Elvest Portfolio Manager Adrian Ezquerro recently sat down with senior Motley Fool (MF) journalist Tony Yoo for their popular ‘Ask a Fund Manager’ interview series. In these interviews, senior Motley Fool journalists ask Australia’s top fund managers the big questions to give investors greater insight into the investing process, the share market, local and global trends, and much more.
MF segmented the interview into five topics, as detailed below. While we have reproduced the entire interview further below, original transcripts can be viewed by clicking on each of the these headings:
- High quality ASX shares beat timing the market every time: fundie
- One very famous and one very obscure ASX share to buy: fund manager
- 2 ASX shares now at a buying opportunity after a shocking 2022: fundie
- One ‘safe’ and one ‘exciting’ ASX share to own for years like Warren Buffett: fund manager
- I regret not buying 2 ASX shares that became 10-baggers: fundie
High quality ASX shares beat timing the market every time: fundie
Ask A Fund Manager: Elvest Co’s Adrian Ezquerro tells how his small-cap fund had 100% cash in June, but that’s not going to matter in the long run.
Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Elvest Co portfolio manager Adrian Ezquerro explains how he launched a new small-cap fund at the bottom of the market this year.
The Motley Fool: Can you introduce yourself? How would you describe your fund to a potential client?
Adrian Ezquerro: My name’s Adrian Ezquerro. I’ve been in the industry for a good period of time now and worked at Clime Investment Management for the best part of 15 years before branching out with Jonathan Wilson to establish Elvest Co this year.
Elvest Co, the name itself points to our focus — it’s an abbreviation of ’emerging leaders investment company’. Everything that we do is focused on emerging leaders and small caps.
Elvest Co, of course, is the manager of the Elvest Fund, so that’s our initial flagship fund and that’s a small cap Australian equities fund that basically invests in 20 to 40 companies that are outside the S&P/ASX 100 at the time of initial inclusion.
Ultimately we’re just seeking to build a portfolio full of really high quality, undervalued emerging leaders with strong long term growth potential. I’ll also add that we have an approach that is based around fundamentals.
When we’re assessing potential investments, we generally look for five key characteristics — emerging industry leadership, strong balance sheets, healthy cash generation, what we call aligned management teams, so we invest alongside a lot of founder led or owner manager type businesses.
And lastly we look for what we call large opportunity sets — so that basically means we’re looking for companies with really significant long-term growth potential.
MF: Would it be fair to say it’s been a tough time this year for small cap and emerging company investors like yourselves?
AE: Yeah, it’s certainly been a tough market for small caps. You can observe that small caps have fallen by quite a bit more than your large cap indices. And that’s particularly prevalent here in Australia and you can also see it with the performance of the Russell 2000 Index in the United States, so that’s replicated across geographies.
In our view, of course, therein lies part of the opportunity and some of the context for that is, from our viewpoint at least, is that we were effectively out of market at the start of the year, so that was good luck more than anything else.
We launched the fund on 1 June and that was interesting in that we were launching a fund with 100% cash coming into a month that proved to be the second worst month since the GFC. It was down over 13% in June. In a sense, that provided us with an opportunity to, to a degree, deploy some cash into a depressed market and we’ve continued to do that with all the volatility we’ve seen.
Having said that though, we’re still sitting on cash of close to 30%, so we feel we’re pretty well positioned to continue taking advantage of any drawdowns or significant volatility that may yet still come our way.
MF: That’s great. Many people would be, myself included, very envious that you had 100% cash in June. That’s great timing.
AE: Yeah, well I can’t take credit for that. I think that luck was on our side. But I think over time in markets, these things even themselves out and really, if you pick high quality companies and you’re sensible with your entry prices, then returns over time will take care of themselves.
MF: Where do you see the market heading in the near future?
AE: Well, it’s interesting, right? I wouldn’t say that we’re heavily macro driven but it would be foolish to ignore some of the headwinds that economies and markets are currently facing. I think it’s really well known, of course, that inflation has surged much higher in major economies and we’ve just seen surprisingly high inflation read from the US and of course it’s impacted markets.
In more recent times we’ve seen bond yields normalising. We’ve had a multi-decade bond rally. That’s now certainly over. We’ve got a period of interest rate normalisation. I think the one significant X factor in this calendar year, we’ve seen the invasion of Ukraine and of course that’s had flow-on effects for energy markets and it’s been a significant impost in terms of its impact on inflation and what that therefore means for consumers and businesses.
There are certainly some headwinds. To a significant extent that is reflected in equity pricing. But I think, looking ahead, there is a chance that we remain in a pretty choppy environment and that therefore it remains really important to focus on high quality companies that have high levels of profitability, margin, and defendable businesses with pricing power.
At a portfolio level, as I’ve already said, I think it’s important to keep some dry powder as well so that you can deploy into these sorts of depressed opportunities when you see good value on offer.
One very famous and one very obscure ASX share to buy: fund manager
Ask A Fund Manager: Elvest Co’s Adrian Ezquerro names a pair of stocks to pick up right now, one of them you would have hardly heard about.
Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Elvest Co portfolio manager Adrian Ezquerro explains the two ASX shares he thinks are buys right now.
Hottest ASX shares
The Motley Fool: What are the two best stock buys right now?
Adrian Ezquerro: Good question. It’s always topical. I think notwithstanding some of the economic challenges we’ve just discussed, there’s certainly a lot more value apparent now in small caps than there was for much of last year. I could probably talk to a bunch of opportunities that we’re pretty excited about but the two I’d highlight to start with would be News Corporation (ASX: NWS) and Fiducian Group (ASX: FID).
Firstly with News Corp, it’s an interesting one. Most of its market value is actually underwritten by its digital real estate division.
That houses a 61.4% stake in REA Group Limited (ASX: REA) and it also has an 80% ownership stake in Move Inc. That’s the owner and operator of Realtor.com in the [United] States. That’s the number two portal, much like Domain Holdings Australia Ltd (ASX: DHG) here.
Now, based on things like market share, profitability, margins, competitive strength, we genuinely believe that REA is one of Australia’s highest quality businesses and so it’s a hugely valuable holding for News Corp and, in our view, that is overlooked.
But, of course, beyond digital real estate, the business also comprises several other really highly cash-generative business units as well. That’s things like subscription video, its Dow Jones business unit, news and information services, and it’s also got a strong position within book publishing.
If you look at it in aggregate, we think REA and Move Inc probably have an aggregate value of close to about $14 billion… That compares to News Corp’s market capitalisation of about $15 billion. The implied value of the balance of the business, which generated EBITDA of about US$1.1 billion in FY22, is valued at about AU$1 billion — less than one times EBITDA.
In our view, not only does News Corp house really high quality assets, it’s particularly cheap at about 15 times earnings and free cash flow yield of over 8%. Notwithstanding some of the headwinds facing advertising, we’re pretty optimistic about the prospects for a solid investment return from this entry point.
The second stock, Fiducian Group, stock code FID, it’s another one I think it’s worth highlighting because it tends to fall under the radar a bit, particularly in small cap land. It’s an integrated financial services provider. It’s got three key operating divisions: financial planning, platform administration, and funds management.
It’s been around for a long period of time. It was founded in 1996 by Indy Singh and despite a pretty incredible track record of self-funded growth, and we think that’s a really important driver of per-share value creation, it’s got a relatively low profile. It’s not covered by any brokers, and yet it’s done particularly well year-on-year for many years now.
Today it’s got about $11.2 billion of funds under management advice and administration. And as that grows, of course, that is a value creator in itself. We think it’s pretty unique in this market in that its financial planning division is seen as an enabler of flows to its high margin platform administration and funds management divisions. We say it’s unique because conceptually, it’s like having a high performing diversified funds management group without any key person risk, combined with a really high margin platform business… and that’s all sitting in the one structure.
The positive long-term performance of the Fiducian funds means that we’re seeing great outcomes for Fiducian’s clients, its advisors and, of course, shareholders that have benefitted for many years.
As it stands, over two-thirds of Fiducian’s funds under advice are on the company’s administration funds management platform. That’s where a lot of the value is created in terms of earnings.
The recent results have been good. We think Fiducian will continue growing earnings at double-digit rates in the coming years as they’ve done for quite a few years in the past. In fact, we’re forecasting compound growth in the order of 15% to 20% over the next three or four years.
Now, a big driver of that, and it’s important to call out, relates to the transition of funds under advice from the recently acquired financial planning arm of the People’s Choice Credit Union, based out of South Australia. That’s added $1.1 billion of funds under advice. We think maybe the market’s under-appreciating the impact this will have on earnings over the coming three years.
To sum up our thinking on Fiducian, it’s another high quality founder-led business. It’s got a strong industry position, bright prospects, and a strong balance sheet. It’s a consistent cash generator and it continues to trade at a pretty big discount to our value, so at this level, we remain quite happy holders.
MF: I see it gives out a 4% dividend yield as well, which is handy.
AE: Yeah, and it’s consistently paid that as well. If you look at the chart of earnings and dividends over the last 10 years, it’s remarkably consistent. The executive chairman owns about a third of the business, so there’s a lot of insider ownership, a lot of alignment. They’ve grown the business both organically and via acquisition, but they haven’t issued shares to do that. That’s why we feel it’s a powerful driver of value creation, because it has grown strongly without diluting shareholders. Capital allocation decisions have been really sensible over a long period of time. Again, that often goes hand in hand with a founder leading the business.
MF: That all sounds so good. I wonder why it’s so under the radar?
AE: It’s relatively small. The market cap is circa $220 million and, as I’ve just said, there’s significant insider ownership, so the free float is relatively low. It’s not as liquid, so that may remove certain brokers and funds from considering it, which is fair enough. But for the individual investor that’s got a decent long-term time horizon, they might be managing their self-managed super fund, it’s probably something worth having on the watch list.
2 ASX shares now at a buying opportunity after a shocking 2022: fundie
Ask A Fund Manager: Elvest Co’s Adrian Ezquerro names some bargains he’d buy right now plus one that’s worth watching for now.
Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Elvest Co portfolio manager Adrian Ezquerro tells what he’d do with a trio of ASX shares that have plunged in 2022.
Cut or keep?
The Motley Fool: Now let’s take a look at three ASX shares that have fallen in a heap recently, to see whether you’d buy or stay away. The first one is Hansen Technologies Limited (ASX: HSN), which has dropped more than 20% since reporting season. What are your thoughts?
Adrian Ezquerro: Hansen’s a stock I’ve followed for a long period of time. Over 10 years now. And I agree, it’s certainly been a topical stock coming out of reporting season.
For those who are unaware, it’s a utilities billing software company. It’s got a fantastic long-term track record with an owner-manager again at the helm. In fact, I think it has compounded EPS [earnings per share] at close to 20% per annum over the past 15 years. It has been an incredible performer.
Looking specifically at the FY22 result, the result itself was in line with expectations. But I think the outlook largely disappointed. So we’re looking ahead in terms of management guidance to slightly lower margins, probably more modest top-line growth than what may have been expected.
But really, the reaction for us, to a degree, provides potential opportunity.
History suggests Hansen excels in executing really value accretive M&A. They’ve done it for many years, have got a great playbook and they’ve added a lot of value for shareholders over the past 10 or 15 years.
As they’re currently placed, they’ve got a strong balance sheet. We think in this market maybe vendor expectations might be becoming a little more realistic and the business is on a circa 7% free cash flow. We remain pretty optimistic on Hansen’s prospects.
In this market, of course, it pays to be patient. Take your time. We’d say it’s probably a buy for a moderate position in a diversified portfolio, particularly for investors with a pretty long-term time horizon.
MF: The next one is online fashion retailer City Chic Collective Ltd (ASX: CCX). The share price has lost almost 70% this year.
AE: In hindsight, you can look back and say that prices were clearly stretched for what we think is still a pretty good quality business. I think it’s done well to get a growing position of emerging leadership within its niche, which is plus-size ladies’ fashion.
City Chic operates largely via the online channel. We think CCX now has a pretty good foundation to grow its business and that’s on a global basis. Like Hansen, we think it’s not without risk, but it’s probably a buy for small to moderate weight in a diversified portfolio.
I think the current market price of about 12 or 13 times forward earnings more than fully accounts for some of the concerns related to its inventory balance.
More on that: the recent result was topical in that FY22 earnings were largely in line with previous guidance, but inventory was higher than what was expected and that’s clearly spooked some investors.
Management did flag strategic investment in inventory last year, and that was particularly around non-seasonal or evergreen clothing that will sell regardless of the time of year. And it did that – from our discussions – largely as it sought to diversify its supply chain.
Once upon a time it was almost exclusively procuring products out of China, and I think in our view it’s quite sensible to seek to diversify that. Now there’s a ring around southeast Asia where they’re procuring products. And in order to secure that, they’ve had to put in initial orders from a range of different suppliers.
Now management has actually guided to the running down of that inventory over the coming year, and this we feel will be a powerful driver that will release strong free cash flow if and when achieved.
Certainly one to watch and we’re leaning towards a buy at this point, City Chic.
MF: The third one is Fisher & Paykel Healthcare Corp Ltd (ASX: FPH), which has painfully dropped 43% year to date.
AE: Yeah, I’d suggest it’s a hold. If you’re in there, for what it’s worth, I’d probably hold on.
I mean, it was a very clear COVID beneficiary and they were really forthright about that. FPH basically said that hospitals were anxious about the potential impact and the strains that they might feel as a result of the impacts of COVID. The CEO himself actually said that they had 10 years’ worth of demand pushed into two years. They ramped up production and fulfilled that need. Clearly, there’s a bit of a glut sitting within their customer base. It was a COVID beneficiary and I think the recent difficulties and subsequent share price reaction reflects the unwinding of the trends that we saw through COVID.
Earnings are now being rebased to perhaps a greater extent than what consensus was expecting, yet it’s still trading at a pretty significant premium in terms of earnings multiples.
To be fair, I think Fisher & Paykel is a high quality business, it’s really well placed with a strong brand and product set that’s been around for a long period of time. It’s got a great track record of execution. While I’d say it’s a hold on valuation grounds as this excess inventory sort of pushes its way through, it’s certainly something I’d be very happy to have on the watch list of interest for the coming year or two.
One ‘safe’ and one ‘exciting’ ASX share to own for years like Warren Buffett: fund manager
Ask A Fund Manager: Elvest Co’s Adrian Ezquerro explains why two stocks look ripe for putting away into the bottom drawer.
Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Elvest Co portfolio manager Adrian Ezquerro nominates two ASX shares that he’d be happy to hold for years to come.
The ASX share for a comfortable night’s sleep
The Motley Fool: If the market closed tomorrow for four years, which stock would you want to hold?
Adrian Ezquerro: This is a really good question. I must admit it’s something I’ve thought about. Being an analyst, you think about these sorts of things and having been well read in Warren Buffett, it’s something I’ve considered for a long period of time.
I actually tend to think about this in two different ways and maybe that might be a bit strange. But anyway, without being too downcast, firstly I think about a scenario where I’m asked about what would happen if, say, I was hit by a bus and I had to nominate one stock to leave to my wife and kids. This is the first way that I would frame it.
With that in mind, this would obviously need to be a stock that’s got a great long-term track record. It’s a strong, well-diversified business, it still has some long term growth potential, but has significant downside protection and preferably pays a regular dividend income.
It’s in this context I’ll nominate Brickworks Limited (ASX: BKW). Brickworks has three core divisions. That’s investments, industrial property and building materials, as the name suggests.
The investment division is basically a 26% shareholding in Washington H Soul Pattinson and Co Ltd (ASX: SOL), and that’s got a market cap in excess of $9 billion. The SOL holding provides exposure to high-quality assets across telcos, energy, financial services and basically the industrial sector of the Australian economy. That’s the investment division.
The industrial property division largely sits within a 50-50 joint venture Goodman Group (ASX: GMG). Brickworks is a massive landholder and over time they sell industrial property into that JV and, which is a property trust. That’s developed into industrial assets and it’s leased on long-term deals to the likes of Amazon.com Inc (NASDAQ: AMZN), Coles Group Ltd (ASX: COL), Woolworths Group (ASX: WOW), et cetera. That’s highly valuable itself.
For context, the current market cap of Brickworks is about $3 billion. If you were to have $3 billion and you were to buy the whole company, you would get that shareholding in Soul Patts, and that’s worth about $2.4 billion at current prices. The net assets of the industrial property and Brickworks’ share of that’s about $1.5 billion. Then you’d get the net tangible asset base of Brickworks building materials business, which minus group net debt is worth a few hundred million.
In total, you get asset backing of about $4.2 billion, which is close to $28 a share on a pre-tax basis. The current market price is between $20 and $21, and for that you get exposed to a really high-quality diversified portfolio at what we feel is a substantial discount to fair value.
And that’s for a business that has consistently grown its ordinary dividend for, I think it’s something like 45, 46 years consecutively. That’s a remarkable achievement. It’s quite rare in the Australian market.
I’d say, on a relative basis to my second stock that I’ll mention, it’s a lower-risk option and certainly more stable with downside protection.
Now, the second way that I tend to think about this type of question is what’s a stock that’s highly likely to substantially grow its earnings in the coming years? And, of course, the extension of that is, what stock might have multi-bag potential?
In this context I’d probably highlight the stock RPMGlobal Holdings Ltd (ASX: RUL). RPM is a leading provider of mine planning and operations software and that’s mainly to global tier one and tier two miners, many of which you’d know. The likes of BHP Group Ltd (ASX: BHP), Rio Tinto Limited (ASX: RIO), Glencore PLC (LON: GLEN), et cetera.
Their products basically improve the efficiency of mining operations. In many cases, it replaces more manual legacy processes with more efficient software solutions.
For context, its market cap is about $350 million. It’s got close to $40 million in cash, so it’s a well-funded business and the CEO has got a pretty good track record. He’s invested quite heavily over the past decade in evolving this business and its software solutions so that it’s now really well positioned as a vendor-of-choice for major mines.
One of the most significant developments, though, in RPM’s recent history is that it successfully transitioned its revenue model from a perpetual licence model to a subscription revenue model.
This is really powerful and it’s important to understand in the context of its recent results because as you take out the value of the more lumpy perpetual sales, which have a higher one-off dollar value, and you transition that to a subscription revenue model, that has implications for your year-on-year cash flow. What it does, though, is it clearly embeds longer-term value in the business.
They’re now about to see the fruits of all that labour. If you look ahead, its revenue base from its software division is largely recurring and it’s now pretty well established in the operations of BHP, Rio, Glencore, and many, many others. We actually see scope for substantial further contracts in the next 12 to 24 months. And for the first time in many years, management has actually provided guidance for the year ahead and I think that reflects their confidence in this pivot towards subscription revenue.
They guided to EBITDA of $14.2 million in the coming year, and that’s up from about $4 million achieved in FY22. And we actually think that that might, firstly, prove conservative and we’re also expecting even more growth in FY24 given the timing of new contract awards.
You’ve got a scenario where you’ve got pretty explosive earnings growth, cash generation we expect to be really strong and… it’s all backed by a growing recurring revenue profile. That’s pretty exciting. Again, it’s not without risk, but if it’s executed to plan, we expect that the stock may do pretty well over the next four or five years.
MF: The company was founded in 1968, which is quite old for a software company, isn’t it?
AE: Actually it started as an advisory business and RPM itself, the initials of some of the founders, evolved out of an advisory business and that advisory business still exists today.
I know I’ve talked about the software division, but that in itself has done pretty well in recent times and they’ve now got an ESG division, which as you can imagine, is seeing a lot of growth in demand.
MF: That’s great. One safe one and one exciting one to hold onto for the next four years.
I regret not buying 2 ASX shares that became 10-baggers: fundie
Ask A Fund Manager: Elvest Co’s Adrian Ezquerro urges investors to not fuss about a few cents difference in the entry price if you’re in it for the long run.
Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Elvest Co portfolio manager Adrian Ezquerro names two ASX shares that he regrets not buying a decade ago.
The Motley Fool: Is there a move that you regret from the past? For example, a missed opportunity or buying a stock at the wrong timing or price.
Adrian Ezquerro: Yeah. I mean, to be honest, I’ve probably had all three of those, but in terms of the absolute dollar cost, it absolutely relates to missed opportunities. Most of my investing regrets relate to not pulling the buy trigger, and that’s particularly after doing a lot of legwork.
I now know that when it comes to a really high-quality business, quibbling over a few cents on entry price can ultimately cost you dollars of long-term value.
When I reflect on something like this, I think about a period of time about 10 or 11 years ago in the aftermath of the GFC. It was a period of time, as an analyst, I actually really enjoyed and I got a good opportunity to do a lot of detailed research on what I now know are a bunch of great quality stocks.
Now it’s quite interesting to look back and consider and observe what these types of businesses have done since.
I’ll give you two examples that come to mind. The first I think of is ResMed (ASX: RMD). It’s a leading medical device company that specialises in sleep apnea, and it has branched out in recent times. At that time it would’ve been trading, I would say in the low $4 range. I’d done a lot of legwork, built my model and wrote the report and went and saw management and they were really gracious with their time.
It was fascinating, I really enjoyed it. But in retrospect, clearly I was conservative and set a target entry price that was just too sharp. It ran away from us and today trades in the mid $30s, so that was certainly an opportunity lost.
MF: It’s one of the stocks that pretty much at every point in its history, investors would’ve thought “This is too expensive”, right? But it just keeps going up.
AE: Yeah, that reflects consistent execution that they’re growing into a large market. They’ve dominated that niche alongside another competitor which has recently stumbled. Notwithstanding some procurement issues, they’re doing their best to take advantage of that opportunity.
Yeah, great quality business, it’s perpetually looked expensive and I think it’s fair to say that that’s exactly the same case as my other reflection in this instance — TechnologyOne Ltd (ASX: TNE), another high-quality business I did a lot of work on about a decade ago.
At that time, it was building nicely off a relatively small base. It certainly ticked a lot of the boxes. It had strong business fundamentals, founder-led, net cash balance sheet, and generating cash. And at the time, and still today, it has quite a positive outlook. As you say, it was something that always seemed to be expensive and certainly felt like that was the case back then.
Similar to ResMed, I was seeking a discount on my assessed value at the time, which in retrospect was too conservative and it was an opportunity missed. It has since executed really well. It’s probably been a 10-bagger since that time.
Anyway, the silver lining of these types of reflections is that you take these learnings over the many years of investing and analysis — it’s all cumulative. You try and bank that knowledge and experience and you keep learning, you hopefully keep improving and one would hope you are less likely to replicate the same sorts of mistakes in the years to come.
MF: And don’t quibble over a few cents for the entry price if it’s going to be a long-term investment. Is that right?
AE: Correct. If you see a really high-quality business and my reflection initially on ResMed, I can’t remember specifics, but it was trading in low $4s and I might have wanted to buy it at $4 or below.
I was trying to be diligent in seeking that margin of safety, or in other words, a discount to value. Ultimately it’s a business that has compounded value over many years and it’s been a great investment from that point in time.
Adrian Ezquerro is a Principal of Elvest Co Pty Limited (ABN 65 657 018 614), Corporate Authorised Representative number 001296195 of Fundhost Limited, and a Portfolio Manager of The Elvest Fund.
Disclosure: Adrian is exclusively invested in The Elvest Fund. Elvest holds shares in NWS, FID, HSN, CCX, BKW and RUL.
The Fund is a long only, small cap Australian equities fund and is open to wholesale investors only. The information provided is general in nature only and has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information having regard to your objectives, financial situation and needs.