This weeks stock pick is from our TAMIM Australian Equity Value (TAEV) portfolio. The underlying fund, which is headed by James Williamson, has achieved a return after fees for investors of 18.4% over the last year, compared to a return of the ASX 300 of negative -9.5%. As we have said before, it is highly unlikely you will find our investments in well-presented good news stories with a strong investor following that always seems to find a way to explain lofty valuation multiples. We are in the business of looking for mispriced assets in the share market that will make us money. Over the years we have been successful investing in two areas of the market: Firstly, we have exploited opportunities in stocks that have been oversold as they have disappointed (or more ideally embarrassed) investors the most in recent years. Many of these companies attract the attention of short sellers; UGL and BRS are recent examples of ours. The second area we have invested in is small to mid-sized companies that are not actively followed by sell side researchers and institutional funds in Australia due to low free float or liquidity. Nuplex is a prime example of this investment strategy.
At the inception of the underlying fund in late 2013, NPX was exactly the type of company we were looking for. Although management had already made significant progress transforming the business from a structurally challenged local manufacturer and distributor (that struggled during the Global Financial Crisis), to a global chemicals company, the entity still travelled under the radar of the investment community. We just loved seeing blank faces when we mentioned NPX as one of our key investments, as it reaffirmed our view that the business was simply forgotten about, unknown or misunderstood by potential investors. The primary listing on the NZ exchange and the fact that the company had no direct listed peer to benchmark against added to the confusion. We acquired our NPX shares in late 2013 on a 7% dividend yield and 10x price to free cash flow multiple, with good prospects for growth and improved margins.
The transformation of NPX over ten years has been significant; the Australia & New Zealand and Specialties business contribution to EBITDA decreased from 86% in 2005 to only 9% in 2015. The Specialties business was sold in late 2014. Under the capable leadership of Group Chief Executive Officer Emery Severin, the company cut costs and re-deployed capital from the declining Australia & New Zealand manufacturing sector into key manufacturing hubs in Europe, Asia and the US. Unlike many businesses which we believe are at risk of major technology disruption from new entrants, in the specialised and relatively small resin sector innovative technologies and products based on new chemistry are been developed by research and development programs of existing incumbents. This is probably because the sector is considered unexciting by many and the profit pool is too small to attract significant outside interest. Furthermore, an outsider is likely to incur considerable losses building a meaningful research and development program from a standing start. The recent NPX Acure launch is one such example of a new chemistry product development which can take years from initial idea to market launch. Acure’s competitive advantages include faster and controllable dry time, longer pot-life and the ability to cure at lower temperatures. The growth prospects of Acure could be material to NPX over the next few years. Overall, although we will see technology improvements from existing participants over the years, the resins sector itself will remain centered around the binding, enhancing and protecting of houses, cars, boats, swimming pools, furniture and fabrics for the foreseeable future.
The changing nature of NPX's EBITDA
Source: Wentworth Williamson
Another important feature of NPX and the resin industry is that it is one of the few industries where it is not economically viable to move production to China to service the World resin demand (although it is important to note that NPX has existing operations in China to service the manufacturing industry domestically). The industry requires relatively small scale localised manufacturing operations given the reliability and timing of supply to global supply chains and only comparatively small quantities are needed for the finished product (such as a car). On the 15th of February 2016, NPX announced that the Board had received an indicative, non-binding, conditional proposal from Allnex) to acquire all its shares for NZ$ 5.55 per share (including the recently announced dividend, which therefore equates to a price of NZ$5.43 per share after the dividend payment). Private Equity backed Allnex is a very similar business to NPX but is approximately 50% bigger. We always felt it would make strategic sense to bring Allnex and NPX together to form a leading, global, independent coating resins producer. We will have an opportunity to vote on the merits of the proposal later this year. At the offer price, our return on our initial investment including dividends would be a very satisfactory return over 80%.
Conclusion While it has been a very tough year for global share markets, and we understand a lot of Australian investors with concentrated blue-chip portfolios are also suffering from a period of negative returns. For those of you reading this at home and sitting on your hands because of concerns about the global economy, and for fear of locking in losses on positions in the last year, we think it is worth noting that value funds prosper in these volatile conditions.
The Fund represents the Wentworth Williamson Australian Equity Fund net of fees and with distributions reinvested. The Index Represents the ASX 300 Accumulation Index and Cash represents the RBA Cash rate.
For those invested in the underlying fund from inception, a million dollar investment would be worth $1,353,829 versus an investment in the market being worth $1,114,546. It is worth reiterating our opening comments: “The underlying fund increased 18.4% for 12 months to March 2016 compared to negative -9.5% for the S&P/ASX 300 Accumulation Index. Furthermore, in a quarter where the market dropped by 2.6%, it was pleasing to see the fund increase by 2.0%. While this won’t always be the case, our primary focus on capital preservation typically sees the fund meaningfully outperform the general share market during down or flat markets.” Happy investing,
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