But why is IAG a long-term stock? “The premium cycle and rise in interest rates are expected to be multiple year phenomena,” Chalmers says.
Bill Pridham: TKH Group
Ellerston Capital portfolio manager Bill Pridham has chosen European technology firm TKH Group as his buy of 2022.
The company, which is a leader in 3D and 2D camera technologies and other smart vision systems, is in a number of long-term growth markets, Pridham says. All up, it operates in markets worth €20bn ($31bn) market but which are expected to grow to €34bn by 2026.
“TKH has a number of other attractive businesses including 70 per cent global share of new tyre manufacturing systems (EVs will be a strong growth driver), subsea cables for offshore wind farms, smart packaging for prescription medication and next generation airport ground lighting systems,” Pridham says. “There is a business listed in the US called Cognex which is a close comparable to TKH’s vision business and when you apply Cognex’s multiple to TKH’s vision business, you are effectively getting the rest of the company for less than zero. This gives us an incredible margin of safety and strong capital upside once the market recognises this embedded value,” he says. “(It’s) classic price discovery.”
Blake Henricks: ResMed
Sleep apnoea specialist ResMed has already had quite a year. The shares have jumped more than 27 per cent in the last 12 months to close at $7.73.
But Firetrail Investments portfolio manager Blake Henricks sees plenty more upside for the stock in the coming year.
“ResMed is a market leader in a consistently growing industry,” says Henricks, a former Macquarie stockpicker who branched out on his own three years ago. It is a well-trodden theme for Firetrail.
In September, Henricks told the JANA Annual Conference that he was looking at companies using technology to expand their markets and, especially, to bring healthcare to the home. “In 2016, ResMed embarked on a digital change and that involved cloud connected devices at home,” he told the conference. “Doctors can find out when they’re patients are using their devices and that reduces costs. That data is being pinged 100 times every second and providing real-time insights.” Now, Henricks tells The Australian that there are unique opportunities.
“Recently, ResMed’s key competitor Phillips initiated a major product recall,” he says. “Our research shows the market share opportunity could last many years as Phillips focuses on existing patients rather than growing. We expect ResMed will be a long term beneficiary of the recall.”
The company did have stellar device sales in the first quarter of the financial year, up 32 per cent off the back of Phillips’ pain. ResMed recently told The Australian that its products had not been caught up in any recall, despite the nation’s medicines regulator, the Therapeutic Goods Administation, quietly seeking details about products similar to Phillips’ from other companies. “ResMed is an innovative and fast growing company that has a track record of improving client outcomes using data,” Henricks says.
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